China's emerging regional trade policy

The Authors

Longyue Zhao, The World Bank, Gaithersburg, Maryland, USA

Mariem Malouche and Richard Newfarmer, The World Bank, Washington, DC, USA

Acknowledgements

The views expressed in this paper are those of the authors, and not necessarily those of the institutions to which they belong. Discussions with Will Martin, Mona Haddad, Yan Wang, Jiayi Zou, Zhongxiu Zhao and two anonymous referees are gratefully acknowledged.

Abstract

Purpose – The purpose of this paper is to provide a timely review and analysis of China's regional trade agreements, its motivations, and its economic implications for Association of Southeast Asian Nations (ASEAN)-China Free Trade Agreement (ACFTA) member countries and other trading partners.

Design/methodology/approach – The paper uses the SMART model of the World Integrated Trade Solution to quantify the economic implications of the ACFTA on merchandise trade flows among member countries and other trading partners. Then, for comparative purposes, the impact of two possible paths beyond the ACFTA is simulated: an East Asia Free Trade Agreement (EAFTA) and the possible Doha Round multilateral trade liberalization.

Findings – The paper finds that, if regional and bilateral trade arrangement (RTA) were only concentrated in tariff reductions, the impact on trade flows would be quite limited. China's trade liberalization will bring the similar impacts to ASEAN in three of the scenarios modeled. Japan and Korea would get more market access to China if an EAFTA were to become reality. Only in a multilateral liberalization would all RTA member countries and the rest of the world benefit.

Research limitations/implications – Three limitations are noteworthy. First, these types of models capture only static gains from trade. Second, the simulations do not include services liberalization, which could readily provide benefits in several multiples of merchandise trade, and third, it is assumed that full removal of all border barriers at once, in a multilateral scenario, would be of illuminating heuristic value but is unlikely to occur in reality.

Originality/value – The paper demonstrates the wisdom of China's simultaneous pursuit of unilateral, regional and multilateral liberalization – because the wider the trading group involved in the liberalization, the more China and its partners will benefit. The tariff reductions in RTAs will have limited effects on expanding merchandise trade, especially when compared with comprehensive and multilateral liberalization agreements.

Article Type:

Research paper

Keyword(s):

China; Trade; Economic performance; South East Asia; Free trade; Trade associations.

Journal:

Journal of Chinese Economic and Foreign Trade Studies

Volume:

Number:

Year:

2008

pp:

21-35

Copyright ©

Emerald Group Publishing Limited

ISSN:

1754-4408

1. Introduction

China has been among the fastest growing economies in the world since it began the process of economic reform and liberalization in the late 1970s. With an average annual growth rate of over 9 per cent for the last two decades, China's output reached $2.65 trillion in 2006. Total trade grew to $1.76 trillion, making China the world's third largest trading country, only after the USA and Germany.

Its growing reliance on international trade gave China an interest in international trading rules. After joining the WTO in December 2001, China has progressively implemented its commitments. These included among other things substantial reductions in most fovored nation (MFN) tariffs, progressive liberalization of services and increased protection for intellectual property. Moreover, China has become an active participant in the WTO Doha Round Negotiations.

While much remains to be done on the multilateral agenda, China's involvement in regional and bilateral trade arrangements (RTAs) has been relatively recent. While China formally participated in the APEC in early 1990s, it proposed its first regional trade agreement with Association of Southeast Asian Nations (ASEAN) in November 2001. In the subsequent five years since, China has launched a flurry of RTA negotiations that – counting those completed or in process negotiation – cover trade with more than 30 economies around the world.

This paper reviews those agreements and takes up three questions. What are the key motivations of Chinese authorities in pursuing regional trade agreements? What are the key characteristics of the agreements and how do these compare with agreements of other OECD countries? Finally, what are the economic impacts of these agreements? To answer these, the following section of this paper reviews China's RTA activities, the allure of RTAs; and the key provisions of the agreements in a comparative context with broader RTA and multilateral arrangements. The third part quantifies their economic impacts on trade flows and regional economic cooperation, and the final section presents conclusions with some policy suggestions that might help China and its trading partners to achieve their objectives.

2. China's recent surge in regional trade agreements

2.1 From multilateralism to regional agreements

China's participation in the world market is a relatively recent phenomenon. As recently as 1990, China's imports and exports amounted to only $104 billion, about 30 per cent of its gross domestic product (GDP). However, after 1992, the government progressively liberalized trade in a series of measures – including the progressive reduction of MFN tariffs from 42.9 to 9.8 per cent and reduction in the coverage of non-tariff barriers to less than 10 per cent of imports (Ianchovichina and Martin, 2001). By the time of it formally joined the WTO in 2001, trade had already reached $570 billion.

After the launching of the Doha Development Agenda in November 2001, China has participated in the negotiations, but has not assumed a leadership position among the various coalitions. Even as it participated in the multilateral round, the government sought to establish new bilateral and regional trading arrangements with other countries. A first foray was the initiation of trade negotiations with ASEAN in November 2001. Since then it has begun a dozen more negotiations (Antkiewicz and Whalley, 2004; Lawrence, 2006).

Today, China has bilateral or plurilateral arrangements covering more than 13 economies, covering about one-fifth of its total trade (Table I). However, because half of the covered trade is with Hong Kong and Macau, it would be easy but misleading to imply that these agreements cover a significant chunk of its “real” external trade. Aside from trade with the special administrative regions, it is the agreement with ASEAN that matters – and it covers 9 per cent of China's total trade. The agreement with Chile covers only less than 1 per cent of China's trade.

Besides that, the China–Pakistan FTA had been signed in November 2006, and was in force in 1 July 2007. The negotiations surrounding China–Australia, China–New Zealand and the China–Gulf Cooperation Council (GCC) FTA have also made significant progress. The China–Iceland FTA has been started the negotiation[1].

Moreover, China is actively pursuing new trade arrangements. In Northeast Asia, China is currently holding discussions with Korea and Japan to study the feasibility of establishing a bilateral or trilateral FTA, and the idea of a greater “East Asia Free Trade Agreement (EAFTA)” that would comprise all 13 major economies in East Asia[2]. The feasibility studies between China and India, China and the Southern African Customs Union (SACU) are also under the way.

With respect to Sri Lanka and Bangladesh, though they are not considered in forms of FTA, they are included in the greater cooperation framework of the Asia-Pacific Trade Agreement (APTA) with China[3]. To the north, China is a member of the Shanghai Cooperation Organization along with Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan. The group signed a Framework Agreement to enhance economic cooperation in 2003 and has proposed a long-term objective to establish a free trade area. China is also a member of the Central Asia Regional Economic Cooperation (CAREC) Program[4].

2.2 The allure of RTAs

Much as with their counterparts in the USA and EU, a quick perusal of Chinese agreements reveals no single overriding motivation but rather a complex array of various economic and political rationales. ASEAN, Chile, Australia and New Zealand, GCC and SACU have quite different economic structures and geo-political significance.

Economic motivations are a likely driver of China's growing interest in RTAs. On the one hand, the government is willing to phase in import competition to drive domestic productivity, a main motivation for China's accession to the WTO. From the perspective of authorities worried on the costs of adjustment, RTAs have the appeal of providing market access to a limited numbers of competitors, so opening can be progressively calibrated to the capability to withstand the winds of competition. On the other hand, RTAs provide a mechanism to lock in preferential market access to selected economies, a strategy that has allowed Mexico and Chile to use bilateral FTAs with their trading partners to guarantee tariff-free access for more than 70 per cent of their respective exports. RTAs also provide a mechanism to build trading relationships with suppliers of energy and resources, necessary to fuel China's growth.

Strategic considerations undoubtedly also play a role. One strategic consideration is a reaction to the RTA activity of other countries, notably the USA and those of the EU, but also increasingly large developing countries, such as Mexico, India and Brazil. To the extent that trading partners of China are entering into FTAs that exclude it, China has an interest in adopting an assertively defensive strategy of signing RTAs with those countries to avoid losing global market share. In fact, the USA, aside from Canada and Mexico, has not yet established large RTAs, though its FTA with the Americas could have been important. The EU has cast a wider net, and indicated recently that it would pursue a new round of FTAs in 2007. In one sense, China would be remiss if it did not mimic this behavior.

A second strategic consideration is access to resources. China became a net importer of oil products in 1993. Now China is the world's third largest crude oil importer after the USA and Japan. In 2005, China imported 127 million tons of crude oil about 40 per cent of its oil consumption. Since most of the world's oil reserves lie in the Middle East region (57 per cent) – more specifically in Saudi Arabia, Iran, Iraq, Kuwait and the UAE – it is natural that China (like other major importers) has sought to built a broad relationship with this region. Similarly, China is also the largest importer of metal sand and scrapped metal, like copper. China is Chile's second largest trading partner, with copper contributing to 30 per cent of its imports from Chile, and 50 per cent of China's imported copper comes from Chile. Setting up RTAs with resource-exporting countries buttresses existing relationships and is conducive to ensuring adequate supplies.

Other considerations are regional. Strengthening economic and trade cooperation with surrounding countries, especially by establishing systematic regional cooperation mechanisms, is an important element of Chinese foreign policy. During the Asia crisis of 1997-1998, China rapidly provided support to the victim countries in the form of providing unconditional loans, which greatly improved China's reputation in the region. The Asian countries also realized the importance and urgency to strengthen the regional cooperation with China. While various rationales drive RTAs around the world, politics in most cases is as important as economics – and in this China is no different than other countries (World Bank, 2005).

To these considerations must be added bureaucratic imperatives. The job of trade negotiators is to negotiate, and, especially if multilateral negotiations are in hiatus, bilateral or plurilateral agreements are an attractive alternative to closing shop. In this Chinese bureaucracies share the same motivations as their counterparts in the EU, USA, Mexico and other countries. Moreover, RTAs are far easier to negotiate than are multilateral agreements, and subsequent implementation may be far less onerous (especially in services and the rules agenda).

Finally, trade disputes are arguably more easily remedied. Accession to the WTO left China short of its goal of full non-discrimatory access to the markets of its major multilateral trading partners. Several discriminatory provisions against Chinese products were embedded in the terms of accession. One is “non-market economy” provision. According to the Protocol on The Accession of the People's Republic of China, WTO Members are permitted to treat China as a non-market economy for the first 15 years of China's membership. This means that trading partners can impose higher anti-dumping duties in trade remedy cases against Chinese products with a much lower standard of proof than for other WTO members. As the USA and the EU have deployed anti-dumping cases against Chinese products, the Chinese government has begun to use its full arsenal of diplomatic, financial and trade incentives to win the support of third countries in its campaign for treatment in the WTO as a full market economy (Zhao, 2004).

In addition to other incentives, the prospect of preferential access to the world's largest and fastest growing market is a powerful incentive to win support.

3. Economic consequences of ACFTA: results and prospects

Because the agreements to date – other than those with Hong Kong and Macau – cover less than 10 per cent of China's merchandise trade, they cannot be expected to have much impact in creating new trading opportunities. However, China has embarked upon a more ambitious agenda, and if it were to conclude agreements with the more than 30 economies in the world it is now negotiation and if nearly all products and services were to be covered, they could eventually cover as much as half of China's international trade (Table I). This would subsume virtually all trade other than that with the USA and the EU.

The ASEAN–China FTA is a potentially important milestone of regional economic integration in the East Asia. Relations between China and ASEAN have undergone significant changes over the past 15 years after China first established official contacts with the original ASEAN-6 in 1991. In the early 1990s, ASEAN's trade with China was relatively small, as compared with China's other major trading partners like the USA, the EU and Japan. However, trade between ASEAN and China has been growing fast, especially after the 1997 Asian Financial Crisis. China–ASEAN trade grew annually by 23 per cent from 1998-2005 and reached to US$130.5 billions in 2005. The share of ASEAN in China's imports went up from 9.0 to 11.4 per cent and the share in its exports rose from 6.1 to 7.3 per cent between 1998 and 2005. China and ASEAN has now been the fourth largest trading partner of each other, ASEAN has now become the fifth largest export market and the third largest importing source of China (Cordenillo, 2005).

However, the variety of China's imports from the ASEAN smallest economies is limited. At the six-digit level of Harmonized System classification, China imports only 15 kinds of products from Brunei (essentially oil) and 165 from Myanmar by contrast to the more than 2,000 products it imports from Malaysia, Singapore and Thailand. Chinese exports to ASEAN are somewhat more diversified (Table II).

China and ASEAN reached the Agreement on Trade in Goods (TIG) to reduce tariff on merchandise trade in 2005. The ACFTA TIG covers tariff-lines representing more than 95 per cent of China–ASEAN trade, which is expected to further promote bilateral trade and to reach $200 billions by 2010. Then ASEAN will be the world's third largest free trade area after the EU and North America Free Trade Aggreement (NAFTA), with a combined population of 1.8 billion and GDP well exceeding US$2 trillion.

There is some debate on whether ACFTA will lead to further trade expansion between China and ASEAN. Stefano Inama argued that there are indications in the legal texts of the ASEAN–China FTA that the agreement may not fulfill such expectations and would not result in significant trade liberalization (Inama, 2005; Wong et al., 2006). Some scholars from ASEAN Member States also share this view such as Tambunan from Indonesia (Tambunan, 2006). Moreover, both China and ASEAN members apply low MFN tariffs on their imports and, therefore, the impact of lower preferential rates would have limited liberalizing effect. Members of the agreement have also the possibility to shield temporarily up to 200 products for which the tariff reduction is longer.

In this section, we use the SMART model of the World Integrated Trade Solution (WITS) (see Appendix) to analyze the implications of the ASEAN-China FTA on merchandise trade flows between ASEAN and China. Then, for comparative purposes, we simulate the impact of two possible paths beyond the ASEAN-China FTA: the implications of joining Japan and South Korea to form the East Asia Community; and the effect of going multilaterally and capping the MFN rates to 20 per cent (as currently discussed in the context of the Doha round)[5].

3.1 Trade creation effects of ACFTA

ACFTA is an agreement gradually liberalizing TIG, which started with a Framework Agreement on comprehensive economic cooperation in general, and the Early Harvest Program especially in 2002, ACFTA TIG Agreement was implemented in July 2005, and the 95 per cent tariff lines will be eliminated until 2010-2015, except few tariff lines listed in their sensitive tracks. In this study, we have first simulated the trade effects of China's full liberalization of its TIG with the ten members of ASEAN by assuming that China will eliminate all import tariffs and provide duty free access for all products from ASEAN countries.

Results indicate that even a full liberalization would only lead to a limited increase of intra-region trade and some trade diversion with other neighboring countries. China's imports from ASEAN would rise by US$5.4 billion, or 7.2 per cent, the largest increase in dollars being recorded with Singapore, Thailand and Malaysia. A smaller amount of trade would be diverted from the other China's trading partners. The largest losers are Korea and Japan. Overall, China's world import would increase slightly, by 0.5 per cent (Table III).

In a second step, we simulate the trade impact of ASEAN members' full trade liberalization vis-à-vis China by assuming that ASEAN countries will give duty-free access for all products from China (Table IV). Overall, imports of ASEAN from China would rise by US$5.6 billion, or 10 per cent increase. The largest gains for China would result from higher exports to Vietnam, Indonesia, Thailand and Malaysia. After taking into account the trade diversion effect, ASEAN overall import would increase by 0.8 per cent.

As a matter of fact, the trade flow between China and ASEAN is unlikely to reach these magnitudes because of the coverage of ACFTA, many products and services are likely to be excluded from the agreement, rules of origin may also be restrictive, and implementation periods can be exceedingly long. These elements mean their economic consequence is likely to be circumscribed.

China–ASEAN trade has increased faster relative to other trading partners. This is also due to the fast expanding bilateral investment (Ohashi, 2006). Recently, ASEAN countries invested approximately $3 billion in China annually, and the accumulated real investment in China reached to $38.5 billion by the end of 2005. Though Chinese enterprises started late in making investment in ASEAN countries, it is growing rapidly. By the end of 2005, Chinese enterprises had signed various labor contracts with ASEAN countries totaled $35 billion, and have completed value of $23.2 billion[6].

3.2 Trade liberalization beyond ACFTA

Beyond ASEAN, China's major trade liberalization initiatives in the future would consist in concluding bilateral agreement with Japan and Korea, and apply the tariff cuts that a Doha deal will eventually entail.

In East Asia, intra-regional trade has expanded faster than extra-regional trade and accounts for more than half of East Asia's trade (Zhai, 2005; Gill et al., 2006). With China being a key player in the region, experts have suggested that ACFTA may be the first step for China in creating an economic counterforce to the USA and the EU. It will likely lead to the negotiations and conclusion of an EAFTA, including Japan and Korea. Some other scholars have also discussed the possibility of a larger grouping, the Asian Union (Gresser, 2004; Hufbauer and Wong, 2005).

From a Chinese perspective, this is possible. Chinese Vice-Premier Wu Yi stressed the significance of the Sino-Japanese economic relations and called for a bilateral FTA and active ties when she visited Japan in 2005. Wu noted that the economic ties are growing both intensively and extensively and developing into a win–win situation. Stressing there are more reasons for co-operation than for competition in the future, Wu brought forward a proposal to speed up the building of the Sino-Japanese FTA (China Daily, 2005).

China has also urged the conclusion of an FTA with South Korea in order to boost the burgeoning trade and investment between the two countries. Chinese Commerce Minister Bo Xilai met with his South Korean counterpart Chung Sye-Kyun and stressed the need to push forward FTA talks. South Korea and China have agreed to make efforts to double the bilateral trade to reach US$200 billion yearly by 2012[7].

The elimination of China's tariffs on imports from ASEAN plus Japan and Korea translate in similar trade creation vis-à-vis a full implement of ACFTA (about 7 per cent increase) and even larger expansion of trade with Japan (15 per cent) and Korea (14 per cent). Trade diversion is also higher. China Taiwan, Germany and Sweden are likely to suffer the most in percentage change (Table V).

China will totally increase export by $19 billions to other EAFTA partners, increased by 5.79, 8.97 and 4.4 per cent to ASEAN, Japan and South Korea, respectively (Figure 1).

3.3 Welfare impact of multilateral trade liberalization

In the third scenario, we assumed that China will not only provide duty-free access for all products from ASEAN countries, but also cap its MFN tariff rate to 20 per cent for all trading partners, that is to reduce its MFN tariff rate to 20 per cent if it is great than 20 per cent, and keep it no change if it is less than or equal to 20 per cent. Then we found that the trade creation will be larger and diversion will be lesser than the full implement of ACFTA and EAFTA. In this scenario, China's import will be increased to $8 billion, of which $5.2 billion from ASEAN and $2.8 billion from the rest of the world. The trade diversion will be decreased to $71 million, much less than ACFTA and EAFTA. The net increase of China's import from the world is $7.9 billion, increased by 1.2 per cent (Table VI).

To sum up the three scenarios, we have found that China's trade liberalization will bring the similar impacts to ASEAN in the three modalities. Japan and Korea will get more market access to China in modal II, EAFTA. Only in modal III, will a multilateral liberalization bring all positive benefits to RTA partners and the rest of the world (Figure 2).

Similar conclusions arrived in a previous research by Newfarmer and van der Mensburgghe (2005). They used a general equilibrium framework and looked also at three scenarios in their paper. They found that only multilateral agreements would bring the most benefits to ASEAN and China compared with bilateral or regional agreements. They compared income gains to East Asia in a multilateral liberalization with gains from an East Asian-wide accord. Under this reform scenario, the global gains in 2015 for East Asia amount to $22 billion, or an increase of 0.6 per cent in baseline income. If ASEAN were to form a preferential trading bloc – roughly approximating the ASEAN plus three formulation – and countries in the Americas or Europe fail to form parallel regional arrangements, gains to East Asia would be about $11.6 billion, or 0.3 per cent of 2015 income. However, the gains would substantially unravel if other regions form similar blocs. The simulations also indicate that China could actually lose from an ASEAN plus three arrangements. It fares better under an arrangement with ASEAN alone, though it would still benefit more from a full multilateral agreement (Newfarmer and van der Mensburgghe, 2005; Menon, 2006).

Finally, three broad caveats are noteworthy. First, these types of models capture only static gains from trade, in the sense that they do not purport to model productivity effects or technological progress associated with trade. Second, the simulations do not include services liberalization, which could readily provide benefits in several multiples of merchandise trade. Third, we assume full removal of all border barriers. This is tenuous for multilateral arrangements because we know the Doha Round even under the most optimistic of assumptions will yield only a portion of the possible liberalization, but the assumption is even more stringent for regional arrangements because many products are excluded and rules of origin often restrict access. The first two assumptions tend to underestimate the results, while the latter tends to produce overstatement of the results. In any case, the purpose is to assess relative interactions among the variables and get a broad idea of orders of relative magnitudes of gains.

4. Conclusion

For a variety of economic and strategic reasons, China is embarked on a new and potentially ambitious program of regional trade agreements. This analysis points to several conclusions: First, the agreements concluded to date have had limited effects on expanding China's overall exports. This is because they cover a relatively small portion of trade, are limited to merchandise trade, and have long periods of implementation.

Second, as with other countries, RTAs are unlikely to supplant China's abiding interest in multilateral liberalization. Even more than most countries, China has an interest in maintaining the multilateral system and expanding the system of global rules because, as a labor-intensive exporter rapidly expanding market share, it is unusually subject to anti-dumping claims, and these are best disciplined through multilateral rules. This suggests care must be taken to ensure that Chinese trade negotiators focus on the big game in town, namely the WTO negotiations, and do not get distracted by bilateral or even plurilateral negotiations.

Third, even as the government pursues these arrangements, it should concentrate on selecting as partners large market countries while at the same time striving to widen the scope of RTA coverage (particularly with respect to services and agriculture), so as to raise the incentives in particular negotiations to put “more liberalization on the table” and to widen the scope of potential benefits. The East Asian community is prospectively interesting in this regard. In fact, it may be easier to negotiate because few of the major parties have an interest in agriculture or rules, sectors that have weighed down the WTO negotiations.

Finally, China continues to have an interest in unilateral liberalization that should not be overlooked. It is easy to get locked into mercantilist mindset that sacrificing defensive interests for offensive gains involves “losses” – when in fact negotiators are trading bad policies and getting a double win–win. Lowering protection unilaterally – as China did to its great benefit in 1992-1998 – can still produce additional income and productivity gains for the economy irrespective of the actions of other countries.

Notes

Iceland is the first European developed country which recognized China's full market economy status and is the first European country negotiating FTA with China. The first round of China–Iceland FTA Negotiation was held in Beijing on April 2007.
Besides the idea of a greater “East Asian Free Trade Agreement”, there are some other conceptions proposed also, such as “East Asian Economic Community”, “East Asian Common Space” and “Pan-Asian Comprehensive Economic Partnership”, While Asian scholars and experts support a closer East Asian regionalism, some American experts have the different opinions. See Bergsten (2006).
APTA (formerly known as Bangkok Agreement) was signed in November 2005, and came into force on 1 July 2006. The six member countries are Bangladesh, China, India, Lao People's Democratic Republic (Lao PDR), Republic of Korea and Sri Lanka.
CAREC was initiated in 1997, aimed at improving living standards and reducing poverty in CAREC countries through more efficient and effective regional economic cooperation. The CAREC Program includes eight countries in the Central Asia region Afghanistan, Azerbaijan, China (focusing on Xinjiang Uygur Autonomous Region), Kazakhstan, Kyrgyz Republic, Mongolia, Tajikistan and Uzbekistan.
Some other quantitative studies see Park (2006) and Saygili and Wong (2006).
Gao Hucheng, China's Vice Minister of Commerce, Press Conference on the 15 Years Anniversary of China–ASEAN Bilateral Dialogue Relationship, 6 September 2006, available at: www.gov.cn/zhibo13/wzsl.htm
See China Daily (2006). China–South Korea FTA feasibility study has now been undertaking.

Figure 1EAFTA impact on trade flows in its partners

Figure 2FTA impact on China's import: a comparison among the three scenarios

Table IChina's merchandise trade with main partners in 2005 (billion US$)

Table IITrade indicators between China and ASEAN

Table IIITrade impact of China's full liberalization of merchandise imports from ASEAN (Million USD)

Table IVTrade impact of ASEAN full liberalization of merchandise imports from China (Million USD)

Table VTrade impact of China full liberalization of merchandise imports from ASEAN, Japan and Korea (Million USD)

Table VITrade impact of ACFTA and China's MFN cap to 20 per cent (Million USD)

References

Antkiewicz, A., Whalley, J. (2004), "China's new regional trade agreements", National Bureau of Economic Research, Cambridge, MA, NBER working paper 10992, .