The Rush to Bilateral Pacts: Throttling Trade While Trying to Promote It

Rhetoric to the contrary, the latest move by ASEAN’s economic ministers to speed up trade among its 10 members may well be nothing more than one more strand in a confused noodle bowl of East Asian trade pacts with the potential to strangle rather than liberate regional trade.

At stake is a global trading regime that, virtually since World War II, has contributed more to Asian prosperity than any other single factor as country after country across the region switched to export-led growth to develop their economies. Starting with Japan, then Taiwan and Korea, then Singapore and Malaysia, it was trade that created Asia’s tiger economies. Bilateral trading agreements are now putting that system in danger.

ASEAN’s goal, according to the 21 August decision by the ministers, is to fully free up intra-regional trade by 2015 rather than 2020 in the region’s attempts to compete with China and India as huge single—or seemingly single—markets. At the same time, other regional pacts under negotiation involve China, Japan and Korea and perhaps Australia/New Zealand. Together with the ASEAN one, in theory these would create a grouping to equal NAFTA, if not the EU with its common external tariff as well as free trade within its borders.

That is a laudable goal even if numerous question marks remain over its practicality given that one member, Burma, has an economy scarcely any more market-driven than that of North Korea. In addition, several other members have traditions of protecting specific industries regardless of the pacts, so that cutting tariffs all the way to zero is of limited use if a wide range of non-tariff barriers remain in place.

In theory at least, ASEAN, with about 8 percent of the world’s population and a combined Gross Domestic Product of more than $700 billion, has the potential to be a meaningful free trade area. But it owes its future to remaining open to the outside world given the role that trade plays in the economies of some members, notably Singapore, Malaysia and Thailand.

In principle, the group can also negotiate trade deals as a single entity with East Asia’s big players, Japan, China and South Korea. Deals are already on the drawing board with these three and even India, although it lags far behind East Asia in liberalizing trade. ASEAN’s free trade progress would be more convincing if individual members of the group were not so busy negotiating their own bilateral deals with others countries within Asia and beyond.

Instead of fostering free trade, these agreements are setting up intense competition for preferential access. For example, Singapore’s bilateral agreement with the U.S. gives it an edge over Malaysia and Thailand in the U.S. market, so K.L. is now considering its own pact with Washington, presumably to get its own back. Thailand’s Prime Minister Thaksin Shinawatra is also pushing one with the U.S. but it has hit opposition from political as well as commercial interests.

Meanwhile, the global system based on the World Trade Organization is being neglected. Asian leaders have paid lip service to the importance of the Doha Round but few have done much to help resolve the current crisis or influence India and Brazil, which purport to represent the interests of developing countries but themselves are notorious for the kind of levels of protection that East Asia abandoned as counter-productive many years ago.

Asia meanwhile is in danger of tying its trade into knots thanks to politically driven decisions that demonstrate a lack of understanding of how cross-border manufacturing and trading systems—most of which are based in Asia but have global markets—actually work. It looks good for prime ministers and economy and trade underlings to wave pieces of paper entitled “free trade in our time” but the reality is very different.

To trade economists like Jagdish Bhagwati or trade practitioners like Victor Fung of Hong Kong’s globe-spanning manufacturing logistics group Li & Fung, this proliferation of so-called FTAs looks like a recipe for confusion that will raise costs, divert trade and generally interrupt the manufacturing systems based on international specialization and computerization that have emerged over the past two decades. These are the systems whereby garments made in Bangladesh or electronics assembled in China have components from half a dozen locations and where processes take place in several countries. To work, these systems need standardized tariffs and rules of origin.

The pace of confusion through FTAs is speeding up. The 21-member Asian Asia Pacific Economic Cooperation group, which is supposed to foster free trade though unilateral and non-discriminatory cuts in tariffs and other barriers, now boasts no less than 21 separate so-called FTAs between members. Another 17 are at various stages of discussion.

These claim to foster free trade by lowering barriers faster than under the WTO’s now-stalled WTO Doha Development Round. In practice they are mostly preferential arrangements which discriminate against others. Thus for example if Mexico signs an FTA with an individual member of ASEAN, other ASEAN members will be disadvantaged and may therefore need to seek their own bilateral deal with Mexico. This is not about creating trade but diverting it from one supplier to another.

These bilaterals have thus become a self-reinforcing phenomenon, in effect a beggar-thy-neighbor competition not very different from the tariff wars of the past which the WTO was created to try to avoid. The worst culprits are those previously assumed to be staunchest defenders of multilateralism as represented by the WTO: the U.S. and Singapore. Not far behind in the rush to sign these deals are China and Australia. Everyone has a separate motive but these are mostly reflective of a narrow industry or political interest, not of freer trade as a whole.

It is generally agreed that big countries with clout do better than small ones when negotiating bilaterals. Some FTA provisions go well beyond the WTO, particularly on Intellectual Property Rights. But in some cases at least, these appear designed to create new benchmarks easily agreed by some small countries with little at stake but which will make extension to the WTO more difficult because they set precedents that others will not accept.

In other cases FTAs cover tariffs but not much else, or are actually inconsistent with existing obligations under the WTO—as is the case with Hong Kong’s Closer Economic Partnership Arrangement (CEPA) with China.

ASEAN’s trade ministers acknowledge the benefits of the WTO because it can deliver genuinely freer trade to small countries that lacked the clout to negotiate bilaterally. Yet they feel compelled to spend huge amounts of time discussing FTAs, whether for show or for diplomatic reasons.

Australia for example, once a fierce opponent of bilaterals, was so determined to please the U.S. that for political reasons it agreed to an FTA that still left its beef and sugar exports subject to strict quotas. Australian farmers got little from a preferential deal which upset Australia’s partners in the Cairns Group of farm exporters. Indeed, the fact that a little progress has been made with agriculture under FTAs has probably reduced pressure from countries such as Australia, Thailand and Chile (all APEC members and FTA enthusiasts) for WTO-driven farm trade reform.

Perhaps the worst aspect of proliferation of bilateral agreements is not the confusion of tariff rates it creates but the absence of common rules or origin or dispute settlement systems—all important components of the WTO system.

For example according to a recent study for the APEC Business Advisory Council conducted by the University of Southern California’s business school there are separate rules of origin for each of the seven FTAs that Singapore, supposedly a bastion of trade sense, has signed.

The only conclusion one can draw is that the deals were signed for political reasons or for access to a specific market or industry, not for the benefit of freer trade as a whole. Indeed, the ability of a few U.S. industries, notably electronics, to maneuver their government into special industry deals with supplying countries has reduced big business pressure for broad-based liberalization.

The EU currently has a moratorium on FTAs, once a favored way of helping ex-colonies. But the moratorium is unlikely to last unless Doha is revived and Asia's economies end their headlong rush for bilaterals. If the EU joins the bilaterals race, the confusion will multiply.

Bilateral pacts are a menace. Regional FTAs can work to liberalize trade but only if they are harmonized to eliminate the multiple rules of origin, tariff levels and dispute settlement systems.

Some noises in this direction have been made by the Asian Development Bank and the APEC secretariat. But there is scant sign yet that governments are putting practical issues and broad liberalization ahead of politics, public relations and special interests.