China and ASEAN Agree to Free Trade Area: But Why?

The Conflict

On November 6, 2001, China and the ten countries that comprise the Association of Southeast Asian Nations (ASEAN) agreed to set up a new free-trade region within ten years, one that could rival the North American Free Trade Association (NAFTA) and the European Union (EU). But the economic advantages of adding China to ASEAN are less clear than some of the political imperatives that may be driving the alliance. In this forum, as in others, China's potential position as a superpower in the near future is being watched with concern and interest.

Political

• In China-ASEAN, China is challenging Japan's dominance in the Asia Pacific. So far, it appears that Japan either cannot, or, more likely, does not, choose to respond to China's challenge.
• ASEAN has a history of very limited intra-ASEAN trade, but political cooperation among members of the group has been more successful.
• Southeast Asian countries believe that China will be the new engine of growth for the region, displacing Japan after thirty years of dominance. They may wish to link up with the next superpower for security, as well as economic, reasons.

Economic

• The influx of Chinese goods into Southeast Asia could swamp local industries.

In the immensely wealthy but little-known sultanate of Brunei on November 6, 2001, China and the ten countries that comprise the Association of Southeast Asian Nations (ASEAN)—Myanmar (Burma), Laos, Thailand, Cambodia, Vietnam, the Philippines, Brunei, Malaysia, Singapore, and Indonesia—agreed to set up a new free-trade region within ten years. Although the region does not yet have a specific name, it is destined to become the world's largest market, stretching over four thousand miles from Manchuria south to Java, with an estimated population of two trillion and current two-way trade of $1.7 trillion. Such a free trade zone could eventually rival the North American Free Trade Association (NAFTA) and the European Union (EU). Amid all the fanfare, however, lurk some disquieting concerns.

China's economy has been growing rapidly, and its trade with Southeast Asia is worth $40 billion a year and rising. This has caused Malaysian prime minister Mahathir Mohamad, among others, to warn that the influx of Chinese goods into Southeast Asia could swamp local industries. There is also a question as to how China will fare with its recent entry into the World Trade Organization (WTO) and what impact this might have on the smaller economies in the region.

Perhaps the greatest challenge will be for the members of ASEAN to act in a concerted manner. That won't be easy given the differences of members' views regarding China. These range from the cool hesitation of Malaysia, Indonesia, and Vietnam to a more open, albeit wary Cambodia and Singapore to the studied coziness of Burma's generals with their giant neighbor to the north.

Given these concerns, why did ASEAN agree to what could become a one-way market for cheap Chinese low-tech goods? And why would China—poised to become the world's second largest economy within a few years given its recent acceptance into the World Trade Organization—decide to attach itself to a faltering, some say irrelevant, economic union, especially when China has the population base to provide its own consumer market?

Historical Background

China

For thirty years after the founding of the People's Republic of China (PRC) in October 1949, China's leaders experimented with a series of five-year plans designed to develop their centrally directed economy. During this time China's dictator Mao Zedong (1893-1976) launched a number of attempts to communize the country, notably the disastrous Great Leap Forward (1958-60), and the chaotic Cultural Revolution (1966-76). In both cases, but especially in the former, millions of peasants died of starvation due to irrational and ill-conceived government policies based on distorted Marxist-Leninist principles.

After Mao's death in 1976, his successor, Deng Xiaoping (1905-97), moved away from Mao's doctrinaire control to implement a plan for economic development, called the Four Modernizations. The plan, initially announced by Premier Zhou Enlai (1898-1976), was designed to update China's agriculture, industry, military, and science and technology. This launched a new pragmatism in contrast to Mao's emphasis on ideology; technical expertise became valued over intellectual conformity. As Deng famously put it: "What does it matter if the cat is black or white, as long as it catches mice?" (as quoted in Time magazine on January 6, 1986).

With this pronouncement, starting in the late 1970s Deng initiated an era of economic reforms that dramatically altered the Chinese countryside in the 1980s and 1990s, and which continue to guide the country's economy today. Had these programs, which included free markets, contract systems, and a burgeoning private business environment, been allowed to flourish unabated, it is possible, even likely, that China's economy would now be much further advanced than it is. Even Deng's pragmatic outlook did not extend to the political realm, however, and China remains a laboratory in which its leaders hope to prove that an open laissez faire proto-capitalist economy can coexist with, and be guided by, a centralized Marxist government. Most analysts do not think so, but the jury is still out.

An Impeded Move Toward Private Enterprise

If the 1980s saw a tentative break from the Marxist grip on China, the 1990s have witnessed a more open and unabashed drive into private enterprise. But the progression has been saddled with a state-sponsored albatross that neither Deng nor his successor, China's current president, Jiang Zemin, has been able to discard. This is the state-owned enterprises (SOE), the tens of thousands of companies, factories, and businesses that employ the bulk of China's workers, eat up the lion's share of the country's resources, and produce about one percent of China's gross domestic product.

These cash cows, many of them huge conglomerates, have become serious problems for the leaders of the PRC. The SOEs are financed by the government, based on the Marxist theory that in a communist state unemployment is impossible. The SOE employees must be retained in order to uphold the theory. Maintaining state support of the SOEs saves jobs and thereby keeps the peace. Needless to say, the SOEs are also a huge drain on the economy. They are due to be phased out as a condition for China joining the WTO, potentially putting tens of millions of people out of work. There's the rub: what to do with as much as a quarter of the population in a rebellious mood? One partial answer is to try to strengthen the economy by increasing exports, and that is where the free trade area comes in. ASEAN thus becomes an extension of China's own domestic market.

If China sees a new free trade zone as a way to help it export its way to prosperity, what does ASEAN, a grouping of highly disparate societies, envision? The answer to this is more problematic, not only because of the uneven states of the economies of these nations, but also due to the different histories each has experienced with China, ranging from the studied alignment of Vietnam and Burma to the decades of political estrangement with Singapore and Indonesia.

ASEAN

ASEAN was established on August 8, 1967, under a decree known as the Bangkok Declaration and signed by the governments of Indonesia, Malaysia, the Philippines, Singapore, and Thailand to promote economic growth, peace, and security in the region. Brunei became a member in 1985, followed by Vietnam in 1995, and Laos and Burma in 1997. After being snubbed for electoral manipulations, Cambodia was belatedly admitted in 1999. From the outset the group has sought to promote both intra-ASEAN trade and international business with the rest of the world.

The first few years witnessed a tenuous, walking-on-eggshells relationship among the five charter members, due at least in part to the unsettling reverberations from the Vietnam War (1964-75). But by the mid-1970s, following the end of the war, the balance of power had shifted from the combatant Marxist economies to those professing free-market capitalism, at least in spirit if not in fact. This change, along with the growing self-confidence of the latter countries, generated a new cohesion, and by 1979 the member states were able to make a concerted response to the takeover of Cambodia (then Kampuchea).

In its first two decades, ASEAN met with some success in opening markets, stabilizing prices, and reforming trade and investment issues. But little was done regarding regional economic integration. As a result, intra-ASEAN trade remained limited. Political cooperation among ASEAN nations was more successful, for two reasons. First, the members' foreign policy goals were and continue to be the same: resist great power interference and seek Western assistance for economic development. Second, the ruling elites shared a conservative approach of making political stability a higher priority than instituting democracy. In addition, ASEAN countries were unanimous in asserting mutual nonintervention in each other's affairs, although in recent years Thailand, and to some extent the Philippines, have quietly questioned this resolve.

Nevertheless, ASEAN's apparent cohesion, given its competitive economies, different political systems, and highly diverse populations, has more often than not proved to be a chimera. The grouping's unity is often held together by vigorous assertions rather than by genuine rapport. This can be seen, for instance, in questions of mutual security in the debate over how to deal with competing claims over the Spratly Islands (see below).

By the 1990s ASEAN as a trading body had grown into prominence due to the stellar performance of Singapore and the impressive growth of the economies in Thailand, Malaysia, Indonesia, and Brunei. At the same time, these nations slowly shed their former anticommunist animosity as Vietnam, Laos, and Cambodia were added to their ranks, and China appeared on their radar screen as a logical trade partner. This set the stage for the eventual, some say inevitable, attraction between the two entities for a more stable and lasting commercial relationship.

Allying with a Future Superpower

Today China looms large in the future of Asia, and in particular of Southeast Asia. This can be seen in the way that China has taken up the slack since Japan's economic stagnation set in over ten years ago. There is much speculation about China becoming a new "economic superpower" that will emerge in East Asia to challenge the roles of Japan, the United States, and Europe. In some ways, such as purchasing power parity (PPP), China may even surpass them by 2005. The question then becomes: Does China compete with ASEAN, or can they complement each other? The answer to this rests on a more fundamental problem: What motivated China and ASEAN to agree to the ASEAN Free Trade Area (AFTA) in the first place?

The Newly Industrializing Economies (NIEs), popularly known as the Four Dragons—South Korea, Taiwan, Hong Kong, and Singapore—have invested heavily in ASEAN, but from the early 1990s their focus has shifted to a more international scope, including an emphasis on China. NIE investment in Southeast Asia remains strong for capital-intensive business, but China is seen as a new frontier for labor-intensive operations and a potential market for exports.

In 1994, however, China announced new investment guidelines, giving priority to high-tech areas such as electronics, automobiles, and petro-chemicals. These are the same areas that ASEAN has focused on for its own development, and since the mid-1990s, ASEAN has witnessed a decline in its comparative advantage (see sidebar) with China, forcing its members to search for ways to strengthen their economies. This brought up two important questions for ASEAN: Will there be enough capital, such as foreign direct investment (FDI) and official development assistance (ODA), to go around? And can ASEAN compete with low-cost Chinese labor?

Some observers do not agree that ASEAN is in competition with China. Economist Adrian Foster in the Far Eastern Economic Review, (FEER) buttresses this view by arguing that China's internal economic dynamics will eat into excess returns as they appear, and that there is no shortage of capital worldwide. In the first case, Foster maintains that in China, as in any other economy, Marxist or not, workers will eventually demand higher wages as the economy grows. At the same time, the rising level of technology will force companies to offer skilled workers higher pay and better incentives to keep them satisfied and motivated. This will nullify China's low-cost labor advantage.

In any case, ASEAN felt compelled to take action given the 1997 economic meltdown (see side-bar) on the one hand, and China's growing economic clout on the other. One strategy was to form an ASEAN Free Trade Area (AFTA) that would expand the ASEAN market. In other words, ASEAN may have decided to finesse China to keep the PRC from engulfing Southeast Asian markets, especially at a time when those economies were barely recuperating from the 1997 meltdown, and were therefore all highly vulnerable. This approach would go a long way in dealing with another perception—that China is destined to become the next Asian power and the most effective way of dealing with Chinese power is to build greater economic integration.

In 1997, for instance, the Far Eastern Economic Review noted, "the notion that growing economic interdependence will temper Chinese assertiveness has gained widespread currency, especially among the ruling elites of ASEAN countries." Southeast Asian countries believed that China would be the new engine of growth for the region, displacing Japan after thirty years of dominance. Therefore, it made sense to link up with a future winner.

There may, however, be another factor in the equation. For the last ten years, China has been seen to exercise its sovereign claims over an ever-expanding domain, in particular in the South China Sea. These claims center in particular on two small island groups, known as the Spratly and Paracel islands. Some or all of these islands are also claimed by Taiwan, Vietnam, the Philippines, Malaysia, Brunei, and Indonesia. According to Frank Um-bach, a German political scientist, in the 2002 article "ASEAN and Major Powers; Japan and China—A Changing Balance of Power," "China's sovereignty claims in the South China Sea … are the litmus test for ASEAN's future relationship to China and a crucial factor for regional stability in East Asia."

A Matter of Security

Therefore, ASEAN's "economic" engagement may be as much for security purposes as for commercial ones. Consider that in spite of various and serious differences among the ASEAN countries, the group's focus on economic issues and its members' strong resolve not to interfere in each other's domestic affairs has enabled ASEAN to hold together as world and regional trade has grown. According to Richard Sokolsky, however, "the impact of the economic crisis on ASEAN's cohesion was amplified by ASEAN's enlargement, which made the organization less homogenous." (The Role of Southeast Asia in U.S. Strategy Toward China,2001). Internal economic strains have generated political tension and reduced the effectiveness of ASEAN to manage regional relations.

With the ending of the Cold War in the early 1990s, security issues have increased in importance. This is because where once the United States could be counted on to maintain a strong military presence to offset Soviet or Chinese power, the region has seen U.S. naval and air forces pull back, especially after being refused the continued use of the bases at Subic Bay and Clark Field in the Philippines. Although some of the slack left by the closing of these bases has been taken up by Singapore, which provides access to, though not permanent occupation of, maintenance facilities, there is a growing sense in ASEAN of being forced to band together against the great powers. As the nearest in proximity, China is one of the most crucial powers to be dealt with. Currently, the territorial dispute among China and four ASEAN states (Vietnam, the Philippines, Malaysia, and Brunei; Indonesia has also shown interest) over the Spratly Islands is the most serious problem affecting the relationship.

The Spratly Islands

The apparent reasons for China claiming a group of reefs seven hundred miles from its closest landfall on Hainan Island may be less significant than implied ones. The Spratlys are important because whoever controls them could control key sea lanes through the South China Sea. These are among the world's major shipping routes that traverse the crucial Malacca and Sunda straits. The area covered by the Spratly group also contains valuable fishing grounds and extensive deposits of oil and natural gas.

These strategic issues aside, however, China's growing interest may reflect an atavistic view that seeks to reclaim what the PRC believes, based on historical grounds, rightfully belongs to the Middle Kingdom. Concerned ASEAN members are on record for opposing this revanchist view. Their fear is that China's increasing military power may embolden it to see the South China Sea as its own "backyard," thereby rendering it less compromising in its territorial demands.

China is pushing the envelope by maintaining garrisons on several sites, such as Mischief Reef, which is also claimed by the Philippines. The potential for serious conflict is obvious—there have already been several minor skirmishes in the past few years. In In China's Shadow: Regional Perspectives on Chinese Foreign Policy and Military Development (1998), Derek da Cunha and Jonathan Pollack have voiced a concern shared by ASEAN that the symbolic aspect of Chinese military activity in the South China Sea may be more important than actual warfare. Why would this be? "Simply because in Southeast Asia, China is not perceived as … a country that has been fully integrated into the international system where it would readily abide by rules and norms of international conduct."

The Role of Japan

Therefore, ASEAN's reason for engaging its powerful neighbor to the north is to apply leverage against the PRC to prevent it from gaining too firm a foothold in ASEAN's own "backyard." On the other hand, it has also been noted that the group's move to deal with China's rising power helps to counterbalance the weight of Japan, which heretofore has enjoyed near total domination of private and government investment in Southeast Asia to the extent that the area was seen as Japan's "back-yard."

The opinion about Japan's precise role, given the China-ASEAN courtship, is mixed. The Christian Science Monitor, for instance, has written that a growing "China and a fiscally beleaguered Japan are ratcheting up a quiet but furious competition for Asian preeminence" (Prusher and Marquand, "Bush Seeks Asian Allies in New War," February 19, 2002). In this scenario, China's increasing national production has forced Japan to react. Because of Japan's stagnant economy, Beijing is making a bid to fill the geopolitical gap. In the December 12, 2001, Seattle Times article "China Poised to Usurp Japan as Asian Engine," syndicated columnist Tom Plate notes the prevailing view is that the Japanese economy will never return to what it was in the 1980s and 1990s, when it served as the locomotive for Southeast Asian growth. "Can China fill that role in decades to come?" he asks. ASEAN's answer: Who else?

The Economist and the Asahi Shimbun (Tokyo) hold to this line as well. The latter's Yamada Atsushi notes in the November 3, 2001, article "ASEAN, China Bypass Japan," that Japan's sluggish pace in creating an ASEAN economic zone in comparison with the smooth dealings China enjoys with Southeast Asia "highlights the lack of vision and strategy of Japanese political leaders." In fact, a big part of the reason for Japan's hesitation in reaching out to ASEAN is the stranglehold that the Japanese farmers and their political representatives have on policy making.

Ever since World War II (1939-45), farmers have been coddled as the final vestige of a Japan as it used to be. There remains a powerful nostalgic incentive to retain this semblance of a one-time utopian "pure" society. In addition, farmers enjoy inordinate political clout: their votes weigh much more heavily in elections due to specially drawn electoral districts, reminiscent of gerrymandering. Consequently, farmers continue to receive massive price supports. And any hint of opening the Japanese agrarian sector to outside competition is anathema to Japan's political leaders.

Japan may at times sign free trade agreements, even some that include farm products. But it is always a bilateral arrangement, never multilateral (as with ASEAN), and it is always with a country having little or no agricultural products, such as Japan's recent accord with Singapore. Less technically developed countries with substantial agrarian bases, such as Vietnam, Indonesia, or the Philippines, make Japan chary about becoming too closely involved with ASEAN. And China is right there, ready to take over Japan's lead role.

Unshackled by farm interests, Chinese leaders have convinced ASEAN that a free trade area would benefit everyone. To ASEAN members looking for export markets, China pointed to its vast domestic consumer potential. To the poor agrarian Indochina countries to which Japan has found it hard to open up, Beijing offered economic assistance. China emphasized its role when it told ASEAN that if it waited for Japan to join, the free trade area might never happen.

However, there may be more to this than meets the eye. Two points should be considered: (1) Economically Japan is still Southeast Asia's major partner and benefactor, and (2) strategically Japan remains a key balance to a rising China. So why is Japan apparently dragging its feet in the face of a Chinese challenge to its dominance in the Asia Pacific?

In spite of the doom-and-gloom assessments about Japan's persistent recession, the figures remain staggering. Its $4.7 trillion economy (compared to a total China/ASEAN annual production of $2 trillion) is eight times larger than all the ASEAN economies combined; it is nearly five times larger than the Chinese economy. And Japan is still the top aid donor to both ASEAN and China, eclipsing the United States and the European Union. In the year 2000 alone, even after ten years of slow or no growth, Japanese business invested $2 billion in ASEAN countries.

Yet the weakness of the Japanese economy continue to bedevil the pundits. David Kruger and Murray Hiebert of the Far Eastern Economic Review, for instance, point out that a "huge volume of bad loans is smothering the nation's banks. Deflation continues. The unemployment rate is at a record high and bankruptcies are rising." ("Battered but Still on Top," 2002). The government predicts no better than zero growth for 2002-03. So why isn't Japan jumping on the bandwagon and stumping for a Japan-ASEAN free trade area to check China's increasing presence in the region?

One reason is that Japan must still consider its powerful farm lobby. Because of this, Japan is more comfortable regarding ASEAN as a political partner focused on security issues, especially in the aftermath of the terrorist attacks on the United States on September 11, 2001. This explains Japan's calling for a more open region beyond simply ASEAN+1 (China) or ASEAN+3 (China, Japan, and South Korea), to expand in the long run to the United States, Australia, New Zealand, and others.

Recent History and the Future

In January 2002, Japan's prime minister, Koizumi Junichiro, made a week-long tour of Southeast Asia. His final stop was Singapore, where he signed a bilateral trade agreement. On the other hand, an overture from Thailand for a similar free trade pact went unanswered, due once again to the farm lobby. So where does this leave the idea of a Japan-ASEAN free trade agreement (FTA)?

ASEAN's secretary-general, Rodolfo Severino, doesn't feel that Koizumi has any intention, at least for now, of being pressured by China's moves towards ASEAN "Japan does not feel threatened by the proposal for an ASEAN-China free trade area," Mr. Severino said.

In short, Mr. Koizumi has decided that it is too early to draw any conclusions from the China-ASEAN proposal. Severino also noted: "The ASEAN-China FTA is too premature for ASEAN to pin all its hopes on." Indeed, it may be that Japan is more prescient than others in failing to jump to conclusions of a Chinese coup. The November 2001 proposal caught analysts off guard, who viewed it as a bold step by Beijing to play off Asian countries against the United States and the European Union. But public pronouncements now seem to have raced ahead of reality. More and more observers believe that an Asian version of the North American Free Trade Agreement (NAFTA) is still a long way off. Japan understands this and is playing its own game.

In the meantime, China continues to invest in Southeast Asia, though usually on a bilateral basis rather than with ASEAN as a group. This economic buildup has led some observers to conclude that ASEAN is nothing more than a temporary stage in Beijing's strategy of "going outside." In fact, China makes no secret of its global ambitions. What we likely are seeing, the observers suggest, is a new flurry of activity that illustrates China's increasing self-confidence and the need for natural resources to feed its growing economy. So what will it be: China's ambition or Japan's complacency?

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Allen Wittenborn

Chronology

October 1949 The People's Republic of China (PRC) is founded.

August 8, 1967 ASEAN is established under a decree known as the Bangkok Declaration, signed by the governments of Indonesia, Malaysia, the Philippines, Singapore, and Thailand to promote economic growth, peace, and security in the region.

1976 Mao Zedong dies and successor Deng Xiaopeng initiates an era of economic reform in China.

1985 Brunei becomes a member of ASEAN.

1994 China announces its new investment guidelines, giving priority to high-tech areas such as electronics, automobiles, and petrochemicals, the same areas on which ASEAN has focused for its own development. ASEAN then witnesses a decline in its comparative advantage with China, forcing its members to search for ways to strengthen their economies.

1995 Vietnam becomes a member of ASEAN.

1997 Asia experiences a widespread economic slump.

1997 Laos and Burma become members of ASEAN.

1999 Cambodia becomes a member of ASEAN.

November 6, 2001 China and the ten countries that comprise the Association of Southeast Asian Nations (ASEAN) agree to set up a new free-trade region within ten years.

November 10, 2001 China officially becomes the one hundred forty-third member of the World Trade Organization.

Comparative Advantage

Comparative advantage: That which a country produces (usually for export) best at the lowest possible price.

The requirements for producing goods vary around the world. Such factors as capital, labor, technology, raw materials, and infrastructure are different in every country. For instance, some countries are rich in natural resources (Russia, Indonesia, Canada), others in cheap labor (Vietnam, Mexico), and still others in advanced technology or large amounts of capital (Japan, United States, Singapore). A country's "comparative advantage" is its use of those factors or resources that it has most in abundance in order to best develop its economy and society. In other words, Singapore would not want to rely on cheap labor, nor would China hope to capitalize on raw materials, of which it has little. That's why the tendency of some undeveloped countries to build great steel mills or five-star hotels is a waste of money that usually only fills a need for greed and ostentation.

The Asian Financial Crisis of 1997

As several Asian economies (in particular South Korea, Taiwan, Singapore, Malaysia, Thailand, and Indonesia) grew and expanded throughout the 1980s and 1990s, investors poured money into projects in much the same way that people in the United States bought up shares of NASDAQ stocks in the late 1990s. This continued in Asia until businesses and the money lent to them, collateralized by inflated real estate values, were worth on paper much more than they could realize in profit. No one realized this at the time, however, because most countries' treasuries had pegged their currency to the U.S. dollar, making it difficult to ascertain the underlying financial and economic strength.

Eventually investors realized that something was amiss, and they began to exert pressure on some countries to open up their economies, including letting their currencies reach their natural level. Thailand was the first country in July 1997 to float its currency, the baht. Overnight the baht collapsed because everybody wanted to sell it, sensing that the Thai economy was a wreck because of the inflated real estate and business values. This "economic flu" was contagious, and before long other Asian economies had caught the bug. By early 2002 some of these countries were starting to climb back, but others, such as Indonesia, remained in the doldrums.