1996-33

November 8, 1996

Pacific Basin Notes: Trade Liberalization in the Pacific Basin

Ramon Moreno


This November, the 18 members of the Asia Pacific Economic Cooperation Forum (APEC)–which includes the U.S.–will hold a summit in Subic Bay, the Philippines, to approve individual and collective plans to liberalize trade and investment. APEC is but one of several organizations focused on trade issues in the Pacific Basin.

The U.S. has considerable interest in transpacific trade. In 1995, U.S. trade with East Asia, Australia, and New Zealand totaled $469 billion, well above the $280 billion in trade with Europe. East Asian economies sell more to the U.S. than to any other export destination (one notable exception is Indonesia, which exports large quantities of oil to Japan); at the same time, nine of the top twenty exports markets for the U.S. are in East Asia. As this region includes some of the fastest growing economies in the world, trade in the Pacific is likely to grow.

One area of concern is whether a free trade environment can be further developed and maintained. In recent years, there has been some uncertainty on this score, as trade disputes on issues such as the openness of Asian markets and software piracy have led sometimes to threats of sanctions and counterthreats of retaliation. In addition, there has been some concern that regional groups would lead to the formation of trade blocs that would discourage transpacific trade or trade with other regions. To shed some light on these issues, this Economic Letter reviews the various paths to multilateral trade liberalization in the Pacific Basin and discusses their implications.

Trade liberalization

While most economists agree that free trade is desirable, the general public in many countries does not always share this view. Economists believe that free trade is beneficial because it enables consumers and firms to buy from the most efficient producers. In addition, modern growth theory suggests that international trade can lead to faster growth by providing access to larger markets and superior management practices and technology. While economic theory also suggests that countries may sometimes benefit from adopting protectionist policies, this will be the case only if: (i) a country is large enough that its application of a tariff reduces the world’s price for the product, or (ii) there are economies of scale in producing the product, or (iii) a country’s producers can extract monopoly profits from such policies. In practice, however–that is, in the current trading environment–countries are unlikely to benefit from protectionism.

For example, many countries have imposed tariffs on imported goods, benefiting their own producers in the short run. But over time, production in protected sectors in many of these countries has stagnated because of inefficiency and lack of competition. In addition, countries with high trade barriers have faced threats of retaliation from their trading partners. These effects have encouraged many countries to liberalize their trade policies, either unilaterally or through negotiations.

Negotiations or discussions affecting Pacific Basin trade have taken place globally under the World Trade Organization (WTO) and its predecessor, the General Agreement on Tariffs and Trade (GATT), and regionally under APEC and the ASEAN Free Trade Area (AFTA)– ASEAN refers to the Association of Southeast Asian Nations.

Global trade liberalization

WTO/GATT has been the cornerstone of trade liberalization since World War II. Its objective is nondiscrimination in trade, which involves: (i) not giving any trading partner better treatment than others, and (ii) lowering trade barriers to the point where foreign goods are treated the same as domestic goods. The first principle is known as “most favored nation” or MFN (because all trading partners receive the same treatment as the “most favored” trading partner) and the second is known as “national treatment” (of foreign goods).

The latest (Uruguay) round of global trade negotiations significantly liberalized Pacific Basin trade. Industrial countries reduced their average (import-weighted) tariff rates on industrial products by 40% and increased the share of duty-free imports from 20% to 43%. Developing countries explicitly recognized unilateral tariff reductions as commitments under WTO/GATT (tariff bindings). The share of tariff bindings increased from 13% to 61% of imports by developing countries and from 74% to 96% of imports by (formerly socialist) transition economies.

Certain sectors that had been kept out of postwar negotiations on trade liberalization are now included, such as trade in agriculture, textiles and clothing, which is now to be liberalized over periods ranging from six to ten years , and trade in services and protection of intellectual property (to prevent software piracy, for example). Furthermore, certain restrictions on foreign investment that affect trade (such as local content or trade-balancing requirements) are to be phased out over a maximum of seven years.

Despite the gains made through global negotiations, trade in the Pacific Basin is still not entirely free. With the striking exceptions of Hong Kong and Singapore, where trade barriers are almost nil, trade barriers on goods in many Asian economies remain significant and are higher than in industrial countries. Also, many new sectors, such as services, are undergoing liberalization only gradually. Given the economic success of Asian economies, the remaining trade barriers are a source of ongoing trade friction. Global trade negotiations currently focus on implementing Uruguay round agreements and are not likely to produce major trade liberalization initiatives in the near future. Partly for this reason, regional groups, such as APEC and AFTA have gained momentum in coordinating efforts at further trade liberalization.

APEC

APEC’s 18 members comprise both developed and emerging market economies on both sides of the Pacific (U.S., Canada, Australia, New Zealand, Japan, South Korea, China, Hong Kong, Taiwan, Papua New Guinea, Mexico, Chile, and the ASEAN members excepting Vietnam). In 1994, APEC countries’ merchandise exports totaled US$ 1.8 trillion (about 44% of world trade), of which about 74% was sold within APEC.

APEC members have agreed to implement free and open trade and investment in the Asia-Pacific region by the year 2020 (2010 for industrialized member countries). Last year, several countries announced initial liberalization measures or “down payments” beyond their previous commitments. For example, China pledged to reduce tariffs on more than 4,000 tariff lines, leading to average tariff reductions of 30%. Indonesia intends to reduce tariffs to 10% (5% for AFTA members) by 2003. Australia has opened its telecommunications sector completely, while Canada has eliminated the remaining restrictions on financial services. A high-level business advisory council (made up of three senior executives from each APEC member country) also has been established, and extensive input from businesspeople is expected in the deliberations at the November summit.

Two features of APEC are worth highlighting. First, it emphasizes “open regionalism,” which implies that any trade liberalization measures the group adopts would apply to APEC and non-APEC members alike. This is in contrast to free trade areas like NAFTA or AFTA, where trade liberalization measures apply only to members.

Second, APEC emphasizes unilateral trade liberalization, which means that each country puts forward a trade liberalization schedule that it is comfortable with. This is in contrast to formal trade negotiations, in which trade liberalization schedules are the outcome of often protracted bargaining. There is some debate on how much unilateral measures can achieve. Formal negotiations involve reciprocity (the quality of the liberalization offers a country makes depends on the offers made by trading partners), and as in any bargaining process, they can lead to significant liberalization on all sides. However, they can also produce stalemates if one country feels it is offering much more than the others or if another country feels domestic conditions do not permit as much liberalization as is being demanded by its trading partners. Since the APEC approach is voluntary, it is less likely to lead to stalemates, but it may involve less liberalization than a negotiated outcome. Perhaps to ensure visible progress, some APEC measures appear designed to encourage more liberalization without formal negotiations. The “down payments” cited earlier signal the commitment to trade liberalization of some members and encourage others to follow suit. APEC has also emphasized “peer pressure.” For example, individual action plans for liberalization are being discussed by APEC. This may encourage those whose liberalization plans are relatively modest to enhance them.

AFTA

AFTA, which was established in 1993, is currently made up of the seven members of ASEAN (Brunei, Indonesia, Malaysia, Philippines, Singapore, Thailand, and Vietnam), and is expected to add three members –Laos, Cambodia, and Myanmar–by the end of the century. AFTA countries have a population of more than 400 million people, larger than the European Union (372 million) or NAFTA (387 million). AFTA trade totals $250 billion, about 20% of which is within the region.

Like other free trade areas, and in contrast to APEC, AFTA intends to lower trade barriers among its members while maintaining trade barriers for nonmembers at levels agreed to under the Uruguay round. Tariffs applied to intra-AFTA trade are to fall to 0-5% by 2003. (This is an acceleration over the original target date of 2008, and a further acceleration to the year 2000 has been discussed.) With the exception of Singapore, this is significantly lower than the MFN tariff rates that apply to non-AFTA members. For example, tariff rate commitments under the Uruguay-round averaged 37% for Indonesia, 22.5% for the Philippines, and 28% for Thailand.

Apart from implementing tariff reductions, AFTA members are discussing a wide range of liberalization measures, including: (i) the elimination of non-tariff barriers between member countries, (ii) trade facilitation measures (for example, harmonizing tariff classifications), (iii) mutual recognition of product standards among AFTA members and the revision of these standards to enhance transparency, and (iv) the establishment of an ASEAN investment region that will be attractive to foreign direct investment. Negotiations on market access in the services sector also are to be completed by the end of 1998 (or possibly earlier in financial services, tourism, and telecommunications).

As noted earlier, AFTA members will liberalize trade with each other, and not (so far) with the rest of the world. This will increase trade among AFTA members, but it will divert trade away from non-AFTA members which may be more efficient producers. While AFTA on balance will benefit its members, the costs of trade diversion are likely to be significant, and AFTA members would be better off liberalizing globally.

Implications

Regional trade initiatives in the Pacific are likely to lead to significant trade liberalization beyond the commitments already made in global trade negotiations. Are these regional initiatives likely to conflict with global inititatives and the WTO? In particular, will they lead to the formation of trade blocs, or to significant and permanent trade diversion?

In the case of APEC, the answer is probably not. APEC spans a huge geographic area and reflects the interests of both developed and less developed economies, as well as of Asian and Western member countries. The very diversity of this group tends to discourage, rather than encourage, trade bloc formation. This can be seen from APEC’s emphasis on “open regionalism” and from the fact that APEC is not set up as a free trade area.

The forces shaping AFTA are somewhat different. AFTA members have both economic and political incentives to achieve closer integration. Also, liberalization among AFTA members may be easier to negotiate at this time because these countries currently trade much more with countries outside AFTA than with each other, and producers from AFTA countries are seen as less of a competitive threat than, say, producers from the U.S. or Japan. Thus, the perceived short-run costs of liberalization within AFTA for domestic producers may be relatively small.

AFTA nevertheless has strong incentives to liberalize trade globally as well as within the region, as the gains from such liberalization are large. AFTA will also continue to rely heavily on outside markets (such as NAFTA and the European Union) to support rapid growth, and opening the AFTA market to others is the best way to minimize trade frictions. In line with this, one AFTA member country has proposed that AFTA extend free trade benefits globally rather than just to AFTA members.

Even if this proposal is not adopted, APEC’s timetable indicates that the less open Asian markets, including those within AFTA, will free their markets to global foreign competition not later than 2020. Whether significant global trade liberalization beyond Uruguay round commitments can be achieved much earlier will depend in part on the success of APEC’s unilateral approach to liberalization.

Ramon Moreno
Senior Economist

Pacific Basin Notes are published occasionally by the Center for Pacific Basin Studies. Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Sam Zuckerman and Anita Todd. Permission to reprint must be obtained in writing.

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