Handbook on East Asian Economic Integration 1788975154, 9781788975155

Citation preview

HANDBOOK ON EAST ASIAN ECONOMIC INTEGRATION

Handbook on East Asian Economic Integration

Edited by

Fukunari Kimura Professor, Faculty of Economics, Keio University, and Chief Economist, Economic Research Institute for ASEAN and East Asia (ERIA), Indonesia

Mari Pangestu Managing Director of Development Policy and Partnerships, World Bank, Washington DC, USA

Shandre Mugan Thangavelu Professor, Jeffrey Cheah Institute for Southeast Asia, Sunway University, Malaysia, and Institute for International Trade, University of Adelaide, Australia

Christopher Findlay Honorary Professor, Crawford School, Australian National University, Australia

Cheltenham, UK

+

Northampton, MA, USA

© The Editors and Contributors Severally 2021 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library Library of Congress Control Number: 2021947687 This book is available electronically in the Economics subject collection http://dx.doi.org/10.4337/9781788975162

ISBN ISBN

978 1 78897 515 5 (cased) 978 1 78897 516 2 (eBook)

Typeset by Sparks – www.sparkspublishing.com

EEP BoX

Contents

List of contributors vii Foreword by Hidetoshi Nishimura ix Acknowledgements xi List of abbreviations xii 1

Introductionto the Handbook on East Asian Economic Integration: An overview of shifting paradigm in globalisation, trade, and investment in East Asia Fukunari Kimura, Mari Pangestu, Shandre Mugan Thangavelu, Christopher Findlay, and Dionisius Narjoko

2

East Asian architecture of integration Mari Pangestu and Shiro Armstrong

21

3

Modelling Asia-Pacific regional integration Peter A. Petri, Michael G. Plummer, and Fan Zhai

49

4

Trade in goods with internationalised production activities Toshiyuki Matsuura and Ayako Obashi

66

5

FDI activities and integration in ASEAN and East Asia Shandre Mugan Thangavelu, Shujiro Urata, and Dessie Tarko Ambaw

88

6

International population mobility in East Asia Aris Ananta and Evi Nurvidya Arifin

1

110

7 Services Christopher Findlay and Hein Roelfsema

137

8

Agricultural development, structural transformation, and East Asian trade Kym Anderson

156

9

Institutional reform, regulatory reform, and integration in East Asia Rashesh Shrestha and Ha Thi Thanh Doan

180

10 Business impediments to economic integration in Southeast Asia Cassey Lee

203

11 Trade creation and utilisation of regional trade agreements Kazunobu Hayakawa and Kohei Shiino

218

12 Trade, poverty, and Aid-for-Trade Jayant Menon and Anna Cassandra Melendez

235

13 Investment in connectivity Andrew Elek and Christopher Findlay

257

v

vi  Handbook on East Asian economic integration

14 Connectivity and the geographical simulation model Ikumo Isono and Damiaan Persyn

273

15 East Asian financial integration in banking, markets and regulation Donald Hanna and Andrew Sheng

299

16 Economic integration, climate change, and sustainable development in East Asia Simon Tay

321

17 Energy transition for fuelling economic integration in East Asia Venkatachalam Anbumozhi

342

18 Reorganisation of production Fukunari Kimura and Dionisius Narjoko

366

19 Skills and human capital development policies of ASEAN Shandre Mugan Thangavelu and Wenxiao Wang

390

20 Digitalisation and market integration Hosuk Lee-Makiyama

413

21 The economics–security nexus and East Asian integration Priya Chacko and Kanishka Jayasuriya

435

Index

454

Contributors

Ambaw, Dessie Tarko – Institute for International Trade, University of Adelaide Ananta, Aris – Professor in Faculty of Economics and Business, Universitas Indonesia Anbumozhi, Venkatachalam – Director of Research Strategy and Innovation, Economic Research Institute for ASEAN and East Asia Anderson, Kym – George Gollin Professor Emeritus of Economics, School of Economics University of Adelaide; and Honorary Professor, Arndt-Corden Department of Economics, Australian National University Arifin, Evi Nurvidya – Senior Assistant Professor in Centre for Advanced Research – Universiti Brunei Darussalam Armstrong, Shiro – Associate Professor, Crawford School of Public Policy, Australian National University Chacko, Priya – Senior Lecturer, Department of Politics and International Relations, University of Adelaide Doan, Ha Thi Thanh – Economist, Economic Research Institute for ASEAN and East Asia Elek, Andrew – Visiting Research Fellow, Australian National University Findlay, Christopher – Honorary Professor, Crawford School of Public Policy, Australian National University Hanna, Donald – Lecturer, Haas School of Business, University of California Berkeley Hayakawa, Kazunobu – Senior Research Fellow, Institute of Developing Economies Isono, Ikumo – Senior Economist, Economic Research Institute for ASEAN and East Asia Jayasuriya, Kanishka – Professor of Politics and International Studies, Murdoch University Kimura, Fukunari – Professor, Faculty of Economics, Keio University; and Chief Economist, Economic Research Institute for ASEAN and East Asia Lee, Cassey – Senior Fellow, ISEAS – Yusof Ishak Institute Lee-Makiyama, Hosuk – Director, European Centre for International Political Economy

vii

viii  Handbook on East Asian economic integration

Matsuura, Toshiyuki – Associate Professor of International Economics, Keio Economic Observatory, Keio University Melendez, Anna Cassandra – Consultant, Asian Development Bank Menon, Jayant – Visiting Senior Fellow, ISEAS-Yusof Ishak Institute Narjoko, Dionisius – Senior Economist, Economic Research Institute for ASEAN and East Asia Obashi, Ayako – Associate Professor of International Economics, School of International Politics, Economics and Communication, Aoyama Gakuin University Pangestu, Mari – Managing Director of Development Policy and Partnerships, World Bank Persyn, Damiaan – Post-Doctoral Researcher, University of Göttingen Petri, Peter A. – Carl J. Shapiro Professor of International Finance, Brandeis International Business School, Brandeis University Plummer, Michael G. – Director, SAIS Europe and ENI Professor of International Economics, Johns Hopkins University Roelfsema, Hein – Associate Professor International Entrepreneurship, Utrecht University Sheng, Andrew – Distinguished Fellow, Asia Global Institute, University of Hong Kong Shiino, Kohei – Associate Professor, Faculty of International Studies, Takushoku University Shrestha, Rashesh – Economist, Economic Research Institute for ASEAN and East Asia Tay, Simon – Associate Professor, Faculty of Law, National University of Singapore; and Chairman, Singapore Institute of International Affairs Thangavelu, Shandre Mugan – Professor, Jeffrey Cheah Institute for Southeast Asia, Sunway University; and Institute of International Trade, University of Adelaide Urata, Shujiro – Special Research Advisor to the President, Economic Research Institute for ASEAN and East Asia Wang, Wenxiao – Assistant Professor, Wenlan School of Business, Zhongnan University of Economics and Law Zhai, Fan – Senior Advisor, Croesus Group

Foreword

Hidetoshi Nishimura

The Association of Southeast Asian Nations (ASEAN) and East Asia have been pioneers of a new international division of labour – international production networks (IPNs) or the second unbundling – since the 1990s. As Richard Baldwin claims, the first-round advancement of communications technology enabled the task-by-task division of labour, which allowed the technologies of developed countries to be combined with the labour of developing countries, leading to rapid economic growth and poverty alleviation in the ‘Great Convergence’. Although some countries in other parts of the world have begun to utilise the mechanics of IPNs, ASEAN and East Asia have led the world in their aggressive involvement in globalisation and the establishment of Factory Asia. Although the de facto economic integration or regionalisation started earlier, the de jure economic integration has quickly caught up with it in ASEAN and East Asia. Indeed, the ASEAN Economic Community has been the most successful initiative for regional economic integration amongst newly developed and developing nations in the world. ASEAN has achieved very clean tariff removals amongst its Member States and has advanced toward deeper economic integration. In particular, the concept of connectivity has played an important role in making economic integration meaningful for economic development. ASEAN has also made a substantial contribution to economic integration of East Asia under ASEAN centrality. Despite these achievements, academic research on Asian economic integration has been sluggish as academicians in North America and Europe were slow to notice the emergence of Asia. Evidence-based policy studies in ASEAN and East Asia were also slow to emerge as various efforts were scattered and fragmented. However, this situation has drastically changed in the last decade. Several leading research institutes have emerged in our region – supporting key research activities and researchers – leading to significant accumulation of academic and evidence-based research activities, both quantitatively and qualitatively, although the world has not fully recognised such development. This handbook is a landmark of economic studies on Asian economic integration in presenting a grand framework for understanding Asian economic integration and compiling a large number of existing significant studies. The coverage of this handbook pertaining to Asian economic integration is truly wide and comprehensive. Starting from a discussion of the integration architecture and modelling issues, trade in goods and services, foreign direct investment, mobility of people, agricultural development, institutional and regulatory reform, business impediments, and the utilisation of regional trade agreements are reviewed. In addition, connectivity, financial integration, environment, energy, and human capital development are also carefully discussed and covered. The mechanics of IPNs as well as the impact of digital technology are also carefully explored in the context of East Asia. The last chapter discusses the security nexus in regional integration. The handbook presents complete references for the accumulated research on Asian economic integration.

ix

x  Handbook on East Asian economic integration

Economic Research Institute for ASEAN and East Asia (ERIA) is privileged to be part of this achievement. Actually, most of the authors in this volume, in addition to our in-house economists, have been frequent participants in research projects and semi-academic events organised by ERIA. Amongst the editors of this handbook, Professor Mari Pangestu has been a spiritual leader of our policy studies, Professor Christopher Findlay has been a long-term mentor and instructor for all of us, and the continuous dedication of Professor Shandre Thangavelu is highly appreciated. ERIA has set up a powerful expert network for raising up young researchers, together with our Chief Economist Fukunari Kimura and Senior Economist Dionisius Narjoko. This handbook will be an essential reference for academic researchers as well as evidencebased policymakers. It could also serve as a textbook for the upper level of undergraduate and graduate classes in universities. I would like to thank all the contributors and look forward to deeper and wider collaboration on East Asian economic integration. Professor Hidetoshi Nishimura President, Economic Research Institute for ASEAN and East Asia

Acknowledgements

The composition of this volume was designed by the editors and the preparation of chapters was supported by ERIA. A number of authors who appear here are members of ERIA research networks.  The editors would like to thank ERIA for their strong support for this project, and in particular appreciate the great encouragement from Hidetoshi Nishimura and the assistance of Dionisius Narjoko, Stefan Wesiak, Yuanita Suhud, and Fadriani Trianingsih.  We also thank Alex O’Connell and Stephanie Mills and their colleagues at Edward Elgar Publishing.

xi

Abbreviations

AANZFTA ASEAN–Australia–New Zealand Free Trade Area ABAC APEC Business Advisory Council ABMI Asian Bond Markets Initiative Asian Development Bank ADB ASEAN Connectivity Coordinating Committee ACCC ASEAN-China Free Trade Area ACFTA ASEAN Comprehensive Investment Agreement ACIA ASEAN Economic Community AEC ASEAN Economic Ministers AEM ASEAN Framework Agreement on Services AFAS Asian Financial Crisis AFC ASEAN Free Trade Area AFTA AFTA–CEPT ASEAN Free Trade Area-Common Effective Preferential Tariff AfT Aid-for-Trade AI Artificial Intelligence AIA ASEAN Investment Area Asian Infrastructure Investment Bank AIIB ASEAN-Korea Free Trade Area AKFTA AMRO ASEAN+3 Macroeconomic Research Office AMS ASEAN Member States APEC Asia-Pacific Economic Cooperation APG ASEAN Power Grid APS Alternate Policy Scenarios ASEAN Plus Three APT APTA Asia-Pacific Trade Agreement ASAs ASEAN Swap Arrangements ASEAN Association of Southeast Asian Nations ATIGA ASEAN Trade in Goods Agreement AUM Assets Under Management BAU Business-As-Usual BEC Basic Economic Categories BIS Bank for International Settlements Biochemical Oxygen Demand BOD BRI Belt and Road Initiative Bilateral Swap Agreements BSAs BTAs Border Tax Adjustments B2B Business to Business B2C Business to Consumer CADP Comprehensive Asia Development Plan The APEC Cross-Border Privacy Rules CBPR xii

Abbreviations xiii

CC Change in Chapter CES Constant Elasticity of substitution CGE Computable General Equilibrium CH Change in Heading CITES Convention on International Trade in Endangered Species of Wild Fauna and Flora CLMV Cambodia, Lao PDR, Myanmar, and Viet Nam CM Common Market CMI Chiang Mai Initiative Chiang Mai Initiative Multilateralization CMIM Carbon Dioxide CO2 COVID-19 The Coronavirus Disease CPEC China-Pakistan Economic Corridor CPTPP Comprehensive and Progressive Agreement for Trans-Pacific Partnership CRS Creditor Reporting System CS Change in Subheading CTC Change-in-Tariff Classification CU Customs Union C2C Consumer to Consumer EAS East Asia Summit EMEAP East Asia and Pacific Central Banks EMS Electronics Manufacturing Services EPAs Economic Partnership Agreements EPZs Export Processing Zones ERIA Economic Research Institute for ASEAN and East Asia ESCAP Economic and Social Commission for Asia and the Pacific ETC Entertainment and Travel Costs ETRs Effective Tax Rates EU European Union EWEC East–West Economic Corridor FAO Food and Agriculture Organization FITs Feed-In-Tariffs FDI Foreign Direct Investment FTA Free Trade Agreement FTAAP Free Trade Area of the Asia-Pacific General Agreement on Tariffs and Trade GATT GATS General Agreement on Trade in Services GDP Gross Domestic Product GFC Global Financial Crisis GHG Greenhouse Gas GMS Greater Mekong Subregion GRDP Gross Regional Domestic Product GRP Good Regulatory Practice GTAP Global Trade Analysis Project GVC Global Value Chain G20 Group of Twenty

xiv  Handbook on East Asian economic integration

HAUPA Heads of ASEAN Power Utilities/Authorities HS Harmonized System IC Integrated Circuit ICIO Inter-Country Input–Output ICT Information and Communication Technology IDE-GSM Institute of Developing Economies-Geographical Simulation Model IGA Investment Guarantee Agreement IIT Intra-Industry Trade ILO International Labour Organization International Monetary Fund IMF The Internet of Things IoT International Production Networks IPNs Intellectual Property Rights IPR Information Technology IT I/O Input–Output Japan Business Council JBC JETRO-IDE Japan External Trade Organization–Institute of Developing Economies Japan-Thailand Economic Partnership Agreement JTEPA Lao People’s Democratic Republic Lao PDR Low Cost Carriers LCC LDCs Least Developed Countries Local Content Requirements LCRs Logistics Performance Index LPI Multilateral Agreement on Air Services MAAS Multilateral Agreement on the Full Liberalisation of Air Freight Services MAFLAFS MAFLPAS Multilateral Agreement on the Full Liberalisation of Passenger Air Services International Convention for the Prevention of Pollution from Ships MARPOL Mergers and Acquisitions M&A Multilateral Development Banks MDBs MEAs Multilateral Environmental Agreements MFN Most Favoured Nation MIEC Mekong–India Economic Corridor MNCs Multinational Corporations Multinational Enterprises MNEs MPAC Master Plan on ASEAN Connectivity MRAs Mutual Recognition Agreements Metric Tons of Carbon Mt-C M2M Machine-to-Machine North American Free Trade Agreement NAFTA NATO North Atlantic Treaty Organisation NBFIs Non-Bank Financial Institutions Nationally Determined Contributions NDCs NEG New Economic Geography NGOs Non-Governmental Organisations NICs Newly Industrialised Countries

Abbreviations xv

NRAs Nominal Rates of Assistance NSEC North–South Economic Corridor NTBs Non-Tariff Barriers NTMs Non-Tariff Measures ODA Official Development Assistance OECD Organisation for Economic Co-operation and Development OEM Original Equipment Manufacturer OEP Open Economy Politics PCBs Policy and Cultural Barriers PECC Pacific Economic Cooperation Council Palm Oil Innovation Group POIG P2P Peer-to-Peer Process and Production Methods PPMs PPPs Public–Private Partnerships People’s Republic of China PRC Preferential Trade Agreements PTAs PTSPE Trans-Pacific Strategic Economic Partnership Agreement RCEP Regional Comprehensive Economic Partnership Research and Development R&D Roadmap for Integration of Air Travel Sector RIATS RIETI Trade Industry Database RIETI-TID Rules Of Origin ROOs RRAs Relative Rates of Assistance Regional Trade Agreements RTAs Regional Value Content RVC Severe Acute Respiratory Syndrome SARS Sustainable Development Goals SDGs Special Drawing Right SDR South East Asian Central Banks SEACEN Special Economic Zone SEZ SHINE Standard Harmonization Initiatives for Energy Efficiency SITC Standard International Trade Classification SMEs Small Medium-Sized Enterprises SMS Semiconductor Manufacturing Services System of National Account SNA SOEs State-Owned Enterprises SO2 Sulphur Dioxide SP Specific Process STRI Services Trade Restrictiveness Index TAGP Trans-ASEAN Gas Pipeline TELMIN The ASEAN Telecommunications and IT Ministers Meeting TFP Total Factor Productivity TiVA Trade in Value Added TLIAP The Logistics Institute-Asia Pacific TPP Trans-Pacific Partnership TPPA Trans-Pacific Partnership Agreement

xvi  Handbook on East Asian economic integration

TRAINS Trade Analysis Information System TRIMs Trade-Related Investment Measures TVET Technical and Vocational Education and Training UNCTAD United Nations Conference on Trade and Development UK United Kingdom UN United Nations UNESCAP United Nations Economic and Social Commission for Asia and the Pacific US United States VAT Value-Added Tax VoIP Voice-over-IP Worldwide Governance Indicators WGI World Health Organization WHO Wholly Obtained WO World Trade Organization WTO

1.

Introductionto the Handbook on East Asian Economic Integration: An overview of shifting paradigm in globalisation, trade, and investment in East Asia Fukunari Kimura, Mari Pangestu, Shandre Mugan Thangavelu, Christopher Findlay, and Dionisius Narjoko

1. INTRODUCTION Several key events have occurred since the work on this volume started in 2018. For the past 2 decades, East Asia has faced protectionist policy challenges from the increasing level of anti-globalisation issues in regional and global trade (Dur et al., 2020). The rise in protectionist policies is reflected by the changes in the extent of new trade interventions since 2009, as indicated by Global Trade Alert (Evenett and Fritz, 2019).1 The harmful interventions, as defined by Global Trade Alert, account for nearly 72% of the total state level interventions from 2009 to 2021 (Global Trade Alert, n.d.).2 The peak of new state level trade interventions occurred in 2018, 2 years after President Trump was elected to office in the United States (US). During this same period, President Trump had been in office for over a year, which led to a shift in US trade policy towards more inward-oriented strategies (Bown and Irwin, 2019). By March 2017, the United Kingdom had begun the work on its withdrawal strategy from the European Union (O’Rourke, 2019). Apart from instances of the application of protectionism, other important global trade issues included problems in Asia-Pacific Economic Cooperation (APEC) processes (Dziedzic, 2018) and in the World Trade Organization (WTO) (Bown and Keynes, 2020), as well as increased bilateral tensions between the US and China (Bown, 2019). By the beginning of 2019, The Economist (2019) was arguing that the trade tensions were compounding a shift that had been under way since the financial crisis of 2008–2009 and that globalisation had given way to a new era of sluggishness. Later that year, Pangestu (2019) reviewed the risks associated with the US–China trade war, noting its consequences in terms of higher protection and greater uncertainty, although with some knock-on effects of trade diversion. In addition, risks were associated with its solution in terms of the application of processes of ‘managed trade’, already apparent to smaller economies. Pangestu also identified, in terms of other changes in the global trade landscape, the growth of regional arrangements associated with greater degrees of discrimination in trade and the emergence of new issues in digital trade and also with respect to the environment and climate change. Another significant global event has been the coronavirus disease (COVID-19) pandemic shock that began in early 2020 disrupting key economic activities within and between countries, as well as regional and global trade and investment. The key dimension of the COVID-19 pandemic shock is the diversion from open economic policies to more inward-looking policies. The chapters in this volume were all conceived before the end of 2019 and the editors determined to retain the original formats rather than seek their redevelopment in the context 1

2  Handbook on East Asian economic integration

of COVID-19. However, in this overview, some remarks are offered with respect to the significance of the events of 2020, and the argument is made that the approach to the analysis of economic integration in the region and its consequences remains highly relevant. Before we present a review of the handbook chapter contents, we offer material on two topics. As noted, at the time of the development of the volume, a major concern was the rising anti-trade sentiment in many countries. We review the state of that debate and the ways in which it is relevant to East Asia, and we refer to chapters in the volume where relevant. We also provide some commentary on a more recent development, which is the experience of the COVID-19 pandemic.

2.  RISE OF ANTI-GLOBALISATION Some significant shifts in the attitudes to trade in the latter part of the last decade are noted above. What was the origin of these shifts? Rodrik (2018: 13) said that anti-globalisation movements are the political backlash to the ‘advanced stages of globalisation’. In that context, a number of drivers of its emergence have been noted, including in chapters in this volume: 1. Many economies have experienced a middle-skill employment shock and shifts in the wage premium towards skilled workers. The gains from trade are unevenly distributed and biased against the unskilled. A study by UNCTAD (2011) showed uneven distribution of gains from trade in India. Although trade increases the wages of unskilled workers, the study observed that 70% of the income generated from trade is going to the top two income groups. Recent research by Menon and Melendez (in this volume) highlights the result that the impact of trade on wages is also dependent on the export intensity of the industries. Firms that are less skilled and labour-intensive, such as the garment and textiles and agricultural sectors, tend to experience less gains from trade in terms of wage increases for the unskilled and less educated (UNCTAD, 2011; Menon and Melendez, Chapter 12 in this volume). 2. As trade increases growth in more open economies, these countries have concurrently experienced a widening wage gap (between the skilled and unskilled) as well as polarisation of semi-skilled jobs. Thangavelu and Wang (Chapter 19 in this volume) show a large decline in the share of semi-skilled jobs (mostly white-collar jobs) as compared to unskilled and skilled jobs in Australia; India; Indonesia; the Republic of Korea (henceforth, Korea); New Zealand; Malaysia; the Philippines; and Thailand. The chapter also shows a widening gender gap, as trade drives growth in the East Asian region. This has a direct impact on the income and wealth of middle-income households. 3. As trade increases growth, we also experience rising business impediments and greater state level interventions (Lee, Chapter 10 in this volume). In most cases, larger enterprises have more access to finance and foreign markets than local small and medium-sized enterprises. The study by Lee highlights the roles of access to skilled workers and to finance as key impediments, along with the effect of government regulations, facing local enterprises in their effort to participate fully in open economy activities. Although larger companies have better access to regional and global markets, the rising state level trade interventions in recent years also affect their investment in markets and technologies overseas.

Introduction 3

4. Over the past 2 decades, East Asia has experienced a massive movement of skilled and unskilled workers, especially the international mobility of unskilled workers (Ananta and Arifin, Chapter 6 in this volume). As well as its contribution to growth, international labour mobility has a direct impact on the wages of the unskilled and the vulnerability of the unskilled and poor. 5. Trade has a more direct impact on the income and wealth of the tradable sectors in urban centres compared with rural centres, creating a rural–urban divide and growth tensions between the rural and urban population (Kastrop et al., 2019). In East Asia, however, there has been a positive response to the experience of a more open external environment, as illustrated in chapters in this volume. Driving forces include the operations of the WTO, China’s entry to world markets, the development of regional agreements, widespread unilateral reform, and the processes of APEC. There has also been a positive side to the consequences and lessons of the Asian Financial Crisis (AFC), which fed into the response to the Global Financial Crisis (GFC). However, as references in the list above to chapters in this volume indicate, the issues that are relevant to the origins of anti-globalisation movements are increasingly important in East Asia. The risk of rising anti-globalisation against trade in East Asia therefore remains. It will be important to recognise the real impacts of trade in the domestic economy and the region. The balancing of the gains of trade with inclusive growth will be the key policy challenge for East Asia as the intensity of the anti-trade movement increases in East Asia. The importance of regional cooperation under the Association of Southeast Asian Nations (ASEAN) and APEC, and also under multilateral trade arrangements such as the Regional Comprehensive Economic Partnership (RCEP), in achieving both sustainable and inclusive growth from trade will be fundamental to manage the impact of globalisation in the region (Pangestu, 2019). Furthermore, even though the economies of the region are not, currently, driven by antiglobalist politics, East Asia remains affected by their trading partners responding to those pressures. That response in a world leader like the US is particularly significant. The question remains of how East Asia would then react. One response is domestic risk management in each economy, anticipating and responding to these movements. Another is to defend the trading system which, as the chapters below illustrate, has provided significant benefit to the region. More specifically, then, the options for the East Asian economies include the following: 1. To respond to their own forces of anti-globalisation, the nature of which has to be defined and identified in a local context, so the responses are more tailored. However, any response is likely to involve better efforts at the management of ‘insecurity’, with a focus on adjustment policies. It will be important to separate these policies from the design of trade policy, but without them it will be much more difficult to maintain an open trade policy. 2. To demonstrate their capacity to cooperate with each other, and gain by doing so, and to reconsider policy tools, e.g. through forms of regulatory cooperation. 3. To anticipate and work with the rest of the region and the rest of the world to manage risks, especially at the WTO to support its operations and devise systems for new issues. This effort can be complemented in APEC, in regional agreements (e.g. the RCEP), and in other plurilateral structures (Pangestu, 2019). 4. To make the case for integration and to explain the role of national governments in the context of international cooperation.

4  Handbook on East Asian economic integration

3.  COVID-19 PANDEMIC SHOCK AND EAST ASIAN INTEGRATION Pandemic (COVID-19) shocks have had tremendous impacts on the global and Asian economies. They have disrupted global production networks. The shocks are felt across all segments of society and have great economic and social impacts on domestic and regional economies. The World Health Organization declared COVID-19 a global pandemic in March 2020. On 10 April 2020, 1.6 million cases had been confirmed worldwide and 96,000 people had died. By 10 February 2021, there were 107 million cases confirmed cases with 2.3 million deaths (World Health Organization, n.d.). COVID-19 is relatively contagious, can be asymptomatic, and has a higher death rate than normal seasonal flu. The public health response to COVID-19, including lockdowns, has sent shockwaves up and down the supply side of production processes as well as on the demand side. The effects of the COVID-19 pandemic have been huge. The World Bank (2021) found that global output fell by 4.3% in 2020 (compared to 2.3% in 2019), while the estimate for East Asia and the Pacific is a growth of 0.9% in 2020 (compared to 5.8% in 2019). Global growth is expected to be 4.0% in 2021 (7.4% in East Asia and the Pacific). The International Labour Organization (ILO, 2021) found that the COVID-19 pandemic led to an 8.8% decline in working hours worldwide (7.9% in Asia and the Pacific). The reduced working hours led to both the loss of jobs (118 million globally, with 62 million in Asia and the Pacific) and less working hours of those in employment. However, the impact of the COVID-19 pandemic is uneven, and lesser skilled and younger workers as well as women and the self-employed are disproportionately affected. Kimura (2021) identified three types of economic shocks generated by the COVID-19 pandemic on domestic and regional economies: 1. The first is a negative supply shock from economic disruptions and border lockdowns, which directly affects global value chain (GVC) activities in goods (e.g. electronic products) and services (e.g. tourism). Trade and investment slowed as did global and regional economic activities. 2. The second is a positive demand shock due to the increased need for medical products, drugs, and key essential items of personal protective equipment (e.g. face masks, gloves, face shields, respirators, and hand sanitisers); and demand for personal computers and telecommunication devices. The initial policy reaction was to impose protectionist policies to divert the key essential products to the domestic economy, but there was a gradual recovery to normal trade activities in these essential products. In this second positive shock, we also observed an increase in services activities for home delivery of food and groceries, increased use of digitally related services such as internet connection services to accommodate the ‘new normal’ of working from home, and home entertainment services. 3. The third was a negative demand shock from the slowdown in economic activities, leading to bankruptcies, unemployment, and greater fragility of the financial markets. This shock will lead to structural changes in business and economic activities, which will have direct impacts on investment in new technologies to create the new ‘normal’ in business activities, and which will affect job creation and destruction. Each of these shocks is mutually reinforcing. They are also persistent, as the COVID-19 virus mutates into new viral strains, creating the risk of another pandemic wave. However, Kimura

Introduction 5

(2021) highlighted the resilience of the GVC to recover and to maintain production activities and linkages. For example, Kimura (2021) showed (using Japanese trade data) the recovery of trade in key GVC products of machinery parts and final products by October 2020. The policy response to the COVID-19 pandemic has involved the closure and lockdown of borders to mitigate and manage the spread of infection of the virus across borders. This has a direct impact on activities in export sectors that rely heavily on the movement of people across borders. An Asian Development Bank study (ADB, 2020) forecast that the pandemic will result in adjustment at the sectoral level, particularly in agriculture and mining, light manufacturing, part components, hotels and restaurants, business services, and transport services. The study also highlighted that trade in services (e.g. tourism, retail, restaurants, hotels, and logistics) will be heavily affected by the pandemic – directly affecting less developed countries that rely on these service sectors for growth and which consist of a large number of micro, small, and medium-sized enterprises. The impact of digital transformation on the demand side of business and consumers due to the COVID-19 pandemic is expected to be significant. The consumption behaviour of people and delivery of services is expected to change significantly in terms of visiting hotels, eating out at restaurants, visiting large retail outlets at shopping centres, and going to the cinema. Digital technology is directly changing individual consumption behaviour so that it requires less face-to-face contact with other individuals by directly offering home entertainment services, online banking services, home delivery of food and groceries, and online commerce and retailing. The behaviour of business is also expected to change significantly as services are provided through digital platforms, and services may also be unbundled into different and separately transacted tasks. We also expect more services to be offered via digital platforms which bring buyers and sellers together across borders, thereby increasing the extent of ‘virtual’ service linkages. The impact of the COVID-19 pandemic shock will intensify the structural transformation of domestic economies and then redirect regional integration through information, communication, and telecommunication technologies. We expect more agglomeration of certain activities in the post-pandemic period, as businesses invest more in artificial intelligence and robotics technologies to increase the productivity of a new ‘normal’ working environment, as manufacturers increasingly buy and sell services themselves (the process of ‘servicification’) and as the service sector continues to grow. At the same time, we expect telecommunication technologies to increase connectivity and linkages across the global economy, fragmenting consumption and production in the GVC. This will affect the service linkages in the GVC. Some key policy issues are critical to manage these outcomes of technological change and structural transformation. These issues arise because of the value of facilitating change. There is a need to: 1. understand the agglomeration and fragmentation effects, and coordinate key policies across countries and, at the regional level, to design and enhance these industrial activities; 2. develop new skills for workers to participate and be retained in the labour market with these new technologies; and 3. develop domestic industrial capacity and the capabilities of local enterprises and small and medium-sized enterprises to participate in the service linkages to support the dynamism of the GVC in the post-pandemic period.

6  Handbook on East Asian economic integration

Finally, the COVID-19 pandemic is expected to accelerate economic cooperation to mitigate and reduce the risk of future health and pandemic shocks. Reacting early to the pandemic shock reduces the pending economic shock. We believe that early policy reaction at the regional level will have a positive impact in flattening any pandemic curve but also have a positive impact on the responses of GVCs and domestic healthcare systems (Kimura et al., 2020). Regional policy coordination will also provide the opportunity to recognise infrastructure and institutional gaps in the healthcare and regional GVC network to mitigate such a pandemic shock. This allows for greater risk management and risk sharing of the pandemic shock (including its social and economic cost) across countries in the region and with businesses. Overall, the COVID-19 pandemic has increased the policy response for greater openness and liberalisation; accelerated technology adoption and innovation (e.g. artificial intelligence and telecommunication technologies); intensified digitalisation and trade; increased the servicification of manufacturing and the extent of service activities; reinforced the second unbundling; and intensified the third unbundling, involving more extensive use of skills and greater human capital accumulation. These are topics of this volume, the content of which we examine in more detail in the next section.

4.  STRUCTURE OF THE HANDBOOK Chapters in this volume are presented in the following sequence. The volume opens with an overview of arrangements for economic integration (Chapter 2), which is followed by a review of the results of modelling of the consequences of variations in those arrangements (Chapter 3). Then, it follows a series of chapters on the forms in which international transactions can be organised – goods, capital, people, and services (Chapters 4–7). Concluding this part is a chapter on trade in agricultural products, which is of special interest in this region (Chapter 8). The chapter list continues to include further attention to elements of policy affecting integration, especially regulation and the institutional arrangements within economies (Chapter 9). A business perspective on these issues is also provided (Chapter 10). This part includes more detail on the treatment of transactions in preferential trade agreements (Chapter 11). With this background, the second half of the volume contains a series of chapters on themes related to economic integration. These include its links to poverty reduction (Chapter 12) and to aspects of connectivity (Chapters 13, 14). There is further discussion on financial markets (Chapter 15), and a review of issues related to the environment (Chapter 16) and to energy markets in the region (Chapter 17). The next three chapters have a focus on the organisation of production (Chapter 18), on human capital development (Chapter 19), and on the emergence of new digital forms of international business (Chapter 20). The volume closes with a chapter on the relationships between economic integration and security (Chapter 21). Readers are invited to consider the chapters in this order, but not all readers may have an interest in all chapters in the volume. The chapters can be read in different clusters, depending on the reader’s interest. For that reason, in the balance of this overview chapter, we present the content of the chapters in a different format. The chapters are grouped here under the following headings: Regional and Multilateral Trading Arrangements • New • Production Networks, Investment Policies, and GVCs

Introduction 7

Transformation, Skills, and Domestic Capacity • Structural • Infrastructure, Digital Technologies, Regional Security, and the Environment The key focus in this format of the presentation of the contents of the handbook is to address contemporary and future policies issues related to trade and to regional economic integration. 4.1  New Regional and Multilateral Trading Arrangements The development of economic integration through regional and multilateral trading arrangements is discussed. The architecture of East Asian economic integration as well as the empirical models for analysing regional integration are present in this part. Various policy implications are also highlighted in the respective chapters. 4.1.1  East Asian architecture of integration (Chapter 2) Pangestu and Armstrong discuss the evolution of the regional integration architecture in East Asia. They argue that integration was initially led by trade and investment flows that were the result of decision making in markets. These included the development of production networks, later referred to as GVCs. They also stress the contribution of China to regional integration, especially after its accession to the WTO in 2001. The region developed more formal frameworks for integration, starting with agreements in ASEAN and then adding agreements with ASEAN’s major trading partners. Pangestu and Armstrong stress that these agreements evolve, depending on the interests of the participants. The result is a lower degree of consistency amongst agreements, and a lesser degree of institutional integration, compared with those in Europe and North America. They stress that APEC plays an important role in this context by providing a set of principles and reference points for the more formal arrangements. APEC has also cemented the importance of the ‘third pillar’ of capacity building alongside liberalisation and facilitation, and the commitment to open regionalism, in which openness with the rest of the world was pursued at the same time as barriers to trade within the region were reduced. In the chapter, Pangestu and Armstrong argue that the East Asia approach has provided strong support for integration, both internally and with the rest of the world. They also observe, noting the debates about integration in the United Kingdom and the US, that the East Asian model has a degree of resilience. To the question of what happens next, in the context of the US withdrawal from leadership of multilateralism, they respond that the East Asian model has shown its capacity to respond to pressures and to innovate. They point to the adoption of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the progress on the RCEP, and they note that the RCEP in particular offers the potential for deeper integration with South Asia – the next key frontier for East Asia. They also argue that the East Asian architecture, based on the leadership of middle powers, will provide a framework in which all the relatively small members can manage their relationships with China, a challenge which is heightened by the US withdrawal. 4.1.2  Modelling Asia-Pacific regional integration (Chapter 3) Petri, Plummer, and Zhai review models for measuring and examining the impact of trade and investment on domestic and regional economies. The chapter focuses on the gravity modelling framework (ex-post) and computable general equilibrium (CGE) (ex-ante) models. The

8  Handbook on East Asian economic integration

authors review the evolution of CGE models to take into account the developments in trade theory, such as models involving heterogeneous firms. The chapter also highlights the key challenges of incorporating the key effects of GVCs, foreign direct investment (FDI) flows, and regulatory barriers. The authors illustrate the application of CGE models to mega-regional arrangements. They find that proceeding with the Trans-Pacific Partnership (TPP) without the US (i.e. with what became the CPTPP) continues to generate benefits to members but at a level only about a quarter of the arrangement with the US. This is because many members already have trade agreements with each other. The authors also find that no member gains from replacing the TPP with the CPTPP, which indicates the significance of the US market. They stress that there are greater gains from large-member groups such as the RCEP compared to smaller arrangements. With respect to the RCEP, they recognise the contribution of its size to the gains available, but note the limitations associated with the presence of existing agreements and their expectation that the RCEP, at least initially, will not offer much more progress than is already contained in those agreements. 4.1.3  Trade creation and utilisation of regional trade agreements (Chapter 11) Hayakawa and Shiino examine the analytical and empirical framework for the utilisation of free trade agreements (FTAs). They first consider the analytical framework for the trade-creating effects of FTAs through the application of the gravity equation methodology. They review the empirical evidence of trade creation in East Asia in terms of the type of trade agreement, whether the impacts are evident via the number of exporters or exports per firm, and according to the treatment of tariffs versus non-tariff measures. The chapter also provides examples of studies which found significant trade diversion effects of preferential agreements. The chapter highlights the dynamic processes associated with regional agreements and the extent to which they support further reductions in most favoured nation tariffs. The chapter reviews a number of studies undertaken to explain variation in the FTA utilisation rates, while presenting an empirical framework based on the ‘new-new’ trade theory of the firm. The authors identify a number of explanators, including the degrees of restrictiveness of rules of origin. The chapter highlights the result that the FTA utilisation rate is positively related to an easing of restrictions on rules of origin in terms of a rule of cumulation, especially because of the support it provides to the development of GVCs. 4.2  Production Networks, Investment Policies, and GVCs The development of regional production networks and GVCs in East Asia is discussed and reviewed in the respective chapters. The analytical and empirical frameworks are discussed, with a key focus on the GVCs in the region. GVCs in manufacturing and services, the role of FDI, and the movement of people are highlighted and discussed. The policy discussions on balancing the effects of agglomeration and fragmentation due to technological impacts in the GVC are discussed. 4.2.1  Reorganisation of production (Chapter 18) Kimura and Narjoko examine the reorganisation of production in East Asia in terms of production networks, the international division of labour, and GVCs. They provide a conceptual framework of unbundling effects in the GVC and related theories of trade and relevant concepts. The chapter reviews the empirical literature on what is called the second unbundling.

Introduction 9

The first unbundling was the separation of consumption and production, facilitated by a fall in trade costs, which promoted the movement of raw materials and finished products. In the second unbundling, promoted by a fall in communication costs, production processes could be decomposed into a series of tasks. The chapter argues that growth in East Asia is best interpreted in terms of the step from the first to the second unbundling. The complementary frameworks discussed are fragmentation theory, economic geography and the place of the core and the periphery, and the concept of trade in value added. An important complementary concept is that of industrial agglomeration. The authors argue that a special part of the experience of East Asia was the formation of production networks that involved not just task sharing across borders (as observed elsewhere in the world) but also connections between locations of industrial agglomeration. The chapter further examines the consequences of the reorganisation of production, both with respect to the impacts of GVCs and to other impacts at the firm level. GVCs here cover the whole international industrial linkages in both the first unbundling (e.g. trade in primary products and materials) and the second unbundling (e.g. back-and-forth trade in parts and components). The chapter also examines the backward and forward linkages in the GVC, focusing on the drivers of the position of firms in Thailand and the Philippines. It also highlights the importance of domestic capacity to participate effectively in production networks. An important driver of that capacity, and another feature of the East Asian market-led approach to integration, is the presence of multinational enterprises, from which skills and technology spill over to local firms. The spillovers occur via a number of channels that include the demonstration effects on domestic firms, movement of skilled labour, exports, local absorptive capacity, and the conducive business policy regime. The chapter also includes a discussion of what is called the third unbundling or cross-border services outsourcing, driven by further revolution in information and communication technology, which will facilitate the division of labour at the personal level. Workers in one nation, in this scenario, will be able to provide services in another in order to complete one task. 4.2.2  FDI activities and integration in ASEAN and East Asia (Chapter 5) Thangavelu, Urata, and Ambaw discuss the key trends of FDI flows in the East Asian region and the key investment policies in the region. The chapter highlights the important impact of FDI on the growth of the region, ranging from its contributions to the ‘flying geese’ model of dynamic comparative advantage to the more recent development of GVCs. Except for a slight decline in the FDI flows during the GFC, the FDI flows to ASEAN and East Asia are stable, but still lag the FDI flows of developed countries. In recent years, the bulk of the inflows have gone to the services sector, especially wholesale and retail trade, as well as to the financial sector, which have been declining in recent years. The authors also stress the significance of flows into the manufacturing sector and other large host sectors such as real estate and agriculture. ASEAN accounts for about 12% of global inflows: its share of inflows grew rapidly in the late 1980s and early 1990s, and has been stable since then. Intra-ASEAN flows account for 15%–18% of the total inflows (Singapore accounts for three quarters of these flows, some of which may have originated elsewhere, including outside ASEAN). Other East Asian economies have accounted for 29% of the inflows, so intra-regional flows account for just under half of the total inflows (OECD, 2019). East Asia (including ASEAN) accounts for about a third of global outflows (UNCTAD, 2019), so the flows into ASEAN are relatively intense (accounting for a higher share of flows into ASEAN than the share of global outflows).

10  Handbook on East Asian economic integration

Thangavelu, Urata, and Ambaw discuss the motivations for FDI flows, including efforts to secure resources, find markets, increase efficiency, and buy what are regarded as strategic assets. They contrast the relative importance of these various motivations between different source countries and over time, noting the contribution of vertical FDI to GVC development. They discuss the impacts of FDI on local firms, and the channels of those impacts, including on productivity, exports, and wages paid. The extent of a positive result is critically dependent on the absorptive capacity of the host economy. The authors also identify a number of policy issues that impede FDI flows and discuss the treatment of FDI in the ASEAN Comprehensive Investment Agreement. Their policy discussion includes reference to investment facilitation and the role of promotion agencies as well as various behind-the-border measures which may impede inflows. They stress the role of liberalisation of investment in the services sector and its contribution to the performance of GVCs, and the participation of host economies in those chains. 4.2.3  Business impediments to economic integration in Southeast Asia (Chapter 10) Lee reviews the impediments to integration from a business perspective. The chapter identifies a set of business impediments, which are factors external to the firm but which affect its performance, in both the domestic economy and in international transactions. These factors might operate with respect to conditions for entry, operations, and exit. With respect to performance, the elements of interest in this review are those likely to be contributors to economic growth. The set of impediments therefore includes measures adopted by governments which affect markets in goods, services, and factors of production, including those with implications for cross-border flows of trade and investment. Further, the chapter reviews the literature that has attempted to measure the extent to which different types of firms are exposed to impediments in various countries. The chapter also summarises data from surveys of firms in which respondents are asked to identify the key impediments to their performance, accounting for country variations. It also examines the impact of these indicators on the propensity to export across countries. The key factors affecting the propensity to export include the terms of access to finance and to land, regulation in labour markets, and corruption, as well as the performance of particular institutions (tax, legal, and customs authorities). Common positive drivers of export participation are firm size, foreign ownership, and firm age. The chapter also highlights the importance of policy reforms that includes specific measures related to infrastructure quality, labour market regulation, foreign investment policy, trade facilitation, and governance. 4.2.4  Trade in goods with internationalised production activities (Chapter 4) Matsuura and Obashi develop the key analytical and empirical framework to understand the trade in goods in East Asia. The chapter refers to the measurement of trade data at the product level and the decomposition of trade to inter- and intra-industry trade in goods. The study breaks down these trade flows by types of products within the region (defined as the RCEP members) and outside it. The authors highlight the difference between primary products, parts and components, and final goods. For all categories, intra-regional trade has grown faster than both world trade in total and East Asian trade with the rest of the world. The region therefore became more integrated. The surge in component trade is evident in data for the 1990s, but again component trade in East Asia grew nearly twice as fast as that in the rest of the world. Both component trade (especially

Introduction 11

so) and final product trade slowed after 2000, but East Asia internally recorded faster growth in both categories. Matsuura and Obashi also observe that East Asian trade exports to the rest of the world are dominated by final products, while imports from the rest of the world are mainly primary and processed products.3 Matsuura and Obashi also discuss other methods of identifying the extent of activity in value chains, using data from input–output tables, rather than the categorisation of trade products. They apply that methodology to review the position of various countries in value chains. They identify drivers of participation in value chains, including location advantages, and decreases in trade costs due to tariff cuts and efforts on trade facilitation. The authors note, however, that significant issues remain in the region with respect to non-tariff barriers. The growth of China has created opportunities for the rest of the region, rather than crowding out other exports. With respect to opportunities for small firms, an issue which is critical to the question of the inclusiveness of integration, the authors identify a range of factors that might encourage participation in trade. They note the relative importance for smaller firms of some of the barriers to exporting. Finally, they discuss the durability of value chains, and they review the debate in the literature on the ‘trade slowdown’. They observe the durability of value chains in machinery industries, but they also ask questions about the long-term effects of the upgrading that is occurring in China in particular, and its implications for sourcing inputs, and for the impact of digital technology. 4.2.5  Services (Chapter 7) Findlay and Roelfsema review the key drivers of trade in services in East Asia. They begin with the key characteristics of services, which leads to the forms in which transactions are organised and thereby the options for international exchange in services. The chapter stresses the requirement for interaction between producers and consumers, which contributes to a higher degree of regional intensity in services trade. New data on trade by different modes are highlighted, and of interest is the continued importance of the delivery of services via offshore establishments. The next stage of services trade development will depend on digital platforms, which also creates the possibility of a more global orientation and falling regional intensity in services trade over time. The process of servicification of manufacturing and the ways in which services are embodied or embedded in goods will have different impacts across the region in cross-border trade compared to value added included in goods. Various features of services contribute to risks of market failures which then drive the regulatory policies applied to services, and which in turn can become barriers to international transactions. The chapter on services includes a review of the various measures of these barriers. The chapter notes that services reform appears to lag in the East Asian region. Chapter 7 also reviews the treatment of services in FTAs. Generally, commitments in FTAs exceed those made in the General Agreement on Trade in Services (GATS). Given the nature of services transactions, and the nature of the regulatory policy which applies, the question remains of the extent to which FTAs can contribute to regulatory reform. 4.2.6  East Asian financial integration in banking, markets, and regulation (Chapter 15) Hanna and Sheng evaluate the degree of integration of capital markets in the group of ASEAN Member States (AMS) plus China, Korea, and Japan (the ASEAN+3 economies). The chapter examines the evolution of the markets, and their regulation, since the AFC in 1997, taking into

12  Handbook on East Asian economic integration

account its consequences and those of the GFC. The chapter highlights the forces which may drive the next round of adjustments and offers an assessment of their current stage. The AFC experience triggered a series of changes in East Asia. These include a more flexible exchange rate regime, to help insulate domestic liquidity. Bond markets were developed to diversify funding sources. Swap arrangements were set up to offer officials greater capacity to respond to capital outflows. Financial regulation was strengthened. However, these reforms were not sufficient to avoid the GFC a decade later, though they did add to the ability of the region to withstand the global shock. The GFC affected the US and Europe more than it did the ASEAN+3 countries because of the use of expansionary fiscal measures, by China in particular. Reforms after this shock include work at the global level to strengthen the banking systems and their capacity to absorb global shocks and those generated by non-bank financial intermediaries (or shadow banks) in their own economies. Meanwhile, the ASEAN economies sought to continue to integrate their economies to generate growth, and included a commitment to open capital markets. ASEAN+3 officials worked on further development of bond markets. Swap arrangements were improved and a macroeconomic monitoring group was set up. The chapter also reviews the state of the region’s financial markets. The authors conclude that markets are still dominated by banks, and that equity and bond markets remain relatively underdeveloped. Financial systems are less complex in the region, but there is growth of shadow banks and new types of instruments. Exchange rate arrangements are evolving, with the possibility of less reliance on the US dollar and more use of the renminbi for transactions and as a store of value (though in the short term there is a degree of lack of confidence in the latter). Economies of the region are relatively large holders of foreign exchange. Savings are growing rapidly and the financial sector is growing faster than gross domestic product (GDP). The diversity of the region provides opportunities in integration but also complicates the process, which the authors describe as likely being a slow and jerky dance, though they hope that the recognition of mutual interests will convert this to a more graceful flow. The chapter concludes with a discussion of current forces which may drive the next rounds of reform and integration. These include the development of new e-payment systems (led by China), the disruptions to traditional banking services from fintech (e.g. trade finance), the contribution of cryptocurrencies to lower the costs of managing payment systems, and other uncertainties associated with the shifts in the design of supply chains and with tensions between the major trading partners. 4.2.7  International population mobility in East Asia (Chapter 6) Ananta and Arifin examine the analytical framework of migration and the key trends in population mobility in East Asia. The chapter reviews the research on the drivers of migration, including factors associated with various stages of development and demographic transition as well as those related to technological change. East Asia will continue to be both a sending and a destination region, but the movement of people might shift more towards mobility (shorterterm movements) than migration. There is a two-way impact of migration, as migrants may not only reside in a number of other countries but may also return home, having accumulated human capital. The chapter also reviews the application of policy measures to migration, including mutual recognition agreements which are relevant for skilled migrants. With respect to mutual recognition agreements in ASEAN, there is more progress for tourism professionals; some progress for accounting, architecture, and engineering; and less progress in fields related to health services.

Introduction 13

The chapter also focuses on the movement of people associated with the ASEAN+3 economies and on longer-term mobility. From 1990 to 2015, the stock of migrants in these economies more than doubled, rising from 6.8 million to 17.4 million. Economies with high shares of migrants to the total population are Macao, Singapore, Hong Kong, and Brunei. Thailand showed the largest growth over this period, to become the largest destination. Malaysia and Singapore also showed large increases, and these three plus Japan and Hong Kong make up the top destination country positions. The largest sending countries are China, the Philippines, Indonesia, Myanmar, and Viet Nam. The countries with the largest remittance flows are India, China, and the Philippines. Ananta and Arifin highlight the drivers of changes in patterns of migration, and show that current source countries can switch to be destination countries. The patterns of migration are relatively intense in the region, which as a sending region accounts for about 14% of the stock of global migrants, but only about 7% of the stock as a destination. While the regional flows are intense, the region has a relatively global orientation in its migrant flows. 4.3  Structural Transformation, Skills, and Domestic Capacity Regional integration and structural transformation in the East Asian region are discussed in the respective chapters. Successful structural transformation is critical to shift to more efficient and productivity-driven economic growth in the AMS. The respective chapters highlight the challenges and opportunities for structural transformation from regional integration in the East Asian region in the agricultural sector and with respect to skills, regulatory reforms, and the capacity to improve the welfare of the people through poverty reduction. 4.3.1 Agricultural development, structural transformation, and East Asian trade (Chapter 8) Anderson examines the analytical framework of agricultural development and key trends in regional trade in agricultural products. The chapter provides the theory of the evolution of agricultural comparative advantage in terms of the development of domestic economies. However, the chapter asks to what extent the actual pattern in East Asia is consistent with that theory. It finds that trade-related policies have restricted the agricultural trade of East Asian economies in various ways. In particular, several countries have restricted their exports of key farm products while their incomes were low, which implies the imposition of a tax on agriculture. Other countries have gradually raised barriers to agricultural imports as the international competitiveness of their farmers declined in the course of economic growth and industrialisation. The chapter identifies the ‘tradition’ of gradually moving away from taxing and towards protecting farmers relative to producers in non-farm sectors. The chapter also observes that there are new and cheaper means of achieving the policy objectives of agricultural policies, even in the region’s poorer countries. One possibility is to allow countries to move away from less-efficient priceand trade-distorting policy instruments to more efficient ones for redistributing the benefits of economic growth and integration. While switching to these new measures is not a trivial task, doing so would help integrate regional trade in these products and provide better options for responding to supply shocks such as pandemics and local events associated with climate change.

14  Handbook on East Asian economic integration

4.3.2  Skills and human capital development policies of ASEAN (Chapter 19) Thangavelu and Wang examine the analytical and empirical framework of the policies on human capital and skills development in the East Asia. The chapter highlights that the long-term experience of the region, and a contribution to the success of economic integration, has been the alignment of the education and training system with the changing demands for skills from the industrial structure. It illustrates the ways in which skill demand shifts, in a more recent context, by mapping various positions in GVCs with the skills required to support the transition to higher GVC activities. The transition is vital to continuing to gain from GVC participation, including its contributions to wage growth and technology transfer. The chapter also discusses the institutional framework for upgrading of skills in the domestic economy and the region. It provides more information on how human capital development might be organised, with reference to the experience in East Asia. The chapter refers in particular to the contribution of technical education and the value of a lifelong learning framework which combines education, training, and learning in employment. In particular, the development of a portfolio of human capital and skills is important for the adjustment to international competition and the structural change that is associated with economic integration. The chapter also refers at various points to the value of mobilising the private sector in the provision of education, including in partnerships. Its presence brings not only additional capacity but potentially also drivers for innovation. The scope of the private sector can be extended to include foreign providers. Education is a tradable service through various formats, including via digital delivery and the portfolio of human capital and skills. Barriers to international education remain high in many economies in the region, and reform offers greater scope to contribute to regional integration in its own right but also to support the success of integration in other sectors. 4.3.3  Trade, poverty, and Aid-for-Trade (Chapter 12) Menon and Melendez evaluate the links between trade growth and poverty reduction in the East Asian region. East Asia’s openness to trade is often credited as one of the main drivers behind the region’s impressive gains in economic growth and poverty reduction. The authors examine the literature to determine whether there is a sound theoretical and empirical basis for this presumed relationship between trade and poverty reduction. Like many other studies on this topic, they find that the linkages are not automatic; the impact of trade on poverty is highly context-specific, and many factors come into play. Complementary policies are necessary to maximise trade’s potential impact on poverty reduction. They also explore the role of Aidfor-Trade in addressing specific trade-related capacity constraints which prevent developing countries from maximising the benefits from trade. 4.3.4  Institutional reform, regulatory reform, and integration in East Asia (Chapter 9) Shrestha and Doan examine the process of regulatory reform associated with economic integration in East Asia. Regulatory reform is associated with the broader category of institutional change, including the rule of law, anti-corruption policy, and the effectiveness of government and the regulatory system. The chapter examines the relationship in two directions – one in which there is a positive relationship from the quality of the institutional environment to economic integration, and the other the reverse – where economic integration becomes a driver for institutional reforms. It is important that better institutional quality can support trade by reducing uncertainty and the associated transactions costs. The link in the opposite direction

Introduction 15

operates via three channels, creating incentives for unilateral reforms to support the competitiveness of domestic firms in more open markets, making commitments to reform in the process of integration (e.g. via trade agreements), and adding to the capacity to undertake reform via collaboration. The chapter also reviews the progress of institutional reform in East Asia since 1998 and focuses on indicators of government effectiveness and regulatory quality, taking data from the World Bank Worldwide Governance Indicators. There is a positive correlation between GDP per capita and institutional quality at a point in time, but not all economies have improved in both dimensions over the whole period. The improvements could be associated with developments in commitments such as accession to the WTO and the adoption of the ASEAN Trade in Goods Agreement. The chapter concludes with three case studies of institutional reform in the AMS. These are trade facilitation; reduction of non-tariff measures (NTMs), including differences in standards; and regulatory reform in general. With respect to the last of these, concerted efforts by each economy as part of the ASEAN process can contribute to improvements and sustained regulatory reforms. On trade facilitation, the chapter highlights instances of AMS making faster progress than might be expected given their level of GDP per capita. On NTMs, the challenges to date have been more significant, with a large number of initiatives associated with progress which is uneven and limited. Actions to accelerate progress, they suggest, include implementing commitments on reporting NTMs and related disputes about them, accreditation of testing facilities for the application of standards, training of personnel, and mechanisms for coordination across government agencies within economies. 4.4  Infrastructure, Digital Technologies, Regional Security, and the Environment The development of soft and hard infrastructure is critical to shift the economic activities in the region to higher value-added activities in the regional and global value chains. The respective chapters discuss the analytical framework and key challenges facing the East Asian countries in terms of infrastructure connectivity, digital technologies, and security issues in the region. 4.4.1  Investment in connectivity (Chapter 13) Elek and Findlay examine the scope for economic integration to resolve issues in the provision of infrastructure finance. The focus is on projects which contribute to connectivity amongst East Asian economies. There is, according to some estimates, a gap between the stock of projects that would be demanded to meet expectations of growth and structural change and the actual flow of projects, according to current trends. The chapter refers to assessments that greater private sector participation in funding would be important to help close the gap. Funding appears to be available, but bottlenecks remain. Various short-term responses such as ‘deal sweeteners’ were noted, but fundamental policy reform at the national level is more important. Reform can be supported in various formats through international cooperation. The chapter reviews options, including capacity building and agreed policy frameworks, to which commitments are made (as in the Master Plan on ASEAN Connectivity (MPAC)), as well as cooperation involving funding flows such as the Belt and Road Initiative. The role of multilateral development banks is also noted in both policy reform and funding flows. The value of coordination to capture spillovers and network effects is stressed. The chapter highlights a virtuous circle between integration and investment for connectivity.

16  Handbook on East Asian economic integration

The direction of policy reform that supports a greater private sector role and helps resolve the funding gap would also lead to much more integrated economies in the region. In the process, these reforms create a virtuous circle, since the connectivity projects which are completed reduce trade costs and lead to higher levels of economic integration overall. This outcome, in turn, supports the returns on the flow of new connectivity investments. 4.4.2  Connectivity and the geographical simulation model (Chapter 14) Isono and Persyn examine the empirical framework for quantifying the benefits of connectivity, including not just the gains from trade but also the implications for the location of economic activities and patterns of trade. This includes a discussion of the drivers of agglomeration that follows from reductions in transport costs, the sensitivity of location decisions to small policy changes in a low transport cost environment, and the redistributive effects. The chapter discusses the scope to include these additional effects to those considered in the traditional methodologies of modelling the gains from trade. Given the presence of these extensive gains from connectivity, the chapter considers the prospects for the MPAC. There is some progress in ASEAN but several issues and thereby constraints remain, including those around decision making, access to funding and to human resources, regulatory reform, and expectations of revenue failing to be met. The chapter considers a number of ways to promote the positive progress of connectivity in ASEAN. One response is to provide more information on the benefits and consequences of connectivity. This can be done in two possible ways. One involves a pair of case studies of actual integration: the examples offered are in air transport and the automotive industry. The other involves the application of a simulation model which is designed to capture the trade and spatial consequences of improved connectivity. In this case, the model could consider the implementation of the MPAC, with a focus on the Greater Mekong Subregion Economic Corridors. One of the important contributions in this chapter is to identify the flow of benefits across countries, even of national projects. This leads to discussion about the scope to share funding in infrastructure projects. Finally, the chapter suggests that the design of projects for connectivity need not be bound by ASEAN membership. Connectivity matters within the group and between its members and others. ASEAN can lead the development of thinking on connectivity, but projects could be developed at a higher level, involving other economies (the authors provide examples of working with China, for instance) or a subregional level. In either case, the modelling work remains useful in order to capture the distribution of consequences beyond those economies directly involved. 4.4.3 Economic integration, climate change, and sustainable development in East Asia (Chapter 16) Tay examines the connections between economic integration and environmental issues, where the treatment of the latter has not kept pace with the former. The chapter notes that the East Asian economies have begun to pay more attention to environmental issues, both because of pressure from the rest of the world but also because of demands to do so from within. In particular, there has been an increase in efforts in this respect by China, Indonesia, and Singapore, as well as India. Originally, the concerns in the region were on pollution that is evident and which affects public health. Over time, there have been two developments – one is greater attention to climate change and the other is more consideration of the determinants of

Introduction 17

environmental outcomes. In addition, there are others, so far of less concern in Asia but more so elsewhere, such as endangered species, biodiversity, and deforestation. The chapter highlights the two-way relationship between trade and the environment. One question concerns the links from trade and growth to better environmental outcomes, and the review of the literature seems to be inconclusive, since the results are dependent on the context of the analysis. There is also lack of attention to climate change in these sorts of studies. The chapter also examines how the treatment of environmental issues might affect the trading systems, the application of its rules, and its operations. For example, some environmental measures may sanction the application of trade measures, demand actions not consistent with trade measures, and insist on the application of standards which add to trade costs. There is also a concern that unilateral action could be applied to trade measures on environmental grounds as an excuse for a protectionist policy. The chapter refers to resentment and suspicion by developing economies about the unilateral application of environmental measures by their trading partners. The chapter also considers the ways in which attempts have been made to resolve these issues cooperatively. The WTO has failed to make any progress, one reason for which is the very different interpretation of WTO text by pro-trade and pro-environment stakeholders. Relevant WTO cases are considered, but the WTO’s dispute settlement process has a lack of consistency and thereby also legitimacy. It is also important to note the failure in ASEAN to connect the economic integration agenda with the rising community interest in environmental issues (as a result of a lack of connection between its three ‘pillars’ of integration). The chapter concludes with discussion of new measures being applied or considered to environmental issues. These include carbon taxes, which in the trade context leads to discussion about the application of adjustments to taxes at the border. Subsidies which are complementary to the operation of carbon management regimes also trigger trade policy concerns. Some countries place greater attention on the application of standards (of product performance but also the process of their production), which as noted can affect trade costs, or at least some effort at regulatory alignment. The development of green finance (tied to environmental performance) for infrastructure projects is another trend of interest. 4.4.4  Energy transition for fuelling economic integration in East Asia (Chapter 17) Anbumozhi reviews the opportunities and challenges in energy market integration in the region. The strong regional growth leads to increased energy demand, and thereby a degree of concern about the security of supply. The extent to which this is an issue varies between economies, depending on their energy sources and their overall balances in supply and demand. These variations also create the scope for gains from cooperation, including through trade in energy. Capturing that opportunity is constrained by a number of barriers, however, including differences in technical standards and concerns about environmental impacts. The former is especially important, for example, in connecting electricity grids. The latter matters more for some conventional fuel sources. The chapter examines a number of other specific issues. One is the scope to develop a clean energy value chain in the region. This is an important part of the response to the environmental constraints to meeting the demand for energy. However, there are a number of constraints on this development, including barriers to trade in the components used in the production of renewables and barriers to foreign investment. A second is the extent of subsidies in place for conventional fuels. The chapter argues the case for a reform of these subsidies, which would

18  Handbook on East Asian economic integration

moderate the growth in demand and remove a bias against energy with lower emissions. A third important topic is the manner in which the region can accommodate China into regional energy markets, given its scale. The chapter includes a discussion of the ways that institutions in the regions, including those led by ASEAN, can help integrate markets and respond to these additional issues. 4.4.5 Digitalisation and market integration (Chapter 20) Lee-Makiyama examines the nature of the integration by digital means and the issues that it involves. The chapter observes that the digital economy involves an ecosystem of infrastructure alongside flows of goods, services, and data. Within that ecosystem, transactions are organised digitally but may lead to either digital or physical delivery. These transactions might be between businesses and will also involve consumers. As an indication of the extent of integration in this area in East Asia, the chapter presents data on the sources of final demand for information technology and information services. The trends indicate that the domestic supply within the ecosystem is very high (about 80%) and that over the decade to 2015 this share only fell by 10 percentage points. This indicates that there is a low degree of integration, which is due to the impact of policy restrictions that impede trade. The chapter refers to work on measuring the restrictiveness of policy, and finds that on average digital trade is more restricted in East Asia than in the world in general, though some economies in the region are relatively open. Recent forecasts for the growth of the digital economy in the CGE modelling framework indicate the consequences of reform, at the economy level, to reduce the levels of restrictiveness. The results of the simulation indicate very large positive results. The chapter also reviews a series of issues associated with the growth of the digital economy, including data localisation requirements, online censorship, cybersecurity, industrial policy, competition policy, and corporate taxation. Key results include (i) the relatively high costs of data localisation requirements; (ii) the presence of inconsistencies in – and the significant consequences of – the different approaches to censoring content which is deemed to be undesirable; (iii) the trade and investment impeding effects of the application of national security tests in the digital economy; (iv) the challenges posed by digital technologies (where network effects are important) to traditional approaches to industry policy; (v) the pro-competition effects of digital technology and, at the same time, the presence of risks of consolidation and of differences in thinking about how to respond (pre-emptively or otherwise in the context of incentives for entry into the long term); and (vi) the risks involved in abandoning traditional principles applied to taxation of income generated by cross-border activity. The chapter concludes with a discussion of three different paths available to East Asia to facilitate digital integration. First, new disciplines in recent trade agreements such as the RCEP and the CPTPP could curb some of the most restrictive practices; second, a regional certification could alleviate issues on data flows, as exemplified by the APEC Cross-Border Privacy Rules; and third, the region could look to converge various regulatory practices in the long term. 4.4.6  The economics–security nexus and East Asian integration (Chapter 21) Chacko and Jayasuriya consider the relationships between integration and security in the context of East Asia. Policy advice in earlier times, with respect to this linkage, was based on a

Introduction 19

positive effect from integration to security. Subsequent improvements in the latter would lower the impediments to integration that might otherwise be present. Since the circle was a virtuous one, then policy advice on integration could rest on its positive consequences for security. Benefits of further integration, if anything, would be understated. The chapter presents some different ways of thinking about the relationship of trade to security. The complicating factors which have not been sufficiently studied are related to domestic political processes. This chapter highlights the reciprocal role of geopolitical relations and global economic relations in shaping the interests of domestic social groups in relation to strategies of trade and regional integration. These issues have been neglected by much of the existing literature on regional integration and the economics–security nexus. Further, the economic relations and security relations are always linked through their mediation by domestic social groups. More recently, the emergence of competing regional regulatory and infrastructure projects very much complicates the anticipation of integration in the region in future.

NOTES 1. For more recent data, see Global Trade Alert (n.d.). 2. Global Trade Alert (n.d.) categorises interventions as follows: (i) red triangle: the intervention almost certainly discriminates against foreign commercial interests; (ii) amber triangle: the intervention likely involves discrimination against foreign commercial interests; and (iii) green triangle: the intervention liberalises on a non-discriminatory (i.e. most favoured nation) basis or improves the transparency of a relevant policy. 3. The indicator of regional integration discussed here refers to shares of trade. An extension in further work is to consider those shares relative to the shares of the respective economies in world trade, that is, an indicator of trade intensity. Studies of this indicator generally report falling intensity in East Asia, and in ASEAN, at least from the mid-2000s (see for example Korwatanasakul (2020)). Falling intensity can follow from success with respect to competitiveness in world trade, often driven by the growth of regional trade, leading at the same time to a rising share of world trade (Korwatanasakul, 2020, p.17). China’s participation in world trade since joining the WTO in 2001 has also contributed to this outcome.

REFERENCES ADB (2020), ‘The Economic Impact of the COVID‐19 Outbreak on Developing Asia’, ADB Briefs, No. 128. Manila: Asian Development Bank. Bown, C.P. (2019), ‘US–China Trade War: The Guns of August’, Trade and Investment Policy Watch, 20 September. Bown, C.P. and D.A. Irwin (2019), ‘Trump’s Assault on the Global Trading System: And Why Decoupling from China Will Change Everything’, Foreign Affairs, 98, pp.125–37. Bown, C.P. and S. Keynes (2020), ‘Why Trump Shot the Sheriffs: The End of WTO Dispute Settlement 1.0’, Journal of Policy Modeling, 42(4), pp.799–819. Dziedzic, S. (2018), ‘APEC 2018: Regional Meeting Ends in Disarray as Leaders Fail to Reach Consensus on Commujnique’, ABC News, 18 November. https://www.abc.net.au/news/2018-11-18/apec-leaders-fail-to-agree-oncommunique-wording/10508974 (accessed 10 March 2021). Evenett, S. and J. Fritz (2019), Going It Alone? Trade Policy After Three Years of Populism: The 25th Global Trade Alert Report. London: CEPR Press. Global Trade Alert (n.d.), Global Dynamics. https://www.globaltradealert.org/global_dynamics (accessed 10 March 2021). ILO (2021), ‘COVID-19 and the World of Work’, ILO Monitor, Seventh edition, 25 January. Geneva: International Labour Organization. Kastrop, C., D. Ponattu, J. Schmidt, and S. Schmidt (2019), ‘The Urban–Rural Divide and Regionally Inclusive Growth in the Digital Age’, G20 Insights, Policy Briefs, 14 June. Kimura, F. (2021), ‘The Impact of COVID-19 and the US–China Confrontation on East Asian Production Networks’, Seoul Journal of Economics, 34(1), pp.27–41.

20  Handbook on East Asian economic integration Kimura, F., S.M. Thangavelu, D. Narjoko, and C. Findlay (2020), ‘Pandemic (COVID-19) Policy, Regional Cooperation and the Emerging Global Production Network’, Asian Economic Journal, 34(1), pp.3–27. Korwatanasakul, U. (2020), ‘Time to Look East: Lessons from Revisiting Asian Economic Integration’, ADBI Working Paper 1110, Tokyo: Asian Development Bank Institute. OECD (2019), OECD Investment Policy Reviews: Southeast Asia. Paris: Organisation for Economic Co-operation and Development. O’Rourke, K. (2019), A Short History of Brexit: From Brentry to Backstop. London: Pelican (Penguin). Pangestu, M.E. (2019), ‘Changing Global Trade Landscape: Developing Country Perspective’, 3rd International Conference on Trade 2019 (ICOT 2019), Advances in Economic, Business and Management Research, 98, pp.216–23. Rodrik, D. (2018), ‘Populism and the Economics of Globalization’, Journal of International Business Policy, 1(1–2), pp.1–22. The Economist (2019), ‘Globalisation Has Faltered’, Briefing, 24 January. UNCTAD (2011), How Are the Poor Affected by International Trade in India: An Empirical Approach, Report UNCTAD/DITC/TNCD/2010/7. Geneva: United Nations Conference on Trade and Development. UNCTAD (2019), World Investment Report 2019: Special Economic Zones. Geneva: United Nations Conference on Trade and Development. World Bank (2021), Global Economic Prospects, January. Washington, DC: World Bank. World Health Organization (n.d.), WHO Coronavirus (COVID-19) Dashboard. https://covid19.who.int/ (accessed 21 February 2021).

2.

East Asian architecture of integration Mari Pangestu and Shiro Armstrong1

1. BACKGROUND Successive waves of economic transformation in Asia have been achieved through openness to trade and investment. Japan’s industrial transformation and modernisation in the post-war period provided a model for the newly industrialised economies of Northeast and East Asia. Many countries in Asia have achieved development and prosperity, with market-oriented reforms which embraced open markets. China’s opening up and accession to the World Trade Organization (WTO) in 2001 was a watershed in the global economy, which shifted the centre of gravity to Asia. Viet Nam and other countries are on similar trajectories. Deeper integration in Asia is already centred on China and will become increasingly so with India over the next decades. No clearly defined or static regional architecture or set of arrangements in East Asia has facilitated the economic rise of these economies. East Asia’s economic integration has been led by market-driven trade and foreign direct investment (FDI). Due to the lack of regional institutions or deep cooperation amongst Asian countries, deeper economic integration is lacking in other areas such as the movement of people, financial integration, and economic policy integration. This is in contrast to economic integration in Europe and North America, which has been institution-led. The European Union built up steadily over time, with deep economic cooperation following political cooperation. The North American Free Trade Agreement (NAFTA), now renegotiated as the United States–Mexico–Canada Agreement, led to deeper integration amongst the United States (US), Canada, and Mexico. In East Asia, integration has been market-led and institution-light. The modes of cooperation and integration have been different. Regional architecture is the set of arrangements, institutions, and mechanisms that support and facilitate regional cooperation. These include the bilateral and regional arrangements and the broader global institutions and frameworks within which they operate. East Asia’s regional architecture has evolved out of its unique circumstances, in the context of the interests that Asian countries have beyond the region. The role and scope of the East Asian architecture are difficult to be clear on and depend on particular issues or dimensions. The US hub-and-spoke security arrangements with East Asian partners – Japan; the Republic of Korea (henceforth, Korea); Australia; and parts of Southeast Asia – have been key to providing stability and security in the broader Asian region. The AsiaPacific Economic Cooperation (APEC) forum facilitates cooperation across the Asia-Pacific. Australia is a crucial supplier of energy and raw materials to Northeast Asia, and actively contributes to cooperation and regional institution building. The main focus of this chapter lies in the Association of Southeast Asian Nations (ASEAN) Plus Six grouping of the 10 Southeast Asian countries2 plus Australia, China, India, Japan,

21

22  Handbook on East Asian economic integration

Korea, and New Zealand. The trans-Pacific relationship with the US is also of importance for the East Asian architecture. This chapter reviews East Asian economic integration and the architecture that supports and facilitates it, and examines how it differs from the rest of the world. It explains how and why Asian economic integration has progressed and deepened in the way it has. The different arrangements, which are largely a consequence of the circumstances and context, are explained before assessing the progress of integration and the evolution of the architecture. Finally, the chapter looks ahead to the next stage of the East Asian economic community.

2. DRIVING FORCES AND PRINCIPLES OF INTEGRATION IN EAST ASIA 2.1  East Asia’s Circumstances East Asia has achieved a high degree of economic integration in a different manner to Europe and North America, the other centres of economic activity and integrated regions. Cooperation and institution building have led the integration in North America through NAFTA and in Europe via the European Union (EU). In East Asia, economic integration has led institutional and political cooperation. The diversity of Asia, with countries at vastly different stages of development and with different economic and political institutions and systems, precluded a one-size-fits-all arrangement from encompassing the entire East Asian region. In fact, the contours of the ‘region’ are not clear. The political distance between many of the major countries in the region – including tensions, territorial disputes, rivalries, and unresolved history – also meant that economic integration had to lead political cooperation (Armstrong and Drysdale, 2011: 8–9). The exception is the case of ASEAN, under which political cooperation amongst the original six members in the 1960s, facing the common threat of the spread of communism during the Cold War, preceded economic cooperation. The inclusion of the later members was also originally politically motivated. Economic cooperation and eventually more formal agreements began in the 1980s, but really only became comprehensive in the early 1990s. Consensus was forged over time for support and commitment to open economic policies in order to achieve development, more often than not after the countries in question began their domestic reform processes and became more confident about opening up. Given the context of East Asia’s diversity and interstate political circumstances, that meant a particular set of arrangements evolved with specific characteristics. These include non-binding voluntary cooperation; outward-oriented economic policies, starting with low ambition but accelerating at a later date; and open regionalism (Garnaut, 1996: 6). While the cooperation was constructed with a regional focus, it was consistent with intensified economic links beyond the region because of the recognition of the importance of extra-ASEAN and East Asian markets. Opening up economies through multilateral or unilateral liberalisation and reform meant that the market would largely determine trade and investment flows. Unlike in Europe and North America, binding trade agreements that gave regional neighbours preferential access to markets was difficult in Asia due to the political differences and the strong economic and security interests beyond the region. East Asian economic integration has largely been market-led, while North American and European economic integration was largely institution-led

East Asian architecture of integration 23

(Drysdale, 1988: 204; ADB, 2008: 241–2). Strong institution-led integration of North America and Europe has been shown to deepen economic integration but also meant ceding sovereignty, which had its limits and allowed less flexibility. Europe was able to move to a customs, currency, and monetary union, but a fiscal union was not feasible politically, creating ongoing challenges. The institutional integration may appear to offer greater progress but involves the perception of ceding sovereignty, which creates challenges and is difficult to manage – Brexit is an example of this. The less institutionalised structures of East Asian economic integration have been criticised for not being ‘deep’ enough, but have allowed more flexible and evolutionary progress, accelerating when necessary. To support that market-led economic integration, East Asia developed, often with the support of the large powers (including the US), a ‘reasonably coherent network of regional organizations, institutions, bilateral and multilateral arrangements, dialogue forums, and other relevant mechanisms that work collectively for regional prosperity, peace and stability’ (Hu, 2009: 4). That architecture evolved to support economically open policies. European economic integration was seen by many as the benchmark for regionalism and deeper integration. The European experience was born out of a different set of circumstances amongst a very different group of countries and evolved over a long period of time to foster economic growth and prosperity through integrated trade, investment, fiscal, financial, and monetary arrangements. In the case of Europe, there was also a political union. European economic integration and regionalism have a longer history than in East Asia. Asian economic integration developed in the context of a more globalised economy (ADB, 2008: 241). Europe and North America developed supranational authorities and ceded sovereignty in doing so, whereas the shallowness of Asian political cooperation and the diversity meant that was not the path in East Asia. There is less of a ‘club’ to withdraw from, as countries participate at their own pace, spurred on by demonstration effects and peer pressure from other countries. The fact that sovereignty is not ceded in the East Asian structure makes it less likely for members to leave. An analysis made after the experience of Brexit indicates that there is in fact no exit clause for ASEAN members. Ultimately, however, the commitments which have been made have been domestic decisions that required marshalling of domestic coalitions for reform. An important aspect of East Asian economic integration has been the trans-Pacific relationship with the US. The hub-and-spoke security arrangements provided stability across the Asia-Pacific and, as the largest economy, the US has been an important part of the East Asian economy (Katzenstein, 2002). That trans-Pacific relationship has been and continues to be vital. The US has been important as a final market but also as a source of stability – it is the largest economy and underpins stability and security in the Asia-Pacific with its hub-and-spoke security architecture. Much of Asia’s financial intermediation is conducted through New York, and the US has played an important role in ensuring an open and rules-based multilateral trading system. Thus, the US remains the largest regional and global public goods provider. Its leadership of the global economic order is what underpinned the framework within which Asian cooperation and the regional architecture developed in the last three decades. However, recent developments – with the US withdrawal from the Trans-Pacific Partnership (TPP) agreement and its general withdrawal from multilateralism, global economic order, and leadership in Asia – have tested the vitality of the relationship. Even before recent developments, the relationship between the US and East Asia was not always politically close. East Asia largely lost confidence in Washington’s interests in the region

24  Handbook on East Asian economic integration

after it failed to aid the economies that were hurt the most during the Asian financial crisis of 1997–1998. The aftermath of the Asian financial crisis saw regional cooperation intensify around accelerating the timeline for achieving the ASEAN Free Trade Area in 1998 – deepening ASEAN economic integration. This led to the ASEAN Economic Community in 2003 and the expansion of bilateral and regional free trade agreements (FTAs) with East Asian partners, which was catalysed by China. The first FTA that ASEAN negotiated with its Dialogue Partners was with China in 2002,3 and this was quickly followed by others (Munakata, 2006). It also led to the ASEAN+3 (China, Japan, and Korea) process and a number of regional initiatives aimed at making the region less dependent on the US. Unlike the progress made on trade agreements, many of those initiatives (e.g. the Asian Monetary Fund and the Asian currency unit) failed to materialise, while other initiatives (e.g. the Chiang Mai Initiative (CMI) and the Asian Bond Market Initiative) are underdeveloped and require further improvements to be attractive. Asian cooperation deepened around the ASEAN+3 processes, but the most successful initiatives have tended to complement and rely on global institutions, rather than aiming to replace them (Drysdale and Armstrong, 2010). The multilateralised CMI requires the involvement of the International Monetary Fund (IMF) and supplements the funds available through the IMF in the event of a crisis. In a political and security sense, the war on terror which preoccupied the US geopolitical and security outlook following 9/11 also saw a decline in the relationships between the US and Asia. In fact, the absence was only redressed after the global financial crisis and the so-called ‘pivot to Asia’ under President Obama. 2.2  Evolutionary Model The circumstances in East Asia meant that regional cooperation started modestly and gradually became more ambitious. Regional architecture emerged around small and middle power countries, largely centred on the ASEAN Member States, with Australia, Korea, and other countries playing important roles in mediating the interests of the larger powers in the region. East Asia’s approach to regionalism has been pragmatic and flexible, based on the principle of ‘variable geometry’ (ADB, 2008: 242). This approach has created an architecture that allows the structure of cooperation to adapt to the priorities of different groups of members. East Asia’s circumstances have meant that regional cooperation has been bottom–up, multitrack, and multi-speed. This is exemplified in the pathfinder approach in APEC, where a group of countries move ahead in initiating and implementing cooperative arrangements before others that are not yet ready to do so (APEC, 2003). This bottom–up approach, which supports markets and subregional cooperation, has been the foundation for eventual broader and deeper regional cooperation (ADB, 2008: 242). Asia’s regional trade agreements (RTAs), comprising more than 100 FTAs in force or ratified by ASEAN and other Asia-Pacific countries, represent around one-third of global agreements.4 Only 20% of intra-ASEAN trade utilises preferential tariffs, with over 70% at the most favoured nation (MFN) zero rate, and more than 90% of some bilateral agreements at the MFN rate (ASEAN, 2015). The nature of FTAs in East Asia has mostly involved low degrees of liberalisation. The main issues covered include tariff reductions, rules of origin (ROOs), technological barriers, inspection and quarantine, trade remedies, and dispute settlement, amongst others. Nevertheless, issues such as post-establishment national treatment for investment (granting of national treatment only after investment has occurred), intellectual property rights, competition

East Asian architecture of integration 25

policy, e-commerce and environmental policy, the movement of labour, and state-owned enterprises have seldom been incorporated. It was not until TPP negotiations (later to become the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP)) that some East Asian countries embarked on binding, ambitious, ‘deep’ regional trade commitments. In force by the end of 2018, the CPTPP chapters cover far-reaching issues (including digital trade) which are relevant to today’s landscape. For example, the CPTPP made it clear that members may not discriminate against digital products, not to apply customs duties to digital products, and to protect source code, amongst others. The agreement also includes provisions which help ensure that cross-border data flows continue unimpeded and that data centres cannot be required to be localised. Many behind-the-border reforms, including regulatory reforms, have progressed through the economic cooperation agenda. Whereas they have been mandated by a supranational authority or binding negotiation in Europe and North America, the reforms progressed much more slowly in Asia, based on the principle of non-interference in other countries. Such an approach, through ASEAN and APEC, was born out of the region’s circumstances; and suited member states that were not able to make strong commitments to each other. However, that cooperation in ASEAN and APEC has been sustained over time. APEC’s 1994 Bogor Goals of free and open trade by 2010 for developed countries and 2020 for developing countries were far-sighted goals to which APEC members committed voluntarily. Progress was made through peer pressure, economic cooperation, and mutual benefit instead of legally binding commitments. They were ambitious and aspirational long-term goals that were not easily defined but allowed members to achieve, and in fact overachieve, at their own pace. East Asia’s flexible and pragmatic approach to regional cooperation and institution building fosters experimentation with new approaches and healthy competition amongst them. The lack of a supranational authority respects countries’ differing needs and sensitivities. An academic debate over ‘institutional Darwinism’ (Pempel, 2010) explains why the contours of the region are not clearly defined and why the variable geometry that has evolved is messy. Such a pragmatic process can deliver more than a one-size-fits-all framework (ADB, 2008: 242). The East Asian approach is not without its weaknesses and limitations. Its flexibility and pragmatism mean that progress is slow and not uniform amongst neighbours. Bilateral negotiations are undertaken to progress issues and interests where they take too long regionally. In addition, not being able to legally bind countries to commitment has its drawbacks. Economic crises, especially the Asian financial crisis, have played an important role in deepening regional cooperation. At times of crisis, countries are more likely to put aside differences and cooperate to build mechanisms that insure against future crises. This was especially so when Washington did not immediately come to the aid of Indonesia, Thailand, and other affected countries in Asia in 1997 and 1998. Confidence in the US and international financial institutions such as the IMF was shaken, and the region started to develop initiatives so that it would be less reliant on the US and Europe. Antipathy towards the IMF remains strong in countries that were recipients of IMF support programmes during the Asian financial crisis, such as Indonesia, Korea, and Thailand. Japanese initiatives such as the Asian Monetary Fund and Asian currency unit did not gain traction amongst Asian neighbours, but initiatives that had a more gradual approach to building confidence and trust survived. The collective leadership around the ASEAN+3 process saw the establishment of the Asian Bond Initiative, CMI currency swap arrangements, and the start of

26  Handbook on East Asian economic integration

regional trade negotiations. Those have persisted and evolved, but have not reached the point of de-linking the region from the US or the IMF. The evolution of those regional institutions continues and is slowly building confidence. The CMI has been multilateralised, expanding bilateral currency swaps from $80 billion in 2008 to $120 billion in 2009 and $240 billion since 2012, and is no longer just bilateral and multilateral amongst the ASEAN+3 members (Sussangkarn, 2011). Trust and confidence are also being built through the ASEAN+3 Macroeconomic Research Office (AMRO) regional surveillance (Chabchitrchaidol, Nakagawa, and Nemoto, 2018).

3. ARCHITECTURE OF THREE DECADES OF EAST ASIAN ECONOMIC INTEGRATION 3.1  ASEAN Centrality Economic cooperation in ASEAN has intensified over time around key principles and the building of an economic community. The many meetings between officials, civil society, and business, as well as between leaders and ministers, provide a rich network of interactions around regional cooperation across economic, political-security, and socio-cultural issues. ASEAN has remained central to East Asian regional cooperation (Figure 2.1). Despite its diversity, it is more coherent than any other subregional grouping and has established trust and deep and effective working relations over many decades. The Plus Three countries—Japan, China, and Korea—continue to have unresolved history and political distance. Despite developing their own China–Japan–Korea trilateral cooperation mechanism, most of the cooperation amongst the three has progressed through ASEAN-centred forums. Regional trade negotiations have occurred in stages, starting with the five ASEAN+1 FTAs with the major Dialogue Partners – China, Korea, Japan, Australia–New Zealand, and India. The last to be completed was with India in 2009. They then progressed to the idea of consolidating the five ASEAN+1 FTAs into an agreement encompassing East Asia, and produced debates as to whether to proceed with the ASEAN+3 grouping or expand to include Australia, India, and New Zealand. The stylised facts of the debate at the time were that China wanted the smaller grouping as it comprised the first three FTAs, among which China would have more influence, whilst Japan wanted the larger grouping of ASEAN+6 to include fellow democracies. ASEAN settled the debate in 2011 when Indonesia, as the chair of ASEAN, achieved agreement on the principles for the East Asia Regional Comprehensive Economic Partnership (RCEP), which basically prioritised the consolidation of countries with which ASEAN already had an FTA and provided for an open accession clause for future expansion. Thus, the starting point was to consolidate agreements with members with which ASEAN already had an FTA, and all five FTA partners decided to start RCEP negotiations in 2012. It is important to note that the principle of East Asia’s RCEP preceded the acceleration of TPP negotiations in 2011–2012. After many years of negotiations, 20 chapters of text negotiations were successfully completed for the 15 RCEP members in November 2019, and India may still join subject to their concerns being addressed. TPP negotiations picked up when the US was the chair of APEC in 2010. The agreement had started in 2005 as the Trans-Pacific Strategic Economic Partnership Agreement (PTSPE or

East Asian architecture of integration 27

Notes: APEC = Asia Pacific Economic Cooperation, ARF = ASEAN Regional Forum, ASEAN = Association of Southeast Asian Nations, EAS = East Asia Summit, Lao PDR = Lao People’s Democratic Republic. The ASEAN Member States are Brunei Darussalam, Cambodia, Indonesia, the Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Viet Nam. ASEAN+3 refers to the 10 ASEAN Member States plus China, Japan, and the Republic of Korea. ASEAN+6 refers to the 10 ASEAN Member States plus China, India, Japan, the Republic of Korea, Australia, and New Zealand. Source: Authors.

Figure 2.1  ASEAN Centrality and Variable Geometry

P4), comprising four small APEC economies – Brunei Darussalam, Chile, New Zealand, and Singapore. It was intended as a pathfinder initiative towards the Free Trade Area of the Asia Pacific (FTAAP). In 2008, the US stated its intention to join, and Australia, Peru, and Viet Nam indicated their intention to join in the same year. It was only in 2010 that negotiations for the TPP gained momentum and Malaysia joined, followed by Mexico and Canada in 2012. The US was promoting the TPP as its pivot to Asia, and the joining of Japan in May 2013 and the subsequent push for negotiations that led to the completion of TPP negotiations in 2015 provided a counterbalance to the RCEP. The TPP also diverted attention away from the RCEP negotiations, as four ASEAN Member States and Japan were also negotiating the TPP. A number of ASEAN countries also subsequently indicated their interest in joining, such as Indonesia, the Philippines, and Thailand. Figure 2.2 shows the overlap in regional trade groupings in East Asia. The concept of the FTAAP, which is not yet a negotiated agreement, comprises the APEC members but does not include some ASEAN members or India. The RCEP is the ASEAN+6 group, which has ASEAN at its core and is centred around the five ASEAN+1 FTAs with Australia and New Zealand, China, Japan, India, and Korea. The guidelines for the RCEP provide for open accession so that

28  Handbook on East Asian economic integration

Notes: ASEAN = Association of Southeast Asian Nations, FTAAP = Free Trade Area of the Asia Pacific, Lao PDR = Lao People’s Democratic Republic RCEP = Regional Comprehensive Economic Partnership, TPP = Trans-Pacific Partnership. Source: Authors.

Figure 2.2  Variable Geometry and Regional Trade Groupings

it can expand to include new members. The TPP, or CPTPP since the US withdrew from the grouping, includes four members from ASEAN, Australia, New Zealand, and Japan, as well as North and South America. The East Asia region involves the economic giants of China and Japan outside ASEAN, as well as the important trans-Asian relationship with India (and South Asia) and the trans-Pacific relationship with the US (and North America). ASEAN has been the institutional anchor of regional cooperation and has from time to time mediated large power relations through its convening of regional forums (Acharya, 2014). This role has become more important for ASEAN as power shifts from the advanced industrial countries of the West to China and India. ASEAN’s centrality in regional economic cooperation is typical of its broader role in the region. Throughout its 50-year history, ASEAN has been an anchor of regional cooperation, mediating relations between large powers, whether the US, the Soviet Union or, more recently, China. By providing unique diplomatic spaces, articulating its members’ interests as a collective, and helping build regional norms, ASEAN has shaped interactions with large powers in the region (Ciorciari, 2017: 252). In recent years, ASEAN’s capacity as a regional mediator has been tested – both by internal divisions around China’s claims in the South China Sea and by rising concerns about the ‘staying power’ of the US in the region, prompted by the election of President Donald Trump (Ciorciari, 2017: 256–57). At the same time, the emerging multipolarity in East Asia means that the leadership of Southeast Asian countries – the ‘second-tier’ economies – will become even

East Asian architecture of integration 29

more critical for furthering regional cooperation. In the vacuum of major leadership for the global economic order, the idea of collective leadership amongst middle powers, which would include ASEAN and countries such as Japan and Australia, has been mooted (Tay et al., 2019). ASEAN and ASEAN Plus arrangements will be increasingly important for aligning regional reform commitments and expectations, and taking practical steps to address emerging issues in the international trade architecture, such as managing data flows (Pangestu and Findlay, 2018). 3.2  ASEAN, APEC, and Open Regionalism ASEAN economic integration is a clear demonstration of open regionalism. Intra-regional trade in ASEAN is around 24%, well below Europe at 60%, North America at roughly 40%, and the broader ASEAN+6 groupings (Figure 2.3). ASEAN does not appear to have high trade integration within its Member States. The RCEP grouping (ASEAN+6) trades intensively within its own region but also with the rest of the world, since it includes the world’s largest trading nation (China), the world’s third largest economy (Japan), and other middle powers that are open economies. Unlike the EU, more than half of East Asia’s trade is with the rest of the world. However, the trade intensity of ASEAN is much higher than that of the other groupings. The trade (exports plus imports) to gross domestic product (GDP) ratio is more than 100% in ASEAN, down from a peak of around 130% before the global financial crisis. Europe’s trade to GDP ratio is around 64%, while the ratios for North America and other regions are lower (Figure 2.4). ASEAN economies trade more on average because of their size, and do so with the rest of the world instead of within Southeast Asia. Assessing regional economic integration via intraregional trade shares would be to misjudge ASEAN (Menon, 2018). The same could be said for FDI, with only one-fifth of FDI in ASEAN from other Member States. The rationale for ASEAN economic integration has always been about increasing competitiveness as a region – by drawing on the complementarity of resources and creating a regional production centre to compete better in the extra-ASEAN market – rather than ASEAN as a single market, as in the case of Europe. This is pragmatic, given the size of ASEAN’s economies and their purchasing power during their rapid catch-up development phase, and since only now are we increasingly seeing ASEAN and East Asia becoming important as a final market. Furthermore, opening up and liberalising amongst neighbours was intended as a ‘training ground’ and confidencebuilding measure for greater opening up (Pangestu, 2017). The deeper cooperation in ASEAN has helped to increase trade with countries outside the region. The preferences of the ASEAN Free Trade Agreement (AFTA) were multilateralised with non-members, given MFN treatment, and 90% of tariff lines have a preference margin of zero (Menon, 2018). This was a deliberate policy choice to ensure that AFTA and similar regional initiatives are stepping stones to promote broader liberalisation that integrates ASEAN into the global economy. Low intra-regional trade shares have persisted, but ASEAN is a crucial part of East Asian production networks involving multinational enterprises from Japan, the US, and elsewhere; and deeper integration with China, centred initially on assembly and later production networks, global value chains (GVCs), and now increasingly as a market for final goods. APEC is not a traditional trade or economic arrangement, with formal, negotiated, enforceable agreements amongst the economies of the Asia-Pacific. It has been organised around the

30  Handbook on East Asian economic integration 70

60

50

40

30

20

10

ASEAN

ASEAN3

RCEP

SAFTA

NAFTA

EU28

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

0

TPP

Notes: ASEAN = Association of Southeast Asian Nations, EU = European Union, NAFTA = North American Free Trade Agreement, RCEP = Regional Comprehensive Economic Partnership, SAFTA = South Asian Free Trade Area. Intra-regional trade shares are measured as the proportion of trade within each region relative to the total global trade of the countries of that region. Source: Authors’ calculations from the UN Comtrade database. https://comtrade.un.org/ (accessed 28 October 2020).

Figure 2.3  Intra-Regional Trade Shares (Intra-Regional Trade to Total Regional Trade (%)): 1980–2015 70 60

ASEAN

50

RCEP

40

SAFTA

30 NAFTA 20 EU28

10

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

0

Notes: ASEAN = Association of Southeast Asian Nations, EU = European Union, GDP = gross domestic product, NAFTA = North American Free Trade Agreement, RCEP = Regional Comprehensive Economic Partnership, SAFTA = South Asian Free Trade Area, TPP = Trans-Pacific Partnership. Source: Authors’ calculations from the UN Comtrade database. https://comtrade.un.org/ (accessed 28 October 2020).

Figure 2.4  Merchandise Trade as a Percentage of GDP, 1980–2014

East Asian architecture of integration 31

idea of open regionalism – economic integration without discrimination against economies outside the region – and has not involved preferential arrangements or measures amongst members. Open regionalism means that whilst there is opening up within a region due to formal or informal economic cooperation, at the same time the region continues to open up to non-members of the region or allows for open accession. Its principle of non-discrimination is the same as that of the WTO and the General Agreement on Tariffs and Trade (GATT) before that. APEC is built on the ‘soft politics’ of regional economic cooperation, based on voluntary and non-binding principles and norms, not the ‘hard politics’ of legally binding economic and political treaties (Armstrong and Drysdale, 2011). APEC is a non-negotiating body, but its norms and principles are intended to be used as a framework for members to undertake concerted unilateral reforms and for issues agreed upon in APEC to be expanded in wider multilateral negotiations. Membership of the various overlapping arrangements of East Asia is a product of history, geography, and circumstance. Which countries are members of which groupings depends on the purpose and mode of cooperation, as the arrangements, agreements, and forums have evolved. Different arrangements have different rules for accession. In aggregate, they comprise what we can call the Asia-Pacific or East Asian architecture. Figures 2.1 and 2.2 show the messy nature of these arrangements, and diagrams of bilateral agreements look even messier. APEC economies have pursued liberalisation aimed at the Bogor Goals, without binding commitments, which meant that the liberalisation which occurred in APEC was not preferential. Since most of East Asia’s liberalisation occurred within the APEC framework, it meant that liberalisation amongst members did not come at the expense of countries outside the APEC region. Armstrong and Drysdale (2011) showed that APEC helped to achieve higher realisation of trade potential amongst members, and between APEC members and countries outside the region, than would otherwise be the case without APEC. Unilateral liberalisation under APEC was done in concert with other countries, so the benefits of opening up to trade and investment were compounded as regional markets were also opening up. Therefore, the unilateral liberalisation provided momentum and deepened integration through market processes. Regional integration progressed with gains realised through consultation, peer encouragement, and voluntary cooperation The APEC grouping has regional and global interests. The non-discriminatory liberalisation that occurred was a boon to the global economy. Regional initiatives such as the Information Technology Agreement and the Environmental Goods Agreement, which agreed to avoid putting tariffs on emerging traded goods in information and communication technology and environmental goods, were implemented in the WTO and thus on an MFN basis once they had reached a critical mass in APEC. The literature on the effect of RTAs has long debated the trade creation versus trade diversion effects of the agreements. The concept of trade diversion can be traced back to Viner (1950). Trade diversion is where preferential tariffs cause trade to be diverted from a more efficient exporter to a less efficient exporter. Trade is created between the members of the customs union or RTA. The existence of some preferential trade agreements (PTAs) has been found to create stumbling blocks rather than building blocks to broader multilateral liberalisation. Limão (2006), for example, estimated that PTAs joined by the US caused the MFN tariffs for its PTA goods to remain higher than they would have been without the PTA. Limão and Olarreaga (2006) found a similar case with import subsidies afforded to RTA partners by the US, the EU, and Japan. On the other hand, Freund and Ornelas (2010) found that trade creation is

32  Handbook on East Asian economic integration

the norm. Evidence from empirical analyses has suggested that the adjustment of other trade policies has succeeded in moderating distortions from discrimination with preferential tariffs (Kennan and Riezman, 1990; Richardson, 1993). Countries also tend to form RTAs with their natural trading partners, with which they have already been trading heavily. As such, the trade diversion effect of RTAs may be less relevant than initially thought (Wonnacott and Lutz, 1989; Krugman, 1991; Baier and Bergstrand, 2004). For the case of East Asia, Lee and Shin (2006) showed that the RTAs of East Asian countries, considered natural trading partners with close proximity and shared characteristics, generate more trade creation. Sattayanuwat and Tangvitoontham (2018) also showed that ASEAN Member States trade with each other at a level higher than without PTAs. The RCEP will involve intra-bloc trade creation, as has the ASEAN–China Free Trade Area, the ASEAN– Japan Comprehensive Economic Partnership Agreement, and the ASEAN–India Free Trade Area. Okabe (2015) also found that the trade creation effects of the ASEAN–China Free Trade Area and the ASEAN–Korea Free Trade Agreement appear in trade in intermediate and capital goods between ASEAN countries and China or Korea. The studies on the trade diversion and trade creation effects of RTAs were conducted for PTAs that were mostly ‘shallow’ in nature – mainly covering tariff reductions and traditional issues – or did not explicitly differentiate between the nature of the RTAs under analysis. In this context, Mattoo, Mulabdic, and Ruta (2017) showed that deep PTAs induce more trade creation than shallow PTAs, increasing trade between countries under PTAs by 44%. The intuitive explanation of how deep agreements can create substantially more trade creation lies in the fundamental difference between shallow agreements and deep agreements. In the traditional concept of liberalisation, members of trade agreements reciprocally reduce tariffs imposed on each other below the MFN rate, which is discriminatory in nature towards non-member countries and thus potentially creates trade diversion. In contrast, deep agreements go beyond reciprocal tariff reduction and touch upon structural issues with public goods components such as competition policies, subsidies, improvements in customs, and others. Many issues covered in deep agreements are non-discriminatory and create positive externalities for other trading partners that are not part of the agreements. Mattoo, Mulabdic, and Ruta (2017) found what Baldwin and Low (2009) and Baldwin (2014) termed ‘negative trade diversion’, where deep agreements bring a positive effect to non-member countries of 19% for a one standard-deviation increase in the depth of a partner’s trade agreement with other countries. These results hinge on the assumption that behind-the-border regulatory changes are non-preferential and benefit all trading partners. ASEAN and APEC stand out amongst all the major regional groupings because they have not created measurable trade diversion. Trade diverted from non-members towards members is measurable in other formal regional groupings such as NAFTA, the EU, the Andean Community, and Mercosur. Armstrong and Drysdale (2011) examined the effects of membership of each of these groupings on the size of trade flows. In general, two countries will trade with each other more if both are members of the same discriminatory trade bloc. If only one country is a member, however, the effect is more complicated. If a country is a member of NAFTA or Mercosur, for example, it is expected to trade less on average with a country outside the bloc than it would if it were not a member. In other words, these groupings exhibit significant trade diversion (Armstrong and Drysdale, 2011: 80–81).5

East Asian architecture of integration 33

In contrast, membership of ASEAN or APEC means that countries are, in general, likely to trade more with each other, regardless of whether one or both trading partners are members. This reflects the principles of open regionalism embodied in APEC. Not only does APEC have a positive effect on trade between members, it also has a measurable effect on members’ levels of trade and investment globally (Armstrong and Drysdale, 2011: 87). As a region, East Asia tends to have higher levels of extra-regional trade than Europe and North America when controlling for trade determinants such as distance, GDP, and common languages. ASEAN and the RCEP countries, in particular, have performed higher in terms of extra-regional trade than the EU and NAFTA groupings since the 1980s. In terms of intraregional trade, NAFTA continues to rank the highest of the four, followed by ASEAN and the RCEP, then the EU (Pangestu and Armstrong, 2018: 30–31). East Asian economies opened up to international trade, investment, and commerce with the support of regional groupings such as APEC and ASEAN – with ASEAN Member States doing so initially through the AFTA, which was then largely multilateralised – in a manner consistent with the multilateral trading system. Most of the tariff and border barrier liberalisation in East Asia was undertaken unilaterally, but in concert, so the benefits of opening up were compounded (Garnaut, 1996). That concerted unilateral liberalisation occurred within the context of commitments to regional and global initiatives. That global context meant that trade liberalisation was non-discriminatory and under the MFN principle. That is why the integration of East Asian economies has been with neighbouring countries in East Asia but also with the rest of the world (Soesastro, 2006). East Asia’s open regionalism has meant that East Asia’s economic integration has progressed alongside the region’s integration into the global economy. Regional integration has not come at the expense of integration with the rest of the world, as in other parts of the world (Pangestu and Armstrong, 2018).

4. PROGRESS AND IMPACT OF EAST ASIAN REGIONAL ARCHITECTURE Political cooperation has lagged economic cooperation in East Asia. The institutions, forums, and mechanisms to further economic integration have been built to facilitate and institutionalise economic cooperation instead of acting as the catalyst or impetus for economic integration. The diversity in the region – with vastly different economic and political systems, levels of development, and endowments – has meant that capacity building has been an important part of the integration process. Countries with less developed institutions and domestic markets have been assisted in joining the regional economy and GVCs, in part due to support from neighbouring countries. The capacity aspect of economic cooperation involves economic and political cooperation. Regional institutions that have evolved to support the integration process are underdeveloped compared with those of Europe or North America, but have nonetheless played an important role. East Asia and ASEAN do not have any supranational institutions, but institutions such as the ASEAN Secretariat have been created to deepen cooperation between states and implement the various blueprints and visions of ASEAN (Soesastro, 2008). The broader East Asia region has been institutionally light, with arrangements and forums more informal and flexible than even ASEAN.

34  Handbook on East Asian economic integration

The ASEAN+3 grouping was largely a response to the Asian financial crisis in the late 1990s to deepen financial and economic cooperation. Cooperation on trade and other issues evolved into the ASEAN+6 and East Asia Summit groupings. Of five different ASEAN+1 FTAs, intellectual property rights, government procurement, competition policy, e-commerce, and environmental issues were only included in the ASEAN–Japan FTA (Minghui, 2018). In the ASEAN–China and ASEAN–Korea FTAs, intellectual property rights, e-commerce, and environmental issues were included as ‘facilitation’ agreements instead of binding commitments. None of these FTAs touched upon labour regulations. The ASEAN–India FTA does not have a chapter on investment or a post-establishment national treatment clause. The ASEAN–China FTA has no performance requirement. Asian agreements typically involve a lower standard of commitment than those found in North America or Europe (Suominen, 2009). It is worth noting that most FTAs in East Asia have adopted a positive list approach, while the ASEAN–Korea FTA involves a negative list approach. Moreover, the FTAs typically give 10 years or more to phase in tariff reductions gradually, with more flexibility granted to developing countries (Minghui, 2018). For ASEAN economies, 94.5% of customs tariff lines have zero tariffs in the ASEAN–China FTA, 93.3% in the ASEAN–Korea FTA, 89.0% in the ASEAN–Japan FTA, 75.6% in the ASEAN–India FTA, and 93.8% in the ASEAN–Australia– New Zealand FTA. In terms of services, Gootiiz (2018) found that all ASEAN Plus agreements have General Agreement on Trade in Services (GATS) Plus commitments, covering a broader and deeper scope of service liberalisation than GATS. Nevertheless, several ASEAN Plus agreements contain a services clause (ASEAN–China, ASEAN–Korea, and ASEAN–India). The Eighth Package of Commitments under the ASEAN Framework Agreement on Services (AFAS) contains the most liberal commitments in services compared with others AFAS packages. Moreover, the breadth and depth of the ASEAN–Australia–New Zealand (AANZFTA) services commitments resemble the commitments made under the eighth AFAS package, considerably improving the sector coverage and depth of commitments, although not as much as the AFAS (Ahsan et al., 2015). Another issue relates to the proliferation of non-tariff measures (NTMs). The coverage ratio of NTMs in ASEAN reaches up to 100% in 6 of the 10 ASEAN Member States. While the concerns underlying the application of NTMs are often valid for consumer protection (e.g. introducing safety standards), many countries in ASEAN have increased NTMs in areas unrelated to protecting consumers. In Indonesia, Cambodia, Myanmar, and the Lao People’s Democratic Republic (Lao PDR), the proliferation of NTMs has largely been in export-related regulations and other measures which are not related to product safety. Moreover, sectors such as machinery and equipment, automobiles, and textiles, which provide many jobs and are intertwined in production networks, are also heavily regulated (Ing, Fernández de Córdoba, and Cadot, 2016). RTAs in Asia and across the Pacific vary considerably in their scope, depth, and coverage, as the political and economic situation in each country is highly heterogenous. Large countries, especially Japan and the US, can extract specific requirements such as the exclusion of sensitive agricultural products and intellectual property rights. ASEAN rules are also more likely to be multilateralised and have less restrictive ROOs (Hill and Menon, 2010). Central to East Asia’s economic cooperation and regional community building is the economic cooperation agenda. Trade and investment liberalisation and facilitation are closely connected to economic cooperation – involving experience sharing, technical cooperation, and capacity building. Various working groups have been established on issues ranging from trade

East Asian architecture of integration 35

facilitation and customs cooperation, investment, services, and intellectual property rights, in the context of ASEAN and its agreements, as well as in the non-negotiating context of APEC. These groups have formed a community of expertise, learning, and exchange which is difficult to evaluate but has been valuable for government officials and governments as they implement domestic reforms, and negotiate regionally and globally. The more developed members have provided much technical assistance to the less developed members. Early in the 1980s, the principle of the three pillars or legs of APEC – liberalisation, facilitation, and economic cooperation or capacity building – carried over as the basic framework of the East Asian architecture. In fact, the FTAs also evolved in nomenclature to become ‘comprehensive economic partnerships’, with the emphasis on partnership. In other words, a conscious effort has been made to ensure that capacity building was provided to support the less developed members in competing and complying with the relevant standards and norms. For instance, trade facilitation has helped East Asian countries to improve the efficiency of exchange of goods and services and played an important role in developing the regional supply chains with the ease of the flow of goods between members. Customs facilitation and the setting up of systems, including the ASEAN Single Window initiative, have played a role. In terms of the movement of people, even though it took some time, the APEC Business Travel Card, APEC and ASEAN lanes at ports, and free visas between ASEAN countries have all helped to create a sense of an Asia-Pacific and East Asian community. 4.1  Global Value Chains Openness to trade and investment, especially in the manufacturing sectors, was helped along by the Information Technology Agreement amongst APEC members, while geographical proximity meant that production networks expanded rapidly in East Asia, where intra-industry trade or the so-called ‘fragmentation’ of production system was broadly built in (Arndt and Kiezkowski, 2001). Outside Asia, particularly in Europe, the organisation of these production networks has been mostly regional. Asia has been remarkable in that its production networks on the demand side tend to be global, extending across the Pacific Ocean largely to the US, and to some degree across Eurasia (Figure 2.4). As Escaith, Inomata, and Miroudot (2018) showed, this pattern has its origins in the export-led growth strategy adopted by Japan in its post-war development, and later by the ‘newly industrialised economies’ of Hong Kong, Singapore, Taiwan, and Korea. The most significant development for the evolution of Asia’s role in GVCs was China’s accession to the WTO, after which developments in information and communication technology and transportation facilitated an unprecedented wave of offshoring. This effective entry of 700 million workers into the world economy had a transformative effect on China’s regional and global comparative advantage (Baldwin, 2008; Drysdale, Zhang, and Song, 2012; Escaith, Inomata, and Miroudot, 2018: 166). The appreciation of the Japanese yen after the Plaza Accord in the mid-1980s and China’s march towards WTO accession and then its integration into the regional and global economy were major turning points for the development of GVCs in Asia (Katzenstein and Shiraishi, 1997). The ASEAN–China FTA and other initiatives helped, but the main driver of the development of production networks across Southeast Asia was the ASEAN agenda, which helped realise a comparative advantage in ASEAN Member States.

36  Handbook on East Asian economic integration

The connectivity agenda, infrastructure development, and opening up to foreign investment in manufacturing – alongside largely stable macroeconomic management – meant that Southeast Asian countries could join in production value chains and become part of Factory Asia. Worldwide trade growth in emerging economies since the 1990s has depended heavily on integration into GVCs. More than half of the exports from emerging economies are related to GVC participation (either through using a high share of foreign inputs, in value-added terms, or by producing high value-added inputs for export in a third country). The share of trade between developing countries that is related to GVCs quadrupled from 1990 to 2015. East Asia leads the world in GVC participation due to its strength in processing manufactured goods. South Asia, in contrast, has the lowest participation in GVCs, though this participation is growing at the world’s fastest rate (Lamy, 2015). The expansion of East Asian GVCs to encompass India and South Asia more fully is a major priority moving forward, requiring the development of regional architecture to facilitate it in South Asia and across Asia. This is the great potential to be had with India being part of the RCEP. New configurations of GVC and production networks can be expected, which would link South Asia with East Asia. This is especially important given the tensions around US–China trade and the need to diversify production locations and reconfigure supply chains, changes in demographics between Northeast Asia and South and Southeast Asia, as well as the comparative advantages and complementarities that could be enriched via the links. This has been one of the most compelling arguments made for the RCEP. 4.2  The Role of Bilateral Agreements ASEAN and APEC supported open regionalism and were consistent with the WTO’s MFN principle. Yet, with the Doha Round stalling at the WTO and bilateral agreements proliferating globally, Asia joined the FTA game proper in the early 2000s (Findlay, Piei, and Pangestu, 2003). The FTAs and Economic Partnership Agreements in Asia formed a complex web of agreements that buttressed regional cooperation and which vary in ambition and coverage (Baldwin, 2008; Kawai and Wignaraja, 2010). By 2017, there were 74 FTAs amongst Asian countries and 80 agreements between Asian countries and non-Asian partners (Asia Regional Integration Center, 2018). That is a rapid expansion from 27 FTAs between Asian partners and 18 FTAs with non-Asian partners in 2000. The FTAs that ASEAN completed with Australia and New Zealand, Japan, China, India, and Korea formed the basis for negotiation of the RCEP mega-regional agreement amongst the ASEAN+6 grouping. The ongoing negotiations amongst the three Northeast Asian countries (China, Japan, and Korea) form the basis for trilateral cooperation and dialogue that has persisted despite political turbulence. The RCEP should also be seen as a platform to build on negotiations between members which do not share bilateral or regional agreements. Just as bilateral agreements between Japan and each ASEAN country became the basis for the Japan–ASEAN Comprehensive Economic Partnership Agreement, and the ASEAN–Australia agreements became the basis for the Indonesia–Australia FTA, the RCEP can form the basis for the Japan–Korea–China trilateral agreement or bilateral agreement between India and China. Bilateral PTAs or FTAs remove tariffs and other trade barriers between members, but often keep those barriers in place for trade and economic exchange for non-members. If those preferential tariff rates are utilised, they can create trade amongst members but also divert trade away from non-members as some trade created can be at the expense of non-members.

East Asian architecture of integration 37

If the utilisation of preferential tariffs is low in a trade agreement – and trade occurs under the MFN rate available to all trading partners – the trade agreement has little effect on the merchandise trade for the two countries. If the utilisation rate of the FTA preferences is high, there is scope for trade being created amongst the members and trade being diverted away from non-members. Whether an FTA is net trade creating or net trade diverting is an empirical question and is taken up in detail in Hayakawa and Shiino (2020). It is often said that agreements which are net trade creating are stepping stones to broader multilateral trade since they contribute more trade to the global system than they divert. Net diversionary FTAs are welfare reducing and are stumbling blocks towards multilateral trade (Bhagwati, 1993; Bhagwati and Panagarya, 1996). The empirical literature on the trade effects of RTAs has expanded rapidly as trade agreements have proliferated since the 2000s. Given the preferential and reciprocal treatment for members underlying the FTAs, a common expectation is trade creation within the trading blocs for member economies and the potential for trade diversion between FTA members and non-members. ASEAN is found to have extra-bloc creation effects, as indicated by estimates shown in Figure 2.3. Urata and Okabe (2007) also concluded that trade diversion has happened at product levels with the EU, NAFTA, and Mercosur, but not with ASEAN. Therefore, ASEAN appears to be a more open region. Previous research, based on survey data, has found low utilisation rates below 30% for FTAs in Asia. By way of comparison, 90% of preference-eligible imports in Canada, the EU, and the US take advantage of these preferences (Keck and Lendle, 2012). This suggests that the ‘noodle bowl’ of Asian FTAs has not been effective in driving trade growth. For instance, firms may not take advantage of the FTAs because they lack knowledge on either the content itself or the advantage of using the provisions. Verico (2017) conducted a field survey of the ASEAN Economic Community (AEC) in Indonesia, which showed that only 56% of 343 manufacturing firms and only 60% of 179 service firms knew about the AEC. The chief reason cited in these surveys for the poor uptake of FTAs is low or no margins of preference. This can arise when the MFN tariff rate is zero, or not much higher than the FTA rate. In 2013, the average intra-ASEAN tariff rate was slightly above 1%.6 To demonstrate this impact, Jongwanich and Kohpaiboon (2008) examined the utilisation of the AFTA using Thai export data in 2005. They found that for the 10 commodity lines (identified by 2-digit HS codes) with margins of preference greater than 10%, the average utilisation rate was 52.4%. Other survey results have also found higher rates of utilisation in the machinery and automotive industries than in electronics and textiles. This accords with the lower margins of preference in the latter sectors (ASEAN, 2015). Surveys have also identified the main costs and benefits of FTAs for businesses. From the Asian Development Bank (ADB) survey of 841 East Asian firms (Kawai and Wignaraja, 2010), the most cited benefits to firms were wider export markets and preferential tariffs which encourage imports of intermediate goods. The most costs cited were increased competition from imported products and the documentation required to take advantage of existing FTAs. The bottom–up approach of regional integration, through bilateral or small group agreements, allows progress in some areas but makes it more difficult to set the standards, rules, and regulations which matter for GVCs. Those are either behind the border or have typically had larger countries or groupings determine the standards and consistent rules. Smaller countries may have different rules and standards imposed on them through different bilateral agreements.

38  Handbook on East Asian economic integration

The literature is mixed on how helpful bilateral arrangements have been for regional or global value chains, which are beyond bilateral by nature. The ROOs for preferential tariff access and the differing rules and standards of the FTAs have created a spaghetti bowl effect, while making progress with liberalisation. This realisation has meant that broader groups of countries are negotiating agreements in the Asia-Pacific. One such agreement grew out of the P4 agreement (covering Brunei Darussalam, Chile, New Zealand, and Singapore) to become the TPP (with Australia, Canada, Chile, Japan, Malaysia, Mexico, the US, and Viet Nam). The other relates to the East Asian RCEP negotiations comprising the ASEAN+6 grouping. The TPP and RCEP signalled a departure from the main mode of cooperation in East Asia, or informal, non-binding cooperation. The TPP was largely driven by US leadership, and countries made commitments in exchange for US market access and to keep the US engaged in the Asia-Pacific. The RCEP, in turn, attempts to bind commitments while entrenching and expanding ASEAN’s economic cooperation agenda. ASEAN centrality played an important role in finding a level of flexibility between the high ambitions of the more developed countries and those of the less developed countries or those with protectionist tendencies such as India. 4.3  Mega-Regional Agreements After the confusion and uncertainty that the US withdrawal from the TPP generated, the remaining 11 TPP members spent most of 2017 salvaging the agreement. These countries concluded the rebranded CPTPP in March 2018 in Chile. The withdrawal of the US, which accounted for 60% of the TPP’s collective GDP and around 40% of the trade within the grouping, changes the character of the TPP. The TPP meant different things to different members. For most, it was an opportunity to keep the US firmly locked into the Asia-Pacific region. It was seen by the Obama administration as the economic arm of America’s ‘rebalance towards Asia’, so that China would not write the rules. It was also an opportunity for further liberalisation and reform, with access to US and Japanese markets the main prize. The agreement aimed to set new standards and rules for commerce in the 21st century – an elusive aim at the global level because of the failure of the WTO’s diverse membership to settle on common goals. The conclusion of the CPTPP does not deliver the key strategic goal of keeping the US entrenched in Asia. Instead, it is a clear statement of the region’s commitment to openness. Holding the line and pushing back against growing global protectionist sentiment maintains pressure on US businesses and consumers that miss out on market opening in East Asia, and keeps open the option of US re-entry down the track. It could also add momentum for broader liberalisation in Asia by facilitating the expansion of membership and by raising ambitions for the RCEP (East Asia Forum, 2018b). The CPTPP is less important because of the US withdrawal, but it is an improvement on the initial TPP agreement because of some of the changes that have been made to it. The CPTPP has more chance of expanding membership since it froze some of the more egregious provisions of the TPP – especially the US-pushed intellectual property protections which were likely to benefit big business in the US at the expense of consumers in the region. The scope of the investor–state dispute settlement provisions has been narrowed, but still gives foreign investors access to an international tribunal to resolve disputes with host governments.

East Asian architecture of integration 39

The agreement still gives those inside the tent veto power over new members, since accession requires agreement from all parties. The inclusion of larger countries such as China, India, and Indonesia will not be easy even if they meet the membership criteria. This mode of cooperation and integration is a departure from the earlier open regionalism mode of economic integration. In contrast, the RCEP has an open accession clause which will allow new members to join, and creates a platform for continued improvements – raising the level of ambition and updating the agreement over time. The RCEP architecture is also intended to be the beginning, not the end point, of East Asia regional integration. It can be used as a platform to expand and incorporate other bilateral and regional agreements as mentioned before, such as providing the basis for the China–Japan–Korea agreement. Given the pattern of the past East Asia architecture, it is also foreseeable that as the RCEP is implemented with the 16 members, not only will you have potential new members, and deepening and broadening of issues addressed, but also continued opening up outside the region. The RCEP could be the catalyst for continued multilateralism, as a mega-regional trade agreement that comprises half of the world’s population and one-third of its GDP, world trade, and investment. Even without India, the percentage of world GDP, trade, and investment is still much larger than that of the CPTPP, at close to 30% compared with less than 20% (Table 2.1). The US will not be a party to the TPP or CPTPP for the foreseeable future, as it deals with domestic structural problems that were the political genesis of the Trump administration. Most of the 11 CPTPP members are also actively engaged in negotiating the RCEP. The RCEP agreement will be important in locking China and India into opening markets and pursuing reform on a parallel track to the CPTPP, especially in a period of global uncertainty when protectionism is on the rise. That will not be easy until India comprehends its strategic interest in economic integration with East Asia and until it ceases playing spoiler in international forums (Armstrong, 2018). The RCEP involves more negotiating members than the CPTPP; and most of Asia’s main economies, including China and India, are partners. The RCEP is a way forward with economic Table 2.1  Comparison of the CPTPP and the RCEP – 2018

Grouping

GDP (US$ billion)

GDP (% of world)

ASEAN RCEP   RCEP (-) India TPP   CP-TPP (-) US World

2 986.4 3.5% 27 388.6 32.2% 24 669.9 29% 31 610.4 0.4 11 030.1 13% 84 929.5 100%

Trade (US$ billion)

Trade FDI inflow FDI Population (% of (US$ (% of Population (% of world) billion) world) (million) world)

2 816.7 7.2% 154.7 11 479.20 29.2% 422.2 10 642.90 27.10% 379.9 10 167.5 25.9% 509.8 5 889.10 15.0% 258 39 266.60 100.00% 1 297.20

11.9% 649.1 32.5% 3 602.50 29.30% 2 249.80 39.3% 830.7 19.90% 503.5 100.0% 7 594.30

8.5% 47.4% 29.60% 10.9% 6.6% 100.0%

Notes: ASEAN = Association of Southeast Asian Nations, CPTPP = Comprehensive and Progressive Agreement for Trans-Pacific Partnership, FDI = foreign direct investment, GDP = gross domestic product, RCEP = Regional Comprehensive Economic Partnership, TPP = Trans-Pacific Partnership, US = United States. Source: Authors’ calculation from World Bank (n.d.), World Development Indicators. http://wdi.worldbank.org/ (accessed 28 October 2020).

40  Handbook on East Asian economic integration

cooperation, underpinned by the ASEAN Plus framework, despite all the region’s political problems. Bringing together the ASEAN+1 trade agreements with China, India, Japan, and Korea, will be difficult – even with ASEAN as the fulcrum and countries such as Australia playing an active and constructive role. The RCEP may take a more gradual approach to liberalisation and rules than East Asia is accustomed to, compared with other major agreements involving Europe or North America. Beyond the initial agreement reached, an economic cooperation framework for RCEP can embrace a comprehensive programme of regional economic integration and development. That would parallel the strategy for creating the AEC. Upgrading of the AFTA of the 1990s to the more comprehensive ASEAN Trade in Goods Agreement was one of the first steps taken to implement the AEC, alongside a broader programme including work to implement the Master Plan on ASEAN Connectivity 2025. Negotiating an innovative umbrella FTA amongst RCEP participants could be pursued in parallel with the other steps needed to achieve deeper economic integration and regional development goals. The completed current framework of the RCEP, agreed in November 2019, should be seen as the beginning – to build on deepening commitments, updating of new issues, and expanding of membership, as well as providing an important signal for continued opening up in a world of uncertainty regarding the global economic order. The challenge ahead for East Asian economic integration will be to deliver on politically challenging behind-the-border reforms. Concerns over adjustment costs, distribution effects, and ceding of sovereignty (limiting policy space) have made it increasingly difficult for reformists to convince politicians of the need for reforms. There is a need to be able to overcome these challenges and have an agenda for behind-the-border measures. This will necessitate a combination of capacity building measures to better understand how to manage precautionary standards, competition policy and a level playing field, and domestic regulations. Capacity building is about understanding the issues and recognising the importance of the regulatory cooperation agenda to strengthen ASEAN’s economic cooperation agenda and expand it to encompass the ASEAN+6 partners, so as to govern international production better (Hoekman and Nelson, 2018). In forging agreement on the CPTPP, Japan – the partnership’s largest economy without the US – has found itself in an unusual leadership position (Terada, 2019). Japan has often relied on external pressure, usually from the US, to advance its diplomatic goals and even to push domestic reforms. The FTAAP was put back on the regional agenda in 2014 when China hosted APEC. There has always been a debate over the purpose of the FTAAP – whether it is intended to be a negotiated FTA of the Asia-Pacific, which was mooted from the beginning of the creation of APEC, or whether it is a way of approaching economic integration in the Asia-Pacific region. The second view looks at the FTAAP more as building on the ongoing regional undertakings of ASEAN+3, the CPTPP, and the RCEP; and aims to further APEC’s regional economic integration agenda. This is the different pathways or variable geometry approach. The RCEP and the CPTPP could form the foundation for defining the pathway towards a FTAAP that is not just regionally but globally liberalising. Consistent with the principles of economic cooperation that have served the region so well until now, APEC leaders agreed that the FTAAP should support and complement the multilateral trading system; work to help achieve the Bogor Goals; and be pursued with a step-by-step, consensus-based approach. It would also need to be a high-quality, ‘next-generation’ agreement, run in parallel to – not as part of – the APEC process, so that

East Asian architecture of integration 41

non-binding voluntary cooperation can be preserved in APEC (East Asian Bureau of Economic Research and China Center for International Economic Exchanges, 2016: 228). Progress towards an FTAAP will require recognition of the importance of ASEAN centrality, and extending the best features of the AEC to achieve an agreement that moves the region towards a single market in the Asia-Pacific. Building on the shared principles that have underpinned Asia’s economic integration to date, it is also important to ensure where possible that regional agreements do not undermine the global multilateral system by adversely affecting non-members. So, although East Asia is attempting to deepen economic cooperation and bind agreements, that does not mean that the open regionalism principle should be compromised. The US and Europe will continue to be major markets for East Asia and will remain important political and security partners as well. East Asian regional cooperation and the architecture that evolves to support that should deepen Asian economic integration, but does not need to and should not need to do so at the expense of the rest of the world.

5.  NEXT STAGE OF EAST ASIAN ECONOMIC ARCHITECTURE 5.1  ASEAN Economic Community The AEC was officially launched at the end of 2015, but is an ongoing process of realising a single market and production base. As such, it aims to go further than traditional trade agreements, also mandating equitable development between ASEAN Member States. Its foundational document is the AEC Blueprint 2015, later updated with the AEC Blueprint 2025, which sets out a range of action areas designed to achieve these goals, including tariff reduction, service liberalisation, investment facilitation, and cooperation on infrastructure development, amongst others (ASEAN, 2008). Economic integration levels within ASEAN differ substantially across sectors and countries. In general, tariff reductions are where ASEAN has made the most progress, having wiped tariff rates to zero on 99% of products amongst ASEAN’s original six members in the 1990s. The newer members – Cambodia, the Lao PDR, Myanmar, and Viet Nam – have also made significant progress on tariffs. Outside tariff reduction, much of the original blueprint’s integration goals remain, in substance, underachieved – despite what the ASEAN Secretariat claims in the newer blueprint. The most important integration challenges facing ASEAN today are in reducing non-tariff barriers, liberalising services, and facilitating the movement of people (Cadot and Ing, 2019; Beverelli, Fiorini, and Hoekman, 2019). While tariff rates have dropped since 2000, non-tariff barriers have proliferated. While rolling back these barriers is an action area in the AEC Blueprint 2015, progress has been scant. This has been primarily due to difficulties in monitoring progress in different countries, a lack of information and transparency around NTMs more generally, and the voluntary basis on which countries are encouraged to reduce the barriers (Tangkitvanich and Rattanakhamfu, 2018: 190–93). However, a distinction needs to be made between NTMs which have protectionist elements and those which are legitimate for consumer protection (Ing and Cadot, 2017). The AEC service liberalisation agenda lacks commitment on behind-the-border barriers. As Tangkitvanich and Rattanakhamfu (2018) noted, some of these services – such as telecom

42  Handbook on East Asian economic integration

services interconnection or ATM access – are problem areas in ASEAN and necessary for the formation of competitive services markets. Legal and regulatory dissonances mean it is unlikely that the AEC’s service liberalisation goals, as they stand, will be enough to foster a true single market in services (Tangkitvanich and Rattanakhamfu, 2018: 198; Ahsan et al., 2015). ASEAN initiatives such as the 2014 Qualifications Reference Framework, and the mutual recognition agreements to promote mobility in eight skill-intensive sectors, are valuable steps in easing the movement of skilled labour. These initiatives have the potential to help close skill gaps between member countries. The free movement of professional workers across ASEAN has not been realised, despite the mutual recognition agreements, some of which have been followed up by the establishment of ASEAN standards and certified standard bodies. Yet, the vast majority of labour flows in ASEAN, recorded or unrecorded, are in low-skilled sectors ranging from agricultural labour to domestic services. Menon and Melendez identified the governance of labour mobility, the protection of migrant workers, and ‘harnessing labor migration for economic development’ as areas where challenges remain (Menon and Melendez, 2015: 8–9). The consensus-based decision-making, non-interference, and flexibility that characterise the ‘ASEAN Way’, and which underscore the organisation’s ongoing success, can also be obstacles to implementation and compliance. Protectionist sentiment and an economic rival mentality between ASEAN states are amongst the causes of halted momentum in reaching the AEC’s targets (Tangkitvanich and Rattanakhamfu, 2018: 200). It is worth noting that the AEC is just one of three ASEAN communities – the others being the Political–Security and Socio–Cultural Communities (Menon and Melendez, 2015: 16). ASEAN states’ substantial achievements and commitments to economic integration in such a turbulent geopolitical context should not be overlooked. The challenge for ASEAN today is sustaining this political cohesion while working to improve the implementation and enforceability of its valuable economic integration commitments. 5.2  Economic Cooperation Despite the problems in pace and concrete progress, the economic cooperation agenda in Asia is becoming more important as other negotiated approaches demonstrate limits and difficulties. Regulatory and other behind-the-border reforms are deeply domestic in nature, and are difficult to negotiate. They can be imposed from other countries, but the political economy of reform suggests that domestic coalitions for reform need to be built up to sustain reform. As reforms become more complex and most of the gains from trade reform move to ‘behind the border’ from ‘at the border’, these structural reforms will become more important. Cementing, strengthening, and expanding the economic cooperation agenda in ASEAN through the RCEP will be one way. That can be complemented by APEC. Issues that affect exchange between countries, such as regulatory harmonisation and standard setting, can be progressed through economic cooperation, but importantly so too can deeply domestic issues that are common challenges or shared interests. Domestic reform agendas and strategies can be helped with cooperation, experience sharing, and capacity building (Pangestu, Ing, and Hadiwidjaja, 2018). One area is in infrastructure investment, where more external sources of funds will be available as the Belt and Road Initiative is rolled out, and ADB7 and other sources of funds become more active. Major infrastructure needs are present throughout Asia, and the opportunity cost of failed projects is high for both source and recipient. Helping recipient countries improve

East Asian architecture of integration 43

governance, and the capacity to assess and manage the large inflows of funds for large infrastructure projects, is important for recipient countries but also has important spillovers to other countries (Elek and Findlay, 2020). A key feature of East Asian open regionalism is reflected in the Fourth Pillar of the AEC – integration into the global economy. That has been a priority for ASEAN for the benefit of East Asia. The WTO’s investment facilitation agenda is also an area of interest for East Asian cooperation. Investment agreements and FTAs have had limited effects on FDI, but investment facilitation has the potential to help countries reform to attract and protect foreign investment. Instead of negotiated outcomes or blunt dispute settlement instruments, the approach is to improve the investment environment and create avenues for the resolution of problems before arbitration. National treatment can be negotiated by treaty, but investment facilitation can improve that treatment. Some 70 WTO members signed up to the Investment Facilitation for Development statement in 2017, including Australia, China, Hong Kong, Japan, Korea, Malaysia, the Lao PDR, New Zealand, and Singapore in the Asia-Pacific (WTO, 2017). Implementation in East Asia and development of the framework and agenda for investment facilitation can be progressed through regional cooperation in Asia. The same applies to the e-commerce initiatives regionally and through the WTO. Plurilateral agreements like the investment facilitation agreement and e-commerce agreement have become more important. Following the lessons from the rise of protectionism in the US and Europe, the economic cooperation agenda in Asia will need to focus on how to sustain support for outward-oriented and open policies. Flanking policies for trade and investment liberalisation have always been important, but there is an opportunity to share experience and build capacity to avoid the problems of the rest of the world and insure against a broad backlash to globalisation in Asia. That includes policies that spread the gains from trade and innovation, reduce inequality, and create robust and well-functioning social safety nets and policies that facilitate, not impede, domestic adjustments. The RCEP may be one of the first agreements to consolidate FTAs by joining up the five ASEAN+1 FTAs. Usually, new agreements or broader regional agreements create layers of FTAs, e.g. trade and economic exchange between Australia and Singapore is conducted under four agreements (the South Asian Free Trade Area, the AANZFTA, the CPTPP, and the RCEP). However, much of the overlap in FTAs – via ROOs and differing standards and rules – can be overcome by reducing the MFN tariff rates, harmonising rules and standards, and using bilateral agreements more strategically for broader reforms and liberalisation. The broader the grouping of FTAs, the larger the benefits. In addition, bilateral agreements can be used to complement regional agreements that have easy accession or docking provisions, sunset clauses for preferences and, importantly, making agreements dynamic. Building on review mechanisms, economic cooperation (as in AANZFTA) and avoiding static commitments when circumstances change, will mean that agreements can change to further progress. Bilaterally, such an approach can become costly, but the broader the grouping and the closer bilateral agreements align with regional processes, the more effective stepping stones FTAs will become to broader liberalisation and reform.

44  Handbook on East Asian economic integration

6. CONCLUSIONS This chapter has provided an analysis of the origins and context of East Asian economic integration for the last three decades. Much of the initial integration occurred through marketdriven trade and investment flows, predicated around assembly, then production networks and GVCs. The rise of China in the last two decades has also had a large impact on the East Asia model of economic integration. Many of the GVCs have their hubs centred in China. More formal agreements – starting with ASEAN and then deepening within ASEAN as well as expanding to ASEAN+1 FTAs with key partners such as China, Japan, Korea, Australia–New Zealand, and India – occurred later and still have some way to go for deeper and institutionalised integration. The process tends to be evolutionary, with flexibility and acceleration when needed, and less deep and institutionalised than in North America and Europe. The centrality of ASEAN within this architecture has also played a key role. Other than ASEAN and the ASEAN+1 FTAs, the evolution of APEC in the region also helped to develop a voluntary set of principles and norms which guided and provided confidence to the domestic reform agenda, as well as providing capacity building. The spirit of APEC and East Asian economic integration has always been about liberalisation, facilitation, and the importance of the third pillar to enable the first two pillars. APEC has become part of the East Asian architecture. In contrast, economic integration in North America and Europe has been more institutionalised – with a regional body overseeing implementation and countries ceding their sovereignty. This has enabled a deeper and more ambitious economic integration agenda, including common policies. At the same time, ceding sovereignty has in some cases created domestic and regional tensions, for example with the United Kingdom’s Brexit from the EU. The East Asian model, as has been the case in the last three decades despite its lack of deep integration and institutional structures, has led to a successful development model for the region, which has seen the increase not only of intra-regional but also extra-regional trade compared with other regions in the world. This has often been termed ‘open regionalism’ because of the process whereby deeper economic integration within the region, including preferential reduction of barriers, was often accompanied by lowering of barriers extra-regionally. This occurred at a time when the world economy was opening up and major powers such as the US led the way in maintaining the global public good of world economic order, openness, and a rules-based trading system. As we all know, this is now being challenged with the withdrawal of the US from multilateralism and the practising of bilateralism and unilateralism. The question ahead of us today is what happens next. To date, the East Asian region has risen to the challenge by continuing the process of opening up through its various bilateral and mega-regional pathways. Despite the US leaving the TPP, the CPTPP was completed in 2018 under the leadership of Japan and other middle powers. The CPTPP has set the precedent in terms of new issues that are not yet on the agenda of the WTO or other mega-regional groupings, and incorporates a membership that includes East Asia and North and South America. Similarly, the RCEP, which has been more ASEAN-led, was concluded in 2019, even though a question remains regarding whether India will join the agreement. Nevertheless, the progress made to date again shows that collective leadership by middle powers in East Asia is providing the signal that continued opening up is taking place and is likely to continue. The key feature of the RCEP is the link between South Asia and East Asia, which, assuming India sees the strategic interest of being

East Asian architecture of integration 45

part of the region, will make it the largest mega-regional agreement in the world. It will be set to reconfigure GVCs to take into account changes in demographics in the region, the middle-income trap faced by the more developed East Asian countries, the uncertainties and disruptions caused by US–China trade tensions, and the need for the region to grow and develop through continued trade and investment – and increasingly data flows. The stature of the region is likely to grow and the role of collective leadership of middle powers in the region – ASEAN, Japan, and Australia, as well as potentially some from North and South America – will be a key and strategic part of the East Asia story in the forthcoming decades. The influence of the US will no longer be vital, and managing China within this wider context can in fact be counterbalanced with such a collective leadership model.

NOTES 1. We are grateful to Sam Hardwick, Yuma Osaki, and Nabil Rizky Ryandiansyah for their research assistance. 2. The members are Brunei Darussalam, Cambodia, Indonesia, the Lao People’s Democratic Republic, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Viet Nam. 3. George Yeo, Singapore’s Trade Minister at the time, explained at ASEAN Business Forum held in Bangkok that China agreed to various concessions to speed up the negotiations right after the 9/11 terrorist attacks in September 2001 (ASEAN Business Forum, Bangkok, 14/10/2002: https://www.mfa.gov.sg/Overseas-Mission/Wellington/ Mission-Updates/2002/10/press_200210_1) 4. See World Bank (n.d.) and Asia Regional Integration Center (n.d.). 5. For the EU and the Andean Community, this coefficient varies in sign and significance depending on the model specification. 6. See ASEAN (2014). 7. ADB rolled out an ASEAN Infrastructure Fund of $500 million in 2011, but it has not been very effective and steps are being taken to improve it.

REFERENCES Acharya, A. (2014), Constructing a Security Community in Southeast Asia: ASEAN and the Problem of Regional Order. London: Routledge. ADB (2008), Emerging Asian Regionalism: A Partnership for Shared Prosperity. Manila: Asian Development Bank. Ahsan, A., A. Mattoo, B. Gootiiz, J.S. Saez, M. Molineuvo, and P. Walkenhorst (2015), ASEAN Services Integration Report: A Joint Report by the ASEAN Secretariat and the World Bank. Washington, DC: World Bank. APEC (2003), 2003 APEC Ministerial Meeting: Summary of Key Issues, 17 October. www.apec.org/Meeting-Papers/ Annual-Ministerial-Meetings/2003/2003_amm (accessed 28 October 2020). Armstrong, S. (2018), ‘The New Trans-Pacific Partnership Hunkers Down Against Trump’, East Asia Forum, 4 March. www.eastasiaforum.org/2018/03/04/the-new-trans-pacific-partnership-hunkers-down-against-trump/ (accessed 28 October 2020). Armstrong, S. and P. Drysdale (2011), ‘The Influence of Economics and Politics on the Structure of World Trade and Investment Flows’, in S. Armstrong (ed.) The Politics and the Economics of Integration in Asia and the Pacific, PAFTAD series, London: Routledge, pp.65–92. Arndt, S.W. and H. Kierzkowski, eds. (2001), Fragmentation: New Production Patterns in the World Economy. Oxford: Oxford University Press. ASEAN (2014), ASEAN Community in Figures – Special Edition 2014: A Closer Look at Trade Performance and Dependency, and Investment. Jakarta: ASEAN Secretariat. ASEAN (2015), ASEAN Integration Report 2015. Singapore: ASEAN Secretariat. asean.org/asean-integration-report-2015-4/ (accessed 28 October 2020). Asia Regional Integration Centre (n.d.), Free Trade Agreements. https://aric.adb.org/fta-country (accessed 28 October 2020). Baier, S.L. and J.H. Bergstrand (2004), ‘Economic Determinants of Free Trade Agreements’, Journal of International Economics, 64(1), pp.29–63.

46  Handbook on East Asian economic integration Baldwin, R. (2008), ‘Managing the Noodle Bowl: The Fragility of East Asian Regionalism’, The Singapore Economic Review, 53(3), pp.449–78. Baldwin, R. (2014), ‘Multilateralising 21st Century Regionalism’, Paper prepared for the OECD Global Forum on Trade: Reconciling Regionalism and Multilateralism in a Post-Bali World, Paris, 4 November. https://repository. graduateinstitute.ch/record/286980?ln=en (accessed 28 October 2020). Baldwin, R. and P. Low, eds. (2009), Multilateralizing Regionalism: Challenges for the Global Trading System. New York: World Trade Organization and Cambridge University Press. Beverelli, C., M. Fiorini, and B. Hoekman (2019), ‘The Impacts of Services Trade Restrictiveness on the Productivity of Manufacturing Sectors in East Asia’, in L.Y. Ing, M. Richardson, and S. Urata (eds.) East Asian Integration: Goods, Services and Investment. Abingdon and New York: ERIA and Routledge, pp. 205–29. Bhagwati, J.N. (1993) ‘Regionalism and Multilateralism: An Overview’, in J. de Melo and A. Panagarya (eds.) New Dimensions in Regional Integration, Cambridge, UK: Centre for Economic Policy Research, pp.22–50. Bhagwati, J.N. and A. Panagarya, eds. (1996), The Economics of Preferential Trade Agreements. Washington DC: AEI Press. Cadot, O. and L.Y. Ing (2019), ‘Non-Tariff Measures and Harmonisation: Issues from the RCEP’, in L.Y. Ing, M. Richardson, and S. Urata (eds.) East Asian Integration: Goods, Services and Investment. Abingdon and New York: ERIA and Routledge, pp. 171–204. Chabchitrchaidol, A., S. Nakagawa, and Y. Nemoto (2018), ‘Quest for Financial Stability in East Asia: Establishment of an Independent Surveillance Unit “AMRO” and Its Future Challenges’, Public Policy Review (Policy Research Institute, Ministry of Finance, Japan), 14(5), pp.1001–24. Ciorciari, J.D. (2017), ‘ASEAN and the Great Powers’, Contemporary Southeast Asia: A Journal of International and Strategic Affairs, 39(2), pp.252–58. Drysdale, P. (1988), International Economic Pluralism: Economic Policy in East Asia and the Pacific. Sydney: Allen & Unwin. Drysdale, P. and S. Armstrong (2010), ‘International and Regional Cooperation: Asia’s Role and Responsibilities’, Asian Economic Policy Review, 5(2), pp.157–73. Drysdale, P., Y. Zhang, and L. Song (2012), APEC and the Liberalisation of the Chinese Economy. Canberra: ANU Press. East Asia Forum (2018b), ‘Moving from Defence to Offence on Trade Strategy’, East Asia Forum, 5 March. www. eastasiaforum.org/2018/03/05/moving-from-defence-to-offence-on-trade-strategy/ (accessed 28 October 2020). East Asian Bureau of Economic Research and China Center for International Economic Exchanges (2016), Partnership for Change: Australia–China Joint Economic Report. Canberra: ANU Press. https://press.anu.edu.au/publications/partnership-change#pdf (accessed 28 October 2020). Elek, Andrew and Christopher Findlay, 2020. ‘Investment in Connectivity’, chapter 13 in this volume. Escaith, H., S. Inomata, and S. Miroudot (2018), ‘Evolution of Production Networks in the Asia–Pacific Region: A Vision in Value-Added and Employment Dimensions’, in S. Armstrong and T. Westland (eds.) Asian Economic Integration in an Era of Global Uncertainty. Canberra: ANU Press, pp.155–83. Findlay, C., H. Piei, and M. Pangestu (2003), ‘Trading with Favourites: Free Trade Agreements in the Asia Pacific’, Pacific Economic Papers, No. 335. Canberra: Australian National University, Australia–Japan Research Centre. https://crawford.anu.edu.au/pdf/pep/pep-335.pdf (accessed 28 October 2020). Freund, C. and E. Ornelas (2010), ‘Regional Trade Agreements’, Annual Review of Economics, 2, pp.139–66. Garnaut, R. (1996), Open Regionalism and Trade Liberalization: An Asia-Pacific Contribution to the World Trade System. Sydney: Allen & Unwin. Gootiiz, B. (2018), ‘Services Negotiations in Southeast Asia: Implications for Low-Income Countries in the Region’, Geneva: International Centre for Trade and Sustainable Development (ICTSD) https://ictsd.iisd.org/themes/development-and-ldcs/research/services-negotiations-in-southeast-asiaimplications-for-low (accessed 10 November 2019). Hayakawa, Kazunobu and Kohei Shiino (2020), ‘Trade Creation and Utilisation of Regional Trade Agreements’, chapter 11 of this volume. Hill, H. and J. Menon (2010), ‘ASEAN Economic Integration: Features, Fulfillments, Failures and the Future’, ADB Working Paper Series on Regional Economic Integration, No. 69. Manila: Asian Development Bank. Hoekman, B. and D. Nelson (2018), ‘21st Century Trade Agreements and the Owl of Minerva’, EUI Working Papers, RSCAS 2018/04. Florence: European University Institute Robert Schuman Centre for Advanced Studies. Hu, R.W. (2009), Building Asia Pacific Regional Architecture: The Challenge of Hybrid Regionalism, Washington, DC: The Brookings Institution. www.brookings.edu/wp-content/uploads/2016/06/07_asia_pacific_hu.pdf (accessed 28 October 2020). Ing, L.Y. and O. Cadot (2017), ‘Ad Valorem Equivalence of Non-Tariff Measures in ASEAN’, ERIA Discussion Paper Series, No. DP-2017-09. Jakarta: Economic Research Institute for ASEAN and East Asia. Ing, L.Y., S. Fernández de Córdoba, and O. Cadot, eds. (2016), Non-Tariff Measures in ASEAN. Jakarta: Economic Research Institute for ASEAN and East Asia and United Nations Conference on Trade and Development.

East Asian architecture of integration 47 Jongwanich, J. and A. Kohpaiboon (2008), ‘Export Performance, Foreign Ownership, and Trade Policy Regime: Evidence from Thai Manufacturing’, ADB Economics Working Paper Series, No. 140. Manila: Asian Development Bank https://www.adb.org/sites/default/files/publication/28379/economics-wp140.pdf (accessed 28 October 2020). Katzenstein, P. (2002), ‘Regionalism and Asia’, in S. Breslin, C.W. Hughes, N. Philips, and B. Rosamond (eds.) New Regionalisms in the Global Political Economy: Theories and Cases. London: Routledge/Warwick Studies in Globalisation. Katzenstein, P.J. and T. Shiraishi, eds. (1997), Network Power: Japan and Asia. Ithaca, NY: Cornell University Press. Kawai, M. and G. Wignaraja (2010), ‘Asian FTAs: Trends, Prospects, and Challenges’, ADB Economics Working Paper Series, No. 226. https://www.adb.org/sites/default/files/publication/28273/economics-wp226.pdf (accessed 28 October 2020). Keck, A. and A. Lendle (2012), ‘New Evidence on Preference Utilization’, Staff Working Paper, No. ERSD-2012-12. Geneva: World Trade Organization. Kennan, J. and R. Riezman (1990), ‘Optimal Tariff Equilibria with Customs Unions’, The Canadian Journal of Economics/Revue canadienne d’Economique, 23(1), pp.70–83. Krugman, P. (1991), ‘Is Bilateralism Bad?’, in E. Helpman and A Razin (eds.) International Trade and Trade Policy. Cambridge, MA: MIT Press, pp.9–23. Lamy, P. (2015), ‘Where Will Emerging Markets Stand in Global Trade?’, in H.S. Kohli (ed.) The World in 2050: Striving for a More Just, Prosperous, and Harmonious Global Community, Volume 2: Future of the Global Market. Oxon: Oxford University Press, pp.133–67. Lee, J.-W. and K. Shin (2006), ‘Does Regionalism Lead to More Global Trade Integration in East Asia?’, The North American Journal of Economics and Finance, 17(3), pp.283–301. Limão, N. (2006), ‘Preferential Trade Agreements as Stumbling Blocks for Multilateral Trade Liberalization: Evidence for the United States’, The American Economic Review, 96(3), pp.896–914. Limão, N. and M. Olarreaga (2006), ‘Trade Preferences to Small Developing Countries and the Welfare Costs of Lost Multilateral Liberalization’, The World Bank Economic Review, 20(2), pp.217–40. Mattoo, A., A. Mulabdic, and M. Ruta (2017), ‘Trade Creation and Trade Diversion in Deep Agreements’, Policy Research Working Paper, No. 8206. Washington, DC: World Bank. Menon, J. (2018), ‘How Should We Measure ASEAN’s Success?’, East Asia Forum, 10 April. www.eastasiaforum. org/2018/04/10/how-should-we-measure-aseans-success/ (accessed 28 October 2020). Menon, J. and A.C. Melendez (2015), ‘Realizing an ASEAN Economic Community: Progress and Remaining Challenges’, ADB Economics Working Paper Series, No. 432. https://www.adb.org/sites/default/files/publication/160067/ewp-432.pdf (accessed 28 October 2020). Minghui, S. (2018), ‘Evaluation of Regional Economic Integration in East Asia’, in S. Armstrong and T. Westland (eds.) Asian Economic Integration in an Era of Global Uncertainty. Canberra: ANU Press, pp.259–86. Munakata, N. (2006), Transforming East Asia: The Evolution of Regional Economic Integration, Washington, DC: Brookings Institution Press. Okabe, M. (2015), ‘Impact of Free Trade Agreements on Trade in East Asia’, ERIA Discussion Paper Series, No. DP2015-01. Jakarta: Economic Research Institute for ASEAN and East Asia. Pangestu, M. (2017), ‘ASEAN@50: Looking Back and Looking Forward’, in ASEAN@50, Volume 1 – The ASEAN Journey: Reflections of ASEAN Leaders and Officials. Jakarta: Economic Research Institute for ASEAN and East Asia, pp.191–206. Pangestu, M. and S. Armstrong, (2018), ‘Asian Economic Integration: The State of Play’, in S. Armstrong and T. Westland (eds.) Asian Economic Integration in an Era of Global Uncertainty. Canberra: ANU Press, pp.15–62. Pangestu, M. and C. Findlay (2018), ‘Regional Leadership Needed to Save Trade Regime’, East Asia Forum, 24 June. www.eastasiaforum.org/2018/06/24/regional-leadership-needed-to-save-trade-regime/ (accessed 28 October 2020). Pangestu, M., L.Y. Ing, and G. Hadiwidjaja (2018), ‘The Future of East Asia’s Trade: A Call for Better Globalization’, Asian Economic Policy Review, 13(2), pp.219–38. Pempel, T. (2010), ‘Soft Balancing, Hedging, and Institutional Darwinism: The Economic–Security Nexus and East Asian Regionalism’, Journal of East Asian Studies, 10(2), pp.209–38. Richardson, M. (1993), ‘Endogenous Protection and Trade Diversion’, Journal of International Economics, 34(3–4), pp.309–24. Sattayanuwat, W. and N. Tangvitoontham (2018), ‘Trade Creation and Trade Diversion of ASEAN’s Preferential Trade Agreements’, IAFOR Journal of the Social Sciences, 3(1). https://doi.org/10.22492/ijss.3.1.0. Soesastro, H. (2006), ‘Regional Integration in East Asia: Achievements and Future Prospects’, Asian Economic Policy Review, 1(2), pp.215–34. Soesastro, H. (2008), ‘Implementing the ASEAN Economic Community (AEC) Blueprint’, in H. Soesastro (ed.) Deepening Economic Integration in East Asia – The ASEAN Economic Community and Beyond, ERIA Research Project Report, No. 2007-1-2. Chiba: IDE-JETRO, pp.47–59.

48  Handbook on East Asian economic integration Suominen, K. (2009), ‘The Changing Anatomy of Regional Trade Agreements in East Asia’, Journal of East Asian Studies, 9(1), pp.29–56. Sussangkarn, C. (2011), ‘Chiang Mai Initiative Multilateralization: Origin, Development, and Outlook’, Asian Economic Policy Review, 6(2), pp.203–20. Tangkitvanich, S. and S. Rattanakhamfu (2018), ‘The ASEAN Economic Community and the East Asian Agenda’, in S. Armstrong and T. Westland (eds.) Asian Economic Integration in an Era of Global Uncertainty. Canberra: ANU Press, pp.186–216. Tay, S., S. Armstrong, P. Drysdale, and P. Intal Jr., eds. (2019), Collective Leadership, ASEAN Centrality, and Strengthening the ASEAN Institutional Ecosystem, ASEAN Vision 2040: Towards a Bolder and Stronger ASEAN Community, Volume II. Jakarta: Economic Research Institute for ASEAN and East Asia. Terada, T. (2019), ‘Japan and TPP/TPP-11: Opening Black Box of Domestic Political Alignment for Proactive Economic Diplomacy in Face of ‘Trump Shock’’, The Pacific Review, 32(6), pp.1041–69. Urata, S. and M. Okabe (2007), ‘The Impacts of Free Trade Agreements on Trade Flows: An Application of the Gravity Model Approach’, RIETI Discussion Paper Series, No. 07-E-052. Tokyo: Research Institute of Economy, Trade and Industry. Verico, K. (2017), The Future of the ASEAN Economic Integration. London: Palgrave Macmillan. Viner, J. (1950), The Customs Union Issue. New York: Carnegie Endowment for International Peace. Wonnacott, P. and M. Lutz (1989), ‘Is There a Case for Free Trade Areas?’, in J.J. Schott (ed.) Free Trade Areas and US Trade Policy. Washington, DC: Institute for International Economics, pp.59–84. World Bank (n.d.), Global Preferential Trade Agreements Database. https://wits.worldbank.org/gptad/trade_database. html (accessed 28 October 2020). WTO (2017), ‘New Initiatives on Electronic Commerce, Investment Facilitation and MSMEs’, WTO 11th Ministerial Conference, Buenos Aires, 13 December. https://www.wto.org/english/news_e/news17_e/minis_13dec17_e.htm (accessed 28 October 2020).

3.

Modelling Asia-Pacific regional integration

Peter A. Petri, Michael G. Plummer, and Fan Zhai

1. INTRODUCTION Regional economic integration has been part and parcel of the economic development process in Asia. This process has been primarily led by domestic economic reforms and unilateral liberalisation of barriers to cross-border trade and investment. Over time the region also embraced concerted economic liberalisation via bilateral free trade areas (FTAs) and regional approaches to economic integration, beginning with the formation of the Asia-Pacific Economic Cooperation (APEC) forum in 1989 and the first significant economic initiative in the Association of Southeast Asian Nations (ASEAN), the ASEAN Free Trade Area (AFTA), in 1992. Starting in the late 1990s, a greater demand for reductions in intra-regional barriers to trade emerged due to, inter alia, the rise of regional production networks on the one hand, and the slow progress of multilateral negotiations under the World Trade Organization (WTO), on the other. As a result, a new wave of Asian regionalism characterised by bilateral agreements gathered momentum in the early 2000s, and the number of bilateral FTAs spearheaded by Asian economies has ballooned since then. Recently, with progress in the Trans-Pacific Partnership (TPP) negotiations (first concluded in October 2015) and the Regional Comprehensive Economic Partnership (RCEP), signed in November 2020, mega-regional trade agreements have become top priorities of Asia-Pacific policymakers. These mega-regionals will consolidate existing overlapping bilateral FTAs, open up new markets, expand scope and coverage, and write new rules for 21st century commerce. We define mega-regional agreements as FTAs between a group of countries or regions with a major share of world trade and investment (Petri and Plummer, 2014). To varying degrees, they feature state-of-the-art provisions for international commerce and address rules of key importance to 21st century economic integration – from digital trade to intellectual property protection and disciplines for state-owned enterprises engaging in international trade. The proliferation of regional trading arrangements in the Asia-Pacific region, including ­mega-regional agreements, has created a strong demand on governments and the private sector for research to gauge their economic impacts. In fact, the economics of FTAs are complicated. While they remove discrimination between partner country and domestic firms and, therefore, form a more efficient regional division of labour (‘trade creation’), they create a new distortion between partner and non-partner countries, and countries within the FTA may end up purchasing imports from less-efficient partner countries. This discrimination not only hurts non-partner exports but raises the price of imports (‘trade diversion’). Hence, trade diversion results in a country potentially purchasing imports from higher-cost sources. Moreover, trade diversion associated with an FTA increases the potential scope for ‘investment diversion’, in which FDI flows to a country merely to take advantage of protected regional access or rules of origin (ROOs). Investment could then flow to inefficient sectors that could dampen job generation (if in capital-intensive sectors, for example) and productivity growth. 49

50  Handbook on East Asian economic integration

This chapter reviews modelling techniques used in the studies of Asia-Pacific regional integration, with a focus on applied computable general equilibrium (CGE) models. It is organised as follows: Section 2 introduces the major modelling approaches for regional integration and discusses salient challenges in the context of the Asia-Pacific. Section 3 reviews key findings from the empirical literature on regional integration; in particular, it illustrates the use of CGE models in investigating Asia-Pacific integration, including the previous work of the authors. Section 4 concludes.

2. METHODOLOGY 2.1  Gravity and CGE Models In the field of applied trade policy analysis, CGE and econometric gravity models are the two most frequently used empirical techniques. The gravity model relates a bilateral trade flow between two countries to various explanatory variables, including economic size, geographical distance between them, and other potential socioeconomic determinants that affect trade costs and preferences, from per capita income to a common language. The gravity equation can be estimated with data across pairs of countries from just 1 year (cross section) or for pairs of countries observed over multiple years (panel data). Since its first application by Tinbergen (1962), the gravity model has been employed literally in thousands of applications. The widespread use of gravity models is partly due to their high explanatory power of real world data. Indeed, the gravity model represents one of the most successful frameworks in empirical economics. Moreover, despite the early perception that gravity equations were better suited for physics than economic analysis, the gravity model is firmly rooted in modern international trade theory (e.g., Deardorff, 1995). Gravity equations can be derived as reduced form equations in all mainstream trade theories – from Ricardian to monopolistic competition models, as well as the more recent firm-heterogeneity innovations in trade theory. Nowadays, structural gravity models – i.e. those theoretically grounded models with sound micro foundations – constitute standard formulations used in applied work. Structural gravity models can provide consistent and unbiased parametric estimates and are appropriate for counterfactual analysis. For example, Eaton and Kortum (2002) and Anderson and van Wincoop (2003) show that trade costs exert bilateral and multilateral effects on trade and GDP in a general equilibrium setting. Consequently, ‘multilateral resistance’ variables need to be added as regressors or need to be controlled for in gravity equations to obtain unbiased estimates. Baier and Bergstrand (2007) adjust for endogeneity in trade policy variables in gravity equations. In the case of applications to regional integration, the most common and simplest approach is to include in a standard gravity model a bilateral or regional binary variable denoting whether trading partners are part of a preferential trading agreement. More sophisticated models tend to derive larger effects than standard specifications. For example, controlling for endogeneity across trade policy variables, Baier and Bergstrand (2007) show that the effects of FTAs on trade flows are four times larger than would otherwise be the case. FTAs actually double on average international trade flows between partners after 10 years. Some studies have emphasised the importance of incorporating actual preferential margins into the analysis of FTAs (e.g. Kawai and Wignaraja, 2011).

Modelling Asia-Pacific regional integration 51

The gravity model provides a useful framework for assessing the impact of policy variables on the bilateral trade flows between countries. However, it is largely an ex post approach: as it analyses existing flows, the gravity model addresses questions related to what actually happened after an FTA was put in place, that is, the consequences of a policy decision already made. Yet, policymakers are more interested in the potential economic effects of policies they are currently considering, which require ex ante analysis. Gravity models only help in this regard in estimating parameters that might be used in ex ante models of trade. Moreover, policymakers are rarely just interested in the trade effects of a potential agreement; rather, they also benefit from information on changes in economic welfare, sectoral adjustment, and distributional impacts resulting from any policy innovation. Addressing such questions is only possible via general equilibrium analysis, which considers key interactions across consumers, firms, governments, and markets and can give more complete and precise answers to pressing policy questions. A CGE model is a numerical implementation of theoretical general equilibrium models. It is based on a set of neoclassical economic assumptions about the motivation of agents in the economy, market structure, consumer preferences, production technology, and market equilibrium conditions. Behavioural equations in CGE models are derived from these assumptions and they determine how the agents in an economic system respond to changes in relative prices and their incomes. In addition to behavioural equations, CGE models also incorporate various accounting identities that define the budget constraints of each agent as well as total resource constraints. In a CGE model, most of the parameters in behaviour equations are elasticities (i.e. they measure the responsiveness of one variable to changes in another) or share parameters, such as the share of consumption demand in aggregate demand. Some of these parameters have known values while others need to be calibrated in the model. Calibration is a step in CGE analysis when values are selected to render the CGE model’s output consistent with real-world data for the benchmark year. A CGE model typically has four agents: (i) firms, (ii) consumers, (iii) investors, and (iv) the government. Firms produce output, which is purchased at home and abroad by consumers, investors, and the government. Firms maximise profits and use market prices in deciding how much output to produce and with which inputs. The sector’s production is represented by a production function, which shows the relationship between inputs and outputs. Various functional forms, such as Cobb–Douglas, Leontief, or constant elasticity of substitution specifications, may be used to model production in a CGE model. These production functions are usually assumed to exhibit constant returns to scale and to be weakly separable between primary factors and intermediate inputs. Further, these production functions employ elasticities of substitution, which define the substitutability of one input for another. In addition, production in a CGE model typically involves a multilevel or nested production process. The use of a nested structure allows for intermediate inputs and for greater flexibility in defining elasticities governing the use of different factors of production. Consumers in each country are often modelled with reference to a representative household. The representative household maximises a utility function which is defined over the consumption of final goods from each industry. Typically, household income, market prices, and the elasticities of substitution between final goods in utility functions determine how much of each good is purchased by the representative household. Consumers are endowed with capital, land, labour, and other factors of production. Based on market prices, they supply their factors and

52  Handbook on East Asian economic integration

receive income in return. Investors receive savings (from consumers and government) and purchase bundles of goods to establish and maintain productive capacity. In a CGE model, the government also administers market-related policies, such as taxes, subsidies, trade tariffs, and quotas (if applicable). The government is often assumed not to have an objective function. For this reason, and because the effects of government policies are of primary interest, policy variables often enter exogenously into CGE models. The market-clearing conditions in CGE models determine prices of all goods and factors. Most are comparative-static in nature, that is, consumers and firms make optimal decisions based on current price signals, with no role for forward-looking expectations. When an external shock or policy change is introduced into a static CGE model, prices and quantities adjust to clear all markets, and the model produces a new state of general equilibrium. However, as there is no explicit time dimension in a static CGE model, it neither provides results on how the economy adjusts to the new equilibrium nor stipulates how long it takes to reach the new equilibrium. To track the adjustment path requires a dynamic CGE model, which explicitly traces each variable through time. In dynamic models, consumers and firms optimise their decisions intra- and inter-temporally, and the resulting equilibrium provides a set of prices that clears markets over a time path. When a policy shock such as an FTA is introduced in a dynamic CGE, the new equilibrium captures the time path of both transitional dynamics and final steady-state. 2.2  CGE Models and Innovations in the Trade Literature CGE models have a long tradition in the analysis of international trade. A typical CGE model of international trade consists of multiple countries that trade with each other; each country contains multiple industries which are linked through an input–output structure. CGE models often follow the Armington specification to model international trade, which assumes imperfect substitutability of goods by country of origin. This allows the model to capture the cross-hauling phenomenon in international trade, i.e. a country imports and exports different varieties of the same goods. The Armington model typically specifies a constant elasticity of substitution (CES) utility function over domestic and imported goods and explains the trade pattern by the relative prices of goods produced in different regions and the fixed Armington taste (share) parameters. The elasticity of substitution across the origin of production, or the Armington elasticity, governs the strength of the relative demand response from different regions to relative prices. Armington elasticities are often adopted from gravity model estimates (e.g. Hummels, 1999; Hertel et al., 2007; and Feenstra et al., 2018). Once the Armington elasticity is determined, the taste parameters can usually be obtained from calibration using observed trade flows. The Armington assumption of national product differentiation is popular in CGE models because it enables the model to match observed trade realities in a tractable way. However, its shortcoming is also obvious: The Armington specification has the effect of locking in preexisting trade patterns and prevents a model from generating large changes in trade in sectors with little or no trade, leading to results referred to as the ‘stuck on zero trade’ problem. Under the Armington specification, if a country’s imports of a given product from another country are zero initially, they will always be zero, even after significant reductions of trade barriers. Thus, in Armington-type CGE models, the trade patterns are largely determined by fixed-taste parameters but these parameters are not explained by the model.

Modelling Asia-Pacific regional integration 53

Inspired by the theoretical and empirical advances in international trade theory over the past four decades, some trade-focused CGE models have gone beyond the Armington specification to model trade behaviour more realistically. The CGE models with monopolistic competition and firm-level product differentiation appeared in the 1980s, soon after Krugman (1979) developed the ‘new trade theory’ model to rationalise intra-industry trade with the Dixit and Stiglitz (1977) love-of-variety specification. For example, Harris (1984) developed a single-country CGE model with imperfect competition and increasing returns to scale to analyse Canadian trade policy, and Brown and Stern (1989) studied the effect of the Canada–United States (US) Free Trade Agreement in a multi-country CGE model with monopolistic competition. Since the early 2000s, the rise of heterogeneous-firm trade theory has led to the introduction of firm heterogeneity into CGE models. In the models of Melitz (2003) and Bernard et al. (2003), each industry is populated by a continuum of firms, instead of a representative firm. These firms are differentiated by the varieties they produce and their productivity. In addition to fixed production costs are fixed costs and variable (iceberg) costs associated with exporting activities. A firm enters export markets if and only if the net profits generated from its exports to a given country are sufficient to cover the fixed exporting costs. Thus, zero-cut-off profit conditions define the productivity thresholds for a firm’s entry into export markets. Typically, the combination of fixed and variable export costs ensures that the exporting productivity threshold is higher than that of production for the domestic market, i.e. only a small fraction of firms with high productivity sell to foreign markets. One key difference between these firm heterogeneity-based CGE models and the traditional CGE models is the introduction of the ‘extensive’ margin of trade. This type of trade has been revealed empirically to be a key driver of trade growth but exits in neither Armington nor ‘new trade theory’ CGE models. In firm-heterogeneity trade models, patterns of trade are determined by variations in several factors, such as market size, number of firms, and technology and trade barriers, rather than the fixed ‘taste’ parameters of, say, Armington models. The illustrative simulations conducted by Zhai (2008) and Balistreri, Hillberry, and Rutherford (2011) have found generally larger welfare and trade expansion effects from trade liberalisation in firmheterogeneity CGE models than in standard Armington CGE models. 2.3  Challenges for CGE Modelling in the Context of Asia-Pacific Integration Regional economic integration is a favourite policy topic of CGE modellers. CGE-based analysis offers quantitative insight into the multifaceted effects of FTAs, including implications for economic agents (winners and losers), benefits and costs, structural change, and, of course, trade. One advantage of CGE models over other modelling tools is that they provide details regarding both structure and institutions of an economy necessary in addressing key questions of interest to policymakers. Nevertheless, changes in technology and the structure of global trade in 21st century globalisation have posed important challenges to modellers, as have the complicated nature of cutting-edge and comprehensive policy coverage of mega-regional trade agreements in the Asia-Pacific. 2.3.1  Global Value Chains (GVCs) A key driver of Asia-Pacific regional integration in the past quarter century has been the emergence of regional production and trade networks. Lower costs of transportation and communications, the technological advances in manufacturing production, and policy-driven facilitating

54  Handbook on East Asian economic integration

measures through trade and investment liberalisation have encouraged enterprises to slice their productive activities into several segments and outsource some of the production tasks abroad. This new form of industrial organisation led to the geographical fragmentation of production, prompting rising trade in intermediate and final goods. As the term ‘Factory Asia’ suggests, Asia-Pacific economies, especially East Asian economies, are now closely linked through regional production networks. While in the 20th century it was clear where a final product was made, this is increasingly no longer the case: A Japanese automobile will have components made in many different countries, with perhaps a relatively small portion of value-added in Japan. Further, the components of that automobile include a range of factor intensities, including capital-intensive, skill-intensive, labour-intensive, and natural resource-intensive components. To a significant extent, CGE models incorporate data on GVCs, since they have production structures that distinguish between different intermediate inputs and between domestic and imported sources for those inputs. However, these data are often not as detailed as researchers would like. Most CGE models are based on national input–output (I/O) tables, in which intermediate inputs to an industry are the aggregation of domestic goods and imports, with the latter not being distinguished by their sources. As a result, the standard CGE models assume that domestic agents (firms, consumers, government, and investors) have uniform preferences in imports, and then allocate the aggregate demand for an input into demand for goods produced domestically and imports using an Armington specification. Yet, recent advances in the development of global multi-region I/O tables such as the Asian Regional Input–Output Tables provided by The Japan External Trade Organization – Institute of Developing Economies (JETRO-IDE), the Organisation for Economic Co-operation and Development (OECD) Inter-Country Input–Output (ICIO) Tables, and the World Input–Output Database (Timmer et al., 2015) have enabled CGE modellers to relax the assumption of a single Armington agent. As multi-region I/O tables provide information on the sources of imports across different end-use categories, the CGE models based on them can incorporate agent-specific import preferences, thereby capturing more realistically the linkages of trade in intermediate goods through international supply chains. In recent years, economists have incorporated I/O linkages and international sourcing of intermediate goods into mainstream trade models, offering some structural interpretations of international trade in intermediate goods and the positioning of countries within the GVCs. For example, Caliendo and Parro (2015) developed an Eaton and Kortum (2002)-type Ricardian model with multi-sectors and I/O linkages to study the welfare effects of the North American Free Trade Agreement (NAFTA). Antras and Chor (2018) extend the Caliendo and Parro model to allow for a more flexible formulation of trade costs – that is, trade costs are not only country pair and sector specific but also user specific – and can use it to fully calibrate all entries of the World Input–Output Table. These trade models with I/O linkages largely employ the assumption of a roundabout production structure, in which an input loop is assumed, and the output of intermediate goods enters a production function as an input to produce other (or its own) products. Under this production structure, the production of intermediate inputs requires that intermediates be produced with the exact same technology and the sequential, multistage nature of production is abstracted away. Most CGE models do not fully integrate the complexities of multistage production in their analysis. As countries differ in the cost at which they can perform individual production stages, allocating the stage of production along the value chain according to each country’s comparative advantage gives rise to more trade and enhanced welfare. Without explicitly modelling

Modelling Asia-Pacific regional integration 55

the sequentiality of multistage production, it is not possible to explain when it is profitable for a producer to turn to foreign partners to complete specific stages in a production process. Theoretical models in this area have shed light on the interactions of different forces – e.g. productivity, factor costs, trade costs, inter-firm transaction costs, and intra-firm coordination costs – in shaping the GVCs, but they are often too stylised to map the actual trade and I/O data. Recent attempts at quantifying the multistage model of GVCs require either cumbersome procedures for calibration and solution (e.g. Antras and de Gortari, 2017; and de Gortari, 2017) or making basic dimensional assumptions about country and stages. Given these difficulties, it might be still premature to have an explicit treatment of multistage production in a CGE model. 2.3.2  Foreign Direct Investment (FDI) Including policies related to FDI in regional trade agreements has received greater priority in recent years, particularly given its close links to services trade and the GVCs. Early attempts to incorporate FDI into a CGE model began with the seminal study by Petri (1997), which laid the groundwork for many subsequent CGE models incorporating FDI. In Petri’s model, production activities are distributed across domestically-owned and foreign-owned firms. By assuming that subsidiaries use inputs sourced from parent (and other) firms, the model partly captures the effect of global supply chains. On the demand side, the Armington specification of national product differentiation is extended to product variety differentiation by both production location and firm ownership. In addition, the model defines investor preferences as a nested imperfect transformation function that allocates a given investment budget across sectors and regions. Barriers to FDI are represented in the model as a ‘tax’ on FDI profits. Petri uses the model to analyse the economic effects of APEC’s Bogor Declaration, and the simulation results suggest that investment liberalisation could account for about one-third of APEC benefits. Many studies have followed Petri’s approach to modelling FDI in CGE models. Notable examples include Dee and Hanslow (2000), who integrate FDI into a Global Trade Analysis Project (GTAP) model to study services liberalisation; Brown and Stern (2001), who extend the Michigan Model to include FDI; and Lejour et al. (2006), who extend the Central Planning Bureau’s WorldScan model to include FDI in services. Subsequent research devoted to modelling FDI in a CGE framework considers the potential productivity effects associated with FDI flows. For example, anchored on the knowledge–capital model of FDI of Markusen (1997), Jensen, Rutherford, and Tarr (2007) develop a small open economy CGE model of Russia to assess the impact of FDI liberalisation as part of Russia’s accession to the World Trade Organization (WTO). In their model, reducing barriers to entry into services leads to more varieties of services and subsequent downstream productivity gains. Recent firm heterogeneity trade theory provides new insights into the determinants of FDI. Helpman, Melitz, and Yeaple (2004) extend the Melitz (2003) model to include a firm’s choice between exports and horizontal FDI. Their paradigm shows that among firms that stay in an industry, the least productive serve only the domestic market while the most productive serve foreign markets via subsidiary sales; and firms with intermediate productivity levels serve foreign markets with exports. Building on their theoretical work, Li, Scollay, and Gilbert (2017) develop a global CGE model with firm heterogeneity and FDI to analyse the impact of the RCEP. They find a positive overall FDI creation effect, despite the potential substitution effect of trade expansion as a result of trade liberalisation within the RCEP. Still, the existing CGE modelling technology for FDI needs much improvement. First, similar to the Armington specification in trade models, Petri’s assumption of product differentiation

56  Handbook on East Asian economic integration

across firm ownership also suffers from the previous criticism of locking in pre-existing trading patterns. The consumers’ choice over products produced by domestic firms or foreign firms is governed by the Armington preference parameters, which are largely a black box in a CGE model. Second, and partly related to the difficulties in modelling GVCs, vertical FDI – i.e. the FDI driven by cost differences and production fragmentation – has not yet been explicitly modelled in a CGE framework. Hence, much progress still needs to be made in modelling FDI in CGE models to provide useful insight to FDI-related policy analysis in regional integration accords. 2.3.3  Trade and regulatory barriers In the early stages of applying CGE models to trade policy analysis, tariffs and quotas (or sometimes tariff rate quotas) were considered to be the more important barriers to trade; modelling these measures in CGE simulations is straightforward. But with the advent of the 21st century, the trade policy landscape changed significantly: as average global tariffs have fallen considerably in developed and, especially, developing economies, other trade impediments have become priorities in trade negotiations. In particular, non-tariff measures (NTMs) in goods and services, behind-the-border regulatory measures, and other trade-related rules were included often for the first time in FTAs, particularly in the more ambitious agreements (Hofmann et al., 2017). The TPP was one such ‘21st century trade agreement’ and went well beyond traditional ‘border’ restrictions to include such areas as digital commerce, intellectual property protection, labour and environmental regulations, cross-border data flows, and state-owned enterprises. These new issues, some of which rarely appear on the radar of trade economists, pose important methodological challenges for CGE models to evaluate the impacts of the new generation of FTAs. Some aspects of NTMs have been addressed in FTA negotiations in the past. They include trade facilitation, custom cooperation, technical barriers to trade, standards, and sanitary and phytosanitary measures. To incorporate them in CGE models, these NTMs must be quantified. Moreover, they must be addressed realistically; some NTMs clearly fall outside the realm of trade policy and are not ‘actionable’. Economists usually seek to obtain the ad valorem equivalent of NTMs through direct price comparisons (price-based approach) or an indirect estimation of gravity models (value-based approach). For example, Kee, Nicita, and Olarreaga (2009) estimate ad valorem equivalents of NTMs for 78 countries by using data on the incidence of NTMs at the product level. Their results are incorporated into a global CGE model by Petri et al. (2012, 2015) to study the impact of Asia-Pacific integration. When incorporating ad valorem equivalents of NTMs into CGE models, they are assumed to be cost-inducing or rent-creating. Liberalisation of NTMs and non-border barriers to trade within the context of a bilateral FTA is often non-discriminatory and, hence, positively affects partner and non-partner countries alike. For example, take trade facilitation measures, such as more efficient customs clearing. Any improvement in this area applies to all trade, not just trade from partner countries. Hence, third countries reap indirect benefits from the bilateral FTAs. This ‘spillover’ effect can be large; indeed, the literature on the European Union’s Single Market Programme suggests that most associated liberalisation and harmonisation measures would apply on a non-discriminatory basis. Rules of origin (ROOs) are key features of regional trade agreements but are rarely addressed in CGE models. Although local content requirements constitute the core of ROOs, the

Modelling Asia-Pacific regional integration 57

legal forms of ROO regimes may vary significantly across countries. ROOs induce compliance costs and lead to incomplete utilisation of preferences when compliance costs of firms exceed preference margins. Instead of directly modelling ROO regimes, some CGE models (e.g. Petri et al., 2012; Ciuriak and Xiao, 2014) introduce ROOs through an exogenous adjustment in preference utilisation rates based on empirical data and impose an ad valorem equivalent of compliance costs. Similar to the NTMs, the ad valorem costs for utilising preference can be estimated using gravity models. The cutting-edge provisions of the TPP (discussed below) have not often been included in CGE models, and early attempts to do so were carried out in an exogenous, ad hoc fashion. In Petri et al. (2012, 2015), we evaluate the impact of the TPP and attempt to incorporate all the major issues into the design of FTA scenarios. We include 21 issue areas being addressed in the TPP and other Asia-Pacific FTAs – including tariffs, NTMs, e-commerce, state-owned enterprises, dispute resolution, and so forth – and assign policy weights to each issue area according to its importance in reducing non-tariff barriers. We also recognise that not all NTMs are actionable and, thus, set limits to potential liberalisation of NTMs in goods and services. Each FTA is rated across the 21 issue areas according to scores ranging from 0 to 1. These scores represent subjective assessments of the extent to which an FTA liberalises a certain area. The final NTM reduction rate of each agreement is equal to the weighted average score across issue areas. Our simulations reveal that the incorporation of these non-traditional policy areas is important to the evaluation of the ‘quality’ of the FTAs and the consequent assessment of their impact.

3. CGE LITERATURE ON EFFECTS OF ASIA-PACIFIC MEGAREGIONALISM As noted above, numerous studies using CGE models have been used to gauge ex ante the potential economic effects of various trade policy innovations. In many ways, the recent trend in mega-regionalism demonstrates how this modelling can help policymakers make major decisions on trade policy. The most ambitious mega-regional accord to date is the TPP, which was signed in October 2015 and included 12 APEC members representing about two-fifths of world output and one-quarter of global trade, ranging widely in income from Viet Nam and Peru to the US and Japan. The US withdrew from the agreement in January 2017 but the remaining 11 countries agreed to go ahead with a slightly revised TPP, to be called the Comprehensive and Progressive Transpacific Partnership (CPTPP). The CPTPP was signed in March 2018 and came into effect in December 2018 when the sixth CPTPP country ratified the agreement. Several additional economies have expressed interest in joining, including the Republic of Korea (henceforth, Korea), the Philippines, Indonesia, Taiwan, and Thailand (‘CPTPP16’). The CPTPP seeks to improve market access by eliminating ‘high-hanging’ barriers to intraregional trade. It will eliminate tariffs on over 96% of goods traded in the region. Its 30 chapters address myriad NTMs, with the bulk of the agreement’s text designed to update or develop new rules for many of the behind-the-border issues discussed above, including trade in services, FDI, the digital economy, competitive neutrality for state-owned enterprises, intellectual property, and regulatory coherence.

58  Handbook on East Asian economic integration

Another mega-regional agreement is the Regional Comprehensive Economic Partnership (RCEP), launched in 2012, which is the culmination of long-standing efforts to pursue Asiacentred integration, mostly based on ASEAN’s efforts to promote regional economic integration (Petri and Plummer, 2014). ASEAN’s ‘Guiding Principles and Objectives for Negotiating the Regional Comprehensive Economic Partnership’ define the goal of RCEP as ‘a modern, comprehensive, high-quality and mutually beneficial economic partnership agreement… [to] cover trade in goods, trade in services, investment, economic and technical cooperation, intellectual property, competition, dispute settlement’ (ASEAN, 2012). The principles stress the need for flexibility, and the agreement will likely include special and differential treatment for developing members. The RCEP was signed in November 2020, including 15 signatories. At the time of this writing, the text is just now being analysed. The RCEP is not as ambitious as the CPTPP but it is surprisingly ambitious in many ways: it should reduce tariffs on 92 percent of intra-regional trade and includes important features such as cumulative rules of origin and 20 chapters covering trade in services, investment, electronic commerce, government procurement and intellectual property, even though some of these chapters do not go much beyond WTO commitments. A key feature will be free trade across Northeast Asia, since no significant bilateral FTA existed between China, Japan and South Korea prior to RCEP. A final mega-regional agreement being discussed is the Free Trade Area of the Asia-Pacific (FTAAP), which was proposed by the APEC Business Advisory Council (ABAC) in 2004 and has been adopted by APEC itself. Since the benefits of next-generation trade rules depend on their coverage of GVCs throughout the Asia-Pacific region, they would be maximised in agreements that span a wide regional membership. The FTAAP would presumably include all 21 APEC member-economies and perhaps others. The original idea was that FTAAP negotiations would be launched in 2020 and would unite the two ‘pathways’ towards regional integration already under way: the Asia-Pacific track (now the CPTPP) and the Asian track (now the RCEP). The template for the FTAAP has obviously not yet been considered, but it will likely fall somewhere between the highly ambitious CPTPP and the less-ambitious RCEP. 3.1  Overview of CGE Results for Asian Mega-Regionalism In the literature several CGE studies have endeavoured to anticipate the potential economic effects of Asia-Pacific mega-regional accords that have been signed (the TPP, the CPTPP, and RCEP), and agreements that have been proposed (expanded CPTPP and the FTAAP). Extensive review of those studies – as well as some original estimates – can be found in USITC (2016), World Bank (2016), and Gilbert et al. (2018) for the TPP; Li et al. (2017) for the RCEP; Ciuriak et al. (2017) for the CPTPP; and Kawasaki (2014), and Park et al. (2010) for the FTAAP. Below we summarise some main lessons and takeaways from this research: Overall, the literature suggests positive welfare gains for all major FTAs in the Asia-Pacific region, meaning that trade creation dominates trade diversion. Gains tend to be relatively small if only tariff reductions are included in the model but much larger when non-tariff barriers are modelled, and firm-heterogeneity is specified. Model specification obviously has an important bearing on results: for example, relative to the baseline, estimates of increases in income from the TPP range from $51 billion (Ciuriak, et. al. 2017,) to $492 billion (Petri and Plummer, 2016). In the aggregate, these net gains tend to be relatively small; even Petri and Plummer (2016) project a net increase in gains of about 1 percent of regional income. Still, these are

Modelling Asia-Pacific regional integration 59

permanent gains to efficiency. To put it in context, the estimated increase in regional gains of $465 billion would be equivalent to a 4 percent return on investments of $11.6 trillion. Usually, exports propel the increase in income, which is intuitive given that the parametric changes relate mostly to trade variables. For example, in Petri and Plummer (2016), exports grow about twice as fast as income for both the TPP and CPTPP scenarios, suggesting an important increase in regional integration. Depth and size also matter; deeper integration templates like the TPP generate far larger results, ceteris paribus, and the larger the number and size of the countries, the greater the welfare effects. In Petri et al. (2017), the CPTPP16 scenario, in which five economies that have expressed interest in joining the CPTPP do so (i.e. Indonesia, Korea, the Philippines, Thailand, and Taiwan), generates income gains that are 50 percent larger than the RCEP, mainly due to a deeper liberalisation template. Gains from the FTAAP are much larger than the TPP due to its being a more inclusive agreement. In sum, the mega-regional literature underscores several key lessons that are generally applicable. First, bigger is better: ceteris paribus, the larger the agreement, the greater (less) the potential for trade and investment creation (diversion) as well as various dynamic effects of regional integration such as economies of scale. Second, deeper is better: the more comprehensive the agreement, the greater the gains from economic integration. In particular, the inclusion of NTMs and non-border, trade-related policy issues generate far larger gains because today NTMs constitute the greater impediments to trade at the border, and non-border issues restrict everything from FDI flows to interaction in ‘21st century’ areas (e.g. digital trade, innovation). Third, the more open the agreement and the greater the spill-over effects of liberalisation, the larger the gains for both partner and non-partner countries. 3.2  An Illustrative Example: Petri et al.’s Modelling of Asia-Pacific Mega-Regionalism In our research, we use a cutting-edge CGE model featuring heterogeneous firms to estimate the potential effects of the TPP since 2011. The details of the model, including the modelling challenges, can be found in Petri et al. (2012). In Petri and Plummer (2016), we update the model to include trade liberalisation information from the actual TPP agreement, including in terms of tariff reduction coverage and other aspects of the agreement. In Petri et al. (2017), we consider scenarios in the wake of the US decision to withdraw from the TPP. Below, we summarise the results of the model as a means of underscoring the likely effects of the agreement. More details can be found in Petri and Plummer (2016), Petri et al. (2017), and at www. asiapacifictrade.org. The aggregate effects on income and exports on selected economies and regions are summarised in Tables 3.1 and 3.2, respectively, for TPP12, CPTPP, CPTPP16, and RCEP. For TPP12, as noted above, we estimate the net gains to global income relative to the baseline to be $494 billion, or 0.4 percent of global GDP. The TPP member-countries would, of course, reap most of the gains: $467 billion, or 1.1 percent of regional GDP. Benefits would be broadly shared across the TPP. The largest members – the US and Japan – would see the largest absolute gains but smaller economies would do best in proportional terms. Malaysia and Viet Nam lead relative gains in the TPP with income increases of 7.7 percent and 8.2 percent, respectively, in 2030 relative to the baseline. Both countries would benefit from reducing distortions in their own markets and establishing stronger positions in regional supply chains through deeper integration. Preferences would accelerate the shift of labour-intensive textile and garment industries from China to Viet Nam.

60  Handbook on East Asian economic integration Table 3.1  Changes in Incomes from Asian Mega-Regional Initiatives 2030    

Change in $2015 Billion % of Income 2030 Income TPP12 CPTPP CPT16 RCEP TPP12 CPTPP CPT16 RCEP

Americas

39 569

208

49

72

2

0.5

0.1

0.2

0.0

Canada Chile Colombia Mexico Peru United States Other Latin America Asia

2 717 463 684 2 169 442 25 754 7 341 50 659

37 4 0 22 11 131 3 202

22 3 0 16 10 –2 0 69

29 5 0 33 11 –6 –1 316

0 0 0 0 0 1 0 253

1.3 0.9 0.0 1.0 2.6 0.5 0.0 0.4

0.8 0.7 0.0 0.7 2.2 0.0 0.0 0.1

1.1 1.1 0.0 1.5 2.5 0.0 0.0 0.6

0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.5

Brunei China Hong Kong India Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand Vietnam ASEAN nie Asia nie Oceania

31 27 839 461 5 487 2 192 4 924 2 243 675 680 485 776 812 497 283 3 272 2 854

2 –18 6 –5 –2 125 –8 52 –1 19 1 –7 41 –1 0 21

1 –10 1 –4 –1 46 –3 21 0 13 0 –5 11 0 0 15

1 –53 1 –16 18 98 84 36 13 19 60 30 25 0 –1 22

0 101 2 57 1 56 24 6 1 2 –3 3 2 1 0 7

5.9 –0.1 1.2 –0.1 –0.1 2.5 –0.3 7.6 –0.1 3.9 0.2 –0.8 8.1 –0.4 0.0 0.7

2.6 0.0 0.2 –0.1 –0.1 0.9 –0.1 3.1 0.0 2.7 0.0 –0.6 2.2 0.0 0.0 0.5

3.7 –0.2 0.3 –0.3 0.8 2.0 3.8 5.4 1.9 3.8 7.8 3.6 5.1 –0.1 0.0 0.8

0.9 0.4 0.4 1.0 0.0 1.1 1.1 0.9 0.2 0.4 –0.4 0.3 0.5 0.2 0.0 0.2

Australia New Zealand Rest of the World

2 590 264 40 720

15 6 60

12 3 14

17 5 39

5 2 23

0.6 2.2 0.1

0.5 1.1 0.0

0.7 2.0 0.1

0.2 0.6 0.1

Africa (Sub-Sahara) Europe EMENA Russia ROW World

4 068 23 189 10 001 3 371 90 133 801

0 48 9 2 0 492

0 12 2 0 0 147

–1 22 15 2 0 449

1 16 5 1 0 286

0.0 0.2 0.1 0.1 0.2 0.4

0.0 0.0 0.0 0.0 0.1 0.1

0.0 0.1 0.1 0.1 0.0 0.3

0.0 0.1 0.0 0.0 0.1 0.2

41 011 15 257 21 961 49 800 465 157 486 201 27 –10 –37 84

1.1 0.0

1.0 0.0

2.2 0.0

0.4 0.1

Memorandum  Income (members) (Members) (Non-members)

     

Notes: EMENA = Europe nie, Middle East and North Africa. nie = not included elsewhere. ROW = rest of the world. Source: Adopted from Petri et al. (2017).

Modelling Asia-Pacific regional integration 61 Table 3.2  Changes in Exports from Asian Mega-Regional Initiatives, 2030     Americas

Change in $2015 Billion % of Exports 2030 Exports TPP12 CPTPP CPT16 RCEP TPP12 CPTPP CPT16 RCEP 7 068

478

72

103

–1

6.8

1.0

1.5

0.0

835 147 120 670 135 3 906 1 255 12 905

58 8 1 32 14 357 9 511

39 6 0 23 12 –10 1 172

56 8 0 45 15 –22 1 874

–1 –1 0 –2 0 3 0 668

7.0 5.3 0.9 4.7 10.3 9.1 0.7 4.0

4.6 4.3 0.1 3.5 9.0 –0.3 0.1 1.3

6.7 5.7 0.0 6.7 10.8 –0.6 0.1 6.8

–0.1 –0.5 0.0 –0.2 –0.2 0.1 0.0 5.2

16 4 976 357 1 360 446 1 190 1 089 491 184 470 506 561 357 93 810 673

1 9 4 1 –4 276 –11 99 –1 35 4 –9 107 –3 2 38

1 –9 1 –3 –3 97 –6 42 0 29 0 –7 31 0 1 28

1 –44 1 –13 49 225 203 71 29 33 170 68 84 –1 0 45

0 259 –1 132 17 136 62 17 4 3 –7 24 17 4 1 17

9.0 0.2 1.0 0.1 –1.0 23.2 –1.0 20.1 –0.4 7.5 0.8 –1.6 30.1 –2.8 0.2 5.6

3.5 –0.2 0.2 –0.2 –0.6 8.1 –0.6 8.6 –0.2 6.2 –0.1 –1.3 8.8 –0.4 0.1 4.2

4.9 –0.9 0.2 –1.0 11.1 18.9 18.7 14.4 16.0 7.0 33.6 12.0 23.5 –1.5 –0.1 6.6

0.9 5.2 –0.3 9.7 3.8 11.4 5.7 3.4 2.2 0.6 –1.5 4.3 4.9 3.9 0.1 2.5

Australia New Zealand Rest of world

589 84 15 503

29 9 79

23 5 14

37 8 10

14 3 –7

4.9 10.2 0.5

4.0 5.8 0.1

6.3 9.2 0.1

2.4 3.1 0.0

Africa (Sub-Sahara) Europe EMENA Russia ROW World

883 9 706 4 021 851 43 36 149

5 49 20 5 0 1 106

1 8 4 1 0 287

0 –7 14 2 0 1 032

1 –9 1 1 0 677

0.5 0.5 0.5 0.5 1.1 3.1

0.1 0.1 0.1 0.1 0.3 0.8

0.0 –0.1 0.3 0.3 –0.2 2.9

0.1 –0.1 0.0 0.1 –0.1 1.9

8 890 1 025 81

4 984 308 –22

7 769 1 102 –70

12 745 546 131

11.5 0.3

6.2 –0.1

14.2 –0.2

  4.3 0.6

Canada Chile Colombia Mexico Peru United States Other Latin America Asia Brunei China Hong Kong India Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand Vietnam ASEAN nie Asia nie Oceania

Memorandum Income (members) (members) (non-members)

     

Notes: EMENA = Europe Middle East North Africa. nie = ROW = rest of the world. Source: Authors’ computations.

62  Handbook on East Asian economic integration

As noted above, the TPP targets deeper integration and will likely generate a very different mix of benefits than earlier agreements. The simulations show that only 6 percent of the benefits from the TPP for its members will be due to tariff effects, while reducing non-tariff barriers on other goods, services barriers, and barriers to investment will account for 37 percent, 41 percent, and 16 percent of total effects, respectively (Petri and Plummer, 2016). The CPTPP generates substantially lower global benefits of $147 billion. The benefits are lower partly because many CPTPP economies already have prior trade agreements with each other. The differences from TPP12 are especially marked for Japan, Malaysia, and Viet Nam, with the benefits of each reduced to about one-third to one-fourth of their TPP12 levels, indicating the importance of the US market for these economies. On the other hand, other economies in North America and Oceania, including Canada, Mexico, and New Zealand, do reasonably well in the CPTPP because they capture some of the benefits that might have accrued to the US. However, no member economy gains from replacing TPP12 with the CPTPP, testifying to the importance of the US market. CPTPP16 performs best among the scenarios that exclude the US, with global gains of $449 billion and $486 billion for member economies, slightly more than in TPP12. The most prominent beneficiaries, in absolute terms, are Japan, Korea, and Taiwan, along with their Southeast Asian partners. CPTPP16 would create a high-quality trade agreement among those three industrialised economies, which currently do not have any trade agreement with each other. The agreement would go further than others in establishing new supply chains in the Asia-Pacific region. Taiwan, in particular, has few agreements with other economies, and so it would benefit disproportionately with income gains of 7.8 percent of GDP. RCEP generates gains of $286 billion. This reflects, on one hand, the economic scale of RCEP – its member economies have the largest combined GDP among all alternatives examined – and the lower ambition of RCEP provisions. The benefits of RCEP are projected to be limited because RCEP members are more competitive than complementary in economic structure. RCEP members have many prior trade agreements with each other and RCEP provisions are not likely to exceed in quality agreements already in place, suggesting limited potential for positive gains due to an improved template for liberalisation. Still, due to its sheer size, RCEP also offers an important upside risk: if the accord leads to rigorous follow-up agreements in the future, as some Asian trade agreements have, it could yield significantly higher long-run benefits.

4. CONCLUSIONS Economic modelling is necessary in order to analyse the potential effects of a regional trading agreement ex ante, or to gauge what the actual effects have been ex post. In this chapter, we review the methodologies behind the two most popular ex post and ex ante techniques, i.e., gravity and CGE models, respectively. While all empirical paradigms have their shortcomings given the complications inherent in the global economy, these models have been popular instruments to evaluate essential policy questions. The chapter focuses its applications on mega-regionalism in the Asia-Pacific region, which is arguably the most exciting area of international commercial policy so far in the 21st century. While the literature differs in terms of the size of the gains of these initiatives, in general, it agrees that these mega-regionals will have relatively significant effects on income and trade

Modelling Asia-Pacific regional integration 63

in the region. In particular, (i) even a TPP without the US (CPTPP) can generate benefits to members, albeit with gains that would be only about one-quarter as large as those expected from the 12-member TPP; (ii) larger regional agreements, such as an expanded CPTPP and RCEP, would produce greater benefits than smaller ones; and (iii) high-quality agreements lead to substantially larger gains from integration than less rigorous ones. For example, the simulations in Petri et al. (2017) estimate that the CPTPP16 agreement could produce gains that are about two-thirds greater than what would be expected from the RCEP agreement, even though the CPTPP economies have only half the GDP of the RCEP region. CGE and gravity modelling have made great strides in recent years. Their inherent ability to address policy-relevant issues suggests that a strong demand to improve these models will continue as they tackle proposed policy innovations in the future.

REFERENCES Abbyad, N. and P. Herman (2017), ‘How Much do Non-tariff Measures Cost? A Survey of Quantification Methods’, Economics Working Paper Series, Working Paper 2017–05–C, May 2017, Washington, DC: USITC. Alexander, P. (2017), ‘Vertical Specialization and Gains from Trade’, mimeo. Anderson, J.E. (2011), ‘The Gravity Model’, Annals of Economic Research, 3, pp.133–160. Anderson, J.E. and E. van Wincoop (2003), ‘Gravity with gravitas: A Solution to the Border Puzzle’, American Economic Review, 93, pp.170–192. Antràs, P. and D. Chor (2018), ‘On the Measurement of Upstreamness and Downstreamness in Global Value Chains’, in L. Yan Ing and M. Yu (eds.), World Trade Evolution: Growth, Productivity and Employment. London: Routledge, pp.126–194. Antràs, P. and D. Chor (2013), ‘Organizing the Global Value Chain’, Econometrica, 81(6), pp.2127–2204. Antràs, P. and A. de Gortari (2017), ‘On the Geography of Global Value Chains’, mimeo, Harvard University. ASEAN (2012), Guiding Principles and Objectives for Negotiating the Regional Comprehensive Economic Partnership. Jakarta: ASEAN. https://www.mofa.go.jp/mofaj/press/release/24/11/pdfs/20121120_03_03.pdf. Baier, S.L. and J.H. Bergstrand (2007), ‘On the Endogeneity of International Trade Flows and Free-trade Agreements’, Journal of International Economics, 71, pp.72–95. Baldwin, R. and A. Venables (2013), ‘Spiders and Snakes: Off-shoring and Agglomeration in the Global Economy’, Journal of International Economics, 90(2), pp.245–254. Baldwin, R.E. and A.J. Venables (1995), ‘Regional economic integration’, in G.M. Grossman and K. Rogoff (eds.), Handbook of International Economics, Edition 1, Volume 3, chapter 31. Amsterdam: Elsevier, pp.1597–1644. Balistreri, E.J., R.H. Hillberry, and T.F. Rutherford (2011), ‘Structural Estimation and Solution of International Trade Models with Heterogeneous Firms’, Journal of International Economics, 83(2), pp.95–108. Berden, K. and J. Francois (2015), ‘Quantifying Non-tariff Measures for TTIP’, Paper No. 12 in the CEPS-CTR project ‘TTIP in the Balance’ and CEPS Special Report No. 116/July 2015. Bernard, A., J. Eaton, J.B. Jensen, and S. Kortum (2003), ‘Plants and Productivity in International Trade’, American Economic Review, 93(4), pp.1268–1290. Brown, D.K. (1993), ‘The impact of a North American Free Trade Area: Applied general equilibrium models’, in N. Lusting, B.P. Bosworth and R.Z. Lawrence (eds.), North American Free Trade: Assessing the Impact. Washington DC: The Brookings Institution. Brown, D. and R. Stern (2001), ‘Measurement and modeling of the economic effects of trade and investment barriers in services’, Review of International Economics, 9(2), pp.262–86. Brown, D.K. and R.M. Stern (1989), ‘U.S.-Canada bilateral tariff elimination: The role of product differentiation and market structure’, in R.C. Feenstra (ed.), Trade Policies for International Competitiveness. Chicago: University of Chicago Press, pp.217–45. Cadot, O. and L.Y. Ing (2014), ‘How Restrictive Are ASEAN’s RoO?’, ERIA Discussion Paper Series, No. 2014-18, September, Jakarta: ERIA. Caliendo, L. and F. Parro (2015), ‘Estimates of the Trade and Welfare Effects of NAFTA’, Review of Economic Studies, 82(1), pp.1–44. Ciuriak, D., J. Xiao, and A. Dadkhah (2017), ‘Quantifying the Comprehensive and Progressive Agreement for TransPacific Partnership’, East Asian Economic Review, 21(4), pp.343–384. Ciuriak, D. and J. Xiao (2014), ‘The Trans-Pacific Partnership: Evaluating the “Landing Zone” for Negotiations’, Working Paper, January.

64  Handbook on East Asian economic integration Costinot, A. and A. Rodriguez-Clare (2013), ‘Trade Theory with Numbers: Quantifying the Consequences of Globalization’, in G. Gopinath, E. Helpman, and K.S. Rogoff (eds.), Handbook of International Economics, Vol. 4. Amsterdam: Elsevier, pp.197–261. Costinot, A., J. Vogel, and S. Wang (2013), ‘An Elementary Theory of Global Supply Chains’, Review of Economic Studies, 80(1), pp.109–144. Deardorff, A. (1995), ‘Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical World?’, NBER Working Paper, No. 5377, December, Cambridge, MA: NBER. Available at http://www.nber.org/papers/w5377. Dee, P. and Hanslow, K. (2000), ‘Multilateral Liberalisation of Services Trade’, Productivity Commission Staff Research Paper, Canberra: Ausinfo. Dixon, P.B., M. Jerie, and M.T. Rimmer (2016), ‘Modern Trade Theory for CGE Modelling: The Armington, Krugman and Melitz Models’, Journal of Global Economic Analysis, 1(1), pp.1–110. Dixit, A. and J. Stiglitz (1977), ‘Monopolistic Competition and Optimum Product Diversity’, American Economic Review, 67, pp.297–308. Eaton, J. and S. Kortum (2002), ‘Technology, Geography, and Trade’, Econometrica, 70, pp.1741–1779. Fally, T. and R. Hillbery (2017), ‘A Coasian Model of International Production Chains’, mimeo, UC Berkeley. Feenstra, R.C., P. Luck, M. Obstfeld, and K. Russ (2018), ‘In Search of the Armington Elasticity’, The Review of Economics and Statistics, 100(1), pp.135–150. Francois, J.F. and C.R. Shiells (1994), ‘AGE models of North American Free Trade’, in J.F. Francois and C.R. Shiells (eds.), Modeling Trade Policy: Applied General Equilibrium, Assessments of North American Free Trade. Cambridge: Cambridge University Press, pp.3–44. Gilbert, J., T. Furusawa, and R. Scollay (2018), ‘The economic impact of the Trans-Pacific Partnership: What have we learned from CGE simulation?’, The World Economy, 41(3), pp.831–865. de Gortari, A. (2017), ‘Disentangling Global Value Chains’, mimeo, Harvard University. Harms, P., O. Lorz, and D. Urban (2012), ‘Offshoring along the Production Chain’, Canadian Journal of Economics, 45(1), pp.93–106. Harris, R. (1984), ‘Applied general equilibrium analysis of small open economies with scale economies and imperfect competition’, American Economic Review, 74 (December), pp.1016–32. Head, K. and T. Mayer (2014), ‘Gravity Equations: Workhorse, Toolkit, and Cook-book’, in G. Gopinath, E. Helpman, and K.S. Rogoff (eds.), Handbook of International Economics, Vol. 4. Amsterdam: Elsevier. Helpman, E., M. Melitz, and S. Yeaple (2004), ‘Export Versus FDI with Heterogeneous Firms’, American Economic Review, 94(1), pp.300–316. Hertel, T., D. Hummels, M. Ivanic, and R. Keeney (2007), ‘How confident can we be of CGE-based assessments of Free Trade Agreements?’, Economic Modelling, 24(4), pp.611–635. Hofmann, C., A. Osnago, and M. Ruta (2017), ‘Horizontal Depth: A New Database on the Content of Preferential Trade Agreements’, World Bank Policy Research 7981, February 2017. Hummels, D. (1999), ‘Toward a Geography of Trade Costs’, GTAP Working Papers 1162, Center for Global Trade Analysis, Department of Agricultural Economics, Purdue University. Itakura, K. and K. Oyamada (2013), ‘Incorporating firm heterogeneity into the GTAP Model’, Conference Paper presented at the 16th Annual Conference on Global Economic Analysis, Shanghai, China, 12–14 June. Jensen, J., T. Rutherford, and D. Tarr (2007), ‘The Impact of Liberalizing Barriers to Foreign Direct Investment in Services: The Case of Russian Accession to the World Trade Organization’, Review of Development Economics, 11(3), pp.482–506. Johnson, R.C. and A. Moxnes (2019), ‘GVCs and Trade Elasticities with Multistage Production’, NBER Working Paper Series, No. 26018, Cambridge, MA: NBER. Kawai, M. and G. Wignaraja (2011), Asia’s Free Trade Agreements: How Is Business Responding?, Cheltenham: Edward Elgar. Kawasaki, Kenichi (2014), ‘The Relative Significance of EPAs in Asia-Pacific’, RIETI Discussion Paper, 14-E-009. Available at: https://www.rieti.go.jp/jp/publications/dp/14e009.pdf. Kee, L.H., A. Nicita, and M. Olarreaga (2009), ‘Estimating Trade Restrictiveness Indices’, The Economic Journal 119(534), pp.172–199. Krugman, P.R. (1979), ‘Increasing Returns, Monopolistic Competition, and International Trade’, Journal of International Economics, 9, pp. 469–79. Lejour, A.M., P. Veenendaal, G. Verweij, and N.I.M. van Leeuwen (2006), WorldScan: a Model for International Economic Policy Analysis, CPB Document, No. 111, The Hague: CPB. Li, Q., R. Scollay, and J. Gilbert (2017), ‘Analyzing the effects of the Regional Comprehensive Economic Partnership on FDI in a CGE framework with firm heterogeneity’, Economic Modelling, 67(C), pp.409–420. Markusen, J.R. (1997), ‘Trade versus Investment Liberalization’, NBER Working Paper Series, No. 6231, Cambridge, MA: NBER. Melitz, M.J. (2003), ‘The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity’, Econometrica, 71(6), pp.1695–1725. Melitz, M.J. and S.J. Redding (2014), ‘Missing Gains from Trade?’, American Economic Review, 104(5), pp.317–321.

Modelling Asia-Pacific regional integration 65 Narayanan, G., D. Ciuriak, and S. Harsha (2016), ‘Quantifying the Mega-regional Trade Agreements: A Review of the Models’, in H.V. Singh (ed.), TPP and India: Implications of Mega-regionals for Developing Economies. New Delhi: Wisdom Tree, pp.93–131. Park, I., S. Park, and S. Kim (2010), ‘A Free Trade Area of the Asia Pacific (FTAAP): Is It Desirable?’, mimeo. https:// mpra.ub.uni-muenchen.de/26680/. Petri, P.A. (1997), ‘Foreign Direct Investment in a Computable General Equilibrium Framework’, Brandeis-Keio Conference, Making APEC Work: Economic Challenges and Policy Alternatives, Tokyo: Keio University. Petri, P.A. and M.G. Plummer (2018), Australia will gain from continued Asia-Pacific trade integration, Minerals Council, September. http://minerals.org.au/sites/default/files/180905%20Australia%20will%20gain%20 from%20continued%20Asia-Pacific%20trade%20integration.pdf. Petri, P.A., C. Findlay, M.G. Plummer, and G. Wignaraja (2015), The FTAAP Opportunity: A Report to ABAC. Manila: ABAC. October. http://www.ncapec.org/docs/ABAC%20Documents/The%20FTAAP%20Opportunity%20 A%20Report%20to%20ABAC.PDF. Petri, P.A. and M.G. Plummer (2016), ‘The Economic Effects of the Transpacific Partnership: New Estimates’, in C. Cimino-Isaacs and J.J. Schott (eds.), Trans-Pacific partnership: An assessment. Washington, D.C: Peterson Institute for International Economics. Also, published in January 2016 as PIIE Working Paper, 16-2. Available at http://www.piie.com/publications/interstitial.cfm?ResearchID=2906. Petri, P.A. and M.G. Plummer (2014), ‘ASEAN Centrality and the ASEAN-US Economic Relationship’, Policy Series 69, March, Honolulu: East-West Center. Petri, P.A., M.G. Plummer, and F. Zhai (2012), ‘The Trans-Pacific Partnership and Asia-Pacific Integration: A Quantitative Assessment’, Policy Analysis in International Economics 98, Washington DC: Peterson Institute for International Economics. Petri, P.A., M.G. Plummer, S. Urata, and F. Zhai (2017), ‘Going It Alone in the Asia-Pacific: Regional Trade Agreements without the United States’, PIIE Working Paper, 17-2, October. https://piie.com/publications/working-papers/ going-it-alone-asia-pacific-regional-trade-agreements-without-united. Plummer, M.G., C. Findlay, P.A. Petri, and G. Wignaraja (2018), Update to the FTAAP Opportunity: A Report to ABAC. Manila: ABAC. http://mddb.apec.org/Documents/2018/SOM/SOM3/18_som3_008.pdf. Plummer, M.G., D. Cheong, and S. Hamanaka (2010), Methodology for Impact Assessment of Free Trade Agreements. Mandaluyong: Asian Development Bank. Scollay, R. and J. Gilbert (2000), ‘Measuring the Gains from APEC Trade Liberalisation: An Overview of CGE Assessments’, World Economy, 23, pp.175–193. Timmer, M.P., E. Dietzenbacher, B. Los, R. Stehrer, and G.J. de Vries (2015), ‘An Illustrated User Guide to the World Input-Output Database: The Case of Global Automotive Production’, Review of International Economics, 23(3), pp.575–605. Tinbergen, J. (1962), Shaping the World Economy – Suggestions for an International Economic Policy. New York: The Twentieth Century Fund. United States International Trade Commission (USITC) (2016), ‘Trans-Pacific Partnership Agreement: Likely Impact on the U.S. Economy and on Specific Industry Sectors’, USITC Publication, No. 4607, Investigation Number: TPA-105-001. https://www.usitc.gov/publications/332/pub4607_new_0.pdf. Walmsley, T., T.W. Hertel, and D. Hummels (2013), ‘Developing a Multi-Region Input-Output Framework from GTAP for Analyzing the Vulnerability of the Asia-Pacific Supply Chain to Natural Disasters’, Paper presented at the 16th Annual Conference on Global Economic Analysis, Shanghai, China, 12–14 June. World Bank (2016), Global Economic Prospects, January 2016: Spillovers Amid Weak Growth. Washington, DC: World Bank. © World Bank. https://openknowledge.worldbank.org/handle/10986/23435 (License: CC BY 3.0 IGO). Yi, K.-M. (2010), ‘Can Multistage Production Explain the Home Bias in Trade?’, American Economic Review, 100(1), pp.364–393. Zhai, F. (2008), ‘Armington Meets Melitz: Introducing Firm Heterogeneity in a Global CGE Model of Trade’, Journal of Economic Integration, 23(3), pp.575–604.

4.

Trade in goods with internationalised production activities Toshiyuki Matsuura and Ayako Obashi

1. INTRODUCTION The East Asian countries have been successfully integrated into the regional and world economy by taking part in internationalised production activities, especially since the early 1990s. As communication costs have fallen substantially, due to information and communications technology-related advancements, in addition to reductions in transportation costs and tariffs, firms have been able to unbundle the production processes across national borders according to international differences in comparative advantages. The regional diversity and adequate supply potential in East Asia, together with the growing demand for final manufactured products from the United States (US) and European markets, encourage the production stage- or taskwise fragmentation of production, thereby leading to the networking of international production chains across borders. The development of such international production networks in East Asia has expanded trade in intermediate goods, especially that in manufactured intermediates, among neighbouring countries within the region. In this chapter we aim to overview the progress of East Asian economic integration through trade in goods, especially in manufactured parts and components. East Asian countries have become integrated regionally and globally through the internationalisation of firms’ production activities, particularly in machinery industries. As a main driver of the expansion of East Asian merchandise trade, we concentrate on machinery parts and components and sort out the necessary conditions that have enabled firms’ production activities to spread geographically across borders. Our discussions range from the initial and geographical conditions, to policy efforts and international cooperation. Although East Asian economic integration through merchandise trade has progressed to a great extent, some may suspect the sustainability of trade expansion and the accompanying gains from trade in the region. In this regard, we provide a review of the relevant empirical evidence found in recent literature. This chapter is organised as follows: Section 2 overviews the data of East Asian merchandise trade and introduces previous studies as to the trade of manufactured parts and components in the region. Section 3 sorts out the conditions for promoting the internationalisation of firms’ production activities. Section 4 briefly looks into the empirical evidences as regards the sustainability of trade expansion in East Asia. Section 5 concludes the chapter by providing policy recommendations and directions for future research.

2.  STRUCTURE OF EAST ASIAN MERCHANDISE TRADE We begin by providing a data overview of East Asia’s trade structure and its evolution over the last few decades. 66

Trade in goods with internationalised production activities 67

2.1  Data Overview of East Asian Merchandise Trade The data overview in this subsection relies on the RIETI Trade Industry Database (RIETI-TID) 2015 (RIETI, 2017), from which we obtain bilateral merchandise trade value data, disaggregated by the stage in the production process, between major countries in the world from 1980 to 2015. In the RIETI-TID database, trade flows are classified into product categories based on the Basic Economic Categories (BEC) codes, in relation to the System of National Account (SNA) criteria. There are three broad categories by production stage: (i) primary goods; (ii) intermediate goods, which are classified further into processed goods (of raw materials) and (manufactured) parts and components; and (iii) final goods, which are further classified into capital goods and consumption goods.1 Here, we define East Asia as eight ASEAN member countries (Brunei, Cambodia, Indonesia, Malaysia, Philippines, Singapore, Thailand, and Viet Nam), People’s Republic of China (hereafter China), Taiwan, Japan, Republic of Korea (hereafter Korea), Australia, New Zealand, and India.2 Also, we use the import price index of the US available at the US Bureau of Labor Statistics website to deflate nominal trade values reported in the RIETI-TID and obtain constant US dollar series.On the top line chart of Figure 4.1, we decompose the world total merchandise trade values (light grey, solid line; measured on the right axis), based on the production stage, into primary goods (light grey, long dash line), processed goods (medium grey, long dash line), parts and components (medium grey, solid line), capital goods (black, short dash line) and consumption goods (black, solid line). To compare the trend in intra-regional trade within East Asia with other trade flows (see Figure 4.1), we decompose world trade into four trade flows: A) intra-East Asian trade, B) exports by East Asian countries to destination markets outside the region, C) imports by East Asian countries from countries outside the region, and D) trade between countries outside the region. Each trade flow is disaggregated into the five product categories by production stage. Table 4.1 shows four panels: 1. 2. 3. 4.

the values of world and East Asian trade in 1990, 2000, and 2015; annual average growth rates of trade during the periods 1990–2000 and 2000–2015; the product composition of trade in 1990, 2000, and 2015; and the proportions of intra-East Asian trade and other trade flows to world total trade in 1990, 2000, and 2015.

In Table 4.1, we look at trade values of final goods as a whole for simplicity. We also combine primary goods with processed goods because three-fourths of world trade in ‘processed goods’ are (semi-)processed raw materials used as intermediate inputs for chemicals, iron and metal products, and petroleum and coal products. The overall trend of the world and East Asia’s merchandise trade has a couple of distinct features. Firstly, among five product categories, the world trade values of parts and components increase at the highest rate of 3.8-fold between 1990 and 2015, while more than doubling in the 1990s (Table 4.1, panel 1). We need to take note that more than 94% of world trade in parts and components occurred in machinery industries. After the v-shaped recovery from the great trade collapse in 2008–2009 due to the global financial crisis, there was another minor decrease in the world total trade values in 2012 and 2015 (see Figure 4.1). Both the great trade collapse and the recent trade slowdown appear to be largely driven by ups and downs of trade in primary

CHAPTER 4 | TRADE IN GOODS WITH INTERNATIONALISED PRODUCTION ACTIVITIES

Figure 4.1: The World and East Asian Trade, by Production Stage, 1990–2015 World merchandise trade

4,000

12,000 10,000

3,000

10,000

Value (billion US $, constant 2000), all merchandise

Value (billion US $, constant 2000) by production stage

Value (billion US $, constant 2000) by production stage

12,000

8,000

3,000 8,000

2,000

6,000

2,000

6,000

4,000

1,000

4,000

2,000

1,000

2,000

0

0 0 1990

1995

1990

2000

1995

2000

2005

Year

2005

Year

0 2015

2010 2010

All merchandise, total (right axis)

Value (billion US $, constant 2000), all merchandise

68  Handbook on East Asian economic integration

Figure 4.1: The World and East Asian Trade, by Production Stage, 1990–2015 4,000 World merchandise trade World merchandise trade

2015

Primary goods

All merchandise, total (right axis) Intermediate: processed goods

Primary goods parts & components Intermediate:

Intermediate: processed goods

Intermediate: parts & components

Final: capital goods

Final: consumption goods

Final: capital goods

Final: consumption goods

Intra-regional vs interregional trade inininEast Intra-regional interregional trade EastAsia Asia Intra-regional vs vs interregional trade East Asia A) A) Intra-East Intra-EastAsian Asiantrade trade

600 600

400 400

400 400

200 200

200 200

0

800 600 400 200

0

1990

East Asian exports to outside B)B)East Asian exports to outside

800 800

600 600

Value (billion US $, constant 2000)

Value (billion US $, constant 2000)

800 800

0

0

1990

1995

1995

2000

2000

2005

2005

2010

2010

2015

1990

2015

1990

C) East Asian imports from outside

800

C) East Asian imports from outside

2000

2000

2005

2010

2005

2010

2015

2015

D) Trade outside East Asia

2,500

2,500

2,000

2,000

1,500

400

1,500

1,000

200

1,000 500 500 0

0 1990

1990

1995

D) Trade outside East Asia

600

0

1995

1995

1995

2000

2000

2005

2005

2010

2010

2015

Year 2015

0 1990 1990

1995

2000

1995

2000

2005

2010

2005

2015

2010

2015

Year

Notes: The total merchandise trade values are disaggregated by the stage in the production process, based on the RIETI-TID’s classification. Nominal trade values are deflated by the US import price index to obtain a constant dollar series. East Asia here is basically defined as ASEAN+6 plus Taiwan, as explained in the text.

Notes: The total merchandise trade values are disaggregated by the stage in the production based theproduction RIETI-TID’s classification. Nominalon trade Notes: The total merchandise trade values are disaggregated byprocess, the stage inonthe process, based thevalues are deflated Source: Authors’ calculation using the trade data (RIETI-TID 2015) and the US import price index (the US BLS). by the US import price index to obtain a constant dollar series. Eastvalues Asia here is basically as ASEAN+6 plus price Taiwan,index as explained in theatext. RIETI-TID’s classification. Nominal trade are deflateddefined by the US import to obtain constant dollar

Source: Authors’ calculation usinghere the trade data (RIETI-TID 2015)as and the US import priceTaiwan, index (theas USexplained BLS). series. East Asia is basically defined ASEAN+6 plus

in the text. Figure 4.2: Value-added Decomposition of East Asian Machinery Exports, 2011

Figure Source: 4.2: Value-added Decomposition of East Asian2015) Machinery Authors’ calculation using the trade data (RIETI-TID and the USExports, import price2011 index (the US BLS). Figure 4.1  The World and East Asian Trade, by Production Stage, 1990–2015

15

15

69

         

6.0% 4.5% 9.9% 6.5% 8.0% 5.5% 5.3% 6.0% 5.1% 3.4%

90–00 00–15

  4.6% 5.1% 6.9% 7.3% 7.1% 7.4% 4.1% 7.2% 4.1% 3.8%

90–00 00–15

Primary + Processed

         

1 167 197 217 125 627

1 872 469 360 192 851

9.1% 3.2% 15.8% 5.9% 11.0% 3.4% 10.6% 2.9% 6.9% 2.1%

90–00 00–15

Parts & components

         

 

Parts & components

490 46 77 45 322

2015

           

4 572 541 1 164 414 2 452

2015

Final goods

6.1% 4.3% 10.0% 6.0% 7.3% 5.5% 4.7% 5.4% 5.4% 3.4%

90–00 00–15

Final goods

2 414 226 520 188 1 479

2000

Final goods 1 337 87 258 119 874

1990

Primary + Processed

Parts & components

Final goods

1990 2000 2015 1990 2000 2015 1990 2000 2015 1990 2000 2015 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 8% 12% 16% 9% 12% 16% 9% 17% 25% 6% 9% 12% 13% 15% 18% 6% 7% 10% 16% 19% 19% 19% 22% 25% 12% 11% 14% 15% 14% 19% 9% 11% 10% 9% 8% 9% 67% 62% 53% 70% 67% 55% 66% 54% 45% 65% 61% 54%

All merchandise, total

1990 2000 2015 1990 2000 2015 1990 2000 2015 1990 2000 2015 100% 100% 100% 45% 39% 43% 15% 20% 17% 41% 41% 40% 100% 100% 100% 51% 39% 43% 17% 28% 26% 32% 33% 30% 100% 100% 100% 20% 18% 24% 18% 24% 18% 62% 58% 58% 100% 100% 100% 57% 51% 61% 12% 19% 12% 31% 29% 27% 100% 100% 100% 46% 42% 45% 15% 17% 14% 39% 41% 41%

All merchandise, total

 

4 884 775 480 934 2 695

Primary + Processed

2 303 270 166 328 1 539

2000

Parts & components 1990

Source: Authors’ calculation using the trade data (RIETI-TID 2015) and the US import price index (the US BLS).

Note: Manufactured goods range from C15T16 to C36T37; among them, machinery industries are defined as C29-C34T35 of the ISIC Rev. 3. classification.

World merchandise trade, total A) Intra-East Asian trade B) East Asian exports to outside C) East Asian imports from outside D) Trade outside East Asia

PANEL 4: The proportions of intra-East Asian trade and other trade flows to world total trade in 1990, 2000, and 2015

World merchandise trade, total A) Intra-East Asian trade B) East Asian exports to outside C) East Asian imports from outside D) Trade outside East Asia

PANEL 3:  The product composition of trade in 1990, 2000, and 2015

World merchandise trade, total A) Intra-East Asian trade B) East Asian exports to outside C) East Asian imports from outside D) Trade outside East Asia

All merchandise, total

PANEL 2: Annual average growth rates of trade during the periods 1990–2000 and 2000–2015

5 884 11 327 694 1 785 903 2 003 642 1 541 3 645 5 998

1 468 138 83 220 1 027

3 295 271 417 384 2 223

2015

World merchandise trade, total A) Intra-East Asian trade B) East Asian exports to outside C) East Asian imports from outside D) Trade outside East Asia

2000

Primary + Processed 1990

2015

1990

2000

All merchandise, total

PANEL 1: The values of world and East Asian trade in 1990, 2000  and 2015

Table 4.1  The World and East Asian Trade, by Production Stages, 1990–2015

70  Handbook on East Asian economic integration

and processed goods. Still, world trade in parts and components, capital goods, and consumption goods all grew, though at a slower pace in recent years, compared to the previous period before the great trade collapse. Reflecting the large increase of world trade in parts and components, the proportion of parts and components to total world trade rose from 15% in 1990 to 20% in 2000, though declined to 17% in 2015 (Table 4.1, panel 3). The percentage of parts and components trade in East Asian outside the region has fluctuated in line with world trade. However, for intra-East Asian trade, the percentage of parts and components increased sharply from 17% in 1990 to 28% in 2000 and remained at a high level of 26% in 2015. The increased and sustained importance of parts and components is a prominent feature of intra-East Asian trade. As a consequence, parts and components accounted for 26% of intraEast Asian trade as of 2015, which is comparable to the share of final goods of 30%. In contrast, parts and components accounted for only 18% of East Asian exports, while the share of final goods still remained high at 58% in 2015. Despite the noticeable increase in the parts and components trade, East Asian countries remain highly integrated with the rest of the world through the export of final goods. Second, intra-East Asian trade values increased 6.6-fold over the last few decades, while trade outside East Asia showed a relatively modest (2.7-fold) increase and East Asian exports and imports grew at a rate between intra-East Asian trade and trade outside the region (Table 4.1, panel 1). In particular, the intra-East Asian trade values of parts and components jumped tenfold, quadrupling more than those in the 1990s, whereas the corresponding change in trade outside the region was limited to 2.6-fold, which was well below the increase in East Asian exports and imports. A similar contrasting trend is observed for capital goods and consumption goods. Consequently, only one-third of world total trade was accounted for by intra-East Asian trade and East Asian exports and imports in 1990 but the proportion rose to about half of 2015, indicating an increasingly important role of East Asia in world trade (Table 4.1, panel 4). The dominance of East Asia in world trade is most noticeable in trade in parts and components. The proportion of intra-East Asian trade to world trade in parts and components increased from 9% in 1990 to 17% in 2000 and further up to 25% in 2015. In contrast, the percentage of trade outside East Asia decreased from 66% in 1990 to 54% in 2000 and further down to 45% in 2015 (Table 4.1, panel 4). Meanwhile, the percentages of East Asian exports and imports remained almost unchanged at 16–19% and 9–11%, respectively. East Asian countries have substantially increased trade in parts and components intensively within the region. In 2015, the share of intra-East Asian trade in parts and components reached 25%, which is comparable to the total shares of East Asian trade in parts and components with outside of the region of around 29% (= 19% + 10%). In contrast, the share of intra-East Asian trade in final goods is still limited to 12%, which is only half of the share of East Asian exports of final goods (25%) to outside of the region. 2.2  Trade in Intermediate Goods and Internationalisation of Production The data overview in the previous subsection highlights the growing importance of trade in manufactured parts and components over the last few decades, especially in the East Asian region. The dominance of trade in intermediate goods concentrating more on manufactured parts and components has long been recognised empirically since at least as early as the 1960s. It also has been studied theoretically, as surveyed in Ng and Yeats (2001) and, more recently,

Trade in goods with internationalised production activities 71

by Baldwin and Lopez-Gonzalez (2015). Indeed, Baldwin and Lopez-Gonzalez (2015) confirm the dominance of intermediate inputs in global trade since 2009, based on their calculation using the World Input–Output Database: on average, half of all goods and services produced in the world are sold for final use (public and private consumption and investment), whereas only 34% of world exports are final goods and services. Such dominance of cross-border transactions of goods that will be inputs into manufacturing processes in other countries would reflect the geographic separation of firms’ production activities where fragmented stages of production are located in different countries where they can be undertaken most efficiently.3 In the East Asian context, in particular, it is well established that the internationalisation of firms’ production activities in machinery industries has shaped the symptomatic trade patterns concentrating on machinery parts and components. In what follows, we overview the previous studies examining the dominance of machinery parts and components in East Asian trade in relation to the internationalisation of production in section 2.2.1. Although existing studies on East Asian trade patterns rely heavily on the analysis of gross values of trade, we introduce an alternative approach based on input–output (I/O) tables in attempting to gauge the true amount of cross-border flows of intermediates in section 2.2.2. In addition, to better approximate the intensity of cross-border sourcing of intermediates, there is an emerging literature featuring the proportion of foreign value-added in the gross values of exports. We review those recent studies, along with a data observation on the value-added decomposition of East Asian machinery trade, in section 2.2.3. 2.2.1  East Asian trade in machinery parts and components As one of the pioneering studies on the transformation of trade patterns in East Asia from the perspective of the internationalisation of production, Ng and Yeats (2001) shed light on a remarkable dynamism and increasing importance of East Asian trade in manufactured parts and components from the mid-1980s. In addition, Ando and Kimura (2005) underline an explosive increase in both exports and imports of machinery parts and components by East Asian countries in the latter half of the 1990s. Ando and Kimura (2005), using the overseas production and sales data of Japanese companies and finely disaggregated trade data, also discuss how the formation of vertical production chains throughout East Asia has fundamentally changed trade patterns. The major players in such international production networks are multinational corporations that belong to machinery industries and whose headquarters are located in the forerunners of regional economic development such as Japan, Korea, and Taiwan. Relatedly, Fukao et al. (2003) point out a rapid increase in vertical transactions in the electric machinery industry in East Asia and find that such vertical intra-industry trade is largely driven by foreign direct investment (FDI) from Japan to neighbouring East Asian countries. Ando and Kimura (2005) group the Harmonized System (HS) 6-digit level product codes into parts and components and finished products for machinery industries (HS 84–92) and compare East Asian countries to others using the proportion of machinery parts and components in total exports and imports, based on data obtained from the UN Comtrade database.4 Ando and Kimura (2005) highlight the significance of the machinery industry in East Asian trade and the fact that most East Asian countries achieved high percentages of machinery parts and components not only in total manufacturing exports but also in imports in 2000.5 Their findings indicate that East Asian countries integrate into the world economy by actively engaging in back-and-forth transactions of parts and components through machinery production networks.

72  Handbook on East Asian economic integration

The follow-up studies by Kimura and Obashi (2010) and Obashi and Kimura (2017) confirm the dominance of machinery parts and components in East Asian trade for 1994, 2007, and 2013. Malaysia, the Philippines, and Singapore had 40% or even higher percentages of machinery parts and components both in total manufacturing exports and imports throughout a couple of decades.6 In stark contrast, for latecomers to ASEAN such as Cambodia, the Lao PDR, and Myanmar, the percentages of machinery parts and components were definitely limited as of 2013. Yet, they are increasingly dependent on trade in machinery parts and components and are establishing trade links for a wider range of machinery parts and components with a larger number of trading partners. Athukorala and Yamashita (2006) present additional empirical evidence suggesting that the growing trade in parts and components has concentrated on intra-regional transactions but, at the same time, has made the East Asian region increasingly reliant on extra-regional exports of final goods. Nevertheless, Kimura and Obashi (2010) trace the development of intra-regional markets as an ultimate source of demand for machinery, by pointing out the fact that East Asian countries have begun to increase intra-regional exports of machinery final goods, as well as parts and components, since 2000. 2.2.2  Analysis of cross-border sourcing based on input–output tables The existing studies reviewed so far rely on the analysis of gross values of trade at disaggregated product level. By looking only at international trade statistics, however, we cannot perfectly distinguish goods used as intermediate inputs from those bought for final use. Even the same products, say, integrated circuit (IC) card readers, can be regarded as intermediates when firms buy them to assemble into sophisticated vending machines or as final goods when households buy them as computer accessories. To tackle this missing information issue and to get closer to the true amount of cross-border sourcing of intermediates, an alternative approach is to turn to I/O tables that keep track of the final-or-intermediate usage, i.e. used as an input into another sector’s production or as final demand explicitly. To approximate the magnitude of cross-border sourcing of intermediate inputs, two different types of measures based on I/O tables have been used in the literature. The first measure, originally proposed by Feenstra and Hanson (1996), focuses on the foreign content of domestic production; more precisely, the share of (direct) imported inputs in gross output or in the total procurements of inputs. The second measure, initially formulated by Hummels et al. (2001), captures the (direct and indirect) imported input content of exports, which is specifically labelled as vertical specialisation. Hummels et al. (2001) report that 21% of the merchandise exports from ten countries of the Organisation for Economic Co-operation and Development (OECD) and four emerging economies (including Korea and Taiwan) are accounted for by the imported inputs in 1990. Such vertical specialisation activities have grown by 28%, accounting for more than 30% of the growth in these countries’ exports between 1970 and 1990. This alternative approach is also far from perfect due to the limited availability of data comparable across countries and, to a lesser extent, disaggregation of the product classification, and because I/O tables are not frequently updated. Amador and Cabral (2009), therefore, take a hybrid approach combining information on cross-border input sourcing based on I/O tables, in the spirit of Hummels et al. (2001), with international trade statistics covering more countries and years. Amador and Cabral (2009) show that the evolution of vertical specialisation activities was especially prominent in high-tech industries and was geographically concentrated in East Asia from 1986 to 2005.

Trade in goods with internationalised production activities 73

2.2.3  Foreign value-added embodied in exports The increasing importance of the internationalisation of production in East Asian and world trade suggests that the conventional analysis based on gross trade data tends to overestimate the intensity of cross-border sourcing of intermediate inputs relative to trade in final goods. Suppose production processes are unbundled across two or more countries. The sum of the trade values of a certain set of intermediates in gross terms is likely to be a multiple of the value of the associated final good because goods in process cross national borders multiple times before becoming part of the final good.7 To better approximate the intensity of cross-border sourcing, more recent studies, evolving from the above vein of literature following Hummels et al. (2001), look at the domestic and foreign value-added contents of the observed trade flows (Koopman et al., 2010; Daudin et al., 2011; Johnson and Noguera, 2012, 2017). For example, Johnson and Noguera (2012, 2017) highlight the growing importance of cross-border sourcing of intermediate inputs through the development of global value chains by demonstrating a decline in the ratio of the world’s total value-added to gross exports of merchandise and services, i.e. an increase in foreign valueadded embodied in world exports.8 At the country level, however, Baldwin and Lopez-Gonzalez (2015) report that on average only 20% of gross exports are attributed to foreign value-added, for which the authors argue that world production is not very globalised, or countries are not highly integrated into the world economy yet. The proportion of foreign value-added in exports primarily approximates the intensity of cross-border sourcing and thereby represents the degree of integration into the world economy by being involved in internationalised production activities. Nevertheless, we have to be careful in the interpretation because the size of the domestic economy and the stage of domestic industrial agglomeration development also affect the proportion. Indeed, according to Baldwin and Lopez-Gonzalez (2015), the foreign value-added shares tend to be lower for large economies such as the US and Japan as well as for natural resource-abundant countries such as Russia and Australia, which rely on primary product exports that are naturally high in local content. These tendencies lead to downward pressure on the global average of the foreign value-added shares. On the other hand, the numbers rise to a very high level for small economies such as Luxembourg. The stacked bars of Figure 4.2 represent the percentages accounted for by machinery in the total gross exports of manufactured goods by East Asian economies to the world, which are decomposed into domestic and foreign value-added, for year 2011. We use value-added trade statistics obtained from the OECD-WTO (World Trade Organization) Trade in Value Added (TiVA) database.9 Among East Asian economies in the sample, Malaysia appears to be highly integrated into the world economy through machinery production networks. Two-thirds of Malaysia’s machinery exports are attributed to foreign value-added, which accounts for more than 30% of its total manufacturing exports. Korea has a remarkably high foreign value-added embodied in machinery exports for a country of its size and level of industrialisation. Although the Philippines and Singapore, in addition to Malaysia, are known to achieve strikingly high percentages of machinery parts and components in total manufacturing exports and imports (in gross terms, as discussed in section 2.2.1), they have a relatively limited foreign value-added embodied in machinery exports. Still, the proportion of machinery in total manufacturing exports reaches 50% for Singapore and 60% for the Philippines, respectively, in Figure 4.2. These observations can be interpreted as indicating the presence of a domestic supplier base, which is well integrated in international production networks, in the Philippines

CHAPTER 4 | TRADE IN GOODS WITH INTERNATIONALISED PRODUCTION ACTIVITIES

74  Handbook on East Asian economic integration

Notes: NZ = New Zealand.

NZ = New Zealand.

Manufactured goods C15T16 C36T37; among them, industries areISIC defined as C29-C34T35 Note: Manufactured goods range from range C15T16 from to C36T37; amongto them, machinery industries are machinery defined as C29-C34T35 of the Rev. 3. classification. of the ISIC Rev. classification. Source: Authors’ calculation using3. export data and value-added indicators (OECD-WTO TiVA).

Authors’ calculation using export data and value-added indicators Figure Source: 4.3: Tariff Equivalent Trade Costs Faced by East Asian(OECD-WTO Exporters TiVA). in Markets of Developed Countries

Figure 4.2  Value-Added Decomposition of East Asian Machinery Exports, 2011 350%

286%Viet Nam, the proportion of machinery in total manufactur300% and Singapore.10 In contrast, for 267% ing exports is less than 30% while more than two-thirds of machinery exports are attributed to 216% 250% value-added. This can be interpreted as supporting the view that foreign Viet Nam plays the role of the world’s factory in the197% sense that it imports a large amount of intermediate inputs for 204% 204% 204% 197% 200% 183% assembly or for further processing into products to be exported. 179% 168% 149%

165%

150%

121%

131%

125%

114% 114% 112% 3. BACKGROUND OF THE EXPANSION OF EAST 96% ASIAN 89% 100% 80% TRADE 78% MERCHANDISE 71%

As 50% discussed in the previous section, one feature of the expansion of trade concentrating on machinery parts and components in East Asia is primarily due to the internationalisation of 0% firms’ production activities in machinery industries. Based onKorea the theory of fragmentation, Develping China India Malaysia Thailand Indonesia Philippines the conditions that enable firms to geographically separate their production activities are (i) countries, average location advantages in production conditions and (ii) reductions in broadly defined trade costs, including tariffs, non-tariff barriers to trade,1989/1997 and any other (behind-the-border) measures re1980/1988 1998/2006 stricting trade. In this section, we discuss these background conditions. Source: de Sousa et al. (2012).

Trade in goods with internationalised production activities 75

3.1  Location Advantages A geographical proximity of East Asian countries with different location advantages in production conditions is thought to encourage cross-border fragmentation of production. Kimura et al. (2007) look at regional differences in income levels as a proxy for differences in location advantages. They argue that East Asian countries are diverse in income levels within the region while European countries uniformly have higher incomes. Countries with different wage levels have different revealed comparative advantages. Ng and Yeats (2001) find that in East Asian countries, low-wage countries have a higher and more extensive revealed comparative advantage in assembly operations while countries with high wages such as Japan have a stronger comparative advantage in the production of components. Diversity in income levels attracts those multinational enterprises (MNEs) that engage in vertical FDI, namely, invest in cheap labour countries and export to high-income countries. Fukao et al. (2003) examine the characteristics of the US and Japanese MNEs’ affiliates located in different regions and point out that the affiliates in East Asia tend to be export-oriented compared with those in other regions. Furthermore, Kimura et al. (2007) argue how these location advantages affect trade flows of parts and components in East Asia by estimating the gravity model. They employ the absolute value of income gaps between trading countries to capture the differences in location advantages. They find a positive correlation between trade flows and income gaps in the case of intra-regional trade in machinery parts and components in East Asia. In contrast, in the case of Europe, the income gap is negatively correlated with trade flows. This implies that trade in Europe is dominated by horizontally differentiated products rather than vertically differentiated ones. 3.2  Reductions in Trade Costs in East Asia This subsection briefly overviews a reduction in broadly defined trade costs in East Asia, including tariffs and non-tariff barriers to trade, and presents some measures of trade costs. Table 4.2  Applied Tariff Rates (%), by East Asian Country, Simple Average of All Products  

1988–90 1991–93 1994–96 1997–99 2000–02 2003–05 2006–08 2009–11 2013–15

China India Indonesia

  81.6 17.8

38.4 56.4 16.7

27.7   12.4

16.5 30.7 9.9

14.5 30.5 6.8

9.9 23.3 5.8

8.7 12.4 6.1

7.9 9.3 4.9

7.6 10.1 5.0

Japan Korea, Rep of. Malaysia Philippines Singapore Thailand Viet nam

4.0 15.4 14.1 25.4 0.4 37.0  

3.6 11.2 12.6 20.8   40.2  

4.0 9.0 9.9 20.5 0.0 20.9 14.5

3.2 8.5 8.9 9.9     15.6

2.7 9.4 7.7 6.5 0.0 15.8 13.6

2.7 8.9 7.5 4.9 0.0 11.7 12.4

2.7 8.8 5.9 5.0 0.0 10.6 10.7

2.5 9.8 5.1 4.6 0.0 10.8 7.6

2.4 8.0 4.8 3.9 0.0 9.9 6.8

Source: The World Bank’s World Development Indicators, Washington DC: World.

76  Handbook on East Asian economic integration

3.2.1  Tariff cuts in East Asia in the 1980s and 1990s East Asian nations have substantially exerted efforts to promote trade liberalisation since the beginning of the 1990s. This is indicated in Table 4.2, which presents average applied tariffs of all products for major East Asian countries. This situation contrasts with that during the 1980s, when tariff cutting in East Asia was limited to Japan and Singapore. In addition, although India still has high tariffs, other East Asian countries reduced tariffs through the 1990s. Although most developed countries in the world have cut their tariffs through multilateral trade negotiations or the emergence of regionalism, tariff cuts in East Asia progressed as part of unilateral trade liberalisation. In the late 1980s and 1990s, inward FDI towards developing East Asian countries substantially increased. Rising wages in developed countries and falling trade and communication costs led firms in developed countries to increasingly relocate their labour-intensive production processes to low-wage countries while exporting skill-intensive intermediate goods from their home country to these countries. Fierce competition emerged among East Asian nations in terms of attracting FDI, which motivated them to unilaterally reduce tariffs on intermediate goods. Although imports of final goods remain blocked, input trade liberalisation fostered vertical FDI to East Asian countries (Hayakawa and Matsuura, 2015). Some countries established ‘duty drawbacks’ systems or duty-free treatments for plants in special export processing zones. However, these systems have been replaced by low or zero tariff rates for intermediate inputs. This phenomenon has been dubbed ‘race-to-the-bottom unilateralism’ (Baldwin, 2006). Furthermore, in 1996, major countries producing information technology (IT) goods agreed to cut their most-favourednation tariffs to zero for a specific list of IT goods through the Information Technology Agreement, which also fostered trade of electronic parts and components in East Asia. 3.2.2  Regional trade agreements in East Asia Regional trade agreements played almost no role in the development of trade in East Asia before 2000. Although the ASEAN Free Trade Agreement (AFTA) was established in 1992, progress in cutting intra-ASEAN tariffs was slow; as a result, the utilisation ratio of AFTA preferential tariffs remained at less than 3% (JETRO, 2003). This low usage reflected the fact that the majority of traded goods between the ASEAN member countries were of the electric machinery industry, and the applied tariffs for those products were already zero or at least very low before the conclusion of AFTA. However, triggered by the Asian financial crisis (1997–1998) and China’s WTO entry, ASEAN countries boldly took the initiative in forming FTAs, for example, starting with the ASEAN–China Free Trade Agreement (effective in 2004), which eliminated tariffs on almost all traded products between ASEAN and China by the year 2010. Following the ASEAN–China FTA, ASEAN extended its framework to other East Asian countries: ASEAN–Korea FTA (effective in 2007), ASEAN–Japan FTA (effective in 2008), ASEAN–Australia–New Zealand FTA (effective in 2010), and ASEAN–India FTA (effective in 2010). Through these new regional trade agreements, tariffs applied to trade between East Asian countries have gradually been eliminated. 3.2.3  Further trade facilitation efforts East Asian countries have made substantial efforts to facilitate trade. The Asia–Pacific Economic Cooperation (APEC) and ASEAN recognise that tariff cuts alone are not sufficient, but reducing non-tariff barriers or enhancing trade facilitation also plays an important role in fostering international trade. Although the progress in reducing non-tariff trade costs has been

Trade in goods with internationalised production activities 77

much more limited compared to tariff cuts, substantial efforts have been made by APEC and ASEAN. For example, since the 1990s, ASEAN has adopted common documentation and started setting up single window and single border crossings (Pomfret and Sourdin, 2009). APEC member countries that used to focus on traditional trade costs shifted their attention to trade facilitation in 2001 and quickly agreed upon ambitious steps to reduce broadly defined trade costs. In addition, they released APEC’s Trade Facilitation Action Plan (TFAP 1) as a road map for achieving their goals, with a focus on four main components: (i) custom procedures, (ii) standards and conformity assessment, (iii) business mobility, and (iv) electric commerce. In 2006, leaders set an additional trade cost reduction target (TFAP 2) for between 2007 and 2010, focusing on the four main components as in TFAP 1 (Shepherd, 2016). 3.2.4  Measuring trade costs and their determinants Measuring trade costs is not straightforward. Tariffs or non-tariff measures (NTMs) are both widely used to measure the trade costs. Although tariff data are accessible through the WTO’s Integrated database, NTM data are relatively hard to obtain. The WTO’s Integrated Trade Intelligence Portal (I-TIP) provides comprehensive information on the NTMs applied by WTO members in trade of both goods and services. I-TIP contains information on members’ notifications of NTMs as well as on ‘specific trade concerns’ raised by member countries at WTO committee meetings. And the data is available after 2008. However, since it is based on members’ notifications, its coverage is not comprehensive. Recently, the United Nations Conference on Trade and Development (UNCTAD) has developed a comprehensive database on NTMs, Trade Analysis Information System (TRAINS): The global database on NTMs by working on all regulations and official documents and classifying them in common methodology across countries.11 As of 2018, the available data is limited to the one collected in 2015. The other concern in using NTM data lies in the aggregation problem. Because trade policy instruments take various forms, one needs to devise a single measure able to encompass different types of trade policy instruments including non-automatic licensing requirements and technical regulations as well as temporary measures, such as anti-dumping duties. Against this backdrop, a large body of research has tried to estimate micro-founded measures of trade costs using international trade data.12 There are two approaches. The first is the so-called border effect estimation.13 Head and Mayer (2000) estimate border effect measures for the European Union (EU) to access the EU’s Single Market Programme by combining international and intra-national trade flows in a gravity framework. In this methodology, comparing international trade flows with intra-national trade flows (log-odds ratio) yields an indication of a ‘normal’ bilateral trade flow by considering usual determinants of trade. Hayakawa (2007) also uses the log-odds ratio method to estimate the border effects in East Asia for 1985, 1990, and 2000. De Sousa et al. (2012) use a comprehensive data set and explore the impact of regional trade agreements, such as the EU, North American Free Trade Agreement, ASEAN, and Southern Common Market (MERCOSUR). The second approach is the geometric average indicator of bilateral trade costs of Novy (2013), which is based on the structural gravity model. In this approach, Novy (2013) proposes an alternative bilateral trade cost measure, which is defined as the geometric mean of trade costs from country i to j and from j to i relative to intra-national trade costs within country i and country j. On the one hand, his methodology does not require the estimation of a gravity model. On the other hand, although it theoretically allows asymmetry of trade costs and unbalanced trade, it is not possible to quantify the asymmetry of bilateral trade costs.

350%

78  Handbook on East Asian economic integration 300%

286% 267%

250% 216% 204%

204% 200%

197%

197%

183%

204%

179% 168%

165%

149%

150% 131%

121%

100%

125% 114%

114%

112%

96%

89%

80%

71%

78%

50%

0%

Developing countries, average

China

India

Malaysia 1980/1988

1989/1997

Thailand

Korea

Indonesia

Philippines

1998/2006

Source: de Sousa et al. (2012).

Figure 4.3 Tariff Equivalent Trade Costs Faced by East Asian Exporters in Markets of Developed Countries

In what follows, we introduce the trade cost estimates according to the above first approach using the border effect estimates by de Sousa et al. (2012), which covers 151 countries and 26 industries in 1980–2006.14 Their estimates indicate that exporters in developing countries face 50% higher international trade costs compared with those in developed countries. However, trade costs faced by developing countries’ exporters substantially decreased from 1980 to 2006. In terms of tariff equivalents, trade costs had fallen from 183% to 89% since 1980. The East Asian countries also enjoyed improved access to developed countries’ markets. Figure 4.3 presents the tariff-equivalent trade cost estimates by exporting countries associated with their access to developed countries. Clearly, the trade costs for China, India, and Thailand have substantially decreased. For these three countries, while the levels of the border costs are higher than the average of developing countries in the 1970s, they have decreased from 204% to 80%, from 286% to 114%, and from 267% to 78% up to 2006, respectively. The estimates of de Sousa et al. (2012) suggest that the EU has had the lowest border effects among the member countries throughout the sample period. However, the North American Free Trade Agreement and ASEAN have substantially caught up with the EU, ending up almost reaching the EU’s level by the end of the 1990s.

4.  PROPERTIES OF EAST ASIAN MERCHANDISE TRADE Thanks to the advancement in the internationalisation of production activities, along with policy efforts to foster it, economic integration in terms of merchandise trade liberalisation has substantially progressed in East Asia. However, some concerns may arise regarding the

Trade in goods with internationalised production activities 79

sustainability of trade growth in the region. This section reviews the literature on the following issues: (i) Does the entry of China into the global market crowd out other East Asian countries? (ii) Does trade liberalisation benefit a handful of large firms only? (iii) Are trade linkages within supply chains in East Asia durable? 4.1  China’s Effect on other East Asian Countries The impact of China’s entry into the WTO has recently attracted much attention. The rise of China has provoked concerns of hollowing out of employment and heated competition for high-income countries in North America and Europe. For example, Autor et al. (2013) reveal that a rise in Chinese imports to the US had a substantial negative impact on local labour markets. Are the East Asian countries highly likely to be exposed to impacts arising from China’s emergence in the global market due to their geographical proximity to China? So far, many studies have extensively investigated China’s impact on other East Asian countries. However, existing evidence suggests that the negative impacts become significant only in some countries or sectors, such as labour-intensive industries. For example, Husted and Nishioka (2013) investigate whether countries lost market shares in the world market due to the growth of Chinese exports. They found strong evidence that rather than developing countries losing market shares, developed countries, especially Japan and the US, were the ones that suffered. Athukorala (2009) estimates a gravity model to examine the export performance of other East Asian countries. Focusing on machinery and transport equipment and distinguishing between final goods and parts and components, he finds that China’s impact is complementary rather than competitive and concludes that the growth of Chinese exports created opportunities for the other East Asian countries to specialise in producing parts and components.15 More recent studies have used plant-product level data to access how firms in East Asian countries reacted to the increases in exports by China. For example, Ing, Yu, and Zhang (2016) investigate the impact of quality upgrades of Chinese exporters on Indonesian plants. The authors find that Indonesian plants increase productivity by 0.4–0.5% in response to a 10% increase in Chinese export quality. They also confirm that such an effect is more pronounced among Indonesian exporting plants. 4.2  Is International Trade in East Asia Dominated by Large Firms? Since the mid-1990s, the increased availability of firm-level data has revealed that not all firms in an industry engaged in international trade and that exporting firms are larger in terms of both sales and employment in addition to having higher productivity and paying higher wages.16 To explain this empirical evidence, Melitz (2003) developed the cornerstone of the theoretical model of monopolistic competition with firm heterogeneity.17 His model provides new insight regarding the within-industry reallocation effect of trade liberalisation and shows that multilateral trade liberalisation leads to average productivity gains through market reallocation. A reduction in trade costs raises the profits of exporting firms in both home and foreign countries and, as a result, both exports and imports will increase. In a heterogeneous firm framework, while more productive firms or larger firms enter the export market and increase their production, non-exporting smaller firms lose market shares due to the surge of imports. Such a market reallocation results in average productivity improvements. However, one may be concerned as to whether or not this insight implies trade liberalisation may benefit small and medium-sized enterprises (SMEs).

80  Handbook on East Asian economic integration

So far, the validity of the Melitz model has been scrutinised by various studies across different countries. However, some studies reveal that neither productivity nor firm size is a dominant factor among determinants of a firm’s decision on whether to export. For example, Todo (2011) reports that although the effect of firm productivity is significantly positive on a firm’s decision to export, its impact is economically negligible, implying that not all large and highly productive firms engage in export or some small firms export their products. Other studies have explored a range of factors that determine the decision to enter the export market. For example, Manova et al. (2015) utilise Chinese firm-level data and show that financial condition does matter for export propensity. Koening et al. (2010) highlight export spillover effects from neighbouring firms. They use French firm-level trade data and find a positive relationship between export propensity and the presence of neighbouring exporting firms. Inui et al. (2015) utilise a Japanese firm-level panel data set where firms are matched with lender banks; they find that information provided by lender banks significantly impacts a firm’s decision to export. These studies imply that policy efforts to remove financial constraints and to mitigate the information asymmetry of foreign market environment may enhance exports by the SMEs. In addition to reallocation effects, a large body of research has argued that engaging in international trade enhances firm productivity. The causal effect of firms’ export on their productivity is often referred to as ‘learning-by-exporting’. De Loecker (2007, 2011) for Slovenia, Park et al. (2010) for China, and Hahn (2005) for Korea find that firms engaged in exports improve their productivity. Lileeva and Trefler (2010) and Bustos (2011) take a step further to investigate the mechanics behind this relationship. They argue that improved access to foreign markets induces firms to simultaneously increase exports, invest in new production facilities, and adopt new technologies. Using Canadian and Argentine firm-level data, they show that investing in more advanced technologies associated with trade liberalisation induces increases in exports and productivity improvements. As for case studies on East Asian countries, Hahn (2012) for Korea, Ito and Lechevalier (2010) for Japan, and Lee (2012) for Malaysia present evidence that exports have a complementary relationship with innovation in terms of adding new products and investment in research and development (R&D). A large body of research has also showed that imported intermediate goods improve firmlevel productivity. Findings by Amiti and Konings (2007) for Indonesia, Goldberg et al. (2010) for India, and Yu (2015) for China all suggest that input tariff reductions lead to increases in imported intermediate goods, enhancing firm productivity. Chen et al. (2017) investigate the impact of input imports on firm-level innovation activity using Chinese firm-level data. They construct a theoretical model where imports stimulate innovation through cost-reducing knowledge spillovers and demonstrate the existence of a complementary relationship between input imports and innovation. They also find that this relationship is more pronounced for imports from high-income countries and for firms in high-tech industries. These results jointly imply that input trade liberalisation stimulates a firm’s innovation in addition to increasing imports of intermediate goods. Furthermore, it results in improved firm productivity. Considering that trade of parts and components has significantly increased in East Asia, firms in the region might improve their productivity by importing intermediate input.

Trade in goods with internationalised production activities 81

4.3  Durability of Supply-Chain Trade in East Asia East Asian countries have become integrated into the regional and world economy by their involvement in internationalised production activities, particularly in machinery industries. Cross-border transactions of intermediate goods through supply chains may evoke the image of footloose investments and may be expected to be not durable. The empirical evidence for East Asia’s trade in machinery parts and components, however, shows that trade linkages through machinery supply chains are rather longer-lived and more stable compared to other types of transactions (Obashi, 2010). This appears to be due to the relation-specific nature of transactions through supply chains unlike those on the spot market with open bidding. Moreover, global supply chains are often blamed as an explanation for the synchronicity and severity of the great trade collapse in 2008–2009 (Bems et al., 2011).18 For Japanese exports of machinery parts and components to neighbouring Asian countries, however, Okubo et al. (2014) present empirical evidence that the impact of the crisis on trade is mainly through the intensive margin and that even once-disrupted trade linkages are more likely to recover quickly compared to other products. Similar empirical evidence suggesting the durability and resilience of trade linkages via supply chains in East Asia is found in Obashi (2011) for the Asian Currency Crisis and Ando and Kimura (2012) for the Great East Japan Earthquake. In the recently heated debate on the factors explaining the ‘slow trade’ phenomenon, in the sense that the increase in world trade volume has been sluggish compared to the growth in world aggregate income since 2010, the durability or potentiality of supply-chain trade in East Asia has been questioned. Ferrantino and Taglioni (2014) argue that global supply chains have contributed to the trade slowdown because the goods that are produced through global supply chains are more sensitive to changes in income than those that are not. From the viewpoint of structural changes in the expansion or contraction of global supply chains, there is also an argument that the growth of gross trade flows will definitely slow down, even if income increases, as at some point firms achieve what they perceive as the optimally dispersed formation of supply chains across borders (see Hoekman, 2015). For example, Constantinescu et al. (2015) argue that the world trade growth has recently been sluggish because China and other emerging countries improved the domestic supply capabilities of once-imported intermediate goods and processing exporters came to rely less on foreign intermediates. Indeed, Kee and Tang (2016) find that such structural transformation accounts for a rise in the domestic value-added ratio of Chinese gross exports, supporting the view that China’s international supply chains may have matured and reached a turning point to contraction. Obashi and Kimura (2018), on the other hand, scrutinise the finely disaggregated gross-value trade data and claim that the recent trade slowdown was attributed mainly to a sluggish growth in trade of primary goods and processed raw materials but not due to a decrease of trade in manufactured parts and components through production networks at least in East Asia.

5.  CONCLUDING REMARKS In this chapter, we overviewed how East Asian economic integration through trade in goods has progressed so far. East Asian countries are increasingly integrated into the regional and world economy by involvement in internationalised production activities, particularly in

82  Handbook on East Asian economic integration

machinery industries, which results in the growing importance of trade in manufactured parts and components especially within the region. We then sorted out the conditions for promoting the geographic separation of firms’ production activities and the expansion of East Asian trade concentrating on manufactured parts and components, ranging from the initial conditions to policy efforts and international cooperation. We also discussed the sustainability of the trade expansion in the East Asian region by looking at empirical evidence found in recent studies. Several policy challenges still exist for further integration in East Asia. Firstly, while tariffs have been reduced and are already reaching low levels, non-tariff barriers remain a key issue in further liberalising and facilitating trade in goods in East Asia. Although many NTMs are primarily implemented for public health or environment protection purposes, they might unnecessarily increase the trade costs in favour of domestic producers. There is a need to improve the transparency of existing NTMs and to increase the economic cooperation in East Asia for greater mutual recognition or harmonisation of technical regulations and product standards through regional and multilateral agreements. Secondly, the development and internationalisation of SMEs are also equally an important policy agenda. Existing studies suggest that involvement in exporting or importing has a complementary relationship with innovation activities and thereby increases productivity. Several studies have also highlighted the major obstacles faced by firms to participation in exporting or importing activities due to heavy financial constraints and information asymmetry of the foreign business environment as well as low productivity of SMEs. Such barriers should be removed in a beneficial way for the development of SMEs. There are several research areas where we could significantly contribute to the literature. Firstly, although the internationalisation of production activities has expanded East Asian trade, and East Asian economic integration has progressed with the strengthening of industrial vertical linkages across borders, there is still ample room for expanding and deepening East Asian production networks. Future research might examine if Viet Nam, which is emerging as an active player in regional production networks, and other ASEAN latecomers, could participate in production networks by enhancing the locational advantages through industrial promotion policies. Secondly, we need to carefully examine the impact of upgrading local industrial agglomerations on international trade. For example, local input suppliers in China and other emerging countries are becoming competitive by improving productivity through their participation in production networks and due to the upgrading of the industrial base. These emerging countries come to rely less on imported foreign intermediate inputs. Such re-bundling or reshoring of production stages or tasks implies that the expansion of production networks would gradually cease, and the supply-chain trade would slow down, leading to a decline in the foreign valueadded content of exports. Future research should carefully evaluate the implications of such re-bundling momentum in emerging countries on the overall trend of merchandise trade and on economic welfare. Thirdly, the firms’ global operation related to sales and procurement patterns are increasingly diversified and complicated: Instead of traditional horizontal and vertical FDI, an export platform FDI with a complex procurement strategy is becoming more pervasive (Baldwin and Okubo, 2014). The impact of the upcoming waves of the digital economy on the firms’ global operation needs to be examined carefully. These changes in technological and economic environment should be considered to examine how the supply-chain trade and, ultimately, the overall trend of merchandise trade will be transformed to a ‘new normal’.

Trade in goods with internationalised production activities 83

NOTES   1. In the RIETI-TID, trade data are available only at the industry level, covering 13 manufacturing industries, some of which include agriculture and mining as an upstream sector. For more details on the database, see the webpage of RIETI: https://www.rieti.go.jp/en/projects/rieti-tid/pdf/1704.pdf.   2. Data for the Lao PDR and Myanmar are not available in the RIETI-TID. Data for Brunei and Cambodia are not fully available throughout the period of interest but are included as part of East Asia. We include only mainland China as ‘China’ and exclude the Special Administrative Region of Hong Kong from our data set.   3. The geographic separation of firms’ production activities across borders has been described under different names from time to time, such as, ‘fragmentation’ (Jones and Kierzkowski, 1990); ‘slicing the value chain’ (Krugman, 1995); ‘outsourcing’ (Feenstra and Hanson, 1996); ‘global production sharing’ (Yeats, 1998); ‘vertical specialisation’ (Hummels et al., 2001); and ‘second unbundling’ (Baldwin, 2016).   4. Ando and Kimura (2005) scrutinised product descriptions of HS codes to create a list for machinery parts and components, which has been revised with more stringent criteria and updated for newer versions of the HS classification by Kimura and Obashi (2010). Similarly, Ng and Yeats (2001) identified Standard International Trade Classification (SITC) product groups that consist solely of components with special interest in the machinery and transport equipment sector. Schott (2004) created a list of HS codes for intermediate goods of machinery and other manufacturing industries by simply checking if each product description contains the word ‘parts’ or ‘component’. Athukorala and Yamashita (2006) consider products categorised under SITC 7 and 8 roughly as parts and components.   5. Kimura and Obashi (2010) report in more detail that machinery parts and components exported and imported by East Asian countries are often related to information and communications technology.   6. The proportion of machinery as a whole, including both parts and components and the final goods, in the total manufacturing exports and imports by these ASEAN forerunners reach 60%–70%.   7. This is in line with a mechanism underlying the ‘multiplier’ trade effects of tariff reductions discussed in Yi (2003).   8. To calculate foreign value-added embodied in exports, we usually must take on the brave assumption that imported intermediate inputs are used evenly in production for domestic sales and for exports. But for some countries, such as China, tariffs on imported intermediates are suspended if used to make goods that are subsequently exported abroad, and thereby customs keep track of the imported intermediates to be exported. Some studies use such special data for so-called processing trade to estimate the foreign value-added content, considering distinct input–output coefficients for processing exports, non-processing exports, and products for domestic use (Chen et al., 2012; Koopman et al., 2012; Upward et al., 2013).   9. The latest 2015 version of the OECD-WTO TiVA database is updated on 4 June 2015 and contains a range of indicators measuring the value-added content of international trade flows, which are derived from the 2015 version of OECD’s Inter-country Input–Output (ICIO) database. To create Figure 4.2, we used indicators for the latest available year of 2011. As in the ICIO database, the industry classification in the TiVA follows the International Standard Industrial Classification (ISIC) Rev. 3. Manufactured goods range from C15T16 to C36T37 and, among them, machinery industries include C29, C30T33, and C34T35. 10. Aldaba (2017) and Tham and Kam (2017) conduct the similar trade-in-value-added analysis for the Philippines and Malaysia, respectively. 11. For ASEAN countries, the detailed procedure to develop this database is reported in Ing, de Cordaba, and Cadot (2016). 12. Some alternative trade cost measures exist. The first is the one proposed by Kee et al. (2009) that overcomes aggregation problems by using both international trade data and NTMs. They estimate a reduced-form import demand function and assess the impact of NTMs on imports to derive trade restrictiveness indices. Their estimates are available on the World Bank website as overall trade restrictiveness indices. Unfortunately, the available data are cross section, covering 167 countries only for 2009. The second is a trade cost measure defined as a gap between free-on-board (FOB) export and import values that include costs, insurance, and freight (CIF). For example, Pomfret and Sourdin (2009) use Australian FOB and CIF import value data and calculate the trade cost based on the gap between FOB and CIF values. They then explore how ASEAN countries reduced trade costs between 1990 and 2007. Although this indicator is simple and easy to calculate, the availability of necessary data is limited to a few countries; most countries provide only the CIF value for imported goods. 13. The border effect estimation dates back to McCallum (1995) and Anderson and van Wincoop (2003), who estimated gravity equations using both intra-national and international trade data. However, those studies used importer and exporter fixed effects to control price indices, which prevent us from estimating origin- or destination-specific border effects. The method of Head and Mayer (2000) enables us to cancel out the price indices and identify the origin- or destination-specific trade cost by taking the log-ratio of international and intra-national trade. 14. An alternative data source for trade cost estimates is the Economic and Social Commission for Asia and the Pacific (ESCAP)–World Bank Trade Cost Database. This database contains the trade cost measure calculated according

84  Handbook on East Asian economic integration

15.

16. 17. 18.

to the methodology of Novy (2013), covering 178 economies in 1995–2015. We prefer estimates by de Sousa et al. (2012) because they cover pre-liberalisation periods. Recently, several studies extensively investigated China’s impact on their local employment in various countries. For the US, Autor et al. (2013) demonstrate that 26% of the decline in US manufacturing jobs from 2000 to 2007 can be explained by rising China import exposure. Malgouyres (2016) for France, Balsvik et al. (2015) for Norway, and Donoso et al. (2015) for Spain report the same pattern as in the US regarding the impact of Chinese imports on local employment. Dauth et al. (2014) compare the impact of trade with Eastern Europe and China on local labour markets in Germany; they found a positive employment effect in export-oriented industries as well as negative impact in import-competing industries. In contrast, East Asian and Southeast Asian countries have benefited from expanded exports to China in export-oriented industries. For example, Feenstra and Sasahara (2018) use global input–output (I/O) tables to quantify China’s employment creation effect in the East Asian and ASEAN countries using global I/O tables. They report that exports to China from ASEAN and East Asian countries contributed to the annual growth of job compensation of 11% in 1990–2013. A pioneering study by Bernard and Jensen (1999) reveal that firms that are larger in terms of both sales and employment are more productive and pay higher wages. In East Asian countries, Aw et al. (2000) for Taiwan, Hahn (2005) for Korea, and Kimura and Kiyota (2006) for Japan demonstrated a similar tendency for exporting firms. One of his model’s major features is the existence of fixed export costs, which means that firms whose productivity is high enough to gain profit by serving foreign countries will become exporters. See Bems et al. (2013) for the literature survey on causes of the great trade collapse.

REFERENCES Aldaba, R. (2017), ‘The Philippines in the Electronics Global Value Chain: Upgrading Opportunities and Challenges’, in L.Y. Ing and F. Kimura (eds.), Production Networks in Southeast Asia. London: Routledge, pp.108–137. Amador, J. and S. Cabral (2009), ‘Vertical Specialization across the World: A Relative Measure’, The North American Journal of Economics and Finance, 20(3), pp.267–80. Amiti, M. and J. Konings (2007), ‘Trade Liberalization, Intermediate Inputs, and Productivity: Evidence from Indonesia’, American Economic Review, 97(5), pp.1611–38. Anderson, J.E. and E. van Wincoop (2003), ‘Gravity with Gravitas: A Solution to the Border Puzzle’, American Economic Review, pp.170–92. Ando, M. and F. Kimura (2005), ‘The Formation of International Production and Distribution Network in East Asia’, in T. Ito and A.K. Rose (eds.), International Trade in East Asia (NBER-East Asia Seminar on Economics 14). Chicago, IL: University of Chicago Press/NBER, pp.177–216. Ando, M. and F. Kimura (2012), ‘How did the Japanese exports respond to two crises in the international production networks? The Global Financial Crisis and the East Japan earthquake’, Asian Economic Journal, 26(3), pp.261–87. Athukorala, P.-C. (2009), ‘The Rise of China and East Asian Export Performance: Is the Crowding-Out Fear Warranted?’, The World Economy, 32(2), pp.234–66. Athukorala, P.-C. and N. Yamashita (2006), ‘Production Fragmentation and Trade Integration: East Asia in a Global Context’, The North American Journal of Economics and Finance, 17(3), pp.233–56. Autor, D.H., D. Dorn and G.H. Hanson (2013), ‘The China Syndrome: Local Labor Market Effects of Import Competition in the United States’, American Economic Review, 103(6), pp.2121–68. Aw, B.Y., S. Chung and M.J. Roberts (2000), ‘Productivity and Turnover in the Export Market: Micro-level Evidence from the Republic of Korea and Taiwan (China)’, The World Bank Economic Review, 14(1), pp.65–90. Baldwin, R.E. (2016), The Great Convergence: Information Technology and the New Globalization. Cambridge, MA: The Belknap Press of Harvard University Press. Baldwin, R.E. (2006), ‘Multilateralising Regionalism: Spaghetti Bowls as Building Blocks on the Path to Global Freed Trade’, The World Economy, 29(11), pp.1451–1518. Baldwin, R.E. and J. Lopez-Gonzalez (2015), ‘Supply-chain Trade: A Portrait of Global Patterns and Several Testable Hypotheses’, The World Economy, 38(11), pp.1682–1721. Baldwin, R.E. and T. Okubo (2014), ‘Networked FDI: Sales and Sourcing Patterns of Japanese Foreign Affiliates, The World Economy, 37(8), pp.1051–80. Balsvik, R., S. Jensen and K.G. Salvanes (2015), ‘Made in China, sold in Norway: Local labor market effects of an import hock’, Journal of Public Economics, 127, pp.137–44. Bems, R., R.C. Johnson and K.-M. Yi (2011), ‘Vertical Linkages and the Collapse of Global Trade’, American Economic Review: Papers and Proceedings, 101(3), pp.308–12. Bems, R., R.C. Johnson and K.-M. Yi (2013), ‘The Great Trade Collapse’, Annual Review of Economics, 5(1), pp.375–400.

Trade in goods with internationalised production activities 85 Bernard, A.B. and J.B. Jensen (1999), ‘Exceptional Exporter Performance: Cause, Effect or Both?’, Journal of International Economics, 47(1), pp.1–25. Bustos, P. (2011), ‘Trade Liberalization, Exports, and Technology Upgrading: Evidence on the Impact of MERCOSUR on Argentinian Firms’, American Economic Review, 101, pp.304–40. Chen, Z., J. Zhang and W. Zheng (2017), ‘Import and Innovation: Evidence from Chinese firms’, European Economic Review, 94, pp.205–20. Chen, X., L.K. Cheng, K.C. Fung, L.J. Lau, Y.-W. Sung, K. Zhu, C. Yang, J. Pei and Y. Duan (2012), ‘Domestic value added and employment generated by Chinese exports: a quantitative estimation’, China Economic Review, 23, pp.850–64. Constantinescu, C., A. Mattoo and M. Ruta (2020), ‘The Global Trade Slowdown: Cyclical or Structural?’, World Bank Economic Review, 34(1), pp.121–42. Daudin, G., C. Rifflart and D. Schweisguth (2011), ‘Who Produces for Whom in the World Economy?’, Canadian Journal of Economics, 44(4), pp.1403–37. Dauth, W., S. Findeisen and J. Suedekum (2014), ‘The Rise of the East and the Far East: German Labor Markets and Trade Integration’, Journal of the European Economic Association, 12(6), pp.1643–75. De Loecker, J. (2007), ‘Do Exports Generate Higher Productivity? Evidence from Slovenia’, Journal of International Economics, 73(1), pp.69–98. De Loecker, J. (2011), ‘Product Differentiation, Multiproduct Firms, and Estimating the Impact of Trade Liberalization on Productivity’, Econometrica, 79(5), pp.1407–51. Donoso, V., V. Martin and A. Minondo (2015), ‘Do Differences in the Exposure to Chinese Impacts Lead to Differences in Local Labour Market Outcomes? An Analysis for Spanish Provinces’, Regional Studies, 49(10), pp.1746–64. DOI: 10.1080/00343404.2013.879982. Feenstra, R.C. and G.H. Hanson (1996), ‘Foreign Investment, Outsourcing and Relative Wages’, in R.C. Feenstra, G.M. Grossman and D.A. Irwin (eds.) The Political Economy of Trade Policy: Papers in Honor of Jagdish Bhagwati. Cambridge, MA: MIT Press, pp.89–127. Feenstra, R.C. and A. Sasahara (2018), ‘The China Shock in Trade: Consequences for ASEAN and East Asia’, in L.Y. Ing and M. Yu (eds.), World Trade Evolution: Growth, Productivity and Employment. Routledge, forthcoming. Ferrantino, M. and D. Taglioni (2014), ‘Global Value Chains in the Current Trade Slowdown’, World Bank Economic Premise, No. 137, Washington DC: World Bank. Fukao, K., H. Ishido and K. Ito (2003), ‘Vertical Intra-Industry Trade and Foreign Direct Investment in East Asia’, Journal of the Japanese and International Economics, 17(4), pp.468–506. Goldberg, P., A. Khandelwal, N. Pavcnik and P. Topalova (2010), ‘Imported Intermediate Inputs and Domestic Product Growth: Evidence from India’, The Quarterly Journal of Economics, 125(4), pp.1722–67. Hayakawa, K. (2007), ‘Measuring Barriers to International Division of Labor in East Asia’, Asian Economic Journal, 21(2), pp.139–53. Hayakawa, K. and T. Matsuura (2015), ‘Trade liberalization in Asia and FDI strategies in heterogeneous firms: evidence from Japanese firm-level data’, Oxford Economic Papers, 67(2), pp.494–513. Hahn, C.-H. (2012), ‘Learning-by-Exporting, Introduction of New Products, and Product Rationalization: Evidence from Korean Manufacturing’, The B.E. Journal of Economic Analysis and Policy, 12(1), pp.1–37. https://doi. org/10.1515/1935-1682.2705. Hahn, C.-H. (2005), ‘Exporting and Performance of Plants: Evidence on Korea’, in T. Ito and A.K. Rose (eds.), International Trade in East Asia (NBER-East Asia Seminar on Economics 14). Chicago, IL: University of Chicago Press/NBER, pp. 53–80. Head, K. and T. Mayer (2000), ‘Non-Europe: The Magnitude and Causes of Market Fragmentation in the EU’, Review of World Economics, 136(2), p.28. Husted, S. and S. Nishioka (2013), ‘China’s Fare Share? The Growth of Chinese Exports in World Trade’, Review of World Economics, 149(3), pp.565–85. Hoekman, B. (2015), The Global Trade Slowdown: A New Normal. VoxEU.org (eBook). Hummels, D., J. Ishii and K.-M. Yi (2001), ‘The Nature and Growth of Vertical Specialization in World Trade’, Journal of International Economics, 54(1), pp.75–96. Ing, L.Y., S. de Cordaba and O. Cadot (2016), Non-Tariff Measures in ASEAN. Jakarta: Economic Research Institute for ASEAN and East Asia. Ing, L.Y., M. Yu and R. Zhang (2016), ‘Indonesia and China: Friends or Foes? Quality Competition and Firm Productivity’, ERIA Discussion Paper Series, DP-2016-29, Jakarta: ERIA. Inui, T., K. Ito and D. Miyagawa (2015), ‘Overseas Market Information and Firms’ Export Decisions’, Economic Inquiry, 53(3), pp.1671–88. Ito, K. and S. Lechevalier (2010), ‘Why some firms persistently out-perform others: investigating the interactions between innovation and exporting strategies’, Industrial and Corporate Change, 19(6), pp.1997–2039. Japan External Trade Organization (JETRO) (2003), Current Status of AFTA and Corporate Responses, November, Japan: JETRO.

86  Handbook on East Asian economic integration Johnson, R.C. and G. Noguera (2012), ‘Accounting for Intermediates: Production Sharing and Trade in Value Added’, Journal of International Economics, 86(2), pp.224–36. Johnson, R.C. and G. Noguera (2017), ‘A Portrait of Trade in Value Added over Four Decades,’ The Review of Economics and Statistics, forthcoming. Jones, R.W. and H. Kierzkowski (1990), ‘The Role of Services in Production and International Trade: A Theoretical Framework’, in R.W. Jones and A.O. Krueger (eds.), The Political Economy of International Trade. Oxford: Blackwell, pp.31–48. Kee, H.L., N. Alessandro and M. Olarreaga (2009), ‘Estimating Trade Restrictiveness Indices’, The Economic Journal, 119, pp.172–99. Kee, H.L. and H. Tang (2016), ‘Domestic Value Added in Exports: Theory and Firm Evidence from China’, American Economic Review, 106(6), pp.1402–36. Kimura, F. and K. Kiyota (2006), ‘Exports, FDI and Productivity: Dynamic Evidence from Japanese Firms’, Review of World Economics, 142(4), pp.695–719. Kimura, F. and A. Obashi (2010), ‘International Production Networks in Machinery Industries: Structure and Its Evolution’, ERIA Discussion Paper Series, DP-2010-09, Jakarta: Economic Research Institute for ASEAN and East Asia (ERIA). Kimura, F., Y. Takahashi and K. Hayakawa (2007), ‘Fragmentation and Parts and Components Trade: Comparison between East Asia and Europe’, North American Journal of Economics and Finance, 18(1), pp.23–40. Koening, P., F. Mayneris and S. Poncet (2010), ‘Local Export Spillovers in France’, European Economic Review, 54(4), pp.622–41. Koopman, R., W. Powers, Z. Wang and S.-J. Wei (2010), ‘Give Credit Where Credit is Due: Tracing Value Added in Global Production Chains’, Research Working Paper, 16426. Koopman, R., Z. Wang and S.-J. Wei (2012), ‘Estimating domestic content in exports when processing trade is pervasive’, Journal of Development Economics, 99(1), pp.178–189. Krugman, P.R. (1995), ‘Growing World Trade: Causes and Consequences’, Brookings Papers on Economics Activity, 1, pp.327–62. Lee, C. (2012), ‘Exporting, productivity and innovation in Malaysian manufacturing’, in S. Urata, C.H. Hahn and D. Narjoko (eds.), Economic Consequences of Globalization: Evidence from East Asia. London: Routledge. Lileeva, A. and D. Trefler (2010), ‘Improved Access to Foreign Markets Raises Plant-Level Productivity…For Some Plants’, The Quarterly Journal of Economics, pp.1051–99. Manova, K., S.-J. Wei and Z. Zhang (2015), ‘Firm Exports and Multinational Activity Under Credit Constraints’, The Review of Economics and Statistics, 97(3), pp.574–88. Malgouyres, C. (2016), ‘The Impact of Chinese Import Competition on the Local Structure of Employment and Wages: Evidence from France’, Journal of Regional Science, forthcoming. McCallum, J. (1995), ‘National Borders Matter: Canada–US Regional Trade Patterns’, American Economic Review, 85(3), pp.615–23. Melitz, M.J. (2003), ‘The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity’, Econometrica, 71(6), pp.1695–1725. Ng, F. and A. Yeats (2001), ‘Production sharing in East Asia: Who does what for whom and why?’, in L.K. Cheng and H. Kierzkowski (eds.), Global production and trade in East Asia. Boston: Kluwer Academic Publishers, pp. 63–109. Novy, D. (2013), ‘Gravity Redux: Measuring International Trade Costs with Panel Data’, Economic Inquiry, 51(1), pp.101–21. Obashi, A. (2010), ‘Stability of production networks in East Asia: Duration and survival of trade’, Japan and the World Economy, 22(1), pp.21–30. Obashi, A. (2011), ‘Resiliency of production networks in Asia: Evidence from the Asian crisis’, in S.J. Evenett, M. Mikic and R. Ratnayake (eds.) Trade-led Growth: A Sound Strategy for Asia. New York: United Nations Economic and Social Commission for Asia and the Pacific (ESCAP), pp.29–52. https://doi.org/10.18356/4eb29f66-en. Obashi, A. and F. Kimura (2017), ‘Deepening and Widening of Production Networks in ASEAN’, Asian Economic Papers, 16(1), pp.1–27. Obashi, A. and F. Kimura (2018), ‘Are Production Networks Passé in East Asia? Not Yet’, Asian Economic Papers, 17(3), pp.86–107. Okubo, T., F. Kimura and N. Teshima (2014), ‘Asian Fragmentation in the Global Financial Crisis’, International Review of Economics and Finance, 31, pp.114–27. Park, A., D. Yang, X, Shi and Y. Jiang (2010), ‘Exporting and Firm Performance: Chinese Exporters and the Asian Financial Crisis’, Review of Economics and Statistics, 92(4), pp.822–42. Pomfret, R. and P. Sourdin (2009), ‘Have Asian Trade Agreement Reduced Trade Costs?’, Journal of Asian Economics, 20, pp.255–68. RIETI (2017), RIETI-TID 2015. http://www.rieti-tid.com/index.php (accessed 15 March 2018). Schott, P.K. (2004), ‘Across-Product Versus Within-Product Specialization in International Trade’, The Quarterly Journal of Economics, 119(2), pp.647–78.

Trade in goods with internationalised production activities 87 Shepherd, B. (2016), ‘Did APEC’s Trade Facilitation Action Plans Deliver the Goods?’, Journal of Asian Economics, 43, pp.1–11. de Sousa, J., T. Mayer and S. Zignago (2012), ‘Market Access in Global and Regional Trade’, Regional Science and Urban Economics, 42(6), pp.1037–52. Tham, S.Y. and A.J.Y. Kam (2017), ‘Trade in Value Added: The Case of Malaysia’, in L.Y. Ing and F. Kimura (eds.), Production Networks in Southeast Asia. London: Routledge. pp.85–107. Todo, Y. (2011), ‘Quantitative Evaluation of Determinants of Export and FDI: Firm-level Evidence from Japan’, The World Economy, 34(3), pp.355–81. Upward, R., Z. Wang and J. Zheng (2013), ‘Weighing China’s export basket: the domestic content and technology intensity of Chinese exports’, Journal of Comparative Economics, 41, pp.527–43. Yeats, A. (1998), ‘Just How Big Is Global Production Sharing?’ Policy Research Working Paper, 1871, Washington, DC: World Bank. Yi, K. (2003), ‘Can Vertical Specialization Explain the Growth of World Trade?’, Journal of political Economy, 111(1), pp.52–102. Yu, M. (2015), ‘Processing Trade, Tariff Reductions, and Firm Productivity: Evidence from Chinese Firms’, Economic Journal, 125(585), pp.943–88.

5.

FDI activities and integration in ASEAN and East Asia Shandre Mugan Thangavelu, Shujiro Urata, and Dessie Tarko Ambaw

1. INTRODUCTION Over the past five decades, East Asia – particularly the member countries of the Association of Southeast Asian Nations (ASEAN) – has relied heavily on multinational corporations (MNCs) to maintain its competitiveness and economic growth. Firstly, foreign direct investment (FDI) causes an injection of capital, new technologies, marketing techniques, and management skills into the domestic economy, potentially raising its competitiveness and output growth. Secondly, FDI can create positive externalities by raising the productivity levels of domestic firms. It is highly likely that the production activities of MNCs could have a significant impact on the operational structure of domestic industries. FDI has played an instrumental role in the economic growth of ASEAN across time, from the flying-geese model of dynamic comparative advantage to the recent development of a global value chain (GVC) integrating East Asia and ASEAN into the regional and global economy. To increase such integration with the regional and global economy, ASEAN is very active in developing key policies, both multilaterally and unilaterally, to integrate FDI and multinational activities in the domestic economy and the region. Given the benefits of FDI, ASEAN countries compete for foreign investment by providing tax incentives, subsidising capital investments, providing extended tax holidays, creating export processing zones, establishing science parks, and liberalising the flow of capital into the domestic economy. A deeper understanding was forged between the diverse countries, and this led to the conclusion of the agreement to set up the ASEAN Free Trade Area (AFTA) in 1992. This agreement aimed to attract more intra- as well as extra-ASEAN FDI through active liberalisation of FDI restrictions within the ASEAN countries. By 1998, the ASEAN Investment Area (AIA) was formed, and it is considered the most significant attempt by ASEAN at liberalising FDI restrictions in the region (Plummer, 2009). The ASEAN Comprehensive Investment Agreement (ACIA) was adopted in 2009 to complement the ASEAN Economic Community (AEC), built on the AIA and Investment Guarantee Agreement (IGA). For the past two decades, ASEAN has been undergoing an important period of regional economic integration. Through the formation of the AEC in 2015, ASEAN targets achieving ‘a single market and production base’, a ‘highly competitive economic region’, a region with ‘equitable economic development’, and one which is ‘fully integrated into the global economy’ (ASEAN Secretariat, 2010: 3). ASEAN aims to build on past agreements such as the AFTA and AIA and to work towards achieving a ‘free and open investment regime’ in the AEC to attract both intra- and extra-ASEAN FDI, with the adoption of the ACIA (ASEAN Secretariat, 2010). Since the 1990s, we can observe a dramatic rise in FDI inflows to ASEAN, with an accompanied increase in the number and intensity of regional trade agreements (RTAs), many of which include key provisions for FDI. 88

FDI activities and integration in ASEAN and East Asia 89

In recent years, the share of global FDI inflows to ASEAN has shown a declining trend. ASEAN’s share of global FDI inflows from 1980 to 2009 dropped from a pre-Asian financial crisis peak of 8.8% in 1991 to only 3.3% in 2009. ASEAN’s share since 2000 is also notably lower than in the 1980s. This chapter examines the development of FDI activities and policies in East Asia, focusing on ASEAN. It discusses the literature on FDI activities in the domestic economy in terms of spillovers, linkages, the GVC, the global network economy, FDI policies, and regional institutional development in investment in ASEAN. This chapter also provides policy discussions and recommendations for further investment liberalisation in the region.

2.  FDI ACTIVITIES AND DEVELOPMENT 2.1  Advantages and Disadvantages of FDI Activities in the Domestic Economy FDI has several potential economic and social benefits for host countries. For example, it helps to create highly skilled and highly paid jobs, increase the transfer of knowledge, enhance domestic productivity, and diversify and upgrade the value-added component of export goods and services (Echandi, Krajcovicova, and Qiang, 2015). All these potential benefits of FDI help to increase a country’s ability to integrate more with the GVC and generate gains from it. 2.2  FDI and Productivity FDI could have a direct and indirect impact on the productivity of domestic firms if the necessary preconditions, such as domestic absorptive capacity, exist in the host economy. This subsection reviews the literature on the effect of FDI on increasing productivity in the host country, i.e. how foreign acquisition of domestic firms affects the productivity of such firms. One of the earliest studies in this area was Conyon et al. (2002), which investigated the effect of foreign ownership of manufacturing firms in the United Kingdom (UK) on firm productivity and wages. Using a specially constructed database of ownership changes for 1989–1994, they found that foreign-owned firms paid 3.4% more in real wages than domestic firms. In addition, the labour productivity of foreign-acquired firms increased by about 13%, suggesting that foreign acquisition of firms improves both wages and productivity in a developed country context. Similarly, Harris and Robinson (2003) provided additional evidence on the role of foreign-owned plants on firm productivity. By using UK manufacturing data for 1974–1995, they found that foreign-owned firms were more productive than domestic firms. Some studies have examined individual manufacturing sectors in developed countries and investigated the effect of foreign acquisition on firm productivity, providing detailed evidence on the benefits of foreign acquisition on firm productivity. For example, Girma and Görg (2007) explored the relationship between foreign ownership and productivity in the UK’s electronic and food industries. Using a combined propensity score and difference-in-differences approach, they showed that any positive impact of acquisition is mainly due to changes in technical efficiency. Furthermore, they highlighted that the pre-acquisition productivity of the target firms played a role in mediating the rate of technology transfer from the MNCs. Several empirical studies have also analysed the causal impact of foreign ownership on firm productivity in developing countries. For example, Arnold and Javorcik (2009) examined the causal relationship between foreign ownership and different aspects of plant performance

90  Handbook on East Asian economic integration

using microdata from the Indonesian Manufacturing Census. The study highlighted the effect of foreign ownership in the context of foreign acquisition and privatisation. To address the endogeneity problem, they used a combination of propensity score matching and difference-indifferences estimation techniques, and found that foreign ownership considerably increases the productivity of acquired firms. The productivity improvement is shown to increase gradually following the acquisition year. Productivity increases and evidence of restructuring are also found in the context of foreign privatised firms. A similar paper in the context of export-oriented market economies is Arnold et al. (2011), which examined the link between service sector reforms – the presence of foreign providers, privatisation, and the level of competition – on the performance of manufacturing firms that rely on services inputs in the Czech Republic. These reforms enhanced firms’ labour productivity by 43.6% and sales by 33.0% 3 years after acquisition. The study also found a positive and statistically significant correlation between foreign acquisitions and downstream manufacturing firm productivity. As such, foreign entry into the service industry is used as the key channel through which services liberalisation helps to improve the performance of manufacturing sectors. 2.3  FDI and Spillovers to Domestic Firms The impact of FDI on the knowledge spillover to domestic firms has been studied extensively in the literature. The exhaustive empirical studies on the spillover effect of FDI can be categorised into three groups: (i) cross-country (e.g. Farole and Winkler (2014) and Alfaro and Chen (2013)); (ii) on individual developing country firms (e.g. Javorcik (2004); Görg and Strobl (2005); Fernandes and Paunov (2012); Du, Harrison, and Jefferson (2012); Javorcik and Li (2013); and Kee (2015)); and (iii) on firms of developed countries (e.g. Javorcik and Spatareanu (2009); Haskel, Pereira, and Slaughter (2007); and Keller and Yeaple (2009)). Kiyota et al. (2008) carefully examined the determinants of the backward vertical linkages of Japanese foreign affiliates in manufacturing for 1994–2000, based on the local backward linkages and local procurement in the host country. Their study highlighted that unobserved affiliate-specific characteristics explain a large part of the variation in backward linkages amongst foreign affiliates. Despite differences in the magnitude of the effects and the channels through which the effect is transmitted, most of the empirical studies have shown that FDI has a positive spillover effect on the productivity of host country firms. In the cross-country empirical studies, Farole and Winkler (2014) used a cross-section of more than 25,000 firms in low- and middle-income developing countries from the World Bank’s Enterprise Surveys to examine the effect of FDI on the productivity spillover of domestic firms. The study considered three forms of mediating factors of the foreign investors: (i) the spillover potential from the foreign firm, (ii) the domestic firm’s absorptive capacity, and (iii) a country’s institutional framework. It found evidence that all three forms of foreign investors’ mediating factors have a positive and statistically significant effect on the productivity of host country firms. Similarly, Alfaro and Chen (2013) employed a rich firm-level panel data set of 60 countries and found that market reallocation and knowledge spillover are major sources of productivity gains in domestic firms. Quantitatively, the study documented an increase in aggregate‐weighted domestic firm productivity by about 1.6% within a 6‐year period. Both the theoretical model and the empirical result of Alfaro and Chen (2013) suggest that ignoring market reallocation leads to a strong bias in comprehending the effect of FDI on the spillover effect of domestic firm productivity.

FDI activities and integration in ASEAN and East Asia 91

Although cross-country studies are widely used in literature, one of their main limitations is the issue of the heterogeneity of firms, which is likely to bias their results. Reaping the benefits of FDI requires an analytical framework that differentiates between specific FDI in each particular country, where institutional, political, and socio-economic environments are likely to be completely different (Echandi, Krajcovicova, and Qiang, 2015). To address such concerns, many empirical works have been conducted using firms at a specific developed and developing country level. The first influential empirical study in a developing country context was Javorcik (2004). Using unbalanced firm-level panel data from Lithuania for 1996–2000, the study found a positive productivity spillover effect from foreign affiliates to their local suppliers in upstream sectors – known as vertical spillover. However, the study indicated that significant spillovers are associated with projects that have a shared domestic and foreign ownership, but not with fully owned foreign investment projects. Following this seminal work, Görg and Strobl (2005) investigated whether productivity spillovers occur via the channel of worker mobility. To that end, they employed data that demonstrated whether the owner of the domestic firm had previous experience in an MNC and related this information to firm productivity. The finding of the study suggests that firms which are run by owners who worked for MNCs in the same industry immediately prior to opening up their own firm are more productive than other domestic firms. More recently, Fernandes and Paunov (2012) examined the impact of large FDI inflows in producer service sectors on the total factor productivity of Chilean manufacturing firms. Using 4,913 firms during 1992–2004 and the fixed effect instrumental variable approach, the study uncovered a positive and statistically significant productivity spillover effect on domestic firms from a forward linkage with the foreign-owned firms. Besides fostering innovation activities, an average 7% causal effect increase is observed in the total factor productivity of Chilean manufacturing firms from the service FDI. In addition, Du, Harrison, and Jefferson (2012) and Javorcik and Li (2013) used Chinese and Romanian firm-level data, respectively, to examine the spillover effects. Du, Harrison, and Jefferson (2012) showed a significant positive productivity spillover effect through backward and forward linkages, but not through horizontal linkages. Similarly, Javorcik and Li (2013) found evidence that a 10% increase in the number of foreign retail chain outlets raised the total factor productivity of Romanian supplying industries by about 2.4–2.6%. Kee (2015) also studied the effect of an increase in sharing of suppliers by garment producers with foreign firms on the productivity growth of domestic garment firms in Bangladesh. On average, one‐third of the productivity growth in domestic garment firms and one‐fourth of the product scope was attributed to the increase in sharing of suppliers by garment-producing foreign firms. The next group of empirical evidence used firm data from developed economies. For example, Javorcik and Spatareanu (2009) employed a unique data set from the Czech Republic, which has information on actual relationships between suppliers and multinationals. The paper found evidence consistent with the theory on both high productivity firms having a higher likelihood of supplying multinationals and suppliers learning from their relationships with multinationals. Using UK firm-level data, Haskel, Pereira, and Slaughter (2007) provided evidence on the positive productivity spillover effect on domestic firms due to the presence of foreign affiliates in a developed country context. Keller and Yeaple (2009) also found a substantially large positive effect of FDI spillover in the United States (US) manufacturing sector, particularly in the high‐tech manufacturing sectors. Several studies (e.g. Havránek and Iršová (2011); Girma, Greenaway, and Wakelin (2001); Görg and Greenaway (2004); and Grima, Görg, and Pisu (2008)) have also shown that many

92  Handbook on East Asian economic integration

empirical studies have found non-significant positive spillovers or even negative effects of linkages. Hence, the authors emphasised that the presence and strength of spillover effects are also dependent on domestic capacities and control variables (firm-, country- or industryspecific). Thangavelu and Narjoko (2014) also highlighted the importance of the development of skills and human capital accumulation as a necessary condition for domestic linkages and spillovers from multinational activities.  2.4  Linkages Between Foreign and Domestic Firms Production linkages are important conduits for the positive impact and spillovers of multinational activities in the domestic economy. MNCs and foreign affiliates typically have more advanced technology and better distributional networks, which create the potential for productivity spillovers on domestic firms when different production linkages are formed with their foreign counterparts (Grima, Görg, and Pisu, 2008). Production linkages, particularly horizontal linkages, have been widely researched; and positive productivity spillovers through such intra-industry relationships can occur through four channels: competition effects, demonstration effects, labour mobility, and exports (Crespo and Fontoura, 2007). Competitive effects highlight the entry of foreign firms into the domestic market as a form of competition with the domestic firms. As a result, domestic firms are incentivised to enhance productivity through better utilisation of resources and usage of more advanced technology, thereby creating positive competition effects. However, as Aitken and Harrison (1999) suggested, domestic firms’ market share can also be eroded by the entry of large foreign firms, especially when there is imperfect competition in the product market. Consequently, the competition effects become negative as firms either function with less efficiency due to higher average operating costs or exit the market. Demonstration effects occur when domestic firms adopt advanced technology or imitate better practices used by foreign firms, which improves their productivity. Similarly, domestic firms may also tap into the knowledge and expertise of workers previously employed by MNCs for improving their productivity. Görg and Strobl (2005) found higher productivity for firms whose owners had worked in an MNC prior to starting their firms compared to their counterparts without MNC experience. As Meyer and Sinani (2009) highlighted, however, such labour mobility can be limited if foreign firms offer higher wages and attract skilled labour from domestic firms. In such cases, the entry of foreign firms may further drain the level of human capital in local companies. Lastly, the presence of MNCs and foreign affiliates can provide distributional networks and relevant knowledge which facilitate export performance. 2.5  FDI and Exports In recent years, the export sector has served as a way to move out of poverty and underdevelopment in several least developed countries (LDCs). However, raising the export volume and diversifying export products is still a key challenge for several LDCs. Some recent studies have suggested that FDI may help to address the export diversification. Using Chinese data for 1997–2003, Swenson (2008) showed that the presence of MNCs largely increases the formation of new export destinations by local Chinese firms. The study showed that information spillover is the main channel to foster the export connection shown by local Chinese firms. Swenson and Chen (2014) used the information on the product, geographical, and trader

FDI activities and integration in ASEAN and East Asia 93

characteristics of Chinese exports to investigate how the presence of multinationals affects the quality, frequency, and survival of new exports by local Chinese firms. Controlling for the selection problem, which would potentially bias the estimates, they found that the presence of MNCs is associated with more frequent, more valued, and longer‐lasting new export transactions. Using data from 40 countries, Freund and Pierola (2016) also found that export growth and export diversification are strongly associated with the presence of foreign MNCs, as they address financial constraints by providing foreign capital.

3.  FDI, WAGES, AND JOBS The other potential benefit of FDI is providing better jobs with higher wage payments. A number of empirical studies have been carried out to examine the link between FDI and wages in both developing and developed country contexts. Even though the studies agree on the positive role of foreign investment on increasing wage payments, they differ on the explanations for why MNCs pay higher wages than their domestic counterparts. Here, we review selected empirical papers that mainly focus on providing brief explanations for the domestic–foreign company wage gap. Lipsey and Sjöholm (2004), Almeida (2007), and Heyman, Sjöholm, and Tingvall (2007) used firm data from Indonesia, Portugal, and Sweden to examine the effect of foreign ownership on wages. They all found a large wage increase (2.2–5.0%). Lipsey and Sjöholm (2004) highlighted that foreign firms generally pay higher wages than local firms. This may be due to several factors: (i) host country regulations, (ii) workers’ preference for locally owned firms, or (iii) foreign employers’ lack of knowledge of the local labour market. Almeida (2007), on the other hand, argued that the significant wage gap is because foreign firms cherry-pick domestic firms that have a more educated workforce during acquisition, and hence pay higher wages for a given workforce quality.  Hijzen et al. (2013) employed firm-level data from three developed (Germany, Portugal, and the UK) and two emerging (Brazil and Indonesia) economies. They documented that the effect of foreign ownership on the wage gap is larger in the case of emerging countries. They concluded that the positive effect of foreign ownership on the wage gap is not primarily driven by its impact on incumbent wages, but by its impact on the creation of high-wage jobs. Another strand of the literature analyses the effect of foreign ownership on the spillover effect of the wage rate of employees in domestic firms. For example, Poole (2013) presented evidence which shows positive multinational wage spillovers through worker mobility in Brazil. The study showed how wages increase when workers leave multinationals and are rehired in domestic establishments.

4.  COMPLEX NETWORKS AND FDI ACTIVITIES A relatively new strand of the literature focuses on studying the interplay of complex networks and FDI activities in the host country. It studies the nature and role of the two forms of FDI (i.e. horizontal and vertical FDI) on domestic firms and plants. Horizontal FDI eliminates trade costs by setting up production facilities in overseas markets, rather than exporting goods from the home country. In contrast, MNCs carry out vertical FDI to exploit low-cost and abundant production factors in the host country. In this section we review this new literature, with a focus on East Asian countries.

94  Handbook on East Asian economic integration

Hayakawa and Matsuura (2011) investigated the validity of the mechanics of complex vertical FDI in Japanese machinery FDI to East Asian countries by estimating a multiple-spatial lag model that controls for spatial spillovers. The study did not find a robust and statistically significant relationship between geographical affiliates, suggesting that production activities are not strongly related amongst distinct geographical locations. However, they uncovered a statistically significant positive relationship in wage differentials amongst those activities in only high-productivity firms. Hayakawa et al. (2013) studied two-dimensional changes in firm behaviour and performance right before and after FDI. The first dimension of change is the difference between horizontal and vertical FDI. The second dimension is the effect of outward FDI on firms’ production and non-production activities in the home country. Using the propensity score estimation approach, their careful empirical analysis showed that the effect of outward FDI differs by FDI type and firms’ production and non-production activities. They provided evidence that vertical FDI increases demand for skilled production workers while horizontal FDI raises demand for non-production workers. The literature has theoretically and empirically explored the relative importance of the motive for engaging horizontal FDI and vertical FDI (Baldwin and Okubo, 2014; Kiyota et al., 2008). Baldwin and Okubo (2014), for example, introduced a novel way of measuring motives in Japanese affiliates by assigning a degree of ‘vertical-ness’ and a degree of ‘horizontal-ness’ to each affiliate. The findings of the study can be broadly divided into three groups. Firstly, they found vast heterogeneity in the internationalisation strategies of Japanese MNCs where the key strategies differ across regions and sectors. Secondly, North American affiliates are more horizontal than multinational affiliates in Asia and Europe. Thirdly, in most sectors and most nations, affiliates were more vertical from 1996 to 2005. Rather than firm-level data, some studies utilise plant-level data to analyse the effect of vertical and horizontal FDI on domestic firms. Focusing on East Asian FDI, Hayakawa et al. (2016) showed that horizontal FDI does not have a statistically significant positive effect on home productivity in plants that have the same activities abroad. In contrast, vertical FDI has a positive and statistically significant effect on the productivity of plants with an input–output relationship, where the activities are relocated from abroad. Such empirical studies, with a context of more detailed plant-level data, help to provide more robust evidence on the effect of different forms of FDI on the performance of host country firms.

5.  FDI ACTIVITIES IN ASEAN AND EAST ASIA 5.1  Trends of FDI Flows for the Global and ASEAN Economies Figure 5.1 illustrates the time series regional plots of FDI. The figure shows that there are significant fluctuations in the FDI flows of the global and developed economies. Although we observe unprecedented growth in FDI flows for the global and developed economies during 1990–2000, the FDI trends declined sharply following the bursting of the 2001/2002 dot-com bubble. In addition, despite the sharp rise in FDI after 2003, the FDI flows declined considerably due to the 2007/2008 global financial crisis for the two groups of countries. The overall trend of FDI flows for the global and developed economies remains almost stable after 2009. Figure 5.1 denotes the FDI flows by regions including ASEAN and ASEAN+3 (ASEAN plus China, Japan, and the Republic of Korea (henceforth, Korea)) countries respectively. The

FDI activities and integration in ASEAN and East Asia 95 $2,500,000.00

$2,000,000.00

$1,500,000.00

$1,000,000.00

$500,000.00

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

$0.00

World Developing economies Developed economies Least developed countries ASEAN (Association of Southeast Asian Nations) ASEAN (Association of Southeast Asian Nations) plus China, Japan, and the Republic of Korea

Notes: ASEAN = Association of Southeast Asian Nations, FDI = foreign direct investment, LDC = least developed country. Source: United Nations Conference on Trade and Development (n.d.), FDI Statistics https://unctadstat.unctad.org/wds/ TableViewer/tableView.aspx?ReportId=96740 (accessed 15 November 2020).

Figure 5.1  Annual FDI Flows (Inflows + Outflows)

figure indicates the overall stable growth of FDI flows to the ASEAN and ASEAN+3 countries. The only exception is the large slump in FDI flow during the global financial crisis, which affected all countries including the ASEAN countries. Although the FDI flows of ASEAN and ASEAN+3 are significantly larger than the FDI flows of LDCs, they lag significantly behind the FDI flows of the developed economies. Figure 5.2 reports the FDI inflows from the perspective of different regions and economies. As the graph indicates, FDI inflows showed a minor decline in 2005 for the whole world, the developed economies, Europe, North America, and South America. However, the FDI flows increased substantially during the sample period for the developing economies, Africa, Asia, ASEAN, and LDCs. Moreover, a closer inspection of the FDI inflows of the ASEAN economy shows that the overall trend of FDI inflow did not show a substantive change from 2010 to 2015, implying the need to conduct investment reforms for foreigners and to provide supportive domestic policy environments that help to attract more FDI inflows to these countries. Figure 5.3 presents the sectoral FDI inflows for ASEAN countries from 2014 to 2017. The figure shows the rising share of FDI into services – the largest FDI recipient sector in the ASEAN countries is the services sector, followed by the industrial and the primary sectors. The three largest FDI recipient sub-sectors are financial and insurance activities, wholesale and retail trade, and manufacturing activities. Even though it receives the largest FDI share in the region, the amount of FDI in financial and insurance activities declined significantly over the

96 1990

Europe 1995

2000

Northern America 2005

2010

Axis Title

Africa 2015

2019

Asia

Developing economies

Developed economies

World

ASEAN

Figure 5.2  FDI Inflows by Region and Economy

Source: United Nations Conference on Trade and Development (n.d.), FDI Statistics. www.unctad.org/fdistatistics (accessed 1 October 2018).

Notes: ASEAN = Association of Southeast Asian Nations, FDI = foreign direct investment, LDC = least developed country.

$0.00

$500,000.00

$1,000,000.00

$1,500,000.00

$2,000,000.00

$2,500,000.00

LDCs

South America

97 2016 2017 2018 2019

Figure 5.3  FDI Inflows in ASEAN, by Selected Industries and Economies, 2014–2019

2015

Source: ASEAN Secretariat (n.d.), ASEANStatsDataPortal, Flows of Inward Foreign Direct Investment (FDI) to ASEAN by Source Country and Economic Sectors (in million US$). https://data.aseanstats.org/fdi-by-sources-and-sectors (accessed 15 November 2020).

2014

Notes: Association of Southeast Asian Nations, FDI = foreign direct investment.

-20,000.00

-10,000.00

0.00

10,000.00

20,000.00

30,000.00

40,000.00

50,000.00

60,000.00

Agriculture, forestry, and fishing Mining and quarrying Manufacturing Electricity, gas, steam and air conditioning supply Water supply; sewerage, waste management and remediation activities Construction Wholesale and retail trade; repair of motor vehicles and motor cycles Transportation and storage Accommodation and food service activities Information and communication Financial and insurance activities Real estate activities Professional, scientific and technical activities Administrative and support service activities Education Human health and social work activities Arts, entertainment and recreation Other services activities Unspecified activity

98  Handbook on East Asian economic integration Table 5.1  FDI Inflows in ASEAN by Selected Industries and Economies, 2014–2017 ($ million) Sector

2014

Agriculture, forestry, and 4 101.39 fishing Mining and quarrying 1 289.81 Manufacturing 5 924.03 Electricity, gas, steam and –50.77 air conditioning supply Water supply; sewerage, 8.89 waste management and remediation activities Construction 166.81 Wholesale and retail trade, 1 400.70 repair of motor vehicles and motorcycles Transportation and storage 300.04 Accommodation and food –27.25 service activities Information and 219.68 communication Financial and insurance 4 879.55 activities Real estate activities 4 654.52 41.26 Professional, scientific and technical activities Administrative and support 49.10 service activities Education 8.80 Human health and social 40.38 work activities Arts, entertainment and 0.03 recreation Other services activities. –1 568.15 742.07 Unspecified activity Total activities 22 180.88

2015

2016

2017

2018

2019

4 126.25

2 752.58

3 824.96

3 768.64

1 707.15

1 190.99 4 404.86 471.69

1 216.60 6 634.65 113.78

665.58 7 426.51 921.01

–800.47 8 173.08 240.36

899.06 8 247.28 1 130.63

28.49

88.85

40.27

28.96

325.10

281.03 1 247.49

113.12 1 736.13

608.88 3 129.45

470.84 3 712.38

–48.51 1 357.70

426.10 42.40

221.40 227.18

190.13 106.49

14.24 96.04

44.03 53.77

771.28

231.70

1 323.98

455.23

–30.77

2 530.78

4 626.98

2 720.36

5 027.70

4 781.08

2 980.22 –24.77

3 491.67 139.18

3 151.84 163.86

1 847.03 146.02

1 505.29 239.26

20.65

50.97

38.13

133.53

166.33

5.20 24.94

16.71 56.00

14.48 113.57

13.36 100.28

12.93 112.56

–18.55

11.04

3.04

91.02

–4.45

186.88 2 123.36 20 819.28

1 229.61 2 024.28 24 988.79

1 445.78 0.04 25 888.59

831.29

420.84 1 442.03 22 360.06

24 349.16

Notes: ASEAN = Association of Southeast Asian Nations, FDI = foreign direct investment. Source: ASEAN Secretariat (n.d.), ASEANStatsDataPortal, Indicators. https://data.aseanstats.org (accessed 15 November 2020).

sample period. On the contrary, the FDI share of wholesale and retail trade, and the manufacturing sub-sectors, showed encouraging growth. Within the primary sector, mining and quarrying receive the largest FDI, followed by the agriculture, forestry, and fishing sub-sector. The major host countries for FDI flows in ASEAN are Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Viet Nam (Figure 5.4). Across the ASEAN Member States (AMS), Singapore was by far the largest recipient of FDI inflows, followed by Indonesia and Viet Nam in 2017 and 2018, respectively.

FDI activities and integration in ASEAN and East Asia 99

Figure 4: FDI Inflows to ASEAN Member States ($ US millions) 100,000.00

80,000.00

60,000.00

40,000.00

20,000.00

-20,000.00

2010

2011

2012

2013

2014

2015

2016

2017

2018

Viet Nam

Thailand

Singapore

Philippines

Myanmar

Malaysia

Lao PDR

Indonesia

Cambodia

Brunei Darussalam

0.00

2019

Notes: ASEAN = Association of Southeast Asian Nations, FDI = foreign direct investment, Lao PDR = Lao People’s Democratic Republic. Source: ASEAN Secretariat (n.d.), ASEANStatsDataPortal, Indicators. https://data.aseanstats.org (accessed 15 November 2020).

Figure 5.4  FDI Inflows to ASEAN Member States

Figure 5.5 shows the source countries of FDI inflows to ASEAN. The major investors in ASEAN are China, the European Union, Japan, Korea, and the US. We observe a rising trend in investment from the European Union, Japan, and China. The FDI inflows to ASEAN from the US have significantly declined. We also observe intra-ASEAN FDI inflows, which accounted for around 15% of total investment in 2018. Most of the intra-ASEAN FDI flows are driven by Singapore, at nearly 80% of total intra-ASEAN FDI in 2018. 5.2  Types of FDI Activities in ASEAN The FDI can be classified into (i) resource-seeking, (ii) market-seeking, (iii) efficiency-seeking, and (iv) strategic asset-seeking. Although all four motives of FDI are present in the ASEAN countries, the distribution of each type of investment may not be uniform. This subsection examines the types of FDI activities in ASEAN. FDI: Several MNCs invest in ASEAN countries to exploit cheap • Resource-seeking resources in the latter countries. ASEAN and UNCTAD (2016) highlighted that

100  Handbook on East Asian economic integration 70,000.00

60,000.00

50,000.00

2013

40,000.00

2014 2015 2016

30,000.00

2017 2018

20,000.00

10,000.00

0.00

Total ASEAN

Total EU

United States

Japan

Korea, Republic of

Australia

China

Others

Notes: ASEAN = Association of Southeast Asian Nations, EU = European Union, FDI = foreign direct investment. Source: ASEAN Secretariat (n.d.), ASEANStatsDataPortal, Indicators. https://data.aseanstats.org (accessed 15 June 2019).

Figure 5.5  FDI Inflows to ASEAN Member States

•

resource-seeking investment in natural gas, mining, and agriculture is the most common form of investment in ASEAN resource-rich countries. For example, Myanmar, Indonesia, and Viet Nam were the major ASEAN host countries for Korean resource-seeking FDI in 2015. Moreover, oil and gas companies (e.g. BG Group and BP from the UK, Shell from the Netherlands, and Total from France) are investing significantly in ASEAN countries to utilise natural resources (ASEAN and UNCTAD, 2017). Efficiency-seeking FDI: This motive of MNCs is primarily driven by cheap factory prices in ASEAN host countries. For example, the labour cost (wage rate) tends to be cheaper in ASEAN countries such as Viet Nam, Indonesia, and the Philippines due to their large population size. As such, MNCs from developed countries locate their production in these countries to exploit the skilled labour and lower labour cost. For example, European carmakers (e.g. Audi, BMW, and Volkswagen), as well as Bosch and Mainetti are operating in Indonesia, Malaysia, Thailand, and Viet Nam for the US and European markets (ASEAN and UNCTAD, 2017). Kiyota and Urata (2008) highlighted the importance of Japanese efficiency-seeking FDI in East Asian and ASEAN countries. This is essential, as efficiency-seeking FDI provides important advantages for resource-rich developing countries in general and for ASEAN countries in particular. First, it helps to

FDI activities and integration in ASEAN and East Asia 101

•

•

create domestic employment in the host countries, which domestic firms may not be able to provide. Second, efficiency-seeking FDI may increase domestic productivity. Third, it may help to transfer technology from foreign-owned firms to domestic firms through labour turnover (Kiyota and Urata, 2008; Javorcik and Spatareanu, 2009). Market-seeking FDI: This type of FDI is mainly determined by the availability of large market size, rapid economic growth, rapid increase in middle-income consumers, and large improvement in infrastructure expenditure in the FDI host countries. Different MNCs, especially from the EU, operate in ASEAN countries. For instance, Siemens from Germany and Alstom from France conduct different infrastructure projects, such as railway upgrading and constructing geothermal plants. Siemens operates in Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Viet Nam for the purpose of accessing local and global markets. In addition, large car manufacturers such as BMW have sales subsidiaries in Indonesia, Malaysia, the Philippines, and Thailand to exploit the region’s growing market (ASEAN and UNCTAD, 2017). Strategic asset-seeking FDI: According to ASEAN and UNCTAD (2017), advanced infrastructure and a strong knowledge economy are the central factors for strategic asset-seeking FDI. Compared with the other nine countries, Singapore attracts the largest strategic asset-seeking related FDI in ASEAN. Delphi Technologies’ autonomous cars, GlaxoSmithKline’s high-level pharmaceutical research and development (R&D) projects, and Dyson’s $561 million technology centre (from the UK) are some of the major strategic asset-seeking FDI in Singapore.

6. INVESTMENT POLICY AND FOREIGN INVESTMENT IN ASEAN Governments around the world have followed different investment policies that help to attract FDI. Broadly, government incentives are grouped into locational incentives and behavioural incentives. Locational incentives include corporate tax reduction, investment tax credits, tax holidays, export incentives, grants, customs duty exemptions, and other efforts to attract higher investment. Behavioural incentives – including R&D subsidies, training, import subsidies for intermediate capital goods, protection of intellectual property rights, increased foreign equity ownership, and regional investment facilitation – help to transfer technology, increase job growth, and increase exports and skills development at both the domestic and regional levels. This section reviews selected recent literature on the effect of investment policy on FDI. There is a clear regional framework for investment in ASEAN under the ACIA. AMS adopted the ACIA framework in 2009 and amended it in 2014 to complement the AEC that was formed in 2015. ASEAN cooperation in investment is implemented by the AIA, adopted in 1998, and the investment protection agreement under the ASEAN IGA. The ACIA builds on both the AIA and IGA to make ASEAN a globally competitive and forward-looking investment area. Under the ACIA, industries in the manufacturing, agriculture, fishery, forestry, and mining and quarrying sectors, as well as services incidental to these sectors, shall be open and national treatment shall be granted to investors. The exceptions are listed by AMS in the Temporary Exclusion List and the Sensitive List. Items on the Temporary Exclusion List are phased out

102  Handbook on East Asian economic integration Table 5.2  Key Elements of the ASEAN Comprehensive Investment Agreement Elements

Actions

Investment protection Provide enhanced protection to all investors and their investments to be covered under the comprehensive agreement

1. 2. 3. 4. 5.

Investor–state dispute settlement mechanism Transfer and repatriation of capital, profits, dividends, etc. Transparent coverage of expropriation and compensation Full protection and security Treatment of compensation from losses resulting from strife

Facilitation and cooperation Transparent, consistent, 1. Harmonise investment policies to achieve industrial predictable investment rules, complementarity and economic integration regulations, policies, and 2. Streamline and simplify procedures for investment applications procedures and procedures 3. Promote dissemination of investment information: rules, regulations, policies, and procedures, including one-stop investment centres and investment promotion board 4. Strengthen database on all forms of investment, covering goods and services, to facilitate policy formation 5. Strengthen coordination amongst government ministries and agencies 6. Consultation with ASEAN private sector to facilitate investment 7. Identify and work towards areas of complementarity ASEAN-wide as well as bilateral economic integration Promotion and awareness Promote ASEAN as an integrated investment area and production network

1. Create the necessary environment to promote all forms of investment and new growth areas in ASEAN 2. Promote intra-ASEAN investments, particularly investment from the ASEAN 6 to CLMV 3. Promote the growth and development of SMEs to MNCs 4. Promote industrial complementarity and production networks amongst MNCs in ASEAN 5. Promote joint investments that focus on regional clusters and production networks 6. Extend the benefits of ASEAN industrial cooperation initiatives to the AICO scheme to encourage regional clusters and production networks 7. Establish an effective network of bilateral agreements on the avoidance of double taxation amongst ASEAN countries

Liberalisation Progressive liberalisation of AMS’ investment regime to achieve free and open investment

1. Extend non-discriminatory treatment, including national treatment and most-favoured nation treatment, to investors in ASEAN 2. Reduce and eliminate restrictions on entry to investment on priority integration sectors 3. Reduce and eliminate restrictive investment measures and other impediments, including performance requirements

Notes: AICO = ASEAN Industrial Cooperation Scheme; AMS = ASEAN Member States; ASEAN = Association of Southeast Asian Nations; CLMV = Cambodia, the Lao People’s Democratic Republic, Myanmar, and Viet Nam; MNC = multinational corporation, SMEs = small and medium-sized enterprises. ASEAN 6 = ASEAN plus Australia, China, Japan, Korea, and New Zealand. Source: Ewing-Chow, M. and J. Kurtz (2014).

FDI activities and integration in ASEAN and East Asia 103

periodically following agreed timelines. The Sensitive List does not have a timeline for phasing out but is reviewed periodically. The key focus areas under the ACIA are given in the table: (i) investment protection, (ii) facilitation and cooperation, (iii) promotion and awareness, and (iv) liberalisation. It is important to highlight that merely focusing on the quality of FDI rules does not necessarily indicate more liberalised policy on foreign investment, as these rules have to be implemented transparently and effectively. Further, effective implementation of the liberalised investment regime critically requires a regular monitoring, coordination, and assessment mechanism to be established. The ACIA provides the regional framework for transparent and effective coordination of FDI activities in the region.

7.  POLICY DISCUSSIONS Several FDI policies have been adopted regionally and by ASEAN. The key objectives and actions undertaken by ASEAN are given in Table 5.2. However, several policy challenges remain in ASEAN in terms of investment promotion and moving the region to the next stage of growth. 7.1  Behind-the-Border Issues and FDI Behind-the-border issues are important to address the effectiveness of investment policies and incentives. The effectiveness of FDI and multinational activities is critically dependent on the domestic absorptive capacity and the domestic rules and regulations. According to Echandi, Krajcovicova, and Qiang (2015), although investment incentives constitute 55% of the liberalisation, promotion, and facilitation measures used by countries to attract FDI, their effectiveness tends to decrease if the host country has unfavourable investment climate conditions. For example, investment incentives in the form of tax holidays are less effective when there are unfavourable investment climates such as macroeconomic instability, poor infrastructure development, and weak government and market institutions. Several empirical papers have examined the effectiveness of investment incentives in the context of developed countries in attracting FDI. For instance, using a meta-analysis, De Mooij and Ederveen (2006) demonstrated that a 1 percentage point increase in the tax rate decreases FDI by around 3.3%. Similarly, Desai, Foley, and Hines (2004) showed that a 10.0% increase in the corporate income tax rates reduces the FDI from 11 American‐owned foreign affiliates by about 5.0%. Thus, there is a need to review both border and behind-the-border issues in East Asia and ASEAN. 7.2  Investment Promotion Agency and FDI An effective investment promotion agency is essential to attract FDI. Increasingly, investment promotion agencies have to develop key platforms to coordinate activities in both manufacturing and services investment. This is one of the main agendas in ASEAN, as investment in the services GVC is increasing and development of the network economy is important to integrate into the global economy. ASEAN has adopted investment single windows that allow foreign investors to gather information on rules and regulations in the domestic and regional economies. The respective AMS have developed key investment promotion and coordination statutory boards, such as the

104  Handbook on East Asian economic integration

Economic Development Boards in Singapore and Malaysia, which coordinate foreign investment in the domestic economy. Investment promotion and coordinating agencies are critical for ASEAN LDCs, where the development of crucial GVC activities is critical to move key industries into more value-added activities. Several recent studies have investigated the effectiveness of investment promotion agencies in boosting foreign investment. For example, Harding and Javorcik (2011a) employed data from 124 countries and demonstrated that an investment promotion agency is strongly correlated with larger FDI inflows. This is relatively higher for sectors that are targeted by the investment agency, and in developing countries where investment asymmetry and red tape are prevalent. The provision of investment-related information through investment promotion agencies reduces information asymmetry, thereby boosting FDI in developing countries. Similarly, using the World Bank’s Global Investment Promotion Best Practices data on 156 countries, Harding and Javorcik (2011b) studied the effect of the quality of investment promotion agencies on attracting FDI. Their study revealed that countries with more professional investment promotion agencies and high-quality websites tend to attract more FDI than others. Specifically, a 60 percentage point increase in the Global Investment Promotion Best Practices score raises FDI by an average of 25%. Gómez‐Mera et al. (2015) conducted a survey of 713 investors and potential investors from Brazil, India, Korea, and South Africa. The study showed that around 70% of investors rely on investment promotion agencies to make investment decisions. The services provided by investment promotion agencies is more helpful for smaller firms, since obtaining investment-related information is costly for such firms. However, the study revealed that investment promotion agencies have played a limited role for investors in developing countries. 7.3  Servicification and FDI Liberalisation of services and development of the services’ GVC is critical for ASEAN and East Asia. Thangavelu, Wang, and Oum (2018) highlighted the ‘servicification’1 of manufacturing activities in ASEAN and the importance of service activities in the GVC. However, there is lack of services liberalisation and a need to deepen the liberalisation of services and investment in the region. Despite the large-scale economic liberalisation and globalisation efforts in several countries in the world, strong protectionist measures are still observed in the service sectors in many developing and developed countries. According to the World Economic Forum (2013), the two main rationales for such strong protectionist tendencies are maintaining national interests and strategically sensitive industries, particularly in the service sectors. UNCTAD (2014) highlighted that the share of FDI restrictions and excessive policy regulations on FDI increased from 6% to 27% from 2000 to 2013. The study indicated that almost half of these FDI barriers are imposed on service-related sectors. Many countries also follow sophisticated FDI protection techniques such as introducing and raising local content requirements. Both cross-country and country-level analysis confirm the adverse effects of entry barriers on FDI and trade in services. Barattieri, Borchert, and Mattoo (2016) explored the effects of policy and economic structure in influencing international mergers and acquisitions (M&A) in the service sectors. The study used bilateral sectoral M&A flow data and detailed information on policy barriers. They found that restrictive investment policies significantly reduce the probability of M&A inflows. A recent study by Arnold et al. (2015) on services liberalisation

FDI activities and integration in ASEAN and East Asia 105

found that banking, telecommunications, insurance, and transport reforms have a significantly positive effect on the productivity of manufacturing firms. 7.4  Political and Economic Risk and FDI It is also important to manage the political and economic risk in the domestic economy from external shocks to create stability in foreign investment in the domestic economy. Foreign firms’ major concern regarding investment decisions is economic shocks and the policy response in the host country. The World Bank’s Multilateral Investment Guarantee Agency (2014) highlighted political risk as the main obstacle for foreign investment. Empirical evidence has also shown the effectiveness of international investment agreements such as bilateral investment treaties and RTAs on attracting FDI (Sauvant and Sachs, 2009).2 7.5  FDI and Knowledge Transfer The key to FDI and investment policy is to create the necessary and sufficient conditions for the transfer of knowledge and technologies to the domestic economy and firms. As discussed above, FDI has multiple benefits for host countries. An essential prerequisite to reap the benefits of FDI in host countries is to understand the transmission channels through which FDI is linked with domestic production. In this context, Farole and Winkler (2014) highlighted that absorptive capacity and host country characteristics play the largest roles in determining FDI spillovers. By employing the data for more than 25,000 manufacturing firms, they found that market-seeking FDI is more likely to develop linkages with suppliers and customers than efficiency‐ and resource‐seeking FDI. Sánchez-Martín, De Piniés, and Antoine (2015) showed that export-oriented FDI and foreign-owned companies that depend on foreign technologies are less likely to develop links with domestic firms. Furthermore, their analysis demonstrated that some sectors (e.g. food, wood, cars, and car parts) are less likely to develop backward linkages than others (e.g. textiles and electronics). Besides the type of FDI and sector-specific characteristics, the size of the host economy also matters a lot. For example, foreign-owned subsidiaries do not procure many service-oriented domestic inputs due to the absence of competent local suppliers that can provide sufficient and quality services. Although export-oriented firms tend to create less linkages and technology spillover to domestic firms, recent studies suggest that higher participation in supply chains may lead to larger transmission of technical knowledge in host country firms (Piermartini and Rubínová, 2014). Higher participation in supply chains leads to higher transmission of technical knowledge through the channel of foreign R&D spending on patent applications in host countries. The positive effect tends to increase when the intensity of the link in the production network between the source and the host countries increases. The next stage of growth of East Asia and ASEAN is in the services GVC, and the service linkages between the services and manufacturing sectors. The liberalisation of trade and investment in the service industries will be critical to develop and create competitive activities in the GVC. The liberalisation of services and domestic capacity to absorb and create domestic linkages will be crucial for sustainable and inclusive growth from multinational activities in the domestic economy and the region.

106  Handbook on East Asian economic integration

7.6  FDI and Human Capital Development The development of skills and human capital is a critical and necessary condition for attracting FDI and increasing the effectiveness of the GVC. The returns from FDI inflows depend on the domestic absorptive capacity of the economy and region. The domestic economy must, in turn, align its infrastructure, human capital, and technologies to provide MNCs with the necessary linkages to the global network and move up the value chain seamlessly with them. If the domestic absorptive capacity can be better aligned to take advantage of the activities of the MNCs, FDI flowing into the region would likely have a greater impact on output growth through productive spillovers (Thangavelu and Narjoko, 2014). At a regional level, ASEAN could play a pivotal role in harmonising tariff and non-tariff measures within ASEAN and reducing the technical barriers to trade by harmonising technical standards across ASEAN countries. This is crucial for ASEAN integration and sustainable growth. 7.7  Increasing Intra-ASEAN Investment There is also a need to increase and improve intra-ASEAN investment in the region and deepen the integration of East Asia and ASEAN. In a globalising world, which is driven by technological changes, it is essential for firms to move up the value chain to survive. Moreover, within a globally integrated production system which involves intra-firm division of labour and value added, it is possible for any part of an enterprise to remain fully integrated in the same corporate network while being located abroad. MNCs will thus continue to look for investment opportunities in developing economies to enhance their access to markets and resources and, ultimately, their competitiveness. Improving and increasing intra-ASEAN FDI is important for AMS from several dimensions. Southeast Asia, in an era of globalisation, is a region which has to compete with other emerging markets, including China and India. Firstly, ASEAN needs to stress its critical mass as a community of closely cooperating economies as opposed to a club of individual and individualistic nation states. This would make ASEAN more competitive and an attractive destination for FDI. Secondly, ASEAN is maturing and represents a growing market to which MNCs are responding, often by taking advantage of the regional division of labour. This is a natural process that should be encouraged. Lastly, as ASEAN’s home-grown MNCs mature, not only can they invest in other ASEAN countries, they can also become potential targets or partners for non-ASEAN MNCs or their subsidiaries to invest in the region.

NOTES 1. ‘Servicification’ of manufacturing refers to the increasing use of services as inputs and outputs of manufacturing activities. 2. Sauvant and Sachs (2009) provided an excellent review of the literature on the effectiveness of bilateral investment agreements in attracting foreign investment. Urata (2015) found that Japan’s RTAs contributed to an expansion of Japan’s FDI to its RTA partner countries.

FDI activities and integration in ASEAN and East Asia 107

REFERENCES Aitken, B.J. and A.E. Harrison (1999), ‘Do Domestic Firms Benefit from Direct Foreign Investment? Evidence from Venezuela’, American Economic Review, 89(3), pp.605–18. Alfaro, L. and M.X. Chen (2013), ‘Market Reallocation and Knowledge Spillover: The Gains from Multinational Production’, Harvard Business School Working Paper, No. 12-111. Cambridge, MA: Harvard University. Almeida, R. (2007), ‘The Labor Market Effects of Foreign Owned Firms’,  Journal of International Economics, 72(1), pp.75–96. Arnold, J.M. and B.S. Javorcik (2009), ‘Gifted Kids or Pushy Parents? Foreign Direct Investment and Plant Productivity in Indonesia’, Journal of International Economics, 79(1), pp.42–53. Arnold, J.M., B. Javorcik, M. Lipscomb and A. Mattoo (2015), ‘Services Reform and Manufacturing Performance: Evidence from India’, The Economic Journal, 126(590), pp.1–39. ASEAN Secretariat (2010), ASEAN Economic Community Scorecard: Charting Progress Towards Regional Economic Integration. Jakarta: ASEAN Secretariat. https://www.asean.org/wp-content/uploads/images/archive/ publications/AEC%20Scorecard.pdf (accessed 10 November 2019). ASEAN and UNCTAD (2016), ASEAN Investment Report 2016: Foreign Direct Investment and MSME Linkages. Jakarta: ASEAN Secretariat and United Nations Conference on Trade and Development. ASEAN and UNCTAD (2017), ASEAN Investment Report 2017: Foreign Direct Investment and Economic Zones in ASEAN. Jakarta: ASEAN Secretariat and United Nations Conference on Trade and Development. Baldwin, R. and T. Okubo (2014), ‘Networked FDI: Sales and Sourcing Patterns of Japanese Foreign Affiliates’, The World Economy, 37(8), pp.1051–80. Barattieri, A., I. Borchert and A. Mattoo (2016), ‘Cross-Border Mergers and Acquisitions in Services: The Role of Policy and Industrial Structure’, Canadian Journal of Economics/Revue canadienne d’économique, 49(4), pp.1470–1501. Conyon, M.J., S. Girma, S. Thompson and P.W. Wright (2002), ‘The Productivity and Wage Effects of Foreign Acquisition in the United Kingdom’, The Journal of Industrial Economics, 50(1), pp.85–102. Crespo, N. and M.P. Fontoura (2007), ‘Determinant Factors of FDI Spillovers – What Do We Really Know?’, World Development, 35(3), pp.410–25. De Mooij, R.A. and S. Ederveen (2006), ‘What a Difference Does It Make? Understanding the Empirical Literature on Taxation and International Capital Flows’, European Commission Economic Papers, No. 261, Brussels: European Commission. Desai, M.A., C.F. Foley and J.R. Hines, Jr. (2004), ‘A Multinational Perspective on Capital Structure Choice and Internal Capital Markets’, The Journal of Finance, 59(6), pp.2451–87. Du, L., A. Harrison and G.H. Jefferson (2012), ‘Testing for Horizontal and Vertical Foreign Investment Spillovers in China, 1998–2007’, Journal of Asian Economics, 23(3), pp.234–43. Echandi, R., J. Krajcovicova and C.Z. Qiang (2015), ‘The Impact of Investment Policy in a Changing Global Economy: A Review of the Literature’, Policy Research Working Paper, No. 7437. Washington, DC: World Bank. Ewing-Chow, M. and J. Kurtz (2014), The ASEAN Economic Community – Investment. Singapore: National University of Singapore, Centre for International Law. https://cil.nus.edu.sg/wp-content/uploads/2014/03/Teaching-Material-Investment.pdf (accessed 2 February 2019). Farole, T. and D. Winkler (2012), ‘Foreign Firm Characteristics, Absorptive Capacity and the Institutional Framework: The Role of Mediating Factors for FDI Spillovers in Low‐ and Middle‐Income Countries’, Policy Research Working Paper, No. 6265, Washington, DC: World Bank. Farole, T. and D. Winkler (2014), ‘The Role of Mediating Factors for FDI Spillovers in Developing Countries: Evidence from a Global Dataset’, in T. Farole and D. Winkler (eds.), Making Foreign Direct Investment Work for Sub-Saharan Africa: Local Spillovers and Competitiveness in Global Value Chains. Washington, DC: World Bank, pp.59–86. Fernandes, A.M. and C. Paunov (2012), ‘Foreign Direct Investment in Services and Manufacturing Productivity: Evidence for Chile’, Journal of Development Economics, 97(2), pp.305–21. Freund, C. and M.D. Pierola (2016), ‘The Origins and Dynamics of Export Superstars’, Working Paper, No. 16-11, Washington, DC: Peterson Institute for International Economics. Girma, S. and H. Görg (2007), ‘Multinationals’ Productivity Advantage: Scale or Technology?’, Economic Inquiry, 45(2), pp.350–62. Girma, S., D. Greenaway and K. Wakelin (2001), ‘Who Benefits from Foreign Direct Investment in the UK?’, Scottish Journal of Political Economy, 48(2), pp.119–33. Gómez-Mera, L., T. Kenyon, Y. Margalit, J.G. Reis and G. Varela (2015), New Voices in Investment: A Survey of Investors from Emerging Countries. Washington, DC: World Bank. Görg, H. and D. Greenaway (2004), ‘Much Ado About Nothing? Do Domestic Firms Really Benefit from Foreign Direct Investment?’, The World Bank Research Observer, 19(2), pp.171–97.

108  Handbook on East Asian economic integration Görg, H. and E. Strobl (2005), ‘Spillovers From Foreign Firms Through Worker Mobility: An Empirical Investigation’, The Scandinavian Journal of Economics, 107(4), pp.693–709. Grima, S., H. Görg and M. Pisu (2008), ‘Exporting, Linkages and Productivity Spillovers from Foreign Direct Investment’, Canadian Journal of Economics/Revue canadienne d’économique, 41(1), pp.320–40. Harding, T. and B.S. Javorcik (2011a), ‘Roll Out the Red Carpet and They Will Come: Investment Promotion and FDI Inflows’, The Economic Journal, 121(557), pp.1445–76.  Harding, T. and B.S. Javorcik (2011b), ‘FDI and Export Upgrading’, Economics Series Working Papers, No. 526, Oxford: University of Oxford, Department of Economics. Harris, R. and C. Robinson (2003), ‘Foreign Ownership and Productivity in the United Kingdom: Estimates for UK Manufacturing Using the ARD’, Review of Industrial Organization, 22(3), pp.207–23. Haskel, J.E., S.C. Pereira and M.J. Slaughter (2007), ‘Does Inward Foreign Direct Investment Boost the Productivity of Domestic Firms?’, The Review of Economics and Statistics, 89(3), pp.482–96. Havránek, T. and Z. Iršová (2011), ‘Estimating Vertical Spillovers from FDI: Why Results Vary and What the True Effect Is’, Journal of International Economics, 85(2), pp.234–44. Hayakawa, K. and T. Matsuura (2011), ‘Complex Vertical FDI and Firm Heterogeneity: Evidence from East Asia’, Journal of the Japanese and International Economies, 25(3), pp.273–89. Hayakawa, K., T. Matsuura and K. Motohashi (2016), ‘How Does FDI Affect Productivity at Home? Evidence from a Plant-Level Analysis’, Journal of Industry, Competition and Trade, 16(4), pp.403–22. Hayakawa, K., T. Matsuura, K. Motohashi and A. Obashi (2013), ‘Two-Dimensional Analysis of the Impact of Outward FDI on Performance at Home: Evidence from Japanese Manufacturing Firms’, Japan and the World Economy, 27, pp.25–33. Heyman, F., F. Sjöholm and P.G. Tingvall (2007), ‘Is There Really a Foreign Ownership Wage Premium? Evidence from Matched Employer–Employee Data’, Journal of International Economics, 73(2), pp.355–76. Hijzen, A., P.S. Martins, T. Schank and R. Upward (2013), ‘Foreign-Owned Firms Around the World: A Comparative Analysis of Wages and Employment at the Micro-Level’, European Economic Review, 60, pp.170–88. Javorcik, B.S. (2004), ‘Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers Through Backward Linkages’, American Economic Review, 94(3), pp.605–27. Javorcik, B.S. and Y. Li (2013), ‘Do the Biggest Aisles Serve a Brighter Future? Global Retail Chains and their Implications for Romania’, Journal of International Economics, 90(2), pp.348–63. Javorcik, B.S. and M. Spatareanu (2009), ‘Tough Love: Do Czech Suppliers Learn from Their Relationships with Multinationals?’, The Scandinavian Journal of Economics, 111(4), pp.811–33. Kee, H.L. (2015), ‘Local Intermediate Inputs and the Shared Supplier Spillovers of Foreign Direct Investment’, Journal of Development Economics, 112, pp.56–71. Keller, W. and S. Yeaple (2009), ‘Multinational Enterprises, International Trade, and Productivity Growth: FirmLevel Evidence from United States’, Review of Economics and Statistics, 91(4), pp.821–31. Kiyota, K., T. Matsuura, S. Urata and Y. Wei (2008), ‘Reconsidering the Backward Vertical Linkages of Foreign Affiliates: Evidence from Japanese Multinationals’, World Development, 36(8), pp.1398–1414. Kiyota, K. and S. Urata (2008), ‘The Role of Multinational Firms in International Trade: The Case of Japan’, Japan and the World Economy, 20(3), pp.338–53. Lipsey, R.E. and F. Sjöholm (2004), ‘Foreign Direct Investment, Education and Wages in Indonesian Manufacturing’, Journal of Development Economics, 73(1), pp.415–22. Meyer, K.E. and E. Sinani (2009), ‘When and Where Does Foreign Direct Investment Generate Positive Spillovers? A Meta-Analysis’, Journal of International Business Studies, 40(7), pp.1075–94. Piermartini, R. and S. Rubínová (2014), ‘Knowledge Spillovers Through International Supply Chains’, WTO Staff Working Papers, No. ERSD-2014-11, Geneva: World Trade Organization, Economic Research and Statistics Division. Plummer, M.G. (2009), ASEAN Economic Integration: Trade, Foreign Direct Investment, and Finance, Advanced Research in Asian Economic Studies, Volume 6. Singapore: World Scientific. Poole, J.P. (2013), ‘Knowledge Transfers from Multinational to Domestic Firms: Evidence from Worker Mobility’, The Review of Economics and Statistics, 95(2), pp.393–406. Sánchez-Martín, M.E., J. De Piniés and K. Antoine (2015), ‘Measuring the Determinants of Backward Linkages from FDI in Developing Economies: Is It a Matter of Size?’, Policy Research Working Paper, No. 7185, Washington, DC: World Bank. Sauvant, K.P. and L.E. Sachs (2009), The Effect of Treaties on Foreign Direct Investment: Bilateral Investment Treaties, Double Taxation Treaties and Investment Flows. Oxford: Oxford University Press. Swenson, D.L. (2008), ‘Multinationals and the Creation of Chinese Trade Linkages’, Canadian Journal of Economics/Revue canadienne d’économique, 41(2), pp.596–618. Swenson, D.L. and H. Chen (2014), ‘Multinational Exposure and the Quality of New Chinese Exports’, Oxford Bulletin of Economics and Statistics, 76(1), pp.41–66. Thangavelu, S.M. and D. Narjoko (2014), ‘Human Capital, FTAs and Foreign Direct Investment Flows into ASEAN’, Journal of Asian Economics, 35, pp.65–76.

FDI activities and integration in ASEAN and East Asia 109 Thangavelu, S.M., W. Wang and S. Oum (2018), ‘Servicification in Global Value Chains: Comparative analysis of selected Asian countries with OECD’, The World Economy, 41(11), pp.3045–70. UNCTAD (2014), ‘World Investment Report: Investing in SDGs: An Action Plan for Promoting Sector Contributions’, in World Investment Report 2014. New York and Geneva: United Nations. Urata, S. (2015), ‘Impacts of FTAs and BITs on the Locational Choice of Foreign Direct Investment: The Case of Japanese Firms’, RIETI Discussion Paper Series, No. 15-E-066, Tokyo: Research Institute of Economy, Trade and Industry. World Bank, Multilateral Investment Guarantee Agency (2014), MIGA Annual Report 2014 : Insuring Investments, Ensuring Opportunities. Washington, DC: World Bank. World Economic Forum (2013), The Global Competitiveness Report 2013–2014. Geneva: World Economic Forum.

6.

International population mobility in East Asia Aris Ananta and Evi Nurvidya Arifin

1.  INTERNATIONAL MOBILITY AND ECONOMY Free flow of labour mobility would complete the process of economic integration, after free trade and free capital flow. With free entry and free exit in the labour market, a region’s market structure would move closer to a competitive market (often called ‘perfect competition’ in economics) and, therefore, improve economic efficiency. The European Union (EU) is an example of ‘complete’ economic integration. We use ‘…’, because it is not possible to have completely free exit and free entry in any regional market. Cross-border labour mobility has important welfare effects on the domestic economy as it has both economic and social implications. Yet, due to the social impacts in the receiving countries, free flow of population and, hence, complete regional integration, can be strongly resisted. Therefore, the relationship between migrants and economy in the receiving countries is often seen as a ‘love-hate relationship’. On one hand, migrants are ‘loved’, needed by the economy. At the same time, they are ‘hated’, resisted by the locals because of social and political issues, such as squeezing local labour market, crowding out of public spaces, rising crimes, and ‘different/ugly’ behaviour. Migrants (foreigners) may also become popular political issues. Brexit, the exit of the United Kingdom (UK) from the EU, is an illustration of the anger of the UK’s ‘local’ population towards migrants from other countries. Trump was successfully elected as president of the United States partly because he played the issue of migrants in the US. At the same time, Asians will be more mobile, though less migratory, in the future (Skeldon, 2010; Skeldon, 2013; Ananta and Arifin 2014). This means there will be less long-term mobility and more short-term mobility. With advanced technologies in transportation and communication, mobility is getting more frequent and faster; now people live in the age of mobility, though the need for uprooting becomes smaller (Skeldon, 2010). Furthermore, population dynamics is now affected more by population mobility than fertility and mortality (White, 2016). Short- and long-term population mobility will change population composition in terms of age, sex, education, ethnicity/race, religion, and language. Such change in population composition may result in social and political resistance (Coleman, 2006). At the same time, this change in number and composition of the population will affect the supply of labour and demand for goods and services in the destination countries. Nevertheless, it should be noted that the population change because of short-term mobility is not recorded in population censuses and surveys. This chapter aims to better understand population mobility in East Asia, here defined as ASEAN plus China, Japan, and the Republic of Korea (hereafter Korea) or ASEAN Plus Three (APT), to help understand East Asian economic integration. It examines population mobility in a limited context, mostly labour mobility in long-term (migration). The discussion is framed 110

International population mobility in East Asia 111

within the overall framework of population mobility. It focuses on international migration as it directly affects regional economic integration. Internal mobility in a country indirectly affects regional economic integration. When a large country like China is fully integrated internally, including free movement of people within the country, regional integration will benefit much more as regional integration can link with all parts of China. However, discussion on internal population mobility is beyond the scope of this chapter. Section 2 of this chapter discusses the concept and measurement of population mobility. Section 3 examines the key trends in long-term population mobility (migration). Section 4 explores the key theories on the nexus between migration and economic development. Section 5 discusses skilled labour migration and institutional arrangements, especially the Mutual Recognition Agreements (MRAs), as an effort for ‘freer’ movement of labour in East Asia. Section 6 examines the ‘migration industry’ as regards the cross-border migration process. Section 7 examines policies related to migration in East Asia.

2.  CONCEPTS AND MEASUREMENT OF POPULATION MOBILITY This chapter is about population mobility, a wider concept than migration. In a statistical sense, migration is limited to population mobility involving someone’s uprooting from his or her usual place of residence. Bilsborrow (2016) mentions the existence of detachment in the process of migration. Changing place of residence involves changes in many aspects such as schools for children; places to shop, work, get health services, and for recreation; community neighbourhood, modes of transportation, and social mobility. Migration is thus a process of uprooting, making a new social network. The United Nations (UN) (1998) defines an international migrant as someone who has changed his/her usual country of residence. He or she should have lived in the country of destination for at least 12 months; if he or she has not lived for at least 12 months, he or she should have an intention to continue living in the country of destination The UN also recognises that this definition is not necessarily the same in legal terms, such as whether the persons are citizens or permanent residents and whether they live legally in the countries of destinations. To illustrate: someone may have changed his/her citizenship in the country of destination but, by this definition, he or she is still a migrant. The statistics on international migration collected and published by the UN uses this definition. Any foreignborn person in a country is a migrant, regardless of his/her legal status. However, some of the countries in the world do not have information on foreign born population. Therefore, the UN (2016) uses information on the legal status, rather than on foreign born population. This is the data used in this chapter, where 81.0 percent of the 232 countries covered by the UN have information on foreign born population. With the UN definition, those who stay for less than 12 months and do not intend to stay long in the countries of destinations are not recorded by the statistical agencies. However, those who move for less than 12 months can affect the labour, goods, and services market in the countries of destination as well as social and political implications. Moreover, this temporary mobility occurs continuously, and the population structure becomes very dynamic in its size and composition, though not recorded in censuses and surveys. It should also be noted that some countries such as Indonesia and Brunei Darussalam use 6 months as the threshold though Indonesia recently shifted to 12 months in its 2020 population census.

112  Handbook on East Asian economic integration

The statistics also miss what White (2016) calls ‘circulation migration’, referring to repeated migration or changing the usual place of residence several times. This is similar to the ‘liquid migration’ of Engbersen and Snel (2017), who also discuss migration, focusing on temporary migration and return to the origins. The movement can also be repetitive. It has a lot of socioeconomic implications as it affects the size and composition of the population. Many terms are used to label non-migration mobility. Zelinsky (1971) calls it ‘circulation’; Bilsborrow (2016) calls it ‘non-permanent or temporary population mobility’ and refers to migration as ‘permanent population mobility’. The UN uses the term ‘international visitors’ for those who stay in a different country for less than 12 months but more than 3 months. The UN also uses ‘long-term population mobility’ and ‘short-term population mobility’. This chapter uses ‘long-term mobility’ to refer to migration, and ‘short-term mobility’ to refer to those who stay for less than the threshold. Short-term mobility includes movements such as commuting (moving back and forth daily or weekly between place of residence and place of work); circulation (repeated movement between usual place of residence and place of work regularly such as thrice monthly); and seasonal mobility (movement due to certain reasons and for a certain repeated period).1 Shortterm mobility can be within a country (internal) or cross-border (international). Willekens et al. (2016) predict that circulars will increase due to many people having multiple residences and multiple citizenships. Bell and Ward (2000) show that short-term population mobility has been more dominant in developing countries. Nevertheless, as discussed later, short-term mobility will also be dominant in developed countries; they will significantly affect the economy of the countries of destination. Examples of international short-term labour mobility can be seen between Johor (Malaysia) and Singapore, as well as Batam (Indonesia) and Singapore. People engage in international short-term mobility to take advantage of higher salaries in the countries of destination and spend the income in countries of origin which have a lower cost of living. Also, they do not want to be uprooted from their own countries. In short, most statistics and studies on population refer to migration. It is still difficult to capture short-term mobility, and yet short-term mobility may dominate the future pattern of world population mobility. Future trade and capital flows may be much affected by this shortterm mobility. Abel and Sander (2014) conclude that the available worldwide statistics on international labour mobility miss much information on contemporary intensities and patterns of global mobility. Therefore, Skeldon (2013) and Willekens et al. (2016) recommend the improvement of quality of data on population mobility for cross-country comparative purposes and to improve our understanding on population mobility and its impact on the economy. Because of data limitation, this chapter focuses on long-term labour mobility. Labour mobility affects the economy of both countries of origin and destination through changes in labour supply and demand for goods and services. Though other types of mobility such as refugees may also affect the socioeconomic situation of destination countries, the discussion is beyond the scope of this chapter. In this chapter, the term ‘sending country’ refers to a country with negative net migration: that is, when the number of out-migrants exceeds the number of in-migrants. On the other hand, ‘country of origin’ refers to a country where migrants come from, regardless of whether the net migration of the country is negative or not. Similarly, the term ‘receiving

International population mobility in East Asia 113

country’ refers to a country with a positive net migration, when the number of in-migrants is greater than the number of out-migrants. The term ‘country of destination’ simply refers to a country where migrants go, regardless of whether that country has a positive or negative net migration.

3.  TREND IN LONG-TERM POPULATION MOBILITY 3.1  Rising Importance of Asia Countries worldwide are getting more interconnected due to various reasons such as availability of easier, cheaper, and faster modern transportation and telecommunication; free trade agreements, institutional reforms, wider job opportunities, and more education; and better quality of life. In addition, conflicts, disasters, and poverty are some other reasons people move to find better places to live. Furthermore, the ageing population in rich countries, especially North America, Europe, and Australia, has resulted in rising demand for young workers. Workers in Asia, Africa, and Latin America have been moving to these three regions for better job opportunities. Chinese and Indian workers, especially the highly skilled ones, have been dominating the out-migration to Europe and North America. Charles-Edwards et al. (2016) show that population mobility in Asia is relatively low, compared to other regions in the world. However, the number and diversity of population mobility in Asia, both within a country (internal mobility) and cross border (international mobility), has significantly increased. Mobility will become a very important force that characterises Asia’s population and society (Charles-Edwards et al., 2016). Abel and Sander (2014) show that Asians tend to migrate within Asian countries such as across regions from South Asia to Western Asia, or within a region of Central Asia. East Asia, as argued by Walmsley et al. (2014), is the hub of sending and receiving countries. It has also become a busy region for trade and capital flows. Some countries need labour for their economy, becoming receiving countries; others have a ‘surplus’ of labour, becoming sending countries. To some extent, population mobility has benefited the sending countries economically through the receipt of a great amount of remittances and improvement in social mobility; and relieving labour shortage as well as enhancing economic activities in receiving countries. In some countries, economic vibrancy and the rapidly ageing population have resulted in a shortage of young workers, creating demand for migrants. Other countries still have young population structures and a surplus of young workers, a potential to migrate and to work in other countries. 3.2  Trend in International Migration into APT Countries This section discusses trends in international migration from 1990 to 2015, using statistics on international migrant stock provided online by the UN, Department of Economic and Social Affairs, Population Division (2015), hereafter the United Nations (2015).2 Migrant stock is basically a lifetime migrant, defined as someone currently living in a country different from the country of birth (United Nations, 2016). Readers should be cautioned that this statistic includes undocumented population and refugees, if any.

114  Handbook on East Asian economic integration

Globally, the number of people living outside their country of birth rapidly increased from 152.6 million in 1990 to 244 million in 2015 (United Nations, 2016). Over this 25-year period, the largest number of migrants lived in Europe, followed by Asia and North America. The remaining lived in Africa, Latin America and the Carribean, and Oceania. Migrants living in Europe and Asia formed more than 60 percent of the world’s international migrants. However, this pattern will possibly change soon when Asia will attract more migrants due to its promising economy, while European is tightening its migration policy. As shown by Oishi (2004), there has been a new pattern emerging since 2000: the Asia-Pacific region has become an increasingly important destination of migration; it is the largest region of destination in the world and, notably, migrants are mostly skilled. The trend will increase with the rise in the implementation of regional economic integration arrangements, such as economic partnership agreements (EPAs), the Regional Comprehensive Economic Partnership (RCEP), the TransPacific Partnership Agreement (TPPA), and the ASEAN Free Trade Area. Within Asia, there are two opposing trends (Figure 6.1). International migration into Southern and Central Asia has been declining, especially in India, Iran and Pakistan, and all five Central Asian countries. In contrast, the trend has been increasing in Eastern, Southeastern, and Western Asia, with Western Asia having a tremendous increase, particularly in the last decade (2005–2015). Saudi Arabia and the United Arab Emirates are the most attractive destinations. C H A P T E R 6 | I N T E R N AT I O N A L P O P U L AT I O N M O B I L I T Y I N E A S T A S I A , 1 0 F E B 2 0 2 1 Focusing on East Asia (including Hong Kong and Macao), Table 6.1 shows that the total number of migrants in this region almost tripled in a quarter of a century, from 6.8 million in 1990 to 17.4 million in 2015, or 4.5 percent of the global migrant stock in 1990 and 7.1 percent Figure 6.1.inTrend in International StockHong in Asia,Kong 1990-2015 2015. In 1990, twoMigrant countries, and Japan, had more than 1 million migrants. 45,000,000

Central Asia

40,000,000

Southern Asia Eastern Asia

35,000,000

South-Eastern Asia

30,000,000

Western Asia

25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 0

1990

1995

2000

2005

2010

2015

Note: The definition of Eastern Asia is different from theAsia one used in this paper, which only China, and the Republic of Korea.only FigureChina, 6.1 includes Hong Kong Notes: The definition of Eastern is different from theincludes one used in thisJapan, chapter, which includes Japan, and Macao.

and the Republic of Korea. Figure 6.1 includes Hong Kong and Macao.

Source: Drawn from United Nations (2015).

Source: Drawn from United Nations (2015).

Figure 6.1  Trend in International Migrant Stock in Asia, 1990–2015

International population mobility in East Asia 115

Then, in 2015, six countries – Hong Kong, Japan, Korea, Malaysia, Singapore, and Thailand – each had more than 1 million migrants. In other words, an increasing number of countries in East Asia have become more attractive to migrants. Table 6.1  International Migrant Stock at Mid-Year by Country of Destination, 1990–2015 International Migrant Stock at Mid-year Country of Destination

1990

1995

2000

2005

2010

2015

WORLD 152 563 212 160 801 752 172 703 309 191 269 100 221 714 243 243 700 236 China 376 361 442 198 508 034 678 947 849 861 978 046 China, Hong Kong SAR 2 218 473 2 443 798 2 669 122 2 721 235 2 779 950 2 838 665 China, Macao SAR 205 047 224 929 240 791 279 308 318 506 342 703 Japan 1 075 626 1 381 097 1 686 567 2 012 916 2 134 151 2 043 877 Korea, Republic of 43 017 123 886 244 178 485 546 919 275 1 327 324 Brunei Darussalam 73 200 84 748 96 296 98 441 100 587 102 733 Cambodia 38 375 92 230 146 085 114 031 81 977 73 963 Indonesia 465 612 378 960 292 307 289 568 305 416 328 846 Lao PDR 22 866 23 526 21 948 20 371 21 185 22 244 Malaysia 695 920 937 368 1 277 223 1 722 344 2 406 011 2 514 243 Myanmar 133 545 113 663 98 011 83 025 76 414 73 308 Philippines 154 071 207 345 318 095 257 468 208 599 211 862 Singapore 727 262 991 492 1 351 691 1 710 594 2 164 794 2 543 638 Thailand 528 693 809 720 1 257 821 2 163 447 3 224 131 3 913 258 Timor-Leste 8954 9743 10 602 11 286 10 983 10 834 Viet Nam 28 118 51 262 56 754 51 768 61 756 72 793 ASEAN + 3 6 795 140 8 315 965 10 275 525 12 700 295 15 663 596 17 398 337 % 4.45 5.17 5.95 6.64 7.06 7.14 Source: Compiled and calculated from United Nations (2015).

Table 6.2 shows the percentage of international migrant stock to the respective population. The first group of countries, those with a very large percentage of migrants, is composed of Macao, Singapore, Hong Kong, and Brunei Darussalam (ranked according to the highest percentage). The remaining countries, are those with small percentages of migrants. Macao has the largest proportion of migrants, where about 6 in 10 people are migrants throughout the 25 years (Table 6.2). This is in contrast to China, Indonesia, Myanmar, and Viet Nam where the migrants comprised only at most 0.1 percent in 2015, meaning less than 1 in 1,000 people is an in-migrant. Figure 6.2 visualises the trend in international migrants presented in Table 6.1. The figure shows Thailand as an increasingly popular country of destination; where people from other countries are making it their new home. The number of migrants in Thailand jumped from only 0.53 million in 1990 to 3.91 million in 2015, or from 0.9 percent of the total population in 1990 to 5.8 percent in 2015.

116  Handbook on East Asian economic integration Table 6.2  Shares of International Migrant Stock to Total Population of Country of Destination, 1990–2015 International Migrant Stock as a Percentage of the Total Population Country of Destination

1990

1995

2000

China 0.0 0.0 0.0 China, Hong Kong 38.3 39.8 39.3 SAR China, Macao SAR 57.0 56.4 55.8 Japan 0.9 1.1 1.3 Korea, Republic of 0.1 0.3 0.5 Brunei Darussalam 28.5 28.7 29.1 Cambodia 0.4 0.9 1.2 Indonesia 0.3 0.2 0.1 Lao PDR 0.5 0.5 0.4 Malaysia 3.8 4.5 5.5 Myanmar 0.3 0.3 0.2 Philippines 0.2 0.3 0.4 C H A P T E R 6 | I N T E R N AT I O N A L P O P U L AT I O N M O B I L I T Y I N E A S T A S I A , 1 0 F E B Singapore 24.1 28.5 34.5 Thailand 0.9 1.4 2.0 Timor-Leste 1.2 1.1 1.3 Viet Nam 0.0 0.1 0.1

2005

2010

2015

0.1 39.8

0.1 39.8

0.1 39.0

59.7 1.6 1.0 27.2 0.9 0.1 0.4 6.7 0.2 0.3 2021 38.1 3.3 1.1 0.1

59.6 1.7 1.9 25.6 0.6 0.1 0.3 8.6 0.1 0.2 42.6 4.8 1.0 0.1

58.3 1.6 2.6 24.3 0.5 0.1 0.3 8.3 0.1 0.2 45.4 5.8 0.9 0.1

Source: Compiled and calculated from United Nations (2015).

4,500,000

China Macao Korea Cambodia Lao PDR Myanmar Singapore Timor-Leste

4,000,000 3,500,000 3,000,000

Hong Kong Japan Brunei Darussalam Indonesia Malaysia Philippines Thailand Viet Nam

2,500,000 2,000,000 1,500,000 1,000,000 500,000 0

1990

1995

2000

2005

2010

Source: Drawn from Table 6.1.

Figure 6.2: Trends in International Migrant Stock in East Asia, 1990–2015 Figure 6.2  Trends in International Migrant Stock in East Asia, 1990–2015

Source: Drawn from Table 6.1.

2015

International population mobility in East Asia 117

The acceleration of the influx of migrants to Thailand has been observed since the turn of this millenium. As seen on row 14 ‘Thailand’ in Table 6.3, the migrants in Thailand are mostly Myanmarese, followed by Laotians and Cambodians. Myanmarese accounted for half of the total migrants in this country (1.97 million divided by 3.91 million). Thailand’s economic prosperity, relying on labour-intensive businesses, has attracted people in neighbouring countries legally and illegally. Some companies have benefited from the cheap labour provided by illegal migrants. Altogether, the migrants from these three countries accounted for about 96 percent of the migrants in Thailand. Migrants from China accounted only for 2.6 percent. The rise of migrants in Thailand was partly a result of its labour shortage. The labour shortage is also partly because the Thais do not want to do low wage jobs and, at the same time, the population in Thailand is ageing. 3.3  Receiving Countries As mentioned earlier, receving countries refer to positive net migration, when the number of in-migrants exceeds the number of out-migrants. Table 6.4 indicates this classification among APT countries in 2015. Receiving countries in 2015 include Thailand, Hong Kong, Macao, Japan, Malaysia, Singapore, and Brunei Darussalam. Hong Kong had the largest number of in-migrants before being overtaken by Thailand in 2010.3 Since 2000, the influx of migrants to Hong Kong has been slowly increasing: from 2.7 million in 2000 to 2.8 million in 2015. Unlike Thailand, the presence of migrants in Hong Kong is more dominant, accounting for about 38–39 percent of the population (Table 6.2) for 2.5 decades. Hong Kong was a destination for 2.8 million in-migrants versus only 1.0 million out-migrants (Table 6.4). Table 6.3 indicates that migrants in Hong Kong are mostly from the APT region, with only 5 percent coming from outside the region. Migrants in Hong Kong come mainly from China (2.3 million), followed by Indonesia (134.6 thousand), and the Philippines (117.9 thousand). Those from Indonesia and the Philippines are more likely labour migrants filling the shortage of caregivers for older persons. On the other hand, people from Hong Kong migrated mainly to non-APT countries (column 5 of Table 6.3), accounting for 65.8 percent. Only about 270,000 people from Hong Kong migrated to China. Japan is a hyper-ageing country experiencing depopulation. Until 2000, Japan was the second most popular destination for migrants in the APT region, with an increasing trend of migrant stock from 1.0 million in 1990 to 1.6 million in 2000 (Table 6.1). In 2005, Japan was the third most popular destination, overtaken by Thailand. Yet, the number of migrants to Japan slowly increased up to 2.1 million until 2010, and then slowly declined to 2.0 million in 2015, when Japan became the fifth most popular destination in this region (Table 6.1). Japan has positive net migration as the number of out-migrants was much smaller, 0.8 million in 2015 (Table 6.4). Japan became a home for migrants from China, Korea, and the Philippines (row 4 of Table 6.3). Altogether they accounted for 67.8 percent. Japanese mainly migrated to outside the APT region, 87.2 percent (695,261 / 797,496 [column 7 of Table 6.3]). Only about 24,000 Japanese were living in Korea in 2015, compared to 552,000 Koreans living in Japan.

118

Total   1. China   2. China, Hong Kong SAR   3. China, Macao SAR   4. Japan   5. Korea, Republic of   6. Brunei Darussalam   7. Cambodia   8. Indonesia   9. Lao PDR 10. Malaysia 11. Myanmar 12. Philippines 13. Singapore 14. Thailand 15. Timor-Leste 16. Viet Nam 17. Others

1

Country of Destination

243 700 236 978 046 2 838 665 342 703 2 043 877 1 327 324 102 733 73 963 328 846 22 244 2 514 243 73 308 211 862 2 543 638 3 913 258 10 834 72 793  

2

Total 209 576 414 327 560 132 779 26 156 503 991 296 556 15 974 4 042 137 235 4 328 944 260 39 652 148 359 689 352 43 335 2 995 25 603  

3

OTHERS 9 546 065   2 307 783 281 611 652 413 750 639 2 055 1 518 70 319 3 114 10 368 33 656 35 952 448 566 100 320 1 123 3 005 4 843 623

4

China 1 041 264 270 252   22 111     515 116         256 61 969       686 045

5

Hong Kong SAR 140 395 24 399 71 305                     22 199       22 492

6

Macao SAR 797 496 6 826 14 185     23 912 204 125 18 391   16 450   13 749   6 550   1 843 695 261

7

Japan

Country of Origin

Table 6.3  International Migration Stock at Mid-Year by Country of Origin and Destination, 2015

2 345 840 186 786 4 832   522 486   153 56 31 064   3 424   6 906   660   1 805 1 587 668

8

46 237                   6 083   82         40 072

9

1 187 142       3 098 30 705       1 231 14 127   39   805 272   990 331 680

10

Korea, Brunei Republic of Darussalam Cambodia

119

3 876 739 39 736 134 593   27 354 33 340 6 165 105     1 070 433   3 304 163 237 660 5 426 7 860 2 384 526

11

Indonesia 1 345 075             260         287   969 267   6 956 368 305

12

Lao PDR

Source: Compiled and calculated from United Nations (2015). 

Total   1. China   2. China, Hong Kong SAR   3. China, Macao SAR   4. Japan   5. Korea, Republic of   6. Brunei Darussalam   7. Cambodia   8. Indonesia   9. Lao PDR 10. Malaysia 11. Myanmar 12. Philippines 13. Singapore 14. Thailand 15. Timor-Leste 16. Viet Nam 17. Others

1

Country of Destination

Table 6.3 (continued)

1 835 252 6 130 15 273   8 012 1 600 48 285 172 2 201       793 1 123 654 1 195 162 128 627 647

13

Malaysia 2 881 797         11 514   52   249 252 292   421   1 978 348   11 187 627 734

14

Myanmar 5 316 320 73 070 117 914 11 864 210 243 38 835 13 457 152 3 915   21 732     15 392 1 203 716 113 4 807 714

15

Philippines 313 884   9 879   2 238   1 541 123 21 907   79 519   820   623 71 1 751 195 412

16

Singapore

Country of Origin

854 327 15 192 19 192 961 41 422 26 225 14 384 30 806 21 907 1 688 8 283   340 19 269   145 11 552 642 961

19

Thailand 37 311               21 907       141         15 263

20

Timor-Leste

2 558 678 28 095 10 930   72 620 113 998   36 436   11 634 87 272   413   5 825 196   2 191 259

21

Viet Nam

120  Handbook on East Asian economic integration Table 6.4  Number and Rate of Migrants, 2015

Country China Hong Kong SAR China, Macao SAR Japan Korea, Republic of Brunei Darussalam Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Timor-Leste Viet Nam

Inmigrants 978 046 2 838 665 342 703 2 043 877 1 327 324 102 733 73 963 328 846 22 244 2 514 243 73 308 211 862 2 543 638 3 913 258 10 834 72 793 17 398 337

Outmigrants

Net Migrants

9 546 065 –8 568 019 1 041 264 1 797 401 140 395 202 308 797 496 1 246 381 2 345 840 –1 018 516 46 237 56 496 1 187 142 –1 113 179 3 876 739 –3 547 893 1 345 075 –1 322 831 1 835 252 678 991 2 881 797 –2 808 489 5 316 320 –5 104 458 313 884 2 229 754 854 327 3 058 931 37 311 –26 477 2 558 678 –2 485 885 34 123 822 –16 725 485

Inmigration Rate

Outmigration Rate

Net Migration Rate

0.1 39.0 58.3 1.6 2.6 24.3 0.5 0.1 0.3 8.3 0.1 0.2 45.4 5.8 0.9 0.1

0.7 14.3 23.9 0.6 4.7 10.9 7.6 1.5 19.8 6.1 5.1 5.3 5.6 1.3 3.2 2.7

–0.6 24.7 34.4 1.0 –2.0 13.4 –7.2 –1.4 –19.5 2.2 –5.2 –5.1 39.8 4.5 –2.2 –2.7

Source: Compiled and calculated from United Nations (2015).

Malaysia and Singapore have been more attractive for migrants than Japan since 2010. In 2015, the number of migrants in Malaysia and Singapore was almost the same (around 2.5 million each). Yet, in relative terms, the migrants in Malaysia only accounted for 8.3 percent, a stark contrast to 45.4 percent in Singapore. Most migrants in Singapore came from Malaysia, and most migrants in Malaysia were from Indonesia, working mostly in the oil palm plantations. Ansah (2016) notes the movement of Africans to Malaysia since 1995. They used to go to Europe and other Western countries; now they are going to the East. Though their presence may still be small, their number is predicted to rise in the near future. They came to Malaysia as students, traders, or business people. Some came for religious reasons. This sudden influx of Africans has resulted in worry, anger, and the perception of being ‘invaded’ among the locals. Ansah (2016) predicts the rise of African towns in Malaysia. Brunei Darussalam is a small country, and the second richest in Southeast Asia as measured by gross domestic product (GDP) per capita. It is a country of migrants. The number of migrants coming to Brunei is steadily increasing, though with a slower growth rate seen since 2000. The percentage of migrants to the total population has been declining but is still quite significant within the Brunei population as a whole. It increased from 28 percent in 1990 to 29 percent in 2000 and then declined to 24.3 percent by 2015. The migrants are mainly from the neighbouring countries of Malaysia, Thailand, and the Philippines. Although Brunei

International population mobility in East Asia 121

Darussalam shares the same island (Borneo) with Indonesia, these two countries have limited connectivity. As a result, migrants from Indonesia do not make up the largest number of migrants in Brunei Darussalam. 3.4  Sending Countries As described earlier, sending countries refer to negative net migration when the number of outmigrants exceeds the number of in-migrants. The sending countries include China, Philippines, Indonesia, Myanmar, Viet Nam, Lao PDR, Cambodia, Korea, and Timor-Leste. Korea is a relatively rich country with a rapidly ageing population. However, in 2015 it was a sending country. Table 6.4 shows the number of out-migrants from Korea was 2.3 million, much larger than the 1.3 million in-migrants to Korea. Among the APT countries, Korea has the fifth-largest number of out-migrants, after China, the Philippines, Indonesia, and Myanmar. The outflow was mostly to outside the APT region (1.6 million), followed by Japan (0.5 million). On the other hand, the inflow was mostly from China and countries outside the APT. As in Korea, all out-migrants from APT countries left for countries outside the APT. China has the largest number of out-migrants (4.9 million), much larger than the number of in-migrants, which was just less than 1.0 million. More than half of the out-migrants went to countries outside the APT. Inside APT countries, the largest number was from Hong Kong SAR. On the other hand, almost one-third of the in-migrants came from countries outside the APT, followed by Hong Kong SAR. China, a large country, sent workers abroad. The government then wanted the migrants back home. In 1997, China launched Spring Light Program, in which China’s professionals went abroad for a short time to give lectures and collaborate on research. In 2002, China persuaded its scholars to come home, giving them the following incentives: more living space and higher professional titles, allowing family members to live in the cities to join the returnees, and strengthening the facilities for scientific research (Wang and Bao, 2015). The Philippines is a sending country with the second-largest number of out-migrants after China in 2015. Filipinos mostly migrated to non-East Asian countries (4.8 million), especially to Europe and North America. The largest number, almost 2 million Filipinos, moved to Germany and the UK. The US and Canada were the third and fourth destinations. Indonesia is a sending country with the third-largest number of out-migrants, mostly leaving for countries outside the APT, especially to Middle East countries such as Saudi Arabia. In APT countries, Indonesians went mostly to Malaysia and Singapore. On the other hand, the inflow of people to Indonesia has been rising because of the growing economy, though the presence of international migrants in Indonesia is still almost negligible, only 0.1 percent of Indonesia’s population.4 As seen in Figure 6.2, the number of international migrants in Indonesia declined from 1990 to reach its lowest of 289,000 in 2005, but rose afterwards to 329,000 in 2015. Moreover, the inflow of people to Indonesia has changed, from mostly Western countries to Asian countries. The Asianisation of the inflow also changed – from the Japanese to the Koreans and to the Chinese. The One Belt, One Road initiative, together with better bilateral relations between China and Indonesia provides an opportunity for both sides to facilitate rapid migration. On the other hand, Indonesians living in China numbered only 39.7 thousand, but more Indonesians were living in Hong Kong (134.6 thousand) and Singapore (163.2 thousand)

122  Handbook on East Asian economic integration

(column 11 of Table 6.3). Most Indonesian migrants (1.1 million) were living in Malaysia but only 2,200 Malaysians were living in Indonesia in 2015 (Table 6.3). Myanmar has the fourth-largest number of out-migrants after China, the Philippines, and Indonesia. The fast increase in migration occurred after the country emerged from a long military rule. Then the migration industry was used to reduce poverty in the country. People from Myanmar went to Thailand and Malaysia. Currently, Singapore is an attractive destination (Ma, 2017). Myanmar had fewer in-migrants, mostly coming from countries outside the APT (54 percent) and the rest coming from China (46 percent). Viet Nam has the fifth-largest number of out-migrants. Interestingly, an increasing number of foreign skilled workers from about 100 countries have been coming to Viet Nam. The foreign workers work as high-level executives, technical workers, or consultants (Viet Nam News, 2018). The Lao PDR is a sending country: the number of out-migrants (1.35 million) greatly exceeds the number of in-migrants (0.22 million). However, as reported in The Laotion Times (2017), the small number of foreign workers has become a never-ending social issue, especially regarding those from Viet Nam, Thailand, and China. Its net migration rate in 2015 is the greatest in negative terms (-19.5) among all countries; that is, almost 20 in every 100 of the population in the Lao PDR lived in other countries, especially in Thailand, Viet Nam, and Cambodia. Only a few migrants crossed the sea to reach the Philippines. The remaining 27.3 percent migrated outside of East Asia. Timor-Leste is the poorest country in Southeast Asia, with a very small population, only larger than that of Brunei. The number of in-migrants and out-migrants in Timor-Leste in 2015 were the smallest, about 10,000 in-migrants and 37,000 out-migrants. In the APT region, out-migration was mainly to Indonesia, but 40 percent of them went to other countries, with the largest number living in Australia, its neighbour, and a few thousands living in European countries like the UK and Portugal. In contrast, the in-migrants came from seven countries of the APT region, most of whom came from Indonesia,5 followed by those from China (see row 15 of Table 6.3). 3.5  Shifting from Sending to Receiving Countries In the future there will be a shift in the pattern, with sending countries becoming receiving countries, which includes countries whose nationals will be invited back home. Sending countries will become receiving countries as some other countries have already done. With low fertility and low mortality, combined with strong economic growth, Indonesia and Viet Nam can become receiving countries. These two countries may follow in the footsteps of Thailand. In-migrants and those on short-term mobility from Africa in general to the APT region may be rising, especially as Nigeria and Ethiopia become even more populous countries, and with rising incomes which facilitates out-migration. The international migrants from Africa, in general, can be both skilled and low skilled. The APT region will likely see more migrants from Africa, especially in the form of short-term mobility. They will enter both current receiving and sending countries in the region. The new receiving countries may be surprised to see the rising inflow of migrants, regardless of their countries of origin. The presence of foreigners in traditional sending countries may still be small in number and percentage but it may result in domestic political debates and social issues in the host countries.

International population mobility in East Asia 123

4. INTERNATIONAL POPULATION MOBILITY AND DEVELOPMENT 4.1   Mobility Transition The relationship between population mobility and development has been long debated. In 1971, Zelinsky published a seminal paper on mobility transition. In the first stage, ‘pre-modern society’, people were mostly immobile. Then, in the second stage, “’early transitional society’, the high population growth rate pushed people to find better job opportunities in urban areas and/or other countries. As the society lacks capital and human capital, foreign capital and highskilled labour come in. In this second stage, as documented by Nayyar (1994) and Stahl and Appleyard (1992), there is an outflow of predominantly low-skilled workers from so-called ‘sending’ countries. Some skilled workers may also start working overseas, resulting in brain drain for the sending countries. These skilled workers are actually still scarce in the sending countries but there is weak demand (i.e. wages are relatively low). Therefore, these skilled workers take the opportunity to work in the more advanced countries. The sending countries suffer because they miss their human capital. At the same time, they receive foreign direct investment (FDI), which uses the presence of cheap labour. The third stage is ‘late transitional society’, with fertility and mortality coming close to replacement level. This stage is characterised by declining migration (long-term mobility) and rising short-term mobility. As discussed in Nayyar (1994) and Stahl and Appelyard (1992), the country may start sending capital and skilled labour abroad. In the third stage, two turning points may occur. One is the labour turning point, when countries start receiving more foreign workers than sending their own workers abroad. The other is the capital turning point, when the outflow of capital exceeds the inflow, giving rise to negative FDI. The labour turning point may occur before the capital turning point. The fourth stage is ‘advanced society’. Some countries become ‘receiving’ countries, with in-migrants starting to outnumber out-migrants. This stage also sees a positive net-migration of low-skilled and semi-skilled workers from countries in the early stages of demographic and mobility transition. The in-migration of skilled workers rises fast, mostly for economic and pleasure reasons. Short-term mobility continues to rise. The fourth stage may be associated with an ageing population and a shortage of young workers and even with a declining number in the labour force. This will result in rising demand for foreign migrants and may bring about the third demographic transition (Coleman, 2006), where migration (mobility) induces social and political conflicts. For political reasons, there may be strong governmental control on international and internal population mobility. Antimigration has been on the rise recently, as seen in places such as the US. The last stage is ‘future super advanced society’. Migration and short-term mobility decelerate as cost of delivery and communication declines. People do not need to move, categorised as the third unbundling by Baldwin (2016), which we discuss in the following section. 4.2  Baldwin’s Three Unbundlings Zelinsky’s prediction in 1971 of future immobility seems to be in line with Baldwin’s (2016) recent work on globalisation and its three unbundlings. Baldwin lists three kinds of cost of

124  Handbook on East Asian economic integration

globalisation: (i) the cost of moving goods, (ii) the cost of moving ideas/knowledge, and (iii) the cost of moving people. These three kinds of cost contribute to the three unbundlings between production and consumption. Before globalisation, production and consumption occurred in the same region/village; people produced what they consumed. Then, the first cost of globalisation – moving goods – changed significantly around 1820 because of the fall in the cost of transporting goods, driven by steam power and the Industrial Revolution, and by Pax Britannica. The market of goods expanded. Outputs did not have to be consumed where they were produced, at this time mainly in what are now called the G7 countries (these were the countries whose experience was analysed by Baldwin). This is the first unbundling – or separation – of production and consumption. But transfering ideas or knowledge was still expensive. Communication technology was still costly and, thus, factories and G7 innovations remained in G7 countries, even if manufactured goods were travelling and being consumed in many places due to the fall in trade cost. The G7 countries became rich. This is the Old Globalisation, bringing the ‘great divergence’ between G7 countries and others. Know-how remained concentrated in G7 countries. The second fall of the cost of globalisation – moving ideas/knowledge – took a long time; it started more than 150 years later, around 1990. The information and communications technology revolution made the transfer of knowledge or ideas across borders or regions easier and much less expensive. Ideas and innovations began to flow and, thus, firms outsourced jobs to developing countries where wages were still low. Therefore, factories were no longer necessarily located in the region of origin. Production sites or factories were built in developing countries but the market was global. Production and consumption were further unbundled. The mix of high-tech-low-wage manufacturing improved job opportunities in developing countries, leading to declining poverty rates in these countries. Incomes rose, creating an emergence of middle-income families. This is the New Globalisation. The Great Convergence of 1990–2014 was characterised by low trade and communication costs. This is the second unbundling – of production and consumption – often called the ‘global value chain revolution’, which was driven by the falling cost of moving ideas and knowledge around the globe. This New Globalisation broke monopoly and was significant in creating job opportunities, as well as internationalising other aspects of trade: meetings, marketing, and negotiations. Furthermore, the third cost – the cost of long-distance, face-to-face communication, or moving people virtually, will soon decline, too. Although the cost of personal travel has declined, the opportunity cost (time lost from travelling) by managers is still high and rising. Future globalisation will reduce the cost of face-to-face meeting. The era of digitalisation, more advanced technology and communication, and telerobotics can replace the traditional face-to-face meetings. People do not need to move physically to have meetings. They may remain in their own offices/homes while conducting meetings virtually through teleconferences. This is the third unbundling. We will have virtual migrants. Labour service will be unbundled from labour’s place of residence. Many activities that require physical presence will be eliminated, replaced by telepresence. This is the future globalisation where residence can also move, virtually, globally, in addition to production and consumption. Some current observations indicate that this trend is already coming. 4.3  An Emerging Pattern of International Population Mobility Will mobility truly decline? Will people stop moving, even without changing their usual place of residence as suggested by Zelinsky (1971) and Baldwin (2016)? Cooke (2011) argues that the

International population mobility in East Asia 125

future pattern is immobility. People may move but they stay rooted in their origins. He shows declining migration in the US in the early 21st century because of economic crisis, ageing population, and changing lifestyle. The existence of dual income earners makes it difficult to migrate. Migration is costly in terms of the cost of resettling, and finding schools for children. With low transportation cost, people may prefer to stay rooted in their usual place of residence but travel long distances for work and leisure. Not changing the usual place of residence does not necessarily mean people are immobile; they may still be mobile but will not uproot themselves. On the other hand, Glorius et al. (2013) examine what happened in Europe after the integration of the EU in 2004–2007. They find a coexistence of both new and old patterns of migration. The old pattern of migration, before the EU integration, can be explained by the usual economic–demographic–social theories. However, the new one shows an unpredictable and liquid pattern of migration. This is a result of free movement of labour and changing demographic pattern (as related to a change in lifestyle and individual preferences, including individualisation and loosening family ties tradition). After EU integration, borders were opened, making the cost of moving cheaper, and enabling people to ‘circulate’ more between countries of origin and destination. It is not seasonal migration. It is unpredictable. They may keep moving, making unpredictable demand on, and supply of, public facilities among connected countries. The challenge is how to measure the magnitude of their mobility. Skeldon (2013) argues that it is almost impossible to forecast future directions and patterns of migration as it is not possible to anticipate political and social-economic changes in the future. However, he observes what has happened in Europe and East Asia and concludes that there was a shift from positive to negative net migration in Europe at the beginning of the 20th century and in Asia, especially East Asia, at the beginning of the 21st century. Nevertheless, it does not mean that international out-migration ceases. It still increases, but in-migration rises much more. There has also been change in composition, from migration to short-term mobility. The traditional receiving countries have changed their policies from accepting legal migration to accepting temporary migrants, neither citizens nor permanent residents. From a demographic point of view, they are all migrants. The rich countries need labour. Yet, Skeldon (2013) observes that from 1995 to 2013 the proportion of international migration to world population remained the same, at around 3 percent. They may be shifting towards short-term mobility. They are less migratory but more mobile. Mobility will be more complex. An emerging pattern of mobility may be dominated by ‘immobility’, movement without change of residence, without uprooting from the origin. Kerr et al. (2016) argue that mobillity will be less bound by locality or even nationality. Their behaviour will also become global. Ananta and Arifin (2014) also find a declining migration rate in Indonesia, and they discuss the possibility of increasing mobility without the need to change people’s usual residence. Shortterm mobility will rise in Indonesia and from/to Indonesia. 4.4  Migration, Trade, and FDI The debate on whether movement of capital and labour is a substitute or complement to international trade started with Mundell (1957), who examines the relationship between trade and factors of production (including labour). He uses the factor price equalisation theorem in the Hecker-Ohlin-Samuelson model (Samuelson, 1948): once the price of goods is equalised, the price of the factors of production will also be equalised, and vice versa. Though there are differences in factor endowment among different countries, movement of factors does not have

126  Handbook on East Asian economic integration

to occur. Free trade can substitute for movement of factors. The prices of commodities will be equalised among different countries, so will the price of the factors. The price-equalisation theorem assumes that mobility of the factors of production (including labour) depends solely on the price of the factors (i.e. workers’ wages). The theorem assumes the following: (i) countries have identical technologies; (ii) countries have identical demand; (iii) production is characterised by constant returns to scale; (iv) production is characterised by perfect competition; and (v) there are no domestic distortions when comparing countries. According to the theory, if the prices in the two countries are different, there will be movement of goods or factors. If wages in country A are lower than that in country B, people from country A will migrate to country B. Without migration, lower wages in country A result in lower prices of goods in country A. Therefore, country A will export the goods to country B until the prices of the goods in the two countries are equal. Because of the rising demand for goods in country A, the demand for labour in country A also rises. Therefore, wages in country A will also rise until wages in the two regions are equal. Therefore, free trade can substitute for migration. Similarly, with free trade, according to the theory, there is no need for movement of capital between the two countries. Furthermore, labour and capital may move in opposite directions. A firm in country B can bring labour from country A to work with capital in country B, or the firm can bring capital from country B to country A with cheaper labour in country A. This process will continue until the wages in countries A and B are equal and the return of the capital is the same in both countries. However, Markusen (1983) drops the assumptions in the price equalisation theorem. The results are different, given differences in factor endowment. By dropping these assumptions, there is no general empirical consensus on the link between migration, trade, and investment. On the other hand, Egger, Ehrlich, and Nelson (2012) show that sociologists, demographers, and some economists used network analysis to examine the links. Their own empirical study, using network analysis, finds a positive bi-relationship between trade and migration – that migration and trade are complements. That is, a rising flow of in-migration stimulates imports from the country of origin through changes in preferences in the country of destination. However, this relationship does not exist when the level of migration is low. They recommend more empirical research to find the possible links between migration, and trade and investment – whether they are substitutes, complements, or neutral. On the relationship between FDI and in-migration, Bang and MacDermott (2018) conclude that FDI from country A to country B may not substitute migration from country B to country A. Among OECD countries, migration is found to complement FDI. As FDI comes from country A to country B, migration rises from country B to country A, partly because of rising income in country B. The impact on migration is larger if country B is from outside the OECD. 4.5  Cost and Benefit of International Migration Labour migration is motivated by relatively higher expected income in the countries of destination than in the countries of origin. Therefore, from the perspective of individual migrants, international migration improves their welfare. However, it may have a different impact on the societies of both countries of origin and destination. In developing countries with limited productive employment, international migration (of mostly low-skilled workers) may alleviate their poverty issues. Remittances from overseas workers may contribute to the development in developing countries. The migration industry

International population mobility in East Asia 127

may create productive job opportunities for the government and the private sector in recruiting, preparing, and placement of workers. Section 6 of this chapter provides a more detailed discussion on this topic. On the other hand, developed countries such as Japan, South Korea, Hong Kong, Taiwan, and Singapore have policies on cheap labour, importing cheap labour to fill up the labour shortage in low-paid jobs. These are the so-called 3-D jobs – ‘dirty, dangerous, and difficult’ – which the locals may not want to do. On the other hand, the locals may not welcome the presence of these migrants. They see migrants as crowding out the market and other public facilities as well as being ‘unsightly’. Some countries want to maintain the purity of their race. The traditional receiving countries, mostly with ageing populations, have also used migrants to increase the number of their young population. But this effort will not be successful because the migrants themselves will age. It can be successful if the migrants stay in the receiving countries only when they are productive; it will not help if they become citizens. At the same time, as in Europe and North America, many countries in Asia have also realised the importance of skilled labour for their development. Searching for global talent in Asia has been rising since 2000, catching up with what has happened in Europe and North America. They have also persuaded their nationals to return. Asian countries have started to intensively bring back their nationals who worked abroad (Oishi, 2014). Kerr et al. (2016) show the continuing global hunt for high-skilled labour. Since 2000, Japan has more progressively begun to recruit skilled foreign workers. It has promoted migration of students as a step to getting skilled migrants. In 2003, Japan promoted the in-migration of workers in information technology. However, only a few worked in Japan. This was partly because of Japan’s very strict requirement, asking foreigners to be able to pass Japanese language proficiency. The number of international students, mostly from China and Korea, has also declined since 2011. One reason is Japan’s rising sentiment against foreigners (Oishi, 2014). On the other side, migration of workers with scarce and needed skills may result in loss of human capital in the countries of origin. This is the so-called brain drain. The Philippines illustrates this case. Because of low salaries in the Philippines, many medical doctors left the country and worked as nurses abroad, especially in the US, UK, and the Middle East. The flow of medical doctors has also ‘disturbed’ the health care system in the Philippines (Soriano, 2016). However, cases of severe brain drain occured mostly in Central American and Carribean countries, more than 50 percent of labour force with tertiary education worked abroad. In sub-Saharan Africa, more than 40 percent of all migrants are skilled workers, though skilled workers comprise only 4 percent of the total labour force. This is different from Asia where skilled workers comprise about 50 percent of all migrants, but the overal migration rate is only 6 percent (Ozden and Schiff, 2006). In contrast, Lee and Kim (2010) discuss reverse mobility among Koreans who obtained doctoral degrees in the US and worked there. South Korea did not lose them (no brain drain) because they gained human capital in the US. They returned home, bringing back the human capital, thus benefiting Korea. The government provided incentives for them at home. In 2000, South Korea issued the ‘Gold Card System’ to bring back their nationals to work in the private sector. It is a global effort to attract skilled workers. Then, in 2001, South Korea provided the ‘Science Card System’ to bring home Koreans and attract foreign skilled workers. This is ‘brain gain’ for South Korea. Moreover, the returning migrants maintain their social and professional relationships with their friends in the US. They may also work abroad again

128  Handbook on East Asian economic integration

while maintaining relationships in South Korea, their home country. Thus, both South Korea and the US gain. This is called ‘brain circulation’. Lee and Kim (2010) also describe ‘diaspora’ as another economic benefit for both sending and receiving countries. Korean graduates do not have to physically return to Korea. However, the government embraces and networks with them such that these graduates benefit Korea. China is similar to Korea, except that China suffered from brain drain, especially in the 1990s, as many Chinese studying for high degrees abroad did not return home. Since then, the rate of returning graduates has increased, and China enjoys brain gain. They returned home mostly because of improved economic and political conditions in China. The government provided incentives for the returnees, though some returnees were not happy adjusting to their home’s political and social norms. Some graduates also ‘circulated’ between China and other countries (Ma and Pan, 2015). Moreover, international migration is no longer a one-way process, where migrants are fully uprooted from the countries of origin. People may even reside in more than one country. Cheaper means of transportation and communication enable people to network with longdistance partners in different countries, as shown by the experience of India and China. International migration benefits both countries of origin and destination (Saxenian, 2005). Migrants may improve economic efficiency and growth in the countries of destination but they may also displace the locals or reduce local wages. Coupled with social issues on the presence of workers, resistance against migrants may also arise. Singapore is an illustration. There has been a large inflow of workers to the nation-city state, who are needed to boost economic growth, as the city population is ageing and there is a need for both skilled and unskilled workers. However, the migrants have created sociopolitical debates in issues such as social integration and cohesion, change in racial composition in Singapore’s future demographics resulting in Singapore’s multiracial identity, and interaction between foreign talents and the ‘Singapore core’ (Yeoh and Lam, 2016). Oishi (2014) shows that there was strong resistance from unions in Australia. The local workers were not happy with lower wages than that of the foreigners. On the other hand, there was no nationwide resistance in China. Resistance depends on the occupation. Less resistance was present in multinational corporations and in the international culinary arts industry. However, resistance was relatively strong in academe, as foreigners were regarded as newcomers. On the other hand, international students are needed to raise China’s international standing.

5. SKILLED LABOUR MIGRATION AND INSTITUTIONAL ARRANGEMENTS 5.1  Mutual Recognition Arrangements (MRAs) ASEAN is different from the EU. Both have the same vision – to create a single regional market and production base. One of the differences is that goods/services, capital, and labour can freely move in the EU while there is limited freedom for labour to move in ASEAN (Koh, 2017). As it is still not politically feasible to have free movement of labour in ASEAN, there has been an effort to promote ‘freer’ mobility by loosening the restrictions on the movement of skilled labour in ASEAN. Free movement of skilled labour is assumed to be less socially and politically sensitive than that of low-skilled labour. In 2007, ASEAN leaders agreed to start

International population mobility in East Asia 129

freeing the flow of skilled labour by constructing and implementing a national and ASEAN qualification framework for labour in ASEAN, the so-called ASEAN Mutual Recognition Arrangements (MRAs). Free movement of skilled labour, along with free trade and free movement of capital, formed the ASEAN Economic Community in 2015. It is a single market and production base in ASEAN. Concerning labour, the leaders agreed to facilitate the mobility of business persons, skilled labour, and talents (ASEAN, 2008; Sugiyarto and Agunias, 2014). Yet, as shown by Sugiyarto and Agunias (2014), the progress in freeing the movement of skilled labour has been slow. First, there were difficulties in adapting domestic policies and regulations to fulfil MRA requirements. Second, political and public support for the MRAs was lacking. Third, many other factors (other than MRAs) still affected the decision to migrate and to hire migrants. The concept of MRAs is actually not new. It started in 1892 when some colonies of New South Wales, Victoria, Queensland, South Australia, Western Australia, and New Zealand agreed to recognise each other’s competency. Since then, many governments and non-state parties have participated in the MRAs as a way to open the market wider for skilled labour across political borders. However, most of the MRAs cover only academic, not on-the-job, qualifications. They are mostly limited to those who have obtained diplomas in developed countries. The number of countries which signed the MRAs rose until its peak in 1970, until the MRAs started to decline in the 1980s. The process of MRAs may be too slow to adapt to the ever-changing pace of business. Its contemporary relevance may be questioned (Mendoza et al., 2017). Actually, the MRAs are wider than those related to labours. Governments of ASEAN countries agreed in 2012 to have a framework for ASEAN MRAs. It is an agreement between two or more countries in regard to export and import of goods. These countries recognise and accept each other’s certification of goods. After being certified in the exporting country, goods can enter the importing country directly without going through procedures already carried out in the exporting country. This framework facilitates the achievement of the goals of the ASEAN Free Trade Area (ASEAN, 2012). The ASEAN MRAs are also carried out for professionals in the services sector, the essential factor in ASEAN integration in trade on services. The MRAs in services aim to harmonise training and educational standards. With this, certification of a skill in any ASEAN country will be recognised by all ASEAN countries. This is expected to increase, or enable freer, movement of skilled labour in the region (ASEAN, 2015). ASEAN identified eight professions for the MRAs in services: engineering, architecture, dentistry, medicine, accountancy, nursing, tourism, and land survey. For the implementation of the MRAs, the most essential requirement is the availability of assessment and certification of professionals which are recognised in all ASEAN countries. Papademetriou et al. (2016) show the following challenges in the implementation of the MRAs in ASEAN: inadequate funding, lack of coordination among government agencies, high turnover of officers, poor data collection and sharing, among others. However, these challenges are not unique to ASEAN. Mendoza et al. (2017) indicate the mismatch between standards of labour and the requirements of business. For example, when workers complete their education, business needs may have changed. The key issue is between centralising and decentralising the monitoring. Centralising is better but very expensive. Decentralising is difficult to monitor.They recommend that countries make dynamic and harmonized living documents. The countries need to have periodic negotiations.

130  Handbook on East Asian economic integration

Vineles (2018) argues the need for enhancing the skills of workers to expand the ASEAN MRAs. Training in the countries of origin should be connected to the demand for skills in the countries of destination, thus requiring close collaboration between countries of origin and destination. Nevertheless, so far, there has been varied progress in the implementation of the MRAs. The best is on tourism professionals. There has been an open, comprehensive framework with the least barriers for tourism professionals in ASEAN to move in the region. It is the only sector which has a full automatic recognition process and has an institutionalised training programme. The tourism sector is mostly unregulated; therefore it is easier to make agreements based on common standards, the ASEAN Common Competency Standards for Tourism Professionals. The MRAs in tourism already have a registration system, called ASEAN Tourism Professional Registration System, a web-based system where would-be workers can register. Once registered, would-be workers are assessed and certified on their qualifications by the Tourism Professional Certification Board using ASEAN Tourism Qualifications Equivalence Matrix in the countries of origin. After passing the assessment and certification, the would-be workers will be interviewed by the National Tourism Professionals Board in the host countries. If they pass, they will get their work permits (ASEAN, 2013). The second best is the group of accountancy, architecture, and engineering professionals. This is a regulated sector which is partially open. It is a regional driven framework, with a lot of barriers to move. It uses a semi-automatic recognition process. The most challenging effort is seen in the group of dental, medical (health), and nursing professionals. This sector is highly regulated; it is very difficult to agree on the standards. The health sector particularly is worried about foreign competition. This group is virtually closed and is dependent on the framework of the country of destination. It has very few opportunities for common recognition. So far, the progress is very limited (Mendoza et al., 2016; Hamanaka and Jusoh, 2016). 5.2 An Indonesian Case Currently, very few foreign professionals, beyond the MRAs, are working in Indonesia though their inflow has been increasing recently. Some come along with FDI. This inflow comes from within and outside ASEAN. This trend may continue. Indonesia has been increasingly active in certification on human resources beyond the eight professions in MRAs. Those dealing with certification, including those who provide training, especially in the eight professions, have been very enthusiastic in implementing the MRAs. Nevertheless, there are still barriers to overcome, including conflict of interest among several stakeholders. From limited interviews conducted in Indonesia by Aris Ananta (one of the authors of this chapter),6 the workers were found to be happy with the MRA programme though they may not be aware of the possibility of their working outside Indonesia. Even when they know that they can work abroad after certification, they may not look forward to working abroad. They are happier working in Indonesia. Working overseas, and even in another region in Indonesia, needs special mental preparation. Migration, particularly overseas migration, entails uprooting from their communities. At the same time, some Indonesians start worrying about the competition from foreign professionals coming to Indonesia.

International population mobility in East Asia 131

Some interviewed employers do not seem to care – and many of them do not know – about the MRAs. Some are even suspicious that the MRAs and the certification are only another bureaucratic layer, only raising the operational costs in their business. They are afraid that these will be another source of bribery. On the other hand, some employers are happy with the MRAs because they can hire foreign professionals and, therefore, increase their bargaining power in the labour market. From the interviews, the first important issue in the implementation of MRAs is resistance from the local business community. They recommend that certification should not be made compulsory. If the certification benefits business, everybody will do it voluntarily. Otherwise, it is an additional cost for the business and prohibits economic growth. The second issue is the perception of foreigners coming to work in Indonesia. Some key Indonesian respondents perceive that there will still be ‘national or local’ barriers against foreign workers entering Indonesia’s labour market, except in very technical jobs. Even in technical jobs, such as plumbing, local resistance may still be present. National or local barriers will particularly exist in professions dealing with people’s health, like nursing and dentistry. Language and culture are the most crucial local barriers. The government should pay attention to these social and political aspects as resentment from powerful professional associations may result in social and political instability. In short, the ‘limited’ free flow of eight types of professional from and to Indonesia in ASEAN will not happen significantly before 2025. Protection in the ASEAN labour market will still be high until at least 2025.

6.  MIGRATION INDUSTRY Hassan, Chowdhury, and Shakur (2017) describe that remittances formed the second-largest source of external funding in developing countries. International migration is closely related to remittances. The Asian Development Bank and the World Bank (2018) showed that the number of remittances and its percentage to GDP have risen fast in Asia. The countries with the three largest number of remittances are India, China, and the Philippines. The role of remittances to development was predicted to continue in the future. Continous flows of remittances may have macroeconomic effects. They reduce output volatility, develop the financial sector, and appreciate the real exchange rate in the sending countries. Economic remittances may also contribute to poverty reduction and improve physical capital such as houses, jewelry, and husbandry.7 The Philippines is a country that gains significantly from remittances. Filipinos can be found in 239 countries, and therefore their remittances do not depend on a particular number of countries. The political and economic situation in a given receiving country does not affect much the steady flow of remittances to the Philippines. Furthermore, Filipinos have a wide range of skills – from low skills such as in construction and domestic services to high skills such as in engineering and computer management. This distribution of skills results in less dependence on what happens to specific economic sectors of a receiving country (Ang and Sugiyarto, 2012). However, poverty is not the cause of overseas migration as people who do not have money cannot afford to go overseas. The migration industry in the sending country may have pushed the supply of overseas labour; it actively markets its services to recruit migrants. Ananta (2009) shows that the migration industry, rather than remittances, may be the main cause of the rising

132  Handbook on East Asian economic integration

flow of Indonesians working overseas. Belanger and Wang (2013), describe the strong role of the migration industry in pushing Vietnamese to work overseas. Similarly, shortage of labour in the receiving countries may not be the most important reason for demand for overseas labour. The migration industry in the receiving countries itself may have pushed the demand for overseas labour. The industry advertises its services to help employers find overseas workers. In short, migration may have created promising business opportunities in both sending and receiving countries. This industry is a business or a commercialisation of migration, with labour recruitment as a critical starting point. The business can be seen in all stages of the migration process: predeparture, employment, and post-employment (return). The migrants must pay all the costs in each stage. The profit has attracted people to ‘help’ the migrants by entering the industry which involves local, national, and transnational parties. The migration industry has become a lucrative business in both sending and receiving countries. Migrants are mostly low-skilled workers, with a gradual movement to semi-skilled workers, such as nurses. In his ethnographic study in the island of Lombok, Indonesia, Lindquist (2010) illustrates the operation of the migration industry. He finds a rising trend of people leaving the island of Lombok to work overseas since the early 2000s. The male workers were mostly going to Malaysia’s oil palm plantations and the female workers to Saudi Arabia as domestic workers. Going to Saudi Arabia has a side benefit: the haj pilgrimage to Mecca. This overseas work has resulted in a significant portion of remittances to Lombok, helping local economic development. It is manifested in the improved quality of houses, which then had tile floors, for example. These houses were known as rumah Malaysia (Malaysia houses) or rumah Saudi (Saudi houses). The remittances have also beem used to build new mosques. Nevertheless, the process of pre-departure, employment, and post-employment can be complicated and is often tainted with small scale corruption. Since migrants may not know what to do, they may be vulnerable to extortion. With the uncertainty and absence of complete information, acting as brokers or sponsors promises lucrative income. The sponsors can be junior high school teachers, former migrants, or even female elderlies. The negative impact of this industry is that some migrants may incur debts from loans to finance their pre-departure and employment processes; yet their wages, when employed, were not sufficient to pay their debt. Belanger and Wang (2013) show that migrants from Viet Nam have been developing strategies to avoid debt. Furthermore, Pratomo and Jayanthakumaran (2018), with respondents from East Java, Indonesia, examined whether the benefits of working overseas for the workers lasted long. They concluded that it did not. The migrants sent remittances home while working abroad. But for a period after returning home, they became poor again as they depleted their savings. The returning migrants could not monetise their human capital. They often returned to poverty after going home. They then wanted to go overseas again. Spitzer (2016) shows a low rate of success in the programme for entrepreneurship in rural Indonesia and the Philippines. Not all returned migrants were interested in entrepreneurship. There was dissatisfaction among returned migrants. Social remittances failed to generate financial benefits. They managed to learn Chinese while overseas, for example, but there was no benefit of speaking Chinese in the rural areas. On the other hand, the World Bank (ABS-CBN News, 2017) shows the Philippines as a success story in managing the migration industry. The Philippines can reap the benefits from the migration industry and increase the welfare, including protection, of the migrants. The country

International population mobility in East Asia 133

established an efficient procedure, reducing the possibilities of corruption and extortion and, therefore, incurring lower costs at all stages of the migration process. Filipino migrants have been successful in empowering themselves in the labour market competition in the destination countries. They can protect their rights, with help from the government of the Philippines (Rodriguez, 2011). In short, government and society should pay attention to the welfare of returnees. They are back home. Many parties gain while migrants are in pre-departure, employment, and post-employment stages. Unfortunately, the industry is not interested in what happens to the migrants after they return home.

7. POLICIES 7.1  Low-Skilled Labour Sending countries should improve three important policies: (i) on the protection and recognition of the rights of overseas workers, (ii) on the productive employability of return migrants so that they keep contributing to society and do not return to poverty, and (iii) on the migration industry, which should be more transparent in its management, programmes, and budgeting. Receiving countries face a trade-off between efficiency and economic growth on one hand and social resistance on the other. Therefore, policies and programmes should be created so that the locals perceive the benefit of having migrants around them. Otherwise, balancing efficiency/economic growth and social resistance is a political decision. 7.2  High-Skilled Labour If foreign high-skilled labour workers in receiving countries are better and cheaper than local ones, then the locals lose jobs and/or have lower wages. Policies of receiving countries (i) should allocate part of the resulting increase in efficiency to help the locals who have lost their jobs and/or are suffering from lower wages; (ii) can prioritise high-skilled workers which are complements to the locals and/or expand job opportunities so that the locals do not lose their jobs; (iii) can involve political negotiation between efficiency and social resistance, like policies on low-skilled labour. To avoid brain drain, the sending countries should create policies on producing ‘brain gain’. These policies should enable the sending countries to reap the benefits of increasing human capital gained through migration of their workers to other countries. Policies should also provide special treatment to return migrants. At the same time, policies should be created to prevent the locals from feeling threatened by the return of the migrants. Moreover, high-skilled labour may stay and work overseas but the government must embrace them. Policies on diaspora must be made to facilitate the contribution of overseas high-skilled workers to the sending countries. 7.3  Remittances and the Migration Industry Policies should maximise the use of remittances to develop the rural areas in the sending countries. Remittances include both economic and social remittances. Since what migrants learn

134  Handbook on East Asian economic integration

outside may not necessarily be useful, policies should enable positive social remittances to spread and negative social remittances to be blocked. The industry should be made more transparent, optimising the use of digital technology so that potential migrants, migrants, and return migrants can follow what is happening in the industry. This transparency will empower migrants and would-be migrants and, therefore, reduce their possible mistreatment. The migration industry should also be managed so that migration does not result in brain drain but in brain gain or brain circulation for sending countries. The industry should also be concerned with what the migrants can do after returning home. How can the industry and government optimise the human capital of return migrants? 7.4  Institutional Arrangement Unlike the EU with its supranational body, ASEAN should come up with agreed institutional arrangements to promote freer mobility of labour, even skilled labour first. ASEAN professionals should be willing to work together and learn from each other. This person-to-person communication may also create the feeling that freeing the movement of professionals in ASEAN will benefit those professionals in the country. 7.5  New Receiving Countries Eventually some currently sending countries will be transformed into receiving countries. Policies should anticipate this development such that people in these countries are not shocked to see the increasing flow of foreigners. 7.6  Improvement on Labour Mobility Statistics As labour will be less migratory, regional and international policies must be made to encourage collecting and standardising statistics on short-term labour mobility. International bodies, such as the United Nations, the World Bank, and the Asian Development Bank, can take the initiative, in particular in the use of Big Data.

NOTES 1. This short-term mobility also covers social visits and tourism. They may also affect the socioeconomic conditions of the countries of destination. However, the discussion on this kind of mobility is beyond the scope of this chapter. 2. The 2015 international migration stock is available here http://www.un.org/en/development/desa/population/migration/data/estimates2/estimates15.shtml. 3. See the discussion on Thailand in the earlier section. 4. Asiati et al. (2018) show the rising presence of foreign workers in Indonesia. They are mostly related to FDI. Some of them are illegal. It is difficult to monitor them. Their numbers increased with the implementation of more visafree countries to Indonesia. 5. Timor-Leste used to be part of Indonesia. Immigrants from Indonesia may have been there before the separation of Timor-Leste from Indonesia. 6. The survey was conducted with a non-random, small number of respondents in 2015, mostly in Jakarta. Some respondents outside Jakarta were contacted by phone. Therefore, the results may not represent Indonesia. 7. Overseas workers may also send social remittances to the countries of origin. What they learn abroad changes their human capital and lifestyle. The acquired human capital and lifestyle may influence their home communities.

International population mobility in East Asia 135

REFERENCES Abel, G.J. and N. Sander (2014), ‘Quantifying global international migration flows’, Science, 343(6178), pp.1520–22. ABS-CBN News (2017), ‘Philippines a world “model” for migrant worker support: ADB’, 9 October 2017. Ananta, A. (2009), Estimating the Value of the Business of Sending Low-Skilled Workers Abroad: an Indonesian case. Paper presented at XXVI IUSSP International Population Conference, 27 September–2 October 2009, Marrakech, Morocco. Ananta, A. and E.N. Arifin (2014), ‘Emerging Patterns of Indonesia’s International Population Mobility’, Malaysian Journal of Economic Studies, 51(1), pp.29–41. Ang, A.P. and G. Sugiyarto (2012), ‘Philippines’ in Global Crisis, Remittances, and Poverty in Asia. Mandaluyong: Asian Development Bank. Ansah, E.S. (2016), ‘Conceptualizing African Migration to Southeast Asia: student. Trader, Businessman and Future of Policy in Malaysia’, Journal of Social Sciences and Humanities, 11(1), pp.59–90. ASEAN (2008), ASEAN Economic Community Blueprint. Jakarta: Association of Southeast Asian Nations Secretariat. January. ASEAN (2012), Concepts of MRAs. Jakarta: Association of Southeast Asian Nations Secretariat ASEAN (2013), ASEAN Mutual Recognition Arrangements (MRA) on Tourism Professionals. Handbook. Jakarta: Association of Southeast Asians Secretariat. January. ASEAN (2015), ASEAN Integration in Services. Jakarta: Association of Southeast Asian Nations Secretariat. Asian Development Bank and World Bank (2018), Migration and Remittances for Development in Asia. Mandaluyong City, Philippines: Asian Development Bank. Asiati, D. et al. (2018), Tenaga Kerja Asing (YKA) Ilegal di Indonesia: Permasalahan dan Upaya Penyelesaiaan.[Illegal Foreign Workers in Indonesia: Problems and Solutions]. Policy paper, LIPI. Jakarta: Kedeputian Ilmu Pengetahuan Sosial dan Kemanusiaa, Lembaga Ilmu Pengetahuan Indonesia. Baldwin, R. (2016), The Great Convergence. Information Technology and the New Globalization. London: Belknap Press of Harvard University Press. Bang, J.T. and R. MacDermott (2018), ‘Does FDI Attract Immigrants? An Empirical Gravity Model Approach’, International Migration Review, 2018, pp.1–17. Belanger, D. and H. Wang (2013), ‘Becoming a Migrant: Vietnamese Emigration to East Asia’, Pacific Affairs, 86(1), pp.31–56. Bell, M. and G. Ward (2000), ‘Comparing Temporary Mobility with Permanent Migration’, Tourism Geographies, 1(2), pp.97–107. Bilsborrow, R. (2016), ‘Concepts, Definition and Data Collection Approaches’, in M.J. White (ed.), International Handbook of Migration and Population Distribution, pp.269–284. Dordreht, the Netherlands: SpringerBiao, Xiang. Emigration Trends and Policies in China. Movement of the Wealthy and Highly Skilled. Washington, DC: Migration Polic y Institute, 2016. Charles-Edwards, E., S. Muhidin, M. Bell, and Y. Zhu (2016), ‘Migration in Asia’, in White, M.J. (ed.), International Handbook of Migration and Population Distribution. Dordreht, the Netherlands: Springer, pp.269–84. Coleman, D. (2006), ‘Immigration and Ethnic Change in Low-Fertility Countries: A Third Demographic Transition’, Population and Development Review, 32(3), pp.401–46. Cooke, T.J. (2011), ‘It is not Just the Economy: Declining Migration and the Rise of Secular Rootness’, Population, Space and Place, 17(3), pp.193–203. https://doi.org/10.1002/psp.670. Egger, P.H., M. Ehrlich and D.R. Nelson (2012), ‘Migration and Trade’, The World Economy, 35(2), pp.216–41. Engbersen, G. and E. Snel (2013), ‘Liquid migration: Dynamic and fluid patterns of post-accession migration flows’, in B. Glorius, I. Grabowska-Lusinska and A. Kuvik (eds.), Mobility in Transition: Migration Patterns after EU Enlargement. Amsterdam: Amsterdam University Press, pp.21–40. Glorius, B., I. Grabowska-Lusinska and A. Kuvik (2013), ‘Concluding Remarks’, in B. Glorius, I. Grabowska-Lusinska, and A. Kuvik (eds.), Mobility in Transition: Migration Patterns after EU Enlargement. Amsterdam: Amsterdam University Press, pp.309–24. Hamanaka, S. and S. Jusoh (2016), ‘The Emerging ASEAN Approach to Mutual Recognition: A Comparison with Europe, Trans-Tasmania, and North America’, IDE Discussion Paper, No. 618, Chiba: Institute of Developing Economies (IDE). Hassan, G.M., M. Chowdhury and S. Shakur (2017), ‘Remittances, Human Capital and Poverty: A System Approach’, The Journal of Developing Areas, 51(1), pp.177–92. Kerr, S.P., W. Kerr, C. Ozden and C. Parsons (2016), ‘Global Talent Flows’, The Journal of Economic Perspectives 30(4), pp.83–106. Koh, T. (2017), ‘ASEAN and EU: Differences and Challenges’, The Straits Times, 22 August 2017. Lee, J.J. and D. Kim (2010), ‘Brain Gain or Brain Circulation? US doctoral recipients returning to South Korea’, Higher Education, 59(5), pp.627–43. Lindquist, J. (2010), ‘Labour Recruitment Circuits of Capital and Gendered Mobility: Reconceptuaizing the Indonesian Migration Industry’, Pacific Affairs, 83(1), pp.115–32.

136  Handbook on East Asian economic integration Ma, A. (2017), ‘Labor Migration from Myanmar: remittances, reforms, and challenges’, Migration Information Source, 18 January 2017. Ma, Y., and S. Pan (2015), ‘Chinese Returnees from Overseas Study: An Understanding of Brain Gain and Brain Circulation in the Age of Globalization’, Frontiers of Education in China, 10(2), pp.306–20. https://doi.org/10.1007/ BF03397067. Markusen, J.R. (1983), ‘Factor Movements and Commodity Trade as Complements’, Journal of International Economics, 14, pp.341–56. Mendoza, D.R., M.V. Desiderio, G. Sugiyanto and B. Salant (2016), Open Windows, Closed Doors. Mutual Recognition Arrangement for Professionals Services in the ASEAN Region. Mandaluyong City, Philippines: Asian Development Bank. Mendoza, D.R., D.G. Papademetriou, M.V. Desidero, B. Salant, K. Hooper and T. Elwood (2017), Reinventing Mutual Recognition Arrangements: Lessons from International Experiences and Insights for the ASEAN Region. Mandaluyong City, Philippines: Asian Development Bank. Mundell, R.A. (1957), ‘International Trade and Factor Mobility’, The American Economic Review, 47(3), pp.321–35. Nayyar, D. (1994), ‘International Labor Movement, Trade Flows and Migration Transition: a Theoretical Perspective’, Asian and Pacific Migration Journal, 3(1), pp.31–47. Oishi, N. (2014), ‘Introduction. Highly Skilled Migration in Asia and the Pacific’, Asian and Pacific Migration Journal, 23(4), pp.365–73. Ozden, C. and M. Schiff (eds.) (2006), International Migration, Remittance, and the Brain Drain. Washington, DC: World Bank Publications. Papademetriou, D.G., G. Sugiyanto, D.R. Mendoza and B. Salant (2016) Achieving Skill Mobility in the Asean Economic Community: challenges, opportunities, and policy implications. Mandaluyong City, Philippines: Asian Development Bank. Pratomo, D.S. and K. Jayanthakumaran (2018), ‘Returned Migration and Remittances Alleviating Poverty: Evidence from Malang, Indonesia’, Economics and Sociology, 11(1), pp.205–17. Rodriguez, R.M. (2011), ‘Philippine Migrant Workers’ Transnationalism in the Middle East’, International Labor and Working Class History, no. 79, Spring 2011, pp.48–61. Samuelson, P. A. (1948), ‘International Trade and the Equalisation of Factor Prices’, The Economic Journal, 58(230), pp.163–84. Saxenian, A. L. (2005), ‘From Brain Drain to Brain Circulation: Transnational Communities and Regional Upgrading in India and China’, Studies in Comparative International Development, 40(2), pp.35–61. Skeldon, R. (2010), ‘Managing Migration for Development: Is Circular Migration the Answer?’ The Whitehead Journal of Diplomacy and International Relations, Winter/Spring 2010, pp.21–33. Skeldon, R. (2013), ‘Global Migration. Demographic Aspects and its Relevance for Development’, Technical Paper, No. 6. New York: United Nations, Population Division. Soriano, J. (2016), ‘PH Doctors Working as Nurses Abroad’, MIMS Today, 22 August 2016. Spitzer, D.L. (2016), ‘Return Migrants Entrepreneurship and the Migration and Development Agenda: A Focus on Filipino and Indonesian Migrant Workers’, Migration, Mobility & Displacement, 2(2), pp.24–39. Stahl, C.W. and R.T. Appleyard (1992), ‘International manpower flows in Asia: an overview’, Asian and Pacific Migration Journal, 1(3–4), pp.417–76. Sugiyarto, G. and D.R. Agunias (2014), ‘A “Freer” Flow of Skilled Labour Migration within ASEAN Aspiration, Opportunities, and Challenges in 2015 and Beyond’, Issues in Brief. IOM and MPI, issue no. 11, December 2014. United Nations (1998), Recommendations on Statistics of International Migration. Revision 1. Statistical Papers, Series M, no. 58, Rev. 1, 1998. United Nations, Department of Economic and Social Affairs, Population Division (2015), Trends in International Migrant Stock: The 2015 Revision (United Nations database, POP/DB/MIG/Stock/Rev.2015). United Nations (2016), International Migration Report 2015. New York: United Nations. Department of Economic and Social Affairs. Vietnam News (2018), ‘Over 80,000 Foreigners Working in Viet Nam’, 11 May 2018. Vineles, P. (2018), ‘Managing Labour Mobility: Stronger ASEAN Integration?’, RSIS, no. 043/2018, 14 March 2018. Walmsley, T., A. Agular and S.A. Ahmed (2014), ‘Labor Migration and Economic Growth in East and Southeast Asia’, in R.H. Adams and A. Ahsan (eds.), Managing International Migration for Growth in East and Southeast Asia. Chapter 1. Washington, D.C.: World Bank. Wang, H. and Y. Bao (2015), Reverse Migration in Contemporary China: Returnees, Entrepreneurship, and the Chinese Economy. Basingstoke, UK: Palgrave Macmillan. White, M.J. (ed.) (2016), Handbook of Migration in Population Distribution. International Handbook of Population, Volume 6. New York: Springer. Willekens, F., D. Massey, J. Raymer and C. Beauchemin (2016), ‘International Migration under the Microscope’, Science, 352(6288), pp.897–99. doi:10.1126/science.aaf6545. Yeoh, B.S.A. and T. Lam (2016), ‘Immigration and Its (Dis) Contents: The Challenges of Highly Skilled Migration in Globalizing Singapore’, American Behavioral Scientist, 60(5–6), pp.637–58. https://doi.org/10.1177/0002764216632831. Zelinsky, W. (1971), ‘The hypothesis of the mobility transition’, Geographical Review, 62(2), pp.219–49.

7.

Services

Christopher Findlay and Hein Roelfsema

1. INTRODUCTION Services, as a share of the economy, generally rise in importance as incomes increase. Not surprisingly, then, as incomes have grown across the region, the services sector has also grown rapidly. Figure 7.1 shows the increase in the services sector share of gross domestic product (GDP) since 2000, in which countries listed on the horizontal axis are ordered by the level of GDP per capita in 2018. The share of services in output is higher in higher-income economies; and the increases in the services share over time is significant in India, China, and some Association of Southeast Asian Nations (ASEAN) economies. Our main interest in this chapter is the link between these changes in the importance of the sector and the growth of trade in services in the region.1 The chapter begins with a discussion of the nature of services, and the links between the growth of the sector and income. With this background, we review the forms of international exchange in services. We also review the barriers to trade and investment, their nature, and how to assess their impact, and we provide examples of studies of these issues. A key focus is on the role of institutions in facilitating this exchange. Later sections examine the nature of ‘servicification’; the contribution of services to manufacturing, including via global value chains (GVCs); and the nature of value chains in services. We discuss what is special in these respects in East Asia. Consideration of the nature of services also facilitates a discussion of the nature of innovation in services. The conclusion identifies some policy priorities and topics for future research.

2.  WHAT IS A SERVICE? The data in Figure 7.1 are based on a list of activities commonly regarded as part of the services sector, which includes wholesale and retail trade (including hotels and restaurants); transport; financial, professional, and personal services, including education, health care, and real estate services; as well as government services.2 Other approaches to a definition are in the negative, i.e. services do not involve producing material goods and they cannot be dropped on your feet. Services are ‘performed’. It is not possible to own a service, since service outputs are not independent units over which property rights can be defined. The commercialisation of services cannot be disassociated from their production, and the production of services requires a relationship of producers and consumers, and therefore some sort of contact. The production of services is also irreversible, and initiating a transaction requires a level of trust. While the effects of the activity can be identified, they cannot generally be stored. What is ‘stored’ is the capacity to provide the service, which then affects the extent of sunk costs of entry to services markets and thereby the nature of competition in service. Services 137

138  Handbook on East Asian economic integration

Notes: GDP = gross domestic product, Lao PDR = Lao People’s Democratic Republic. Source: World Bank (n.d.), World Development Indicators. https://data.worldbank.org/indicator (accessed 13 April 2020).

database: Figure 7.1  Services Share ofData GDP, from 2000 and 2018 World Development Indicators Last Updated: 12/20/2019

are also highly differentiated, and less standardised, given the elements of ‘co-production’, and Nain imperfectly 2000 competitive 2018 markets. for this reason are likely to Country be provided Myanmar 37.1 43.15255 Services have also been defined from the point of view of the features of transactions, i.e. a person or of a good belonging to some economic unit which is ‘a change in the condition of Cambodia 36.90323 39.49207 brought about as the result India of the activity42.73293 of some other economic unit’ with prior agreement 49.12861 (Hill, 1977: 331; see also Hill There has been a debate about this Lao(1999) PDR and Gadrey 42.2317(2000)). 41.60838 definition, based on its exceptions (Rynne, 2019). For example, many services involve matchViet Nam 38.73464 41.11793 making rather than generating a change in condition (financial services), and many services Philippines 59.96859 offer platforms or make options available51.57715 without prior agreement. In addition, the notion of Indonesia 33.36864 43.41193 contracting out or co-production is not unique, since it occurs in other sectors. The common element, however, in these views on the56.9085 nature of services is that it is a valueThailand 54.65753 adding activity involving access (or person)52.15702 without an ownership change. There are Chinato an asset39.78648 various options for the organisation of this access. The 52.95788 condition of an asset may change and the Malaysia 46.3015 asset owner pays. Alternatively, the asset does not change but access to it creates value for othKorea, Rep 51.63245 53.56384 ers, and the user pays. In all these cases, a transaction is involved. The outcomes may be tangible Brunei Daru 35.30581 37.33688 (e.g. changes in the condition of goods versus the mental condition of people) and the outcomes Japan 65.86158 69.11516 in some cases may be ‘storable’ (e.g. long-term changes in people versus temporary benefits). The decision to provide access to an asset for its modification New Zealan 61.81126 65.6means engaging in this activity household where the asset66.55918 is held. The same value-adding process outside the organisation or Australia 64.32174

Singapore

60.66452 69.37699

Services 139

might also be organised ‘in-house’, so from this perspective services are about being willing to make a contract with outsiders. The benefits of doing so to the asset owner are those of accessing specialists who operate at a larger scale in a competitive market, including international providers, compared with the use of in-house providers. The costs of proceeding in this manner include those of managing the transaction rather than working in-house, where staff would be expected to respond to direction. From the point of view of the service provider, some risks are not faced and some costs are not incurred in this mode of production. We have noted that the share of the services sector in GDP increases with GDP per capita. There have been several explanations for this trend, many focusing on the income elasticity of demand for services, which might be greater than 1 (Findlay and Pangestu, 2016). A change in the calculus related to the willingness to contract out transactions of this type also contributes to this growth (Mercer-Blackman and Ablaza, 2018). A driver of that shift could be an increase in the confidence in the use of markets, which in turn may be related to the establishment of the rule of law and the reduction in the costs of the design and implementation of contracts, i.e. the change in the quality of institutions in an economy (Bylund, 2011). Services production involves a degree of simultaneity, which creates some issues because of the asymmetries between the consumer and the producer in access to information. It can be too late, for instance, when the consumer discovers that the producer provides lower than expected quality. Regulation, and the associated institutional development, helps resolve the failure in markets. However, as noted below, differences in the nature of that institutional response across countries complicate the development of international exchanges in services. A long-time concern has been that services are relatively labour-intensive and will be characterised by slower productivity growth. However, the growth of the service sector is a result of decisions by firms to reorganise themselves, which they do for benefit, and which is a positive contribution to productivity growth. Whether the provision of services is subject to different trajectories of productivity growth is then an empirical question (Maroto-Sánchez and Cuadrado-Roura, 2009). The challenges of services automation, given their characteristics, may be a contributor to slower productivity growth, but there is also scope for new technology to increase services productivity, depending on the policy environment (Sorbe, Gal and Millot, 2018). Innovation in services occurs in different ways. Some involves initiatives by the asset owners to procure value-adding activities. Service providers may also tender to asset owners’ options for the provision of services, which may be activities already done in-house or the provision of new sources of value. Alternatively, other users may offer to pay asset owners for access in order to provide new services. Innovation also involves entrepreneurial activity to create new markets in which services contracts are undertaken (Christensen et al., 2019).

3.  INTERNATIONAL TRADE IN SERVICES While services require some form of contact, they can still involve an international transaction. There are various options for trade, evident in the ‘modes of supply’ (presented here by the World Trade Organization (WTO) from the perspective of importer country A).3 Mode 1: Cross-border A user in country A receives services from abroad through its telecommunications or postal infrastructure. Such supplies may include consultancy or market research reports, telemedicine, distance training, or architectural drawings.

140  Handbook on East Asian economic integration

Mode 2: Consumption abroad Nationals of country A have moved abroad as tourists, students, or patients to consume the respective services. Mode 3: Commercial presence The service is provided within country A by a locally established affiliate, subsidiary, or representative office of a foreign-owned and controlled company. Mode 4: Movement of natural persons A foreign national provides a service within country A as an independent supplier (e.g. consultant, health worker) or employee of a service supplier (e.g. consultancy firm, hospital, construction company). Services trade (across borders, in the first two modes) has been growing faster than goods trade, especially business services. In the decade from 2006, services trade grew by more than 65% compared with 38% for goods, according to balance of payments statistics. Drivers of this growth have been ‘modern’ services such as financial, business, and information technology related services, which now account for half of the world’s exports (Rickards, 2019). Services trade was also relatively resilient compared with goods after the global financial crisis (Loungani et al., 2017). Business services were the main contributors to this resilience (Ariu, 2016), which is explained in terms of the sunk costs incurred in their establishment, and their lack of ‘storability’. Services trade accounts for only about 23% of world trade (goods and services combined)4 compared with 17% in the early 1980s (Rickards, 2019: Graph 1). Trade costs are relatively high in services compared with goods trade; also, services trade costs remained stable in the previous decade, while goods trade costs fell by 15% (Miroudot, Sauvage, and Shepherd, 2013). However, from 2009 to 2017, services trade costs fell by 9%, following technological change, better infrastructure, and policy reform (WTO, 2019). Technological change is reducing the cost of trading services – data flows are becoming more important and the prospect is for increasing amounts of services to be provided at a distance (Baldwin, 2019). The United States (US), United Kingdom, Japan, and the euro area account for 50% of world services exports and 40% of imports (Rickards, 2019). The importance of developing economies in services trade is increasing, especially by China, which is the world’s 4th largest services exporter and 3rd largest importer. Other important exporters in the region are Hong Kong and the Philippines, as well as India. The whole of Asia accounted for a quarter of global services trade from 2005 to 2017, of which East Asia accounted for 55% (ADB, 2018). Services dominate foreign direct investment (FDI) flows and, globally, accounted for nearly 60% of greenfield FDI projects in 2016 (and 45% of mergers and acquisitions projects) (UNCTAD, 2018). Services FDI accounts for 40% of FDI into all of Asia, of which Northeast Asia accounts for the majority (ADB, 2018). Efforts have also been made to collect data on the extent of the other modes of supply, by combining data from balances of payments with data for sales of foreign affiliates. At the global level, mode 3 is more important, while modes 1, 2, and 4 together account for less than half of total services trade (Wettstein et al., 2019). Figures 7.2(a) and 7.2(b) compare the different rates of growth in trade by mode for a selection of East Asian economies for exports and imports. Three countries stand out. China’s exports have grown by setting up service trade affiliates in foreign countries (mode 3), and probably connected with the mobility of people towards

Services 141

a) Exports China Singapore Cambodia Viet Nam Philippines India Thailand Hong Kong Taiwan Republic of Korea Indonesia Malaysia Australia New Zealand Japan 0

10 Mode 1

20 Mode 2

30 Mode 3

40

50

60

Mode 4

Figure 7.2a  Trade in Services by Mode of Supply, Exports, 2005–2017 (%)

b) Imports China Singapore Cambodia Viet Nam Philippines India Thailand Hong Kong Taiwan Republic of Korea Indonesia Malaysia Australia New Zealand Japan 0

10 Mode 1

20 Mode 2

30 Mode 3

40

50

60

70

Mode 4

Source: World Trade Organization (n.d.), Trade in Services Data by Mode of Supply (TISMOS). https://www.wto.org/ english/res_e/statis_e/trade_datasets_e.htm (accessed 13 April 2020).

Figure 7.2b  Trade in Services by Mode of Supply, Imports, 2005–2017 (%)

142  Handbook on East Asian economic integration

those locations (mode 4). China also has high growth rates in imports in mode 2, reflecting its consumption abroad of education and the rise of leisure travel. There is a dramatic rise of service exports and imports in Viet Nam. Regarding modes 1 and 3, the pattern of Viet Nam is quite similar to that of China. In mode 2, Viet Nam is a substantial exporter of services, reflecting its increased popularity as a holiday destination. Interestingly, when compared with China, we observe substantially lower levels of cross-border mobility of people in mode 4, reflecting the development of Viet Nam’s services capability when compared with more advanced AsiaPacific countries. Lastly, across the board, the Philippines is extending its presence as a service exporter and importer in global trade. The general tendency is that mode 3 is increasingly important for global trade in services, because services often require direct contact with customers and local adaptation. Higher levels of economic development and sophistication of customers require and make feasible the establishment of foreign sales affiliates. This normally goes together with higher levels of temporary migration and cross-border mobility, as captured in mode 4. It is interesting to see that the activity of inward flows of people in mode 4 is increasing, especially for Australia and Japan. With respect to service provision, these two countries with high levels of GDP are becoming increasingly open to service provision from temporary workers from abroad. Other policies also affect the international performance of the services sector. According to ADB (2012), three critical elements drive productivity growth in services: (i) the regulatory environment, as it applies to services; (ii) the quality of the national infrastructure; and (iii) access to human capital. ASEAN countries that are performing well in manufacturing are found to be less efficient in terms of the realisation of their export potential in modern services: computer and information services, business and professional services, and telecommunications services. Nasir and Kalirajan (2016) noted that since services trades do not depend on port infrastructure, what matters more is power and urban transport. They also highlighted the role of training and education in information technology. 3.1  Servicification of Manufacturing Another perspective on questions of interest comes from the literature on ‘servicification’, i.e. the increasingly close linkages between services and manufacturing industries (Low, 2013; Lanz and Maurer, 2015; Mercer-Blackman and Ablaza, 2018; Miroudot, 2019). As noted already, services are embodied in goods. Manufacturing industries increasingly contract out or outsource their access to inputs such as accounting, legal, design, research and development, and human capital management services (Lanz and Maurer, 2015). This is widely observed in many developed countries such as Australia (Breunig and Bakhtiari, 2013) and Japan (Jiang, Belohlav, and Young, 2007). Service outsourcing improves firms’ performance by generating higher profits or higher exports (Jiang, Belohlav, and Young, 2007; De Backer and Miroudot, 2013). It also strengthens firms’ research and development activities and promotes innovation (Görg and Hanley, 2011; Breunig and Bakhtiari, 2013). Outsourcing could be organised either in the home economy or through international transactions, i.e. offshoring (Görg, Hanley, and Strobl, 2008). The rising trend of using foreign-sourced services (alongside domestic inputs) in manufacturing has been observed in Asian countries (Thangavelu, Wang, and Oum, 2018). Drivers include the quality of domestic regulation. Advances in telecommunications and transportation have dramatically increased the ‘tradability’ of services, thus

Services 143

leading to more service offshoring activities in manufacturing firms (Amiti and Wei, 2009). Using more foreign service inputs improves the export performance of manufacturing firms, especially in developing and emerging countries (Díaz-Mora, Gandoy, and González-Díaz, 2018). Outsourcing and offshoring elements of the servicification of manufacturing also enables some Asian countries (e.g. India, the Philippines, Taiwan, and Indonesia) to undertake some services tasks (e.g. after-sales services and telecommunications services) (Anukoonwattaka, Scagliusi, and Mikic, 2015). There are trade-offs in the use of outsourcing, since contracting costs are incurred. Manufacturing firms retain the model of in-house provision in order to reduce outsourcing costs (Gereffi, Humphrey, and Sturgeon, 2005) and to keep core strategic functions related to these services within firms (Kaleka, 2011; Lodefalk, 2014; Miroudot and Cadestin, 2017). Some studies used the share of apparently services-related employment in the total employment of manufacturing firms as the proxy for ‘in-house’ servicification, i.e. the number of identified specialists who work in roles which could have been contracted out (Boddin and Henze, 2014; Miroudot and Cadestin, 2017; Fort, Pierce, and Schott, 2018). ‘In-house’ can also mean offshore (Ali-Yrkkö et al., 2011; Ivarsson and Alvstam, 2010). This perspective has also drawn attention to a 5th mode of supply (Cernat and KutlinaDimitrova, 2014) − services whose value added is incorporated into (or embodied in) goods which are traded across international borders. In value-added terms, therefore, services account for about 50% of all exports, compared with less than 25% in gross terms (Rickards, 2019; see also Mercer-Blackman and Ablaza (2018) for other estimates for Asian economies). Another element of servicification represents the situations in which manufacturing firms sell bundles of goods and services in both domestic and foreign markets. This is also referred to as services being ‘embedded’ with goods, or as ‘servitisation’. Hybrid offerings of manufacturing products and services strengthen firms’ competitiveness through diversification (Nordås and Kim, 2013; Baines et al., 2009; Mastrogiacomo, Barravecchia, and Francesc, 2017; Gao et al., 2011; Lodefalk, 2014). ‘Factoryless goods producers’ (Miroudot, 2019) is another outcome. These firms are not involved in manufacturing, but provide related services to deliver goods to customers. They might provide inputs for others to transform or they might ask the firm responsible for manufacturing to organise procurement. Servicification of manufacturing highlights the importance of service trade liberalisation in improving manufacturing productivity (Amiti and Wei, 2009; Arnold, Javorcik, and Mattoo, 2011). The level of the extent of restrictions on services trade is negatively correlated with manufactured exports, and the main channel of effect is via the impact of policy on FDI (Hoekman and Shepherd, 2017; Arnold et al., 2016; Nordås and Kim, 2013; van der Marel and Sáez, 2016; Nordås and Rouzet, 2017). 3.2  Global Value Chains and the Increased Role of Services Services are the ‘glue’ in GVCs, facilitating the global production of manufactured products (Low, 2013; Gereffi and Fernández-Stark, 2011). Low and Pasadilla (2015) reviewed a series of case studies on the role of services in GVCs and identified policy implications. Services activities have their own GVCs (Findlay, Kimura, and Thangavelu, 2019), but what shape are they (see Miroudot and Cadestin, 2017)? The idea of the value chain works for industries where value adding occurs in a sequence of steps. Another is a value network where

144  Handbook on East Asian economic integration

value is created by linking customers, e.g. insurance and banking. A third is a value shop where consumer problems are solved, e.g. medical services, consultancy (specialists in different locations), and engineering. Value shops involve more tailoring and personalisation. Relevant knowledge may be scattered and brought together to solve problems, e.g. in large consulting firms. Value shops may be rising in importance (Miroudot and Cadestin, 2017). In any valuecreating process, all three formats may exist: e.g. in the car industry, chains in vehicle production, shops in vehicle design, and networks in distribution and finance. A key question is the way in which services reform supports the development of value chains in manufacturing and in services themselves. In further work, the services trade restrictiveness index (STRI) methodology could be applied to these questions.

4.  REGIONAL INTEGRATION IN TRADE IN SERVICES Hamanaka (2013) examined the degree of regional integration in services trade in modes 1 and 2. Asia’s intra-regional (total) trade share in services is less than in goods, except when China is excluded (China is not (yet) a services trade hub), compared with North America where the services share is higher than in goods (the US is a services trade hub). Asia’s intra-regional trade intensity in services is greater than 1, and this intensity is higher than that of goods. In addition, services trade intensity is higher in Asia than that of the European Union and North America. Data on the bilateral flows of services trade are available from the Organisation for Economic Co-operation and Development (OECD)−WTO Balanced Trade in Services data set for 2012 (data are currently available from 1995 to 2012). Service trade intensities, calculated from these bilateral flows between regions, are shown in Table 7.1. In the case of ASEAN, the share of exports to the region is nearly three times that expected according to the region’s share of world imports of services, and this intensity is even higher in South America. The European Union has relatively intense trade within its region, but less than ASEAN. Countries participating in the Regional Comprehensive Economic Partnership (RCEP) negotiations (ASEAN+6)5 have relatively high intensities at the group levels. On the other hand, the North American Free Trade Agreement (NAFTA) members and South Asia show a more diverse pattern of services trade. 4.1  Drivers of Regional Integration Drivers of the extent of regional integration include both standard gravity equation variables but also the impact of policy, and the degree to which it affects the patterns of trade. The latter topic is the focus of the next section. Other contributors to the relatively high degree of intensity in trade in services include the presence of a shared language across major cities (Chinese) and the nature of the geography of the region, which is a bigger inhibitor of goods trade than services trade (Hamanaka, 2013). Various papers have applied the gravity model to services, with mixed results. Kimura and Lee (2006) estimated a gravity model for bilateral service and goods trade between 10 OECD countries and others for 1999 and 2000, and found that the gravity model works for services. They also found interesting differences between goods and services. They found that distance has a larger negative impact on services while a common border has a larger impact on goods,

Services 145 Table 7.1  Services Trade Intensities, 2012

Trading partner/exporter ASEAN Plus Six Countries South Asia EU28 NAFTA South America Rest of the World

ASEAN

Plus Six countries

South Asia

EU28

NAFTA

South America

2.80 1.81 1.84 0.46 0.76 0.42 1.15

2.26 1.09 1.30 0.44 1.20 0.64 1.49

1.65 0.69 1.28 0.62 1.62 0.64 1.29

0.46 0.21 0.11 1.42 0.78 0.75 1.17

0.85 1.20 0.98 0.75 1.24 2.12 0.99

0.54 0.81 0.78 0.64 1.74 4.65 0.82

Notes: ASEAN = Association of Southeast Asian Nations, EU = European Union, NAFTA = North American Free Trade Agreement, OECD = Organisation for Economic Co-operation and Development, RCEP = Regional Comprehensive Economic Partnership, WTO = World Trade Organization. Intensity is calculated as the share of exports of the origin region to a destination region relative to that region’s share of world imports. Source: OECD–WTO Balanced Trade in Services Statistics (n.d.), https://www.oecd.org/sdd/its/balanced-trade-inservices.htm (accessed 13 April 2020).

and a common language has a larger impact on services. There is also a complementary relationship between goods exports and services imports. In studies outside East Asia, some find no influence of distance (Kandilov and Grennes, 2012) while some find that it does matter (Anderson, Milot, and Yotov, 2014) and others find that a common language has a larger positive impact on services than for goods (Lejour and de Paiva Verheijden, 2007; Head, Mayer, and Ries, 2009; Ceglowski, 2006). Income differences have a positive effect on bilateral services flows (Braymen and Briggs, 2015; Dao, Pham, and Doan, 2014). Religious similarity contributes to increased international trade in services through establishing ‘trust-related institutions’ by reducing unobserved transaction costs stemming from cultural and institutional differences (Lee and Park, 2016). In addition, religious pluralism (variety) fosters trade even more than religious similarity, suggesting that in facilitating trade, religious openness matters more than religious similarity. Finally, a strong dominant religion discourages trade in services, whereas the presence of a religious minority encourages trade in services.

5.  BARRIERS TO TRADE IN SERVICES Barriers to trade in services are not taxes on an ‘entity’ crossing a border. Barriers include impediments to entry and to operations (Dee, 2003). Some are profit-creating (the former) and some are cost-creating (the latter). Domestic providers may face similar impediments. This section refers to methods for measuring barriers to trade in services (Findlay and Warren, 2000), studies of the application of those measures, and the treatment of services in trade agreements.

146  Handbook on East Asian economic integration

5.1  Methods of Measurement The OECD examines policies which apply to services trade restrictions. These are scored and weighted to produce a composite, referred to as an STRI, taking values between 0 and 1 (higher values are more restrictive) (Geloso Grosso et al., 2015). The index is calculated for 22 services sectors for 44 economies (the OECD members plus a number of non-members). It is derived from a series of questions, the responses to which are compiled by researchers based on their interpretation of legislation and regulation. The index includes restrictions on foreign entry and movement of people, other discriminatory measures, and barriers to competition. The OECD has applied this methodology in a series of sectoral and country papers,6 including a longer study of the services sector of Australia (OECD, 2018) from which a series of cross-cutting and sector-specific policy proposals was derived. Highly restricted sectors tend to be air transport and legal, accounting, and auditing services (OECD, 2019). Distribution and logistics tend to be more open. Figure 7.3 shows the performance of different economies in terms of the OECD STRI values. The figure shows the number of times an economy appears in the top 10 rankings of STRI values (in terms of openness) compared with their average ranking (high rankings to the left). Data for Asia-Pacific economies available in the OECD database are identified in the chart. Economies with higher rankings tend to appear more often in the top 10 group. 25

Number of top 10 rankings across all sectors

20

15 AUS JPN KOR

10

5 NZL

0

MYS

0

5

-5

10

15

20

25

30

35

CHN

40

IDN

IND

45

Average ranking

Notes: AUS = Australia, CHN = China, IDN = Indonesia, IND = India, JPN = Japan, KOR = Republic of Korea, MYS = Malaysia, NZL = New Zealand, OECD = Organisation for Economic Co-operation and Development, STRI = Services Trade Restrictiveness Index. Source: OECD (2019).

Figure 7.3  OECD STRI Ranks by Economy, 2018

Services 147

Australia and Japan have the highest position, according to Figure 7.3. While China on average ranks at a low (or closed) level in terms of the STRI values (close to India and Indonesia), the OECD also reports that China is the best recent global performer in terms of a reduction in STRI values. This was mainly due to the introduction of a negative list for FDI. Over a longer period, Indonesia has been the best performer in terms of the degree of change in its index value. The first World Bank Services Trade Restrictions Database covered 103 countries; five sectors (telecommunications, finance, transportation, retail, and professional services) for each country; and delivery modes 1, 3, and 4. Data are available for various years from 2008 to 2011. Data were collected from public sources for some countries and via interviews with local law offices in others (Borchert, Gootiiz, and Mattoo, 2012). The WTO and the World Bank developed a set of services trade restrictiveness indices for 2016, covering 68 countries and five major services sectors, including 23 subsectors (Borchert et al., 2019). Policy measures are classified into conditions affecting entry, operations, and competition, as well as other regulations. Data were collected from the OECD data set for OECD countries and from responses to a questionnaire by local law firms for others. The indices were designed to be comparable to the original World Bank STRI and to be consistent with the OECD collection.7 Figure 7.4 shows the STRI scores, with economies ranked by the degree of restrictiveness in 2016. Countries that have high levels of restrictiveness (e.g. Indonesia, Thailand, and China) have substantially reduced barriers to service trade in the past decade. However, this is far

Japan

33.3

37.4

37.2 36.8

Australia

41.8 41.7

New Zealand Republic of Korea

44.7

49.3 52.2 49.6

Viet Nam China

55.7

Thailand

63.4 66.2

59.9

Philippines

62.4 61.3

Malaysia

61.8 62.3

Indonesia

64.5 0

10

20

30 2008

Note: STRI = Services Trade Restrictiveness Index. Source: WTO and World Bank (n.d.).

Figure 7.4  STRI Scores, 2008 and 2016

40 2016

50

60

69.6

70

80

148  Handbook on East Asian economic integration

from a general trend, as we can observe that other countries with high barriers (e.g. Malaysia, the Philippines and, to a slightly lesser extent, Viet Nam) did not move significantly regarding trade restrictiveness. We also see diverging trends in the group of countries that started in 2008 with relatively low restrictions on trade in services. Whereas the Republic of Korea and Japan have made substantial efforts to reduce restrictiveness on trade in services, it is much less the case for Australia and New Zealand. As noted, technological change is providing new ways of trading services − including via digital transmission. Both the OECD and the European Centre for International Political Economy have also developed STRIs which apply to digitally enabled services (see Ferencz (2019) and Ferracane, Lee-Makiyama, and van der Marel (2018), respectively). Chapter 20 of this volume provides a more detailed discussion of policy issues with respect to this form of trade. 5.2  STRI Studies STRIs can be applied in quantitative work in a three-step process: first, ‘use qualitative information about services trade barriers to derive a frequency-type index; [then] estimate the effect of this index on cross-national differences in domestic prices or quantities, while controlling for other relevant factors; [finally] incorporate the resulting counterfactual values of prices or quantities into a partial or general equilibrium model to assess economy-wide effects’ (Dee, 2013a: 4). Dee (2013a) reviewed research related to the first two steps, and provided one of the few examples of the third step (Dee, 2013b) with a focus on the Asia-Pacific region. Examples of these studies are those on the links of policy reform to connectivity between economies: Borchert et al. (2017) found that moving from intermediate levels of restrictiveness to open regimes could lead to an increase in cellular teledensity (by 20 percentage points) and to an increase in flight connections per airline (by 25%). Using a WTO measure of policy in air transport, Geloso Grosso and Shepherd (2009) identified significant effects of restrictions on manufactured goods trade amongst Asia-Pacific Economic Cooperation (APEC) members. Jafari and Tarr (2017) presented an ad valorem equivalent of restrictiveness indexes in the World Bank Services Trade Restrictions Database for 11 services sectors and 103 countries, by applying parameters of price or cost effects estimated in other studies to their wider sample of economies. They reported data by sector and region. Compared with a benchmark of North America, East Asia and the Pacific showed higher rates in transport and fixed line telecommunications. Other studies have examined the effects of services policy, measured by STRIs, alongside regular gravity equation variables (Nordås and Rouzet, 2017, using the OECD database); and the impact of institutional quality on reform (Beverelli, Fiorini, and Hoekman, 2017, using the World Bank database). Some papers have examined the effects of regulatory differences (Nordås and Rouzet, 2017; van der Marel and Shepherd, 2013; Crozet, Milet, and Mirza, 2016). There are papers on the implications for manufacturing: Duggan, Rahardja, and Varela (2013) found that reform of the service sector in Indonesia improved total factor productivity in manufacturing, and Winkler (2018, using World Bank Enterprise Surveys data) found a similar spillover. Other research has identified implications for goods trade (He and Findlay, 2014; van der Marel and Sáez, 2016; Hoekman and Shepherd, 2017; Ariu et al., 2019).

Services 149

5.3  Treatment of Services in Trade Agreements Francois and Hoekman (2010) concluded that, in the WTO, the General Agreement on Trade in Services (GATS) was not successful in achieving liberalisation of services trade because most policy change was undertaken unilaterally (Francois and Hoekman, 2010: 673). The drivers of GATS commitments include country size, skills endowments, and regulatory capacity (Roy, 2011). Of special interest is the higher level of commitments in democracies, reflecting the interests of the general population rather than special interests. Other studies have found higher commitments by richer countries (which have better regulatory systems through which to organise commitments), a contagion effect amongst trading partners, and a positive effect of a history of making commitments in preferential agreements, while political variables which might reflect the outcomes of lobbying by interest groups have no influence (Egger and Lanz, 2008). There has been some discussion of whether a plurilateral agreement is a better track (Sauvé, 2014; Adlung and Mamdouh, 2018). Some studies have examined the questions of who forms preferential agreements in services (Sauvé and Shingal, 2016; Egger and Shingal, 2018). Similarity is important. A common result is that commitments in those agreements exceed those in the GATS (Roy, Marchetti, and Lim, 2007; Dee and McNaughton, 2014; van der Marel and Miroudot, 2014). However, commitments are often less liberal than actual policy (Dee, 2014; Dee and Findlay, 2009; Dee and McNaughton, 2014). ASEAN Member States and their Plus One partners show significant variations in commitments between sectors (some are thereby regarded ‘sensitive’); commitments under the ASEAN Framework Agreement on Services are higher than in the Plus One agreements; and there are cross-country similarities in the level of commitments (Ishido, 2015). Gootiiz and Mattoo (2017) concluded that ASEAN Member States have relatively restricted policy regimes compared with the rest of the world, although with considerable variation across the membership. They also found that ASEAN members have not liberalised with each other compared with non-members, and that there had been little change in the 4 years leading up to the study. Exceptions were in air transport and some professional services. Other research has examined the effects of commitments, which are generally but not always positive (Ceglowski, 2006; Kimura and Lee, 2006; Lennon, 2009; Park and Park, 2011; van der Marel and Shepherd, 2013; Zhou and Whalley, 2014; Dee, 2008). These free trade agreement (FTA) studies concentrated on the development of commitments to market access provisions, and commitments in that respect relative to GATS and to actual policy. Given the nature of services transactions, and the nature of the applicable regulatory policy, the question remains regarding the manner of the contribution of FTAs to regulatory reform and institution building in partner economies.

6.  POLICY CHANGE Reform is not straightforward, however, with some challenges linked to the role of domestic institutions and behind-the-border operations. Impediments to reform include a lack of understanding of the importance of services for other sectors of the economy, the influence of state-owned enterprises in some sectors which resist reform, and the popular view that health and education should not be more open to foreign participation (Findlay and Pangestu, 2016).

150  Handbook on East Asian economic integration

At the same time, there are some differences compared with the reform of trade barriers in goods. The impediments are not necessarily the result of rent-seeking. Some impediments are cost-creating. In the case of cost-increasing measures, then, reform could be employmentcreating (Dee, 2013b). In addition, domestic labour and capital in protected sectors may have different interests, given the scope for FDI to follow reform and increase the demand for labour, while competing with established domestic providers (Dee and Findlay, 2008). Case studies of reform in APEC economies show many lessons (Findlay, 2014): (i) changes in ownership (e.g. privatisation) should be preceded by the introduction of competition; (ii) political leadership and commitment, with a clear vision of the end point of the reform process, are important; (iii) the gap of actual practice to good practice has to be recognised; (iv) the costs of the current regime should be understood; (v) the commitment to reform is continuous as circumstances change (e.g. new technology emerges); (vi) reform happens faster when it is motivated from within the regulated sector; (vii) experiments can be useful to demonstrate the feasibility and benefits of new models; (viii) coordination across services may be required; and (ix) universal service obligations should be identified and funded directly. Despite the prospective gains from reform, trade agreements have been slow to deliver, particularly in relation to progress on actual policy practice. One reason is that the reciprocity mechanisms on which they are built have been less effective devices to manage political economy issues (Dee and McNaughton, 2014). Winning the ‘domestic political battle’ matters. Removing inconsistencies in regulatory structures is worth pursuing: Hoekman and Pasadilla (2017) proposed a form of economic cooperation and capacity building for doing so. These are elements of the APEC Services Competitiveness Roadmap (APEC, 2016). Complementary reforms that raise the quality of systems of governance amplify the benefits of reform. Services reforms may meet resistance from incumbent suppliers. The development of services value chains can assist adjustment and add to the competitiveness of incumbents, as would access to the appropriate human capital, which could be supplied more efficiently by a more open education sector. These perspectives also help drive the choice of policy priorities. Progress in that respect depends on a good policy review process, which includes consultation with the private sector (Findlay, Kimura, and Thangavelu, 2019).

7. CONCLUSION The nature of services production, the scope for international transactions in services, and the impediments to those transactions have been reviewed in this chapter. Services have become more important in the region − driving a growth in international exchange in services through various modes. These forms of exchange are impeded by a variety of complex measures, developed in response to the market failures associated with services markets. While recognising these issues, there is scope for reform, including the alignment of regulation. The literature, in application in East Asia and elsewhere, has found significant benefits from services reform. However, East Asian economies are generally outliers in reforms of services compared with reforms of trade in goods. Reforms offer a spur to growth and understanding and managing reforms in services is a priority. A value chain perspective will assist, it is argued here, both because it helps mobilise support for reform from amongst services users, and provides support for adjustment through the development of value chains in services. Growth in earlier periods was driven by catching up in the application of technology in manufacturing

Services 151

and the same opportunity now arises in services. Even higher degrees of regional integration in services would be likely to follow. There is a rapidly growing body of work on services trade and investment, including a focus on East Asian economies. This activity has been driven by new data on trade and investment flows, and on the measurement of policy. However, important questions remain for study − including those related to the growth of the services sector, productivity in services production, and trade in services, but especially the progress of reform. For example: are the critical elements of innovation in services – where do services markets • What come from? are the productivity effects of the growth of the services sector in services and in • What manufacturing? are the consequences of services reforms? How can the measures of restrictiveness • What be converted to ‘wedges’ that can be analysed in economy-wide models? are services now traded and how are the modes of supply bundled together? How • How will technological change affect trade in services? What shapes are services value chains? are further applications of STRI measures? How can services reform strategies be • What defined? STRI methodology has been applied to the question of impediments to digital • The transactions, but can it also be applied to the development of measures indicating restrictions on value chain development, both in goods and services?

is the relationship between FTA participation and domestic institution building • What which supports regulatory reform?

NOTES 1. Findlay (1990) provided a review of earlier literature. The literature reviewed here includes that focused on East Asia, which is augmented with work about other regions where those references help widen the picture of a process or outcome. 2. The services under this approach correspond to divisions 50–99 in the International Standard Industrial Classification (ISIC). See United Nations (2008). 3. Taken from WTO (n.d.: Box A). 4. Based on Department of Foreign Affairs and Trade (2019: 14). See also Rickards (2019). 5. ASEAN members plus Australia, China, India, Japan, the Republic of Korea, and New Zealand. 6. See OECD (n.d.) for the data and the reports. 7. This database is available at WTO and World Bank (n.d.). This site includes data on the General Agreement on Trade in Services (GATS) commitments, commitments in trade agreements, and other services statistics.

REFERENCES ADB (2012), Asian Development Outlook 2012 Update: Services and Asia’s Future Growth. Manila: Asian Development Bank. ADB (2018), Asian Economic Integration Report 2018: Toward Optimal Provision of Regional Public Goods in Asia and the Pacific. Manila: Asian Development Bank. Adlung, R. and H. Mamdouh (2018), ‘Plurilateral Trade Agreements: An Escape Route for the WTO?’, Journal of World Trade, 52(1), pp.85–111. Ali-Yrkkö, J., P. Rouvinen, T. Seppälä, and P. Ylä-Anttila (2011), ‘Who Captures Value in Global Supply Chains? Case Nokia N95 Smartphone’, Journal of Industry, Competition and Trade, 11(3), pp.263–78.

152  Handbook on East Asian economic integration Amiti, M. and S.-J. Wei (2009), ‘Service Offshoring and Productivity: Evidence from the US’, The World Economy, 32(2), pp.203–20. Anderson, J.E., C.A. Milot, and Y.V. Yotov (2014), ‘How Much Does Geography Deflect Services Trade? Canadian Answers’, International Economic Review, 55(3), pp.791–818. Anukoonwattaka, W., M. Scagliusi, and M. Mikic (2015), ‘Servicification and Industrial Exports from Asia and the Pacific’, ESCAP Trade Insights, No. 10. Bangkok: United Nations Economic and Social Commission for Asia and the Pacific. APEC (2016), ‘2016 Leaders’ Declaration, Annex B: APEC Services Competitiveness Roadmap (2016–2025)’. https://www.apec.org/Meeting-Papers/Leaders-Declarations/2016/2016_aelm/2016_Annex%20B.aspx (accessed 13 April 2020). Ariu, A. (2016), ‘Crisis-Proof Services: Why Trade in Services Did Not Suffer During the 2008–2009 Collapse’, Journal of International Economics, 98, pp.138–49. Ariu, A., H. Breinlich, G. Corcos, and G. Mion (2019), ‘The Interconnections Between Services and Goods Trade at the Firm-Level’, Journal of International Economics, 116, pp.173–88. Arnold, J.M., B. Javorcik, M. Lipscomb, and A. Mattoo (2016), ‘Services Reform and Manufacturing Performance: Evidence from India’, The Economic Journal, 126(590), pp.1–39. Arnold, J.M., B.S. Javorcik, and A. Mattoo (2011), ‘Does Services Liberalization Benefit Manufacturing Firms? Evidence from the Czech Republic’, Journal of International Economics, 85(1), pp.136–46. Baines, T.S., H.W. Lightfoot, O. Benedettini, and J.M. Kay (2009), ‘The Servitization of Manufacturing: A Review of Literature and Reflection on Future Challenges’, Journal of Manufacturing Technology Management, 20(5), pp.547–67. Baldwin, R. (2019), The Globotics Upheaval: Globalization, Robotics, and the Future of Work. New York: Oxford University Press. Beverelli, C., M. Fiorini, and B. Hoekman (2017), ‘Services Trade Policy and Manufacturing Productivity: The Role of Institutions’, Journal of International Economics, 104(C), pp.166–82. Boddin, D. and P. Henze (2014), ‘International Trade and the Servitization of Manufacturing: Evidence from German Micro Data’, European Trade Study Group Working Paper. European Trade Study Group. https://www.etsg.org/ ETSG2014/Papers/186.pdf (accessed 13 April 2020). Borchert, I. et al. (2019), ‘Applied Services Trade Policy: A Guide to the Services Trade Policy Database and the Services Trade Restrictiveness Index’, WTO Staff Working Papers, No. ERSD-2019-14. Geneva: World Trade Organization, Economic Research and Statistics Division. Borchert, I., B. Gootiiz, A. Grover Goswami, and A. Mattoo (2017), ‘Services Trade Protection and Economic Isolation’, The World Economy, 40(3), pp.632–52. Borchert, I., B. Gootiiz, and A. Mattoo (2012), ‘Guide to the Services Trade Restrictions Database’, Policy Research Working Paper, No. 6108. Washington, DC: World Bank. Braymen, C. and K. Briggs (2015), ‘Income Differences in Services Trade Partners’, Applied Economics Letters, 22(8), pp.593–96. Breunig, R.V. and S. Bakhtiari (2013), ‘Outsourcing and Innovation: An Empirical Exploration of the Dynamic Relationship’, The BE Journal of Economic Analysis and Policy, 13(1), pp.395–418. Bylund, P. (2011), ‘The Origins of Markets and Money’, Mises Daily Articles, 13 October. https://mises.org/library/ origin-markets-and-money (accessed 13 April 2020). Ceglowski, J. (2006), ‘Does Gravity Matter in a Service Economy?’, Review of World Economics, 142(2), pp.307–29. Cernat, L. and Z. Kutlina-Dimitrova (2014), ‘Thinking in a Box: A “Mode 5” Approach to Service Trade’, Journal of World Trade, 48(6), pp.1109–26. Christensen, C.M., E. Ojomo, G.D. Gay, and P.E. Auerswald (2019), ‘The Third Answer: How Market-Creating Innovation Drives Economic Growth and Development’, Innovations: Technology, Governance and Globalization, 12(3–4), pp.10–26. Crozet, M., E. Milet, and D. Mirza (2016), ‘The Impact of Domestic Regulations on International Trade in Services: Evidence from Firm-Level Data’, Journal of Comparative Economics, 44(3), pp.585–607. Dao, N.T., V.N. Pham, and Q.H. Doan (2014), ‘Analyzing the Determinants of Services Trade Flow Between Vietnam and European Union: Gravity Model Approach’, MPRA Paper, No. 63982. Munich: Munich University Library, Munich Personal RePEc Archive. https://mpra.ub.uni-muenchen.de/63982/1/MPRA_paper_63982.pdf (accessed 13 April 2020). De Backer, K. and S. Miroudot (2013), ‘Mapping Global Value Chains’, OECD Trade Policy Papers, No. 159. Paris: Organisation for Economic Co-operation and Development. Dee, P. (2003), ‘Modelling the Policy Issues in Services Trade’, Économie internationale, 2–3(94–95), pp.283–300. Dee, P. (2008), ‘Multinational Corporations and Pacific Regionalism’, in J.J. Palacios (ed.) Multinational Corporations and the Emerging Network Economy in Asia and the Pacific. London: Routledge, pp.250–84. Dee, P. (2013a), ‘Measuring and Modelling Regulatory Restrictions in Services’, in P. Dee (ed.) Priorities and Pathways in Services Reform – Part 1: Quantitative Studies. Singapore: World Scientific, pp.1–27. Dee, P. (2013b), ‘Assessing Services Reform’, in P. Dee (ed.) Priorities and Pathways in Services Reform – Part 1: Quantitative Studies. Singapore: World Scientific, pp.289–358.

Services 153 Dee, P. (2014), ‘Does AFAS Have Bite? Comparing Services Trade Commitments with Actual Practice’, Journal of Asian Economics, 35, pp.46–64. Dee, P. and C. Findlay (2008), ‘Services: A “Deal-Maker” in the Doha Round?’, in P. Dee (ed.) Services Trade Reform: Making Sense of It. Singapore: World Scientific, pp.263–82. Dee, P. and C. Findlay (2009), ‘Services in PTAs – Donuts or Holes?’, in S. Jayasuriya, D. MacLaren, and G. Magee (eds.) Negotiating a Preferential Trading Agreement: Issues, Constraints and Practical Options. Cheltenham UK: Edward Elgar, pp.97–128. Dee, P. and A. McNaughton (2014), ‘Promoting Domestic Reforms Through Regionalism’, in G. Capannelli and M. Kawai (eds.) The Political Economy of Asian Regionalism. Tokyo: Springer, pp.105–42. Department of Foreign Affairs and Trade (2019), Trade in Services Australia 2017–18. Canberra: Government of Australia, Department of Foreign Affairs and Trade. Díaz-Mora, C., R. Gandoy, and B. González-Díaz (2018), ‘Looking into Global Value Chains: Influence of Foreign Services on Export Performance’, Review of World Economics, 154(4), pp.785–814. Duggan, V., S. Rahardja, and G. Varela (2013), ‘Service Sector Reform and Manufacturing Productivity: Evidence from Indonesia’, Policy Research Working Paper, No. 6349. Washington, DC: World Bank. Egger, P. and R. Lanz (2008), ‘The Determinants of GATS Commitment Coverage’, The World Economy, 31(12), pp.1666–94. Egger, P.H. and A. Shingal (2018), ‘Determinants of Services Trade Agreement Membership’, EUI Working Papers, RSCAS 2018/19, Global Governance Programme 307. Florence: European University Institute Robert Schuman Centre for Advanced Studies. Ferencz, J. (2019), ‘The OECD Digital Services Trade Restrictiveness Index’, OECD Trade Policy Papers, No. 221. Paris: Organisation for Economic Co-operation and Development. Ferracane, M.F., H. Lee-Makiyama, and E. van der Marel (2018), Digital Trade Restrictiveness Index. Brussels: European Centre for International Political Economy. Findlay, C. (1990), ‘Trade in Services in the Asia‐Pacific Region’, Asian‐Pacific Economic Literature, 4(2), pp.3–20. Findlay, C. (ed.) (2014), Priorities and Pathways in Services Reforms – Part II: Political Economy Studies. Singapore: World Scientific. Findlay, C., F. Kimura, and S. Thangavelu (2019), ‘New Frontiers for Services in Globalisation’, Policy Brief, No. 2019-08. Jakarta: Economic Research Institute for ASEAN and East Asia. Findlay, C. and M. Pangestu (2016), ‘The Services Sector as a Driver of Change: Indonesia’s Experience in the ASEAN Context’, Bulletin of Indonesian Economic Studies, 52(1), pp.27–53. Findlay, C. and T. Warren, eds. (2000), Impediments to Trade in Services: Measurements and Policy Implications. London: Routledge. Fort, T.C., J.R. Pierce, and P.K. Schott (2018), ‘New Perspectives on the Decline of US Manufacturing Employment’, Journal of Economic Perspectives, 32(2), pp.47–72. Francois, J. and B. Hoekman (2010), ‘Services Trade and Policy’, Journal of Economic Literature, 48(3), pp.642–92. Gadrey, J. (2000), ‘The Characterization of Goods and Services: An Alternative Approach’, Review of Income and Wealth, 46(3), pp.369–87. Gao, J., Y. Yao, V.C.Y. Zhu, L. Sun, and L. Lin (2011), ‘Service-Oriented Manufacturing: A New Product Pattern and Manufacturing Paradigm’, Journal of Intelligent Manufacturing, 22, pp.435–46. Geloso Grosso, M., F. Gonzales, S. Miroudot, H.K. Nordås, D. Rouzet, and A. Ueno (2015), ‘Services Trade Restrictiveness Index (STRI): Scoring and Weighting Methodology’, OECD Trade Policy Papers, No. 177. Paris: Organisation for Economic Co-operation and Development. Geloso Grosso, M. and B. Shepherd (2009), ‘Liberalising Air Cargo Services in APEC’, MPRA Working Paper, No. 17781. Munich: Munich University Library, Munich Personal RePEc Archive (Sciences Po, Groupe d’Économie Mondiale). Gereffi, G. and K. Fernandez-Stark (2011), Global Value Chain Analysis: A Primer. Durham, NC: Center on Globalization, Governance & Competitiveness, Duke University. Gereffi, G., J. Humphrey, and T. Sturgeon (2005), ‘The Governance of Global Value Chains’, Review of International Political Economy, 12(1), pp.78–104. Gootiiz, B. and A. Mattoo (2017), ‘Regionalism in Services: A Study of ASEAN’, The World Economy, 40(3), pp.574–97. Görg, H. and A. Hanley (2011), ‘Services Outsourcing and Innovation: An Empirical Investigation’, Economic Inquiry, 49(2), pp.321–33. Görg, H., A. Hanley, and E. Strobl (2008), ‘Productivity Effects of International Outsourcing: Evidence from PlantLevel Data’, Canadian Journal of Economics/Revue Canadienne d’économique, 41(2), pp.670–88. Hamanaka, S. (2013), ‘Cross-Regional Comparison of Trade Integration: The Case of Services’, ADB Working Paper Series on Regional Economic Integration, No. 108. Manila: Asian Development Bank. He, X. and C. Findlay (2014), ‘Policy Restrictions and Services Performance: Evidence from 32 Countries’, Journal of International Commerce, Economics and Policy, 5(1).

154  Handbook on East Asian economic integration Head, K., T. Mayer, and J. Ries (2009), ‘How Remote is the Offshoring Threat?’, European Economic Review, 53(4), pp.429–44. Hill, P. (1999), ‘Tangibles, Intangibles and Services: A New Taxonomy for the Classification of Output’, The Canadian Journal of Economics/Revue canadienne d’économique, 32(2), pp.426–46. Hill, T.P. (1977), ‘On Goods and Services’, The Review of Income and Wealth, 23(4), pp.315–38. Hoekman, B. and G. Pasadilla (2017), Structural Reform and Services. Singapore: Asia-Pacific Economic Cooperation Policy Support Unit. Hoekman, B. and B. Shepherd (2017), ‘Services Productivity, Trade Policy and Manufacturing Exports’, The World Economy, 40(3), pp.499–516. Ishido, H. (2015), ‘Services in ASEAN+1 FTAs’, in C. Findlay (ed.) ASEAN and Regional Free Trade Agreements. Oxon: Routledge, pp.115–48. Ivarsson, I. and C.G. Alvstam (2010), ‘Supplier Upgrading in the Home-Furnishing Value Chain: An Empirical Study of IKEA’s Sourcing in China and South East Asia’, World Development, 38(11), pp.1575–87. Jafari, Y. and D. Tarr (2017), ‘Estimates of Ad Valorem Equivalents of Barriers Against Foreign Suppliers of Services in Eleven Services Sectors and 103 Countries’, The World Economy, 40(3), pp.544–73. Jiang, B., J.A. Belohlav, and S.T. Young (2007), ‘Outsourcing Impact on Manufacturing Firms’ Value: Evidence from Japan’, Journal of Operations Management, 25(4), pp.885–900. Kaleka, A. (2011), ‘When Exporting Manufacturers Compete on the Basis of Service: Resources and Marketing Capabilities Driving Service Advantage and Performance’, Journal of International Marketing, 19(1), pp.40–58. Kandilov, I.T. and T. Grennes (2012), ‘The Determinants of Service Offshoring: Does Distance Matter?’, Japan and the World Economy, 24(1), pp.36–43. Kimura, F. and H.H. Lee (2006), ‘The Gravity Equation in International Trade in Services’, Review of World Economics, 142(1), pp.92–121. Lanz, R. and A. Maurer (2015), ‘Services and Global Value Chains: Some Evidence on Servicification of Manufacturing and Services Networks’, WTO Staff Working Paper, No. ERSD-2015-03. Geneva: World Trade Organization, Economic Research and Statistics Division. Lee, C.W. and S. Park (2016), ‘Does Religious Similarity Matter in International Trade in Services?’, The World Economy, 39(3), pp.409–25. Lejour, A. and J.W. de Paiva Verheijden (2007), ‘The Tradability of Services Within Canada and the European Union’, The Service Industries Journal, 27(4), pp.389–409. Lennon, C. (2009), ‘Trade in Services and Trade in Goods: Differences and Complementarities’, wiiw Working Papers. No. 53. Vienna: The Vienna Institute for International Economic Studies. Lodefalk, M. (2014), ‘The Role of Services for Manufacturing Firm Exports’, Review of World Economics, 150, pp.59–82. Loungani, P., S. Mishra, C. Papageorgiou, and K. Wang (2017), ‘World Trade in Services: Evidence from a New Dataset’, IMF Working Paper, No. 17/77. Washington, DC: International Monetary Fund. Low, P. (2013), ‘The Role of Services in Global Value Chains’, in D. Elms and P. Low (eds.) Global Value Chains in a Changing World. Geneva: Fung Global Institute, Nanyang Technological University, and World Trade Organization, pp.61–81. Low, P. and G. Pasadilla (2015), Services in Global Value Chains: Manufacturing-Related Services. Singapore: APEC Secretariat. van der Marel, E. and S. Miroudot (2014), ‘The Economics and Political Economy of Going Beyond the GATS’, The Review of International Organizations, 9(2), pp.205–39. van der Marel, E. and S. Sáez (2016), ‘Servicification, Regulation and Economic Performance in GVCs’, in World Bank Background Paper prepared for the Making Global Value Chains Work for Economic Development and Shared Prosperity conference, Beijing, 17–18 March. van der Marel, E. and B. Shepherd (2013), ‘Services Trade, Regulation and Regional Integration: Evidence from Sectoral Data’, The World Economy, 36(11), pp.1393–405. Maroto-Sánchez, A. and J.R. Cuadrado-Roura (2009), ‘Is Growth of Services an Obstacle to Productivity Growth? A Comparative Analysis’, Structural Change and Economic Dynamics, 20(4), pp.254–65. Mastrogiacomo, L., F. Barravecchia, and F. Franceschini (2017), ‘A General Overview of Manufacturing Servitization in Italy’, Procedia CIRP, 64, pp.121–26. Mercer-Blackman, V. and C. Ablaza (2018), ‘The Servicification of Manufacturing in Asia: Redefining the Sources of Labor Productivity’, ADBI Working Paper Series, No. 902. Tokyo: Asian Development Bank Institute. Miroudot, S. (2019), ‘Services and Manufacturing in Global Value Chains: Is the Distinction Obsolete?’, ADBI Working Paper Series, No. 927. Tokyo: Asian Development Bank Institute. Miroudot, S. and C. Cadestin (2017), ‘Services in Global Value Chains: From Inputs to Value Creating Activities’, OECD Trade Policy Papers, No. 197. Paris: Organisation for Economic Co-operation and Development. Miroudot, S., J. Sauvage, and B. Shepherd (2013), ‘Measuring the Cost of International Trade in Services’, World Trade Review, 12(4), pp.719–35.

Services 155 Nasir, S. and K. Kalirajan (2016), ‘Information and Communication Technology-Enabled Modern Services Export Performances of Asian Economies’, Asian Development Review, 33(1), pp.1–27. Nordås, H.K. and Y. Kim (2013), ‘The Role of Services for Competitiveness in Manufacturing’, OECD Trade Policy Papers, No. 148. Paris: Organisation for Economic Co-operation and Development. Nordås, H.K. and D. Rouzet (2017), ‘The Impact of Services Trade Restrictiveness on Trade Flows’, The World Economy, 40(6), pp.1155–83. OECD (n.d.), Services Trade, Services Trade in the Global Economy. http://www.oecd.org/trade/topics/services-trade/ (accessed 13 April 2020). OECD (2018), Australian Services Trade in the Global Economy. Paris: Organisation for Economic Co-operation and Development. OECD (2019), OECD Services Trade Restrictiveness Index: Policy Trends up to 2019. Paris: Organisation for Economic Co-operation and Development. Park, I. and S. Park (2011), ‘Regional Liberalisation of Trade in Services’, The World Economy, 34(5), pp.725–40. Rickards, P. (2019), ‘The International Trade in Services’, RBA Bulletin, March. Sydney: Reserve Bank of Australia. Roy, M. (2011), ‘Democracy and the Political Economy of Multilateral Commitments on Trade in Services’, Journal of World Trade, 45(6), pp.1157–80. Roy, M., J. Marchetti, and H. Lim (2007), ‘Services Liberalization in the New Generation of Preferential Trade Agreements (PTAs): How Much Further than the GATS?’, World Trade Review, 6(2), pp.155–92. Rynne, B. (2019), ‘Concepts, Characteristics, Measurement and Definition of Services’, in ‘The Role of the Services Sector in Growing Australia’s Economy’, PhD thesis, University of Adelaide. Sauvé, P. (2014), ‘Towards a Plurilateral Trade in Services Agreement (TISA): Challenges and Prospects’, Journal of International Commerce, Economics and Policy, 5(1), pp.1–16. Sauvé, P. and A. Shingal (2016), ‘Why Do Economies Enter into Preferential Agreements on Trade in Services? Assessing the Potential for Negotiated Regulatory Convergence in Asian Services Markets’, Asian Development Review, 33(1), pp.56–73. Sorbe, S., P. Gal, and V. Millot (2018), ‘Can Productivity Still Grow in Service-Based Economies? Literature Overview and Preliminary Evidence from OECD Countries’, OECD Economics Department Working Papers, No. 1531. Paris: Organisation for Economic Co-operation and Development. Thangavelu, S.M., W. Wang, and S. Oum (2018), ‘Servicification in Global Value Chains: Comparative Analysis of Selected Asian Countries with OECD’, The World Economy, 41(11), pp.3045–70. UNCTAD (2018), ‘Global Investment Trends and Prospects’, in World Investment Report 2018. Geneva: United Nations Conference on Trade and Development, pp.1–35. United Nations (2008), ‘International Standard Industrial Classification of All Economic Activities (ISIC), Rev.4’, Statistical Papers, Series M, No. 4/Rev.4. New York: United Nations Department of Economic and Social Affairs. https://unstats.un.org/unsd/publication/seriesM/seriesm_4rev4e.pdf (accessed 13 April 2020). Wettstein, S., A. Liberatore, J. Magdeleine, and A. Maurer (2019), ‘A Global Trade in Services Data Set by Sector and by Mode of Supply (TISMOS)’. Geneva: World Trade Organization. https://www.gtap.agecon.purdue.edu/ resources/download/9235.pdf (accessed 13 April 2020). Winkler, D. (2018), ‘Productivity Spillovers from Services Firms in Low- and Middle-Income Countries: What Is the Role of Firm Characteristics and Services Liberalization?’, ADBI Working Paper Series, No. 884. Tokyo: Asian Development Bank Institute. WTO (n.d.), ‘GATS Training Module: Chapter 1: Basic Purpose and Concepts’. https://www.wto.org/english/tratop_e/ serv_e/cbt_course_e/c1s3p1_e.htm (accessed 13 April 2020). WTO (2019), World Trade Report 2019: The Future of Services Trade. Geneva: World Trade Organization. WTO and World Bank (n.d.), Services Trade Policy Database. https://i-tip.wto.org/services/default.aspx (accessed 13 April 2020). Zhou, N. and J. Whalley (2014), ‘How Do the “GATS-Plus” and “GATS-Minus” Characteristics of Regional Service Agreements Affect Trade in Services?’, NBER Working Paper, No. 20551. Cambridge, MA: National Bureau of Economic Research.

8.

Agricultural development, structural transformation, and East Asian trade Kym Anderson

Economic integration occurs with the lowering of costs of doing business across space. Two important manifestations are an expansion of trade across national borders, and a convergence of domestic prices on the prices of like products in international markets. Trade costs can be natural or governmental. Natural barriers to trade tend to fall following investments in transport and communication infrastructure and technological advances in the provision of their services. National governmental barriers to international trade, however, can change in either direction: they have fallen over the very long term, but around that long-run trend there have been periods when trade barriers have risen in subsets of countries, particularly for agriculture. This chapter focuses first on the decline in natural trade barriers and its impact on the agricultural competitiveness of various types of countries in East Asia relative to the rest of the world as factor endowments, technologies, and demand patterns have changed in the course of economic growth. It then turns to past and prospective developments in policies affecting agricultural trade and the consequences for actual or ‘revealed’ comparative advantages in farm products in the region. Openness has not characterised the agricultural markets of East Asian economies. On the contrary, historically, several countries restricted their exports of key farm products while their incomes were low, while others gradually raised barriers to agricultural imports as the international competitiveness of their farmers declined in the course of economic growth and industrialisation. This tradition of gradually moving away from taxing and toward protecting farmers relative to producers in non-farm sectors is not inexorable though. The most affluent countries of the region are now lowering their farm protectionism, replicating (albeit more hesitantly) the agricultural reforms of West European countries. Even in the region’s poorer countries, the administrative costs of using more-direct means of achieving society’s objectives continue to fall: thanks to the latest developments in information and communication technologies, new policy instruments are becoming available to address those concerns. That will allow countries to move away from far less-efficient price- and trade-distorting policy instruments for redistributing the benefits of economic growth and trade integration. After elaborating in Section 1 on the origins of agricultural trade, Section 2 lays out the modern drivers of the evolution of agricultural comparative advantage as economies grow. Section 3 shows the extent to which actual trade patterns in East Asia are consistent with that theory. Then, Section 4 traces the changes in trade-related policies that have altered agricultural trade in East Asia. Section 5 focuses on prospects for further agricultural development, trade growth, and economic integration as East Asia’s economies advance and further alter their trade-related farm and food policies. The final section concludes.

156

Agricultural development, structural transformation, and East Asian trade  157

1.  ORIGINS OF AGRICULTURAL TRADE The move from hunter/gatherer to the domestication of crops and animals for food and beverage production began about 10 000 years ago. Agriculture is thus the world’s oldest industry. For most of those 10 millennia, long-distance agricultural trade has contributed to the process of global economic growth and poverty reduction, but by concentrating trade not on the bulky outputs from farming – whose international trade costs were prohibitive until recently – but rather on farm inputs. Most notable among those inputs are crop seeds or cuttings, breeding animals (and their associated diseases picked up by humans), and farm production technologies. Those inputs and technologies were gradually spread beyond their place of origin, which was in the Near East/Western Asia region for most of today’s major foods, apart from rice, which is thought to have been first domesticated in the Yangtze Valley in China (Molina et al., 2011). The other major goods from which our foods are derived include wheat, barley, cattle, horses, pigs, poultry, goats, and sheep (Hirst 2014). The complementarity between knowledge of local growing conditions on the one hand, and new crops and animals and the associated technical knowhow on the other (including through the domestic and international transmission of new crop varieties), led to very substantial output growth. That in turn supported population growth. So even though this exchange of farm inputs may not have accelerated gross domestic product (GDP) per capita or caused commodity prices to greatly converge across countries prior to 1800, Jones (2002, Ch. 4) argues that it certainly boosted agricultural output and national food security in many countries. Perhaps the most notable beneficiary country is China, where four major crops from the Americas (maize, peanuts, sweet potatoes, and white potatoes) were being cultivated within a century of Columbus’s voyages. Being dryland crops, they did not stress China’s irrigation capability but rather encouraged the conversion of forests to arable land. Jones (2002: 55) notes that this globalising impact contributed to the world’s population increasing about 120% between 1500 and 1800, compared with only 18% between 1200 and 1500.1 A few high-valued unprocessed products began to be exported to Europe from the 17th century, including spices from the islands of what is now Indonesia (Milton, 1999). Since 1800, the ever-lowering cost of international commerce gradually allowed trade in farm outputs in raw or processed form to be added to long-distance trade in farm inputs. The development of the steamship played a crucial role in making international trade cheaper (Findlay and O’Rourke, 2007; Mohammed and Williamson, 2004). On top of that, the increasing speed of ocean transport has implied cost savings additional to those indicated by freight rate data, especially for perishable products. This has led to the prices of farm and other products converging across countries, and hence also to the convergence of relative factor prices. As further evidence of the fall in transport costs, O’Rourke and Williamson (2002) and Findlay and O’Rourke (2007, pp. 402–405) point to the huge declines in commodity price gaps between Europe and Asia between about 1840 and World War I. That and the development of refrigeration in the late 19th century generated gains from greater national specialisation in the production of certain export crops and, simultaneously, the opportunity for consumers in open economies to access, via imports, an ever-widening range of foods (and other products) at lower prices – including the extended seasonal availability of perishable foods. This gradually raised the potential for welfare improvements via increased diet diversity and improved nutrition and health, which in turn extended mortality by many years.

158  Handbook on East Asian economic integration

In addition to its contribution to the long-run decline in food price gaps within Asia and between it and other continents, trade between countries has also been hugely important in offsetting short-term seasonal shortfalls in food availability, both within and between years (Burgess and Donaldson, 2010). As a consequence, famines are virtually a thing of the past, except where deliberately contrived by a country’s leaders for local political purposes.2 With lowered transport costs, and the ever-rising incomes of consumers that raise the demand for variety in all things including foods, plus the emergence of modern supermarkets to satisfy those demands (Reardon et al. 2012a, 2012b), one might expect the range of products available in food markets to have grown exponentially over the past two centuries. That indeed has happened in terms of the number of processed food items available in large affluent cities. Even so, just a dozen basic foods account today for 77% of the calorie intake and 72% of the protein consumed by the world’s population. They are three grains (wheat, rice, and maize), four meats (beef, mutton/lamb, pork, and poultry), two edible oils (from soybean and oil palm), plus potatoes, milk, and sugar (FAO, 2016). These dozen basic farm products could not have become so dominant in the world without international trade in agricultural inputs/technologies or their products, given the small number of regions of the world from which those key species originated.

2. DRIVERS OF AGRICULTURAL TRADE AS ECONOMIES GROW One of the best-known facts about growing economies is that their farm sector’s shares of GDP and employment tend to fall over time. The reasons for the declines in a closed economy are well known: low and falling income elasticities of demand for food (Engel, 1857), plus rapid advances in farm production technologies (Federico, 2005; Alston, Babcock and Pardey, 2010; Fuglie, Wang, and Ball, 2012), mean that the domestic prices and quantities of farm products relative to non-farm products fall in the course of economic growth. It is less obvious that the farm sector of a small open economy – especially one with an abundance of farmland relative to other primary resources, labour time and capital – would have to face relative decline as its economy grows. The fact that it nonetheless almost always does has to do with the rising demand for non-tradable goods and especially services as incomes rise. Being non-tradable, enough of those products can be produced only by drawing mobile resources from sectors producing tradables. While some of those non-tradables are farm products (including many fresh fruits and vegetables), most are non-farm products, and so agriculture’s shares of national GDP and employment tend to fall with the expansion of open, land-abundant economies (Anderson, 1987; Anderson and Ponnusamy, 2019). Agriculture’s share of national exports depends on the country’s comparative advantage, however, and so need not fall as the world economy expands. Indeed, the tradability of the sector’s output is likely to increase as trade costs are lowered through investments in transportrelated infrastructure. If a country’s trade costs fall faster than the rest of the world’s, and if farm products gain more from those investments than non-farm products, the country may strengthen its agricultural comparative advantage over time (Venables, 2004). According to the workhorse theory of comparative advantage developed in the 20th century, we should expect agricultural trade to occur between relatively lightly populated economies that are well-endowed with agricultural land and those that are densely populated with little

Agricultural development, structural transformation, and East Asian trade  159

agricultural land per worker (Krueger, 1977; Deardorff, 1984). Leamer (1987) develops this model further and relates it to paths of economic development. If the stock of natural resources is unchanged, rapid growth by one or more countries relative to others in their availability of produced capital (physical plus human skills and technological knowledge) per unit of available labour time would tend to cause those economies to strengthen their comparative advantage in non-primary products. By contrast, a discovery of minerals or energy raw materials would strengthen that country’s comparative advantage in mining and weaken its comparative advantage in agricultural and other tradable products, ceteris paribus. It would also boost national income and, hence, the demand for non-tradables, which would cause mobile resources to move into the production of non-tradable goods and services, further reducing farm and industrial production (Corden, 1984; Freebairn, 2015). Conversely, a depletion (or fall in the international prices) of mineral, forestry, or fishery resources would strengthen the country’s comparative advantage of agriculture and other sectors producing tradables and weaken the demand for non-tradables. In the early stages of economic development, a country with high trade costs typically is agrarian, with most working on the land and producing the majority of GDP when estimated to include home-produced food. If that country has a relatively small stock of agricultural land (and other natural) resources per worker, labour rewards would be low. As trade costs fall or governmental trade restrictions are removed, the country would develop a comparative cost advantage in unskilled labour-intensive, standard-technology manufactures (as in Japan during the Meiji Restoration, 1868–1912). Then, as the stock of industrial and human capital per worker grows, there would be a gradual move toward exporting manufactures that are relatively intensive in their use of physical capital, skills, and knowledge. With the further lowering of trade costs, more and more services become internationally tradable too, further reducing the importance and competitiveness of the farm sector in resource-poor economies. Natural resource-abundant economies, however, may attract migrants from more-densely populated countries seeking to become farmers in a frontier region, thereby raising the settler economy’s total, if not per capita, GDP. In such economies, the agricultural sector’s share of GDP would fall slower than in economies that are growing equally rapidly but are less landabundant. If resource-rich economies invest relatively more in capital (including new technologies) specific to primary production rather than manufacturing, they would not develop a comparative advantage in manufacturing or services until a later stage of development, at which time their exports from those sectors would be relatively capital intensive. This is more likely if new technologies developed for or imported by the primary sector become increasingly labour-saving as real wages rise – leading potentially to what are known as factor intensity reversals, whereby a primary industry in a high-wage country can retain competitiveness against low-wage countries by adopting more capital-intensive technologies. Additionally, agriculture’s share of GDP would decline less rapidly if farm productivity growth outpaced that of other sectors – as it did in high-income countries between 1970 and 2007, according to Herrendorf, Rogerson, and Valentinyi (2014). Agriculture’s share of national employment, however, would continue to decline, and more so the more those new farm technologies were biased toward saving labour relative to land or other productive factors, other things equal. Trade patterns are also affected by growth in domestic demands, insofar as preferences are non-homothetic (Markusen, 2013). Food has an income elasticity of demand of less than one, for example. While this may dampen somewhat the decline in comparative advantage in farm

160  Handbook on East Asian economic integration

products in resource-poor emerging economies, it does not do so initially when consumers switch from staples to higher-valued foods, including intensively fed livestock. The above theory of sectoral changes and evolving comparative advantages has been used successfully to explain the 20th century flying geese pattern of comparative advantage and then disadvantage in unskilled labour-intensive manufactures. This occurred as some rapidly growing East Asian economies expanded their endowments of industrial capital per worker relative to the rest of the world – the classic example being clothing and textiles (Anderson, 1992; Ozawa, 2009). It has also been used to explain the evolving trade patterns between Asia’s resource-poor first- and second-generation industrialising economies and their resource-rich trading partners (see, e.g., Anderson and Smith, 1981), and the prolonged importance of agriculture in some New World settler economies, such as Australia and New Zealand (Anderson, 2017). Comparative advantages in the 21st century are being affected also by the increasing fragmentation of industrial production into ever-more processes and the associated rapid expansion in the number of links in their global value chains (Baldwin and Robert-Nicoud, 2014). This ‘unbundling’ of manufacturing processes and associated services is intensifying intra-regional trade in intermediate goods, in addition to leading to massive growth in exports of final manufactured goods and some services to the rest of the world (Baldwin 2016) – while agricultural production processes have been less affected by this unbundling phenomenon. The workers required for these newly established processes in developing countries tend to be relatively skilled, however. Automation, robotics, and artificial intelligence are reinforcing this skill bias in many new non-farm jobs (Baldwin 2019). Insofar as people in rural areas receive less/ lower-quality education than those in urban areas, they struggle to secure such jobs if/when they migrate to a city and so may simply end up earning little more in the informal service sector than they did in agriculture. Meanwhile, the share of primary products in national exports is declining faster in those emerging countries that are benefitting from this unbundling of manufacturing. Policies also affect trade. Preferential trade arrangements, such as customs unions and free trade agreements (FTAs), influence not only the direction of trade of member countries but also its composition because of trade diversion. FTAs in particular slow the ‘unbundling’ process because of their restrictive rules of origin that reduce imports of intermediate goods from third countries relative to FTA partners (Conconi et al., 2018). The commodity composition of a country’s trade also can depend on sectoral policies. In those industrialising economies whose growth has been accompanied by increases in protection from agricultural imports, selfsufficiency in farm products falls less. Likewise, global farm trade is dampened if poor agrarian economies protect their emerging manufacturers from import competition or tax their farm exports or overvalue their currencies, each of which discourages farm production and encourages domestic food consumption. Other things being equal, reforms to such trade-restricting policies cause an agricultural trade growth spurt and result in a higher share of global farm production being traded across national borders, as well as raising economic welfare globally and in the reforming countries. The distributional effects of changes in trade policies are different from those due to declining transport costs though: the latter (especially within countries – see Donaldson, 2018) often benefit both producers and consumers of food, whereas increases in agricultural protection or the removal of food export restrictions benefit net sellers of food at the expense of food buyers.

Agricultural development, structural transformation, and East Asian trade  161

3.  PATTERNS OF AGRICULTURAL TRADE IN EAST ASIA Global merchandise trade grew faster in the half century following the formation of the General Agreement on Tariffs and Trade in 1947 than in any other half-century in history: between 1950 and 2000, world exports of all goods grew at 5.25% per year, compared with 3.46% in 1850–1913 (Federico, 2005). However, agricultural trade grew less rapidly than trade in other goods from 1950. As a result, agriculture’s proportion of global goods trade fell from 0.5 in 1913 and 1937 to 0.4 in 1951, 0.24 in 1961, 0.12 in 1981 and 0.07 in 2001 and 2011 (Federico, 2005: 29; WTO, 2015). The slower growth of farm trade is partly due to the fall in agriculture’s share of global GDP (it is now only 3%, down from more than 50% not much earlier than 1900). It is also partly due to the accelerating fragmentation of industrial production into ever-more processes and the associated rapid expansion in the number of links in their global value chains. The latter shows up in the global shares of sectoral exports to sectoral GDP, which rose during 1995–2010 from 66% to 105% for manufacturing while hardly changing (a rise from 53% to 58%) for agriculture. Baldwin (2016) shows that East Asia has been especially affected by the unbundling of manufacturing processes and the associated services. Since agricultural production processes have been less affected by this phenomenon, the declines in farm sector shares of GDP, employment, and especially exports in East Asia have been accelerated by it, as has the decline in the region’s ‘revealed’ comparative advantage in primary products. Relative factor endowments are still an important contributor to trade patterns, however, especially of countries with extreme endowment ratios. East Asia has a mixture of economies that range from extremely natural resource-poor to moderately resource-rich per worker, as well as having some near neighbours with similar extremes, such as India and Bangladesh on the one hand, and Australia and New Zealand on the other. Indicators of relative factor endowments are imperfect, but Table 8.1 provides some examples. Countries are ranked in the table according to hectares of total land per worker as of 2000–2004, shown in column 1. If agricultural land, exploitable mineral reserves, and forests and fish stocks were evenly distributed over the earth’s land mass, that indicator could be a good proxy for natural capital per worker. Column 2 shows hectares of agricultural land per capita in that same period, which is reasonably highly correlated with total land per worker. However, agricultural land varies hugely in terms of its productive capacity. A new World Bank study (Lange, Wodon, and Carey, 2018) provides a value-based indicator of agricultural land per capita for 2014 (column 3 of Table 8.1), whose values are only modestly rank-correlated with column 2. That study also provides value-based per capita indicators of mineral (sub-soil) resources and of other (produced, including human) capital, shown in columns 4 and 5 of Table 8.1. The latter is quite closely correlated with per capita GDP (shown in the final column), with the notable exception of the Middle East and North Africa region. Columns 3 to 5 of Table 8.1 are close to the relative factor endowment ratios in the trade theory developed by Leamer (1987) and discussed in the previous section. They require imagining not just Leamer’s two-dimensional triangle but rather a three-dimensional triangle-based pyramid – because there are four rather than his three factors of production. Countries are points within that pyramid. The closer a point is to the agricultural land apex of the pyramid, the stronger is likely to be its comparative advantage in farm products. This suggests the East Asian economies might be ranked in terms of their agricultural comparative advantages roughly as follows: Cambodia, Myanmar, the Lao PDR, Thailand, Viet Nam, Indonesia, Malaysia,

162  Handbook on East Asian economic integration Table 8.1 National GDP and Agricultural Land, Mineral Resources, and Other Capital Endowments, Per Capita, Asian and Other Countries Relative to the World, 2000–2004 and 2014

  Taiwan Korea, Rep. of Japan Viet Nam Philippines China Thailand Indonesia Myanmar Cambodia Malaysia Lao PDR Bangladesh India All developing Asia United States Sub-Saharan Africa Latin America ME+N Africa New Zealand Australia World

GDP Mineral Other capital Total land Agric. land Agric. land value per resources per per capita,c per capita,b per worker,a per capita,a 2000–2004 2000–2004 capita,b 2014 capita,b 2014 2014 2014 8 9 12 18 21 28 32 40 59 65 74 151 4 15 24

5 5 5 14 19 54 39 27 42 49 41 42 8 22 34

low 48 25 104 65 156 131 78 na 82 143 135 36 59 102

1 1 1 35 8 63 9 43 low 0 109 51 1 15 63

high 273 355 13 17 60 35 25 low 6 136 12 6 9 33

208 256 350 18 26 71 54 32 12 10 103 20 10 14 37

144 165

178 148

117 78

119 39

640 11

503 17

207 280 326 1799 100

171 91 550 2856 100

139 83 366 202 100

122 2287 high 1584 100

73 19 high 500 100

91 108 409 571 100

Notes: GDP = gross domestic product, ME = Middle East. a Based on hectares. b Based on US dollars at market exchange rates. c Other capital refers to non-natural produced (including human) capital. Source: Author’s compilation drawing on 2000–2004 WDI data assembled in Sandri, Valenzuela and Anderson (2007) and 2014 World Bank data in Lange, Wodon, and Carey (2018).

Philippines, China, Taiwan, the Republic of Korea (henceforth, Korea), and Japan. Since Hong Kong and Singapore have virtually no farmland or mineral resources per worker and have more than four times the world average per capita endowment of produced capital, they would be ranked after Japan. This ranking of countries can be compared with the ranking provided by indicators of agricultural comparative advantage. One commonly used indicator of trade specialisation is the net exports of agricultural and processed food products as a ratio of the sum of exports and imports of those goods. This trade specialisation index (which ranges from −1 to +1) is shown for 2014 in Figure 8.1 for East Asian economies plus some comparator countries. Its country

Agricultural development, structural transformation, and East Asian trade  163

1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 Note: ME = Middle East. Source: World Bank (2017) and WTO (2015).

Figure 8.1 Net Exports as a Ratio of the Sum of Exports and Imports of Agricultural and Food Products, Asian and Other Key Trading Economies, 2014

ranking is close to that suggested by the above relative endowment proxies: Thailand, Viet Nam, and Indonesia are to the left (though not as much as the strongest of farm product exporters in Australasia and South America); Taiwan, Korea, and Japan are to the right, together with the oil-rich Middle East and North Africa region; and Malaysia, the Philippines, and China are in between. This wide range for East Asian economies, covering both sides of the zero axis, suggests there is ample scope for intra- as well as extra-regional trade in agricultural products. Note that Singapore and Hong Kong are oddly placed in Figure 8.1, given their extreme population densities: the value of Singapore’s exports of farm products almost matches its imports, and in the case of Hong Kong those exports well exceed the value of such imports. Both of course are entrepôt states, but both also add value to the products they import before re-exporting them. In 2014, Singapore’s imports of farm goods were US$15 billion, and its exports were $12 billion, while Hong Kong’s imports were US$28 billion, and its exports were $92 billion. This very unusual result for Hong Kong reflects the fact that in early 2008 its tariffs on wine were abolished and it became an importer and storer of vast quantities of fine wines, for later re-export to China. (Note that in the trade statistics, ‘agricultural and processed food products’ includes beverage and tobacco.) Prior to 2008, the share of merchandise exports made up of agriculture and food for Hong Kong was similar to that for Singapore at less than 3%, in contrast to its 16% share in 2015. This is a reminder that even in farm product space there is scope to add value to primary products as they are moved along the value chain and transformed into luxury products. The Netherlands is another example of a densely populated

164  Handbook on East Asian economic integration

country capable of such transformation, its trade specialisation index in 2014 being a positive 0.21. Another indicator of agricultural comparative advantage is due to Balassa (1965). His socalled ‘revealed’ comparative advantage index can be defined as a country’s share of agricultural and processed food products in its total value of merchandise exports divided by that share for the world as a whole. Although this index ignores imports (and services trade), and is distorted by national trade policies, a country having an index value greater than one could be expected to be a relatively strong competitor in international food markets, while those with the strongest comparative disadvantage in such products would have an index value close to zero. Table 8.2 Indexes of ‘Revealed’ Comparative Advantage in Agricultural and Food Products, East Asian and Other Key Trading Economies, 1960 to 2014a 1960s

1970s

1980s

1990s

2000–2004

2014

Japan Western Europe United States and Canada Australia and New Zealand

0.3 0.6 1.0 3.0

0.2 0.7 1.2 2.6

0.1 0.8 1.2 2.9

0.1 1.0 1.2 3.1

0.1 1.1 1.2 3.5

0.1 1.0 1.2 2.3

Above high-income countries

0.8

0.8

0.9

1.0

1.0

1.0

Cambodia China Indonesia Korea, Rep. of Lao PDR Malaysia Myanmar Philippines Taiwan Thailand Viet Nam

3.5 2.1 2.1 1.1 0.6 2.2 2.8 3.0 1.7 3.0 na

3.3 2.0 1.5 0.6 0.6 2.9 2.7 3.0 0.8 3.4 na

4.2 1.3 1.1 0.4 1.3 2.5 2.6 2.1 0.5 3.4 na

1.0 1.0 1.4 0.3 1.2 1.4 3.3 1.1 0.4 2.2 3.1

0.2 0.6 1.7 0.3 0.8 1.1 2.6 0.7 0.3 2.0 3.0

0.7 0.3 2.4 0.2 0.7 1.3 1.4 1.1 0.1 1.7 1.6

na na 2.2

2.0 na 1.9

1.6 1.8 1.8

1.3 1.5 1.9

1.2 1.4 2.1

0.9 1.7 na

All developing countries: Upper middle-income Lower middle-income Low-income

Notes: a Revealed comparative advantage index, following Balassa (1965), is the share of agriculture and processed food, beverages, and tobacco in national exports as a ratio of that sector’s share of global exports, hence unity for the world. The 1960s is 1961–1969, except for China which is 1965–1969. Source: Compiled by the author from World Bank (2017) and FAOSTAT.

Agricultural development, structural transformation, and East Asian trade  165

Table 8.2 provides a time series of that index. A persistent decline in the Balassa index of comparative advantage in agriculture is evident since the 1960s for most of the East Asian countries, and for middle-income countries. (The slight upturn in 2014 has since reversed following the slump in historically high fossil fuel prices after 2014.) For the high-income group as a whole, and especially for Western Europe, the index of ‘revealed’ comparative advantage in farm products has risen and is at or above one. By contrast, that index for low-income countries has hovered around two for the past half-century. In terms of the total value of farm trade, East Asia is the world’s major net importing region. In 2014, its net imports were three times that of the Middle East and North Africa region, while South Asia and Sub-Saharan Africa were close to self-sufficient (Figure 8.2). Eight of the world’s largest agricultural traders are East Asian economies. In order of 2014 value of farm trade, they are: China, Japan, Korea, Indonesia, Thailand, Malaysia, Viet Nam and Hong Kong (Table 8.3). These indicators of national comparative advantage and global importance in agricultural trade are affected by not only relative resource endowments but also policies that distort that trade. So before examining prospects for future trade, it is necessary to first examine trends in distortions to agricultural prices and international trade.

150

100

50

0

-50

-100 Notes: ME = Middle East, NZ = New Zealand, US = United States. Source: World Bank (2017).

Figure 8.2 Net Exports of Agricultural and Food Products, East Asia and Other Key Trading Regions, 2014 (US$ Billion)

166  Handbook on East Asian economic integration Table 8.3 Shares of Largest Agricultural Traders in Global Agricultural GDP and Trade, and in the World’s Total GDP and Population, 2014 (%, Net of Intra-EU Trade) Agricultural GDP

Exports

Imports

(X–M)/(X+M) Total GDP

Population

China European Union United States Japan Russia India Brazil Korea, Rep. of Mexico Saudi Arabia Canada Australia Indonesia Turkey Argentina Thailand Malaysia New Zealand Viet Nam Hong Kong

22.0 20.0 18.1 5.9 3.3 3.0 2.7 2.6 2.2 2.1 2.0 1.9 1.8 1.1 0.8 0.7 0.7 0.4 0.4 0.0

5.8 14.0 14.3 0.8 2.4 3.5 6.9 0.9 2.1 0.0 5.4 3.1 3.3 1.3 2.9 3.2 2.4 2.2 2.1 0.0

12.3 13.3 11.4 6.0 6.0 2.0 1.0 2.6 2.2 1.8 2.8 1.2 1.6 1.5 0.2 1.2 1.5 0.4 1.3 1.5

–0.36 0.03 0.11 –0.76 –0.43 0.27 0.75 –0.49 –0.02 –1.00 0.32 0.44 0.35 –0.07 –.87 0.45 0.23 0.69 0.24 –1.00

13.3 23.7 22.3 5.9 2.3 2.6 3.0 1.8 1.7 1.0 2.3 1.9 2.6 1.0 0.7 0.5 0.4 0.2 0.2 0.4

18.8 7.0 4.4 1.7 2.0 17.8 2.8 0.7 1.7 0.4 0.5 0.3 3.5 1.0 0.6 0.9 0.4 0.1 1.3 0.1

Above top 20

91.7

76.6

70.8

0.04

87.8

66.0

Notes: EU = European Union, GDP = gross domestic product. Sources: World Bank (2017) and (WTO 2015).

4. POLICY DEVELOPMENTS AFFECTING AGRICULTURAL TRADE A key contributor to slow growth in regional and global farm trade has to do with trade-restricting policies. The lack of strong General Agreement on Tariffs and Trade disciplines on agriculture’s trade-related policies allowed two separate developments in farm policies between the 1950s and the 1980s: agricultural protection growth in high-income countries, and agricultural export taxation in low-income countries. Since the 1980s, however, there have been substantial reductions in distortions to agricultural incentives in both high-income and developing countries (Anderson, 2009a). The longterm taxing of farm exports has all but disappeared over the past three decades, but progress in reducing agricultural protection has not been uniform across countries and regions. Indeed, it

Agricultural development, structural transformation, and East Asian trade  167

has been least in Northeast Asia – and agricultural taxation has been replaced by rising protection of farmers in some key emerging economies in Asia. The overall pattern of price distortions continues to be one that discriminates against farm trade. Thus, the variance in rates of assistance across commodities within each country, as well as in aggregate rates across countries, remain substantial. This indicates that resources within the farm sector of each country in East Asia and globally are still not being put to their best use. In particular, it means that the world’s most competitive export-focused farmers are still discriminated against in two respects: by the anti-trade structure of assistance within their own country’s agricultural sector, and by the protection from import competition still afforded farmers in other countries. That is, the integration of agricultural markets within East Asia and globally continues to be hampered by government policies. Specifically, this pervasive anti-trade bias in the policies of both groups of countries also has lowered the share of global agricultural production that is traded internationally. As recently as 2007, that share was just one-sixth for grains, less than one-twelfth for livestock products, and especially low for rice and dairy products. Even though it is higher for sugar and oilseeds, in 2014 it averaged just 12% for all farm products and processed food, compared with 28% for other manufactures and 41% for minerals and energy products (Narayanan, Aguiar, and McDougall, 2012). Of course, the bulkiness of some farm products relative to other goods partly explains that low share of farm production traded internationally, but governmental trade barriers have exacerbated the situation. Had there been less of an anti-trade bias in policies affecting farmer incentives in many countries, it is also very likely that international food prices would have been less volatile. Evidence of these patterns of market distortions was highlighted by Anderson and Hayami (1986), but is now provided for a much larger sample of countries and much longer time series by a World Bank study that calculated the nominal rates of assistance (NRAs) for more than 80 countries that together account for more than 90% of the world’s agricultural and food markets, population, and GDP (Anderson, 2009a). The NRA is defined as the percentage by which government policies have raised producer returns above what they would be without the government’s intervention (or the percentage by which government policies have lowered returns, if the NRA is less than zero). Since farmers are affected by the prices of not just their own outputs but also those of non-agricultural producers who compete with them in the common national markets for mobile labour and capital, the World Bank study also estimated the relative rates of assistance (RRAs). The RRA is defined as the percentage by which government policies have raised prices of tradable farm products relative to prices received by producers of non-farm tradable products (most of which are manufactures – see Anderson et al., 2008).3 Figure 8.3(a) shows the speed and extent to which assistance to agriculture, as captured by the RRA, gradually changed from negative to positive in Northeast Asia,4 while Figure 8.3(b) shows that mainland China taxed its farmers far more than either Korea or Taiwan at similar real income levels in earlier decades. It is true that during the past two decades, China’s RRA has not risen as fast as had happened earlier in its three neighbours; but it has risen as assistance to farmers in higher-income countries (including Japan and Korea) is falling. Indeed, the convergence of NRAs between some emerging East Asian countries and the members of the European Union (EU) was completed a decade ago, and in recent years, the NRA of Indonesia and the Philippines has been above that of the EU, and China’s is approaching the EU’s (Figure 8.4).

168  Handbook on East Asian economic integration (a) Percent by 5-year periodsa

250

China

200

Japan

Rep. of Korea

Taiwan

150 100 50 0 -50 -100 (b) By real per capita GDPb

Relative Rate of Assistance, %

225 175

Rep. of Korea

125

Japan

75

Taiwan

25 -25

China 7

8

9

10

11

ln real GDP per capita

-75 Notes: GDP = gross domestic product. a The NRA for agriculture for China is for 1981–1984, and the last period shown for Taiwan is 2010–2011. b Real GDP per capita is shown on the horizontal axis in natural logs at 1990 International Geary-Khamis dollars, from www.ggdc.net/maddison/maddison-project/data.htm. These have been updated to 2016 by taking the latest PPP estimates in 2011 dollars from the World Bank’s International Comparison Project (http://icp.worldbank.org) and splicing them to the Maddison series. Source: Author’s compilation from Anderson and Nelgen (2013), except agricultural NRA estimates for years 1995–2016 for China, Japan, and the Republic of Korea, which are from OECD (2020).

Figure 8.3 Relative Rate of Assistance to Agriculture, China and Other East Asian Economies, 1955 to 2016

Agricultural development, structural transformation, and East Asian trade  169

140

1985-89 1995-99 2005-09 2015-19

120 100 80 60 40 20 0 -20 -40

EU28

Japan

Rep. of Korea

China

Indonesia Philippines

Notes: EU = European Union. a The nominal rate of assistance is the percentage by which gross returns to farmers have been raised by national farm policies (predominantly import restrictions). The final column is 2013–2015 for Indonesia. Source: Compiled from estimates in Anderson and Nelgen (2013) for Asia for the first two columns, otherwise from OECD (2020).

Figure 8.4  Agricultural Nominal Rates of Assistancea in East Asia and EU28, 1985 to 2019 (%)

Moreover, the NRAs vary greatly across products in these countries, as illustrated for example for China, the Philippines, and Viet Nam in Figure 8.5. Viet Nam is especially striking, with an average NRA of almost zero, but its product NRAs range from more than 140% for sugar to −50% for rubber and tea. The greater the range of product NRAs within the sector, the higher the welfare cost of a given average NRA for the overall sector, because it indicates the extent to which resources within the agricultural sector have been misallocated away from their most efficient use (Lloyd, 1974). Trade policy instruments (export and import taxes, subsidies, or quantitative restrictions plus dual exchange rates) have accounted in recent years for no less than three-fifths of agricultural NRAs globally. The share is even higher in East Asia, where most of the farmer assistance is provided by this most-distorting of policy instrument sets (OECD, 2020, Figure 1.8). This means they account for an even larger share of the global welfare cost of agricultural price distortions, since trade measures also distort consumer prices, and welfare costs are proportional to the square of a trade tax (see Anderson, Martin and Valenzuela, 2006). Phasing out such measures would boost farm trade, ‘thicken’ international food markets, and lower the volatility of prices in those markets. It would also ensure that the region’s productive resources in the farm sector would be put to their best use and so make agricultural production more sustainable. Because food price volatility can cause political unrest in both rich and poor countries, it leads governments in many countries to insulate domestic food markets from gyrations in international prices. In East Asia this is particularly the case for rice. Insulation is invoked

10 20 -100 -30 -50 on East Asian economic integration 170  Handbook

(a) China 120 150 130 100 110 80 90 60 70 50 40 30 20 10 0 -10 -30 -20 -50

(b) Philippines

160 120 140 100 120 80 100 80 60 60 40 40 20 20 0 -20

(c) Viet Nam 150 130 110 90 70 50 30 10 -10 -30 -50

Source: OECD (2020). 120

Figure 8.5 Agricultural Nominal Rates of Assistance by Product, China, Philippines, and Viet Nam, 100 2015–2017 (%) 80 60

Agricultural development, structural transformation, and East Asian trade  171 100 80 60 40 20 0 -20 -40 -60 -80 China

Philippines

Viet Nam

Indonesia

Japan

Rep. of Korea

Note: a Share of producer price due to government trade and support policies. Source: OECD (2020).

Figure 8.6  Rice Producer Transfers,a East Asian Countries, 2000–2017 (%)

especially in price upswings, as in 2008 (Figure 8.6). It may reduce the volatility of domestic prices in countries that insulate heavily, but the collective impact of such interventions by a large number of countries is to increase the volatility of international food prices and, thereby, of domestic prices in more-open countries. Alterations in both export and import restrictions have contributed to this finding. However, if a similar proportion of the world’s food-exporting countries insulate to the same degree as a group of food-importers, each country group will fully offset the others’ attempts to prevent their domestic prices from moving as much as the international price. That is, these policy actions are as futile as everyone in a football stadium standing in an attempt to get a better view of the field (Martin and Anderson, 2012). Yet, they add very substantially to the volatility of international food prices, especially rice (Jensen and Anderson, 2017). Moreover, developing countries as a group would probably see less of their people fall into poverty when international food prices spike if they and all other countries agreed to abstain from altering trade restrictions in the hope of insulating their domestic markets from such spikes (Anderson, Ivanic, and Martin, 2014).5

5. PROSPECTS FOR AGRICULTURAL TRADE GROWTH IN EAST ASIA The projected decline in food self-sufficiency continues to concern some groups in East Asia, notwithstanding the fact that the region’s access to food is projected to continue to improve (Anderson and Strutt, 2014a, 2014b). One or more of the following policy responses, including market-distorting measures and research investment measures, may be triggered by that

172  Handbook on East Asian economic integration

concern. We evaluate these in this section and find that only a subset of such policies would boost most households’ economic access to food and hence national food security. In examining these options, it is helpful to keep in mind that any market-distorting measure tends to reduce national income and hence the aggregate capacity to access food, in addition to having effects on real income distribution. Expanding public investments in areas where the marginal social rate of return is above the opportunity cost of funds, by contrast, not only raises the level of national income in the short-run but also can raise the long-run rate of economic growth, because those investments enhance the nation’s aggregate stock of capital. These two sets of policies are considered sequentially, before then turning to generic social protection measures as another way to assist the most food-insecure households. 5.1  Market-Distorting Measures As discussed above, there are numerous market price-distorting measures used by East Asian governments in their attempts to ensure social stability through improving national food security and reducing farm–nonfarm income inequality and poverty. The most common are trade measures such as an import tariff, which is the equivalent of a production subsidy plus a consumption tax at the same rate as the tariff (as is also an export subsidy). Similarly, an export tax (or an import subsidy) is the equivalent of a production tax plus a consumption subsidy at the same rate as the trade measure. All such price-distorting trade measures tend to reduce national income, the extent of which depends on, among other things, the price elasticities of domestic demand and supply. In theory, a measure that distorts just the production or consumption side of the domestic market at the same rate as a trade measure would reduce national income less than that trade measure. That is not always true in practice though. A case in point is the rice policy of Thailand’s government that was introduced in October 2011. The government bought rice from farmers at above the market price and stored it, pending a rise in the export price. However, because the international price did not rise, much of that stored rice was spoiled and the government has been disposing of some of the rest at a loss. Such production subsidies, when combined with inefficiently managed public storage activities, therefore, may involve an even greater national loss than a trade measure. Moreover, that government expenditure could have been used instead to invest in high-payoff rural public goods (see below). India’s government also buys grain from farmers at above-market prices when the latter fall below a threshold level, and has similar wastage problems to Thailand. India also subsidises farmers’ purchases of key inputs, such as fertiliser, electricity, fuel, credit, and seeds. During the decade to 2005, these input subsidies amounted to around 10% of the value of farm production (Pursell, Gulati, and Gupta, 2009: 361; Hoda and Gulati 2013: 1), and in 2014–2016 the rate was still more than 7% (OECD/ICRIER, 2018, Table 3.12). They are more wasteful than an equivalent transfer to farmers via an output subsidy, because in addition to over-encouraging output, they also distort the mix of inputs used in production. Moreover, when many of those subsidised inputs are provided by inefficient government agencies, as is the case in India (Hoda and Gulati, 2013, p. 2; Jha et al., 2013), this adds further to their wastefulness. Similarly, food consumer subsidies can be much more wasteful in practice than in theory. India is again a case in point, as it has broadened its rice and wheat consumer subsidy schemes so as to extend discounts to two-thirds of India’s households from 2013 (Kishore, Joshi, and Hoddinott, 2014). This has involved annual payments averaging US$20 billion, or about 7%

Agricultural development, structural transformation, and East Asian trade  173

of the government’s budget or almost 2% of India’s GDP (OECD/ICRIER, 2018: 39 and Table 4.4). Apart from the wasteful corruption and losses by the public procurement and distribution system associated with such schemes,6 recent studies in both India and China demonstrate that such consumer subsidies do almost nothing to boost nutrition, as consumers tend to eat the same amount of nutrients but do so by switching, for example, from less-preferred coarse grains to subsidised rice and wheat (Jensen and Miller, 2011; Kaushal and Muchomba, 2015). To avoid the budgetary outlays that producer or consumer subsidies involve, some other food-importing countries in situations similar to how China’s is becoming have imposed import restrictions on at least their key food grains (e.g., Japan, Korea, and Indonesia for rice – see Anderson, 2009a, 2009b). In the interest of boosting farm incomes to reduce the urban–rural income gap, Japan and Korea have imposed import restrictions also on meat and milk products – but not on coarse grains and oilseed products required for animal feedstuffs, which means that sub-sector would still not be self-reliant insofar as it continues to depend on imported ingredients for feed. According to Global Trade Analysis Project (GTAP) modelling, such a trade policy response by China would encourage resources to move toward rice, wheat, and livestock production, so self-sufficiency would fall further for crops that provide inputs into animal feedstuffs, and also for other crops. Moreover, the tariff equivalents of such import restrictions would range from 114% for wheat to 255% for red meats. These are well above China’s bound out-of-quota tariffs, and so very clearly would be inconsistent with China’s WTO commitments under international law (Anderson and Strutt, 2014b). Moreover, such a policy response would impose a burden on households that are net buyers of those grain, meat, and milk products, because domestic consumer prices for those products would increase along with the producer price hike. In short, such a policy response to declining food self-sufficiency undermines national food security by reducing the vast majority of households’ economic access to food. 5.2  Growth-Enhancing Investment Measures In contrast to price-distorting measures, which re-distribute well-being between farmers, food consumers, and taxpayers but at the expense of overall national welfare, investment in rural public goods can raise national income, boost economic growth, and, in some cases, enhance the food security of both farm and nonfarm households. 5.2.1  Public agricultural research and development (R&D) investments China’s public agricultural R&D expenditure has risen considerably in recent decades but was still only four-fifths of the Asia-Pacific average in 2008. It has been shown in general that the marginal returns from boosting such levels of public investment in most developing countries are extremely high (Hurley, Rao, and Pardey, 2014; Pardey et al., 2018). The evidence from Brazil is particularly compelling: during the 1980s and 1990s, Brazil invested more than four times as intensely as China in public agricultural R&D as a percent of national agricultural GDP. It is, therefore, not surprising that Brazil’s outputs of both crop and livestock products have more than doubled since the early 1990s, and its food self-sufficiency has been boosted commensurately. And by biasing that research toward labour-saving technologies, that investment also helped farmers adjust to rising rural wages – something that is becoming more pressing also in East Asia as the supply of under-employed labour in rural areas shrinks.

174  Handbook on East Asian economic integration

Raising agricultural R&D spending is clearly something governments can choose to do if they wish to slow their decline in food self-sufficiency. In addition to also boosting national income growth, such investments would tend to lower domestic consumer prices for some foods and so would benefit not only farmers but also net buyers of those foods, thereby contributing to both the availability and access dimensions of food security. This contrasts with food import restrictions, which raise domestic prices and, thus, benefit net sellers of food but at the expense of net buyers of food. More people will be harmed than helped by such a policy measure in China, for example, now that more than half of China’s workers are employed in urban areas and barely one-quarter still work on farms, and Chinese households below the US$1.25 international poverty line are net buyers of food on average (Anderson, Ivanic, and Martin, 2014). Not surprisingly, all of the above policies would reduce the relative importance of agricultural imports. In contrast to an agricultural protection growth scenario, increases in agricultural productivity offer the opportunity not only to improve agricultural self-sufficiency rates but also to raise overall levels of both farm production and national economic welfare. 5.2.2  Investments in rural infrastructure and human capital Poor infrastructure, such as rural roads, adds to the farm-gate price of farm inputs and also to the gap between the farm-gate and market prices of outputs. It thereby depresses farmer incentives and reduces consumers’ economic access to food. So too do poor-quality telecommunications in rural areas, through raising the costs of such things as price information in distant markets and e-banking and farm credit. Better rural infrastructure also improves the opportunities for farm household members to earn part-time incomes off the farm by lowering commuting costs. Experiences in numerous East Asian countries show that part-time off-farm earning opportunities for farm household members can reduce rural poverty and the farm– nonfarm income gap – and without reducing farm production greatly, thanks to the capacity to move to labour-saving techniques as rural wages rise (Otsuka, Estudillo, and Sawada, 2009). China has been investing vast sums in infrastructure in recent decades, but whether there have been sufficient investments flowing into rural areas to ensure its marginal rate of return is driven down to that from further urban infrastructure investment is a moot point. As for education and health investments, they tend to be lower in quality as well as quantity in rural versus urban areas. This means the productivity of future farm workers and managers will be lower than is socially optimal, and farm production will be less. But it also means those wishing to work part- or full-time in nonfarm jobs will be less successful in finding and thriving in such positions and thus in repatriating earnings back to their relatives still working the farm. Both outcomes lower national economic growth and contribute to the farm–nonfarm household income gap (Rozelle et al., 2005). 5.3  Reversing the Growth in Distortions to Farm Product Markets The reforms to market-distorting policies that China undertook in the 1980s and 1990s to reduce the discouragement of farm production contributed substantially to national economic growth and welfare in addition to boosting rural incomes. However, the switching since then to increasingly positive assistance to farming in East Asia, and to raising some consumer prices of food above international levels, is lowering national economic growth and welfare and reducing economic access to food for all but those farm households that are net sellers of foods that are protected from import competition. True, higher-income countries in decades past followed

Agricultural development, structural transformation, and East Asian trade  175

a similar agricultural protection growth path, but they have since come to realise that this path is not very effective in closing the farm–nonfarm income gap. Moreover, reversing that process has proven to be very painful politically for the governments of those countries – which is all the more reason not to follow that policy path in the first place. Yet policy reversals have happened, and they have been sustained. For the OECD membership as a whole, their average rate of assistance to farmers is now less than half what it was a generation ago (OECD, 2020). A reluctance to abandon the use of trade-restricting measures sometimes stems from concerns about the reliability of import suppliers. China has already begun to address this by contracting foreign farmers to supply Chinese markets with specific products. More of such investments in land-abundant countries in Latin America, Africa, Australia, and elsewhere can further enhance the security of supplies at lower cost than by protecting Chinese farmers from import competition for such land- and water-intensive crops. 5.4  Reducing Insulation of National Rice Markets Because domestic rice markets in Asia are subject to government interventions aimed not only at being self-sufficient but also at reducing fluctuations in the domestic price (by varying import or export restrictions), and because Asia represents around 90% of the global rice market, the international rice market is very thin and therefore prices vary greatly from season to season. During 2006–2008, for example, international rice prices rose 113% on average. But Jensen and Anderson (2017) estimate that they would have risen only 79% had governments not altered their grain trade restrictions during that period, which is not much more than the period’s actual rise in domestic rice prices (which was 53% on average across all developing countries). Clearly, if countries could trust each other to share rice reserves in times of shortfall rather than alter their border restrictions, potentially all countries could be better off. The recent attempt to do that among ASEAN countries has yet to bear fruit, however, not least because India – a major interventionist and insulator – was not involved. Clearly both exporters and importers need to cooperate for maximum benefit, however. If climate changes make tropical crop yields even more volatile in the future, the benefits from the greater integration of rice markets, or the costs of remaining insulated rather than open, will rise.

6. CONCLUSION: IN SEARCH OF MORE-EFFICIENT AND MORE-EQUITABLE FOOD SECURITY MEASURES Fortunately for East Asia, there are politically feasible alternative policy instruments to market-distorting policies that are more efficient and effective in improving national food security, reducing the gap between farm and nonfarm household incomes, and reducing extreme poverty. The information and communication technology (ICT) revolution recently has made it far cheaper and easier than in the past to target income supplements, as and when needed, to the poorest and hence most food-insecure households, whether they be urban or rural. Such payments were unaffordable in developing countries in the past because of the fiscal outlay involved and the high cost of administering small handouts. However, the ICT revolution has brought financial inclusion to East Asia at an astonishing fast pace in recent years: the share of rural households with a bank or mobile-money account rose from 50% to 70% in East Asia between 2011 and 2017, and it is already above 20% in the poorest of East Asia’s countries

176  Handbook on East Asian economic integration

Note: * Data are 2014 rather than 2011 for the Lao PDR and Myanmar. Source: Demirgüç-Kunt et al. (2018).

Figure 8.7 Share of Rural Households with a Bank or Mobile-Money Account or Equivalent, Asian Developing Economies and High-Income Countries, 2011 and 2017 (%)

(Figure 8.7). This phenomenal advance in access to electronic banking is making it possible for conditional cash transfers to be provided electronically as direct government assistance to even remote rural households. This should allow East Asian countries to follow Europeans in re-instrumenting their support to poor farmers via direct payment measures untied to farm production, rather than relying on inefficient and inequitable price-support instruments, such as trade restrictions. What if countries are still unsatisfied with the contribution of their farmers to national food security, as reflected in food self-sufficiency ratios, or feel their farmers are missing out on the benefits of rapid economic growth and industrialisation? Again, agricultural import protection measures are far from first-best ways of dealing with these socio-political concerns. As just outlined, alternative measures include subsidising investments in agricultural R&D, in rural education and health, and in roads and other rural infrastructure improvements. The political challenge of encouraging countries to switch from trade to domestic policy instruments for addressing non-trade domestic concerns is evidently non-trivial. Yet, the evidence summarised above shows some reform has been possible during the past three decades. With luck, the emergence of new, lower-cost social protection mechanisms involving conditional cash e-transfers might edge governments one more step away from the use of beggarthy-neighbour trade measures. The increasing volatility of weather patterns as climates change also should nudge governments to rely more on trade to smooth fluctuations in domestic food prices.

Agricultural development, structural transformation, and East Asian trade  177

NOTES 1. For a detailed analysis of the impact of maize adoption on China’s population and economy, see Chen and Kung (2016). On the broader questions of whether globalisation has contributed to overall economic growth over past centuries, see the comprehensive literature survey in Meissner (2014). 2. This type of consumption smoothing over time has also been facilitated by international financial integration. See Islamaj and Kose (2016). 3. In calculating the NRAs for each sector of the economy, the methodology outlined in Anderson et al. (2008) also includes the implicit trade tax distortions generated by dual exchange rates, drawing on the methodology of Dervis, de Melo, and Robinson (1981). China adopted a dual exchange rate system in 1979, whereby earners of foreign exchange were required to convert a portion of it at the over-valued official exchange rate but were able to retain the rest for converting at a legal secondary market rate that was always more attractive to them than the official rate. This system created distortions analogous to an import tariff and an export tax at a rate that was higher, the smaller the retention ratio and the larger the gap between the two rates. The retention ratio was gradually raised over the 1980s and early 1990s, which drew the two rates together. By 1994, the scheme was replaced by a single foreign exchange rate. Details of how this policy contributed to distortions to prices of tradables in China during 1981–1993 are available in Huang et al. (2009) and Huang and Rozelle (2018). 4. Both China and India showed little sign of moving away from being slight net exporters of farm products through the 1970s, 1980s, and 1990s, even though their non-farm sectors were growing strongly. It is only since the turn of the century that China has switched to being a significant net importer of food. A key reason for the long delay in that switch is its gradual move away from very heavily taxing farmers relative to manufacturers in the 1970s and 1980s, to assisting them more than manufacturers since the late 1990s in China’s case (Anderson, 2009b, 2018). 5. Since the same basic logic applies when international prices slump, it throws into doubt any virtue in the proposal in the World Trade Organization’s (WTO) Doha Round, from a large group of Asian and other developing countries, for a Special Safeguard Mechanism (SSM) to be established. The proposed SSM would allow developing countries to raise their applied tariffs on specified farm products when either their import price falls or the volume of imports surges beyond threshold levels. The purported price-insulating benefit for farmers in food-importing countries is likely to be illusory because the behavioral responses to a price slump by governments of agricultural-importing countries typically are offset by similar policy reactions by agricultural-exporting countries (Thennakoon and Anderson, 2015). 6. Hoda and Gulati (2013, p. 3) suggest that two-fifths of those foodgrain stocks leak away.

REFERENCES Alston, J.M., B.A. Babcock and P.G. Pardey (eds.) (2010), The Shifting Patterns of Agricultural Production and Productivity Worldwide, Midwest Agribusiness Trade Research and Information Center, Iowa State University, Ames IA. Anderson, K. (1987), ‘On Why Agriculture Declines with Economic Growth’, Agricultural Economics, 1(3), pp.195–207. Anderson, K. (ed.) (1992), New Silk Roads: East Asia and World Textile Markets, Cambridge and New York: Cambridge University Press. Anderson, K. (ed.) (2009a), Distortions to Agricultural Incentives: A Global Perspective, 1955–2007, London: Palgrave Macmillan and Washington DC: World Bank. Anderson, K. (2009b), ‘Distorted Agricultural Incentives and Economic Development: Asia’s Experience’, The World Economy, 32(3), pp.351–84. Anderson, K. (2017), ‘Sectoral Trends and Shocks in Australia’s Economic Growth’, Australian Economic History Review, 57(1), pp.2–21. Anderson, K. (2018), ‘From Taxing to Subsidizing Farmers in China Post-1978’, China Agricultural Economic Review, 10(1), pp.36–47. Anderson, K. and Y. Hayami (1986), The Political Economy of Agricultural Protection: East Asia in International Perspective, London: Allen and Unwin. Re-published in Volume 1 of a World Scientific Reference on Asia-Pacific Trade Policies, edited by K. Anderson, Singapore: World Scientific, 2020. Anderson, K., M. Ivanic, and W. Martin (2014), ‘Food Price Spikes, Price Insulation, and Poverty’, in J.-P. Chavas, D. Hummels and B.D. Wright (eds.), The Economics of Food Price Volatility. Chicago: University of Chicago Press for NBER, pp.311–39. Anderson, K., M. Kurzweil, W. Martin, D. Sandri, and E. Valenzuela (2008), ‘Measuring Distortions to Agricultural Incentives, Revisited’, World Trade Review, 7(4), pp.675–704. Anderson, K., W. Martin, and E. Valenzuela (2006), ‘The Relative Importance of Global Agricultural Subsidies and Market Access’, World Trade Review, 5(3), pp.357–76.

178  Handbook on East Asian economic integration Anderson, K. and S. Nelgen (2013), Updated National and Global Estimates of Distortions to Agricultural Incentives, 1955 to 2011. Available at www.worldbank.org/agdistortions. Anderson, K. and S. Ponnusamy (2019), ‘Structural Transformation to Manufacturing and Services: The Role of Trade’, Asian Development Review, 36(2), pp.32–71. Anderson, K. and B. Smith (1981), ‘Changing Economic Relations Between Asian ADCs and Resource-Exporting Developed Countries’, in W. Hong and L. Krause (eds.), Trade and Growth in the Advanced Developing Countries. Seoul: Korea Development Institute Press. Anderson, K. and A. Strutt (2014a), ‘Emerging Economies, Productivity Growth, and Trade with Resource-Rich Economies by 2030’, Australian Journal of Agricultural and Resource Economics, 58(4), pp.590–606. DOI 10.1111/1467-8489.12039. Anderson, K. and A. Strutt (2014b), ‘Food Security Policy Options for China: Lessons from Other Countries’, Food Policy, 49(1), pp.50–58. Balassa, B. (1965), ‘Trade Liberalization and Revealed Comparative Advantage’, Manchester School of Economic and Social Studies, 33(2), pp.99–124. Baldwin, R.E. (2016), The Great Convergence: Information Technology and the New Globalization, Cambridge MA and London: Harvard University Press. Baldwin, R. (2019), The Globotics Upheaval: Globalization, Robotics and the Future of Work, New York: Oxford University Press. Baldwin, R.E. and F. Robert-Nicoud (2014), ‘Trade-in-Goods and Trade-in-Tasks: An Integrating Framework’, Journal of International Economics, 92(1), pp.51–62, January. Burgess, R. and D. Donaldson (2010), ‘Can Openness Mitigate the Effects of Weather Shocks? Evidence from India’s Famine Era’, American Economic Review, 100(2), pp.449–53. Chen, S. and J.K.-S. Kung (2016), ‘Of Maize and Men: The Effect of a New World Crop on Population and Economic Growth in China’, Journal of Economic Growth, 21(1), pp.71–99. Conconi, P., M. García-Santana, L. Puccio and R. Venturini (2018), ‘From Final Goods to Inputs: The Protectionist Effect of Rules of Origin’, American Economic Review, 108(8), pp.2335–65. Corden, W.M. (1984), ‘Booming Sector and Dutch Disease Economics: Survey and Consolidation’, Oxford Economic Papers, 36(3), pp.359–80. Deardorff, A.V. (1984), ‘An Exposition and Exploration of Krueger’s Trade Model’, Canadian Journal of Economics, 5(4), pp.731–46. Demirgüç-Kunt, A., L. Klapper, D. Singer, S. Ansar, and J. Hess (2018), The Global Findex Database 2017: Measuring Financial Inclusion and the Fintech Revolution, Washington DC: World Bank. Dervis, K., J. de Melo and S. Robinson (1981), ‘A General Equilibrium Analysis of Foreign Exchange Shortages in a Developing Country’, Economic Journal, 91, pp.891–906. Donaldson, D. (2018), ‘Railroads of the Raj: Estimating the Impact of Transportation Infrastructure’, American Economic Review, 108(4–5), pp.899–934. Engel, E. (1857), ‘Die Productions und Consumtionsverhältnisse des Königreichs Sachsen’, Zeitschrift des statistischen Bureaus des Königlich Sächsischen Ministerium des Inneren, 8–9, pp.28–29. FAO (2016), Food Balance Sheets, Rome: Food and Agriculture Organization, accessed 28 January at http://faostat. fao.org/site/368/default.aspx#ancor. Federico, G. (2005), Feeding the World: An Economic History of Agriculture, 1800–2000, Princeton NJ: Princeton University Press. Findlay, R. and K.H. O’Rourke (2007), Power and Plenty: Trade, War and the World Economy in the Second Millennium, Princeton NJ: Princeton University Press. Freebairn, J. (2015), ‘Mining Booms and the Exchange Rate’, Australian Journal of Agricultural and Resource Economics, 59(4), pp.533–48. Fuglie, K.O., S.L. Wang and V.E. Ball (eds.) (2012), Productivity Growth in Agriculture: An International Perspective, London: CABI. Herrendorf, B., R. Rogerson, and A. Valentinyi (2014), ‘Growth and Structural Transformation’, in P. Aghion and S.N. Durlauf (eds.), Handbook of Economic Growth Vol. 2A, Amsterdam: Elsevier, pp.855–941. Hirst, K.K. (2014), Plant [and Animal] Domestication: Table of Dates and Places, accessed 28 January at http:// archaeology.about.com/od/domestications/a/plant_domestic.htm. Hoda, A. and A. Gulati (2013), ‘India’s Agricultural Trade Policy and Sustainable Development’, ICTSD Issue Paper 49, Geneva: International Centre for Trade and Sustainable Development, September. Huang, J. and S. Rozelle (2018), ‘China’s 40 Years of Agricultural Development and Reform’, in R. Garnaut, L. Song and C. Fan (eds.), China’s 40 Years of Reform and Development. Canberra: ANU Press, Ch. 24. Huang, J., S. Rozelle, W. Martin and Y. Liu (2009), ‘China’, in K. Anderson and W. Martin (eds.), Distortions to Agricultural Incentives in Asia. Washington DC: World Bank, Ch. 3. Hurley, T.M., X. Rao and P.G. Pardey (2014), ‘Re-examining the Reported Rates of Return to Food and Agricultural Research and Development’, American Journal of Agricultural Economics, 96(5), pp.1492–1504. Islamaj, E. and M.A. Kose (2016), ‘How Does the Sensitivity of Consumption to Income Vary Over Time? International Evidence’, CEPR Discussion Paper 11241, London, April.

Agricultural development, structural transformation, and East Asian trade  179 Jensen, H.G. and K. Anderson (2017), ‘Grain Price Spikes and Beggar-thy-neighbor Policy Responses: A Global CGE Analysis’, World Bank Economic Review, 31(1), pp.158–75. Jensen, R.T. and N.H. Miller (2011), ‘Do Consumer Price Subsidies Really Improve Nutrition?’, Review of Economics and Statistics, 93(4), pp.1205–23. Jha, R., R. Gaiha, M.K. Pandey and N. Kaiker (2013), ‘Food Subsidy, Income Transfer and the Poor: Comparative Analysis of the Public Distribution System in India’s States’, Journal of Policy Modeling, 35, pp.887–908. Jones, E. (2002), The Record of Global Economic Development, Cheltenham: Edward Elgar. Kaushal, N. and F. Muchomba (2015), ‘How Consumer Price Subsidies Affect Nutrition’, World Development, 75, pp.25–42. Kishore, A., P.K. Joshi and J. Hoddinott (2014), ‘India’s Right to Food Act: A Novel Approach to Food Security’, Ch. 3 in IFPRI’s Global Food Policy Report 2013, Washington DC: International Food Policy Research Institute. Krueger, A.O. (1977), Growth, Distortions and Patterns of Trade Among Many Countries, Princeton NJ: International Finance Section. Lange, G.-M., Q. Wodon and K. Carey (eds.) (2018), The Changing Wealth of Nations 2018: Building a Sustainable Future, Washington DC: World Bank. Leamer, E.E. (1987), ‘Paths of Development in the Three-Factor, n-Good General Equilibrium Model’, Journal of Political Economy, 95(5), pp.961–99. Lloyd, P.J. (1974), ‘A More General Theory of Price Distortions in an Open Economy’, Journal of International Economics, 4(4), pp.365–86. Markusen, J.R. (2013), ‘Putting Per-Capita Income Back into Trade Theory’, Journal of International Economics, 90(2), pp.255–65. Martin, W. and K. Anderson (2012), ‘Export Restrictions and Price Insulation During Commodity Price Booms’, American Journal of Agricultural Economics, 94(2), pp.422–27. Meissner, C.M. (2014), ‘Growth from Globalization? A View from the Very Long Run’, in P. Aghion and S.N. Durlauf (eds.), Handbook of Economic Growth. Amsterdam: Elsevier, pp. 1033–69. Milton, G. (1999), Nathaniel’s Nutmeg, London: Sceptre. Mohammed, S.I. and J.G. Williamson (2004), ‘Freight Rates and Productivity Gains in British Tramp Shipping 1869– 1950’, Explorations in Economic History, 41(2), pp.172–203. Molina, J. et al. (2011), ‘Molecular Evidence for a Single Evolutionary Origin of Domesticated Rice’, Proceedings of the National Academy of Sciences, 108(20), pp.8351–56. Narayanan, B.G., A. Aguiar and R.A. McDougall (eds.) (2012), Global Trade, Assistance, and Production: The GTAP 8 Data Base, Center for Global Trade Analysis, Purdue University, West Lafayette. OECD (2020), Producer and Consumer Support Estimates, online database accessed at www.oecd.org. OECD/ICRIER (2018), Agricultural Policies in India, OECD Food and Agricultural Reviews, Paris: OECD. O’Rourke, K.H. and J.G. Williamson (2002), ‘When Did Globalisation Begin?’, European Review of Economic History, 6(1), pp.23–50. Otsuka, K., J.P. Estudillo, and Y. Sawada (eds.) (2009), Rural Poverty and Income Dynamics in Asia and Africa, London and New York: Routledge. Ozawa, T. (2009), The Rise of Asia: The ‘Flying-Geese’ Theory of Tandem Growth and Regional Agglomeration, Cheltenham: Edward Elgar. Pardey P. et al. (2018), ‘The Shifting Structure of Agricultural R&D: Worldwide Investment Patterns and Payoffs’, in N. Kalaitzandonakes, E. Carayannis, E. Grigoroudis, and S. Rozakis (eds.), From Agriscience to Agribusiness: Innovation, Technology, and Knowledge Management. Springer: Switzerland. Pursell, G., A. Gulati and K. Gupta (2009), ‘India’, in K. Anderson and W. Martin (eds.), Distortions to Agricultural Incentives in Asia. Washington DC: World Bank, Ch. 10. Reardon, T., K.Z. Chen, B. Minten and L. Adriano (2012a), The Quiet Revolution in Staple Food Value Chains in Asia: Enter the Dragon, the Elephant, and the Tiger, Manila: Asian Development Bank and Washington DC: IFPRI, December. Reardon, T., C.P. Timmer and B. Minten (2012b), ‘The Supermarket Revolution in Asia and Emerging Development Strategies to Include Small Farmers’, Proceedings of the National Academy of Science of the USA, 109(311), pp.12332–37. Rozelle, S., Q. Li, L. Zhang and A. de Brauw (2005), ‘Labor Market Emergence and Returns to Education in Rural China’, Review of Agricultural Economics, 27(3), pp.418–24. Sandri, D., E. Valenzuela and K. Anderson (2007), ‘Compendium of National Economic and Trade Indicators by Region, 1960 to 2004’, Agricultural Distortions Research Project Working Paper 01, World Bank, Washington DC, October. Available at www.worldbank.org/agdistortions Thennakoon, J. and K. Anderson (2015), ‘Could the Proposed WTO Special Safeguard Mechanism Protect Farmers from Low International Prices?’, Food Policy, 50(1), pp.106–13. Venables, A.J. (2004), ‘Small, Remote and Poor’, World Trade Review, 3(3), pp.453–57. World Bank (2017), World Development Indicators, Washington DC: World Bank. World Trade Organization (WTO) (2015), International Trade Statistics 2015, Geneva: World Trade Organization.

9.

Institutional reform, regulatory reform, and integration in East Asia Rashesh Shrestha and Ha Thi Thanh Doan

1. INTRODUCTION The process of economic integration can stimulate growth-enhancing reforms in domestic institutions and regulatory regimes, which are usually difficult to implement because of domestic political factors. Reforms create winners and losers, thus pro-reform coalitions are a precondition for a reform’s success (Rodrik, 1996; Krueger, 2002). Many attempts at institutional reforms are unsuccessful, especially those in developing countries which are led by international institutions and donors (Andrews, 2013). When the economy opens for international integration, domestic institutions face additional pressure from the competition that results from globalisation. As countries pursue international economic integration as a vehicle for economic growth, they are also compelled to address weaknesses in governance. However, not all changes to the institutional and regulatory set-up are necessarily welcomed by domestic stakeholders, and the pain caused by market-oriented reforms can lead to a backlash against integration itself (Rodrik, 2011). The extent to which economic integration leads to meaningful and lasting reforms depends on the manner in which such reforms are implemented, which in turn is determined by the characteristics of economic integration. The deep economic integration of East Asia, which has been ongoing since the 1980s, has no doubt influenced, and in some cases determined, the trajectory of the domestic institutional and regulatory changes of countries in the region. In the 1980s and early 1990s, global and regional economic forces increased Japanese investment in Southeast Asia and paved the way for the formation of production networks. These networks are considered some of the most sophisticated in the world, and are behind the impressive growth performance of the region (Kimura and Obashi, 2016). The trade and investment linkages have bound together the economic fortunes of East Asian countries. What began as a market-led process has now been enshrined in numerous bilateral and regional trade agreements that characterise the region’s integration architecture (Chia, 2013). The scope of the agreements transcends trade to include behind-theborder issues such as trade facilitation, non-tariff measures (NTMs), and good regulations, as well as emerging issues such as the flow of data and e-commerce, and thus touches upon areas of domestic policymaking. The institutional and regulatory reforms emanating from East Asia’s regional integration can arguably be long-lasting due to the distinctive features of its regional architecture. For reforms to be long-term, they need to focus on problem solving, making incremental progress, and involving a wide range of agents – a process called ‘problem-driven iterative adaptation’ (Andrews, 2013: 17). These ingredients of successful reform are present in East Asia’s regional integration architecture. As the region is comprised mostly of middle powers, the process of integration has been more collaborative than hegemonic (Baldwin, 2012; Intal, 2018). Unlike the European Union (EU), where a supranational entity enforces commitments on members, 180

Institutional reform, regulatory reform, and integration in East Asia 181

the region has created a set of cross-national collaboration platforms where relevant issues are discussed, and the path forward is devised through deliberation. Rather than demanding binding commitments on specific domestic policy, countries agree to a set of principles and frameworks that can be implemented in each country according to the structure of the domestic political economy. The process inevitably leads to slow progress, which can be frustrating to globalisation enthusiasts. However, if recent data on institutional and regulatory quality in the region are any indication, the reforms are arguably stable because they are circumscribed by domestic political realities. In this chapter, we review the literature on the relationship between reforms and economic integration. We highlight the channels through which economic integration might influence domestic reforms. We find that the economic literature linking institutional quality to economic integration has mostly highlighted two issues: (i) poor institutions act as a tax on economic activity, and (ii) the quality of contract enforcement is an important determinant of international transactions. Another strand of literature has discussed the role of economic integration in facilitating domestic reforms amongst integration partners by creating feedback mechanisms. These mechanisms include changes in the domestic political coalition in favour of further reforms to take advantage of integration, the requirements of formal integration agreements, and the creation of platforms for cooperation where behind-the-border reforms can be pushed. We then discuss the East Asian regional architecture, particularly focusing on its collaborative mechanisms which are created to instigate reforms. In this regard, we contrast the regional integration mechanism approach of the Association of Southeast Asian Nations (ASEAN) with the supranational approach of the EU. Next, we evaluate the available data to study the patterns of regulatory and institutional reform in East Asia. There are many challenges in studying reforms, with the measurement of institutional and regulatory quality being the most challenging. The quality of institutions and regulations is a multi-dimensional concept that is hard to summarise in a few proxies (Kunčič, 2014). In this chapter, we rely on the World Bank’s Worldwide Governance Indicators (WGI), which have been widely applied in the empirical analysis of the relationship between governance and economic outcomes. We argue that some of the improvements in institutional and regulatory quality, especially for developing countries of ASEAN, can be attributed to the ASEAN integration agenda, which has been enshrined in the ASEAN Economic Community (AEC) Blueprint. While institutional quality and economic development go hand in hand in general, developing ASEAN countries have shown remarkable progress in reforms. The WGI data show that the region has made steady progress in the quality of its institutions and regulations. The least developed countries of the region, which are all members of ASEAN, have made rapid progress in recent years. Some of this progress can be attributed to the closer economic integration of ASEAN, as the promulgation of the AEC endeavours to create a single production base in the ASEAN region. ASEAN integration is further bolstered by its free trade agreements (FTAs) with each major economy of the region (Australia; China; India; the Republic of Korea (henceforth, Korea); Japan; and New Zealand), and its engagement in regional platforms such as the East Asia Summit and Asia-Pacific Economic Cooperation (APEC). Finally, we provide a case study discussion of key areas of institutional and regulatory reform where the ASEAN process has contributed, drawing on the authors’ experiences from participating in ASEAN initiatives. The areas include trade facilitation, the implementation of good regulatory practice (GRP), and NTMs, each of which go beyond tariff liberalisation and

182  Handbook on East Asian economic integration

touch upon areas of domestic reforms. We argue that collaborative ASEAN projects on these topics have helped push reforms in the region, in particular by encouraging the exchange of knowledge and best practices amongst ASEAN countries – where world leaders in regulatory and institutional quality share the table with lagging developing member states – although progress is slow and many challenges remain.

2.  LITERATURE REVIEW The importance of institutional and regulatory quality for economic growth and resilience has been verified in many studies.1 Broadly, institutions are formal rules or informal forms of conduct, along with the manner in which they are enforced. Institutions serve to reduce uncertainty and transaction costs, and clarify the environment in which economic interactions take place. Institutions, especially economic institutions such as the structure of property rights and the depth of markets, are fundamental drivers of economic growth because they set up the rules of economic transactions, which in turn determine the allocation of resources (North, 1990; Acemoglu, Johnson, and Robinson, 2005). Likewise, regulatory quality ensures that the economy is business-friendly and does not impose huge costs on the private sector. For developing countries lacking in capital, good institutions are necessary to gain the confidence of foreign investors. On the other hand, complicated regulations and policies discourage private sector development, encourage rent-seeking activity, and reward politically connected firms – all of which misallocate resources and hurt economic growth and international integration. There is a large literature which finds that good institutional environments facilitate bilateral trade and investment, and thus deepen integration. While the existing literature has not agreed on a common definition of institutions, studies linking institutional quality and economic growth and integration focus on the rule of law, anti-corruption policy, efficiency and effectiveness of the government, democracy, and the regulatory system. Anderson and Marcouiller (2002) found that strong institutions support trade by reducing uncertainty and the associated transaction costs. Modelling import demand as a function of institutional quality, the study shows that insecurity arising from corruption and imperfect contract enforcement acts as a tax on trade. Empirically, the study finds a robust relationship between bilateral trade and strong institutions, where the legal system is capable of enforcing commercial contracts, and the formulation and implementation of economic policy are transparent and impartial. Ranjan and Lee (2007) incorporated the quality of goods into a theoretical model linking contract enforcement to trade. Their model predicts that contract enforcement matters for trade in both differentiated and homogeneous goods. However, the magnitude is larger in the former case. Levchenko (2007) modelled institutional quality as a source of comparative advantage. Assuming that firms in some sectors must make relationship-specific investments, imperfect contract enforcement leads to distortion in the factor market and unequal factor return across industries. As a result, countries with better institutions specialise in institutionally dependent goods. For these countries, the gain from trade exceeds what can be explained by the conventional factor abundance differences. Nunn (2007) classified traded goods according to the intensity of contract enforcement. In particular, he measured the ratio of intermediate inputs that require relationship-specific investments, and examined the impact of contract enforceability on trade patterns. The study found that countries with good judicial quality and contract enforcement specialise in contract-intensity goods.

Institutional reform, regulatory reform, and integration in East Asia 183

For Asia and the Pacific, Helble, Shepherd, and Wilson (2009) showed that a more transparent trading environment is associated with trade expansion. Utilising a composite index to measure economic freedom, Francois and Manchin (2013) analysed the linkage between institutional quality and bilateral trade. The finding suggests that low institutional quality in developing countries limits market access to advanced economies. More recently, Álvarez et al. (2018) investigated the extent to which institutional quality affects aggregate as well as sectoral bilateral trade. The study also looked at whether the interaction between institutional quality and trade changes over time. Consistent with previous studies, the paper found a positive relationship between institutions and trade flows. The relationship is strongest in the agricultural sector, suggesting ample benefits from strengthening institutions for countries specialising in this sector. In particular, regulatory quality and government effectiveness in managing agriculture could further boost trade. In addition to lowering trade, weak institutions also discourage foreign firms from entry into or expansion at the destination market. By providing favourable treatment and protection to local firms and maintaining an inefficient market, weak institutions limit foreign firms from fully exploiting their competitive advantage (Taglioni and Winkler, 2016). Daude and Stein (2007) argued that bad institutions might act as a tax by increasing the cost of doing business. In addition, the uncertainty about the future returns due to incomplete contract enforcement results in underinvestment by foreign firms. Their empirical analysis confirmed these conjectures. In particular, the unpredictability of laws, regulations, and policies; the excessive regulatory burden; government instability; and lack of commitment play a significant role in limiting foreign direct investment (FDI). Following this line of argument, Buchanan, Le, and Rishi (2012) found that good institutions not only attract more FDI but also reduce FDI volatility. Globerman and Shapiro (2002) incorporated both FDI inflows and outflows into their analysis. They showed that a better governance structure, including the rule of law and the regulatory environment, not only attracts more FDI but also provides support to domestic firms’ foreign investment. The impact is more pronounced for small and developing economies. Related literature at the firm level focuses on contract enforceability and firms’ global activities. Ma, Qu, and Zhang (2010), for example, investigated how legal system obstacles affect firms’ exports through relationship-specific investment. They found that a good legal system, which has lower licensing barriers and regulatory uncertainty, stimulates exports of firms that use more customised intermediate inputs. Ahsan (2013) analysed the heterogeneity of productivity gains from input trade liberalisation due to differences in the speed of contract enforcement in the case of India. The author constructed a measure of judicial efficiency at the state level. Poor contract enforcement leads to hold-up problems in which input suppliers underinvest in input quality as the buyer can withdraw from the transaction at any time. Better judicial efficiency helps solve this problem by incentivising buyers to form contractual relationships with foreign input suppliers. Other things being constant, firms locating in states with more efficient judicial efficiency gain more. Araujo, Mion, and Ornelas (2016) studied how contract enforcement and export experience shape firms’ export dynamics. They found that good institutions of the destination countries encourage firms’ entry and survival in the export market. However, firms’ export growth decreases with the institutional quality. Another strand of the literature also posits a link from economic integration to institutional reforms. Economic integration can be a driver of domestic reforms due to feedback mechanisms. These feedback mechanisms could theoretically operate on three levels – integration may create incentives for unilateral reforms, the integration process may involve specific

184  Handbook on East Asian economic integration

commitments to reforms, and integration could lead to the development of institutional architecture where countries embark on reforms in a collaborative manner. The first channel is that unilateral reforms may be pursued to maximise the benefits from the current level of economic integration. Combining integration with domestic reforms may be in the country’s best interest. Institutions and regulations provide the ‘enabling conditions’ that determine the value of economic activity, and thus are important determinants of trade and investment flows. Poorly designed regulations can hamper the productivity growth of firms (Syverson, 2011), which can reduce competitiveness and hamper the goals of integration. Good institutions are associated with diversity of economic activity. Bournakis and Tsoukis (2016) studied the impact of institutional quality on export performance amongst Organisation for Economic Co-operation and Development (OECD) countries. Benáček et al. (2012) found that institutions, social governance, and political risk are key factors in determining FDI flows, although the results differ depending on the groups of countries considered. Another impetus for unilateral reforms is the changing domestic political economy following liberalisation. In the framework proposed by Baldwin (2012), initial integration begets more integration through a feedback mechanism in which new interest groups emerge in favour of liberalisation. The export-oriented sector may demand additional improvements in the business environment. Thus, tariff agreements usually give way to discussion about deeper behindthe-border issues. However, growth-oriented reforms are not automatic, as is evident from the experience of many developing and former-Soviet countries (Rodrik, 1996). To create a more conducive domestic environment for reforms, policymakers may strategically embrace international commitments. While unilateral liberalisation by a country is indeed possible, bilateral and regional agreements seem to be the preferred method for deeper integration, partly to make it more politically palatable (Chia, 2013). The second channel emerges because the process of integration makes it necessary to close the gap between domestic practices and those of integration partners, leading to formal agreements on numerous domestic policy issues. Foreign investors want to ensure that their investments are protected through strong property rights and the rule of law, and foreign companies do not want to face greater barriers than their local counterparts due to onerous regulations. Because of sunk costs in investment, there is an incentive to curtail the policy choices of one’s partners by agreeing ex ante to preclude domestic policies that harm each other’s interests. Bilateral investment agreements have been used by developing countries to reassure investors (Elkins, Guzman, and Simmons, 2006). Since the 2007 crisis, there has been greater scepticism towards unfettered globalisation through multilateral negotiations, partly because it severely curtails the domestic policy space or compels countries to pursue unpopular policies (Rodrik, 2011). At the same time, preferential trade agreements have continued to proliferate as the preferred mechanism for further integration. Bilateral and regional agreements have gone deeper in domestic reform commitments. In particular, FTAs between developed and developing country partners may induce domestic reforms in the developing partner (Ferrantino, 2006). For example, the bilateral agreements of both the United States (US) and the EU have usually included agreements on a broader set of trade facilitation issues as well as labour and environmental standards. Some of the provisions require changing domestic laws and regulations to meet the standards set before the treaty is ratified and enters into force (Harrison et al., 2019). The EU and Viet Nam signed a trade agreement and an investment protection agreement on 30 June 2019, which includes agreement to

Institutional reform, regulatory reform, and integration in East Asia 185

reduce regulatory barriers and overlapping red tape through, for example, increased use of international standards in its regulations (European Commission, 2018). Bilateral and regional reform commitments are also more likely to be implemented since negotiations take place between like-minded countries with similar economic conditions (Chia, 2013). Economic integration and domestic governance are often at odds with each other – the deeper the integration, the narrower the scope for domestic policies. Rodrik (2011) posited a globalisation trilemma between integration, democracy, and national sovereignty. Thus, the scope of integration is limited by what is feasible given the domestic political economy. Arguably, agreements are implemented as parties can pick and choose the most feasible commitments. Empirical evidence on the impact of trade agreements on reforms is limited, and mostly focuses on economic outcomes rather than reforms per se. Only a few empirical papers test this hypothesis, with mixed results. This is mostly because the investigation involves many empirical challenges. The first issue is measurement – it is very difficult to find accurate measures of institutional and regulatory quality. The most widely used indicator is the WGI compiled by the World Bank. The indicators are usually based on perception surveys, which are a very noisy signal of underlying institutional quality. Nonetheless, more recently, empirical analysis of the process of institutional reforms has been under way, with the development of new data sets (Sobel, 2017). These studies have found great diversity in institutional quality and attempt to explain these differences in terms of the colonial legacy, foreign aid, or the domestic social structure. However, there remains a large gap in our understanding of the process of institutional reforms, including the role of bilateral and regional trade agreements. Besides measurement, endogeneity of the main explanatory variable – integration – poses another problem. Economic integration is usually measured by its outcome (trade and FDI) or by indicators of formal agreements, such as accession to the World Trade Organization (WTO) or participation in FTAs. In the latter case, studies attempt to exploit the timing of FTA or WTO negotiations (either the beginning of the negotiation period or the agreement’s entry into force) to set up a difference-in-differences type of analysis, where the institutional quality of countries with and without participation is compared in the before and after periods. However, the issue is that countries choose to enter into negotiations for WTO accession and FTAs, so those countries may have a different appetite for reforms than countries which do not enter into negotiations. Thus, there may a third unknown factor (e.g. domestic political economy) that is driving the decisions to both participate in FTAs and carry out domestic reforms. This leads to omitted variable bias in the estimation. Finally, there is huge diversity in the regulatory and institutional reform commitments of an FTA, so an indicator of whether an FTA exists may be more or less uninformative. For example, EU trade agreements often contain provisions for labour and environmental standards with the trade and sustainable development chapters of its FTAs with partner countries. These agreements, even when fully enforced, may only impact a small part of the overall domestic institutions. Thus, the impact on the macro institutional structure may be hard to detect empirically. Ferrantino (2006) studied the impact of FTA negotiations with the US or WTO accession on institutional quality over 1996–2004. The paper simply compared the World Bank’s governance indicators for countries before, during, and after the negotiation of agreements. Tang and Wei (2009) studied the impact of WTO/General Agreement on Tariffs and Trade (GATT) accession on economic outcomes, taking into account the degree of reform commitments the countries were subjected to as a precondition for accession. They studied developing countries’ performance over 1981–2003. Their findings indicate that rigorous accession procedures are

186  Handbook on East Asian economic integration

more likely to predict growth in income and investment that last up to 5 years after accession, but the effect is limited to countries that were compelled to make wide-ranging reforms. Büthe and Milner (2014) studied how the structure of preferential trade agreements impact the success of developing countries in attracting investment. They found that PTAs that have investment clauses are more likely to increase investments. Some domestic reform areas may be too controversial to include in even bilateral and preferential trade agreements. On such issues, the regional architecture may still act as a facilitative medium. This forms the third channel by which the integration process may help push ahead domestic reforms. Integration may lead to the creation of a collaborative platform where issues are discussed and debated. Although these discussions do not yield binding commitments, countries could agree on a set of principles that guides domestic reforms and policymaking on a voluntary basis. Integrated countries can benefit from a collaborative approach to reforms. Close economic ties mean that reforms in one country can have spillover effects in another. The following section discusses this feature of the East Asian economic integration architecture.

3.  ARCHITECTURE OF EAST ASIAN ECONOMIC INTEGRATION East Asia has emerged as one of the most integrated regions in the world. One indicator of the level of integration is how costly it is to move goods across borders. The United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) and the Asian Development Bank (ADB) estimated that the intra-regional trade costs (based on the inverted gravity estimation) are 76% amongst the ASEAN 4 countries (Indonesia, Malaysia, the Philippines, and Thailand); 55% amongst the East Asia 3 countries (China, Japan, and Korea); and 78% between the East Asia 3 and the ASEAN 4 (UNESCAP and ADB, 2019). No other inter- or intra-regional trade cost estimate is lower, except for trade between the East Asia 3 and the US (65%), indicating low barriers to the movement of goods amongst East Asian countries. Such a deep level of integration not only pertains to very low tariffs for intra-ASEAN trade, but a deeper integration agenda touching upon a wide range of behind-the-border issues. While the roots of East Asian economic integration lie in market-led cooperation, and arose before any formal regional architecture was established (Dee, 2007; Chia, 2013), it is now underpinned by commitments enshrined in regional trade agreements (Pangestu and Armstrong, 2018). Dee (2007) pointed out that ‘from the 1980s, East Asia developed high levels of intraregional trade in response to market forces, not preferential trade agreements’ (Dee, 2007: 406). Since then, numerous bilateral and regional trade agreements have been implemented to formalise the commitments and push for deeper integration. In light of the Asian financial crisis, East Asian countries recognised a need for greater economic cooperation and institutionalisation of their economic interdependence (Kawai, 2005). The promotion of deeper integration and institution building at the regional level were important objectives of these agreements (Dee, 2007). The integration process has led to formal forums for collaboration and cooperation, where countries come together to debate, discuss, and set common goals for the institutional and regulatory aspects of economic integration. Established in 1989, initially for informal senior official and ministerial-level dialogue, APEC’s aims include accelerating regional economic integration through regional economic and technical cooperation and structural reform which is consistent with, and supportive of, the multilateral trading system. ‘APEC’s initiatives to

Institutional reform, regulatory reform, and integration in East Asia 187

synchronize regulatory systems is [sic] a key step to integrating the Asia-Pacific economy’ (APEC, n.d.). Cooperation and consensus, rather than binding commitments and treaty obligations, are the modus operandi of APEC. Capacity building projects are designed to help implement the initiatives adopted by APEC member countries, including regulatory reform. The East Asia Summit – comprising the ASEAN Member States (AMS), Australia, China, India, Japan, Korea, and New Zealand – began meeting in 2005 and regularly discusses issues impinging on integration. These regional architectures have emphasised domestic reforms that support economic integration. Pangestu and Armstrong (2018: 17) argued that the ‘framework of national reforms in East Asia have [sic] been driven by international commitments’. Nowhere has this approach been more apparent than in ASEAN. Within East Asia, ASEAN has been the most advanced in creating formal regional institutions to support economic cooperation (Baldwin, 2012). The AEC Blueprint, promulgated in 2015, aspires to create a region with a single market and production base. In this regard, the region has completed its trade liberalisation process, with almost 99% of tariff rates at 0% for intra-ASEAN trade under the ASEAN Trade in Goods Agreement (ATIGA). The AEC Blueprint explicitly aims at solving behind-the-border issues such as trade facilitation, GRP, and non-tariff barriers to accelerate domestic reforms and deepen the level of integration. Reluctant to cede national sovereignty to a supranational body in exchange for deeper integration, the Southeast Asian regional cooperation mechanism has evolved into a unique transnational arrangement called ‘regulatory regionalism’. This takes the form of multiple cross-country governance networks, each with its own set of responsibilities. The ASEAN structure comprises sectoral working groups that deal with various aspects of domestic policy. For example, within the economic pillar, the ASEAN Trade Facilitation Joint Consultative Committee is responsible for the implementation of the ASEAN trade facilitation agenda, while the High-Level Task Force on ASEAN Economic Integration has taken on the agenda of instituting GRP amongst countries in the region. ASEAN’s decision-making process is consensus-based; legally binding decisions are excluded. This is quite different from the supranational approach prevalent in the EU, which is the most widely used benchmark for regional integration. Supporting the EU’s integration process is the development of a regional common regulatory regime combined with regulatory reform at the national level. Decision-making and the implementation of commonly agreed policies are done through a complex system combining EU institutions and national governments. Checks and balances are in place to prevent each single body from exerting excessive power. The European Commission, European Parliament, and European Council constitute the bloc’s law-making bodies. The complex system of regional bodies is supported by national institutions – government ministries and departments, regulatory agencies, and regional and local authorities – which provide indispensable inputs to their EU representatives on whether to accept or reject European Commission proposals. Moreover, at the local level, they are in charge of the implementation and enforcement of laws and regulations. It is worth noting here that the EU system does not aim to replace the role of national entities. Instead, the architecture of the EU is designed to provide a balance between its member states’ sovereignty and mutually beneficial policies for the region. Differences in regional characteristics explain the distinct models that the EU and ASEAN have followed. First, the development gap amongst the AMS is far more pronounced than that of the EU in its early phase. Even though the EU expanded its membership to less developed

188  Handbook on East Asian economic integration

countries in Central and Eastern Europe, the region is still dominated by advanced economies. On the other hand, with only 10 members, ASEAN’s individual gross domestic product (GDP) per capita features least developed, middle-income, and high-income levels. The significant development gap amongst ASEAN countries is reflected in the vast differences in the regulatory framework and the quality of governance and institutions, not to mention diverse political schemes, languages, and cultural norms, which could lead to conflicting interests and impede ASEAN’s efforts to deepen regional economic ties. In addition, individual ASEAN countries are far more integrated than EU countries in the global market, as some of their most important trade partners are outside the region. Singapore, for example, has signed 25 FTAs, only six of which are within the ASEAN or ASEAN Plus model.2 More than half of Viet Nam’s FTAs are with non-ASEAN partners (WTO, 2020). Engagement with China and Japan through the global value chain, in particular, acts as an important driving force of the trade and FDI pattern in ASEAN. With relatively similar factor endowments and dependence on rich natural resources, the key export products of some of the AMS are more substitutable than complementary. Without further innovation to increase the products’ value added and support industrial upgrading, ASEAN countries may find themselves in a rivalry position in the international market. The EU, on the contrary, relied on intra-regional trade and investment to thrive. In its early phase of development, intra-EU trade already accounted for almost 40% of total trade. This ratio reached 50% after the establishment of the Customs Union (Plummer and Click, 2009). Intra-ASEAN trade, on the contrary, has been around 25% of total trade and has remained relatively stable in the past few years. For ASEAN, diverse national interests add complexity to the achievement of a harmonised and converged regulatory system, let alone an institutionalised supranational bloc. One major drawback of ASEAN’s integration model is the lack of strong commitments to move forward with the integration agenda, resulting in delays in the implementation of regional agreements. The ASEAN Free Trade Agreement, for example, only loosely defined ‘free trade’ as having a 0–5% tariff range instead of full tariff elimination. There is ample flexibility for the AMS to complete their liberalisation roadmaps with the exclusion of sensitive products, varying across country timelines subject to the level of development. Moreover, the implementation of NTM commitments shows limited progress on the ground. Liberalisation in the services sector and the mobility of skilled workers also require substantial work to be done. The success of ASEAN’s integration approach has been of much debate within academic circles. The ‘ASEAN Way’ of decision-making, based on consultation and non-confrontation, can be a double-edged sword as it can help deal with difficult domestic policy issues but only if members agree to engage, which means progress can be slow. Stubbs (2019) systematically assessed the points made by ASEAN’s proponents and detractors across multiple fronts. On the economic front, commentators who wish to see greater liberalisation lament the slow process, although it is not clear whether ASEAN has achieved more than what would have been possible through the existing multilateral process of the WTO, given the failure of the Doha Development Round. It is worth noting that tariff liberalisation of the agriculture sector was achieved within ASEAN, as tariff rates were reduced to zero in 99% of product lines by 2018, which was a major reason for the failure of the Doha round. However, this sector is still heavily protected through NTMs, which is a topic of ongoing discussion amongst AMS in these transnational forums.

Institutional reform, regulatory reform, and integration in East Asia 189

4. INSTITUTIONAL AND REGULATORY REFORMS IN EAST ASIA What have been the recent trends in institutional and regulatory reforms in the region? We use the World Bank’s WGI to provide a picture of the dynamics of institutional and regulatory quality in East Asia (see Kaufmann, Kraay, and Mastruzzi, 2010, for a detailed description of the database). The WGI provides measures on six dimensions of governance: (i) voice and accountability, (ii) political stability and the absence of violence, (iii) government effectiveness, (iv) regulatory quality, (v) rule of law, and (vi) control of corruption. The data are compiled from 30 different sources.3 The WGI is standardised and is designed to range from −2 to 2, so individual country scores are not absolute performance measures but relative to the performance of other countries included in the data set. Data are available for 1998–2018, making them amenable for understanding long-term trends in reforms. The data are widely used in studies of the relationship between institutions and economic performance (Álvarez et al., 2017). We focus on two dimensions: (i) government effectiveness, which we take as a measure of institutional quality; and (ii) regulatory quality, which is the measure of good regulations. Government effectiveness ‘captures perceptions of the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to such policies’ (World Bank, n.d.). Likewise, ‘regulatory quality captures perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development’ (World Bank, n.d.). Amongst East Asian economies, we focus on the 10 ASEAN countries, Australia, China, Japan, Korea, New Zealand, as well as Hong Kong. The level of economic growth amongst these countries varies significantly, with GDP per capita ranging from $1,000 for Cambodia to $55,000 for Australia. Accordingly, we find four tiers of economies in East Asia: (i) Hong Kong and Singapore have the best performance (rank close to 100); (ii) the second tier (rank 60–90) comprises Brunei, Japan, Korea, Malaysia, and Thailand; (iii) the third tier includes Cambodia, China, Indonesia, and Viet Nam; and (iv) the fourth tier includes the Lao People’s Democratic Republic (Lao PDR) and Myanmar. The Lao PDR, Myanmar, and Viet Nam have seen the fastest rise in rankings (Figure 9.1). The level of a country’s GDP is strongly correlated to the measures of institutional and regulatory quality, as seen in Figure 9.2. More developed countries have better quality institutions. However, when compared with the global joint distribution of level of development and quality of institutions, we find that most East Asian countries are performing better than expected, as most of the East Asian countries are above the quadratic best fit line. This is especially true for the measure of government effectiveness, where only Myanmar is below the best fit line. Regulatory and institutional quality are distinct measures, and they progress at a different pace. Figure 9.3 shows how the countries have progressed in these two dimensions. The arrows pointing northeast indicate improvement in both rankings, whereas those pointing southeast indicate a fall in the regulatory quality index. Not all countries improved along both dimensions. Cambodia and Thailand improved in government effectiveness but reduced rank in regulatory quality. Myanmar and the Lao PDR increased regulatory quality but did not achieve much improvement in government effectiveness.

190  Handbook on East Asian economic integration

Figure 1: Regulatory Quality Ranking (100 = Best) of Selected East Asian Economies, 2000 and 2018

120

Percentage Ranking

100 80 60 40 20 0

BRN

CHN

HKG

IDN

JPN

KHM

2000

KOR

LAO

MMR

MYS

PHL

SGP

THA

VNM

2018

Notes: BRN = Brunei Darussalam, CHN = China, HKG = Hong Kong, IDN = Indonesia, JPN = Japan, KHM = Cambodia, KOR = Korea, LAO = Lao People’s Democratic Republic, MMR = Myanmar, MYS = Malaysia, SGP = Singapore, THA = Thailand, VNM = Viet Nam. Source: Authors’ calculation from Worldwide Governance Indicators data (World Bank, n.d.).

Figure 9.1  Regulatory Quality Ranking (100 = Best) of Selected East Asian Economies, 2000 and 2018

The trajectory of institutional and regulatory reforms is not even over time. Figure 9.4 shows the trends over time in both indicators (government effectiveness and regulatory quality) for groups of like economies. Amongst high-income economies in the region (in the top panel), Australia, New Zealand, and Singapore consistently outperform their peers in government effectiveness. Hong Kong, Korea, and Japan have been steadily making progress during this period, while the trend for Brunei Darussalam stayed flat until 2010, after which we see improvement. On the regulatory quality side, we see two distinct camps of high-income economies, with Australia, Hong Kong, New Zealand, and Singapore consistently scoring higher than the rest. Korea and Japan have been steadily improving, while Brunei Darussalam’s performance has fallen slightly. Amongst the middle-tier countries (in the mid panel), Indonesia has narrowed the gap with the rest of its peers, with both regulatory quality and government effectiveness steadily improving. Since the transition to democracy and decentralisation, Indonesia has made many unilateral reforms, but its natural resource-dependent economy means it is less responsive to external pressures. It is still struggling to attract FDI and integrate to the global value chain, which is attributed to its complicated regulatory environment. Malaysia remains the leader of this pack, but its performance has been uneven and registered a gradual decline. China is the only nonASEAN country in this group, and has shown recent progress in government effectiveness. The least developed economies of the region (Cambodia, the Lao PDR, Myanmar, and Viet Nam, in the bottom panel), all of which are in ASEAN, progressed at a different pace. Viet Nam, which was leading in government effectiveness, saw discrete improvements in 2005 and 2015. These coincide closely with Viet Nam’s accession to the WTO in 2007 and the implementation of the ASEAN agreements in the early 2010s. In fact, each of the four ASEAN members registered rapid progress after the ASEAN Free Trade Area was consolidated into a comprehensive trade liberalisation agreement called ATIGA. Regulatory quality improved

Institutional reform, regulatory reform, and integration in East Asia 191

Notes: BRN = Brunei Darussalam, CHN = China, HKG = Hong Kong, IDN = Indonesia, JPN = Japan, KHM = Cambodia, KOR = Korea, LAO = Lao People’s Democratic Republic, MMR = Myanmar, MYS = Malaysia, SGP = Singapore, THA = Thailand, VNM = Viet Nam. Source: Authors’ calculation from Worldwide Governance Indicators data (World Bank, n.d.).

Figure 9.2  Relationship Between Regulatory Quality and GDP and Government Effectiveness and GDP

only slightly for Viet Nam, but the least performing Myanmar has made rapid progress in regulatory quality since 2010, catching up with the Lao PDR. We do not observe much progress in this regard for Cambodia. As these countries integrate further regionally, and as many ASEANlevel initiatives are implemented, we can expect further improvements in these countries. To check if improvement in the least developed AMS is following a universal trend exhibited by their peers, we plot trends for Cambodia, the Lao PDR, Myanmar, and Viet Nam along

192  Handbook on East Asian economic integration

Notes: BRN = Brunei Darussalam, CHN = China, HKG = Hong Kong, IDN = Indonesia, JPN = Japan, KHM = Cambodia, KOR = Korea, LAO = Lao People’s Democratic Republic, MMR = Myanmar, MYS = Malaysia, SGP = Singapore, THA = Thailand, VNM = Viet Nam. Source: Authors’ calculation from Worldwide Governance Indicators data (World Bank, n.d.).

Figure 9.3  Improvements in Regulatory Effectiveness and Government Quality Rankings, 2000 and 2018

with four or five other countries in the rest of the world which were in the same GDP per capita bracket in 2015 (Figure 9.5). We note that not all comparable countries had similar improvements in their regulatory and institutional quality. In the regulatory quality estimate, all countries except Cambodia have improved their standing amongst the comparison countries. The most impressive in this regard is Myanmar, which started out at the bottom of its group and has climbed to joint second. Cambodia’s one-time improvement in 2011 has since eroded, and has fallen from the top of its group to third. In government effectiveness, the gains are impressive all around. Cambodia moved from the bottom to second position, with most improvements coming after 2010. The Lao PDR’s gains in the mid-2010s were not sustained. Myanmar’s trajectory is the steepest in its group. Viet Nam has caught up with India, after consistently trailing until 2010. The above comparison does not account for all the factors that go into improvements in institutions, and it would be misleading to attribute all of the gains exhibited by developing ASEAN countries to the region’s integration agenda. Some of Viet Nam’s gains, for example, are certainly related to its WTO accession process. Myanmar’s gains are most certainly related to its political transition, which began in 2010. In the next section, we highlight some case studies that illustrate how ASEAN initiatives may have contributed to improving the regulatory and institutional environment in the region.

Institutional reform, regulatory reform, and integration in East Asia 193

Note: Lao PDR = Lao People’s Democratic Republic. Source: Author’s compilation from Anderson and Nelgen (2013), except agricultural NRA estimates for years 1995–2016 for China, Japan, and the Republic of Korea, which are from OECD (2020).

Figure 9.4  Trends in Regulatory Quality and Government Effectiveness in East Asia, 1998–2018

194  Handbook on East Asian economic integration

Notes: GDP = gross domestic product, Lao PDR = Lao People’s Democratic Republic. Peer countries were selected to compare with the four ASEAN countries (Cambodia, the Lao PDR, Myanmar, and Viet Nam) based on GDP per capita. Cambodia (GDP per capita of $1,024) is compared with countries whose GDP per capita is $1,000–$1,100; Myanmar (GDP per capita of $1,335) is compared with countries whose GDP per capita is $1,200–$1,400; the Lao PDR (GDP per capita of $1,538) is compared with countries whose GDP per capita is $1,400– $1,650; and Viet Nam (GDP per capita of $1,667) is compared with countries whose GDP per capita is $1,650–$2,000. The range of GDP per capita for the peer countries is adjusted to have at least four comparison countries. GDP per capita data pertain to 2015 and are taken from the World Bank’s World Development Indicators (World Bank 2020). Source: Authors’ calculations from Worldwide Governance Indicators data (World Bank, n.d.).

Figure 9.5 Trends in Regulatory Quality and Government Effectiveness of Least Developed ASEAN Countries and their Peers

Institutional reform, regulatory reform, and integration in East Asia 195

5. CASE STUDY OF THE AEC: TRADE FACILITATION, NTMS, AND GRP As discussed earlier, the success of the ASEAN approach to integration has been the subject of much discussion in the literature. In this section, we discuss how the process of ASEAN integration has contributed to accelerate institutional and regulatory reforms amongst the AMS in a collaborative manner by taking stock of the progress in three beyond-the-border issues: trade facilitation, NTMs, and regulatory reform in general. 5.1  Trade Facilitation Trade facilitation entails a set of domestic reforms to complement tariff liberalisation, touching upon improvements in customs administration and the transparency of trade-related regulations (Persson, 2008). Many of these eventually require reforming the domestic laws and regulations, as well as the attitude of the bureaucracy. ASEAN has taken up the issue of trade facilitation as a priority area for the region, which is enshrined in the ATIGA and the AEC Blueprint (ASEAN, 2016). One benefit of the ASEAN initiatives is that the AMS are ahead of other comparable countries in their status of trade facilitation initiatives. UNESCAP and ADB (2019), in their report on the status of trade facilitation in the region, noted that ‘the ASEAN regional integration processes appear to have played a significant and positive role in trade facilitation implementation’ (UNESCAP and ADB, 2019: 9). Thus, the ASEAN process has achieved good results in this area. The inclusion of trade facilitation in the AEC Blueprint meant that ASEAN-specific initiatives were put in place. In 2017, the ASEAN Economic Ministers (AEM) set a goal of lowering trade costs in ASEAN by 10%, mostly through rapid implementation of trade facilitation measures – most of which appear in both the AEC Blueprint and the WTO Trade Facilitation Agreement. To achieve this goal, the ASEAN regional architecture was set in motion. The ASEAN Trade Facilitation Joint Consultative Committee, comprising senior-level representatives from each member countries’ trade-related agencies, meet at least twice a year to discuss progress in the implementation of trade facilitation measures. This body has been implementing the trade facilitation agenda since 2016 and has helped achieve progress through three channels: knowledge sharing, joint implementation, and regional initiatives. Regarding knowledge sharing, AMS can learn from one another’s initiatives. AMS which are at different stages of economic development and trade facilitation are working together to achieve seamless trade in the region. The region comprises the top performer in trade facilitation (Singapore) alongside emerging countries (Cambodia, the Lao PDR, and Myanmar). Advanced ASEAN countries have already put in place facilitative measures such as advanced rulings, pre-arrival processing, and authorised economic operators for a long time. These cases of good practices in AMS are worth emulating by other AMS. The ASEAN process can help countries learn from one another. The second channel of cooperation can be found in the development of ASEAN-specific measures of trade transaction costs, which was an essential step towards measuring the success of the common goal of reducing trade transaction costs. As part of this effort, each AMS conducted a time release study during 2018–2019 to assess the bottlenecks in their border procedures for importing and exporting. While each country conducted the time release study according to methodology recommended by the World Customs Organization, the countries

196  Handbook on East Asian economic integration

agreed to a minimum scope of the time release study so that consistent information could be produced. To our knowledge, this is the first instance where countries collaborated in the process of identifying bottlenecks in their respective procedures and could be the first step towards even further collaboration in trade facilitation. Third, ASEAN’s efforts towards cross-border paperless trade in the form of the ASEAN Single Window (ASW) are noteworthy. The National Single Window and the ASW have been the flagship initiative on trade facilitation in ASEAN since the mid-2000s. While each AMS is developing paperless trading systems in the form of the National Single Window, the ASW will facilitate cross-border paperless trade by enabling the exchange of trade documents. These initiatives have contributed to rapid progress in the implementation of trade facilitation initiatives in the region. According to the Global Survey on Digital and Sustainable Trade Facilitation (United Nations Trade Facilitation Survey), which tracks progress in the implementation of trade facilitation agreements, many ASEAN countries had fully implemented a larger proportion of the measures than what is expected from their level of per capita GDP in 2015. This is illustrated in Figure 9.6.

Notes: GDP = gross domestic product, Lao PDR = Lao People’s Democratic Republic, ROK = Republic of Korea. Source: Author’s calculations using data from the United Nations Trade Facilitation Survey and the World Bank’s World Development Indicators (World Bank 2020).

Figure 9.6  Implementation of Trade Facilitation Measures in East Asia

5.2  Good Regulatory Practice International regulatory cooperation is now the frontier issue in international economic integration due to its importance in reducing the cost of cross-border trade. The process of accelerating regulatory reforms in the ASEAN region has followed a similar process to that of trade facilitation. First, ASEAN elevated the issue of GRP as a key enabler of integration by forming

Institutional reform, regulatory reform, and integration in East Asia 197

the ASEAN Work Plan on GRP in 2017. Given the renewed emphasis on better regulations and following through on the importance of GRP in the AEC Blueprint 2025 , the AEM adopted the ASEAN Work Plan on GRP, 2016–2025 at the 23rd AEM Retreat in March 2017, and the AEC Council Ministers endorsed it in April 2017. It has also been underscored that enhanced regulatory practice and capacity of individual AMS are key to the successful delivery of national development agendas, and to implementing regional commitments and achieving ASEAN’s long-term competitiveness. The High-Level Task Force on ASEAN Economic Integration was tasked with overseeing the implementation of the work plan. An important step in the process was the agreement on the set of ASEAN GRP core principles: (i) clarity in policy rationale, objectives, and institutional frameworks; (ii) produce benefits that justify costs and be least distortive to the markets; (iii) be consistent, transparent, and practical; (iv) support regional regulatory cooperation; (v) promote stakeholder engagement and participation; and (vi) be subject to regular review for continued relevance, efficiency, and effectiveness (ASEAN, 2018). The next task is for each country to implement these principles in their national regulation process by developing an efficient regulatory management system. While national differences in the regulatory process are inevitable, adhering to this set of principles will ensure an improvement in the regulatory environment and reduce the unnecessary regulatory burden on businesses and the public. The difference within ASEAN on the regulatory quality is large, as Singapore and Malaysia have good processes in place, while Cambodia, the Lao PDR, and Myanmar have only recently begun implementing regulatory reforms. Again, the ASEAN process can help these lagging countries learn from the leaders in the regulatory process. The concerted effort made by each country, as part of the ASEAN process, can lead to sustained regulatory reforms. 5.3  Non-Tariff Measures4 ASEAN has achieved significant improvements in tariff liberalisation. The average tariff on intra-ASEAN trade is as low as 0.2%. On the contrary, NTMs, defined as policy measures other than ordinary tariffs, which can affect international trade by changing the price or quantity traded, are on the rise. From 2015 to 2018, the number of NTMs in ASEAN increased by 15% to about 9,500 measures (Doan et al., 2019). NTMs include a wide array of policy instruments. Some NTMs are used as a commercial policy tool, such as quotas or price controls. These measures are often regarded as non-tariff barriers, aimed at protecting domestic producers, and are against WTO rules. On the other hand, technical tools – such as sanitary and phytosanitary measures and technical barriers to trade – are designed to protect consumers’ health and safety and the environment. Since NTMs originate in domestic regulations, they are deeply linked to the quality of institutions and governance of each country. In principle, these measures serve legitimate public policy goals, and thus are legal. Given their legitimacy, the prevalence of NTMs is not necessarily a bad sign for the economy. As the economy grows and consumer wealth rises around the world, the demands on governments for health, safety, and environmental protection also increase. However, even good NTMs can incur significant costs because of poor design and implementation, and thus restrict deep economic integration. Associated with NTMs is a plethora of technical and administrative procedures which could be time-consuming and costly for firms to comply with, creating uncertainty

198  Handbook on East Asian economic integration

for investors and increasing trade costs. Thus, domestic reforms are necessary to make them least onerous. In the AMS, both imports and exports are heavily regulated by NTMs. For example, more than 80% of traded value in agricultural products is subject to NTMs. Further, NTMs affect 60–80% of the traded value in manufacturing sectors with deep participation in the global value chain, such as machinery and electrical machinery, and transportation (Doan et al., 2019). The costs associated with these NTMs are high. Ing and Cadot (2019), for instance, estimated that the ad valorem equivalent of NTMs is up to 5.7% in manufacturing and 16.6% in agriculture, implying significant added trade costs. The increasing fragmentation of the international production network, where goods move across borders multiple times, magnifies these costs. A barrier on imports of intermediate inputs, for example, could result in higher costs for firms in the downstream sectors, thus reducing competitiveness in the export market. On the contrary, lower accumulated trade costs could enable firms’ entry and growth in the global value chain. Indeed, Shepherd (forthcoming) found that the ASEAN average effective rate of protection, i.e. the ad valorem equivalent rate, taking into account both costs on inputs and final goods, has doubled when NTMs are included, compared with the estimate with the tariff per se. To promote regional integration towards the realisation of the AEC, ASEAN has introduced various initiatives to address NTMs. The streamlining and simplification of NTMs is mentioned in four areas: (i) the ATIGA, (ii) the AEC 2025 Trade Facilitation Strategic Action Plan, (iii) the Guidelines for the Implementation of ASEAN Commitments on NTMs on Goods, and (iv) the GRP Core Principles. First, the ATIGA includes provisions relevant to ensuring the transparency and management of NTMs, including (i) the responsibility to notify NTMs which can potentially affect the ATIGA’s operation to all AMS, (ii) the publication of trade-related information through national trade repositories and the ASEAN trade repository, (iii) the elimination of non-tariff barriers, and (iv) the construction of an ASEAN NTM database. In addition to the general provisions on NTMs, the ATIGA contains provisions on the harmonisation of standards, technical regulations, and conformity assessment procedures; mutual recognition arrangements; and the development of a single regulatory regime in certain priority integration sectors. Second, the Strategic Action Plan, particularly item 3, provides a strategic objective that ‘Put[s] in place an effective and responsive regional approach to efficiently address the trade distorting effect of NTMs with a view to pursuing legitimate policy objectives while reducing cost and time of doing business in ASEAN’ (ASEAN, 2017). Third, the Guidelines for the Implementation of ASEAN Commitments on NTMs on Goods, provide a general framework to improve the transparency and management of NTMs. The recently adopted non-binding guidelines provide for operationalising key ATIGA elements and provisions related to NTMs, as mentioned above. Fourth, ASEAN has also adopted the GRP Core Principles. Notwithstanding the comprehensive sets of initiatives, progress on the ground is uneven and limited. For example, the NTM sections of the national trade repositories are missing for some countries, whereas for others a centralised trade repository with NTM information is fully operational. Similarly, the notification obligation is not strictly implemented, as no official cases have been reported to the relevant ASEAN bodies. Even for the most progressive initiative – the harmonisation of standards and conformance – implementation is uneven across the AMS. Some countries have yet to establish an accreditation body, relying instead on accredited testing facilities in other AMS. This lack of facilities prevents countries from fully benefiting from mutual recognition agreements.

Institutional reform, regulatory reform, and integration in East Asia 199

Remaining challenges include (i) enhancing member countries’ technical infrastructure capability to support the adoption of harmonisation standards; (ii) the ability to support local industry by making available accredited testing and certification of products in some AMS; and (iii) continuous training of personnel to support and sustain the work on standards, technical regulations, and conformity assessments. In addition, the establishment and effective operation of an inter-ministerial coordinating agency in charge of NTMs would ensure the smooth implementation of policy. The absence of a coherent mechanism and institution could create difficulties – not only for collecting and classifying data but also for drafting good regulations. The lack of coordination could create inconsistency in regulations issued by government agencies across ministries.

6. CONCLUSION Regulatory reform can contribute to creating an effective, market-oriented business environment; enhancing healthy competition; and facilitating trade and investment. The process of East Asian economic integration has given rise to regional architectures that serve as a platform for collaboration in domestic reforms. While the roots of integration in the 1980s were purely market-driven, the architecture has evolved to cover areas beyond trade in goods. ASEAN, in particular, has put forth an impressive integration agenda that seeks to develop a common production base by fostering a seamless flow of goods amongst the members. This entails reducing many beyond-the-border barriers to trade. Key initiatives in this regard include addressing NTMs, trade facilitation, and regulatory quality. ASEAN’s approach of discussion, deliberation, and collaboration may have helped to accelerate reforms amongst its least developed members. The role of the East Asian architecture in facilitating reforms amongst its members is an important issue. Reforms in general are difficult, but the process of integration creates pressures for reforms. There are arguably greater incentives to pursue deeper integration amongst East Asian countries due to the emergence of sophisticated international production networks. It is impossible to confidently attribute reforms to a particular integration architecture due to confluence of domestic politics as well as the coexistence of a myriad of international agreements, each of which exerts its own reform pressure. The improvements observed amongst the least developed ASEAN countries since 2010, when they started outperforming many of their peers, suggest that the ASEAN process may have helped these countries to reform more quickly. The approach taken by ASEAN and its East Asian partners could prove fruitful in tackling newer challenges to integration, such as the flow of data and digital trade, which are a product of technological change. Looking forward, we expect to observe bolder reforms to address new challenges and further stimulate regional integration. For the past few years, we have witnessed swift changes in the global economic landscape at an unprecedented scale. Rising uncertainty due to the US– China trade tensions and the backlash against globalisation observed in both advanced economies and developing countries, could redefine the world order. On the other hand, the new wave of FDI relocation also presents opportunities for the region to attract more foreign investors and the associated know-how. To cope with the great uncertainty ahead and build resilience, domestic policy reform – supported by regional cooperation – is vital. This reform requires strong regional commitments to reducing trade barriers, encouraging the adoption of

200  Handbook on East Asian economic integration

new digital technology, investing in information and communication technology infrastructure, and establishing a regulatory framework to address cybersecurity and support cross-border data flows.

NOTES 1. On the issue of resilience, Haggard (1999) argued that the institutional characteristic was an important determinant of how deeply East Asian countries suffered from the 1997 Asian financial crisis and how quickly they recovered from it. 2. FTAs between ASEAN as a whole and one or more outside trade partners, e.g. ASEAN–China and ASEAN–Korea. 3. The list of data sources is available from the WGI website (World Bank, n.d.). 4. The discussion in this section is largely based on Doan et al. (2019).

REFERENCES Acemoglu, D., S. Johnson, and J.A. Robinson (2005), ‘Institutions as a Fundamental Cause of Long-Run Growth’, in P. Aghion and S.N. Durlauf (eds.), Handbook of Economic Growth, Volume 1A. Amsterdam: Elsevier, pp.385–472. Ahsan, R.N. (2013), ‘Input Tariffs, Speed of Contract Enforcement, and the Productivity of Firms in India’, Journal of International Economics, 90(1), pp.181–92. Álvarez, I.C., J. Barbero, A. Rodríguez-Pose, and J.L. Zofío (2018), ‘Does Institutional Quality Matter for Trade? Institutional Conditions in a Sectoral Trade Framework’, World Development, 103, pp.72–87. Anderson, J.E. and D. Marcouiller (2002), ‘Insecurity and the Pattern of Trade: An Empirical Investigation’, The Review of Economics and Statistics, 84(2), pp.342–52. Andrews, M. (2013), The Limits of Institutional Reform in Development: Changing Rules for Realistic Solutions. New York: Cambridge University Press. APEC (n.d.), About APEC. https://www.apec.org/About-Us/About-APEC/ (accessed 30 October 2020). Araujo, L., G. Mion, and E. Ornelas (2016), ‘Institutions and Export Dynamics’, Journal of International Economics, 98, pp.2–20. ASEAN (2016), ASEAN Trade Facilitation Framework. Jakarta: ASEAN Secretariat. https://asean.org/wp-content/ uploads/2016/08/ASEAN-Trade-Facilitation-Framework.pdf (accessed 30 August 2020). ASEAN (2017), AEC 2025 Trade Facilitation Strategic Action Plan. Jakarta: ASEAN Secretariat. https://asean.org/ storage/2012/05/AEC-2025-Trade-Facilitation-SAP-FINAL-rev.pdf (accessed 25 September 2020). ASEAN (2018), The ASEAN Good Regulatory Practice (GRP) Core Principles. Jakarta: ASEAN Secretariat. https:// asean.org/storage/2017/11/ASEAN-GRP-Core-Principles-FINAL-ENDORSED.pdf (accessed 25 September 2020). Baldwin, R. (2012), ‘Sequencing Asian Regionalism: Theory and Lessons from Europe’, Journal of Economic Integration, 27(1), pp.1–32. Benáček, V., H. Lenihan, B. Andreosso-O’Callaghan, E. Michalíková, and D. Kan (2012), ‘Political Risk, Institutions and Foreign Direct Investment: How Do They Relate in Various European Countries?’, IES Working Paper, No. 24/2012. Prague: Charles University Institute of Economic Studies. https://www.econstor.eu/handle/10419/83436 (accessed 30 October 2020). Bournakis, I. and C. Tsoukis (2016), ‘Government Size, Institutions, and Export Performance Among OECD Economies’, Economic Modelling, 53, pp.37–47. Buchanan, B.G., Q.V. Le, and M. Rishi (2012), ‘Foreign Direct Investment and Institutional Quality: Some Empirical Evidence’, International Review of Financial Analysis, 21, pp.81–89. Büthe, T. and H.V. Milner (2014), ‘Foreign Direct Investment and Institutional Diversity in Trade Agreements: Credibility, Commitment, and Economic Flows in the Developing World, 1971–2007’, World Politics, 66(1), pp.88–122. Chia, S.Y. (2013), ‘The Emerging Regional Economic Integration Architecture in East Asia’, Asian Economic Papers, 12(1), pp.1–37. Daude, C. and E. Stein (2007), ‘The Quality of Institutions and Foreign Direct Investment’, Economics & Politics, 19(3), pp.317–44. Dee, P. (2007), ‘East Asian Economic Integration and Its Impact on Future Growth’, World Economy, 30(3), pp.405–23. Doan, H.T.T., S. Rosenow, and S.M. Buban (2019), ‘Non-Tariff Measures and Regional Integration in ASEAN’, in Ha Thi Thanh Doan and S. Rosenow (eds.), Non-Tariff Measures in ASEAN – An Update. Jakarta: ERIA, pp.1–31.

Institutional reform, regulatory reform, and integration in East Asia 201 Elkins, Z., A.T. Guzman, and B.A. Simmons (2006), ‘Competing for Capital: The Diffusion of Bilateral Investment Treaties, 1960–2000’, International Organization, 60(4), pp.811–46. European Commission (2018), ‘EU–Vietnam Trade and Investment Agreement: Main Benefits Factsheet’. Brussels: European Commission. https://trade.ec.europa.eu/doclib/docs/2018/october/tradoc_157444.pdf (accessed 2 September 2020). Ferrantino, M.J. (2006), ‘Policy Anchors: Do Free Trade Agreements and WTO Accessions Serve as Vehicles for Developing-Country Policy Reform?’ https://papers.ssrn.com/sol3/papers.cfm?abstract_id=895272 (accessed 18 July 2020). Francois, J. and M. Manchin (2013), ‘Institutions, Infrastructure, and Trade’, World Development, 46, pp.165–75. Globerman, S. and D. Shapiro (2002), ‘Global Foreign Direct Investment Flows: The Role of Governance Infrastructure’, World Development, 30(11), pp.1899–919. Haggard, S. (1999), ‘Governance and Growth: Lessons from the Asian Economic Crisis’, Asian‐Pacific Economic Literature, 13(2), pp.30–42. Harrison, J. et al. (2019), ‘Labour Standards Provisions in EU Free Trade Agreements: Reflections on the European Commission’s Reform Agenda’, World Trade Review, 18(4), pp.635–57. Helble, M., Shepherd, B., and Wilson, J.S. (2009), ‘Transparency and Regional Integration in the Asia Pacific’, The World Economy, 32(3), pp.479–508. Ing, L.Y. and O. Cadot (2019), ‘Ad Valorem Equivalents of Non-Tariff Measures in ASEAN’, in L.Y. Ing, R. Peters, and O. Cadot (eds.), Regional Integration and Non-Tariff Measures in ASEAN. Jakarta: ERIA, pp.40–64. Intal Jr., P. (2018), ‘East Asia’s Transformation and Regional Architecture’, in S. Armstrong and T. Westland (eds.), Asian Economic Integration in an Era of Global Uncertainty. Canberra: ANU Press, pp.235–58. Kaufmann, D., A. Kraay, and M. Mastruzzi (2010), ‘The Worldwide Governance Indicators: Methodology and Analytical Issues’, Policy Research Working Paper, No. 5430. Washington, DC: World Bank. Kawai, M. (2005), ‘East Asian Economic Regionalism: Progress and Challenges’, Journal of Asian Economics, 16(1), pp.29–55. Kimura, F. and A. Obashi (2016), ‘Production Networks in East Asia: What We Know So Far’, in G. Wignaraja (ed.), Production Networks and Enterprises in East Asia. Tokyo: Springer/Asian Development Bank Institute, pp.33–64. Krueger, A.O. (2002), Political Economy of Policy Reform in Developing Countries. Cambridge, MA: MIT Press. Kunčič, A. (2014), ‘Institutional Quality Dataset’, Journal of Institutional Economics, 10(1), pp.135–61. Levchenko, A.A. (2007), ‘Institutional Quality and International Trade’, The Review of Economic Studies, 74(3), pp.791–819. Ma, Y., B. Qu, and Y. Zhang (2010), ‘Judicial Quality, Contract Intensity and Trade: Firm-Level Evidence from Developing and Transition Countries’, Journal of Comparative Economics, 38(2), pp.146–59. North, D.C. (1990), Institutions, Institutional Change and Economic Performance. New York: Cambridge University Press. Nunn, N. (2007), ‘Relationship-Specificity, Incomplete Contracts and the Pattern of Trade’, The Quarterly Journal of Economics, 122(2), pp.569–600. Pangestu, M. and S. Armstrong (2018), ‘Asian Economic Integration: The State of Play’, in S. Armstrong and T. Westland (eds.), Asian Economic Integration in an Era of Global Uncertainty. Canberra: ANU Press, pp.15–61. Persson, M. (2008), ‘Trade Facilitation and the EU–ACP Economic Partnership Agreements’, Journal of Economic Integration, 23, pp.518–46. Plummer, M. and R.W. Click (2009), ‘The ASEAN Economic Community and the European Experience’, in K. Hamada, B. Reszat, and U. Volz (eds.), Towards Monetary and Financial Integration in East Asia. Cheltenham, UK: Edward Elgar Publishing, pp.13–40. Ranjan, P. and J.Y. Lee (2007), ‘Contract Enforcement and International Trade’, Economics & Politics, 19(2), pp.191–218. Rodrik, D. (1996), ‘Understanding Economic Policy Reform’, Journal of Economic Literature, 34(1), pp.9–41. Rodrik, D. (2011), The Globalization Paradox: Democracy and the Future of the World Economy. New York: WW Norton & Company. Shepherd, B. (forthcoming), ‘Effective Rates of Protection in a World with Non-Tariff Measures and Supply Chains: Evidence from ASEAN’, ERIA Discussion Paper Series. Jakarta: Economic Research Institute for ASEAN and East Asia. Sobel, R.S. (2017), ‘The Rise and Decline of Nations: The Dynamic Properties of Institutional Reform’, Journal of Institutional Economics, 13(3), pp.549–74. Stubbs, R. (2019), ‘ASEAN Sceptics Versus ASEAN Proponents: Evaluating Regional Institutions’, The Pacific Review, 32(6), pp.923–50. Syverson, C. (2011), ‘What Determines Productivity?’, Journal of Economic Literature, 49(2), pp.326–65. Taglioni, D. and D. Winkler (2016), Making Global Value Chains Work for Development. Washington DC: World Bank.

202  Handbook on East Asian economic integration Tang, M.-K. and S.-J. Wei (2009), ‘The Value of Making Commitments Externally: Evidence from WTO Accessions’, Journal of International Economics, 78(2), pp.216–29. UNESCAP and ADB (2019), Asia–Pacific Trade Facilitation Report 2019: Bridging Trade Finance Gaps Through Technology. Manila: Asian Development Bank. World Bank (2020), ‘World Development Indicators Online database’. https://datacatalog.worldbank.org/dataset/ world-development-indicators (accessed 30 August 2020). WTO (2020), Regional Trade Agreements Database. https://rtais.wto.org/UI/PublicMaintainRTAHome.aspx (accessed 31 August 2020).

10. Business impediments to economic integration in Southeast Asia Cassey Lee

1. INTRODUCTION A key feature of the history of human civilisation is the geographical expansion of the web of economic interactions and exchanges. This process began well before the emergence of national boundaries and modern firms as we know them today. It is by no means a process that has always led to a progressive enlargement of geographically connected and integrated markets. On a larger stage, economic globalisation has waxed and waned with the rise and fall of economic interdependence between national and regional economies through changes in crossborder flows of trade (goods and services) and factors of production (labour and capital). Many of these changes have been brought about by the implementation of laws, regulations, and policies by states; and sometimes, more dramatically, by the collapse of states. These changes alter the environment within which business enterprises operate. Depending on the nature of such changes, the businesses of enterprises can be impeded or can flourish. From the perspective of businesses and policymakers, an understanding of the nature of business impediments and the roles they play in economic integration is important. This chapter attempts to provide an analysis of this topic in the context of economic integration in Southeast Asia. The overall framework that is adopted in this chapter is one anchored in a micro-level analysis at the firm level. The outline of the rest of this chapter is as follows. Section 2 discusses some of the key terms and definitions in discussing business impediments and economic integration. Section 3 will briefly review the theoretical and empirical literature with a view to providing a framework for the analysis of business impediments and economic integration. The issue of measuring business impediments is discussed in Section 4. This is followed by a discussion on the empirical literature on business impediments and firm performance. The state of business impediments and how they relate to economic integration in Southeast Asia are explored in Section 6. Policy implications are explored in Section 7. Section 8 concludes.

2.  CONCEPTS AND DEFINITIONS Some clarification on the concepts and definitions used in this study is necessary to avoid any misunderstanding and to place this study within the existing literature. In this study, the term business impediment is defined as any factor that is external to a firm that adversely impacts (i.e., impedes) its performance. Performance can be measured in various ways, for example, growth, profitability, productivity, and exporting. External factors that may adversely affect a business include laws, regulations, and policies that are implemented and enforced by the 203

204  Handbook on East Asian economic integration

government (state) in the goods and services markets as well as factor markets (e.g., labour and capital). Such factors can impact domestic and cross-border business operations. Economic integration is a process involving reductions in impediments to cross-border business activities, such as trade and investment. From a national policy perspective, the process of economic integration involves the implementation of measures that abolish discrimination between enterprises from different national states (Sapir, 2011). In terms of existing research, there is no distinct body of literature using the term ‘business impediment’. However, the literature that is relevant is based on the World Bank’s programme on improving the climate or environment for businesses. Stern (2002: 144) attempts to classify some of the factors affecting the business environment by using the term investment climate – which he defines as ‘the policy, institutional, and behavioural environment, both present and expected, that influences the returns and risks associated with investment’. According to Stern (2002: 145), the factors that affect investment climate can be classified into three broad categories, namely:1 1. Macroeconomic stability and openness – which covers fiscal (tax, deficit, debt), monetary, and exchange rate policies. 2. Governance and institutions – which covers transparency, control of corruption, rule of law (legal system, law enforcement, control of crime, corruption), intellectual property right, trust, social capital, social network, effective regulatory regime (competition law and regulations), public service provision, and labour regulations. 3. Infrastructure – which covers the quality of infrastructure, such as power, water, transport, telecommunications, customs, and finance. The literature utilising the World Bank’s microdata on the business/investment climate has mostly focused on governance and institutions. This literature is reviewed in the next section. Within the context of economic integration, business impediments include domestic factors or constraints that affect cross-border trade and investment. These may include domestic constraints (such as licencing and permits) that can impact: (1) the productivity of domestic firms, which affects their ability to export; and (2) the entry of foreign firms into domestic markets. Some of these issues are featured prominently in the firm-level literature on globalisation.

3.  LITERATURE AND FRAMEWORK The impact of business impediments on the performance of firms can be contextualised within a broad framework. The value of doing this is to put in perspective and relate business impediments to the broader literature on firm performance and economic integration. 3.1  Growth Theory A useful starting point would be growth theory. This makes sense for at least three reasons. First, economic growth is an important goal of policymakers, at least at the macro level. Second, a fair bit of empirical research on firm performance focuses on productivity, which is a key element of growth theory.2 Finally, firm-level dynamics can be analysed within the context of creative destructive processes that are featured in Schumpeterian growth theories. Regardless

Business impediments to economic integration in Southeast Asia 205

of which growth theory is adopted, a key goal of reducing or removing business impediments would be the enhancement of economic growth. The question of how the removal or reduction in business impediments affects economic growth can then be examined in terms of the various drivers in these growth theories. The classic Solow-Swan (Neoclassical, AK) Growth Theory postulates that economic growth is driven by factor accumulation (capital and labour) and productivity growth. In the empirical analysis of this theory, the so-called Solow residual is a measure of total factor productivity (TFP) and is associated with technological change or innovation. In the Endogenous (New) Growth Theory, some fraction of the capital and labour is used as inputs for innovation activities, such as research and development (R&D) (Romer, 1986). Human capital has also been regarded as an important input that can enhance economic growth (Lucas, 1988). Subsequent contributions linked innovation to the creation of product variety, which can enhance productivity (Romer, 1990). Another important variant of growth theory is the Schumpeterian Growth Theory. In the growth model by Aghion and Howitt (1992), technological change is driven by a creative destructive process that entails the entry of new innovators and the exit of old innovators. The creative destructive phenomenon provides a useful way to think about the turnover of firms (entry-exit) at the micro level. 3.2  Microfoundations of Growth, Trade, and Business Impediments Based on what we know about growth theories, how should we think about business impediments in terms of their effects on firms and economic growth? Business impediments in the goods/services markets and factor markets, such capital (e.g. access to credit), labour (e.g. labour laws), and human capital, clearly affect the performance and behaviour of firms (Burgess and Venables, 2004). For example, burdensome regulations could reduce the incentives for firms to undertake investments and workers to upgrade their skills (human capital). The vibrancy of markets could also be affected by regulations that prolong the exit of inefficient firms and that prevent the entry of innovative firms. Within the context of economic integration, how would business impediments affect trade and growth? A key aspect of trade is the enlargement of markets for firms – this is emphasised in both endogenous growth models (Grossman and Helpman, 1991) as well the Schumpeterian growth model (Aghion and Howitt, 2009). Larger markets allow firms to grow, but only if they are competitive and innovative in both domestic and foreign markets. Exposure to greater competition in domestic markets driven by economic integration results in the entry of more productive firms and the exit of less productive firms. This selection effect is a key feature in the heterogenous firm literature in the international trade literature (Melitz, 2003). The within-industry selection and reallocation effects can be directly linked to aggregate productivity growth (Foster, Haltiwanger, and Krizan, 2001; Foster, Haltiwanger, and Syverson, 2008). Thus, business impediments that adversely affect economic integration can affect economic growth through the same mechanisms discussed earlier. Reducing the entry rate of new firms from abroad can constrain an important source of entrepreneurship and innovation in domestic markets. Another effect of business impediments on cross-border trade and investment is to slow down the exiting rate of inefficient and non-innovative domestic firms, which reduces resource reallocation, resulting in lower productivity. Business impediments that increase the cost of accessing markets abroad can also reduce firms’ incentives to innovate.

206  Handbook on East Asian economic integration

The next step in framing the business impediment–growth framework is to link up the various factors affecting the business climate to the micro elements of economic growth, such selection effects (entry and exit). This can be done as follows: Factors that affect the starting-up of businesses by domestic and foreign firms. • Entry: These include ease of getting: (1) operating licences, (2) construction permits, (3) prop-

• • •

erty registration, (4) access to electricity, (5) access to credit, (6) contract enforcement, (7) employment of workers, and (8) bribery. In the case of entry by foreign-owned firms, additional business impediments may include equity restrictions, technology transfer requirements (intellectual property [IP] protection), investor dispute settlement mechanisms, and regulations on the hiring of foreign workers. Operations: Factors that affect the day-to-day running of businesses. These include: (1) the employment of workers (2) bribery, and (3) customs clearance. Exit: Factors that affect the departure of non-performing firms from markets. These include insolvency resolution and state-enacted support, or barriers that prolong the exit of such firms.

Finally, whilst business impediments generally have the same effects on firms around the world, their importance and impact may differ with the level of development of an economy. The level of development goes beyond income per capita. It includes market and institutional elements that can be associated with income per capita. Xu (2011), for example, argues that countries at the early stage of development could rely on informal market-supporting institutions, such as reputation mechanisms, relationship contracts, and informal trade credit. However, as markets become larger and transactions more complicated, more formal arms-length contracts and institutions become important (Xu, 2011: 332). Another interesting study is that of Chavis et al. (2011) who showed that more firms switch out of informal finance toward bank finance as they become mature. Thus, business impediments that constrain access to formal financing become more important as economies develop. The above arguments apply to the process of economic integration as well. Formal contracts and institutions are important for cross-border trade and investment. Thus, as countries become more open, transactions and contracts also become more complicated. For countries to become more integrated to the regional and global economy, informal institutions need to be transformed into formal institutions (global standard). Likewise, informal firms need to be transformed into formal firms to gain access to bank finance, imports, exports, and FDI. An additional issue that becomes important in the case of economic integration is the harmonisation of regulations and laws. When laws and regulations differ significantly across countries, the additional costs to be incurred by firms may be impediments to importing, exporting, and investing activities. There are two harmonisation approaches to overcome these problems: (i) positive harmonisation – where countries aim to enact similar laws and regulations; or (ii) negative harmonisation – where countries dismantle laws and regulations (Maletic, 2013). Both are likely to have different effects on cross-border trade and investment.

4.  MEASURING BUSINESS IMPEDIMENTS The measurement of business impediments is a key step in assessing the importance of various factors affecting the domestic business environment and cross-border trade and investment.

Business impediments to economic integration in Southeast Asia 207

Drawing from the literature on business climate, there are at least three ways of measuring business impediments – de jure and de facto. In the de jure approach, the impediments facing business are measured by undertaking surveys that involve seeking the opinions of experts (e.g. lawyers). Such surveys are premised upon the notion of a ‘standardised firm’ – that is, how would a ‘typical’ (standardised) firm be affected. Thus, only one standardised answer is reported for all firms in the country. This is the approach used by the World Bank’s Doing Business Report. In the de facto approach, surveys are carried out by interviewing executives and owners from firms. In these surveys, the actual experiences of firms in facing and dealing with various types of business impediments are recorded. As firms are heterogenous, one can obtain a range of responses. The conditioning of such responses by various variables – such as firm size, age, ownership, and exporting – can reveal how various types of businesses are affected by business impediments. This is the approach adopted in the World Bank’s Enterprise (Investment Climate) Surveys. Which approach provides a better measure of business impediments and how are the two approaches related? Besley (2015) shows that some of the de jure measures may not be positively correlated to the de facto measures. For example, the number of procedures to start a business (de jure) is positively correlated with firms indicating regulation is the biggest obstacle to doing business (de facto). However, the time taken to start a business (de jure) is negatively correlated with firms indicating that regulation is the biggest obstacle to doing business (de facto) (Besley, 2015: 110). As to the question of which measure is better, there are advantages and disadvantages associated with the de jure and de facto approaches. Besley (2015) argues that whilst enterprise-level surveys (de facto approach) are better at exploring the heterogeneity of business impediments (investment climate), the doing business surveys (de jure approach) may be more reliable (due to sampling issues). In addition, Hallward‐Driemeier and Pritchett (2015) also highlight another possibility – a phenomenon they term as ‘fast firms’. In countries where de jure regulations are strict but state institutions are weak, ‘fast firms’ – that is, firms with abundant financial resources and good political connections – can by-pass regulatory constraints. What this implies is that surveys using the de jure and de facto approaches may not necessarily capture the true magnitude and nature of business impediments facing ‘fast firms’. In the context of economic integration, such a phenomenon may affect cross-border trade and investment – foreign firms may need local partners that are fast firms. This is particularly true in economies dominated by large business groups with deep political connections.

5. MEASURING THE EFFECTS OF BUSINESS IMPEDIMENTS IN EMPIRICAL STUDIES The measurement of business impediments is only important if they adversely impact the performance of firms. It is also useful to examine what type of business impediments are important and what type of impacts they may have. A number of micro-level studies at the firm or enterprise level have emerged since the early 2000s. A comprehensive review is not possible given the space limitation. Instead, a number of key studies are highlighted to give a flavour of the coverage and methods used.

208  Handbook on East Asian economic integration

One early study is that of Johnson, McMillan, and Woodruff (2002). Using survey data involving small manufacturing firms from Poland, Romania, Slovakia, Ukraine, and Russia, the authors find that a firm’s perception of secure property rights is significantly related to the amount that entrepreneurs choose to reinvest out of their profits. To measure property rights, an additive index of property-rights insecurity was created from responses to questions on whether the firms made any extra-legal payments for licences and services as well as payments for protection. The study by Dollar, Hallward-Driemeier, and Mengistae (2005) focuses on the link between investment climate and firm performance using firm-level survey data from Bangladesh, China, India, and Pakistan. For performance variables such as productivity and profitability, the authors find that the quality of infrastructure services (measured by power outages) and customs processes (customs delays) matter. In the context of economic integration, trade facilitation measures involving customs clearance are clearly important. Fisman and Svensson (2007) use a unique data set from Uganda containing information on estimated bribe payments. In the survey, firms were asked to estimate what firms in the industry would make informal payments to public officials to deal with customs, taxes, licences, regulations, and services. The authors find that the bribe rate (i.e. bribe payment/sales) is negatively associated with firm growth (based on average sales). In the study by Cai, Fang, and Xu (2011) using firm-level data from China, the authors use a different measure of corruption, namely, entertainment and travel costs (ETC) expenditures. The authors argue that ETC contain expenses that include ‘grease money’ that help firms obtain better government services and protection money to lower tax rates. They find that ETC overall has a significantly negative effect on firm productivity. One can relate such activities to the behaviour of the ‘fast firms’ alluded to by Hallward‐Driemeier and Pritchett (2015). Finally, it is important to take into account how laws and regulations could be asymmetrically applied to firms of different sizes. Using firm-level data from France, Gourio and Roys (2014) argue that small firms can be regulated less than large firms. The threshold effects of such regulations are determined by the official micro, small, and medium-sized enterprise definition. Thus, in so far as there are size-related regulations that may impede businesses, their effects could be asymmetric across firms of different sizes. Regulations with such effects may neutralise the advantages that larger firms have in participating in activities related to the process of regional economic integration, such as exporting.

6. BUSINESS IMPEDIMENTS AND ECONOMIC INTEGRATION IN SOUTHEAST ASIA The current state of business impediments and their effects on economic integration can be examined by looking at the statistical correlation between trading activities (exporting and importing) of firms and the various factors related to business impediments. This can be analysed comparatively at the firm level using survey data from the World Bank’s enterprise surveys for 2015/2016. The data cover 4,694 manufacturing firms from eight developing countries from Southeast Asia.3 For most countries in the World Bank dataset, the composition of firms is quite evenly distributed across the three size categories of small, medium, and large (see Table 10.1).4 In terms

Business impediments to economic integration in Southeast Asia 209

of sample size, the number of firms surveyed is relatively small for two countries, namely Cambodia and the Lao PDR. Thus, sample representativeness may be an issue for selected industries in some of these countries (see Table 10.2). Table 10.1  Distribution of Manufacturing Firms Surveyed by Size Number of Firms Country

Small

Cambodia

50

45

40

135

Indonesia

332

378

344

1 054

Lao PDR

33

50

27

110

Malaysia

134

210

241

585

Myanmar

176

103

75

354

Philippines

284

394

359

1 037

Thailand

223

259

244

726

Viet Nam Total

Medium

Large

Total

161

284

248

693

1 393

1 723

1 578

4 694

Percentage Distribution Country

Small

Medium

Large

Total

Cambodia

37.0

33.3

29.6

100.0

Indonesia

31.5

35.9

32.6

100.0

Lao PDR

30.0

45.5

24.5

100.0

Malaysia

22.9

35.9

41.2

100.0

Myanmar

49.7

29.1

21.2

100.0

Philippines

27.4

38.0

34.6

100.0

Thailand

30.7

35.7

33.6

100.0

Viet Nam

23.2

41.0

35.8

100.0

Total

33.6

36.7

33.6

100.0

Source: World Bank.

More specifically, a number of business impediments are examined. These include: (1) power outages, (2) insufficient water supply, (3) telecommunications, (4) transport, (5) access to finance, (6) customs and trade regulations, (7) business licencing and permits, (8) tax rates, (9) tax administration, (10) labour regulations, (11) political instability, (12) courts, (13) corruption, (14) inadequately educated workers, and (15) access to land.5 Table 10.3 summarises the various types of business impediments encountered by manufacturing firms in eight developing Southeast Asian countries. From the summary table, the most important business impediments are clearly inadequate infrastructure particularly in power supply, telecommunications, and transport. Given the

210

Food Tobacco Textiles Garments Leather Wood Paper Publishing, printing, and recorded media Refined petroleum product Chemicals Plastics and rubber Non-metallic mineral products Basic metals Fabricated metal products Machinery and equipment n.e.c. Office, accounting, and computing machinery Electrical machinery and apparatus n.e.c. Radio, tv, and communications equipment and apparatus Precision instruments Motor vehicles, trailers, and semi-trailers Other transport equipment Furniture Recycling

38 0 4 39 7 1 0 10 0 1 2 9 6 4 2 0 2 0 2 1 0 6 1 135

164 4 109 165 52 21 5 17 1 93 127 151 34 33 11 0 7 0 0 3 4 35 18 1054

20 0 8 18 2 23 0 3 4 6 3 3 2 4 8 0 1 0 0 0 0 5 0 110

158 0 19 63 4 12 2 25 4 86 30 15 20 10 20 1 84 8 3 6 0 13 2 585

84 2 7 37 7 25 13 3 0 10 16 5 11 43 50 0 5 0 1 6 0 18 11 354

159 1 5 151 5 5 7 22 1 149 161 28 10 154 22 0 122 7 6 4 2 15 1 1037

161 0 20 155 3 8 8 4 1 8 161 10 2 30 16 1 74 43 3 8 2 8 0 726

130 0 24 140 14 21 8 12 2 18 19 131 14 97 35 0 9 0 1 3 0 12 3 693

914 7 196 768 94 116 43 96 13 371 519 352 99 375 164 2 304 58 16 31 8 112 36 4694

Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Thailand Viet Nam Total

Source: Author’s compilation using World Bank Enterprise Surveys 2015/2016.

Note: n.e.c. = not elsewhere classified.

15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 Total

Code Industry

Table 10.2  Distribution of Firms Across Industries in Data Sample

211 7.9 8.2 1.3 12.6 2.9 8.4 0.5 1.6 6.2

Courts

Political Instability

20.3 15.6 0.0 14.9 17.9 12.8 7.8 6.5 12.4

15.4 10.7 4.5 9.9 3.7 10.5 0.6 2.0 7.2

Business Licencing

Customs and Regulation

10.2 15.9 12.7 18.1 4.3 17.8 2.4 2.6 11.4

10.7 0.8 12.7 14.2 5.4 6.2 1.8 7.3 5.7

53.4 25.7 56.0 20.5 97.7 41.5 7.8 35.5 34.2

Insufficient Water

Source: Author’s computation based on data from World Bank’s enterprise surveys.

Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Thailand Viet Nam All

Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Thailand Viet Nam All

Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Thailand Viet Nam All

Power Outage

10.8 13.3 4.6 11.7 9.6 26.2 0.9 6.8 12.3

Corruption

9.9 15.9 25.5 14.9 6.3 22.2 4.3 5.8 13.2

Tax Rates

12.2 17.7 3.7 13.4 3.1 21.5 20.4 4.7 14.9

Telecommunication

23.7 13.3 27.3 15.9 9.7 7.4 1.7 8.1 10.1

Educated Workers

3.8 10.7 1.8 12.1 5.8 15.5 1.7 2.3 8.5

Tax Admin

13.0 19.7 33.9 15.1 5.9 22.9 3.2 9.1 14.8

Transport

Table 10.3  Share of Manufacturing Firms Surveyed Indicating Problematic Types of Business Impediments (%)

17.1 16.6 10.9 9.8 20.5 4.9 1.2 8.2 9.7

Access to Land

17.2 14.1 8.2 14.2 3.8 5.6 3.6 3.1 8.2

Labour Regulation

7.9 21.9 7.4 10.6 13.8 10.6 2.8 10.3 12.0

Access to Finance

212  Handbook on East Asian economic integration

diversity of the countries surveyed, it is not surprising to find that the severity of the different types of business impediments varies across countries. For Myanmar, power outages are a severe business impediment – some 98% of the manufacturing firms surveyed indicated they experienced this problem. For Thailand, inadequate telecommunication is the most important problem based on the highest percentage of responses indicating this to be an obstacle to their operations. How are these business impediment factors related to economic integration? One approach is to examine the determinants of exporting using factors related to the business impediments as explanatory variables in a probit regression. The dependent variable is a binary variable indicating whether a firm is a direct exporter or not. Two types of explanatory variables are used in the regression model, namely, firm characteristic and business impediment. More formally, the propensity to export (EXP) for firm i can be estimated using the following specification:

EXPi = β0 + FIRMiʹ β1 + IMPEDEiʹ β2 + εi where FIRM is the vector of firm characteristics, IMPEDE is the vector of business impediments, and ε is the error term. The firm characteristic variables that are used as explanatory variables in the regression model include the number of workers (as a proxy for firm size), a foreign ownership dummy, and the age of firm. The explanatory variables that represent business impediment include power outage, insufficient water supply, telecommunications as an obstacle, access to finance, customs and trade regulations, business licencing and permits, tax rates, tax administration, labour regulations, political instability, courts, corruption, an inadequately educated workforce, and access to land. The business impediment variables are constructed by creating binary variables from Likertscaled variables. The Likert scale covers five points: (i) no obstacle, (ii) minor obstacle, (iii) moderate obstacle, (iv) major obstacle, and (v) very severe obstacle. The binary variable is coded with the value 1 for responses in categories (iv) and (v) of the Likert scale; otherwise the value is zero. The results of the estimation are summarised in Table 10.4. Overall, exporting is positively and significantly correlated with firm size (number of workers), foreign equity participation (10% or more), and the age of the firm. This is consistent with findings in the literature (Greenaway and Kneller, 2007; Wagner, 2007). In terms of business impediments, infrastructure inadequacy is surprisingly not an impediment to exporting for most countries in the region. Taking the region as a whole, factors that are likely to impede exporting include problems related to access to finance, labour regulations, corruption and access to land. As the level of development varies across countries in Southeast Asia, there are variations across these countries in terms of business impediments that are likely to affect exporting. Clearly, larger datasets are needed for comparative studies on business impediments and economic integration in Southeast Asia. The microdata dataset from the World Bank Enterprise Surveys is a useful starting point, despite its limitations. There are alternative datasets from business surveys that provide additional insights into business impediments in the region. One such dataset comes from the Survey on Trade and Investment Facilitation conducted in 2015 by the Japan Business Council (JBC).6 Nine Southeast Asian countries are included in the survey. Findings from the survey mirror some of the business impediments identified in the World

213

0.000568*** (0.00013)  1.298*** (0.155)  0.0226*** (0.0058)  0.194 (0.144) –0.142 (0.65) –0.039 (0.286) –0.187 (0.227)  0.25 (0.267) –0.405 (0.318)  0.203 (0.33) –0.458 (0.333)  0.0487 (0.278)  0.442** (0.224)  0.462 (0.348) –0.0537 (0.257) –0.29 (0.318) –0.565* (0.298) –1.841*** (0.168) 722

Indonesia

–1.347***   (0.52) 53

–10.56   (1,038)

12.05   (1,038)

 0.00227   (0.00194)  0.671   (0.663) –0.0138   (0.0335) –0.298   (0.593)  1.381**   (0.679) –0.799   (1,295)  7.123   (1,081)

Lao PDR

Source: Author.

Note: Standard errors in parentheses; *** p