FTAs: US, PRC and Taiwan participation

The basic economic ideas underlying the international law governing FTAs are rooted in the concept of comparative advantage. The efficiency gains offered by economic specialization consistent with comparative advantage can only be reaped fully in a world without the artificial barriers to international trade created by protectionist national laws.

Almost all states have imposed significant restrictions on trade, but many states are willing to remove most barriers with some of their trading partners, and most would be willing to remove or reduce some barriers toward some trading partners (provided they are free not to do so with others).

Given that a global free-trade regime is unattainable, what achievable option should a liberal international economic regime’s rules tolerate? The World Trade Organization (WTO) opts primarily for a most favored nation (MFN) or normal trading relations (NTR) rule that requires a state not to discriminate among its trading partners, thereby according each trading partner treatment no worse than the most generous terms it provides to any other partner.

This is consistent with the idea that such a regime is likely to come closer to the idealized liberal and efficient order than would a regime in which each state negotiates a bilateral arrangement with each of its trading partners. The plausible claim is that the series of discrete agreements including some especially liberal and some especially illiberal arrangements would, in the end, be dominated by the latter.

The WTO regime allows a major “carve out” from its MFN/NTR principle: FTAs. In simplified terms, the FTA exception allows two or more member states to remove substantially all trade barriers among themselves while maintaining their less liberal structure of MFN/NTR-conforming laws regulating trade with all other WTO members. This is based on the assumption that true FTAs are likely to produce significant net gains in trade liberalization - that the radical lowering of restrictions on trade among FTA members will stimulate trade and specialization along the lines of comparative advantage among the FTA members, and that this will outweigh any marginal liberalization that might have been foregone among FTA members and other WTO member states. The basic trade-off is the same as that underlying WTO’s embrace of the MFN/NTR norm. But it is claimed that the balance is likely to come out the other way in the special circumstances of an FTA.

Increasingly, the economic argument for FTAs and trade liberalization has become bound up with issues of investment. Capital-exporting countries’ firms go abroad to establish facilities to produce goods and services for consumption in their home markets or in third-country markets. Such a strategy benefits from, and may depend on, low barriers to exports from the host country. Through rules limiting protectionist Trade-Related Investment Measures and through terms in individual members’ protocols of accession (including China’s), the WTO has begun to provide mechanisms to support such liberalization of investment restrictions.

These liberal principles of global economic efficiency and welfare are often honored in the breach and fail to account for the content of real-world FTAs and the motivations behind them.

The Politics of US FTAs with East Asia

The US has been among the most zealous proponents of trade liberalization and a frequent participant in FTAs. Washington was the largest moving force behind the WTO, and after the EU, NAFTA is arguably the most important FTA today. Recent years have brought several initiatives that have established, are working toward, or advocate FTAs with key trading partners in East Asia, including Singapore, Thailand, Malaysia, South Korea and Taiwan.

Several related factors do much to explain the US interest in FTAs. They suggest that Washington is likely to continue to support some FTAs in East Asia, although not without controversies and limitations.

First, FTAs often serve American national economic interests and, more importantly, are seen by US policymakers as doing so. As the world’s largest economy and the developed world’s most dynamic economy, the US can expect to reap a large share of the gains from a more open international economy. Such benefits make it worthwhile for the US to bear a disproportionate share of the costs of supporting a liberal order.

FTAs offer a means of getting some benefits of a liberal order at lesser costs. This can make FTAs attractive partial substitutes and complements for the US’ broader pursuit of a liberal international economic order. Because the costs of underwriting a liberal order often include being relatively open even when the hegemonic power’s trading partners are less so, the “level playing field” of an FTA and the easier monitoring of cheating that FTAs may provide can be especially attractive.

Given the importance of East Asian economies in American trade, they make particularly promising FTA partners. The largest cluster of countries outside of the Americas with which Washington has been negotiating FTAs is in East Asia. The relative openness of many of the region’s economies means there is less distance to be traveled between the status quo ante and an FTA. Given the size of the US economy and trade sectors compared to those of its East Asian partners other than Japan and China, the US is often in the position to enjoy the advantages of a favorable imbalance of power in negotiating FTAs. And given the US’s importance as an export market for many East Asian states, regional governments have good reason to seek liberal trading relations with the US.

While such arrangements, again, must in principle take the form of true FTAs if they are to be more liberal than the rules governing relations with all WTO members, they do not do so in practice. This allows the US’s real-world FTAs to include features addressing perceived threats to US interests that more thoroughgoing liberalization would pose.

Second, the US remains generally committed to maintaining liberal foreign trade laws and regulations. A state that favors an internationally open economy and maintains correspondingly liberal trading laws will try to insist that its trading partners limit their use of illiberal or mercantilist measures. Absent such pressures, the liberal state’s trade law regime is likely to prove unsustainable politically, due to the perceived costs to the national interest or the harms to particular economic sectors of allowing other states’ “cheating” and “free-riding.”

The pursuit of reciprocity by a state favoring a liberal order fits the WTO’s basic MFN/NTR rule, but the WTO’s structure for FTAs - in its imperfect practice - may be more rigorously reciprocal and easier to monitor by virtue of its simplicity, as well as more liberal. Again, the pro-liberal order state is most likely to pursue FTAs with important trading partners that have complementary economies and liberal regimes. To the extent that FTAs asymmetrically reduce barriers imposed by one partner, the greater beneficiary or deficit state has additional reasons to favor an FTA. Here too, East Asian states often fit this bill for the United States.

To be sure, US trade liberalism has been far from pure. Protectionist sentiment in Congress and among vocal vulnerable constituencies appears to be on the rise in a period of chronic trade deficits and controversies over outsourcing and in the wake of Democratic gains in the midterm elections The “fast track” authority that facilitated recent trade liberalizing agreements is soon to expire. More generally, there is little reason to think that FTAs are not scarce goods in US politics or that the US is on an inexorable march toward numerous FTAs.

Still, in practice, the international regime for FTAs has left the US free to accommodate protectionist pressures by inserting illiberal and asymmetrically favorable terms into FTA agreements. FTA arrangements that so depart, sometimes to considerable degrees, from WTO ideals generally have escaped significant challenge. The more powerful party in FTA negotiations thus can hope to exploit its advantage and get something perhaps “better” than the level playing field that a true free-trade requirement would impose and better than the relatively leveling effect or, worse yet, free-riding and cheating by other parties that the multilateralizing WTO process often tolerates. The US-side costs of FTAs are thus less extreme than a simple reading of the WTO’s standard of removing “substantially all” barriers to trade.

Third, interest group politics often supports FTAs (or at least liberalization) with East Asian partners. This point is illustrated by comparison to the US’s decision in 2000 to support WTO membership for the PRC and to grant China permanent normal trading relations (PNTR). Pushing against PNTR was organized labor, which was worried about losing jobs due to increased imports of Chinese goods and services produced with low labor costs. On the same side were NGOs and politicians critical of China’s human rights record and seeking to preserve the leverage previously provided by the annual review of Beijing’s human rights record in conjunction with renewal of China’s MFN privileges. Those interest groups and their allies, however, could not overcome formidable business interests and proponents of liberal trade and improved Sino-American relations that pushed in the opposite direction.

The price of PNTR’s passage included the US’ retention of its ability to impose protectionist measures against Chinese exports and the establishment of new commissions to monitor China’s human rights record and PRC behavior more broadly. It was clear from the beginning that industry groups would undertake and would press executive branch agencies to monitor China’s compliance with its WTO commitments. The chronic bilateral trade imbalance, along with high-profile contemplated PRC acquisitions of well-known US companies, have fostered US pressure on China to revalue its currency and spawned congressional consideration of punitive tariffs on Chinese goods. Intellectual property rights protection remains a chronic issue.

Some of the same types of interest group alignments greet FTAs or potential FTAs with East Asian partners. In some respects, these face hurdles that may be greater than those that China PNTR/WTO overcame. Other things being equal, an FTA agreement is more likely to draw earnest opposition from affected groups than would lesser trade liberalization or (as occurred with China) merely making an unconditional commitment to a status quo of standard trade barriers. And the US jobs and industries imperiled by FTAs with more advanced industrialized East Asian countries are ones that are higher-end than those immediately imperiled by the PRC’s WTO entry and arguably are more central to American national economic interests.

Indeed, the fear of damage to the high-tech sector has become a prominent argument against free trade and trade liberalization agreements. Still, US FTAs with relatively developed East Asian states have been moving forward largely because: labor and other free trade opponents have lesser stakes in the outcomes and lessened influence in Washington (despite Democrats’ gains in the 2006 elections); prospective East Asian FTA partners do not provide a focal point for political opposition akin to China’s unsavory image as an unfair trader and repressive political regime; and the collapse of the Doha Round of global trade talks has shifted trade-liberalizers’ focus from WTO universalism toward FTAs.

Fourth, FTAs can serve as an economic instrument in the pursuit of security goals that loom large in US foreign policy, especially in the post-9/11 world and in the face of rising Chinese power. They can be means for strengthening economic relations that can create greater coincidence of overall interests and in turn greater security cooperation or strategic alignment.

This fits both the US-ROK proposed FTA and the stalled US-ROC FTA. US proponents of the Taiwan FTA have asserted that the FTA has a major political and security dimension, affirming US support for Taiwan’s continued autonomy. Taiwanese advocates have made parallel arguments and stressed the importance of a US-Taiwan FTA for safeguarding Taiwan’s democracy as well as its ability to endure the consequences of China’s effort to marginalize Taiwan.

Finally, this political dimension of US FTA possibilities in East Asia also has a defensive aspect. Whatever otherwise might be FTAs’ contributions to enhancing US relations with East Asian states, they also can serve as a counter to China’s mounting drive to establish FTAs - and, in turn, political influence - with many of the same states, as well as China’s broader drive to accumulate political influence in the region, sometimes in ways that pointedly exclude the United States.

China and the Politics of FTAs with East Asia

For China, as for the US, there are several powerful reasons for pursuing FTAs and integration in a liberal international economic order, and for being wary of FTAs and other liberalization measures. These reasons are largely political and not rooted in the simple liberal economic logic of the WTO’s international law of FTAs.

First, a broadly liberal international trading order that includes China serves the national economic interests defined by reform-era Chinese leaders. For nearly thirty years, economic development has been the predominant goal, supported by international economic openness. Beijing has pursued a Chinese variation of the East Asian development strategy of export-led growth and specialization according to evolving comparative economic advantage. In the Chinese version, foreign investment, particularly in export-oriented sectors that benefit from low trade barriers abroad, has played a central role.

Second, and contrarily, PRC ideology and practice have stopped well short of establishing significant FTAs or providing much support for trade liberalization beyond the extant international norms. China’s few departures from mainstream positions have consisted mostly of tepid support for a developing countries’ agenda that has included moderately illiberal elements.

Also, like the US, China is in a position to reap the gains of selective and asymmetrical illiberalism that can come to the more dominant trading partner and larger economy in bilateral or limited multilateral negotiations that result in the well-short-of-free-trade FTAs that are becoming common features on the international economic and legal landscape. The most developed Chinese FTA pursuit to date, the ASEAN-China FTA (ACFTA) partners China with mostly much smaller states and will build primarily on bilateral deals between China and the ASEAN members.

In addition, the WTO regime and China’s political and regulatory structure permit sneaky protectionism. The WTO’s formidable formal dispute resolution mechanisms and the diffuse multilateral politics of challenging non-compliance are relatively effective when trade barriers are not embodied in national laws and policies but take forms that are prominent on the list of complaints about Chinese practices: local protectionism; shadowy collaboration between local authorities and government-linked enterprises; business decisions that based on considerations other than price and quality; poor implementation of WTO-mandated laws; opaque subsidies to state-owned companies; trade-affecting foreign investment rules and their application to specific projects; and an exchange rate policy that confers trade advantages.

Third, China’s uneven and ambivalent approach to trade liberalization can be partly explained in terms interest group politics with Chinese characteristics. The PRC’s sharply expanded engagement with the increasingly liberal international trade order has delivered unevenly distributed benefits within China. The well-known story is one of support for trade liberalization from the “winners” - central and southern coastal provinces, internationally competitive sectors, ministries associated with those sectors and with foreign trade and investment, and elite leaders. It was former Shanghai chief Jiang Zemin who, as president and general secretary, led China through its accession to the WTO, closer economic integration with Hong Kong and Taiwan, the genesis of the ACFTA proposal, and the adoption of the “three represents” policy to embrace the rising, largely coastal urban entrepreneurs. Many initial or emergent winners continue to face a bright future, often one that would be enhanced by greater access to foreign markets through FTAs and other means.

On the other side of the story, pressures against liberalization come from the “losers” - inland and northeastern provinces, unreconstructed state enterprises, inefficient industrial sectors, ministries associated with them, and an increasingly restive laid-off or poorly paid collection of factory workers, dispossessed farmers (their land-use rights often lost to development projects), and rural-to-urban economic migrants. Newly vulnerable sectors include banking and financial services, agriculture, intellectual property-pirating enterprises and telecommunications and other sectors that have been the object of specific WTO-related liberalization commitments. Concern about or demands from these sources might yield concrete, trade-undermining moves - including abandonment of some FTA initiatives - consistent with the Hu Jintao leadership’s so-far largely rhetorical shift to concern for the less well-off and an emphasis on equity and “human development.”

Fourth and finally, whenever China has engaged the question of FTAs, political considerations have loomed large. The ACFTA initiative, envisioned as a decade-long project, aims not just to increase economic ties between China and Southeast Asia states, but also thereby to raise China’s political influence in an area that is vital to its ambitions to be a major power in the region. Even early ACFTA discussions have afforded Beijing important opportunities to sell its doctrine of China’s “peaceful rise” and emphasis on benign economic cooperation to its wary neighbors. China’s ACFTA gambit also offers a means to counter American and Japanese influence in the region and to anticipate the political gains that Washington and Tokyo have begun to seek through their stepped-up pursuit of FTAs with regional states.

Beijing’s ACFTA strategy may be less promising or fruitful than it appears. The political gains are front-loaded while the economic costs for China are yet to accrue. The PRC has already been reaping some of the diplomatic benefits from its reassurance, engagement, and economics-over-politics tactics. But, with the details of FTAs still in the works and their implementation still further off, it remains an unsettled question how much China will be willing to open its economy to the threats that strongly trade-liberalizing FTAs will pose.

The appeal to China of a Japan-Korea-China FTA or a Shanghai Cooperation Organization (Russia, China, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan) FTA (SCOFTA) is broadly parallel to that of the ACFTA but a good deal harder to achieve. With Japan and Korea already among China’s key trading and investment partners, an FTA would have significant economic potential - and peril. With deepened economic ties, China could reasonably hope for increased political influence, accelerating what critics fear could be an asymmetric economic interdependence-driven Finlandization of Japan and Korea. While any such trilateral FTA remains speculative, Beijing’s efforts can press back against the tightening of the US-Japan security relationship and capitalize on recently increased anti-Americanism in South Korea. US consideration of an FTA with Korea provides an additional, defensive or responsive element to PRC reasons for floating an FTA that includes the ROK.

A SCOFTA remains a less serious pursuit. Its economic appeal for China is relatively straightforward if relatively modest. But even talk of it could enhance the economic leg of the broader diplomatic effort of China to build cooperation among central and northern Asian mainland states to check US hegemony.

The most political aspect of Beijing’s approach to FTAs has lain elsewhere. As in so many areas of China’s foreign policy, the most volatile politics involve Taiwan.

US FTAs Including Taiwan, and PRC FTAs Excluding Taiwan

Taiwan is, on economic grounds, an obvious FTA candidate for the US It has a relatively open economy, one that has moved far from its protectionist and illiberal past, one that has done much to satisfy US requirements of support for liberal trade rules, and one that has seemingly bridgeable gaps to what an FTA in practice would require. Taiwan also has the high trade to GDP ratios that make it disproportionately important as a trading entity and thus a more significant FTA prospect. It is a major trading partner for both China and the US As with FTAs generally, membership in FTAs with major trading partners would expand trade among the partners and increase each partner’s total trade and gains from trade. While these economic effects likely would not be large in a US-Taiwan FTA, that does not distinguish it from many others that are on the table. Indeed, estimates of the economic benefits of a US-Taiwan FTA place it near the top of the list of contemplated US FTAs. The greater economic gains for Taiwan, however, could lie in second-order effects, with other regional states entering into FTAs with Taiwan if the US were to break the pattern of Taiwan’s exclusion from such arrangements.

Any given FTA, of course, would also skew Taiwan’s trade toward its FTA partners. A US-Taiwan FTA is expected to produce more trade diversion than trade creation. An ACFTA excluding Taiwan likely would divert ASEAN states’ trade from Taiwan to the PRC. It would also encourage substitution of ASEAN-produced goods for some of China’s imports from Taiwan, cutting into the growth of cross-Strait trade that has become important to Taiwan. A Japan-Korea-China FTA or SCOFTA would have broadly parallel effects.

For Taiwan, even the economic is fraught with security implications. The great concern for Taiwan of a Taiwan-excluding ACFTA is that it will increase economic dependence and promote political ties between the ASEAN states and China just the way Beijing apparently seeks. Already unsupportive of Taipei on issues of Taiwan’s autonomy and international status, China’s ACFTA partners would be even more reluctant to roil relations with the PRC. Taipei’s real fear is that an ACFTA would be another potent tool in Beijing’s diplomatic kit for marginalizing the ROC. Much the same would apply if the PRC’s notion of a China-Japan-Korea FTA were to go forward. The potential political loss for Taiwan would be especially great in the case of Japan, which remains the principal regional state that has the will and the capacity to work to balance China and that has recently articulated an interest in Taiwan’s security. A SCOFTA would be less significant, given the SCO states’ more limited economic relations with and lack of diplomatic support for Taiwan.

The politics of a US-Taiwan FTA are simpler fare. For Taiwan, US willingness to enter into an FTA would be an affirmation of the broader US commitment to Taiwan. President Chen and others have phrased it as such. So too have congressional supporters of a US-Taiwan FTA. While it formally implies nothing about statehood or state-like status, Taiwan’s status as a partner or even partner candidate in an FTA would imply standing with the US akin to that of Canada, Mexico, Singapore and Korea. Chinese sources have made this basic argument, suggesting that an FTA would be a step along the road to Taiwan independence. Moreover, Taiwanese sources and American supporters have played the democracy and human rights card, linking a US-Taiwan FTA to support for those values, as they are embodied in Taiwan - and thereby invoking principles that also are relevant to claiming state- or state-like status.

For precisely such reasons, Beijing does not welcome the prospect and has been no less chilly to the prospect of a US-Taiwan FTA than it was to the more easily deterred prospects of a Japan-Taiwan or Singapore-Taiwan FTA. Partly because much of Washington does not want such diplomatic frictions with Beijing, the Taiwan FTA faces an uphill fight. The steepness of the climb is increased by the waning of the influence of the Taiwan caucus and Taiwan lobbying in Congress and by the increasing tendency in Washington to regard Taiwan as a subordinate issue in the broader universe of US-PRC relations.

Here, the problem is largely structural, reflecting the rising relative power and importance of China. But some of the tactics of Taiwan and its friends in Washington have contributed to the problem. The argument that a Taiwan-US FTA is purely about trade and economics inevitably sounds disingenuous. Because there is undeniably a component that is political and that does have implications for Taiwan’s international status, there is an understandable temptation to engage in arguments that make claims about security commitments and recognition of Taiwan’s democracy. Indeed, it may be almost necessary to do so, given Taiwan’s economic unimportance relative to the PRC and given that Beijing has politicized the issue. But once these political elements are on the table, the politically useful claim that an FTA is really just about economic interests and principles becomes unsustainable.

There are, of course, genuine international economic issues and domestic interest group concerns for the US with a Taiwan FTA. But what remains most distinctive about a possible US FTA with Taiwan is that, like all matters involving Taiwan, it is deeply entangled with the politics of the Sino-American bilateral relationship and the politics of Taiwan’s international status as a state or state-like entity.

FTAs and politics

The pursuit of FTAs that include or exclude Taiwan differs in degree, but not in kind, from what we see in other existing or prospective FTAs involving the US, China, Taiwan or others. In all of them, states’ international and domestic political interests play a central role in determining whether to seek or accept and FTA and with what terms. While adopted and contemplated FTAs in the region generally do move toward the economic liberal ideals that underpin the economic arguments and the international law of FTAs, they do so unevenly and imperfectly, in large part in reflection of calculations of political interest and exercises of political power.