On January 1, 2010, the China-ASEAN Free Trade Agreement (CAFTA) came into force, part of the Chinese government’s effort to promote the idea of trade liberalization as well as to facilitate the development of the country’s southwestern region. The new FTA includes China and the Association of Southeast Asian Nations’ 10 member countries, covering a population of 1.9 billion and involving about US$4.5 trillion of trade volume. However, implementation won't be easy, and anxiety over China’s growing clout in world trade is on the rise in countries like the U.S. and Japan.
Knowledge at Wharton Staff
On January 1, 2010, the China-ASEAN Free Trade Agreement (CAFTA) came into force, part of the Chinese government’s effort to promote the idea of trade liberalization as well as to facilitate the development of the country’s southwestern region. The new FTA includes China and the Association of Southeast Asian Nations’ 10 member countries, covering a population of 1.9 billion and involving about US$4.5 trillion of trade volume.
CAFTA will allow 90% of all goods — that is, around 7,000 items traded between China and ASEAN countries — to be zero-tariff. Meanwhile, by 2015, duties on other “highly sensitive” commodities will be cut to no more than 50%, which would include toilet paper in China, popcorn in Indonesia and snowboard boots in Thailand.
“Clearly, China is hoping that the implementation of the China-ASEAN free trade area could serve as an impetus to promote regional trade liberalization, at least between China and the ASEAN countries, especially since the recent multilateral trade negotiation under the WTO auspices — the Doha Round — went into an impasse,” notes Zheng Hui, a finance professor at Fudan University in Shanghai. “However, China is now facing a great challenge in getting the agreement formally implemented, since the trade structure between China and the ASEAN countries is mainly competitive rather than complementary.”
On the other side of equation, there are growing anxieties from ASEAN countries on the prospects brought by the implementation of CAFTA, and there are concerns from other countries, such as Japan and U.S., about the growing clout of China in world trade.
Help Wanted
The idea to establish CAFTA was first proposed in 2000 by China’s Prime Minister Zhu Rongji. The initial framework agreement was signed two years later in Phnom Penh, Cambodia, with the intention of gradually reducing tariffs on tradable commodities. In addition to fostering regional trade liberalization, another incentive for China to push CAFTA was that China wants to make its underdeveloped western region a more attractive international trade hub.
“The central government’s decision to propose CAFTA in 2000 was strongly driven by the provincial government leaders in the southwest, mainly Guangxi, Yunnan, Chongqing and Sichuan,” says Zheng. “Compared to the coastal cities in eastern China, such as Shanghai and Guangzhou, the internal logistics cost is much higher for the inner western regions. With profit margins of less than 5% for exports, the goods produced in the inner southwest lost their price competitiveness when Japan and the U.S. became trading partners. Against this backdrop, the only alternative is the neighboring ASEAN countries.”
“Facilitating the construction of highways in southwest China is evidence of Beijing’s intention to reduce the internal logistics cost in the region,” notes Wang Yizhi, professor of information science at the Shanghai Academy of Social Sciences. He anticipates that with the implementation of CAFTA, the southwest would benefit the most because of its geographic proximity to neighboring trading partners, such as Laos, Vietnam and Cambodia. On top of that, he says, provincial leaders in Guangxi and Yunan are also lobbying Beijing, hoping that Beijing authorities will allow the two provinces to become a pilot area to settle cross-border trade deals in renminbi. “That would push the development of a closer trade relationship between China and ASEAN countries, because transaction costs in trade would fall even further,” he notes.
But what’s in it for the ASEAN countries, as they open the door wider to “Made in China” goods? Among the ASEAN members are four of China’s major trading partners: Singapore, Malaysia, Indonesia and Philippines. “Singapore has always been a firm supporter of trade liberalization, and most of the tariff is already near zero,” says Zheng. Malaysia also has a trade surplus with China, thanks to its raw materials exports.
It’s a different story with its other two trading partners. “China and ASEAN countries both specialize in producing low-cost manufactured goods,” notes Zheng. “If the tariff of most of the tradable commodities is down to zero, the high-tariff industries such as textiles and electronics in Indonesia and the Philippines would be hit hardest by the blitz of low-cost Chinese manufacturing goods.”
For that reason, there is a strong opposition to the implementation of the FTA in Indonesia. The government has sought to soothe concerns that industries including textiles, iron and steel as well as electronics would suffer from the onslaught of cheap Chinese imports. Indonesia has notified the ASEAN council of its plan to modify the implementation of the FTA by renegotiating 228 tariff categories in eight sectors to offer local industries more time to prepare for the flood of cheap Chinese imports.
Prior to 2009, China-ASEAN trade expanded rapidly, with volume skyrocketing from US$78 billion in 2003 to US$231 billion in 2008. However, China-ASEAN trade in 2009 shrank 8% from the previous year, to US$212 billion, and it is expected to fall further this year.
The major goods China imports from ASEAN countries are intermediary goods, such as machinery, minerals and fuels, plastics, fats and oils, rubber and organic chemicals. According to Charles Freeman of the Center for Strategic and International Studies, a Washington, D.C.-based public policy research institute, and a former assistant U.S. trade representative for China affairs, “China uses these goods to produce low-cost products and sell them mainly to the United States and the European Union,” which were hit by the economic downturn. Freeman adds that the future trade pattern between China and ASEAN countries will mainly rely on “whether China could increase its role as a consumer to absorb the goods it produces.” With limited domestic demand, if China continues to be vulnerable to the external economic shocks, “further collaboration on trade issues between China and ASEAN countries would become more difficult,” says Freeman.
Worried Bystanders
Trade liberalization between China and the ASEAN countries is also under pressure from Japan and South Korea. Currently, the regional trade framework in East Asia — called “10+3” — is based on setting up free trade zones with Japan, South Korea and China. “Japan and South Korea are eager to integrate ASEAN countries into their political sphere,” notes Wang from the Shanghai Academy of Social Sciences. “For instance, the Japanese government has always tried to integrate ASEAN countries into its manufacturing system, which is much easier since the trade pattern between Japan and ASEAN countries is mainly complementary, because Japan specializes in producing high-tech electronic products and ASEAN countries produce intermediary and low-cost manufacturing goods. With the implementation of CAFTA, there is a growing fear in Japan that ASEAN countries will gradually become China’s backyard.”
On the part of ASEAN countries, there is growing nervousness that ASEAN nations would become China’s backyard due to China’s rising role in East Asia. Reportedly, every ASEAN nation leader to sit with President Obama during his Asia trip asked questions about trade, and they all hope for a more active American presence in the region to strike a balance, so that the ASEAN nations would not be pulled into a China-dominant landscape.
Meanwhile, the U.S. could also find itself in a more disadvantageous trading position because of CAFTA. “If China has better market access to ASEAN countries, it would put the United States at an economic disadvantage,” says I.M. Mac Destler, a professor at the School of Public Policy at the University of Maryland, College Park. However, he adds, a lot “depends on how fully CAFTA is implemented, how complete it is and whether it would involve Korea and Japan and finally become an East Asian Free Trade Agreement.”
“The United States should not oppose the trade initiatives China is taking, but needs to look to be part of them. Moreover, the U.S. should start its own FTA initiative, building on the Trans-Pacific Partnership negotiations, which include the U.S., Singapore, Vietnam, Australia and New Zealand.” However, Destler notes that whether the Obama Administration could launch its own FTA initiatives depends on “whether the administration could push the Congress to renew the Trade Promotion Authority.”
The Trade Promotion Authority was an act that allows the Congress to grant the U.S. president the authority to negotiate FTAs. After an FTA deal is closed by the Executive Branch, Congress must vote on it within a certain time frame without amendments. The authority expired in 2007 without being renewed by Congress. Without it, even if U.S. trade representatives could successfully negotiate an FTA deal with other countries, Congress could “put the deal on the shelf” without voting forever.
Ambassador Susan Schwab, a former trade representative under the George W. Bush Administration and a professor at the School of Public Policy at the University of Maryland, College Park, notes that CAFTA makes China less interested in the Doha Round, the multilateral trade negotiation within the WTO Framework, because it is now finding it much easier to negotiate regional FTAs.
Schwab suggests that such regional agreements can have a negative impact on the U.S. and on smaller developing countries. She predicts that U.S. workers would suffer to the extent that U.S. multinational companies with branches both in the US and in ASEAN countries could now be forced to produce and sell goods from their plants in ASEAN countries to stay competitive. She also notes that small- and mid-sized companies (SMEs) in the U.S. would be negatively affected, since multinational companies could invest behind the external tariffs of the regional agreements and continue their trade with China and the ASEAN countries, while SMEs could not.
As to what strategies the U.S. should take, Schwab says first, it should continue pushing hard to breakthrough the Doha Round, and encourage China and other developing countries to actively participate into the multilateral trade negotiations. Second, the Obama Administration should push the Congress on the passage of pending FTAs with South Korea, Peru, Columbia, and accelerate the negotiation of new FTAs between U.S. and other East Asian Countries. However, Schwab also points out that the Obama Administration is facing political obstacles in adopting those strategies due to the Administration’s close tie with the labor unions, which oppose the trade agreements.
Freeman at the Center for Strategic and International Studies states, “The idea of trade liberalization is unpopular here in the United States. If ASEAN countries do become China’s backyard, the United States might be more aggressive in promoting its trade agenda within East Asia. However, there is not a whole lot that the United States can do unless it fundamentally alters its political strategy.”
