East Asian countries often apply lower tariffs than they are ‘allowed’ to under MFN rules when trading with each other. They do not extend these concessions to the rest of the world. The result is striking – a de facto PTA (preferential trade area) in East Asia.
This finding sheds new light on East Asian regionalism. On paper, regional integration is proceeding apace. But there are concerns about the real depth and stability of PTAs in the region. Skeptical observers argue that intensive treaty-making in the region overstates Asian countries’ commitment to liberalisation and integration. Noting the weaknesses of many of the regional PTAs – for example, Baldwin (2007) finds that firms in ASEAN countries use the ASEAN Free Trade Area for less than three per cent of their total trade – critics contend that real integration remains shallow and disjointed. Moreover, PTAs have proliferated during a time of rapid growth in the region. It is unclear whether they are underpinned by firm political commitments that can endure bad times as well.
How confident, then, can we be about East Asian economic integration? Looking at applied tariffs offers ground for cautious optimism. Three patterns emerge.
First, East Asian countries are much more likely to have gaps between the tariff ceilings agreed to with their partner nations, and the actual rates implemented (binding overhang) in relationships with other East Asian countries than with the rest of the world. For non-agricultural goods, the binding overhang is never larger outside the region than within, and for agriculture products only Cambodia, Myanmar, and Malaysia grant more preferences to countries outside the region than within.
Second, East Asian countries exhibit no binding overhang under PTAs both in and out of the region. Only China and Japan set applied tariff rates that do not match the preferential bound rates, but these exceed the legal ceiling created by the PTAs. However, these violations (perhaps attributable to anti-dumping duties or similar provisions) are smaller in the region than outside it, particularly for China.
Third, East Asian countries exhibit virtually no binding overhang under MFN rates outside the region, but significant binding overhang within. The only exception is Japan, which has applied tariffs at about 60 per cent of the MFN rate outside the region for non-agricultural goods; this is, however, still six times larger than the within-region rate 9 per cent.
How can we explain this de facto PTA, and what does it tell us about regional integration in Asia? Several competing explanations are possible, each with different implications for regional integration.
First, it could be that these tariff concessions are negotiated between countries as PTAs, but not codified in international law because countries wish to keep them informal. However, interviews with trade diplomats from the region do not reveal diplomatic efforts to negotiate such agreements. Moreover, econometric analysis reveals that the same factors that lead to PTA formation do not predict levels of binding overhang. There is thus no evidence for a ‘secret’ PTA in East Asia.
A second explanation could be that binding overhang patterns are driven by the larger geopolitics of the region, with countries using applied tariffs as carrots and sticks in larger diplomatic bargains. In East Asia, China’s series of PTAs with southeast Asian countries prompted Japan, worried of being marginalised, to pen its own deals with the same states. Again, the empirical evidence points against this idea. China, which joined the WTO quite late and faced a highly demanding accession process, likely has little scope under its WTO tariffs to grant further concessions. Moreover, Southeast Asian countries grant about the same concessions to Japan as they do to Korea, even though the latter has not sought the same kind of regional leadership. Japan actually grants larger concessions to Hong Kong and Taiwan—in both absolute and relative terms – than the PRC does, despite those economies’ deep integration with the mainland.
Turning from diplomatic explanations to economic ones, a third possibility is that countries use binding overhang to give themselves extra flexibility over tariff policy. Uncertainty over future economic conditions (e.g. exchange rates, current account balances, the needs of domestic firms) makes it useful to be able to adjust tariffs. While trade agreements set ceilings over which tariffs may not be raised without incurring retaliation, rates may be adjusted under this maximum.
If this is true, the implication would be negative for regional integration, because it would mean that countries in East Asia are more uncertain about their trade with each other than with the rest of the world. Strikingly, however, this does not seem to be the case. The statistical analysis reveals that measurements of uncertainty are positively related to binding overhang in general, but not for trade between East Asian countries.
What, then, can explain the de facto PTA in East Asia, if not the diplomacy, geopolitics, or the desire for flexibility? The answer is rooted in the regional structure of the East Asian economy. Following the decline of Japanese manufacturing competitiveness in the mid- to late-1980s, Japanese companies increasingly relocated production to lower-cost countries. Other leading Asian countries soon followed suit. The result today is a ‘factory Asia’ with manufacturing disaggregated across the region. It is not uncommon for components to be produced in several countries and assembled in yet another before final export to Japan, Europe, or North America. Indeed, intra-East Asia exports of machinery parts and components grew 452 per cent from 1990 to 2003, accounting for more than half of intraregional export growth (Kimura, 2006). Because this production model depends on moving parts between various production sites, low tariff rates are essential. Indeed, econometric analysis shows a clear link between the component trade and the de facto PTA. Component products are associated with lower applied tariffs within the region, but not outside of it.
The results, then, support a ‘bottom up’ view of East Asian regionalism. On the one hand, this is an encouraging finding because it shows that the political institutions that govern economic integration remain sitting on a firm foundation of economic interests. On the other hand, the results also reinforce Baldwin’s worry that ‘no one is in charge’ of one of the most important economic governance questions on the planet.
Thomas Hale is a PhD Candidate in the Department of Politics at Princeton University, and a Visiting Fellow in Global Governance at the London School of Economics.