Asia’s Free Trade Agreements: How is Business Responding?

Asia’s Free Trade Agreements

Author(s): Kaway Masahiro and Ganeshan Wignaraja (eds)

ISBN: 978-1-84980-386-1

Publisher: Edward Elgar

Year: 2011

Price: $125.00

Reviewed by Benoit Rousseau Leduc, Senior Economist, Government of Canada, and part-time lecturer, University of Ottawa School of Political Studies.

By 2012, Asian countries had signed a total of sixty free trade agreements (FTAs), a situation that risks creating a disconcerting maze of paperwork for businesses. Some argue that overlapping trade rules undermine the growth of international trade. Many think that it increases costs for businesses rather than encouraging trade. But is it the case?

This joint study by the Asian Development Bank (ADB) and the ADB Institute answers this question pragmatically with a series of surveys done across Asia, and published as a series of country studies that explore policy implications for the region. The publication is “the first comprehensive survey of the business impacts of East Asian FTAs in multiple countries” and, in fact, is it likely one of the first multi-country surveys on the impact of trade agreements on businesses found anywhere.

Although each national survey was done with a small sample, combined they provide a fairly consistent cross-country set of responses from businesses in China, Japan, Korea, Singapore, Thailand and the Philippines. The authors estimate that as many as 28 percent of all surveyed firms use FTAs. Survey results suggest fairly consistently that the percentage of firms that plans to eventually use FTAs is twice as high as current users, in all the country studies.

Inevitably, the percentage of firms that use FTAs drops for Small and Medium Enterprises (SMEs):  In Thailand and Singapore, 17 and 18 percent of SMEs used FTAs, respectively. In Japan, for all firms surveyed in a separate government survey completed in 2007, only eight percent of SMEs used FTAs. The studies thus point to some issues that need to be addressed to facilitate small-firm participation in international trade.

Having as many as sixty FTAs across Asia is likely to discourage businesses from taking advantage of their preferential clauses. This is the main criticism spelled out by the observation that governments have created a spaghetti bowl or a noodle bowl (depending on regional culinary tastes) of regulations around trade. Understanding how this situation came about helps highlight the value of business surveys in the current international context.

The World Trade Organization (WTO) was set up in 1995 to re-instill life to global trade after close to 50 years of growth averaging seven percent yearly under the GATT.  It would achieve this goal with various agreements aimed at reducing the prevalence of discretionary policies akin to protectionism, by forbidding domestic rules of origins and export subsidies while providing a more stringent judiciary institution to settle disputes.

One of the main loopholes with the WTO agreements, however, is the inability for WTO member countries to challenge the content of bilateral or regional free trade agreements, as long as they cover “substantially” all traded goods. In practice, signatories to a free trade agreement have been unrestrained in their ability to set import quotas and “regional” content requirements in any way they chose. This has provided, and continues to provide governments a chance to re-introduce a degree of protection, albeit indirectly and on a regional basis.

As such, the debate on the spaghetti bowl or the noodle bowl of FTAs is fundamentally a debate about the effectiveness of the WTO and the FTAs themselves. There are multiple types of rules found in regional trade agreements. such as rules of origins that, when piled up across hundreds of different agreements worldwide can contribute to impede the functioning of the world trading systems. An additional example identified in the publication is that most Asian FTAs require direct shipping, which is likely to conflict with the complex supply chain and logistics requirements of large firms.  For FTA member countries, the rule of the game is freer trade within the zone and better trade management outside the zone.

In part, the reduced ability to offer protection and subsidies to domestic businesses, under the WTO, has created an incentive for sovereign governments to re-establish protection through regional rules. A number of government representatives, like Brazil’s first female President Dilma Rousseff, consider that “legitimate defense measures” should not be confused with protectionism, as she made clear to the UN General Assembly in 2012, echoing a number of development economists.

No doubt, maintaining a degree of protection can be justified in economic theory. Shielding smaller firms from unlimited global competition can be justified in some circumstances. With this in mind, imposing separate rules of origins in each trade agreement opens small local firms to competition in a gradual manner. In turn, this gradualist approach makes it easier to prevent fears of de-industrialization or fears that some countries will fall indefinitely in the “periphery.” Having multiple agreements can serve as a buffer, encouraging further trade integration at a modest speed. After all, diplomats gain in being modest.

The question, then, is whether countries really need to adopt tens of such agreements to manage trade more freely, or whether this is the bureaucratic kingdom rising again.

This is where the ADB studies are useful, and this is also where the story gets murkier. Having different rules of origins for each agreement makes it more difficult to take advantage of FTAs, because identifying the origins of part or components is not always easy, and obtaining a certificate of origins can be time consuming (p. 120). The ADB country studies are a useful reminder that small firms do not know whether their articles are eligible for FTAs because their trade volumes are low, and they have no real incentive to invest time to find out (p. 95). With more agreements, the investment in time required to take advantage of FTAs is higher.

So, while having multiple agreements is meant to gradually expose SMEs to global trade, in some sort of catch-22, it also increases information asymmetries for SMEs.  Generally speaking, large firms that account for a majority of trade (in value) would be the most inclined to invest in human resources to obtain information related to rules of origins. As the authors point out, “as more FTAs are concluded and the complexity of the Asian noodle bowl increases, the negative business impact is likely to intensify” (p. 262).

In line with these observations, one of the most important findings of the ADB country studies is how important access to information is to smaller firms with low trade volume. Survey participants in the majority of countries indicate that governments should make sure that information on FTAs should be more easily accessible for small firms (through SME training programs, for instance), and that rules of origins should remain simple and consistent across FTAs. In the two countries with a larger sample of SMEs, the Philippines (64 SMEs) and Thailand (107 SMEs), only 24 percent of SME respondents considered themselves knowledgeable about FTAs in the latter case, and 90 percent of surveyed firms mentioned information access as an issue in the former case. These numbers are telling.

Overall, this publication provides an excellent approach to FTA assessment that should be more widely pursued by other countries (only in Japan do government agencies appear to conduct a regular survey of the impact of FTAs on businesses).

Beyond the current analysis provided in the ADB studies, there would be value in doing industry-by-industry analyses to better understand the impact of rules of origins and non-tariff barriers on specific industries, as one would expect to find costlier barriers in highly competitive high-technology areas.