doi: 10.1111/j.1748-3131.2006.00024.

x Asian Economic Policy Review (2006) 1, 215234

Regional Integration in East Asia:

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Achievements and Future Prospects

Hadi SOESASTRO
Centre for Strategic and International Studies

Economic integration in East Asia has been largely market driven. Attempts in the late 1980s to
establish an East Asian regional economic grouping failed to materialize for a number of reasons.
The financial crisis in 1997 1998 has strengthened the realization of regional countries that they
need to have some self-help mechanisms to overcome that crisis and to prevent future crises. This
led to the development of several functional integration programs, including the network of bilateral
swap arrangements known as the Chiang Mai Initiative. However, progress remains slow. The
question that has arisen is how far these efforts need to be supported by institutional integration.
Should the ASEAN Plus Three, the main regional cooperation process in East Asia involving the
10 South-East Asian countries plus China, Japan, and South Korea, be deepened institutionally?
Meanwhile, the region has seen the establishment of a new process, the East Asia Summit, involving
the above 13 countries plus Australia, India, and New Zealand. How will these different
arrangements contribute to East Asias economic dynamism and prosperity as well as peace and
political stability?

Key words East Asia, functional integration, institutional integration, market integration,
regionalism

1. Introduction
The rise of East Asia began to unfold at the end of the twentieth century when East Asian
countries embarked on regional dialogue processes to promote and manage economic
interactions among themselves and with the world economy. This did not come out of
the blue. East Asian countries have achieved remarkable progress in their economic
development over the past quarter century, rapidly increasing their economic interactions
intraregionally and with the rest of the world. Economic growth in the region occurred in
a sequential fashion. Following Japans footsteps, the economies of South Korea, Taiwan
(Chinese Taipei), and Hong Kong graduated to become newly industrializing economies
(NIE). They were followed by a number of South-East Asian countries and China. The East
Asian story was about the emergence of a dynamic regional division of labor. In the late
1980s, predictions were made that by the turn of the century, East Asia would consist of
NIEs and near-NIEs. It was not all smooth sailing as the region was hit by the financial
crisis in 19971998. If anything, the crisis provided a major stimulus to East Asians to
contemplate the creation of a regional arrangement. They have come to realize that they
now have a greater stake in the world economy, and that they share a common interest in
sustaining their growth and development through regional cooperation and integration.

Correspondence: Hadi Soesastro, Centre for Strategic and International Studies, Jalan Tanah
Abang III/23-27, Jakarta 10160, Indonesia. Email: hadisoesastro@gmail.com; hadi_s@pacific.net.id

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Regional Integration in East Asia Hadi Soesastro

Regional integration can happen or be pursued along the following three processes,
which may have some overlaps. They are: (i) market integration that can happen more or
less spontaneously; (ii) functional integration that involves the adoption of various liber-
alization and facilitation as well as development cooperation (capacity building) efforts in
a coordinated or concerted fashion with the aim of promoting further market integration;
and (iii) institutional integration that involves the setting up of mechanisms or organiza-
tions that will move and deepen the process of regional integration (Pascha, 2004). This
paper is organized along these different processes (or phases) of integration. It concludes
with some speculations on the direction of East Asian regionalism.

2. Market Integration
East Asian integration has been largely market driven. Trade and investment, particularly
foreign direct investment (FDI), have been the main drivers. Market integration is the least
controversial among the three processes of integration. This is so because the positive
welfare effects to the parties engaged in free and open exchanges are quite straightforward.
It is not immediately clear how best to measure the degree of market integration. Most
studies have looked at the growing share of intraregional trade to total regional trade as
indication of market integration. Ng and Yeats (2003) proposed that East Asias intra-
regional trade has increased because the East Asian countries appear to be natural trading
partners. They also pointed out that the increase in trade intensity indices was also accom-
panied by the increase in trade complementarity indices, suggesting growing similarities
between the export profile of one country, or group of countries, and the import profile
of others, which could account for the expansion of intraregional trade.
Back in the early 1990s, when exploring whether a de facto East Asian trade bloc was
forming, Frankel (1991) argued that the rise of intraregional trade was accounted for
mainly by the rapid growth of their economies or their role in world trade. Lincoln (2004)
used Frankels methodology to look at the region a decade later and concluded that
something very interesting is occurring (p. 45). It has now become a familiar story that
in East Asia, intraregional export trade has increased, but not as rapid as intraregional
import trade.
Tables 1 and 2 show changes in the share of intraregional trade, exports and imports,
respectively, for various groupings in East Asia and AsiaPacific.
The two tables indicate that intraregional trade shares have risen in all groupings in
East Asia: Association of South-East Asian Nations (ASEAN), ASEAN Plus Three (APT),
and the newly established East Asia Summit (EAS) process (or East Asia-16), as well as the
AsiaPacific Economic Cooperation (APEC). In the case of APT, in 1980, 27.2% of the
exports of these countries went to other countries in the grouping and 23.4% of their
imports came from within the grouping. These shares have increased, and by 2003, 33.4%
of exports went to others in the grouping while the share of their imports from the
grouping increased much faster to reach 41.6%. The fastest increase in intraregional trade
occurred in the first half of the 1990 until the financial crisis hit the region. It has slowed
down since then. All those groupings experienced the same pattern of development in

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Table 1 Intraregional export trade share (percentages)

Grouping 1980 1985 1990 1995 2000 2003

ASEAN 16.7 18.4 18.6 24.0 22.3 21.0

ASEAN Plus Three 27.2 25.6 25.4 34.6 32.4 33.4
East Asia Summit (East Asia-16) 31.6 30.5 29.6 37.9 35.6 37.0
APEC 54.4 65.1 67.3 72.8 72.3 70.8

Source: Computed from International Monetary Fund, Direction of Trade Statistics.

Table 2 Intraregional import trade share (percentages)

Grouping 1980 1985 1990 1995 2000 2003

ASEAN 14.1 17.2 14.8 17.5 20.9 21.7

ASEAN Plus Three 23.4 28.2 27.4 37.1 40.0 41.6
East Asia Summit (East Asia-16) 28.4 33.3 32.2 40.5 42.9 44.2
APEC 53.2 62.8 65.5 71.7 72.0 68.2

Source: Computed from International Monetary Fund, Direction of Trade Statistics.

their intraregional trade. No particular grouping appears to have experienced more rapid
integration than the other groupings.
All different groupings in East Asia, that is excluding APEC, do show the same pattern
of development, namely a clear shift toward a regional bias on the import side and not so
much on the export side. What does this signify?
Kawai (2005a) as well as Lincoln (2004) concluded that the expansion of intraregional
trade in East Asia has not been at the expense of extraregional trade, thus giving credence
to the proposition that market integration in East Asia has been largely outward oriented.
How has such market integration come about?
First, countries in East Asia have been liberalizing their trade and investment regimes.
This happened at a time when there was a strong push factor for outward investments from
Japan due to the Yen revaluation in the mid-1980s. The favorable coincidence of strong
pull and push factors has led to increased trade and investments, especially export-
oriented investments. Urata (2005) and Kawaii (2005a,b) have written a great deal about
the so-called tradeFDI nexus, namely the simultaneous expansion of and the mutual
reinforcement between trade and FDI. The underlying determinant of this nexus is the
establishment of regional production networks and supply chains by multinational
corporations (MNCs) (Kawaii, 2005b), or what Baldwin (2006) has called Factory Asia.
In their detailed study, Ng and Yates (2003) have shown the remarkable increase in the
relative importance of machinery and electronics products in East Asias intraregional

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trade and the expansion of production networks (international production sharing) as

reflected in trade in parts and components.
The early regional production networks emerged with Japan at their core. Urata (2005)
has shown the strong trade orientation strategy of Asian affiliates of Japanese firms, more
so compared to those in North America and in Europe. The share of their exports in total
sales and the share of their imports in total procurement rose from around 30% in the early
1990s to close to 60% a decade later. Asian affiliates of US MNCs also exhibit the high
export orientation. Over time, as other East Asian countries became important sources of
FDI in the region, the production networks have expanded. Data as compiled by Kawai
(2005b) show that cumulative investments from the Asian NIEs over the period 19902003
have been substantial. The share of the Asian NIEs cumulative investment was 55% in the
case of China, 35% in Vietnam, 32.7% in Indonesia, and 28.6% in Malaysia, much larger
than that from Japan (8.3%, 5%, 15%, and 18.8%, respectively). The importance of FDI
cannot be stressed enough. Tachiki (2005) rightly suggested that FDI plays an uninten-
tional bottom-up role in integrating East Asia. Although unintentional, it has exerted a
powerful impact on the region. This is often not sufficiently recognized.
Second, the formation of regional arrangements in East Asia thus far, ASEAN (and AFTA
[ASEAN Free Trade Area]) being the only case in point, were not meant to promote regional
import substitution schemes. Having examined the trends of intra-industry trade in East Asia,
Ng and Yeats (2003) concluded that East Asia has been successful in its integration into both
regional and global markets. In addition, they also showed that regional integration in East Asia
has not distorted the composition and direction of trade of individual East Asian countries in
ways that incorporate major economic efficiencies as was supposedly the case with MER-
COSUR.1 They concluded, instead, that East Asian countries global and regional exports
appear to be evolving in ways that are fully consistent with their comparative advantage.
Third, the rise of China has a profound effect on East Asia. About half of the increase
in East Asias share in world trade has been accounted for by China. In a similar fashion to
that of ASEAN before, China has rapidly been integrated into East Asias production
networks. Unlike ASEAN, however, Chinas exports are even more oriented towards the
rest of the world than ASEANs exports. Processed exports are entering regional and
particularly global markets, while imports for processing are sourced mainly from within
the region. The rise of China has further expanded Factory Asia and has established a
new pattern of triangular trade involving increased Chinese imports from East Asia and
Chinese exports to third markets.
In addition to market-driven trade and investment integration, there is a reasonable
amount of market-driven financial integration in East Asia. This results from the increased
deregulation of the financial system, opening of financial services to foreign institutions,
and liberalization of the capital account in many East Asian countries (Kawai, 2005c).
Financial integration implies an increase in capital flows and a tendency for the prices and
returns on traded financial assets in different countries to equalize on a common-currency
basis (de Brouwer, 2005).
It is not easy to measure the degree of regional financial integration. Rajan (2005) has
suggested that measures of regional financial integration can be classified into three

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categories: (i) price-base measures, such as interest parity conditions; (ii) quantity-based
measures, such as gross capital flows; and (iii) regulatory and institutional measures, such
as restraints on capital flows. These measures are rough and incomplete. Lamberte (2005)
reported on the observation made by Park (2002) that although East Asian countries have
been slow in liberalizing their capital account and stock markets, their overall degree of
domestic financial liberalization had reached on average the European level by 1995. Using
annual data from 1980 to 2002, Kawai and Motonishi (2005) found that a wide variation
in cross-country correlation patterns exists across selected financial variables. Real stock
prices and, to a lesser extent, real effective exchange rates are positively correlated across
East Asia, but real money supplies are not. Furthermore, they found that Chinas real
effective exchange rates exhibit positive correlations with those of many emerging eco-
nomies, but other real financial variables are not strongly positively correlated with those
of many emerging economies.

3. Functional Integration
When governments embark on regional cooperation and agree to implement collective
action plans and programs, they are promoting functional cooperation that could lead to
functional integration.
East Asia-wide functional cooperation began with the establishment of the APT
process. The APT was an ASEAN initiative. It started out as a modest undertaking. Foreign
ministers from the three North-East Asian countries China, Japan, and South Korea
were invited for an informal meeting over lunch during the ASEAN Foreign Ministers
Meeting. There was no specific agenda at that meeting. Soon it attracted the involvement
of heads of state. The first APT Summit was held in December 1997 in Kuala Lumpur,
Malaysia, at the height of the financial crisis.2 Indeed, it was the crisis that provided the
impetus for the summit. The APT process became more serious. The process is said to be
driven by ASEAN, hence called ASEAN Plus Three. However, the agenda setting has not
been monopolized by ASEAN, but the process appears to be guided by the ASEAN way.
At the 1998 summit, South Koreas President Kim Dae-jung proposed the establish-
ment of an East Asia Vision Group (EAVG) to craft out a mid- to long-term vision for the
cooperation. At the summit in 2000, President Kim Dae-jung further proposed the
establishment of an East Asia Study Group (EASG), consisting of officials, with the man-
date to assess the recommendations of the EAVG when they become available. The EASG
was to sort out a practical number of concrete measures that should be given priority and
be relatively easy to carry out. The EAVG submitted its report to the leaders at the summit
in 2001. The group envisioned East Asia moving from a region of nations to a bona fide
regional community where collective efforts are made for peace, prosperity and progress.
The economic field, including trade, investment, and finance, is expected to serve as the
catalyst in this community-building process. The EAVG recommended 57 concrete measures
encompassing six areas of cooperation. Of these, the EASG proposed 26 implementable
measures, 17 for immediate implementation and 9 for possible implementation in the
medium or long term.

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In response to the financial crisis, the region saw the gathering of a momentum for
policy-induced integration. As observed by Stubbs (2002, p. 448), the crisis has added to
the sense of common history that has emerged in the region as . . . nearly every government
in East Asia felt its reverberations and had to deal with the fallout of the crisis. ASEAN and
APEC appeared to have been helpless, and there was great resentment with the way the
International Monetary Fund (IMF), in conjunction with the US Treasury, handled the
crisis. The APT process was seen as the best vehicle for developing a strategy to dealing with
future crises. In May 2000, on the sidelines of the annual meeting of the Asian Development
Bank (ADB) in Chiang Mai, Thailand, the APT finance ministers met to discuss the need
to build a regional financial framework, which led to the adoption of the so-called Chiang
Mai Initiative (CMI). This opened the way toward more proactive regional cooperation
and integration efforts in the financial field in East Asia.

3.1 Financial cooperation and integration

Financial cooperation in ASEAN did not start until 1997, 30 years after its establishment.
As if they acted on some premonition, the ASEAN finance ministers met for the first time only
a few months before the financial crisis hit the region. The meeting emphasized three particular
issues: the importance of strengthening the supervisory and regulatory framework of the
banking sector; the need to liberalize the financial services sector further in a gradual fashion,
including through the World Trade Organization (WTO); and the utility of the ASEAN
Swap Arrangement in view of the dramatic changes in the global financial environment.
When the crisis hit, ASEAN was not in the position to do anything for its members.
The Swap Arrangement was far from adequate. An informal proposal from Japan to
establish an Asian Monetary Fund was shot down. The crisis-hit countries had to resort to
the IMF. On December 1, 1997, a Special ASEAN Finance Ministers Meeting took place
in Kuala Lumpur to discuss the causes of the crisis and the policy responses. They agreed
to renew the Swap Arrangement that was due to lapse in August 1999, but no other con-
crete initiatives were taken. The finance ministers began to toy with the idea of cooperative
efforts to redefine the criteria for sound economic policies. This would be an important
step in the direction of developing regional surveillance. Indeed, the crisis has opened up
a window of opportunity for the region to become more open to collective monitoring and
review of policies (Soesastro, 1998).
The most concrete step taken by the finance ministers concerned the regional surveil-
lance mechanism within ASEAN. This mechanism was developed within the general
framework of the IMF with the assistance of the ADB, but it was subsequently watered
down to a surveillance process. The process is based on peer review and is aimed at
providing recommendations on possible actions that could be taken at the country and/or
regional level. For ASEAN, this was the first instance in which members agreed to make
comments on each others internal development. The effectiveness of the surveillance
process has been questioned. It may well be that financial cooperation could more
meaningfully be undertaken within the wider East Asian region.
The heightened interest in the wider East Asian region for devising collective
measures to prevent financial crises in the future has offered the region an opportunity to

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undertake an interesting experiment. At issue is whether financial and monetary, rather

than trade and investment, cooperation could become the main drivers for regional eco-
nomic integration. Financial integration refers to the opening and cross-border linkage of
financial markets, institutions, and systems. Monetary integration refers to cooperative
arrangements in exchange rates and/or monetary policy.
Higgot (2000) enthusiastically proclaimed that a new monetary regionalism was
emerging in East Asia, and the region might well become the first region that builds a
grouping based on monetary and financial cooperation rather than increased inter-
regional trade concentration. Higgot could have been led to draw this conclusion following
the launching of the idea of Asian Monetary Fund, the establishment of the Manila Frame-
work Group (MFG) as a regional surveillance process, and the adoption of the CMI. Ito
(2000) was doubtful whether financial and monetary integration could precede trade
integration. He was also not convinced that APT is the right grouping. Rajan (2005)
pointed to the complex set of causal interconnections between trade, financial, and
monetary integration. He argued that the region should focus on steps to enhance
trade-come-financial cooperation by reducing distortions and barriers to cross-border
economic activity, while monetary integration should be eschewed for now.
A number of initiatives to promote financial cooperation and integration have been
taken by ASEAN and APT. The main areas of financial cooperation in East Asia are:
(i) information exchange and surveillance processes; (ii) resource provision mechanisms;
and (iii) the development of the Asian bond market.

Regional surveillance
The first regional surveillance process, the MFG, was established in November 1997.
The group consisted of deputies from the finance ministries and central banks of 14
AsiaPacific countries. In addition to surveillance, their agenda included other initiatives
such as cooperation (financial ecotech) and development of cooperative financial
arrangements to supplement the resources of the IMF and other international financial
institutions. Wang (2002) was of the view that the MFG was not a very successful
mechanism for regional financial cooperation. First, it did not clearly specify the objective
of information exchange and surveillance. Second, there was no actual peer-review
process. Third, issues relating to financial sector reform were not adequately discussed.
The MFG was dissolved in November 2004, in part because the APT process has
instituted its own Economic Review and Policy Dialogue Process. Other regional bodies,
such as APEC and the Executives Meeting of East AsiaPacific (EMEAP) Central Banks,
are also involved in reviewing recent economic and financial developments in member
economies. The APT process is similar to the ASEAN Surveillance Process. It has a
template to monitor short-term capital flows, and it has established an APT Early Warning
System (EWS).
Strengthening the surveillance mechanism is a key task for further financial coopera-
tion and integration. It may not be easy to construct a credible EWS given the lack of
reliable statistics in most developing countries. Because not all crises are alike, a one size
fits all system will not be useful.

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Regional financing facility

Japans concept of an Asian Monetary Fund was discussed at the ASEM finance ministers
meeting in September 1997 and informally also at the joint meeting of the IMF and the
World Bank in Hong Kong in the same month. The idea received immediate support from
the finance ministers of Indonesia, Malaysia, and Thailand, but it was opposed by the USA,
China, and the IMF. As a result, Japan was unwilling to pursue it further. Instead, the
Manila Framework, adopted by a subset of APEC economies in November 1997, was seen
as a substitute for the setting up of a regional monetary institution.
The desire to develop mechanisms for resource provision within the region led to the
adoption of the CMI. This initiative called for: (i) an expanded ASEAN Swap Arrangement
that would include all ASEAN countries and a network of Bilateral Swap and Repurchase
Agreement (BSA) among APT members; (ii) use of the APT framework to promote the
exchange of consistent and timely data and information on capital flows; (iii) establish-
ment of a regional financing arrangement to supplement existing international facilities;
and (iv) establishment of an appropriate mechanism (the EWS) that could enhance the
ability to provide sufficient and timely financial stability in East Asia.
The ASEAN Swap Arrangement has since been expanded to cover all ASEAN members
and the total amount has seen increases. The maximum drawdown amount by each
participating member is limited to twice their committed amount, and the swap transactions
have a maturity not exceeding 6 months, subject to rollover for a period not exceeding
6 months. The network of BSA is designed to provide short-term liquidity assistance.
Participating countries can draw on the BSA for a period of 90 days and may be renewed
seven times. The interest rate is linked to London Inter-Bank Offer Rate (LIBOR). The
disbursement above 20% (previously 10%) of the maximum amount of the drawing is
tied to IMF conditionality. The total amount of the BSAs currently come to about $US50
billion. Japan has played a leading role in terms of both number and amount.
In its report, the EASG stated that the CMI should be regarded as a launch pad from
which to broaden and deepen APT cooperation and coordination to ensure financial
stability. As a key provider of financial resources, the amount available under the CMI will
need to be increased and the system be multilateralized. As the main supplier, Japan wants
to see that APT can develop an effective surveillance mechanism in which it can exercise
its influence commensurate with its financial contribution. Japan and China could not
always agree on operational matters, including the surveillance mechanism. Chinas
unwillingness to grant leadership to Japan in East Asias financial cooperation efforts could
be the most serious roadblock to the further development of the CMI (Stubbs, 2002;
Wang, 2002).

Asian bond market

The Asian Bond Market Initiative is the latest and so far perhaps the most successful
initiative taken by APT in the financial area. The initiative was endorsed by APT finance
ministers in August 2003. Its aim was to develop an efficient primary and secondary bond
market. Over time, this scheme should supplement government bond markets with
corporate bond markets. This necessitates the development of credit enhancement

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mechanisms and ratings. A great deal has been written now about the development of the
Asian bond market, and the ADB has a website with an informative live page on the Asian
bond market. In the following month, September 2003, APEC finance ministers gave their
support to the regional initiative to develop bond markets. They set up an APEC initiative
to promote securitization and credit guarantee markets to enhance the efficiency of bond
markets.
In addition to the initiatives by APT and APEC, the EMEAP group of regional central
banks has launched the Asian Bond Fund (ABF) initiative. APT and APEC initiatives deal
with supply side issues, such as new debt instrument offerings, debt instrument rating and
enhancements as well as infrastructure improvements (Lamberte, 2005), whereas the ABF
initiative deals with the demand side. Under ABF-1 (June 2003), EMEAP members
committed to invest a total of $US1 billion in dollar-denominated bonds issued by Asian
sovereign or quasi-sovereign issuers in EMEAP economies (excluding Australia, Japan,
and New Zealand). ABF-1 is managed by the Bank of International Settlement. In December
2004, ABF-2 was launched with the commitment to invest $US2 billion in local-currency
bonds issued by sovereign and quasi-sovereign issuers in selected EMEAP countries.
ABF-2 is also aimed at enhancing domestic and regional infrastructure. It is a major
development as it creates a pooled investment of national bonds.

3.2 Trade integration or fragmentation?

The report of the EAVG that was submitted to the leaders at the summit in 2001 proposed
that the creation of an East Asian Free Trade Area (EAFTA) is one of the means toward an
East Asian Economic Community. The other recommendation is that liberalization of
trade in East Asia should be well ahead of the Bogor Goals set by APEC.3 The EAVG also
suggested that in order to facilitate the formation of a region-wide FTA, East Asia needs to
consolidate all existing bilateral and subregional FTAs within the region. A Ministerial
committee needs to be established to oversee the development of an EAFTA. Can the
development of EAFTA be guided by ASEANs experience in forming a regional trading
arrangement (RTA)?
The EAFTA has been placed on the agenda of APT, in part because regionalism is on the
rise in East Asia. FTA has become a familiar concept, and creating a FTA is what immediately
comes to mind when policy makers contemplate the strengthening of regional cooperation
and integration. Following the recommendation of the Vision Group, the EASG placed the
formation of an EAFTA as a long-term goal, taking account of the variety of differences
in developmental stages and the varied interests of the countries in the region. The
officials could not hide their cautious stance, and they proposed that the impact of an
EAFTA on the region be studied. At the APT Summit in Vientiane in November 2004,
leaders exchanged views on the establishment of an EAFTA and welcomed the initiative by
the APT economic ministers to set up an expert group to conduct a study on the feasibility
of EAFTA.
The idea of an EAFTA might have been overtaken by the greater interest in the
region to develop ASEAN + 1 trading arrangements and other bilateral FTAs. The EAVG
raised the possibility that EAFTA be formed through a building block approach and

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consolidating existing bilateral and subregional FTAs in the region. It appears that the
region has decided, by default rather than by design, to use the building block approach.
ASEAN is pretty much at center stage as it has embarked on bilateral initiatives with the
three partners in North-East Asia as well as others outside of East Asia (AustraliaNew
Zealands Closer Economic Relations [CER] and India).
This, however, was not an ASEAN initiative. It all began with the approaches by China.
ASEAN on its part did not regard free trade areas as a major element in its international
economic diplomacy. In 2001, at the ASEANChina Summit in Bandar Seri Begawan,
China came up with a proposal to establish an ASEANChina Free Trade Area within 10
years. It was understood in many quarters in ASEAN that the agreement reached at that
summit was only to study the proposal. In the course of the development, however, both
sides were engaged in a negotiation. Within 1 year, at the summit meeting in Phnom Penh
in November 2002, the heads of state of ASEAN and China were ready to sign a framework
agreement on comprehensive economic cooperation (CEC), which included a FTA.

ASEANChina
The framework agreement on CEC contains three elements: liberalization, facilitation,
and economic cooperation. The liberalization element covers trade in goods, trade in
services, and investment. In the context of liberalization, the agreement provides for
special and differential treatment and flexibility to the newer ASEAN members as well as
flexibility to address sensitive areas.
The framework agreement contains an early harvest program that covers all products
in chapters 1 to 8 at the eight- or nine-digit level (HS code): live animals, meat, fish, diary
produce, other animals products, live trees, vegetables, and fruits and nuts. Products under
this program are divided into three categories for tariff reduction and elimination, but
tariffs will have to be brought to zero for all three categories within 3 years. However, the
program allows for an exclusion list and different time frames between the ASEAN-6
(Brunei, Indonesia, Malaysia, Philippines, Singapore, and Thailand) and the CLMV (new
members Cambodia, Laos, Myanmar, and Vietnam), for whom zero tariffs will be reached
in 2010. Initially, it was thought that China would offer the early harvest program on a
non-reciprocal basis, but this turned out not to be the case. Moreover, some agricultural
commodities of great interest to ASEAN, such as rice and palm oil, were excluded from the
program. Some ASEAN countries (e.g. the Philippines) did not immediately join the program.
Beyond the early harvest, tariff reduction and elimination of manufactured goods will
be pursued along two tracks, the normal track and the sensitive track. Applied most favored
nation (MFN) tariffs of products listed in the normal track should be gradually reduced or
eliminated in accordance with specified schedules and rates to January 1, 2010, for ASEAN-6
and China, and to January 1, 2015, for CLMV. Reduction of tariffs of products in the sensitive
list will be in accordance with mutually agreed end rates and end dates. The number of
products in the sensitive list is subject to a maximum ceiling, also to be mutually agreed upon.
The negotiation on the FTA for goods beyond the early harvest was concluded by the
end of 2004. The Agreement on Trade in Goods of the Framework Agreement on CEC,
or for short, the ASEANChina FTA (ACFTA), is only the first portion of a series of

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agreements to implement the framework agreement. At the Vientiane Summit, ministers

also signed an Agreement on Dispute Settlement Mechanism of the Framework Agreement
on CEC. This will be followed by an agreement on services, an agreement on investment,
and others. It is indeed rather surprising that ASEAN and China were able to produce
those two agreements within such a short time.
The ACFTA contained the modality for tariff reduction and elimination for tariff lines
both in the normal track and the sensitive track. In the normal track there are three sets of
schedules. The first applies to ASEAN-6 and China. The implementation began on July 1,
2005, and by 2010 all rates will become zero. The second schedule applies only to Viet-
nam, where all tariffs will be brought down to 0% in 2015. The third schedule applies to
Cambodia, Laos, and Myanmar, where some tariffs will still be higher than in Vietnams
schedule, but from 2011 onwards they will be the same.
In addition, agreement was also reached to bring as many tariff lines to the 05%
range. For instance, for ASEAN-6 and China, by January 1, 2007, at least 60% of tariff lines
placed in the normal track must be reduced to 05%. However, some flexibility is
allowed in 2010, whereby up to 150 tariff lines could still have tariffs but should be
eliminated not later than January 1, 2012. For the CLMV countries, this flexibility allows
for having tariffs on up to 250 tariff lines to be eliminated not later than January 1, 2018.
In terms of tariff lines in the sensitive track, the agreement subjects the number of tariff
lines to a maximum ceiling. Tarrif lines in the sensitive track are further classified into a
sensitive list and a highly sensitive list (Table 3).
The Rules of Origin (ROO) for the ACFTA, as stipulated in the agreement (Annex 3),
are similar to those in AFTA. They are relatively simple and quite liberal. In fact, ACFTA
should be commended for this.
The Agreement on Dispute Settlement centers on arbitral proceedings in case consulta-
tions fail to settle a dispute. The agreement stipulates the appointment, composition,
functions, and proceedings of arbitral tribunals. It came into force on January 1, 2005. How
well this mechanism will function will be known only when it is being used. This mechanism
is perhaps more straightforward than the one recently adopted by ASEAN as part of its efforts
to realize the ASEAN economic community. The ASEAN mechanism is yet to be tested.
The ACFTA could be a model for other ASEAN FTAs, particularly if the partner country
is a developing country. It should be noted that while tariff reduction and elimination are
scheduled to be completed in 2010 for the ASEAN-6 and China, and 2015 for the CLMV
countries for the normal track, reduction of tariff lines in the sensitive list (to 05%) could
be extended to 2018 and 2020, respectively. It should be in the interests of ASEAN and
China to try to accelerate this process. The modality adopted in the Agreement can accom-
modate this. However, political will has to be there for this to happen. It also should be
noted that the ACFTA is only the first step in the implementation of the framework agree-
ment. Negotiating an agreement in services and investment may prove to be more difficult.

ASEANJapan
In January 2002, during his visit to Singapore, Prime Minister Koizumi of Japan
announced Japans interest in forming an economic partnership agreement with ASEAN,

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Table 3 ASEANChina FTA: tariff lines in sensitive and highly sensitive lists (HS 6-digit)

Country Sensitive Highly sensitive

Brunei 66 34
Cambodia 350 150
Indonesia 349 50
Laos 88 30
Malaysia 272 96
Myanmar 271 0
Philippines 267 77
Singapore 1 1
Thailand 242 100
Vietnam NA NA
China 161 100

NA, not applicable.

which might have a FTA component. Japan has completed a bilateral FTA with Singapore,
the JapanSingapore Economic Partnership Agreement, which is the first FTA for Japan.
Japan has since concluded FTAs with Malaysia, the Philippines, and Thailand, and is
negotiating one with Indonesia. It was immediately obvious that Japan was reacting to the
earlier move by China towards ASEAN.
At the ASEANJapan Summit in November 2002, in their joint declaration the heads
of state/governments agreed to implement measures for the realization of a comprehensive
economic partnership (CEP), including elements of a possible FTA, which should be
completed as soon as possible within 10 years. A committee was established to draft a
framework for the realization of an ASEANJapan CEP.
An agreement with Japan, being a developed economy, must strictly adhere to Article
XXIV of the WTO to cover substantially all trade. There cannot be a long exclusion list of
sensitive items. In contrast, the ACFTA could avail itself of the WTO enabling clause.
Nonetheless, ASEAN and China agreed to limit the so-called sensitive track to 10% of total
import value. The Japanese side has made it known that they understand substantially all
trade to mean at least 90% of the value of trade. It should also be closely observed whether the
ASEANJapan CEP will adopt an equally simple and liberal ROO as in AFTA and ACFTA.
The problem is that Japan already has a bilateral agreement with selected ASEAN
countries, including Singapore, in which the adopted ROO is less liberal than AFTA and
ACFTA. The CEP between ASEAN and Japan signed in Bali stipulates that schedules of
liberalization concessions between Japan and individual ASEAN countries that have
concluded a bilateral FTA or economic partnership agreement will not be renegotiated and
will be annexed to the ASEANJapan CEP agreement. Nothing is said about the ROO.
Japan has adopted a dual strategy in regard to negotiating free trade agreements with
ASEAN, namely with ASEAN as a group and selectively with certain ASEAN countries.

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The strategy is to move faster on the latter. It has been said that the origin of this dual strategy
was bureaucratic in that the Ministry of Economy, Trade and Industry (METI) was cham-
pioning for an agreement with ASEAN while Gaimusho (Ministry of Foreign Affairs
[MOFA]) preferred bilateral agreements. MOFA thought that it would be very difficult for
Japan to have FTAs with the CLMV countries.
How Japan will handle this problem in the ASEANJapan CEP is unclear. It can make
use of the special and differential principle to provide a longer time frame for the CLMV
countries as in the case of ACFTA. However, because Japan is negotiating bilateral FTAs
with most of ASEAN-6, it could well be that the liberalization schedules will be different
even amongst ASEAN-6, and that similar agreements with CLMV will be postponed to a
later date. The focus of the agreement with CLMV will be initially on facilitation and
cooperation. This could suggest that the ASEANJapan CEP will essentially be an umbrella
agreement for separate FTAs. It is unclear whether this is consistent with the principle of
a single undertaking.
In this sense, the agreement with Japan could be different from the agreement with
China. In the ACFTA, ASEAN can act as a hub, but in relation to Japan, ASEAN countries
become spokes.

ASEANSouth Korea
A Joint Declaration on Comprehensive Cooperation Partnership was signed at the Summit
in Vientiane in November 2004. The establishment of an ASEANKorea FTA (AKFTA) is
seen as a natural extension of the existing relations as well as a stepping stone to elevate
the ASEANSouth Korea relationship to a higher and more comprehensive level.
AKFTA will be similar to other ASEAN FTAs in terms of its comprehensive scope and
provision for flexibility to deal with the CLMV countries. The possibility of achieving early
results will be considered in developing a framework agreement. However, the kind of
early harvest program to be included will not be confined to agricultural products as in the
case of the ASEANChina CEC, but will include manufactured products that are not
sensitive to either side. In fact, it might exclude many agricultural products.
The negotiations on AKFTA commenced in early 2005 and will be completed within
2 years. While AKFTA was conceived at a much later date than the other FTAs, the intention
is to realize it at an earlier date, with a goal of achieving as high a level of liberalization as
possible, whereby at least 80% of products will have zero tariffs in 2009, and with considera-
tion for special and differential treatment and additional flexibility for the CLMV countries.

ASEAN agreements
The three agreements (ASEANChina, ASEANJapan, and ASEANSouth Korea) are
being negotiated separately, and are at different stages in the negotiations. Each is in a sense
tailor-made and is based on its own template. An immediate question is whether ASEAN
has the capacity to minimize the spaghetti bowl or perhaps more appropriately coined
for East Asia, the noodle bowl syndrome that results from these different agreements.
It may be too late for ASEAN to develop its own template that it will bring to the
negotiating table with the three North-East Asian partners as well as with other parties

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(AustraliaNew Zealand CER and India). ASEAN should be in an advantageous position

being placed as a hub, at least in the East Asian context. China, Japan, and South Korea,
among themselves bilaterally or as a subregion are yet to agree to develop their own
arrangements. This is not likely to happen in the near future. Ideally, the hub should extend
the same preferential treatment to all spokes. It should be noted that the more spokes are
added to the hub, the more diluted will be the benefits for each spoke (Bonapace, 2005).
What is the incentive for ASEAN to exploit its position as being in the hub? As Rajan
and Sen (2005) have pointed out, being a hub would increase its attractiveness as an export
platform as producers there can benefit from duty-free access. Producers in the hub have
cost advantages vis--vis in the spokes as they are able to obtain their intermediate goods
at lower prices. ASEAN, however, is a relatively weak hub as it is dealing with economically
more powerful economies. At the very least, ASEAN can aim at minimizing transactions
costs that arise from a set of agreements that apply different rules. Different ROO is the
most prominent case in point.
AFTAs ROO are considered simple and liberal. The 40% ASEAN content requirement
applies to all products eligible for tariff reduction. There are no complex product-by-product
rules of origin. To improve the operational procedures, a number of changes have been
introduced. These include (i) standardized method of calculating local/ASEAN content;
(ii) a set of principles for determining the cost for ASEAN origin and the guidelines for
costing methodologies; (iii) a clear and specific treatment of locally-procured materials;
and (iv) an improved verification process, including on-site verification. ASEAN is currently
working on the practical implementation of an alternative criterion in determining origin.
The so-called change in tariff classification (CTC) rule will become applicable to products
that cannot fulfill the 40% local/ASEAN content requirement. The introduction of this
alternative substantive transformation rule will make the system more flexible.
The ROO in the ACFTA uses the AFTA method and the parties are negotiating to
specify products in ACFTA, which will use CTC as a criterion for determining origin. It
remains to be seen how different the ROO in the ASEANJapan and ASEANSouth Korea
agreements will be. Both Japan and Korea have more restrictive rules. The ROO in Japan
Singapore EPA applied change of tariff heading test (CTC) for most of the products and
the value added test of up to 60% (with a combination of subheading changes) for other
products. Textile fabrics and articles (HS59) come under the manufacturing and
processing operations.
Park (2005), Director at the Korea Customs Service, believes that under current
circumstances it will be difficult to harmonize preferential ROO. However, the region
could begin to elaborate common principles necessary for origin determination that are
transparent, consistent, simple, clear and predictable. These could be implemented as
follows: (i) adoption of generic ROO system by using the CTC rule as the main criteria;
(ii) use single-level value-added rules as supplementary criteria; and (iii) for specific
sectors (auto, textile, and clothing) use the specified process method.
In his provocative paper, Baldwin (forthcoming) argued that the problem of managing
the noodle bowl is indeed much more than just ROO or other technical matters. There
are such critical matters as trade and investment in services or dealing with IPR that

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have encroached into these new age FTAs. At the core is the disturbing fact that trade
liberalization in East Asia, unilaterally, bilaterally, or regionally, is not disciplined by WTO
rules or any other common rules. He believes that an East Asian regionalism based on such
a fragile system will soon be subject to new tensions. He advanced the argument that to
manage the noodle bowl, East Asia needs to have a top management. Essentially, he was
hinting at the need for region-wide institutions. An EAFTA is one option. This issue will
be examined in the next section.

3.3 Interconnectivity
A third important area for functional cooperation toward regional integration is to
overcome physical barriers. Transportation and telecommunication infrastructure linking
economic activities and people inside and among countries are clearly beneficial to
regional integration and community building. Expanding such infrastructure will reduce
transactions costs. This issue was raised at the Fourth APT Summit in Singapore in
November 2000 by Chinese Prime Minister Zhu Ronji, who proposed that the APT should
focus on the following areas of cooperation: the development of Mekong River Basin
transportation and communication infrastructure, information technology, human
resources development, agriculture, and tourism.
APT has not moved into these areas in a big way. There are no shortages of inter-
governmental agreements on regional cooperation in transport and telecommunications
sectors (see Lamberte, 2005). ASEAN also has a number of such projects, including
highways and railways to connect several of its members. It also has developed an ASEAN
power grid. Developments have been slow. One possible reason is the lack of a regional
authority that can overcome the parochial management by national bureaucracies and in
some instances problems of sovereignty. This could also point to the need for Baldwins
top management.

4. Institutional Integration
East Asia has been in search of an institutional identity. Countries in East Asia have sought
to establish a regional structure of sorts that can provide a framework for East Asian
leadership and influence on regional and international affairs (Drysdale & Ishigaki, 2002).
They want to raise East Asias international profile and voice. The first attempt was
Malaysias proposal for an East Asian Economic Group, later modified by ASEAN into an
East Asian Economic Caucus, but failed to materialize.
The desire has remained strong. However, when it comes to expressing willingness to
commit to making binding agreements to create effective institutions, governments either
gloss over it or remain silent. Here is where East Asian regionalism seems to come to a dead
end. ASEAN, despite its ambitions to create an ASEAN community, has yet to overcome
this barrier as well.
To be sure, East Asia is on the path of regional integration. But East Asian integration
can only go so far as its current modality will carry it. It may also be a fragile process of
integration. The European model of integration is certainly not what East Asia should

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Table 4 East Asian and European integration

East Asia Europe

Integration type Market integration dominant Functional and institutional

integration
Rules Flexible, consensus Binding agreements
Movers MNCs National politicians, European
union bureaucrats
Government role Facilitator Leader
Trade World market, intraregional growing Intraregional
Investment Production networks growing Dense links
Monetary integration Still weak Tight (euro)

Source: Adapted from Pascha (2004).

Note: MNCs, Multi-national corporations.

necessarily aim for. Pre-conditions, circumstances, and objectives of countries in Europe

are different from what they are in East Asia. Nonetheless, comparing the East Asian
integration modality today to the European model of integration can suggest the kind of
regional architecture that could be developed in East Asia.
East Asian integration as summarized in Table 4 describes its market integration face
and phase. It has stepped into areas of functional cooperation and integration led by
governments. Circumstances, such as proliferation of FTAs in the region that come under
no common discipline, have necessitated governments to step up their roles from facilita-
tors to more proactive participants in the integration process. This is so, if only to prevent
a fragmentation of the region. The region will need to promote, and to some extent has
undertaken, various functional cooperation and integration efforts. In doing so, the risk of
government failures increases. These can be minimized if anticipated properly and timely.
To be sure, although functional and perhaps institutional integration are being pro-
moted, East Asias market-driven integration should be preserved and remain dominant.
East Asia must come up with an architecture that can accommodate this. This would
require an understanding by all regional players about how far the venture will and can go
in terms of broadening, widening, and deepening. Broadening in terms of area coverage
of the venture; widening in terms of expanding membership; and deepening in terms of
the domestic impact of regional integration.
The region is now forced to have a clear idea as to where it wants to go as the APT is
now not the only vehicle for regional community building in East Asia. A failure to do so
will result in an ambiguous East Asian architecture. Pempel (2005) has referred to reactive
regionalism, suggesting opportunistic behavior guiding the process of regional integration.
This may not always be fatal.
The holding of the East Asia Summit (EAS) in December 2005 may be a case of
government failure referred to earlier. Heads of governments from 16 countries engaged
in a 3-hour dialogue. They produced the Kuala Lumpur Declaration and a Declaration on

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Avian Influenza Prevention, Control and Response. They agreed to convene regularly and
have already set the date for their next meeting in the Philippines. They believe that the
EAS could play a significant role in community building in the region.
The idea of an EAS was first muted in a report by the EAVG. The original proposal was
to transform the APT to an EAS process. The essence of this transformation is to replace
the ASEAN-driven APT process with one in which all members have equal roles. This was
to happen after a lot of preparation and a consolidation of the APT process.
Malaysia made a move to host the first EAS when it chaired ASEAN in 2005. It is no
secret that Malaysia wants this very much. Earlier, it had failed in its bid to host the Sec-
retariat for APT in Kuala Lumpur. Malaysia feels that it is entitled to become the main
driver of the East Asian process. Some 15 years ago it was Malaysias Prime Minister
Mahathir who first proposed the establishment of an East Asian economic group.
With the establishment of the APT, an East Asian process becomes a reality. The APT
is widely regarded as the embryo of an East Asian cooperation arrangement. Some have
speculated that it is the first step toward institutional integration in East Asia. The APT is
ASEAN-driven because ASEAN is the least objectionable among the participants to take
the lead. The rivalry between China and Japan has made it impossible for either of these
two big powers in the region to do so.
By 2004, concerns were raised whether the APT was beginning to loose momentum.
Malaysia may have thought that asserting some leadership could help accelerate the
process of East Asian community building. Its proposal to launch the EAS was immediately
backed by an enthusiastic China that simultaneously offered to host the following Summit.
Other APT members were caught off guard. The beginning of a rift in East Asia was
immediately apparent. For different reasons several countries began to form a coalition to
oppose the proposal.
Japan cannot accept Chinas growing role and became worried that it might dominate the
process. Earlier on China has shown its forcefulness and resoluteness in proposing and swiftly
negotiating a free trade agreement with ASEAN, forcing Japan to limp behind. Indonesia
thought ASEAN was not sufficiently consolidated to be effective in the drivers seat of APT.
A premature launch of the EAS would further weaken ASEANs role in the East Asian process.
Having sensed the half-hearted support by the group as a whole, Malaysia proposed that
APT be maintained and that the EAS be developed in parallel. This provided an opening for
others to come up with ideas of how to make sense of having two parallel processes that seem
to be indistinguishable apart from their names. Singapore proposed that India be brought in.
Indonesia and Japan proposed to expand the membership to Australia and New Zealand.
For Indonesia and Singapore, the expansion of membership helps differentiate the two
processes, and they also believe that it would be beneficial for the East Asian region to deepen
relations with the three countries that are in East Asias immediate neighborhood. India,
Australia, and New Zealand could bring fresh air to the East Asian process. They were invited
not as counterweights to China. ASEAN has been comfortable to work with both China and
Japan. Japan was much more worried about Chinas dominant role in East Asia. Ultimately,
this has created the image of an EAS that wants to promote community building in the region
but at the same time the members are erecting a fence around one of their own, namely China.

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In the immediate future not much can be expected from the EAS. Rather than
demonstrating what leaders have asserted, namely that they have a lot in common, the EAS
exposed the deep rift and the rivalries within the group. Serious efforts must now be made
to overcome this problem. Leaders in China and Japan must show their statesmanship.
China must stop its Japan-bashing, and Japan must come to terms with its own past and
understand why a visit by its Prime Minister to the Yasukuni Shrine creates so much uproar.
Unless this is done in good faith, it is simply futile for the group to begin to seriously
articulate the vision for East Asia and the institutional arrangements that would be
necessary to realize it.

5.5 Concluding Note

The Kuala Lumpur Declaration on EAS reflects the state of play in the region. It confirms
the members lowest common denominator. They are prepared to be engaged in a forum
for dialogue, not only on economic issues but also on political and strategic issues. They
want the summit to be an open, inclusive, transparent and outward-looking forum. They
strive to strengthen global norms and universally recognized values, without mentioning
democracy and human rights. Interestingly, they agree that ASEAN is the driving force,
working in partnership with the other participants of the East Asia Summit.
Senior Minister Goh Chok Tong of Singapore has his vision for East Asia. To a large
extent it conforms to Japans idea. Five main points can be drawn from his recent speech
(Goh, 2006). First, East Asian integration must continue to be largely market-driven,
namely driven by the commercial logic of the market that sees in diversity, potentially
profitable synergies. Because of this, the prime responsibility of all governments, irrespect-
ive of political system, is to create national conditions that will facilitate and not hinder
market flows. Second, East Asian integration will necessarily require a more active role for
states. This suggests that various other functional cooperation efforts will need leadership
from governments. Third, since regional integration is a strategic imperative for the entire
region, the way each state orders its domestic policies can no longer be of purely domestic
concern. This suggests that the concept of absolute sovereignty must be abandoned.
Fourth, ASEANs role in the drivers seat mandates it to reconcile and to assuage the
tensions between the mayor players and their competing interests. Therefore, ASEAN
integration is a vital and irreplaceable part of the entire East Asian project. Fifth, the archi-
tecture of East Asian integration consists of flexible and multiple overlapping networks,
rather than institutionalized bureaucracy (like the European Union). It is an architecture
of variable geometry and flexible boundaries, and in some fashion the USA should have
a part in it. This is an even broader vision of an East Asian community that appears to have
been outlined with the EAS in mind.
Goh did not suggest that APTs agenda will be absorbed by the EAS. The two processes
are likely going to co-exist for some time. The broad vision for EAS will not have the
structure to address the problem of managing the noodle bowl that has the potential to
undermine East Asias integration and the working of an efficient Factory Asia. This task
can be pursued by APT. It has the creation of an EAFTA on its agenda. This is in line with

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Baldwins suggestion that the European Free Trade Association (EFTA) provides the best
model for the long-run shape of East Asian economic integration since EFTA is purely
intergovernmental but it has efficient secretariat and enough institutional structure to deal
with new challenges such as new members and expansion of the integration regime. An EAFTA
could be the answer for the region if it is outward-oriented, efficient and at the same time
capable of reducing capacity gaps amongst East Asian countries that are extremely diverse.

Notes
1 MERCOSUR or Mercado Comn del Sur (Southern Common Market) is a customs union
between Brazil, Argentina, Uruguay, Paraguay and Venezuela, formed in 1991.
2 In 1997, Japan proposed to ASEAN to hold an ASEANJapan Summit to commemorate the 30th
anniversary of ASEAN. ASEAN responded with a proposal to invite the leaders from China and
South Korea. This became the first APT (informal) Summit.
3 APECs Bogor Goals stipulate the achievement of free and open trade and investment in the
region by 2010 for developed members and 2020 for developing members.

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