In President Obama’s landmark speech in Canberra last month, an over-riding theme was that the United States welcomes China’s rise so long as it plays by the global rules.

Yet those rules are dynamic, and there is a need to have China involved in setting them given the scale of China and its importance to the regional and global economy, as well as to global security.

China needs to help set the rules and agree to them so that it has buy-in — not have those rules created around it. The latter scenario may have been possible a decade ago, but not now. It is crucial, then, that a major trade policy initiative in the Asia Pacific, such as the Trans-Pacific Partnership (TPP), include China, else it will become one of the set of rules created around China, constraining not promoting one of the main trans-Pacific economic relationships.

As the major growth engine of the global economy, China’s exclusion from the TPP raises questions about the TPP’s likely success. The TPP’s purpose is to weld the region together and lock in growth of trans-Pacific economic relationships. The central strategic challenge for the TPP, therefore, relates to China’s membership.

But can China join? And should it join? The biggest risk of the TPP is political: that it might divide the region strategically between its members and the rest, with China being on the outside. The TPP has been supported by two prominent US trade policy figures, Fred Bergsten and Jeffrey Schott of the Petersen Institute of International Economics, as a way, they say, for the US to engage in East Asia as ‘China propelled the advance of Asian regionalism’. ‘These countries are well on the way toward creating an Asian bloc, a development that could “draw a line down the Pacific” by discriminating against [the US]’, they add.

Yet if the TPP proceeds on terms set by the US, it would be very difficult for China to join, and the TPP itself, according to Christopher Findlay, may ‘drive the region apart with systematic exclusion of non-members, including China’. This wedge through the middle of the Pacific will be political as well as economic. China would have to join the TPP on US terms as the TPP has now become a creature fashioned largely by Washington. Bergsten and Schott give priority to Japanese and Korean membership, envisioning the use of those strengthened alliance relationships to balance the influence of China.

The difficulty for China in joining the TPP stems from aiming for an agreement designed by, and for, countries able to digest US-moulded intellectual property rights (IPR), labour and environment standards, and other commercial settings. Many will be watching the conditions which are defined for Vietnam’s entry, the least developed country in the current TPP line-up. If the standards of entry for Vietnam are appropriate, there will need to be long phase-in periods to meet them. The benefits of US market access may dominate potential costs for Vietnam; this is not necessarily the case with China.

The US has been pushing for more regulatory discipline for state-owned enterprises (SOEs) in the negotiations around the TPP and, in particular, competitive neutrality between SOEs and private enterprises in member economies. Vietnam and Malaysia are the two economies currently involved in the TPP negotiations in which SOEs are prominent or dominant. Reform of SOEs and the privatisation process is a deeply domestic issue that will not be resolved quickly in China.

The WTO accession experience shows that locking China into reforms can only occur, especially now given its size, when it is committed to using external institutions as tools in its own interest to open up and reform its domestic economy. A TPP agenda and negotiations in which the US effectively declares itself the gatekeeper is likely to make it extremely difficult for China to commit to the TPP and join.

If China is ever to accede to the TPP, the agreement would need to be designed with open accession terms that allow China to meet its own interests. It is not that China should not be bound by TPP rules: it is that China would need to be persuaded to bind itself, consistently with its own reform agenda, in the areas covered by the TPP and on its own terms. If the TPP ends up being a set of related bilateral agreements (a bowl of noodles within a bowl of noodles), for which the US has thus far revealed a preference (see Claude Barfield), China will have to negotiate bilaterally with the US in order to join a broader TPP — no matter what the wishes of other members; and any agreement would require separate approval by the United States Congress. That is rightly viewed as a set-up.

Expansion of membership and creation of an inclusive agreement was the original aim of the TPP, and that is where its potential economic benefits lie. But easy expansion of membership is perhaps the biggest challenge. The risk is that, once an agreement is negotiated in whatever shape or form, sign-on by non-members in the region (an explicit goal) will be difficult with extra requirements for new members and individual-member veto over new membership, notably, by the US. If the agreement requires consensus from members (or incumbents) on new entrants rather than the meeting of carefully-constructed and transparent rules of entry, effective veto-power on new membership will be built into the arrangement.

A transparent and established process with clear criteria in application for membership is needed for two reasons. First, it will give members less discretion over the conditionality they can add to individual members for accession. Second, a membership bid would not have to be triggered by an invitation from members — membership that is contingent on invitation would create maximum discretion for incumbents and is not congenial to expanding membership. Automatic sign-on is not constitutionally easy for the US given that Congress will have to approve each new member separately. But that was exactly the original idea of the TPP’s predecessor, the P3 and P4 agreements with Chile, Brunei, New Zealand and Singapore.

Perhaps China should announce it wants to join negotiations right away, not to play spoiler, but so that it can engage directly in defining what the rules for much of Asia Pacific trade should be. That would be the surest strategy in ensuring that the TPP was open and dynamic, not static and exclusive. Otherwise there are likely to be one of two broad outcomes from the TPP initiative. The first is that the US succeeds quickly, as it has signalled it wants to, in locking the other 8 pliant negotiators into an early deal that is full of exceptions and has limited or negative liberalising effect but the exclusionary features of which maintain symbolic pressure on non-members like China. This might be called the just-another-trivial-FTA-outcome. The second is that the negotiators hold to more rigorous liberalising targets that will take much longer to negotiate. That is likely to entrench Chinese exclusion more deeply. Either way there is no indication that the intention is to draw China into the process. And that will not only be to China’s cost, but also to cost of China’s partners in the region and global welfare.

Shiro Armstrong is a research fellow at the Crawford School of Economics and Government at the Australian National University and is co-editor of the East Asia Forum. He is also editor of the new book The Politics and the Economics of Integration in Asia and the Pacific (Routledge, 2011). A longer version of this essay can be found here as EABER Working Paper No. 71, 9 December 2011.

1. U.S. trade policy in Asia: Going for the Trans-Pacific Partnership?
2. The Trans-Pacific Partnership
3. Trans-Pacific Partnership update

East Asia’s pursuit of policy strategies of openness to trade and investment have resulted in its being economically one of the world’s most internationally-integrated regions — both intraregionally and towards the rest of the world.

South Asia, on the other hand, is one of the world’s least integrated regions and, measured in terms of intraregional trade as a share of total trade, is the region with the lowest integration globally. Intraregional trade in South Asia was 3.5 per cent of total South Asian trade in 2009, up from a low of 2 per cent in 1967 but significantly lower than the 19 per cent in 1948. Intraregional trade in East Asia was 40 per cent in 2009.

The differences in regional economic integration mean that the effect of political tensions between countries on trade is more pronounced for South Asia than it is in East Asia.

Trading partnerships between open economies are determined by comparative advantage and market forces, and the advantages of proximity are also important. A region with low economic integration is likely to be losing out on the benefits that flow from trade due to economic proximity. But additionally, because political interactions tend to occur much more frequently between neighbours, higher economic interdependence can ameliorate the adverse effects of political tensions that may arise between neighbouring countries.

Political tensions can, of course, act as a barrier to economic integration; and lack of economic integration and interdependence can constrain improving political relations. The relationship between India and Pakistan is an obvious example of the latter. The East Asian case is very different, where the region’s economies enjoy high levels of trade and economic integration, despite unresolved historical issues and long-standing political mistrust in some of the region’s bilateral relationships.

Political tensions between Japan and China from 2001 to 2006, for example, rose to a level where leadership visits between the two countries were suspended and there were large protests in China against Japan and boycotts aimed at Japanese goods. Yet these political tensions did not derail economic relations, nor significantly affect the continued growth of Sino-Japanese trade. The start of this period of political tension coincided with China’s accession to the World Trade Organisation (WTO) in December 2001.

It was not simply the increased trade and positive news from China joining the WTO that offset the conflict and tension between Japan and China. But it was China’s commitment to the global trading system after 1986, with rapid trade liberalisation and economic reform, that gave Japanese firms confidence in dealing with Chinese counterparts. China steadily adopted, and constrained itself to, global trading rules and norms through its 15-year accession march towards membership of the GATT and later the WTO. The experience of the Japan-China relationship shows the importance of countries’ integrating into the global economy and being part of the global trading system for bilateral relationships to prosper.

The experience of the cross-Straits (China-Taiwan) relationship highlights the importance of intraregional economic integration in improving bilateral economic relations. Political relations between Beijing and Taipei have been even more difficult than Japan-China relations. Taiwan had banned imports from China up until the early 1990s for political reasons. In the 1990s, these bans were lifted gradually, and then more rapidly after both China’s and Taiwan’s accession to the WTO in 2001. Taiwan and China have become increasingly integrated into the complex production networks in East Asia. As their economies’ integration into the regional economy deepened, indirect interdependence increased and the indirect as well as the direct costs of Taiwan’s discrimination against mainland Chinese imports became more apparent. The trading relationship is now more ‘normal’ despite the residual trade bans that are still in place. Deep integration into the regional economy has carried the bilateral Taiwan-China economic relationship beyond being simply bilateral in nature.

In contrast, the non-integrating East Asian economies of North Korea and Myanmar are important examples of closed economies whose bilateral relations with their neighbours and beyond are dominated by political conflict.

Unlike Taiwan-China relations, where impediments to trade were reduced over time as the regional economy became more integrated around them, the under-development of South Asian economic integration and interdependence means there is less incentive to reduce barriers to trade or improve poor infrastructure, lift bans on investment and ease people movement across borders.

Pakistan has only recently reciprocated most favoured nation (MFN) status in trade with India and maintains a narrow positive list (786 items) of goods that India may export to Pakistan. At the same time, India’s tariff rates remain high, especially for goods of particular interest to Pakistan, such as textiles, leather and onyx, and non-tariff barriers are substantial. The relationship between India and Pakistan is not nested in robust regional cooperation, so bilateral economic dealings are swamped by bilateral political dealings and negative-sum or zero-sum security issues.

East Asia’s experience suggests that bilateral economic relations nested in a highly integrated region that is outward-looking and globally oriented helps to dampen, and even reverse, the effects of political conflict on trade. Thus political problems that limit economic integration in South Asia are likely to become more tractable if the whole region is tied more closely into positive trade and economic relations, trans-regionally and globally, and committed to full observance of the global rules of trade.

Shiro Armstrong is a research fellow at the Crawford School of Economics and Government at the Australian National University and is co-editor of the East Asia Forum. He is also editor of the new book The Politics and the Economics of Integration in Asia and the Pacific, Routledge.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Asia’s global impact‘.

1. India, China and Asian economic integration
2. Asian economic integration and cooperation- Challenges and way forward
3. North-East Asian economic integration: APEC or FTA games?

While in Honolulu for the APEC summit recently, President Obama announced a 12-month timeframe to complete negotiations for the Trans-Pacific Partnership (TPP).

Some have welcomed this development, but, in truth, it is a disappointing one. It fails the TPP’s basic aim of creating a substantial agreement and a clear timetable for tackling outstanding issues in the negotiations — and it ignores the distractions likely to swamp the US in late 2012.

Attention will now turn to Bali and the East Asia Summit (EAS), widely regarded as focused on political and security issues and without an economic agenda — but that is mistaken. Asian economic integration has progressed a great deal due to the EAS process. For example, the EAS has been important in helping to facilitate debates over the relative importance of ASEAN+3, with its associated East Asia Free Trade Agreement, and ASEAN+6, with its Closer Economic Partnership for East Asia.

While financial and non-financial integration are yet to be combined in Asia, continued preoccupation with trade in the vein of 1950s tariff debates is a clear sign of outdated thinking. Economic integration will go beyond market access issues at the border to several aspects of regulatory cohesion whether it is pursued in Asian or Asia Pacific venues. Tariffs, for example, remain important to particular exporters, but most international businesses are more concerned with other barriers to their operations across national borders.

Asian processes are likely to have a greater focus on infrastructure development and a greater commitment to narrowing development gaps. The latter will likely result from the adaptation of supply chains to local circumstances and by encouraging innovation throughout these supply chains, rather than through continued flows of aid. Significantly, with political gridlock in the US and the rigidity of US ‘trade’ diplomacy, Asian countries should have plenty of room to coordinate and control their own Asia Pacific institutions and focus on such initiatives.

Still, many think the TPP has an advantage over the processes associated with the EAS, since the former has proceeded to a negotiating stage; and even some Asian officials affirm that American-led processes — negotiations — generate quicker and clearer conclusions than Asian processes. Some rebalancing away from Western-oriented negotiations to Asian consensus building should nevertheless be expected.

APEC’s founding purpose, for example, seems to have been a desire to link the West Pacific with the East Pacific by reconciling Asian processes of consensus building and Western notions of reciprocity through binding commitments and monitoring. Managing the tension between consensus and commitment has been an enduring theme throughout APEC’s history.

Today, several global trends are starting to push the emphasis toward consensus building.

First, wider participation in international economic processes and modern communications technology mean that international negotiations occur in national capitals, rather than plenipotentiaries meeting in seclusion (as in the early GATT rounds). The idea of ‘single undertakings’ was a device to promote compromise among likeminded negotiators and to socialise the concept of binding in the 1950s. Despite still having some merits, this approach is often a barrier to achieving widespread agreement among economies. Selecting members of a club is much more a matter of consensus than negotiating reciprocity.

Second, the width of the integration agenda contrasted with reciprocal agreements on tariffs is another point in this same direction. Several observers, most recently the Pacific Economic Cooperation Council in its statement to APEC this year, have concluded that the offer and acceptance modality of conventional negotiations is not appropriate for the barriers which are important in retarding services trade.

Third, events in the last year have raised questions over the West’s emphasis on concepts such as binding, agreements, monitoring and verification, and sanctions. While many observers are still sceptical of ‘voluntary cooperation’, consensual objectives and peer-review, recent events in Europe cast serious doubt over any unqualified preference for black-letter negotiated agreements.

Though a completed piece of paper, signed and dated, is an easy way to denote success, the term ‘negotiation’ should also signal each party’s commitment to reaching an agreement — and the relative commitment of participants in Asia Pacific and Asian processes is yet to be tested.

Some observers believe the US promotes ‘deep’ agreements with ‘massive political commitments’, while the only alternative is a ‘China-led model’ which is ‘relatively shallow and easier for governments to join’. They are likely to be wrong on several fronts. The current models are shallow and deep in different ways, but it is the Asian model which best accommodates supply chains and the importance of innovation. The sole notions of ‘US-led’ and ‘China-led’ are both superficial. Instead, the challenge for the US and its political institutions will now be to accommodate other TPP members. For Asia, its processes often draw on all members — and its challenge will be to regulate this approach.

Gary Hawke is a Senior Fellow at the New Zealand Institute of Economic Research and Professor Emeritus and former Head at the School of Government, Victoria University of Wellington, New Zealand.

1. U.S. trade policy in Asia: Going for the Trans-Pacific Partnership?
2. Obama in Asia
3. Institutional architecture in Asia: Challenges for the US and Russia

The Trans-Pacific Partnership (TPP) trade agreement got a big boost around the APEC meeting in Honolulu. A broad framework was announced, progress highlighted, and a 12 month deadline for a deal was set.

The TPP is the first trade agreement which President Obama did not inherit from his predecessors, and it is seen as a means of keeping the US engaged in Asia. Understandably then, the pressure to show that progress had been achieved at the Honolulu summit was on everyone’s mind.

The TPP aims to be a high-quality, 21st century agreement that furthers economic integration in the Asia Pacific, with the current negotiations including Australia, Brunei, Chile, Malaysia, New Zealand, Peru, Singapore, the US and Vietnam. Prime Minister Noda’s much-anticipated announcement on Japan’s intention to join the other nine APEC economies in the ongoing TPP negotiations is another important development on this front. Japan’s decision to start consultations with countries currently negotiating the TPP in order to join negotiations certainly elevates the importance of the initiative.

But Japan’s involvement, and the recent announcement around the APEC meeting, does little to resolve the cross currents that confront East Asian regionalism and Asia Pacific economic integration.

One risk is that the APEC process could lose momentum by some of its membership getting bogged down in TPP negotiations that might well turn out to be less than fullsomely productive. Trade deals take time; and they are likely to take even longer with more parties around the negotiating table. The TPP should not be rushed, and so it is important that the success of APEC meetings should not be tied to announcable progress on the TPP. A lack of progress on the TPP is not a lack of progress in the APEC process: one should not bring down the other.

Progress on binding regional trade agreements has been difficult through APEC because of the diversity of membership and the nature of cooperation in APEC. The failure of the WTO’s Doha Round has added impetus to the TPP negotiations. Yet it is not clear the TPP is the answer to a lack of progress in a weakened global trading system.

Less than half of APEC’s member economies are committed to negotiating a TPP at this stage, but more importantly, the end agreement and design of the TPP may mean that some key economies find it difficult to join. The most important of those is China. The so-called platinum standards the US is pushing for in the TPP — stronger intellectual property rights, stronger labour and environmental standards and regulatory discipline of state-owned enterprises — will make it hard for developing countries and transitional economies to join.

The fact that other countries in the region have seen that China — their biggest trading partner — may find it difficult to join the TPP seems in fact to have elicited a tactical response from East Asia, re-energising cooperation in a number of ways. Long-term political rivals China and Japan elevated the urgency of the ASEAN+6 Closer Economic Partnership Agreement, which is now cast in terms of an East Asian FTA. The ASEAN response (driven by Indonesia) has been to propose an ASEAN+1 template. Given ASEAN has FTAs with each country in the plus-six grouping (Australia, New Zealand, India, Japan, South Korea and China), the idea would be to harmonise those arrangements, consolidate them, and then open the process to others (the US, for example). Although neither East Asian response is well articulated, agreed on or entrenched at this stage, they are not favourable developments for the US.

There are also signs that the TPP might turn out to be little more than a bunch of bilateral deals itself, and that won’t do much to solve the problem of overlapping FTAs in the region — one of the TPP’s core goals. Unless it is designed with uniform concessions and commitments to all members, not only will the TPP fail to overcome the ‘noodle bowl’ of overlapping FTAs in Asia, it will add another bowl of noodles within the current bowl.

Japan, in its approach to TPP membership, recognises the possibility that China will not join the TPP any time soon. Given the importance of China to Japan, both economically and strategically, Japan has signalled it will move forward on a bilateral FTA with China at the same time as it moves to join the TPP negotiations. FTAs with South Korea and the EU are also in the works.

The East Asia Summit (EAS), which the US and Russia joined last year, is seen as another way to keep the US engaged in Asia. The EAS now comprises ASEAN+6 plus the US and Russia. While any additional opportunity for dialogue in the region is welcome, it is still a young institution that has not established a strong agenda. Its focus is leaning toward political-strategic issues, which are important, but without a prominent place for positive-sum economic issues (the international financial institutions have not been invited to the Summit this year), the big powers could end up dominating the talks, focussing on zero-sum or negative-sum security issues.

East Asian economic integration has been market-driven, not institution-driven, and production networks have flourished despite FTAs in which the rules-of-origin issue complicates the sourcing of imported intermediate inputs. The Asia Pacific region, and especially East Asia, has enjoyed rapid growth of trade and development based on the idea of open regionalism.

The priority in East Asian economic integration is to promote the participation of least-developed economies in the production networks, as well as deepening the integration and specialisation of middle-income economies in those supply chains. This is an integration agenda beyond a narrow trade agenda. The TPP is not currently pointed in that direction and risks overshadowing East Asian and ASEAN-style economic cooperation within APEC — an approach which is still quietly delivering real progress in economic integration, as it has in years past.

Dr Shiro Armstrong is a Research Fellow at the Crawford School of Economics and Government, the Australian National University, and Editor at the East Asia Forum. 

1. North-East Asian economic integration: APEC or FTA games?
2. East Asian Free Trade Area: bank on it
3. A closer look at East Asia’s free trade agreements

Suddenly Asia has emerged as a major player in the global economy.

Asia already accounts for 27 per cent of world GDP and the Asian Development Bank (ADB) 2050 Report issued last May suggests that it will account for as much as 51 per cent a generation hence. The economies of the developed world are slipping back into recession. Asia, especially China, India and Indonesia continue their exceptional and rapid growth with the rest of the region, including Australia in tow. Asia is a region with high levels of interdependence within the region itself, especially within East Asia and between it and the rest of the world. It has a deep stake in the strength of the global economic system that supports open trade and international capital flows.

What sort of changes will these developments wreak in the regional and global order?

There are great expectations of Asia not only as an engine of global growth — led by China but with other emerging economies adding dynamism to the global economy — but also of its leadership at a time of global economic fragility. The new global order, centred on the G20, includes six Asian powers and provides a platform for Asian leadership. But is Asia up to the task? And do the institutional structures and arrangements within Asia provide the foundations that are needed to build coherent policy strategies to deal with the economic problems the world now faces?

The latest issue of East Asia Forum Quarterly addresses these questions. Shekhar Shah’s essay from this volume is our lead essay this week. Shah argues that, while the G20 is central to the new international order, the six Asian economies within the G20 are key to rebuilding the global economic order within a generation, as the realities of the change that has taken place in the world economy now require.

A generation might seem a very leisurely pace of change, but, Shah suggests, it will take time for both the West and the East to adjust to the new economic realities they confront. Pretending otherwise will rule out real opportunities for shaping the G20 into the longstanding forum it needs to become. It must learn from the Asian experience of steady, even if sometimes slow, progress with economic cooperation.

There are two priorities according to Shah. ‘First, on the immediate question of sustaining global demand, it now seems clear that the G20 has not been able to repeat the success it had in dealing with the 2008 crisis in the much harder task of rebalancing the global economy’. That earlier success bred complacency the G20 can no longer afford. Its Asian members, as the ADB has claimed, are ‘passive onlookers in the debate on global rule-making and reluctant followers of the rules’. This has to change or the G20 will lose its way.

Yiping Huang argues that what China wants is reform, not radical change, of the existing international economic system from which China has been among the biggest beneficiaries.

Much will depend on how the Asian emerging newcomers, including India, take up their responsibilities to shepherd the G20 agenda. There is a lot to lose if the G20 descends into nothing more than the old G7 plus others. ASEAN has had considerable experience in coordinating policy responses and domestic policy choices, both those that have been successful and those that have failed. Asian members should bring this experience to the G20. ASEAN’s durability and openness to change presents an opportunity for the Asian G20 members to bring this ASEAN spirit to the G20. This will equip the G20 to be effective over the generation that will be required to rebuild the global economic order.

According to Ishrat Husain, the strengths of the Asian economies clearly show why they should be in the driver’s seat, or at least the co-pilot’s seat, of the G20. He sees advantage in using regional arrangements like ASEAN + 6 in East Asia and SAARC in South Asia for consultation among member countries in the region to add their voice to the G20, through the six Asian G20 countries as a conduit.

Given the size and strength of Asia in the global economy, Mohsin Khan suggests, the region clearly still ‘punches below its weight’ in the global financial institutions like the IMF, for example This is part conscious choice by Asian countries to keep the IMF at arm’s length, reflecting memories of the IMF’s role in the Asian financial crisis. Asia has also not really pushed to have a larger say in global financial circles, but instead has chosen to develop its own regional arrangements and institutions. Playing its rightful role in the IMF need not detract from regional arrangements. The global and regional institutions can and should work together in a complementary way.

‘Adopting an explicit longer-term framework’, Shah argues, ‘allows us to think about future developments that need to be shaped now, such as the G3 relationship between the US, China and India, and the shape it will be in 10 years from now. The relationship between these countries will be important in determining future G20 strategies. India is today by far the poorest member of the G20. But it is nonetheless the fourth biggest economy in the G20, measured at purchasing power parity, and the 11th biggest measured at market exchange rates. Laying the foundations of a more cooperative relationship now will go a long way towards shaping it in productive ways for the future’.

This is Asia’s global moment. Will it meet the test? The verdict is out and far from certain. But this issue of EAFQ provides the outline of the agenda with which Asia must deal if it is to measure up, both economically and politically.

Peter Drysdale and Shiro Armstrong are the editors of the East Asia Forum.

1. Asia’s challenge: to rebuild the global economic order in a generation
2. East Asia and the new world economic order
3. Asia’s global responsibilities: Delivering through global and regional arrangements

Australia at last is taking up the challenge of comprehensively thinking through its new strategic circumstance in Asia, and taking Asia seriously.

On 28 September, Prime Minister Julia Gillard gave a timely and important speech to launch a new White Paper on Australia in the Asian Century. The Gillard speech changes the fundamental premise of the debate about Australia’s place in the world. The White Paper will provide a comprehensive review of economic and strategic change in Asia and its implications and opportunities for Australia. It will involve whole-of-government input, external expert advice and broad consultation across the community.

In Asia’s emergence in the 21st century we are experiencing changes of ‘type, not degree’, as Gillard says.

The big story is China and its rapid rise. ‘When Great Britain industrialised’, Gillard reminds us, ‘it took seventy years — the whole period from 1830 to 1900 — for its economy to quadruple’. That had a major impact on the world. By comparison, ‘[i]n the last twenty five years the economy of China, a nation of 1.3 billion, has grown by a factor of twenty’.

And India is not far behind. India has a more favourable demographic structure than China and, on its current track, the Indian economy could become larger than the US economy by mid century and larger than China not long after that.

China and India are committed to industrial catch-up and, given this, they will likely continue to grow at around their current trajectories, albeit with some bumps along the way. Both countries’ huge population sizes, the simple arithmetic tells us, means that their economies will become bigger than the established industrial powers before their people become as rich as them.

Australia’s immediate neighbour Indonesia is now a larger economy than Australia’s in purchasing power parity terms and already the 15th largest economy in the world, growing at 6 per cent a year — a rate many would consider below potential. The transition to democracy and having the world’s largest Muslim population makes Indonesia a key player in global affairs. It is safe to predict the continued growth in Indonesian power, influence and importance.

And Japan continues to be an important player as the world’s third-largest economy, but faces big challenges. Japan’s quandaries include dealing with a shrinking population and workforce, escaping from economic stagnation, reconstruction after the Tohoku earthquake, tsunami and Fukushima nuclear meltdown, and, perhaps most importantly, managing the fact that its largest economic partner (China) is different from, and a potential strategic competitor with, its security ally (the United States).

Gillard states bluntly that ‘these relationships (with our neighbours) will not manage themselves’.

It is 22 years since Ross Garnaut delivered the report on Australia and the Northeast Asian Ascendency that shaped and guided Australian policy strategies towards its northern neighbours through the 1980s and 1990s. Now Gillard has broadened the scope of the newly-commissioned White Paper to the whole of Asia, including India and Southeast Asia.

Many countries around the region are grappling with the issues that Australia has now chosen to confront explicitly. Australia needs a framework and vision to manage the issues of today in a coherent manner that deals with the issues of tomorrow. It needs to re-think not only its foreign policies but a whole raft of domestic policies if it is to cope with the scale of the impact of what is going on in Asia on its economic, strategic, social, environmental and other interests. The stakes are high.

Hugh White has posed the big question about how Australia and the region might manage the political and security implications of the changes in economic and political power that are taking place in Asia between the United States and China. Gillard’s vision is for Australia to be ‘[s]trong in the Asian century — with an ally in Washington and respect in Beijing’.

Australia is the most important, stable supplier of strategic raw materials to the region, hence fueling Asia’s growth, and also plays a role in maintaining economic openness in the region. The key for Australia is to get its policy strategies right in dealing with its northern neighbours but also to play its role in developing effective regional economic and political security.

The White Paper is tasked with assessing how to achieve these important goals and the widely-respected former Secretary of Treasury, Dr Ken Henry, is a confident choice to map Australia’s future in Asia.

Gillard clearly states that we are not in the business of creating new institutions but that we need to build around the existing institutions and structures — ‘Groups with the right membership and mandate to address the full range of security, political and economic issues facing the region’. What is needed is a flexible but robust set of arrangements that keeps the Unites States engaged but allows the development of an agenda that takes account of broadening regional needs.

The immediate priorities are ‘working in the G20 to deal with structural imbalances, at APEC to open the region as a whole’ and working on building the EAS up as an institution since ‘[w]e’ve got the EAS off the starting blocks now but there’s a long race ahead’, as Gillard cautions.

Of Australia’s strategic environment, Gillard rightly concludes: ‘Australia hasn’t been here before’.

Governments in Australia in the past decade or two have not been willing to accept and to face the reality of the changes we face in our region front-on. Gillard is changing the game and taking up the challenge. Her call for a rethink and a new strategy on Australia’s engagement with Asia is an entirely positive development and has come not a moment too soon.

Shiro Armstrong is a Research Fellow at the Crawford School of Economics and Government, The Australian National University, and Editor of the East Asia Forum.

1. Australia hasn’t been here before
2. Australia’s strategic future after the white paper
3. Connecting Asian and global cooperation

China briefly stopped exports of rare earth elements to Japan last year following a maritime collision near Diaoyu/Senkaku islands and the subsequent political fallout.

The reaction from Japan and other major buyers was alarm and protest as the metals are crucial to high-tech industries and China supplies over 90 per cent of rare earths globally (holding an estimated 37 per cent of the world’s reserves).

An unregulated, booming rare earths industry in China, combined with a very low international price for the metals, led to reductions in exports well before the collision in waters surrounding disputed territory in the East China Sea. China’s gradual tightening on exports turned to a screeching halt of exports after the incident last year with what was effectively a de facto export embargo, as customs stopped the shipment of rare earths. Exports were quickly resumed, partly because of the recognition that the ban wasn’t in China’s economic interests and partly because of the fear of WTO action by the US and Europe.

The unregulated rare earths industry in China has been a cause of significant environmental damage and the gradual restrictions on exports might also be seen in the context of an attempt to consolidate and regulate the industry in China. This is a second best policy instrument for dealing with the difficulty in internalising the price of the environmental damage in the industry.

The gradual tightening of exports of raw materials by China, including the use of quotas and export duties, was recently ruled illegal by the WTO. That serves as a warning on restricting exports of rare earths by the same methods. But the immediate damage to China’s trade interests came from the de facto export ban.

Some may think that there is no threat to China’s exports of rare earths, given its dominant position in global supply. But the temporary export ban had big consequences.

It raised the global prices of rare earths and, in the medium term, much larger supplies from outside China are coming on stream as previously unviable projects become economic. Those projects will take a little time to come on stream but China’s dominance of the market has been checked. There may be an over-supply as early as 2013 as there are over 200 rare earths projects under way at the moment, according to Jack Lifton.

China was right to recognise the potential damage to its industry and to lift the de facto export ban shortly after it was imposed. Japanese and other high-tech users will be stuck importing rare earths from China in the short run but the risks in dealing with China have increased. The long-term effect is to undermine China’s reputation as a reliable supplier — and not just for rare earths. With the increased risk factored in, foreign firms will look elsewhere to procure parts and components if the price is similar to that in China.

The United States learnt this lesson in 1973 with the temporary ban on exports of soybeans to Japan. The US lost market share in the long run and took a big hit to reputation. Brazil suddenly found itself making a large investment in soybean production out of Japan and became a significant supplier of soybeans to the global market.

While it’s difficult to know why or who in the Chinese system implemented the export ban, and why or who moved quickly to reverse it, the ban appeared principally designed to reduce domestic angst building up from the Japanese detention of the Chinese trawler captain off the Diaoyu/Senkaku Islands. It can also be reasonably assumed that the removal of the export ban was pushed by those who took a broader view of what was in China’s interests.

There was an attempt to limit the damage done. The robustness of the WTO as a constraint on such behaviour was also tested. The failure of the Doha Round raises questions about the future of the WTO and whether at some point in the future the WTO’s ability to restrain such behaviour might weaken.

Shiro Armstrong is a Research Fellow at the Crawford School of Economics and Government, The Australian National University, and Editor of the East Asia Forum.

1. China’s export restrictions on rare earths
2. China and the supply chain of rare metals: Table of [dis]contents
3. Rare metals after the Japanese nuclear crisis

The Doha Development Round of World Trade Organisation trade negotiations is in deep trouble and could become the first Round to fail.

What will happen if Doha fails?

If Doha is indeed all about agriculture, then not much will have been lost from a producer’s perspective, given current world food prices. And we will still have the WTO rules (dispute settlement mechanism and enforcement) though vastly weakened because of damage to the institution of a failed Round. But if Doha can’t do agriculture, then it surely can’t do behind-the-border reform. And the multilateral system will be further weakened with countries chasing more free trade agreements (FTAs).

The EAF this week features a series of essays on Doha led by Richard Baldwin and Simon Evernett who warn that ‘2011 is a fork in history’s road’ and that ‘if the US and China are unwilling to break the deadlock in 2011, no deal is likely before 2020’.

That matters. A failed Doha ‘would damage the multilateral system in an era when multilateral cooperation is in short supply’ as Peter Drysdale says. Drysdale goes on to argue that it is important since ‘The multilateral trading system is the economic sinew that constrains the exercise of international political muscle in ways that damages global wellbeing and inflicts national self-harm.’

The lack of progress on Doha signals a retreat from the days when international economic diplomacy helped diplomacy on other fronts — especially security. That does not bode well for relations between countries (read China and the United States) with different political systems that would tend towards conflict rather than cooperation without the positive sum economic diplomacy underlying the zero or negative sum security dialogues and interactions.

Ed Gresser explains that Doha is an example of a larger international system problem. Put bluntly, it is an example of the US being prepared to do a deal with anyone but China. We see the signs of this with the Trans-Pacific Partnership (TPP) agreement too with the United States making sign-on by China close to impossible.

What then, of progress with trade reform?

Making progress on trade reform (and economic reform more generally), will not be delivered in trade negotiating forums. As Krugman says, the case for free trade is primarily unilateral. And political will must be urgently mobilised at home.

What’s needed now (from both optimists and pessimists on the Round) is to keep ripping the fig leaf off current efforts at economic diplomacy. Doha is becoming a joke because, as Sourabh Gupta explains, the US keeps shifting the goal posts, with its take-it-or-leave-it diplomacy designed to ensure ‘anyone but China’ outcomes. FTAs are a joke because they are with nations that don’t matter in the total scheme of global trade and are designed by the powerful to exclude anything that matters or brings real gains. It’s hard to see how such FTAs could create a serious domino effect that is likely to bring in the other big players, as some still argue. If FTAs were about trade and economics, the United States would be negotiating with China and a Japan-China FTA would be on the table as well. So current economic diplomacy has become empty of content.

The world does not yet have a plan B. And losing all that has been gained in the 10 years of negotiating Doha is a monumental waste. What gains have been achieved should be locked in with a take-what-there-is deal because there is enough there and it is critical not to weaken the whole system at this juncture.

Leaders ‘should argue that Doha needs to be done to preserve one of the world’s most precious public good – the rules-based, WTO-centric trade system’. ‘It is a system’, as Baldwin and Evenett remind us, ‘that has created so much prosperity in America and lifted so many people out of poverty in China, India and Brazil’ that’s worth saving.

And while further actual trade and behind-the-border reform will now require mostly unilateral effort, a Plan B on economic diplomacy is vital because of the implications for security.

Philippa Dee is Adjunct Associate Professor at the Crawford School of Economics and Government at the ANU and Shiro Armstrong is currently a Visiting Fellow at Columbia University and Editor of the EAF.

1. Implementing the G20 commitment to World Trade Reform
2. Trade policy needs to go global
3. The end of Doha as we have known it: what next for Australian trade policy?

The Trans-Pacific Partnership (TPP) aims to be a high quality, 21st Century economic agreement among its nine members. It is also supposed to encourage others to join in. Led by the United States, there is a strong push to deliver TPP this year in time for the APEC meeting in Honolulu in November.

But rushing a quick deal on the TPP should not be at the expense of a good economic agreement. The priority is to progress it on the right terms. The economic and political consequences of getting it wrong are too great.

The sixth round of negotiations for the TPP finished in Singapore recently. The nine negotiating states of Australia, Malaysia, Peru, the United States, Vietnam, Brunei, Chile, New Zealand and Singapore sent 400 officials to discuss reducing trade and investment barriers among potential members, simplifying the rules of origin in their trade agreements, liberalizing services trade and other related issues such as government procurement and intellectual property right protection.

Criticism of the Obama administration’s lack of progress on trade policy, and the desire to see the United States engage more substantially in Asia — a hankering from both Asia and within the United States — has elevated the TPP to fill both those gaps. The need for tangible progress on Obama’s promise to double US exports to help fix the economy and a big announcement on TPP in Honolulu in November when US eyes turn to the Asia Pacific region, both raise the stakes and the expectations in America. Yet the desire for a big announceable above all else at APEC is dangerous.

If the TPP is to make a real difference and do what its proponents reckon it will, the urgency to complete such a complex deal by November may be reckless. The complexity arises partly from the diversity of the nine putative members and the 25 agreements they already have in place with each other. Agreements between two parties that benefit members at the expense of non-members are hard enough. Many agreements in the region either complete by excluding the sectors that would bring the largest benefits from opening up (often agriculture in trade and utilities in services and investment), or fail to progress due to those sensitive sectors. Two Australian examples of this are the Australia-US FTA (AUSFTA) excluding US sugar and dairy while the Australia-Japan FTA is stalled on agriculture. Nine parties trying to reach a deal in haste is likely to result in a lowest common denominator agreement that excludes sensitive areas that should be the main areas of focus in liberalizing.

A quick agreement with exemptions and exclusions without an inclusive framework will mean accession for future members will have to be negotiated separately with each member. That is a laborious and counterproductive process which will likely build layer upon layer of exclusions, exemptions and protection. It will leave power of veto for economic, political and whatever reasons with individual original signatories.

FTAs, or trade liberalization through international negotiation, lack one of the key mechanisms for helping to solve the problem of sensitive sectors — that is, a mechanism for giving voice to the domestic interests who are hurt by import substitution. Any mechanism that levers off ‘offensive’ and ’defensive’ interests will fail to do this (including WTO process). Such a domestic mechanism was important for unilateral reform in Australia in the 1980s that opened up sensitive sectors.

The risks of a quick deal on the TPP — one that is full of exceptions, allows continued protection of sensitive sectors, and excludes ready accession by others — go well beyond getting just another ineffective trade agreement.

The TPP is supposed to weld the Asia Pacific region together. Without careful consideration, design and a manageable framework, it will do the reverse, excluding key partners and making it difficult for others to join. There is a risk that the TPP will drive divisions that will prevent, and not foster, further economic interdependence in the region. If it serves, as it would under those conditions, to split the region into political camps, it will have dangerous political consequences.

The relationship between Japan and China has shown that economic integration can proceed despite political tensions because the relationship was nested in a robust and broad multilateral framework. The WTO framework has ameliorated political tensions as trade between Japan and China has been conducted under a global rules based system. Traders and investors have maintained confidence in continuing to do business even when political tensions flared up because of the strength of the system. It has meant the economics dominates the politics, and not the other way around. For the same reason, the broader the framework in Asia and the Pacific the better.

What then should the TPP be aiming to achieve?

Its original advocates saw its benefits as deriving from a comprehensive deal that is inclusive, both in terms of being open to membership by others and one that sits comfortably alongside other initiatives in the region.

Openness has brought prosperity, poverty reduction and remarkable modernization of economies in the Asia Pacific. This has come through greater engagement in the global trade and economic system under the WTO trade and open investment regimes. The aim now is to get rid of residual trade barriers on a defined schedule and remove regulatory and institutional behind-the-border barriers to trade in order to reap more benefits from moving towards a single regional economy. It is not to create an inward looking bloc that retains higher barriers to trade against those outside the group on a range of ‘sensitive’ commodities. The aim is to make it easy for others to automatically join on to the agreement, subject to their acceptance of its terms. It is not to create barriers to their accession that have to be negotiated separately with every member.

Why not have automatic sign-on provisions for third party countries, even outside the Asia Pacific region? If TPP members give significant concessions on trade barriers and remove behind-the-border barriers in sensitive sectors, extending membership to others who are prepared to do likewise on the same terms (in respect of phase-in and all other conditions) should be automatic. There is no reason why, for example, Japan, should it succeed in opening up its agriculture to the US and Australia through joining TPP, would want to withhold its concessions from others in South America, Europe or Africa, who were prepared to scrap tariff barriers, and undertake other reforms required of eligibility for TPP membership should they wish to take that step.

If APEC is the vehicle chosen for prosecuting TPP, it would be prudent to frame it as an arrangement that is open to all APEC members and globally, consistently with APEC modalities and success thus far. A big but flawed announceable which undermines the economic and political foundations of trans-Pacific cooperation would benefit no one.

Shiro Armstrong is a research fellow at the Crawford School of Economics and Government at the Australian National University and currently an Australian Government Endeavour Research Fellow and the Gary Saxonhouse Prize Fellow visiting the Center on Japanese Economy and Business at Columbia University. He is co-editor of the East Asia Forum.

1. Trans-Pacific Partnership update
2. Trade policy needs to go global
3. Trans-Pacific Partnership talks in Singapore: Now it gets difficult

The Economic Cooperation Framework Agreement (ECFA) that Taiwan and China signed on June 29 this year is a milestone in relations across the Straits. It normalises economic relations between Taiwan and the Mainland. Up to this point, Taiwan has had discriminatory trade and investment policies towards China under the guise of political-security concerns that severely limited economic engagement across the Straits. These measures meant that Taiwan had effectively cut itself off from participating fully in the East Asian production networks.

Taiwan is now free to institutionalise economic relations with other important trading partners such as the US, Japan, EU, ASEAN and Australia. Is it in Taiwan’s best interest to now join the FTA game with partners around the region and around the world?

There is a strong desire in some quarters in Taiwan to sign preferential trade deals now that it can and there will be pressure from external powers too. Taiwan may seek to sign trade deals for geopolitical reasons, but not for economic reasons.

The economic rationale for Taiwan to join the FTA game is weak.

The best economic argument for FTAs are that Doha is stalled and liberalisation via FTAs is the only alternative and may be better than nothing. There is now enough evidence that this isn’t the case (see work by Philippa Dee in the World Economy). Taiwan has very little leverage in negotiating trade access bilaterally with its major trading partners. So unilateral liberalisation is a better option. Unilateral liberalisation has served East Asia well in the past and the principle of open regionalism has brought into being a region that is economically much more integrated than Europe or North America, yet depends on those markets for final goods exports. There is evidence of this in recent studies by Zhi Wang (pdf) and myself and Peter Drysdale.

Taiwan is ideally placed to pursue a global strategy, and a strategy that focuses on domestic structural and regulatory reforms. The economic gains from structural reforms dominate gains from FTAs, even if FTAs are region wide. Estimates suggest that comprehensive unilateral regulatory reforms would deliver five times the gains of an ASEAN+3 agreement. The gains from bilateral FTAs are trivial.

Now that Taiwan can ‘go global’, a strategy of getting its own house in order will deliver larger gains, and faster, than when Taiwan had effectively cut itself off from China. A global strategy does not discriminate in trade dealings and instead lets market forces determine trade flows and economic integration. Making the Taiwanese economy stronger, more flexible, efficient and resilient will help it reap the gains from globalisation and integration into the Asian and global economy. ECFA is a framework for removing that discrimination against China; Taiwan should not now introduce discriminatory trade elsewhere.

The China-ASEAN FTA which comes into force next year is viewed by some as a threat to Taiwan and others in Asia that aren’t party to it. There is hope that it sets off competitive liberalisation through other FTAs. That would add more noodles to the mess of FTAs in the region. To date Taiwan has only signed 4 FTAs and they are with Central American countries that do not have significant trade shares in Asia. So Taiwan has a clean slate when it comes to FTAs.

The political capital and resources required in negotiating and signing FTAs are better spent elsewhere. There are political risks to Taiwan signing preferential deals with other countries that discriminate against the mainland. Article 16 of the ECFA is a termination clause where either China or Taiwan can notify the other of termination of the ECFA which takes effect 180 days later.

Taiwan can minimise political risk and maximise economic gains if it enters bilateral arrangements that avoid preferential treatment or allow ready sign-on by other countries. Taiwan has strongly pushed that point in one of its very few submissions to the WTO:

we propose new provisions… requiring parties of RTAs to provide an accession clause for third-party members, which would expand the reach of RTAs and thereby promote broader, more inclusive and comprehensive trade liberalization (paragraph 7)

third parties will not be granted automatic accession to RTAs. However, the original parties to the RTAs will be required to afford third parties, in good faith, adequate opportunity to negotiate individual terms of accession to the RTAs (paragraph 9)

(h/t to John Ravenhill).

Taiwan lifted itself into prosperity without FTAs despite, but also because of, its being politically between a rock and a hard place. Commitment to the multilateral trading system through unilateral tariff liberalisations, in which APEC played a significant role, was one way of doing that. Recent economic troubles, which gave the government a window of opportunity to sign ECFA, were not the result of Taiwan’s inability to join FTAs. They resulted from the global economic slowdown and significantly Taiwan’s being left out of the East Asian production networks.

The restrictions on trade and investment across the Strait have prevented deepening of Taiwan’s specialisation in the regional and international economy. This has slowed Taiwan’s climb up the value-added chain. Taiwan has not been able to add value to some cheap intermediate imports from China and is limited in what it can export to China. Taiwanese firms have not been able to take full advantage of China’s upstream or downstream processing capacity. As recently as 2006, Taiwan’s imports from China were half of what might have been expected given the size of the Chinese and Taiwanese economies, their distance apart and their trade structure. Taiwan’s imports from Chin was less than 50 per cent of its potential. Korea’s trade with China, for example, was much closer to its potential than was Taiwan’s trade with China (see references here). This severely limits the engagement of foreign MNEs in Taiwan as they look to participation in production networks with China as part of the advantage of location in East Asia.

FDI into Taiwan has been low and there is much fanfare that Taiwan will now become a more attractive destination after ECFA. Some wrongly point to the lack of FTAs as the reason low FDI in Taiwan. The real reason is that by severely limiting trade flows with the mainland, Taiwan was not an attractive destination for foreign capital. Everything else equal, why build a factory in Taiwan when you could set up in Korea or Vietnam, for example, and enjoy relatively unfettered trade with China, one of the largest, most dynamic and most important economies in the region.

Pursuing deep domestic reforms is not an easy strategy to pursue when there is pressure to sign FTAs. It may seem a lonely strategy although that is nothing new for Taiwan. But given its unique circumstance, Taiwan is in a position to become an exemplar of a new drive towards multilateral liberalisation and structural reform. Efficient specialisation in the international economy involves heavy interdependence across the Straits: global engagement reduces the economic and political risks associated with that.

It may be an outlier in the region but the economic gains and minimisation of geopolitical complications that come with a strategy that eschews preferential trade agreements is likely to provide maximum momentum and confidence in taking Taiwan’s economy to the next level.

Shiro Armstrong is a Research Fellow at the Crawford School of Economics and Government at the Australian National University and Editor of the East Asia Forum.

This article is based on a paper presented to ‘Beyond ECFA: Taiwan and Regional Integration in the Asia Pacific’, hosted by the Institute for National Policy Research in Taipei and available as a working paper here.

1. Taiwan and its new economic agreement with China
2. Taiwan in from the cold, with China’s blessing
3. A US-Taiwan FTA