TCS Daily

Vision Impaired

By Alan Oxley - August 22, 2005 12:00 AM

China now has global economic muscle. It is sustaining growth in the global economy and its cheap goods are holding inflation at bay. So when China suggests rearranging current agreements or formalizing new ones, people go along, even if it may not be in every partys economic self-interest.

China is pursuing the creation of an East Asian economic community, a free trade area, covering China, Japan, South Korea and the ASEAN countries. This idea, along with a formal summit schedule to make it so, was agreed to when the Leaders of ASEAN met at their Summit in Vientiane, Laos last November.


Why not create a single market in East Asia? These economies are big traders, accounting for just over a quarter of world trade. They also trade a lot with each other. But there is more to creating a free trade area than simply signing an agreement and saying it is so.


First, the goal of free trade areas is to create economic growth, not just expand trade. It is possible to increase trade and weaken an economy at the same time. While Japan expanded trade over the last twenty years, the core of its economy stalled, resulting in a recession that lasted for a decade.

Second, a free trade area is only successful if all goods are traded freely and investors are free to put their money where they will get the best return. These are the conditions essential for creating efficiency and growth and which do not yet exist in many East Asian countries. When governments decide who should trade and invest, thats a sure prescription for limiting growth.

Governments are often a major obstacle in creating true free trade areas. When governments negotiate free trade areas, more often than not, they set them up to serve political rather than economic ends. This is quite understandable. A free trade area or agreement is a highly effective, non-military way of building closer relations.


The problem is that politically-motivated free trade areas carry economic risk. The process of economic integration in Europe demonstrates this perfectly. Western Europe has created a single, open market based on a Customs Union which is similar to a free trade area. In a customs union, members remove trade barriers among them and adopt common tariffs with third parties.


But the real aim of the European Customs Union was to promote political union. The economic community was simply a stepping stone, not the means to an end. The result is that Europe has never fully formed its free trade area. Agriculture and services, the biggest sectors in each European economy, are still heavily regulated and are not being properly integrated into the free market. Consequently, Europe's growth has been consistently lower than the US, Canada, Australia and New Zealand.


So the key question is what sort of Asian economic community does China want: a market which aims to increase efficiency, trade and investment, or does it have the European model -- a stepping stone to a political union -- in mind?


Officials in Beijing might regard a political union built around its leadership a natural result of an economic union, but those in Tokyo, Hanoi, and Jakarta (to name a few) would not.


If the goal is an economic community forged to produce economic efficiency and freedom, which Asian economy will be its champion? Large economies usually set the standards. In East Asia, the biggest economies are Japan and China.


But at this time, China cannot credibly set the standards for a free market community. Its transition to the free market is not yet complete -- property rights are not yet fully secure and the judiciary is not yet independent; not to mention every large business is required to have a cell of the Chinese Communist Party.


While Japan is the leading market economy in East Asia, it still shows signs of a mercantilist legacy. The Government expects and is expected to direct the economy. The Ministry of Finance does not hesitate to enter the stock market to boost share prices when needed.


If other nations of East Asia agree to form an economic community with China and Japan as the standard setters, they are condemning themselves to a sub-par economic future. Again, Europe is a showcase. France, Germany and Britains refined mixed free market and government models still rule the day and are preventing the European Union from achieving higher growth rates.


Is this the vision for the future for East Asia? I sure hope not.


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