Resident Scholar Claude Barfield

Since 1999, when Japan and Korea made the strategic decision to add bilateral free trade agreements (FTAs) to their portfolio of trade policies, a number of international trade economists have predicted that sooner or later a "domino effect" would ensue in East Asia. Once any two of the largest economies involved in the region--Japan, China, Korea, and the United States--negotiated an FTA, they reasoned, the others would have to fall in line because of their close connection through production-sharing arrangements and the potentially large impact of trade and investment diversion.

The US/Korea FTA may well be the tipping point that produces such a result. It is no coincidence that the day after the US/Korea agreement was initialed, Japanese Prime Minister Shinzo Abe called for restart of stalled Japan/Korea FTA negotiations--and he added that Japan "needs to consider" an FTA with the United States. Ultimately, the chain of events triggered by the US/Korea negotiations could also lead to a regional pact that includes all of the nations in Southeast and Northeast Asia. But we are a long way from that result.

Backing up, it is important to understand the political and economic realities as they exist in East Asia today. Over the past seven years, East Asian nations have signed over 70 bilateral FTAs, both among themselves and with nations outside the region. Singapore is the champion, with a dozen agreements in force or under negotiation; Japan is negotiating or has concluded some ten agreements; Korea, similarly has five agreements in negotiation or signed; China has signed or is negotiating some ten agreements--and so it goes on down the line, with Thailand, Malaysia, the Phillipines, Australia and New Zealand all busy with FTA negotiations. In addition, there are several dozen FTAs on the drawing board, where actual negotiations have yet to begin.

What is important to note about this long list, however, is that to date negotiations among the largest East Asian economies--Japan, Korea, and the PRC--have not advanced very far (It is true that the agreement between the PRC and the ASEAN nations as a group is significant politically, but it did not reach level of a tipping point because of the relatively small trade and investment numbers involved). There are important trade policy reasons for this lag among the big economies; but the most important reasons are political and historical: because of Japan’s record of 20th century imperialism and brutality, its relations with China and Korea have been difficult and often fraught with hostility.

The U.S./Korean FTA, thus, must be viewed in the context of this fluid and rapidly evolving East Asian regional situation. And here is where "size matters," as the colloquial phrase goes. Of the 14 FTAs in force or signed since the Bush administration launch its "competitive liberalization" drive in 2001, Korea is far and away the most important from an economic perspective. This FTA will result in a preferential economic alliance between the United States, the world's largest economy and biggest trading nation, with Korea, the world 11th largest economy ($1 trillion). Korea is the United States’ 7th largest goods trading partner; in turn the U.S. is Korea’s second largest trading partner.

Beyond this, the U.S./ Korean FTA is a "gold standard" FTA: that is, it goes well beyond rules negotiated in the WTO; and it covers virtually all aspects of trade (with important additions also on investment rules). Thus, the preference that the two nations have granted exclusively to each other in the new FTA will have repercussions for virtually all aspects of trade with their other major trading partners. For instance, 95 percent of all merchandise goods between the two countries become duty-free within three years; and most of the remaining items will have zero tariffs within ten years. In agriculture, within five years a large number of products will be opened to U.S. exporters, including wheat, corn, soybeans, hides, and cotton; many processed food products, such wine, pet food, orange and grapefruit juice, breads, and pastry; and a number of fruits and vegetables, such as grapefruit, lemons, avocados, almonds. Through other means, market access has been expanded for U.S. beef, pork, pears, apples and oranges. In services, Korea liberalized key business sectors, including financial, legal, accounting, audiovisual, and express delivery services. In audiovisual, financial and telecommunications services, U.S. companies gained the rights to own 100 percent of Korean companies. A new investment agreement was forged that provides a more comprehensive legal framework for foreign investors in Korea, including a transparent and binding international arbitration mechanism for disputes. Finally, there were a number of other breakthroughs in areas such as government procurement, pharmaceuticals, intellectual property and regulatory due process.

The bottom line is that the deep and comprehensive substance of the agreement will have a great impact on future trade flows between the two nations and their major trading partners, not the least Japan whose firms sell and buy many of the same products in both markets. Substantial trade diversion will inevitably occur as the US/Korea FTA preferences come into force.

Given this background, what are the potential scenarios for future trade negotiations in East Asia? As noted above, economic imperatives will vie with political and historical tensions to govern the policy outcomes. A tentative list of options would include the following:

• Japan has already signaled the desire to reopen FTA negotiations with Korea. It has two other potential alternatives: one, to seek an FTA with the United States (possibly beginning with a study group coming out of Prime Minister Abe’s visit to Washington later this month); and two, suggest (a la NAFTA) a trilateral negotiation among the three countries: Japan, the US, and Korea;
  
  
• Because negotiating a separate FTA with the PRC presents political difficulties for the U.S., Japan and Korea, the only way to include the PRC would be to go the regional route through the Asia Pacific Economic Forum (APEC). Thus, the U.S., Japan and Korea could suggest that serious negotiations begin on the proposal for a Free Trade Area of the Pacific (FTAAP), an idea that was endorsed by APEC members (for the long term) in November 2006
  
  
• If FTAAP appears too ambitious, the U.S., Japan and Korea, could back a proposal to expand regional free trade through a "coalition of the willing": that is, building from a core of APEC members, with a so-called docking provision that would allow other nations in the region to join when they were ready.
  
  
• Less likely, but possible, ASEAN nations could take the lead. ASEAN has negotiated an FTA with the PRC and is in negotiations with Japan. ASEAN could propose that, with ASEAN as a core, a regional FTA could be constructed by adding Korea and the United States to its negotiating agenda. This would finesse the China problem but would present other problems, such as how to include Taiwan and what course to take regarding Myanmar.

It is not possible to predict which--if any--of these paths trade negotiations will take. But what is certain is that the U.S./Korea FTA has triggered a tectonic shift in regional trade relations and in future potential institutional frameworks.

Claude Barfield is a resident scholar at AEI.