Abstract

The current trade turmoil is not limited to negative economic effects stemming from the series of recent trade measures erected by the United States as part of the escalating U.S.–China trade war. The more serious issue that will unfold in the middle to long term is the potential collapse of the rule-based trading regime. The weakening of the multilateral trading system centered by the World Trade Organization (WTO) seems to continue. East Asia has been one of the largest beneficiaries of the rule-based trading regime in its course of extending and deepening international production networks and must now take proactive moves to defend and preserve this stable economic environment. Two crucial tasks in the preservation of the WTO are efforts to maintain the functionality of the dispute settlement mechanism and the revival of the WTO as a forum for future trade negotiations. At the same time, East Asia must develop a network of mega–free trade agreements (FTAs) to partially supplement a possible loss of the multilateral framework.

1.  Introduction

Donald Trump's election as President of the United States in November 2016 has led to turmoil and uncertainty surrounding the durability of trade relationships and trade policies. The U.S.–China trade war, in particular, has generated great uncertainty globally. Countries including ASEAN member states and other East Asian countries have watched closely, as they have sought to learn what sort of deal will be concluded in the negotiations between these two giants.

The direct economic effects of tit-for-tat bilateral tariff imposition by the United States and China are simple to predict, as they are exactly the opposite of those that arise when some countries in a multi-country world form a FTA. From the viewpoint of the third countries (country C), the formation of a FTA by country A and country B may lead to mild negative trade diversion effects for country C. On the contrary, a trade war between country A and country B may lead to small positive trade diversion effects for country C as country C gains some opportunities to export to country A or country B as countries A and B block each other's products. Indeed, some ASEAN member states have benefited in this way. The effects have been especially strong for Vietnam and Thailand, where inward foreign direct investment by Chinese and other multinationals have relocated activities away from China.

Third countries, such as the ASEAN nations, do not have to feel guilty in taking advantage of such economic opportunities because by doing so they can partially mitigate the detrimental economic consequences of the trade war, and that is certainly good for the world. However, this mitigating effect may not last, because third countries may become the new targets of aggressive U.S. trade policy if the United States experiences growing trade deficits with these third countries. More importantly, in the medium to long term the trade benefits experienced by third countries are jeopardized by the potential collapse of the WTO rules-based trading regime.

ASEAN and East Asia have aggressively developed international production networks (IPNs) since the late 1980s. On the institutional side, the rule-based trading regime has provided crucial soft infrastructure that has supported the growth of these IPNs. Policymakers must now reaffirm the importance of a stable trading environment with minimized uncertainty and take a proactive move to defend the rule-based trading regime.

This paper is organized as follows: Section 2 presents the concept of the rule-based trading regime and demonstrates its particular importance for countries in ASEAN and East Asia. Section 3 reviews how the multilateral trading system, which is the core of the rule-based trading regime, has been shaken by recent trade policies enacted by the United States and its counterparts. Section 4 argues that the effects of a diminished multilateral trading system will be long-lasting. Section 5 presents two tasks nations must undertake if they wish to save the WTO. Section 6 notes how recent efforts to formulate mega-FTAs may partially offset the adverse effects stemming from the weakening of the multilateral trading system. The last section concludes.

2.  The rule-based trading regime

International trade theory and microeconomics generally support the creation of a rule-based trading regime because of the benefits of freer trade with less uncertainty. Currently, three forms of trade institutions provide policy channels that are aligned with economic logic. The first is the multilateral trading system that is centered by the WTO. In the WTO, most commitments are offered on a “multilateral” basis. In other words, the benefits and obligations are applied to all WTO members, though with some exceptions such as special and differential (S&D) treatments for developing economies. Further, under the WTO umbrella, some limited commitments are developed on a “plurilateral” basis among a subset of WTO members. Regional trade agreements (RTAs) including free trade areas and customs unions are the second set of institutions that govern trade rules. These RTAs are loosely subject to WTO discipline as specified in GATT Article 24, GATS Article 5, and others. The third set of institutions that come into play are each country's trade and domestic policies. These, too, are partially disciplined by WTO rules.

More recently, liberalization progress and new rule-making have occurred through the expansion of RTAs while the WTO retained its prior commitments with few advances. Trade liberalization through RTAs is not a perfect substitute for advances in WTO policies, however. Nonetheless, although the failure to advance is a disappointment, the WTO should not be scrapped. First, the use of WTO policies continues to impose a level of policy discipline on unilateral, bilateral, and regional trade policies. Second, the WTO disciplines trade-related policies that largely have a non-discriminatory nature such as trade facilitation and intellectual property protection. Third, the WTO provides a dispute settlement mechanism though the scope is limited to the extent of WTO-based commitments. Thus, even if RTAs increase in importance in the future, loss of the WTO or withdrawal of the United States from the WTO would be costly, particularly for small newly developed and developing economies.

East Asia, including northeast Asia and ASEAN, has been one of the greatest beneficiaries of the rule-based trading regime in the world since the mid 1980s. Notably, East Asia has aggressively utilized IPNs (Ando and Kimura 2005) or the second unbundling (Baldwin 2016), particularly in machinery industries. Time-sensitive, sophisticated IPNs with tight business-to-business linkages can be developed only in a setting that provides a stable and predictable trade policy regime with limited policy uncertainty. This helps explain why IPNs have flourished only in a limited number of countries in the world.

The most favored nation (MFN) tariffs secured by the WTO have been crucial for ASEAN and East Asia product exports. The Information Technology Agreement (ITA), under the umbrella of the WTO since the latter half of the 1990s, has contributed to the development of IPNs, particularly in the electronics industry by MFN-based tariff cuts.1 ASEAN and East Asian countries have also utilized the dispute settlement mechanism of the WTO to solve their own trade disputes. Since the early 2000s, East Asia has actively developed a hub-and-spoke FTA network centered on ASEAN, which has contributed to the expansion and deepening of IPNs. However, the multilateral trading system has also remained of vital importance.

3.  The multilateral trading system under attack

The multilateral trading system is now in jeopardy due to trade policy changes that have been triggered by new Trump Administration trade policies, which have widely deviated from the existing norms of the rule-based trading regime.

First, the Trump administration has insisted that its trade partners must revise their previously agreed-upon FTAs such as the Korea–U.S. FTA and the North American FTA, or NAFTA. NAFTA's new replacement, called the U.S.–Mexico–Canada Agreement (USMCA), includes a number of protectionist policies such as forced imports, voluntary export restraints, loosening of existing liberalization commitments, prohibition of exchange rate manipulation, and strict rules of origin tied to a labor cost clause. Bilateral negotiations with other trading partners, including Japan, are under way or are about to start to obtain “deals” rather than “rules.”

Second, the abuse of trade-restricting measures has also been activated since the beginning of 2018. Section 232 of the Trade Expansion Act of 1962 is a U.S. domestic law that allows the administration to impose trade barriers in support of national security. Based on this law, the United States imposed 10 percent and 25 percent tariffs on selected aluminum and steel products imported from nominated countries based on a debatable threat to U.S. national security. Automobiles are also subject to investigation for the possible application of Section 232. It is highly likely that these are inconsistent with the WTO norm. Furthermore, based on Section 301 of the Trade Act of 1974 and related articles, the United States imposed 25 percent or 10 percent tariffs on a wide range of products imported from China, claiming the issues of intellectual property right protection and other complaints. It is obvious that such unilateral and discriminatory imposition of trade barriers is not consistent with the WTO norm.

Third, a number of trading partners including the EU, Canada, and China have retaliated in response to the United States’ use of trade barriers based on Section 232 or Section 301, by erecting retaliatory or rebalancing measures against the United States, and some of these measures also seem to be WTO inconsistent.

Fourth, the Appellate Body (AB) of the WTO dispute settlement mechanism may cease to operate later this year. Because the United States is blocking the reappointment of AB members, the AB now has only three judges filled out of its seven positions. When the terms of the two of the three remaining members expire in December 2019, the AB will no longer be able to function, because its rulings require a minimum of three judges. Although the United States raised several relatively minor points that it wants the AB to fix, it is unclear whether action on these items will cause the United States to come back and save the AB or not. Without the AB, the enforcement of the WTO rule would be substantially weakened.

Due to these issues working against the spirit of the WTO, confidence in the rule-based trade regime has been seriously degraded. Because rule-based trade has supported the development of IPNs through the second unbundling, the effects of anti-trade measures on long value chains are difficult to predict due to the negative feedback they may transmit. Uncertainty about the trade regime will slow investment, which may later lead to negative shocks in asset markets. As a result, the U.S.–China trade war may also harm other countries in East Asia.

4.  Why is the risk likely to last long?

The current negotiations between the United States and China need to be watched carefully. Nevertheless, even if the two countries arrive at a settlement, any resolution will probably include a number of trade-restricting measures. President Trump's trade policy creates headaches for U.S. trade partners’ trade with the United States, but that is not the only issue. For a number of reasons, the current degradation of the rule-based trade regime may continue for a long while into the future.

First, the rise of populism in politics and protectionism in trade policy appears to be here to stay, particularly in some developed countries. Many countries are struggling to adjust their economies in light of rapid technological progress and globalization, particularly in taking care of the industrial adjustments and employment impacts of these developments. Because these trends are expected to widen income inequality that will not be resolved in the short term, international trade is likely to become a victim.

Second, newly developed economies including China have grown rapidly and have become major players in the global arena. As a result, a big task is figuring out how to integrate these countries in the rule-based trade regime. In addition, the compatibility of state capitalism with a rule-based trade regime is raising further challenges that are not simple to solve.

Third, the global imbalance remains a major source of political attention in world economic discussions. These imbalances have led to discord, particularly in the case of China's surplus with the United States, and with regard to trade imbalances within the EU. Macroeconomics has engaged in an ongoing debate about the sources of macro imbalances and whether existing imbalances are excessive or acceptable. In the context of international trade, the existence of bilateral trade imbalances have triggered political responses even though a nation's overall trade balance with the world is more economically meaningful than any of a country's bilateral trade deficits.

Fourth, the WTO is at risk not only because of AB concerns, but also as a result of its failures as a negotiating forum. The bitter experience of the unsuccessful Doha Development Agenda suggests that further progress through multilateral agreements (i.e., including all WTO member countries) is extremely difficult to achieve.

Fifth, rulemaking has lagged the developments stemming from technological changes and globalization. In particular, the impact of digital technology is huge. A delay in responding to a new economy would make the rule-based approach unattractive.

5.  Saving the WTO

We must save the WTO and the multilateral trading system. This is currently an important discussion point in various international forums including the G20, which was hosted by Japan this year.2 It is easy to criticize the United States, and we have a number of reasons for doing so. We do not want the United States to walk away from the WTO, however. On the other hand, there are a number of issues we would like China and other newly developed economies to reform, although their claims for S&D treatment are strong so that the credibility of their commitments is diminished. Above all, the consensus method in decisionmaking, which provides a “veto” for any single member country, effectively hobbles efforts that would allow the WTO to expand its scope.

There are two tasks—one that needs to be taken care of in the short term and other to be completed in the medium and long term. In the short term, the AB issue must be resolved. The official reasons the United States has given for its blockage of the appointment or renewal of AB members appear to be superficial, and the actual intentions of the White House are not clear even among the trade experts in Washington, DC. A number of issues related to the United States’ use of Section 232 and Section 301 as a justification for tariffs will certainly come before the WTO dispute settlement system if the system survives. If these cases are heard, the WTO dispute system will probably rule that the United States’ use of Section 232 and Section 301 violates WTO rules. Given this outcome, trade partners have to ask themselves whether the United States still wants to allow the AB to survive.

If the AB ceased to work as the arbiter of trade disputes, the multilateral dispute settlement system will most likely leave the current two-tier trial system, returning to the much weaker enforcement mechanism such as the prior panel-only system from the GATT era. Alternatively, if the United States intends to leave the WTO completely, trade partners will need to pursue disputes with the United States at other international courts. If this occurs, the dispute settlement system will be even weaker and power politics will emerge.3 In either case, the rule-based trading regime will suffer from a loss of credibility.

In the middle and long term, the WTO should be revived as a negotiating forum. Two main agenda items exist here. First, the forum setting must provide increased flexibility. The wrecked Doha Development Agenda bitterly illustrated the difficulty of using a multilateral approach to expand the scope of the WTO. Many still hold the adamant belief that a multilateral approach is the best way to go. However, to reactivate the WTO as a negotiating forum, countries must acknowledge the merits of an active use of plurilateral agreements as the path to further liberalization and new rule-making. Currently, there are three forms of plurilateral agreements: (i) agreements that are brought into the WTO and applied on MFN basis, such as the ITA; (ii) agreements under the WTO that apply only to the signatory countries, such as the Government Procurement Agreement (GPA); and (iii) agreements that are not formally under the WTO umbrella, such as the proposed Trade in Services Agreement, which was negotiated but not concluded. A multi-speed multilateral approach is another possible choice. Depending on the topic concerned, a flexible approach must be applied.

The second is scoping a new agenda. We have already spent vast time in negotiating over three built-in agenda items from the Uruguay Round—agriculture, non-agricultural market access, and services. Although these are certainly important areas for further liberalization, it is obvious that an immediate return to these topics in the aftermath of the Doha Development Agenda failure will not activate the WTO. Rather than sticking to this old agenda, the WTO may regain its credibility by exploring the possibility of an expanded topical scope.

Some relatively small agenda items, including the expansion of the membership of the ITA II4 and the conclusion of the Environmental Goods Agreement5 must be pursued. Further, other large categorical agenda items present opportunities for reform. The first series would seek to incorporate newly developed economies such as China into the rule-based trading regime by addressing subsidy, government procurement, and state-owned enterprises. These issues would be assisted by requiring countries to comply with the WTO notification policy, as this would provide information on country compliance with their WTO commitments, including those pertaining to subsidies. Some initial effort on the notification item is already underway. A second topic in need of negotiation is the development of policies that respond to recent technological advancements such as e-commerce. To this end, at the 2019 Davos meetings, 76 countries and regions agreed to start negotiating new e-commerce rules. In June 2019 at the G20 in Japan, the concept of “Data Free Flow with Trust” was adopted, and the opening of the Osaka Round for data-related rule-making was proposed. This could be an important step towards revival of the WTO. It is not yet clear, however, whether all the members of the WTO, explicitly or implicitly, are ready to allow this negotiation under the umbrella of the WTO.

Newly developed and developing economies have often been hesitant to agree to new WTO agenda items, due to their fears of additional commitments and obligations. In support of this reluctance, developing countries often point to their entitlement to S&D treatment and “policy space.” At other times, developing countries have blocked discussions of new issues by instead raising older issues such as the treatment of agriculture. Nonetheless, although developing countries may fear the introduction of new areas of negotiation through the WTO, if the multilateral trading system is lost, the newly developed and developing countries, and those without any meaningful FTAs in particular, will suffer far worse economic damage. Under a weaker WTO, the current MFN world will instead be replaced by a power-politics world. Any countries that lack significant power, such as the majority of newly developed and developing countries, will not fare as well as they would under a continuation of the WTO and its protections.

A final issue related to countries that seek developing country treatment under the WTO is the fact that countries self-declare status as a “developing country.” Although the criteria are hard to define, the continued claims of “developing” status by countries such as the Republic of Korea, Singapore, and China raises international frictions due to the fact that “developing countries” are allowed to claim S&D treatment to avoid full commitment to WTO discipline. Progress on this issue is also essential to the future health of the WTO system.6

6.  The formation of mega-FTAs

In the trade regime turmoil, mega-FTAs may rise in value as a partial substitute for the multilateral trading system. In a worst-case scenario, East Asia would need to conduct its trade in a world without the WTO or the WTO without the United States. For example, if the WTO discipline, which includes the provision of MFN tariff promises, is instead replaced by policy discretion, East Asian countries will instead need to depend on preferential tariffs provided by RTAs. Although RTA dispute settlement mechanisms have yet to be effectively used, if they were activated RTAs might reduce some, but not all, political uncertainty. If they step up their efforts along these lines, mega-FTAs may become a basic institutional infrastructure for East Asia.

The uncertainty caused by current trade turmoil has accelerated country engagement in the formation of mega-FTAs. For example, the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (CPTPP) was signed by 11 countries in March 2018 and went into effect among six countries (Mexico, Japan, Singapore, New Zealand, Canada, and Australia) on 30 December 2018. Vietnam followed on 14 January 2019. Although Malaysia may reconsider its participation in the CPTPP under Prime Minister Mahathir, Brunei may soon ratify the agreement. Peru and Chile are still engaged in the ratification process, while Thailand, Chinese Taipei, and other East Asian countries have begun serious consideration of accession to the CPTPP.

The Japan–EU Economic Partnership Agreement (JEEPA) also became effective on 1 February 2019. It separated investment protection and investment-related dispute settlement from the main agreement to accelerate the ratification process on the EU side. By doing so, the ratification is needed only at the EU level, rather than going to each EU member country; the latter method was also applied in previous cases including the EU–Korea, EU–Canada, and EU–Vietnam FTAs.

The early conclusion of the Regional Comprehensive Economic Partnership (RCEP) is now more important than ever for most of the negotiating countries. The quality of a concluded agreement matters, of course. However, the standard of liberalization and rule-making achieved by the CPTPP is probably too ambitious as an immediate goal for the RCEP. Thus, rather than spending too much time in RCEP negotiation, an attractive alternative is the quick conclusion of a base agreement in the first round, which is gradually upgraded over time. The contents of a living agreement of this form would follow the same process that was taken as ASEAN deepened its economic integration. ASEAN must have the RCEP concluded to keep its centrality in East Asian economic integration. China would be more motivated to have it now to build up a stable relationship with the neighbors. Japan also has an incentive to participate because the RCEP connects Japan with China and Korea. An early conclusion would help Japan avoid a possible backlash following from a so-called poison clause, which might be imposed in upcoming Japan–U.S. trade talks; Canada and Mexico acquiesced to such a clause in the USMCA, when they agreed to consult with member countries if they want to pursue a FTA with non-market economies.

Mega-FTAs may support a coalition of trade-friendly middle power countries that want to defend rule-based trade. They may also provide a bridge across superpowers, rather than setting a wall between them. Furthermore, we would like to avoid a link between politics and international trade through mega-FTAs. CPTPP and JEEPA set a standard for a high level of liberalization commitments and new rule-making, which may make some of the countries in the region with weaker political/economic reform capability difficult to be engaged in such a high-level agreement. However, this is exactly the time to step forward to bold domestic reform, too.

7.  Conclusion

East Asia has long been a free rider in the rule-based trading regime and has achieved its own economic development. However, East Asia can no longer take this comfortable environment for granted. It should instead take proactive steps to minimize the further erosion of the rule-based trading regime.

The defense of the multilateral trade system requires a number of decisive steps, beginning with saving the WTO. To this end, the AB issue must be resolved, and the WTO needs to be updated to restore its role as a negotiating forum. Simultaneously, East Asian countries may choose to elevate their efforts to form mega-FTAs, which may become more important as world multilateralism weakens.

Notes

1 

Roughly speaking, about the three-fourths of world trade is still conducted under MFN tariffs, 60 percent of which are zero tariffs.

2 

The author is a lead co-chair of Task Force 8 (Trade, Investment and Globalization), T20 (Think 20) for G20 2019 Japan. Seven policy briefs including two on WTO reform are posted on the T20 Japan Web site (https://t20japan.org/publications/policy-briefs/).

3 

At the Global Solutions Summit in Berlin on 18 March 2019, Pascal Lamy, former Secretary General of the WTO, explicitly mentioned a possibility of WTO minus the United States and claimed that the United States would pay the cost particularly on intellectual property protection.

6 

In October 2018, Chinese Taipei announced its intention to quit “developing country” status in the WTO (Nikkei Asian Review, 17 October 2018). In March 2019, The United States argued that the “developing country” status no longer makes sense for China (Nikkei Asian Review, 2 March 2019).

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