Joint Report and Policy Recommendations on
Strengthening Economic Cooperation among China, Japan and Korea
Trilateral Joint Research
Development Research Center of China
National Institute for Research Advancement of Japan
Korea Institute for International Economic Policy of Korea
The Trilateral Joint Research Project has been undertaken by the Development Research Center of the State Council (DRC) in China, the National Institute for Research Advancement in Japan (NIRA) and the Korea Institute for International Economic Policy (KIEP) since 2001. To date, the three institutes, representing their respective countries, have jointly formulated two sets of policy recommendations concerning the promotion of trade and direct investment in the region, which were submitted to the leaders of China, Japan and Korea at meetings in Brunei in 2001 and Phnom Penh in 2002.
Given the successful completion of the first stage of the joint research project in 2002, the three institutions recommended to the leaders the launch of a new research phase from 2003, studying the topic of "Long-term Economic Vision and Medium-term Policy Directions". The research will be carried out on a step-by-step basis, beginning with the "Economic Effects of Possible Free Trade Area among China, Japan and Korea," as the research theme for 2003.
The concepts presented in the joint policy recommendations formulated thus far have led to progress in high-level cooperation among the three countries. A particular success was the establishment in 2002 of a meeting of the economic and trade ministers of the three countries, which was recommended in the report of the joint research project in 2001. Tripartite dialogues have been intensified at all levels, including private business, government and academia. It was recently announced that a visa would be waivered for a short-term entry for business purpose by the Chinese government. All of these mechanisms will contribute to the facilitation of trade and investment in the region.
This report consists of a summary of the research activities conducted thus far in 2003, including analyses of data and model simulations, in addition to an analysis of a joint business survey. The policy recommendations have been developed jointly, based on analysis and intensive discussion.
I. Preliminary Macroeconomic Vision of the Three Countries
Recent Trends of Trade and Direct Investment in the Region
According to various statistical sources, China, Japan and Korea jointly accounted for about 24 percent of world population, about 18 percent of world Gross Domestic Product (GDP), and about 13 percent of world exports in 2002. The shares of their macroeconomic variables in the world total have demonstrated increasing trends for the past ten years. China has led the growth, recording an astonishing growth rate of 7 to 8 percent in recent years, while Japan and Korea have recorded more modest growth rates.
The economic integration of China, Japan and Korea has been progressively intensifying through the increase of intra-regional trade and investment. The past several years have seen a continuing trend towards the intensification of trade relations among the three countries. Japan and Korea increased their intra-regional exports as a share of their total exports in 2002. China followed the same trend, however the ratio of intra-regional exports to total exports decreased slightly in 2002, reflecting her increased exports to the United States.
Among the three countries, China has been a continual recipient of foreign direct investment (FDI) from Japan and Korea. The years since China's accession to the World Trade Organization in 2001 have seen an investment boom to China. This trend appears likely to continue for the near future.
A Long-term Macroeconomic Scenario
To lay the groundwork for formulating a long-term vision for the region, the joint research teams preliminarily established a macroeconomic scenario to sketch out the growth of GDP and trade. Among various feasible scenarios, this report discusses a scenario which assumes comparatively high growth, reflecting trends of growth for the past few years, together with a successful implementation of national development/ economic plans. As a result, the outlook is rather on the optimistic side, foreseeing the achievement of the goals of the five-year plan in China, successful implementation of economic reform measures in Japan, and a continued and successful post-crisis economic adjustment in Korea.
The scenario indicates that the shares in world production and trade represented by the region (China, Japan and Korea) will become larger in the long-term. In particular, exports from the region will grow faster than they will in the rest of the world, and this growth will also be faster than the region's growth in production. The region will be "a world production and export base ", accounting for approximately one-fifth of the world's GDP and trade.
Under this scenario, the economies of the region will require markets to absorb the increase in their products. Internally, the markets of the three countries should further integrate in terms of trade to ensure intra-regional demand. Moreover, it is imperative for the three countries to maintain free trade and investment system throughout the world, to ensure full absorption of their increased product.
Another important factor in the achievement of high growth in the region is to ensure and promote intra-regional FDI flows. FDI flows will stimulate the international dissemination of technology, and raise the level of potential technological progress in the three economies. The inflow of FDI will also bring about more active competition in the markets of host economies. This is not only the case in China, but also in Japan and Korea.
II. Regional Integration and its Effects ? The Experience of Europe and North America
Among the many existing and upcoming regional trade arrangements, two trade blocs draw special attention because of their substantial impact on the world economy as a whole. First, the European Union (EU) continues to broaden and deepen its ongoing economic integration. Reaffirmed by the European Council in 2000, many expect the advent of a much-enlarged EU encompassing many Central and Eastern European countries in 2004. Having successfully concluded a Free Trade Agreement (FTA) with Mexico, the EU will also form a cross-regional FTA with Latin American countries. Moreover, the EU has deepened its integration through the circulation of a unified currency, the euro, in all euro zone countries since January 1, 2002.
Meanwhile, after having abandoned its long-standing opposition to preferential trading bloc in the 1980s, the U.S. has been pursuing economic integration in the Americas. In 1992, the U.S. signed the North American Free Trade Agreement (NAFTA) with Canada and Mexico. At the Summit of Western Hemisphere Countries in Miami in 1994, regional leaders agreed on forming the Free Trade Area of the Americas (FTAA). In 2001, 34 regional leaders met in Quebec City and pledged to continue to move forward with negotiations for an FTAA by 2005. Furthermore, the U.S. announced the Enterprise for ASEAN Initiative in 2002 to promote an FTA between the U.S. and ASEAN countries. In May 2003, the leaders of the U.S. and Singapore signed an FTA, the first to be signed in Asia by the U.S. The U.S. strategically seeks the enlargement of the free trade area toward ASEAN.
The Impacts of an FTA - in the Cases of EU and NAFTA
Surveying a huge sample of empirical research on the impacts of FTAs in the cases of EU and NAFTA, the trilateral research teams have concluded that regional free trade agreements seem to have generated welfare gains and expansion of income for the participants. Typically, these estimates covered gains in efficiency from trade liberalization, reduction of non-tariff barriers and trade costs because of the facilitation of trade and the streamlining of procedures, gains in productivity from scale effects, promotion of intra-regional FDI, and pro-competitive effects caused by market integration. The estimated magnitudes of the impacts are from a half percent to six percent of GDP as a whole, depending on the coverage of measures and the specifications of the models employed in the estimates.
In spite of the positive gains, FTAs are a double-edged sword. While they remove trade barriers between the members, they may also become inward-looking and protectionist-oriented blocs. If this is the case, they can act as a brake on the pace of international trade liberalization. One approach whereby regional trade arrangements can remain outward-looking is expansion of membership. While the EU and NAFTA may once have completed the trading blocs in their regions, they have planned for further expansion of their memberships. This represents an important lesson.
III. Macroeconomic Effects of a Trilateral Free Trade Area
Scope of the Model Simulation
The research teams jointly conducted a model simulation to estimate the economic effects of an FTA among China, Japan and Korea with various assumptions and scenarios. The model employed here was a multi-regional and multi-sector general equilibrium model with the most frequently used database from Global Trade Analysis Project. The simulation was conducted assuming a trilateral FTA, which means zero bilateral tariff rates between any combination of the three countries.
The common specifications of the model simulation include: perfect competition under the assumption of constant returns to scale; free movement of capital that leads to a change of current accounts; and partial substitutability between the same kind of commodities from different places of production. The final specification is called "Armington structure".
Macroeconomic Impacts of a Trilateral FTA
Table 1 demonstrates the impacts of a trilateral FTA on welfare and GDP. Generally, all the three counties will benefit from an FTA in terms of these macroeconomic variables. In this sense, establishing a trilateral FTA will be a win-win-win situation. The tariff reduction will stimulate bilateral exports among three countries. This is exactly the outcome expected by the enterprises in the three countries, as evidenced in the business survey introduced in the next section.
Table 1: The impacts on welfare and GDP of a trilateral FTA
Economic welfare gains (billion US$) GDP growth (%) China 4.7 - 6.4 1.1 - 2.9 Japan 6.7 - 7.4 0.1 - 0.5 Korea 11.4 - 26.3 2.5 - 3.1
The estimated magnitudes of the macroeconomic impacts on welfare and production are from two to three percent of GDP in China and Korea, and a half percent in Japan, depending on various assumptions and specifications. The simulation results are comparable to those in the cases of EU and NAFTA. The direct impacts of the FTA may appear modest in the long-run growth rates. However, the FTA and any other forms of regional trade arrangement will be essential to ensure free trade and investment in the region.
The simulation results indicate several important implications. First, any country excluded from the trilateral FTA will suffer welfare loss, if excluded from the trilateral FTA. The negative effect may reflect possible trade diversion (2). Second, the total macroeconomic benefit will be larger in the case of a trilateral FTA than any combinations of bilateral FTA. As for regional trade arrangements in East Asia, it is found that the largest gains to the three countries, as well as other countries in the world, are brought about from the largest-scale FTA, namely an FTA among China, Japan, Korea and the ASEAN countries. Third, the effects of capital accumulation, including FDI, are expected to bring about much larger benefit than the static, efficiency gains from trade liberalization in a trilateral FTA. Therefore, the effects of an FTA would crucially depend upon the improvements made to the investment environment such as the improving trading systems, enhanced transparency, promoting FDI and inducing domestic investment.
IV. Results of the Joint Business Survey
Objectives and Scope of the Joint Business Survey
The research teams conducted a questionnaire survey of business enterprises from April to June 2003. The objectives of the survey were to investigate: (i) the views of business enterprises with respect to a trilateral FTA among China, Japan and Korea; (ii) the expected effects of the FTA on regional integration in Northeast Asia, (iii) the strategies that would be adopted by business enterprises after the establishment of the trilateral FTA; and (iv) the desired policy measures to be adopted by the respective governments to promote regional economic integration, and the economic cooperation mechanisms to be set up between the three countries before the establishment of the FTA. This report concentrates on the first and fourth objectives, which have direct policy-related implications.
During the survey period, the same questionnaires, translated into local languages, were sent to 1,650, 1,920, and 2,461 business enterprises in China, Japan and Korea respectively. The enterprises were either listed large or medium- sized firms, or firms with trade or investment relations in one or both of the other countries concerned. Therefore, the survey is not an opinion poll, reflecting the opinions of all groups of the societies of the three countries. The number of valid responses was 203 (12.3 percent), 346 (18.0 percent) and 203 (8.2 percent) in China, Japan and Korea respectively. The rates of response appeared rather modest, and the results should be treated with a certain caution.
General Views on the Trilateral FTA
In general, a large proportion of the respondents supported the idea of establishing an FTA among China, Japan and Korea (Table 2). The percentage of respondents answering "Support" to this question was 85 percent in China, 79 percent in Japan, and 71 percent in Korea.
Table 2: Do you agree or disagree with the idea of an FTA among China, Japan and Korea? (Unit:%)
China Japan Korea Approval 85.3 78.7 70.9 Objection 1.5 5.9 13.3 Conditional approval or objection 13.2 14.2 15.8
The respondents who supported the FTA were then asked for their opinion on the most appropriate time to launch the FTA negotiations. An early launch of FTA negotiation was generally supported (Table 3). The percentage of respondents answering "The sooner, the better," or "Within 3 years" to this question was 83 percent in China, 79 percent in Japan, and 69 percent in Korea. Respondents in China were the most active in supporting the trilateral FTA and early negotiations, those in Korea were the most cautious, and those in Japan rested in-between the two positions.
Table 3: When would it be best to launch of the FTA negotiation among the three countries? (Unit:%)
China Japan Korea As an immediate action (as soon as possible) 47.4 46.7 23.6 Along a short-term plan (within 3 years) 35.9 32.5 45.8 Along a medium-term plan (within 5 years) 14.6 18.0 25.7 Along a long-term plan (within 10 years) 2.1 2.0 4.9
The survey asked a question on the reasons enterprises supported the FTA (Table 4). The highest percentage of respondents in all three countries chose the answer "Because an FTA will bring expansion of exports to the other two countries", with 70 percent in China, 67 percent in Japan, and 69 percent in Korea. The second highest answer in China was "Because of reduction in importation costs from Japan or Korea," while in Japan and Korea it was "Because of reduction in costs of customs and procedures".
Table 4: What is the reason of your approval? (Multiple answers) (Unit:%)
China Japan Korea The FTA will bring expansion of exports to other two countries 69.8 66.7 68.8 Reduction in cost of customs and procedures 55.7 66.7 51.4 Reduction in importation cost from other two countries 63.0 46.7 45.8 Reduction in transaction cost with affiliated or subordinated company in other two countries 14.6 38.0 22.2 The FTA will promote cultural and personnel exchange, therefore it brings about political stabilization of this region 47.4 20.4 34.7 The FTA will promote investment from other two countries 59.4 3.9 5.6 Benefit from specialization within three countries 48.4 29.0 26.4 Stabilization of import and (or) export prices 35.4 17.3 30.6 Other 3.1 2.7 1.4
The survey also asked a question on the reasons other enterprises objected to the FTA (Table 5). The highest percentage of respondents in China and Korea chose the answer "Because excessive external competition pressures in the domestic market will bring about our failures in business". In Japan, while the percentage of respondents choosing this answer was high, the highest percentage answered "Other reasons, such as hollowing-out of industries ".
Table 5: What is the reason of your eobjection'? (Multiple answers) (Unit:%)
China Japan Korea Excess external competition pressures at domestic market will bring our failure in business. 55.6 47.4 48.1 The FTA will bring de-industrialization; therefore it hinders economic growth. 3.7 63.2 22.2 I can't be certain whether partner countries obey the law such as intellectual property right. 40.7 57.9 18.5 Cultural and historical obstacles cannot be bypassed. 18.5 10.5 0 Other. 3.7 10.5 7.4
To determine the most urgent needs of the enterprises, a question was asked on the policy measures the respondents consider necessary to provide a framework for economic cooperation between China, Japan and Korea before the establishment of an FTA (Table 6). The survey found that "An economic cooperation mechanism that accelerates trade and investment in the region" was supported most strongly in all three countries. In Japan and Korea in particular, much lower percentages of respondents answered with other alternatives, including the promotion of information technology, the promotion of exchange of personnel and the development of human resources, and the improvement of environmental protection.
In addition, two policy-related questions were asked on the operation of an FTA: one concerned the expected structure of the FTA agreement, and the other concerned measures and systems to promote the establishment of the FTA. When asked the question "When the FTA is implemented, what policy measures do you expect to add to the clause?" the highest percentage of respondents answered that streamlining customs procedures was the most necessary (Table 7).
Table 6: If three countries agree to establish a regional economic cooperation mechanism before FTA, what type of the economic cooperation do you expect? (Multiple answers) (Unit:%)
China Japan Korea The economic cooperation mechanism that accelerates trade and investment in the region. 81.7 71.0 79.8 The economic cooperation mechanism that promotes development and transfer of Information Technology and industrial technology in the region. 68.6 43.8 35.0 The economic cooperation mechanism that promotes interchanges of personnel and human resources development. 52.9 35.2 28.1 The economic cooperation mechanism that aims to the improvement of environment protection. 39.3 21.3 17.2 Other 1.6 3.7 0 No reply 0 5.2 3.0
Table 7: When the FTA is implemented, what policy measures do you expect to add to the clause? (Multiple answers) (Unit:%)
China Japan Korea Streamlining custom procedures 75.7 81.8 49.3 Promotion of personnel exchange by exemption of visa, joint research, etc 69.43 44.1 24.6 Liberalization of Foreign Direct Investment 33.2 41.4 19.2 Reservation of anti-dumping tariff 45.1 15.1 14.3 Reservation of rules of safeguard 46.6 19.4 13.3 Nothing, because I object to the FTA 1.1 3.7 3.4 Other 0.5 1.5 3.4
With regard to the question "What policy measures and institutional systems should be adopted to establish an FTA?" the highest percentage of respondents in all three countries chose the answer "To consider, together with the FTA, establishing a Comprehensive Economic Partnership Agreement with elements such as facilitation of trade and investment and functional cooperation" (Table 8). The percentages of enterprises responding differently were low.
Table 8: What policy measures and institutional systems do you think that the governments of China, Japan and Korea must adopt in order to promote the establishment of the FTA? (Multiple answers) (Unit:%)
China Japan Korea To consider, together with the FTA, establishing the Comprehensive Economic Partnership Agreement, which includes elements such as facilitation of trade and investment, functional cooperation. 69.9 78.7 65.5 To establish a joint working group that carries out the consultations about enforcement the FTA 56.6 19.4 25.1 Leaders should express their commitments to the FTA. 42.7 36.4 11.3 To establish an extensive official, business and academic dialogue mechanism or forum among three countries 56.6 23.1 6.4 Nothing, because I object to the FTA 1.5 3.7 2.0 Other 1.5 1.2 0.5 I don't know. 0 4.9 1.5
The past several years have seen a continuing trend towards the intensification of trade and investment relations among China, Japan and Korea. Under the preliminary macroeconomic scenario discussed by this study, Northeast Asia, consisting of China, Japan and Korea, will become a major production and export base in the long-term, accounting for approximately one-fifth of world production and export. Thus, realizing the more efficient, transparent and liberalized business environment of the three countries will contribute to the regional economy as well as the world economy. To achieve this, it will be imperative for the three countries to promote the establishment of a free trade and investment system with fair, transparent and predictable rules in the region and in the world, or it will not be possible to fully absorb the increased product of the region.
According to the simulation, an FTA will bring about massive macroeconomic benefits to the three countries in terms of production, trade and economic welfare. The estimated results are comparable to those in the cases of the EU and NAFTA. The simulation results indicate that any country excluded from the trilateral FTA will suffer welfare loss and the total macroeconomic benefit will be larger in the case of a trilateral FTA than any combinations of bilateral FTA. While the direct impacts of the FTA may appear modest, approximately several percentage of GDP, the FTA with effective measures to ensure fair and transparent trade and investment rules will provide the three countries possibility of further economic growth. In addition, an FTA should not be taken as a means to block the economies from the outside. An FTA might then lead to trade diversion, as well as bringing about protectionist-oriented trade policies. Instead, any combination of FTA should be a building block, pursuing the final goal of global trade liberalization.
According to the business survey, most of the responding enterprises supported a trilateral FTA and its early negotiation. They mainly expected an expansion of the markets in the region. Before the establishment of an FTA, enterprises considered important an economic cooperation mechanism to accelerate trade and investment in the region. They also would like to see reduction of tariff and non-tariff barriers, facilitation of trade and investment as well as measures to ensure transparent and predictable trade and investment rules under an FTA. A large percentage of enterprises wished to add streamlining customs procedures, together with tariff reduction to the FTA.
Joint Policy Recommendations
The following are the policy recommendations made jointly to the leaders of China, Japan and Korea by the three institutions involved in the research program (3).
Establishment of a Research Agenda for a Trilateral FTA
According to the simulation, an FTA will bring about massive macroeconomic benefits to the three countries in terms of production, trade and economic welfare, in this sense, the establishment of a trilateral FTA will be a win-win-win situation. Given the perception of the respondent enterprises and the macroeconomic benefits expected, a sense of urgency should be shared by the governments of the three countries. For next year, it is recommended to deepen the joint research by conducting a sector-oriented study on a trilateral FTA with further examining policy and institutional aspects. The "Sector Impacts and Policy Study of a Trilateral FTA" will enable us to make concrete and realistic recommendations. The study next year will also contribute to identifying suitable arrangements that will accelerate trade and investment in the region.
Trade Facilitation and Improvement of the Environment for FDI
The business survey underscored a demand from the enterprises, before the establishment of a trilateral FTA, to further facilitate trade and improve the environment for FDI. The previous phase of the joint research recommended several concrete measures, including establishment of communication channels of laws and regulations, a training system for customs, inspection and quarantine institutions, establishment of a trade dispute early warning system, and improvement of business person mobility, and establishment of a platform or network of information exchange among the three countries. While some of the recommendations have been implemented, the governments are urged to consider the remaining measures to be realized.
Contribution to Tripartite Dialogue Including Academia, Business People and Government Officials in China, Japan and Korea
Recently, tripartite dialogue has emerged in various areas, including ministerial and official meetings, business fora, and academic conferences. Frequent and intensive exchanges under such dialogues will create the foundation to promote the integration of the three countries. To further strengthen the tripartite dialogue mechanisms, it is recommended that the representative institutions participating the trilateral research should actively cooperate with the tripartite dialogue mechanisms by providing of research inputs.
Further Development of the Long-term Economic Scenarios and Common Policy Agenda of the Three Countries
The three institutions identified the importance of sharing common views on the long-term scenarios for the three countries. The joint research project this year began with the preliminary discussion of a scenario for macroeconomic growth. The study of scenarios and the common policy agenda should be continued and further elaborated for the next several years. The scope should cover a wider range of common policies for the development of economies and industries, concerning areas such as information technology, standardization of technology, and standardization and conformity.
(2) In addition, enterprises whose country does not have an FTA relationship with its trading partner sometimes suffer from discriminatory treatments.
(3) The recommendations do not imply any official agreements between the governments of the three countries.
[ Executive Summary ]
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