About How to Design, Negotiate, and Implement a Free Agreement in Asia

This reference book, intended to complement the training courses on agreements (FTAs) conducted by ADB, aims to increase the knowledge and capacity of officials who are actively involved in designing, negotiating, and implementing FTAs. Building on theories and good practices and FTA experience of countries worldwide, the book explains important facts and benchmarks to be How to Design, Negotiate, and Implement a considered when preparing, negotiating, and enforcing FTAs in Asia. How Negotiate, to Design, and Implement a About Asian Development Bank Free in ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries substantially reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to two thirds of the world’s poor. Nearly 1.7 billion people in the region live on $2 or less a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. In 2007, it approved $10.1 billion of loans, $673 million of grant projects, and technical assistance amounting to $243 million. ASIA Free Trade Agreement in Asia

Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org Publication Stock No. BBK-119108 ISBN: ISBN 978-971-561-684-3 Printed in the Philippines

How to Design, Negotiate, and Implement a Free Trade Agreement in Asia

Office of Regional

April 2008 © Asian Development Bank

All rights reserved. Published April 2008. Printed in the Philippines.

Publication Stock No. BBK119108 ISBN 978-971-561-684-3

Cataloging-In-Publication Data

Asian Development Bank. How to design, negotiate, and implement a free trade agreement in Asia. Mandaluyong City, Phil.: Asian Development Bank, 2008.

1. Trade agreement. 2. Asia. I. Asian Development Bank.

The views expressed in this book do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent.

ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use.

Use of the term “country” does not imply any judgment by the authors or the Asian Development Bank as to the legal or other status of any territorial entity.

ADB encourages printing or copying information exclusively for personal and noncommercial use with proper acknowledgement of ADB. Users are restricted from reselling, redistributing, or creating derivative works for commercial purposes without the express, written consent of ADB.

Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines Tel: +63 2 632 4444 Fax: +63 2 636 2444 www.adb.org

For orders, please contact: Department of External Relations Fax: +63 2 636 2648 E-mail: [email protected] Foreword

he continuing spread of free trade agreements (FTAs) in the developing world—particularly T in Asia—has spurred intense debate. Viewed pragmatically, against the backdrop of slow progress in global trade talks, FTAs can promote continued trade liberalization, induce structural reforms in the concerned, and widen market access across a vibrant economic region, where the demand for greater intra- regional trade is rapidly increasing. On the negative side, the proliferation of bilateral FTAs can create the so-called “noodle bowl” effect as multiple rules of origin arising from overlapping agreements cause harm particularly to small and medium enterprises with limited capacity to comply with them. The resulting market fragmentation would be more costly even for major multinational companies because of rising transaction costs and regulatory barriers. The flow of foreign direct investment and the associated transfer of technology and know‑how to smaller economies would also decline. Nevertheless, FTAs are a growing reality. If we recognize that and hope to foster regional trade agreements as building blocks of global trade and investment integration, we cannot stand idly by and wait for a comprehensive global resolution. We strongly support the Doha negotiation process, while recognizing the need to consolidate and streamline regional and bilateral FTAs into an eventual Greater Asian FTA. The recent proliferation of FTAs in Asia and the Pacific is placing mounting strain on the region’s FTA negotiating capacity and on the knowledge and technical skills of government officials. The areas of interest now go beyond conventional trade in goods and services and extend to intellectual property rights, , and labor and environmental issues, among others. iv | How to design, negotiate, and implement a free trade agreement in asia

The capacity constraints are especially With this reference book, we expect to acute in poorer countries, which also lack help shape common perspectives among the institutions to train their officials. government officials in Asia and the This reference book is intended to be Pacific on what a desirable FTA should used mainly in present and planned FTA be, as we look forward to the eventual training courses of the Asian Development harmonization of FTAs in this region. This Bank, to increase the knowledge and comprehensive version is the first step capacity of officials who are active in in that direction. We hope this reference designing, negotiating, and implementing book will serve the increasing demand for FTAs. Building on theories of international FTA knowledge in the region. trade economics and the good‑practice FTA experiences accumulated by both front-runners and late beginners in this area, the book explains important facts and benchmarks to be considered when JONG-WHA LEE preparing, negotiating, and enforcing FTAs. Head Rather than going into the details of specific Office of Regional Economic Integration topics, this reference book covers the overall FTA process and its main features. Acknowledgments

he Office of Regional Economic Integration (OREI) of the Asian Development Bank (ADB) has T conducted training courses in free trade agreements (FTAs) for mid-level government officials in Asia since October 2006. Starting with the second program in July 2007, we expanded participation to all ADB developing member countries to meet the growing demand for FTA training in the region. Around 100 government officials from all over Asia participated in the training. From the outset, we felt a need for a reference book on FTA for the training course. Drafting a structured text material for the courses was the main objective of this project. But this book serves other purposes as well. Government officials who are or will be involved in FTA negotiations can get background knowledge and guidelines on practical issues from this reference book. The general public, including the academe and students who are interested in practical aspects of FTA, can also benefit from this. It avoids excessively academic or technical terms and is written in language that is accessible to everyone with basic, common-sense ideas about economics, international trade, and FTAs. Negotiating free trade agreements: a guide, prepared by the Australian Department of Foreign Affairs and Trade, was the benchmark for this project. Nevertheless, we have tried to cover a wider scope of issues ranging from fundamental theories to actual components and practical issues related to FTAs. Jong Woo Kang, Economist, OREI, organized this project and coordinated the overall production of the publication. Michael Plummer of Johns Hopkins University was overall editor of the project. A group of international experts, ADB professional staff, and consultants contributed to this reference book. Michael Plummer of Johns Hopkins University and Ganeshan Wignaraja, Jong Woo Kang, and Rosechin Olfindo (staff consultant) of ADB wrote Part I: Economics of a Free Trade Agreement. vi | How to design, negotiate, and implement a free trade agreement in asia

Several academics and experts Dorothea Lazaro, ADB consultant on trade contributed to Part II: Coverage of a Free facilitation. Trade Agreement. Rachel MacCulloch Finally, Part III: Negotiating, of Brandeis University wrote on trade in Implementing, and Evaluating Free Trade goods and on environmental and labor Agreements was written by Jong Woo standards; William James of ADB, on rules Kang and Dorothea Lazaro of ADB. of origin; Christopher Findlay of Adelaide Special thanks go to those who University, on trade in services (with responded to our FTA questionnaire and substantial contribution from Aik Lim to the resource persons and participants Hoe of the ); who gave valuable comments on Part III Arthur Appleton of Appleton Luff Inc., on during the FTA training courses. intellectual property, dispute settlement mechanisms, sanitary and phytosanitary standards, and technical barriers to trade; Siow Yue Chia of the Singapore Institute of International Affairs, on investment and JONG WOO KANG FTA-plus issues, including government Project Manager and Economist procurement and competition policy; and Office of Regional Economic Integration Contents

Tables, Figures, Case Studies, Boxes viii Acronyms and Abbreviations x

ECONOMICS OF A FREE TRADE AGREEMENT Trade Trends: Regionalization versus Regionalism 1 Why Enter into a Free Trade Agreement?— 1 Political and Economic Goals 6 Economics of Consolidation/Harmonization 18 Summary 25 Appendix 27

COVERAGE OF A FREE TRADE AGREEMENT Trade in Goods 31 Rules of Origin 49 2 Trade in Services 57 Investment 75 FTA-Plus Chapters 83 Dispute Settlement Mechanism 92 Appendix 99

NEGOTIATING, IMPLEMENTING, AND EVALUATING FREE TRADE AGREEMENTS Introduction 109 Preparing for FTA Negotiations 114 3 Structuring the Negotiating Team 120 The Negotiation Process 123 Managing Consultations 125 Implementing an FTA 127 Evaluating an FTA 133 Appendix 135

References 139 Tables, Figures, Case Studies, Boxes

Tables Table 1.1 Types of Free Trade Agreements (FTAs) Involving Asia and the Pacific Countries, 2007 4 Table 2.1 Product Origin—Wholly Obtained Principle 51 Table 2.2 Tests for Determining Origin of Processed or Manufactured Goods 51

Figures Figure 1.1 Number of Free Trade Agreements Involving Asia and the Pacific Countries, 1990–2007 3 Figure 1.2 Number of Free Trade Agreements Involving Asia and the Pacific Subregions, 2007 3 Figure 2.1 WTO Dispute Settlement Flowchart 93 Figure 3.1 Model FTA Process 110 Figure 3.2 Three Levels of FTA Committees 120 Figure 3.3 Elimination Modalities for Negotiating FTAs 124 Figure 3.4 When Consultation Should Be Conducted 127 Figure 3.5 New RTA Transparency Mechanism 131

Case Studies Case 2.1 Republic of Korea–Chile Free Trade Agreement 33 Case 2.2 Specific Commitments for the Movement of Natural Persons under the Japan-Philippines Economic Partnership Agreement 73

Boxes Box 1.1 A Brief History of Multilateral Governance under the World Trade Organization—From the GATT Rounds to Doha 2 Box 1.2 ADB’s Free Trade Agreement Database 3 Box 1.3 GATT 1994, Article XXIV 5 Box 1.4 Computable General Equilibrium Models and Free Trade Agreements 10 Box 2.1 WTO Disciplines in Trade-in-Goods Provisions 32 Box 2.2 Economics of Preferential Rules of Origin 50 Tables, Figures, Case Studies, Boxes | ix

Box 2.3 NAFTA Product-Specific Rules of Origin— Textiles and Apparel 57 Box 2.4 How Services Are Traded—The Four “Modes of Supply” in the GATS 58 Box 2.5 Meeting the Requirements of GATS Article V 60 Box 2.6 A Traditional GATS-Style Positive List 65 Box 2.7 A Simplified Positive List 66 Box 2.8 An Annex 1 Reservation List 67 Box 2.9 An Annex 2 Reservation on “Future Measures” 67 Box 2.10 Typical Features of Financial Services Provisions of FTAs 70 Box 2.11 Typical Features of Telecommunications Services Provisions of FTAs 71 Box 2.12 Movement of Natural Persons—Provisions on Business Visitors 72 Box 2.13 Bilateral Investment Treaties 78 Box 3.1 How the US Negotiates a Trade Agreement 112 Box 3.2 US Trade Strategy 114 Box 3.3 Japan’s FTA Strategy 116 Box 3.4 Useful Information and Sources for Negotiators 118 Box 3.5 Typical Composition of Working Groups in the Negotiating Team 121 Box 3.6 ASEAN Approaches to Negotiation 123 Box 3.7 Negotiation Approach under the GATS 123 Box 3.8 US Interagency Structure 125 Box 3.9 Interagency Coordination Mechanism in the Republic of Korea 125 Box 3.10 Negotiating Skills and Good Negotiating Habits 126 Box 3.11 Examples of Consultation Mechanisms 128 Box 3.12 Australia’s Treaty Approval Process 130 Box 3.13 Legal Changes Made in Singapore 132 Box 3.14 Examples of FTA Websites 132 Box 3.15 US Monitoring and Enforcement System 134 Acronyms and Abbreviations

AD antidumping ADB Asian Development Bank AFTA ASEAN Free Trade Agreement AIA ASEAN Investment Area APEC Asia Pacific Economic Cooperation ARIC Asia Regional Integration Center ASEAN Association of Southeast Asian Nations BIT bilateral investment treaty BTA bilateral trade agreement CER Closer Economic Relations (Australia–New Zealand free trade agreement) COO certificate of origin CTH change in tariff heading CTSH change in tariff subheading DSU Dispute Settlement Understanding EC European Community EFTA European Free Trade Agreement EU European Union FDI foreign direct investment FOB free on board FTA free trade agreement GATS General Agreement on Trade in Services GATT General Agreement on Tariffs and Trade GPA Government Procurement Agreement GSP Generalized System of Preferences HS Harmonized System IP intellectual property IPR intellectual property rights JCT joint coordinating team JMEPA Japan-Malaysia Economic Partnership Agreement JPEPA Japan-Philippines Economic Partnership Agreement JSEPA Japan-Singapore Economic Partnership Agreement JSG joint study group LDC least-developed country MAI multilateral agreement on investment MEA multilateral environmental agreement Acronyms and Abbreviations | xi

MFN most-favored nation MNC multinational corporation MRA mutual recognition agreement NAFTA North American Free Trade Agreement NGO nongovernment organization NTB nontariff barrier OECD Organisation for Economic Co-operation and Development PRC People’s Republic of China ROOs rules of origin RTA regional trade agreement SAFTA Singapore-Australia Free Trade Agreement SEOM Senior Economic Officials Meeting SOE state-owned enterprise SP specified process SPS sanitary and phytosanitary standard TBT technical barriers to trade TPRG Trade Policy Review Group TPSC Trade Policy Staff Committee TRIMS (Agreement on) Trade-Related Investment Measures TRIPS (Agreement on) Trade-Related Aspects of Intellectual Property Rights USTR United States Trade Representative WCO World Customs Organization WIPO World Intellectual Property Organization WTO World Trade Organization

Part I: Economics of a Free Trade Agreement

Trade Trends: Regionalization versus Regionalism

egionalism, which we will define generally here to include any formal preferential trading arrangement R between two or more countries, came late to Asia.  Before the turn of the 21st century, there were few regional trading agreements in existence. While successful Asian economies by and large exploited the international marketplace effectively, they did so in the context of the General Agreement on Tariffs and Trade (GATT)/World Trade Organization (WTO) framework (see Box 1.1 for an overview of the evolution of the multilateral system). However, regionalization, which we will define as a market-led process of increasing economic interaction, has been building up momentum in Asia for decades, spurred by unilateral liberalization, market-oriented reforms, and successful economic growth in Asia consistently above the global average (with the exception of the Asian Crisis years, 1997–1998). Hence, formal preferential trading arrangements in the region, particularly in the form of free trade areas (FTAs), are being developed as a means of enhancing regionalism (“the flag following trade”) rather than the other way around, as was true of such agreements as colonial preferences or even the early years of European economic integration. In most of Asia, regionalism is being used as part of the overall process of economic reform, to buttress the outward-oriented development strategies of the region’s economies.

 Unless specified otherwise, “Asia” throughout the reference book is taken to include the Asian Development Bank’s (ADB) 47 regional member countries (see list in http://aric.adb.org/technotes.htm#countrygroupings).  | How to design, negotiate, and implement a free trade agreement in asia

Box 1.1: A Brief History of Multilateral Governance As we will see throughout this reference under the World Trade Organization— book, regionalism has both positive and From the GATT Rounds to Doha negative elements. After all, FTAs all have The General Agreement on Tariffs and Trade (GATT) discriminatory features and, therefore, was signed in 1944, with the immediate objective of are “second best.” There are in fact no preventing future trade wars and the inconsistent guarantees that a “free trade area” will be commercial policies that had plagued international a movement in the direction of free trade, trade in the 1930s. It was originally intended to be a its name notwithstanding. It depends very temporary body; the International Trade Organization (ITO) was supposed to replace it as a permanent much on the agreement. We will argue in body with international legal status, on a par with the this book that the current FTA movement other “Bretton Woods Institutions”—the International in Asia is outward-oriented, and that the Monetary Fund and the World Bank. The ITO was intentions of economies engaged in never ratified; however, the GATT came into effect on 1 these agreements are pro-market and January 1948 as an ad hoc organization that would take consistent with multilateral rules. a permanent, legal form only in 1994, with the creation of the World Trade Organization (WTO). However, to be certain that regionalism The GATT was designed to reduce international will support efficient regionalization and barriers to trade on a nondiscriminatory, or “most- competitiveness, policy makers must favored nation” (MFN), basis. This would be achieved understand the complicated nature of through concerted, multilateral negotiations called these agreements and learn to embrace “rounds.” Since the creation of the GATT, there have been eight rounds, i.e.: Geneva, 1947–1948; Annecy, the positive elements while minimizing France, 1949; Torquay, England, 1950–1951; Geneva, the potentially negative ones. Part I was 1956; the Dillon Round, 1960–1962; the Kennedy written with this in mind. Round, 1963–1967; the Tokyo Round, 1973–1979; and the Uruguay Round, 1986–1993. The current WTO negotiations have been dubbed the Doha Development Agenda, to underscore the importance of developing Rise of Free Trade Agreements countries in this series of talks. Earlier GATT rounds in Asia and the Pacific were successful in reducing tariffs on manufactured goods. The Uruguay Round began to address more complicated issues, from quantitative restrictions in The rapid spread of regionalism has sensitive areas like agriculture and textiles and clothing become one of the most important to trade-related areas such as investment measures and intellectual property protection. The Doha Development recent developments in the global trade Agenda was initiated to go further down the road of system. The proliferation of bilateral and “deep” integration. The process has been difficult, given plurilateral FTAs is fundamentally altering the political sensitivity of many of the key areas being the world trade landscape. Trade between addressed. In fact, the 2003 Ministerial Meeting in FTA partners now makes up nearly 40% Cancun, Mexico ended without any agreement. of global trade, and new agreements The Hong Kong Ministerial Meeting in December 2005  was successful in keeping the Doha negotiations alive. increasingly address issues beyond trade. The WTO members agreed to undertake liberalization Asia is a latecomer in the move toward negotiations generally under four pillars: Non- FTAs compared with Europe, the Americas, Agricultural Market Access (NAMA), Agriculture, Services, and Africa, but has seen an unprecedented and Rules (including those pertaining to administrative increase in total FTA activity since the actions, e.g., antidumping and , and regional trading agreements). The primacy of the 1990s. By Asian Development Bank (ADB)  “development dimension” of the talks was reemphasized. estimates, at least one Asian country is The leaders at the meeting set April 2006 as the deadline for the Doha package. However, no agreement has yet  World Bank (2005). However, the amount of trade been forthcoming. that is actually preferential is smaller because of the costs of compliance with free trade agreements (FTAs), particularly those associated with the rules-of-origin Source: Updated from ADB (2006). requirement.  Asia in the ADB FTA database refers to Asia and the Pacific. part I: Economics of a free trade agreement | 

involved in 204 FTAs in various stages investment liberalization, promotion of of implementation: 95 concluded, 60 domestic competition, harmonization of under official negotiation, and 49 being standards, and upgrading of technology proposed (see Box 1.2 for information on development). The recent increase in ADB’s FTA Database, which gives up-to- FTAs has also been driven by the richest date information and analysis regarding and largest economies in the region such emerging and existing FTAs). This is a as the PRC, Japan, Republic of Korea, dramatic increase from the fewer than 10 Singapore, and, Thailand, suggesting a FTAs involving Asian countries in the early link between FTA growth and economic 1990s (see Figure 1.1). prosperity, although the exact causation The rise in the number of FTA still needs to be explored further. initiatives in Asia is driven by a number of factors including: (i) a defensive response to the proliferation of trading Box 1.2: ADB’s Free Trade Agreement Database blocs and FTAs in other major regions; Launched in October 2006 by ADB and managed (ii) uncertainty over progress in global by its Office of Regional Economic Integration, the Free trade talks under the WTO framework; Trade Agreement (FTA) Database in the Asia Regional (iii) the need to improve productivity in Information Center (ARIC) website (www.aric.adb.org) the face of the heightened competitive tracks FTAs of 47 regional members of ADB and provides three types of information: (i) FTA trends (statistical tables pressure from the economic emergence of on the status and various categories of FTAs in Asia and the People’s Republic of China (PRC) and the Pacific); (ii) available resources on each FTA (i.e., legal India, in particular with respect to documents, official summary, studies and researches, economies of scale through market news, opinions and editorials, FTA membership, and an integration; (iv) the perceived need for external link to the UNESCAP database); and (iii) a comparative FTA toolkit—an innovative feature deeper integration with trading partners, of the FTA database—which allows side-by-side due in part to the demonstration effect comparison of around 80 chapters/provisions of more of successful regional integration accords than 40 concluded FTAs. The list of FTAs on the ARIC elsewhere; and (v) the promotion of website is based on official sources (joint statements, “beyond the border” structural reforms as declarations, press releases, and government websites). part of a competitiveness strategy (e.g., The information about them is also from official sources, research sites, and online news items. Source: ADB.

Figure 1.1: Number of Free Trade Agreements Figure 1.2: Number of Free Trade Agreements Involving Asia and the Pacific Countries, Involving Asia and the Pacific 1990–2007 Subregions, 2007

250 120

100 200 Proposed Under Negotiation 80 150 Concluded 60

100 40

50 20

0 0 East Asia Central Asia South Asia Pacific 1990 1997 2000 2007

Source: ADB FTA Database. Available: www.aric.adb.org Source: ADB FTA Database. Available: www.aric.adb.org  | How to design, negotiate, and implement a free trade agreement in asia

Among the Asian subregions, East Asia  are with countries outside the region is the most active in forming FTAs: at least (see Table 1.1). The fact that many FTAs one East Asian is involved in extend beyond the Asian region itself any of 112 FTAs, almost twice the number underscores the importance of external of FTAs involving Central or South Asian markets particularly for the of countries (see Figure 1.2).  The Pacific is final products. The formation of cross- the least involved in FTA formation among regional agreements is driven by several the four Asian subregions. Given the rise factors including energy security, access to in the market-based regionalization of minerals and other natural resources, and East Asian economies over the past 20 efforts by countries to “lock in” reforms years, that is, the increase in the regional by making them part of a formal trade shares of trade and investment due to treaty with a major developed country or market-driven activity, the deepening of region.  regional economic interdependence is the most fundamental rationale behind the recent economic regionalism in East Table 1.1: Types of Free Trade Agreements (FTAs) Asia—an example of the “flag following Involving Asia and the Pacific trade.” Since the Asian Crisis of Countries, 2007 1997–1998, East Asian economies have Regional Bilateral Plurilateral Total embarked on various initiatives under the Coverage FTAs FTAs FTAs general rubric of economic regionalism Within Asia-Pacific 73 25 98 in trade/investment and money/finance. Outside Asia-Pacific 83 23 106 The crisis prompted the subregion’s Total FTAs 156 48 204 economies to realize the importance of economic cooperation and to make efforts Source: ADB FTA Database. Available: www.aric.adb.org to institutionalize such interdependence.  An important feature of the rise in the number of FTAs in Asia is the growing Around half of the established FTAs number of overlapping agreements and involving at least one Asian country have the so-called Asian “noodle bowl,”  that not been notified to the WTO. A large has emerged from the proliferation of portion of the WTO-notified FTAs involve bilateral and plurilateral FTAs in the East Asian economies, indicating significant region. Each FTA can be quite different adherence in East Asia to WTO rules and in coverage, depth of liberalization, and procedures for FTAs. However, many of the the specific that make the provisions of recent agreements formed accord function (e.g., rules of origin). by East Asian economies extend beyond According to ADB estimates, Asian the WTO regulatory framework (“WTO- countries are involved in 156 bilateral plus agreements”) to include provisions and 48 plurilateral FTAs in various related to a host of “deep” issues such as stages of implementation. Many of these , investment, government agreements—especially the new ones, procurement, competition, intellectual property, and environment and labor rules. Such provisions are often included in FTAs  Unless specified otherwise, “East Asia” in this reference book refers to the 10 Association of Southeast Asian between developed and developing Nations (ASEAN) countries plus the People’s Republic countries, no doubt reflecting the emphasis of China (PRC); Hong Kong, China; the Republic of Korea; Mongolia; Taipei,China; and Japan. that developed economies give to these  See Kawai and Wignaraja (2007). issues.  See Kawai (2005).  The terms “noodle bowl” and “spaghetti bowl” are used interchangeably throughout this book.  See ADB (2006). part I: Economics of a free trade agreement | 

Box 1.3: GATT 1994, Article XXIV Free trade agreements (FTAs) represent a departure of comprehensive coverage, i.e., the contribution from the General Agreement on Tariffs and Trade to the expansion of world trade is “increased if the (GATT)/ World Trade Organization (WTO) guiding elimination of duties and other restrictive regulations principle of nondiscriminatory trade, i.e., most- of commerce extends to all trade, and diminished if fvored nation (MFN) treatment, among signatories. any major sector of trade is excluded.” Free trade Article XXIV of GATT 1994 and the Uruguay Round areas that exempt significant areas, such as “Understanding on the Interpretation of Article XXIV agricultural trade or a major manufacturing sector of the General Agreement on Tariffs and Trade” provide via highly restrictive rules of origin, appear to violate the rules governing free trade in goods. Article V of the this coverage guideline. With respect to the time General Agreement on Trade in Services (GATS) gives allowed for a new agreement to be phased in, the the corresponding rules for free trade in services. Understanding specifies that the “reasonable length Article XXIV recognizes the desirability of of time” of Article XXIV “should exceed 10 years only increasing trade through voluntary agreements in exceptional cases” and that “where… parties to between two or more members, but it also cautions an interim agreement believe that 10 years would countries that such an agreement should be to be insufficient they shall provide a full explanation facilitate trade among the members and not raise to the Council for Trade in Goods of the need for a barriers to trade with non-partner countries. This longer period.” provision clearly restricts the common external However, the Tokyo Round agreements, signed in tariffs imposed by the members of a . 1979, contained more lenient rules on preferential However, the preferential margin created by a free trading accords between developing countries. trade area in effect raises barriers to trade with non- These include the “Decision on Differential and partner countries, resulting in , i.e., More Favourable Treatment, Reciprocity and Fuller the substitution of partner for lower-cost Participation of Developing Countries,” known as the imports from non-partners. Some economists have Enabling Clause. Under its terms, developing countries suggested that countries forming free trade areas are subject to less scrutiny in complying with Article should be required to reduce MFN tariff rates to XXIV. Thus, developing countries can potentially agree offset this tendency. to reduce but not eliminate tariffs and other trade As defined in Article XXIV, a free trade area is a barriers or be more selective in sectoral coverage. group of two or more countries (“customs territories”) In practice, however, no FTAs among GATT or WTO in which duties and other regulations of commerce members, whether developed or developing, have are eliminated on substantially all the trade between been challenged successfully by other members. This them in products originating in the member countries. laissez-faire attitude could change in the future, given Article XXIV distinguishes between a free trade area, the increasing concern among WTO members about where trade barriers have been removed, and an the effects of proliferating FTAs and their implications agreement that will eventually lead to the formation for progress in multilateral trade liberalization. The of a free trade area. However, key concepts in this Doha Development Agenda includes negotiations definition are left undefined. How much trade is aimed at “clarifying and improving disciplines and “substantially all trade”? Should the amount of trade procedures under the existing WTO provisions covered be measured in value terms or according applying to regional trade agreements.” As an initial to the percentage of product categories included? result of the effort, a “transparency mechanism” Other than tariffs, which “regulations of commerce,” announced in 2006 provides for early announcement e.g., trade barriers, must also be eliminated? Exactly and notification to the WTO of any new FTA, with an which goods are considered to have originated in the eye to prompt review of its compliance with WTO member countries? Here the agreement must spell rules. But whether prompt notification can affect the out rules of origin for any good produced in the area provisions of new FTAs remains to be determined. By but incorporating intermediates imported from non- mid-2006, when the transparency mechanism was members. Finally, how long a period is permissible announced, the process of assessing the consistency between the signing of an agreement to form an FTA of FTAs with WTO rules had already created a growing and the elimination of barriers on substantially all backlog of cases awaiting evaluation. trade? Almost all FTAs are phased in over time, often Regardless of WTO scrutiny, countries planning to allowing more than 10 years for some tariffs to negotiate a free trade agreement should be aware of be eliminated. the potentially adverse economic and political effects, The 1994 “Understanding on the Interpretation of both on themselves and on their excluded trading Article XXIV” was intended to reduce the ambiguity partners, of arrangements that cover some but not concerning the coverage and timing of free trade all goods, specify an unduly long phase-in period, or agreements. It begins by recognizing the importance divert trade from lower-cost sources. Source: WTO website. Available: www.wto.org  | How to design, negotiate, and implement a free trade agreement in asia

This burgeoning number of agreements circumstances generally dominate. In fact, in the region has raised concern in the while one can list a number of accords light of its potential to add greatly to the with a dubious economic rationale but complexity of international trade and to strong political motivations, no major the administrative costs of trade. The web accord made good economic sense but of differing trade arrangements can tangle was politically untenable. Hence, while administrative procedures—e.g., customs this book emphasizes the economics procedures, technical standards, rules of of regional trading arrangements, the origin—and thereby raise the cost for both important political dimensions of each enterprises and governments. To mitigate agreement should also be respected. such adverse effects, some have called for the creation of a region-wide FTA Gains from Trade with harmonized rules of origin among other business-friendly provisions. In this The “gains from trade” argument, regard, the Association of Southeast Asian first developed by the famous British Nations (ASEAN) could form a natural economist David Riccardo, has been hub for East Asia and for Asia in general.  used to promote the need for trade Given their complicated and inherently liberalization over the past two centuries. discriminatory nature, many of these In short, as a country specializes in the subregional and regional initiatives would products that it produces most efficiently, be more efficiently handled at the global compared with other countries, and then level. After all, Article XXIV of the GATT/ the goods in surplus, it is able to WTO was intended to be an exception improve its standard of living. On the to the MFN rule (see Box 1.3). But what supply side, efficient structural adjustment happens when the exception becomes the takes place: the country uses its resources rule? We address this and related issues in in the most productive way. On the the rest of this section. demand side, firms are able to source the most cost-effective inputs and consumers are able to purchase imports at the lowest Why Enter into a Free Trade price. When all countries specialize in Agreement?—Political their “” products, and Economic Goals the entire world is better off and global prosperity is maximized. As Nobel Laureate Paul Samuelson As noted above, the major surge in has noted, the principle of comparative FTAs is fundamentally changing the advantage might be the only proposition international commercial landscape, with in the social sciences that is both true and Asian economies being an important nontrivial. It is also counterintuitive to part of this process. This trend did not many. For example, in the debates over develop by accident. In this section, we the North American Free Trade Agreement consider some of the general economic (NAFTA) between Canada, Mexico, and and political goals behind the formation the United States (US), opponents of the of FTAs. agreement in Mexico argued that there To begin with, we should stress that, was no way Mexico could compete with while economics may be an important a technological superpower like the US, motivation in setting up an FTA, political and in the US those that opposed NAFTA insisted that the US could not compete  See Kuroda (2007). with Mexicans, whose wages were only part I: Economics of a free trade agreement | 7

a fraction of those at home. Riccardo industry trade (say, automobiles for demonstrated more than a century earlier automobiles). Recent trends in East Asia that both were wrong. With free trade, underscore this process. At first, trade the US and Mexico would produce the was inter-industry—and, hence, there products in which they had inherent was not much of it. But particularly comparative advantage, and both would since the Asian Crisis, East Asian benefit. In a hospital, a medical doctor countries have been engaging much can perform all the roles of a nurse and more in intra-industry trade, a process much more specialized tasks. But there that is responsible in part for the rising still is a role for the nurse, who can intra-regional trade share and greater specialize in more routine, less specialized economic symmetry (Rana 2006). In activities, leaving the doctor to specialize fact, most of the world’s trade takes place in more advanced tasks. In accepting this between developed countries (with the division of labor, each will prosper and same economic characteristics) and is of the hospital will be more efficient. the intra-industry variety. This does not mean that the doctor This leads us to the distinction between and the nurse will be paid equally. The “horizontal” and “vertical” specializations former will be more productive in the in production. Horizontal specialization area requiring a high degree of expertise relates to production according to than the latter and, hence, will receive comparative advantage in the traditional a higher salary. Likewise, countries with sense discussed above; vertical higher productivity will have a higher specialization focuses on the many parts standard of living than lower-productivity and processes that make up the countries. In addition, under a regime of production of a final good, i.e., the “value free trade, countries do not decide what chain.” While efficient division of labor they will produce. Economics, rather than will always dictate specialization in what politics, dictates comparative advantage. the country does best relative to other But as the Hungarian economist Bela countries in the global trading system, Balassa has noted, comparative advantage multinational corporations (MNCs) have is man-made; policy matters. Japan, for transformed radically how they organize instance, began after World War II as productive processes and source inputs. one of the world’s most labor-abundant For example, while in the 1950s and countries, and exported low-cost, labor- 1960s an MNC might have produced an intensive products for decades. But its entire automobile in the Philippines for evolution over time, driven by forward- sale in the local and international looking government policy, allowed it to markets, today that same MNC would shift its comparative advantage into have operations in the Philippines that high-tech, capital-intensive . Many would be part of a global production other Asian countries are also moving up process, in which the MNC would exploit the development ladder. the comparative advantages of each Further, as economies evolve over country in its network to produce the time from low-skilled production, of automobile most efficiently. This value agricultural and labor-intensive goods chain would see labor-abundant countries for example, into more sophisticated producing labor-intensive components, products, their comparative advantage capital-intensive countries producing tends to merge. Economic integration capital-intensive components, high-skill- changes from inter-industry trade intensive countries producing high-skill- (say, oil for computer chips) to intra- intensive components, and so on. The  | How to design, negotiate, and implement a free trade agreement in asia

production of automobiles and electronics trade increases efficiency and prosperity, is increasingly characterized by this sort government policy at the national level of value-chain process in the modern plays a key role in determining to what economy. The rising importance—and, degree each will be successful. often, dominance—of electronics in the But what is the difference between exports of most East Asian economies free trade and FTAs? Unlike multilateral testifies to the importance of the vertical liberalization under the GATT/WTO, FTAs division of labor that is being created tend to be controversial in economic and by these value chains, a process that policy circles for a variety of reasons, in turn is driving economic integration most of which are linked to the fact that and more generally. It is preferential trading arrangements, such still driven by comparative advantage; as FTAs and customs unions, are by their however, in addition to having very nature discriminatory. We explain comparative advantage in particular the economics of FTAs in the rest of this products, economies have comparative section, and focus on political-economy- advantages in processes and components related issues in the next section. that are part of a vertical division of production. Static effects Further, this process allows developing countries to tap more easily into global The “static effects” of FTAs generally production chains. In the past, the refer to the effect on price changes production of an entire automobile in induced by preferential tariff (and the Philippines would have required a nontariff) liberalization. Free trade demanding set of national economic areas remove discrimination between prerequisites such as available inputs partner countries and domestic firms, and skill sets that could have been and, hence, home and country prices of discouraging to the MNC. Perhaps the tradable goods—that is, exports, imports, Philippines would have been bypassed and -competing products—tend in favor of a more developed country to be equalized as barriers to trade are with these attributes already in place. reduced. Relatively inefficient domestic However, within the context of the production therefore contracts (“trade vertical division of labor discussed creation”) in favor of production in above, the Philippines would only have partner countries. This is essentially the to have comparative advantage in a same efficiency-enhancing effect as in subset of these skills to participate in the Riccardo’s model. However, FTAs create production chain. Hence, these value a new form of discrimination, that is, chains hold important advantages for between the exports of partner and non- less-developed countries, which can now partner countries. Partner-country exports tap into globalization far earlier than in will displace more efficient non-partner the past. exports in the home market if the degree In sum, the “gains from trade” of preferential access is sufficient (“trade argument, based on the principle of diversion”). Trade diversion implies a less comparative advantage, explains the efficient international division of labor, inherent logic of international free trade and, since the home country will lose as the “first best” policy option, i.e., one tariff revenues and will pay a higher price that should lead to greater welfare for all for its imports, the importing country countries. Comparative advantage is also loses. Thus, the net (static) effects of an a dynamic process, suggesting that, while FTA will depend on the degree of trade part I: Economics of a free trade agreement | 9

creation compared with trade diversion areas, on the other hand, are generally (“allocative efficiency”). Note that trade far more comprehensive in the treatment liberalization under the WTO should of sectors across the board. Thus, while not involve any trade diversion, as MFN FTAs lead to potential trade diversion treatment implies nondiscrimination because of discrimination between between sources of imports. This is why countries, the existing multilateral regime it is “first best” option. On the other suffers from negative efficiency effects hand, since FTAs discriminate in favor because of discrimination between of partner countries, regionalism is the products. “second best” and, therefore, does not Second, regionalism holds another guarantee a more efficient division of advantage over multilateralism in that it labor in the grouping. allows like-minded countries to address In comparing the economics of far more issues and in a shorter period of nondiscriminatory trade liberalization, time. By choosing one or several partners such as that taking place under the with similar policy goals, countries are auspices of the WTO on the basis of MFN able to make more progress in deep treatment, on the one hand, and integration than they could in the discriminatory trade liberalization in the extremely diverse WTO context. The context of an FTA, on the other, we recent interest in regionalism on the part should keep in mind the qualitative of OECD countries that have traditionally differences between accords. First of all, shunned it (the US, Japan, the Republic while trade diversion does exist in the of Korea, Australia and New Zealand, context of an FTA, it is also true that FTAs and so on) derives from their desire to tend to be more comprehensive in the address these many issues and their coverage of goods (and services). In fact, understanding that they cannot resolve Article XXIV of the GATT/WTO, which them in the context of the WTO, or at dictates minimal requirements for FTAs, least not in the short or medium run. insists on the coverage of substantially A successful conclusion to the Doha all goods. But no such requirement exists Development Agenda would, perhaps, under the GATT/WTO. Countries include give momentum to regionalism, but this as many sectors as they deem fit through is not certain. The incentives for entering negotiations. This has led to a good deal into new bilateral and plurilateral of piecemeal liberalization under the accords, as well as for deepening existing GATT/WTO, leaving protection on some ones, would remain. agricultural and labor-intensive products practically untouched after successive Dynamic effects multilateral rounds. The exclusion of individual products can be problematic Economists tend to focus on the static on efficiency grounds, particularly when effects of economic integration. Price it involves products that are used as changes in FTAs drive the theoretical inputs in the productive network. For and empirical FTA literature mainly example, duty-free inputs on steel will because they are easier to conceptualize cause exaggerated protection of value and estimate than other effects of added (the “effective rate of protection”) regionalism (see Box 1.4). However, in the automotive sector. The exclusion the static effects of FTAs tend to be less of tariffs on imported lumber will do the important from the point of view of sheer same in the furniture industry if the latter economic impact and the implications of is excluded from liberalization. Free trade regionalism for economic development. 10 | How to design, negotiate, and implement a free trade agreement in asia

Box 1.4: Computable General Equilibrium Models and Free Trade Agreements Computable general equilibrium (CGE) models The Global Trade Analysis Project (GTAP) model, are often used by the World Bank, the World Trade constructed in 1992, is the applied general- Organization (WTO), and ADB, among others, to equilibrium model in wide use. The standard GTAP estimate the welfare effects of free trade model assumes perfect competition and constant aggreements (FTAs) and other trading agreements. returns to scale, while some extensions of the These models evolved from the earliest models of model assume imperfect competition. The dynamic the economy that showed inter-industry links. model (GTAP-Dyn) extends the standard model While earlier models could capture only very simple to incorporate dynamic behavior. It includes all general-equilibrium relationships, more recent the special features of the standard model such models are able to incorporate market mechanisms as sophisticated consumer demands and inter- and policy instruments that work through price sectoral factor mobility, as well as new treatment incentives. of investment behavior and additional accounting The earliest global trade model was the Michigan relations to keep track of foreign ownership of Model of World Production and Trade, which was capital. Backed by an international consortium of designed to gauge the employment impact of the agencies and universities, GTAP created a consistent Tokyo Round. This model, with its set of equations global data set for use in analyzing international extended to include the features of the New Trade issues and has become the basis for Theory (imperfect competition, increasing returns all global CGE models. to scale, and product differentiation), was also used The LINKAGE model, developed by the World in analyzing the effects of the US-Canada FTA. The Bank, is a recursive dynamic applied general- extended Michigan Model was later applied to equilibrium model with neoclassic features. It country groups selected from the original 34- comes with an aggregation facility, which is used country Michigan Model. to aggregate the extensive GTAP database into a The MIRAGE model, another imperfect tractable data set for simulation. An extension of competition model, developed by the Centre the LINKAGE model, the General Equilibrium Model d’Etudes Prospectives et d’Informations for Asian Trade (GEMAT), is an applied general- Internationales (CEPII) in Paris, describes imperfect equilibrium model of the global economy with a competition in an oligopolistic “Cournot” focus on Asia and is primarily used by ADB. It framework, which accounts for horizontal product incorporates firm heterogeneity in production and differentiation linked to varieties and geographic fixed trading costs in modeling production and origin. The modeling is done in a sequential dynamic trade, thereby better capturing the extensive margin setup, where the number of firms in each sector is in international trade growth and trade-induced progressively adjusted, and installed capital is productivity enhancement. assumed to be immobile even across sectors. The appendix to Part I gives a more explicit Compared with other CGE models, MIRAGE explicitly example of the theoretical foundations of a CGE describes foreign direct investment and trade and includes an actual application to various FTA barriers, on the basis of a unique database for tariff scenarios. The exercise demonstrates how the results barriers (MacMap), and introduces vertical product of these models should, and should not, be used by differentiation. policy makers in negotiations. Source: ADB (2006); World Bank (2004); Plummer and Wignaraja (2006)

After all, price changes induce one-time direction of FTA formation in Asia, we effects, and are called “static” for that find that the economic policy goals of reason. On the other hand, “dynamic FTAs in the region focus on these effects” refer to the medium- and long- dynamic effects, rather than mere price term implications of regional integration changes. Below, we consider some of the and, as such, tend to be more significant. most important dynamic effects in the Dynamic effects are also more pervasive, context of FTAs—economies of scale, affecting almost all areas that relate to technology transfer and foreign direct an economy’s competitiveness. From investment (FDI), and structural policy articulated policy statements and the change and reform. part I: Economics of a free trade agreement | 11

Economies of Scale. If a firm’s average attract FDI inflows, through unilateral costs fall when its output expands, it will and concerted trade liberalization and be able to sell at more competitive other means. Bilateral and regional FTA prices as its market grows. This type formation attracts such long-term, risk- of production function would be sharing investment flows by creating characterized by “economies of scale,” of a more integrated marketplace within which the degree depends on the product which MNCs can enjoy a regional type. Economies of scale exist in the division of labor with low transaction production of many agricultural, natural- costs and exploit product-level economies resource-intensive, and manufacturing of scale. sectors, as well as services. This effect is Greater FDI flows can have important intuitive to both business people and salutary effects on the economy by consumers, who are used to paying less bringing in long-term foreign capital for larger purchases. and foreign exchange, providing ready- The importance of economies of scale made international customers through in the context of FTAs is also intuitive. the foreign firms’ global networks, By creating a larger market for firms stimulating local competition, and operating in partner countries, an FTA will putting pressure on government bodies allow producers to take advantage of a to embrace “best practices” vis-à-vis larger customer base and, hence, produce investment measures and regulations. at a lower average cost on all sales. Firms But perhaps the most important benefit will even be able to lower prices for from FDI, at least for developing Asia, is existing customers—the “cost-reduction technology transfer. effect” (Corden 1972). As a result, they The investment effect on trade creation will become more competitive not only at and trade diversion is also worth noting. home but also in foreign markets. An MNC that believes an FTA between It is clear that exploiting economies India and ASEAN will lead to greater of scale is an important motivation for economic dynamism in Asia will be regional integration. Resource pooling compelled to invest more in India. and market sharing have been explicit Since the resulting investments would goals of ASEAN essentially since its be consistent with India’s dynamic foundation. ASEAN has deepened comparative advantage, this is known as economic integration considerably over “investment creation,” i.e., India (and time and is now creating an ASEAN the rest of the world) experiences a more Economic Community, in part to compete efficient distribution of global investment. with the PRC and Indian markets, which However, suppose that the MNC decides otherwise would have an important to invest in India not because of a in economic perceived increase in dynamism in that scale. Deep integration in the European country but because it will now have Union (EU) has been pushed by the need preferential access to the ASEAN market. to compete with the US for the same In other words, although investing in, say, reasons. Bangladesh might have been more cost- effective, the MNC diverts investment to Technology Transfer and Foreign Direct India because of this regional accord. The Investment. The link between FDI and motivation would be the same as in technology transfer has been firmly “tariff hopping” FDI. This effect is known established. It is one of the primary as “investment diversion.” India may be reasons why Asian countries seek to pleased that it can draw in more FDI, 12 | How to design, negotiate, and implement a free trade agreement in asia

but Bangladesh will certainly suffer. goal of ASEAN (and other economies in Moreover, the investment in India could Asia) is mainly to bring in third-country very well go into sectors in which India MNCs, that is, to attract greater FDI is not internationally competitive but inflows from OECD countries. Developed merely competitive relative to ASEAN, countries are by far the most important producing negative efficiency effects even global investors. In 1995–2005, intra- there. ASEAN FDI was only 14% of total FDI While conceptually clear, investment inflows, and almost half of that share was creation and diversion is difficult to Singaporean investment in Thailand and estimate. We observe a change in FDI Malaysia alone. Thus, it makes sense for flows empirically but are unable to FTAs to focus on non-partner countries as trace directly the motivation for the well as partner countries. Multinational investment—MNCs obviously do not corporations in developed countries also announce their management strategies. have the advantage of having the most However, we would expect investment sophisticated technologies, and their creation to follow trade creation, and global reach can pave the way to ready- investment diversion to follow trade made export markets. diversion. To demonstrate this, let us In fact, ASEAN has always placed return to our India-ASEAN example and, emphasis, implicit or otherwise, on further, let us focus on electronics. If attracting non-partner FDI. The ASEAN tariffs on electronic products in ASEAN Investment Area (AIA), which was were equal to zero—they are indeed very founded in 1998 and will be an important low in the main ASEAN markets—there pillar in building the ASEAN Economic would be no incentive for investment Community, explicitly charts a path for diversion, as the MNC even with its the national treatment of partner- and newly gained preferential access would non-partner country investors, albeit have no real benefit from investing in within different time frames—2010 for India; all countries would have tariff-free investors from partner countries and 2020 access. Hence, if it still speeded up its for those from non-partners. investments in India, we would attribute this to investment creation. On the other Structural Policy Change and hand, if the electronics markets in ASEAN Reform in “New Age” Free Trade were highly protected, the potential for Agreements. Modern FTAs, particularly investment diversion would be great, those with OECD countries as partners, as would be the potential for trade go well behind the traditional focus diversion. on tariffs to include other border and Using an FTA to attract FDI from third behind-the-border measures. These countries, as well as partner countries, is measures now receive far greater often a key motivation for such an accord. attention in negotiations and tend to be This is certainly the case in ASEAN, more important to the modernization and whose free trade agreement (the AFTA) competitiveness of economic systems, is thought of more as an investment in part because of the success of the agreement than as a trade agreement. GATT/WTO in bringing down tariffs and In other words, the goal of AFTA is rendering them less significant. Examples to reduce transaction costs to MNCs of these behind-the-border areas are: wishing to use ASEAN as an integrated complex measures specific to the service production platform to exploit vertical sectors; laws related to corporate division of labor. Note, however, that the and public governance; the national part I: Economics of a free trade agreement | 13

treatment of partner-country investors; Competitiveness Incentives. As is the case competition policy, including the reform with trade liberalization generally, greater of state-owned enterprises; and other exposure to international competition “sensitive sectors” with important has important salutary effects on a links to the rest of the economy. The partner country in an FTA. Increased inclusion of these nontraditional areas exposure to competition from partner- underscores how far FTAs have gone country producers not only leads to trade beyond mere to creation, and, therefore, greater structural include microeconomic policies that used efficiency, but also increases the potential to be considered the exclusive domain of profits for competitive, or potentially national economic policy. competitive, firms. An important incentive Policy harmonization issues are to invest in more efficient productive especially pertinent in this regard. processes and technology is thus created. Although the most significant effects of In other words, the FTA enables the firms the program of the EU are to adapt new technologies from abroad held to be in many of the behind-the- by increasing the potential for success in border areas mentioned above, perhaps using those technologies to break into one of the most important areas of partner-country markets. cooperation can be classified under the rubric of “harmonization issues,” such Political Economy of Protection as mutual recognition of product testing and professional certification, standards The areas covered by regional trading conformance, and customs and transit. arrangements constitute a subset—though Adopting universal harmonization an increasingly large one, as mentioned standards would maximize gains in all above—of overall macroeconomic and of these areas. Doing so worldwide is, microeconomic policies. Moreover, all however, much more difficult, and that existing and emerging trade accords is why the GATT/WTO has made such in Asia are FTAs, rather than customs little progress in these areas. On the other unions, meaning that the economic hand, like-minded countries in an FTA are policies of member countries continue to able to address these nontraditional areas be independent. 10 Thus, the question of that improve the business environment by how FTAs will affect the policy stance of reducing costs, leveling the playing field acceding countries will be crucial to the for foreign investors, and pushing policy ultimate success of the accord. For example, reforms toward best practices. in the NAFTA debates discussed above, One final point pertains to the limits almost all American economists supported of harmonization. In many ways, the agreement not out of any conviction “harmonization” implies creating a level that regionalism was the best way to go—a playing field. However, the playing majority saw regionalism as a threat to field must be in good shape, that is, the the integrity of the multilateral system, in region should adopt not only compatible which they strongly believed—but rather policies (harmonization) but also best because they felt it was the best way to practices. Otherwise, harmonization lock in the progressive economy-wide may only reduce diversity in a region reforms that Mexico had set in motion while doing little to improve the business environment, which, after all, should be 10 The one exception might be the ASEAN Economic Community initiative, which may ultimately have to the overriding goal. create a customs union to reach its goal of a common market. 14 | How to design, negotiate, and implement a free trade agreement in asia

in the process leading up to NAFTA. In policy. This aspect of endogenous tariff addition, accession to ASEAN has facilitated formation has been explored through economic reform in the transitional ASEAN political, rather than purely economic, economies that joined in the 1990s, well models. In general, this approach focuses beyond what was needed to meet the on the domestic government’s political exigencies of ASEAN-based agreements. In objective of maximizing national welfare this section, we consider some aspects of as determined from its own point of the complicated interaction between FTAs view, rather than from the economy’s and policy-making. perspective. In line with this, the government’s objective function consists of Dynamic policy considerations three major variables, i.e., domestic firms’ profit, aggregate consumer surplus, and A government can try to protect its tariff revenue, which can be represented domestic market from foreign competition in the simple objective welfare function

by levying tariffs on imported goods or W(πL ,C, τ). It should be noted that this erecting nontariff barriers such as quotas “national welfare” function differs from of various kinds, discriminatory sanitary what a neoclassical economy connotes. requirements, or even administrative In the political-support approach to action (e.g., antidumping and trade-barrier formation, the government countervailing duties ). 11 While tariffs, trades off political backing from along with internal sources such as consumers against higher industry profits income, corporate, and value-added because higher protection for domestic , generate for importing industry will inevitably lead to higher countries, such a tax at the border sale prices of goods (and, hence, will be can itself be used as a policy variable opposed by consumers). If the government to influence the economy’s industrial gives greater weight to consumers’ surplus structure. Hence, tariff formation can be, than to the domestic firms’ profit, the and usually is, affected by various factors effective tariff rate will be lower, and vice other than tax revenue maximization. versa. The local firms will lobby their After all, if revenue maximization were government for higher protection for their indeed the goal of a tariff regime, the industries. If the tariff revenue collected is country should favor an across-the- to be redistributed among domestic actors, board tariff that does not discriminate an altruistic government would choose a across commodities when setting up tariff to maximize aggregate support from its commercial policy regime. Such an its constituents. The altruistic government approach would imply far less efficiency endeavors to maximize social welfare costs than a tariff structure that differs under the political incentive to gain public across commodities. 12 The fact that confidence in order to win elections or homogeneous tariffs are rarely in evidence carry favors from various constituents. implies that countries tend to use their These policy considerations of the tariff structure as a form of industrial importing country government, in turn, have strategic implications for the 11 This does not mean that all sanitary requirements and exporting sector. Faced with the importing administrative actions are protectionist. However, they have been used as “hidden” protectionist vehicles. government’s welfare maximization 12 The argument for an optimum tariff rate suggests that problem, exporting firms behave tariff rates should be set according to relative elasticity between the demand for and supply of the imported strategically to maximize profit under good to maximize terms-of-trade gains. Given the given constraints. An exporting firm not compliance costs and potential rent-seeking behavior, however, a uniform tariff can have great advantages only competes against the local firms in over a complex one. the market of the host country, but also part I: Economics of a free trade agreement | 15

engages in strategic behavior in responding These dynamic policy considerations to trade barriers in the country to which in the formation of trade barriers suggest the firm will be exporting (i.e., the the possibility of suboptimal trade policy destination country). This dynamic aspect implementation. While freer trade of strategic behavior is most evident in is better for the economic welfare of firms’ comportment under administrative both the exporting and the importing protection regimes of the importing countries, policy considerations in the country. Even in the context of rapid domestic market will inevitably lead globalization and with many FTAs that the government to suboptimal policy have emerged as important policy vehicles, decisions for protection. For example, administrative protection measures, antidumping protection is technically such as antidumping and countervailing triggered when the sale price of an duties, have become the most important exported commodity is lower than its trade barriers in industrialized (and some price in the country of origin, and this developing) countries. The rationale and price differential causes material injury effects of these protective measures, as well to the domestic industry of the importing as exporting firms’ strategic behavior in country through unfair competition. facing the domestic government’s threat of However, with the emergence of many protection, must be explored in a political interest groups in the industrial sector, the economy context. Although it is not yet governments become more vulnerable to proven whether this kind of strategic external pressures from industry interests interaction exists in the real world, much to say that has occurred. After research reveals that this political-economy all, most businesspeople would define context can explain a large portion of dumping as merely selling at a price formation. This approach is that is lower than their domestic price. certainly more realistic than the logical Furthermore, given the difficulty of neoclassic approach, which would suggest forming organized consumer-interest that all countries should adopt free trade, groups, the balance of influence will with the exception of “infant industries,” tilt toward more heightened protection strategic trade policy, and the (theoretical) regimes at the cost of consumers’ optimal tariff argument. 13 welfare and efficient allocation of global resources. 13 The infant-industry argument suggests that temporary, short-term protection should be used to protect a certain industry in the case of a financial bottleneck Implications of rent seeking in developing countries. While there are examples of successful infant-industry protection, often the Except in the presence of market failure argument is used merely as an excuse for traditional protection: most infant industries never grow up. (e.g., where there exist externalities or Strategic trade policy refers to protection geared to imperfect competition), a standard result encourage economies of scale in an industry by creating a captive domestic market (and, with lower average of economic theory is that government costs, enhance competitiveness in global markets) or intervention in markets tends to lead to the protection of one (comparative-disadvantage) to a less efficient outcome. Tariffs and, sector that is a necessary input to a comparative- advantage sector. This argument, too, is problematic; certainly, nontariff barriers are no while the former argument would lead to retaliation, different. As discussed above, a tariff the latter has very weak theoretical foundations. Finally, while it would be logical for them to do so in theory, distorts consumption patterns and the countries do not apply tariffs according to an “optimal structure of production, thereby damaging criterion,” that is, they do not apply tariffs to improve terms of trade by forcing down import prices. Besides, the static welfare of the country. Tariff the criterion would not apply even theoretically to small barriers raise revenue for the government, and developing countries: as they cannot influence their respective terms of trade (they are price takers), the but other sources of revenue, such as optimal tariff would always be zero. value-added taxes and direct taxes 16 | How to design, negotiate, and implement a free trade agreement in asia

(e.g., income taxes), tend to be less revenue from intra-regional trade, will distortionary. Nontariff barriers are even have less of a fiscal impact. However, worse; they have the same negative firms may try to include protection in the effects on consumers and the productive agreement itself to perpetuate protection structure but often do not produce any and rents. Complicated rules of origin are revenue at all for the government. a case in point. Still, there are strong political reasons for applying tariffs. In addition to the Political and strategic considerations process described above in terms of dynamic policy considerations, support for Most existing preferential trading protection is usually justified to the public arrangements were either created as in order to protect national security, jobs, economic arrangements in support of the environment, even a way of life. After political goals or at least consistent with all, the economic case for free trade is the diplomatic strategy of the founding so strong that it has essentially created countries. Economic cooperation in these a consensus in mainstream economics, a arrangements is seen as an important field where there is very little consensus vehicle for the pursuit of political goals in other areas. However, except for a (which, in themselves, have important few small states, no country completely economic ramifications). The EU has been embraces free trade. The political effective in using preferential trading economy of , therefore, is arrangements as diplomatic tools over obviously extremely important. the past 40 years, in part out of necessity. As long as there is protection, there will Commercial policy was (and still is) the be an incentive for rent seeking. 14 Without only truly unified policy at the regional hard-and-fast rules based on economics level (Messerlin 2001). (e.g., free trade or uniform tariffs), To the extent that these regional comparative-disadvantage industries will accords add to the political stability of always have a strong incentive to lobby the region, they do service to economic government officials. This type of rent development in general and to the goal seeking is very costly to the economy. of policy reform in particular, even if the The economic case for FTAs is arrangements have weak substance to actually strengthened in the context them. This, of course, is an important of rent seeking if the agreement is part of the early success story of ASEAN. comprehensive. Trade creation will Although most ASEAN countries had reduce the lobbying strength of the most only recently achieved independence inefficient domestic firms and, hence, and were struggling to create nation- their capacity to rent-seek. Moreover, if states (complete with many territorial tariff revenues are being used inefficiently disputes), the arrangement established or, worse, are being diverted to the an important dialogue process that pockets of customs officials, the creation prevented overt hostilities between these of an FTA, which obviously reduces tariff countries. To say that the (intentionally) weak economic cooperation initiatives 14 The term rent seeking was first used by American in ASEAN had nothing to do with the economist Ann Krueger for a theory developed by subsequent dynamic growth in the region economist Gordon Tullock. Tullock’s theory addressed the active creation of monopolies, with the aim of is to seriously understate its role. achieving supernormal profits or market control, However, there is also danger in in competitive conditions. See A. O. Krueger, “The Political Economy of the Rent-Seeking Society,” letting political goals dictate economic American Economic Review, vol. LXIV (1974), 291–303. agreements. If the overriding goal part I: Economics of a free trade agreement | 17

is political, then the parties forming is not particularly pertinent, at least from an agreement will tend to make it as an economic perspective. restrictive as possible. This will mean that As is the case with multilateral they will include sectors that will be trade- liberalization, FTA negotiations produce a diverting and avoid liberalizing sectors complicated matrix of political interaction. that will be trade-creating, guaranteeing First, certain producers’ interests will be that the FTA will be inefficient. A “positive pitted against those of consumer groups. list” approach to trade liberalization, Since free trade tends to favor producers in which countries specifically offer the that rely heavily on imported inputs, they commodities that they would be willing will generally back FTAs (as well as the to include in a package—as opposed to WTO) but, given the potential for trade a “negative list” approach, in which all diversion, special producer interests will commodities are included apart from attempt to reduce the scope and coverage those that are explicitly excluded—is of the agreement. Sectoral conflict will especially vulnerable to this problem. also take place: manufacturing industries, ASEAN’s original Preferential Trade for example, that have dealt with many Agreement (PTA) and the South Asian rounds of global trade liberalization may Association for Regional Cooperation’s well favor a given FTA, as they expect South Asian Preferential Trade Area to benefit from trade creation, that is, (SAPTA) used the “positive list” approach, expansion into partner-country markets. and accomplished very little, if anything, However, sensitive manufactures will in stimulating trade. resist. Also, agriculture, which has been Moreover, in the more political accords, mainly excluded from GATT/WTO countries signing an agreement will rounds, tends to be the most complicated list increasing intra-regional trade and sector of all because it is often the most investment as the main goal. But such an protected. The OECD, for example, objective is political rather than economic. spends $300 billion per year protecting its If the FTA reduces transaction costs and agricultural producers, which constitute increases efficiency in the region, it will less than 5% of its workforce. Protection be successful. But this does not necessarily is easiest to sell to the public in this sector mean that it will increase intra-regional because of the need for a certain level trade and investment. For example, if of agricultural production for national the accord brings in a great deal of FDI security reasons, health issues, and the from outside the region, this would serve “multifunctionality” of agriculture (a term to improve the competitiveness of the much favored by the French that suggests member countries and, hence, would the need to protect agriculture not only mean that the FTA is a success. But it for the reasons just cited but also because could very well be that the production of its positive effects on protecting and fragmentation associated with this FDI as beautifying the countryside). part of a global production chain could There will also be conflicts due to firm also reduce intra-regional trade—and size. Large firms, which produce with certainly, given the fact that the FDI came economies of scale, are often in favor of from outside the region, intra-regional FTAs as the greater efficiencies from a FDI will fall. The important thing is larger market in an FTA will have a “cost that the economies have become more reduction” effect (Corden 1972). Small competitive, trade and investment has and medium-sized producers, on the other increased, and welfare has improved. The hand, will tend to oppose preferential nationality of trade and investment flows trade agreements as they anticipate being 18 | How to design, negotiate, and implement a free trade agreement in asia

vulnerable to partner competition. An or an inward-looking one at worst? This is FTA that opens up the retail-food sector, the essence of the “building blocs” versus for example, will lead to a proliferation “stumbling blocs” debate. The literature of supermarkets and a contraction in the would suggest that several possible number of “mom and pop” stores. Even negative policy consequences (i.e., immigration groups will have a role: inherent “stumbling bloc” tendencies) trade can serve as a substitute for factor could emerge from an FTA, while other flows, and so anti-immigration groups tendencies would be consistent with tend to support FTAs (provided they do multilateral goals and market-friendly not liberalize labor flows). This was the domestic liberalization. We review the case with NAFTA, which was generally general arguments for each side below. 15 supported by anti-immigration groups in the US. Stumbling Blocs In FTA negotiations, therefore, governments have to negotiate not Maximizing terms-of-trade gains only with their partners but also with a complex web of domestic interests. Regional integration increases the size of Compromises will have to be made across an economic zone and, hence, increases groups within a country and across market power. The potential benefits of countries in the FTA. Sometimes structural exploiting such an advantage by imposing change in the FTA can be facilitated an “optimal tariff” (i.e., maximizing the through a compensation mechanism difference between the terms-of-trade (e.g., the Trade Adjustment Assistance gains from a tariff regime against its program in the US): since the country is costs in terms of efficiency) are familiar better off with trade creation, it makes from the international trade literature. good economic sense to compensate the Moreover, FTAs and customs unions, losers. However, constructing efficient, because of the trade-diversion effect, well-targeted compensation mechanisms improve the terms of trade of the region can be complicated, and certain interests relative to the rest of the world. The larger will still oppose liberalization. This the grouping, the larger the potential complicated mix of considerations improvement in the terms of trade. underscores the critical importance of In reality, the first effect is probably establishing channels of communication not particularly relevant, as even customs with different groups domestically unions do not impose tariff regimes before and during negotiations, as well according to optimum tariff rules. 16 as putting in place an astute, diverse Moreover, in the case of both customs negotiating team. These topics are dealt unions and FTAs, changes in the external with in depth later in the book. tariff regime cannot on average be more protective than the pre-integration

Economics of Consolidation/ 15 See Frankel (1997), on which some of these topics are based. Harmonization 16 Nor are they at the country level, as noted earlier. While the optimum tariff argument is one of the three classic economic arguments in favor of protection (the others being the infant-industry argument and Does regionalism support unilateral or strategic trade policy), it is well recognized as a multilateral reform goals, or does the theoretical argument. Tariffs are generally implemented for political and political-economy- discrimination inherent in a related reasons, not as a means of trying to extract lead to a “second best” outcome at best, terms-of-trade gains. part I: Economics of a free trade agreement | 19

status quo, according to Article XXIV if all the talent is engaged in regional of the GATT/WTO. There can still be deals. Critics of regionalism suggest that negative sectoral effects as some areas such a capacity constraint can only be may see their tariffs rise, but in this case detrimental to multilateral liberalization, other GATT/WTO members can sue for and even policy reform at the national compensation. level. For example, after Viet Nam joined With respect to the terms-of-trade ASEAN in 1995, it worked not only to effect, since trade diversion undeniably enter into AFTA but also to implement results from preferential trading a number of other accords, including arrangements, it is certainly a concern. an extensive bilateral trade agreement But trade diversion is a one-time price (BTA) with the US in 2001. On top of effect and, hence, static. In fact, as that, it was working on “ASEAN+3” discussed above, it is the static cost of initiatives. Given its human-capital preferential trading accords. capacity constraints, this could very well have delayed its drive to join the WTO, Special interests manipulating the contents which was realized only at the end of and scope of the agreement 2006. Or perhaps not. A counterargument This concern obviously also manifests would be that Viet Nam was able to ready itself in domestic policy formation. This its economy for the WTO through the is especially a problem in the context outward-oriented policies of ASEAN, and of accords between developed and the BTA itself was essentially a means developing countries, in which the former of preparing Viet Nam for WTO entry, obviously have the upper hand, as special including legal and administrative reforms interests tend to be far better organized that would in any event be necessary. and funded. Article XXIV of the GATT/ The agreement is replete with references WTO is not particularly strict in regulating to WTO protocols and WTO-consistent FTAs, and with special-interest groups free reforms, from service liberalization to rent-seek, the outcomes could be less to “TRIPS-plus.” These negotiations efficient. Of course, this could also have have also sharpened the expertise of a positive effect: for example, special- Vietnamese negotiating authorities. interest groups in developed countries no doubt push for better protection Building Blocs of intellectual property rights (IPR), competition policy, treatment of FDI, and Locked-in policy change better trade and investment facilitation, but these could also have important Regional integration can be seen as a positive effects on efficiency and policy- blueprint for market-friendly reform making in developing countries. and increased competitiveness in the international marketplace. Without Waste of scarce negotiating resources ASEAN (and eventually the BTA), one can easily argue that Viet Nam would Particularly (but not exclusively) in the not have made as much progress (and case of developing countries, the scarcity its joining the WTO would no doubt of well-trained and well-experienced have been further delayed). This effect experts in trade negotiations implies an also applies to industrialized regions. opportunity cost of less resources being When Greece (1981) and Spain and devoted to multilateral negotiations Portugal (1985) joined the EU, they 20 | How to design, negotiate, and implement a free trade agreement in asia

were essentially “newly industrialized eventually form an FTA with “home”) and economies,” each having undergone “rest of the world.” Furthermore, assume political instability/transition only a few that, in autarky, there are six industries, years before. They each made significant with the linear cost structures of the firms strides in modernizing their policies and in the home country being such that two economies as a result of EU accession, and are globally competitive (in goods A and today have significantly closed the gap B), two are competitive only regionally with advanced industrial economies. (in goods C and D, in a potential FTA with “partner”), and two will never Improved negotiating power for smaller units be competitive with trade (in goods E and F). Now, assume that the “home” Traditionally, the possibility of small government puts to a vote whether or not countries joining together and working the country should move to free trade. as one cohesive unit in trade negotiations Firms producing A and B will vote yes, as has always been considered an important they will benefit from a larger market, but advantage of regionalism. This would the other four firms will vote against it, as apply both to smaller countries as well free trade will put them out of business. as to larger units. Free trade areas are We remain in an autarkic equilibrium. less effective in this regard relative to But suppose now that the home country customs unions, as the former do not votes on whether or not it should have an include a and, FTA with “partner.” The firms producing hence, divergences in interests will persist goods A, B, C, and D will vote in favor, and will make cooperation more difficult. and those producing E and F, against. The However, a well-developed system of FTA will pass. Eventually, competition forming joint positions even in an FTA can from the partner country will force out ensure that the whole will be greater than the production of goods E and F in the the sum of its parts. home country (trade creation), and there will be no trade diversion (as we began A dynamic weeding process as a first step in autarky). The remaining firms in the toward free trade home country will, therefore, eventually produce only A, B, C, and D. Next, assume It could very well be that the process of that the home country votes once again structural adjustment unleashed by a on whether or not it should have free regional trading arrangement through trade. The votes will now be two in favor trade creation could, in effect, facilitate (A and B) and two against (C and D); multilateral accords. As the weakest assuming that consumers have even a (and, therefore, more resistant to any little say would be sufficient to usher in international competition) are weeded free trade, because of the FTA “stepping out, through an FTA or other means, stone” process. the stock of opposition to trade falls in importance, thereby making multilateral Competitive liberalization to attract initiatives easier. international capital, as well as a Perhaps a heuristic example will positive “threat” illustrate the point. Suppose that the trade policies of a country (let us call it “home”) Regional integration can be used as are determined by domestic firms, and a means of rendering the component “home” trades with two other countries— economies more efficient, competitive, “partner” (i.e., the country that will and market-friendly. While a grouping part I: Economics of a free trade agreement | 1

may or may not adopt global “best and active participation in the practices” in regulatory, legal, and WTO, would contradict this stance other issues, it can reduce the stock of in favor of a regionally closed divergences across countries, thereby system. making it easier to integrate globally. (ii) Reductions in trade barriers within By reducing transaction costs across a preferential trading arrangement countries, an FTA can enhance its make it more attractive for a attractiveness to MNCs. As an FTA country to reduce external barriers, “deepens,” and policy externalities thus in effect “MFN-izing” regional become increasingly important, the concessions, because the most incentive to internalize them through important cost of regionalism, as monitoring, information sharing, noted above, is trade diversion and closer cooperation, etc., increases. lower external barriers will reduce Because trade and financial links are the associated costs. becoming increasingly important and (iii) “Weeding out” least-competitive recognized, countries within an FTA soon industries, and making the find it useful—or even necessary—to political economy of trade further financial and macroeconomic liberalization more favorable cooperation. It may also be true that over time, seems to have been regional agreements can be used as important empirically. 17 implicit and explicit “threats,” particularly (iv) The membership of FTAs and since FTAs seem to have a tendency to other cooperative accords tends grow over time. to expand and to become more In sum, both the “stumbling bloc” and diverse over time, thereby “building bloc” arguments have theoretical reducing regional sources of merit. But in practice, the inclination of support for protectionism in a the regional accord tends to be extremely particular country and industry, important. Clearly, if the group is being as well as reducing the overall formed to enhance inward-looking potential for trade diversion. development strategies or to isolate the This has been true for the EU, region from global competition, this initial NAFTA, AFTA, the South American policy direction would set in motion many Common Market (Mercosur), and of the problems discussed above. In fact, other agreements. this approach led to the downfall of many regional trading agreements in the past, Inconsistencies between Agreements: especially in Latin America (e.g., the “Spaghetti Bowl” Effect Latin American Free Trade Area). Yet, if outward-looking economies were to form The boom in the number of separately a regional grouping, regionalism is likely negotiated FTAs has often been blamed to promote the goals of domestic policy for the “spaghetti bowl” or “Asian noodle reform and multilateral liberalization. bowl” effect in the region. As mentioned These factors, among others, are earlier, these FTAs can be quite different responsible: from one another in coverage, depth of liberalization, and the specific regulations (i) It is unlikely that a country that make the accord function (e.g., the wishing to promote outward- 17 “Anecdotally” would perhaps be more accurate, as looking policies, including the empirical literature on this subject is not well extensive unilateral liberalization developed. 22 | How to design, negotiate, and implement a free trade agreement in asia

“rules of origin” discussed below). Their but also influencing the input-sourcing inherent inconsistencies and (sometimes) decisions of the firm in a way that could contradictions could be a real problem hamper efficiency. Thailand, for example, in the global marketplace. A strong has FTAs with both Australia and New advantage of the WTO framework is that Zealand. And even though Australia and it generally, but not totally, avoids this New Zealand themselves form one of the problem. most advanced FTAs in the world (the Complicated “rules of origin” (ROOs) Closer Economic Relations agreement), in FTAs are often cited as the most the set of ROOs for Thailand’s FTA with obvious example of the “spaghetti bowl” each is different. Hence, a Thai producer problem. Later in this reference we discuss that exports to both Australia and New ROOs at length. Suffice it to note here Zealand may need to have a different that they are necessary in FTAs to avoid production strategy for exports to each “trade deflection.” An example would market. That would be costly in a number best illustrate the point. Suppose that of ways to the Thai producer, which could India and Malaysia were to form an FTA. lose scale economies, among others. Further, assume that tariffs on television Exactly how costly these different sets are high in India but are low in ROO regimes are to any given country is Malaysia. Once the agreement is in place, unclear. Some economists estimate the Japanese exporters, for instance, will have compliance costs at 3–5% of the value of an incentive to “deflect” their exports exports, but others suggest that the cost from India to Malaysia, where they will is lower. And governments can reduce the pay a low tariff, and then reexport the associated costs by providing information television sets to India from Malaysia to to exporting firms and importers. The take advantage of duty-free access. This Singapore Government, for example, puts will lower the tariff costs for the Japanese out an interactive CD-ROM that provides exporter. To avoid this possibility, any details to Singaporean firms regarding India-Malaysia FTA should include ROOs the ROOs for any product and any FTA for products that seek to take advantage of involving Singapore. the FTA. What is clear is that the “spaghetti The problem is that ROOs can be used bowl” effect—in terms of ROOs or as a protectionist technique, with high other aspects of FTAs that tend to be ROOs being used as a way of protecting inconsistent between countries—does domestic interests. Each FTA tends to have at least some economic cost. be unique and can choose its own ROO Greater harmonization of policies in regime—Article XXIV is completely silent these agreements, in ways that would be on the issue—but many of them tend to more consistent with economic efficiency be extremely complicated, especially when (“best practices”), would obviously be the FTA includes an OECD country. NAFTA, advantageous, particularly as the number for example, is a liberal FTA by most of FTAs in the region continues to grow. measures, but its ROO regime is infamous: We consider a set of best practices in the the ROO for automobiles, for example, is next section. 62.5% and for certain textiles, 100%. Moreover, the diversity of these ROO Enhancing Consistency in Agreements: regimes is problematic. A country with Best Practices many FTAs could end up having different ROOs for trade in a certain product for One way to avoid inconsistency each FTA, potentially creating confusion associated with the “spaghetti bowl” part I: Economics of a free trade agreement | 

effect would be to have rules that govern of protection, as well as on trade FTAs. Article XXIV does have some diversion. general rules, but they are extremely (ii) Product coverage: Services. Again, general and have proven very difficult comprehensive coverage and a reasonable to tighten. At the Doha Development time period for implementation are Agenda negotiations, for example, the best from an economic perspective, problem of the growing number of FTAs and transparency is important in was evident, but, even with a successful some areas. Services present some outcome, any improvement in FTA special and important challenges. rules is likely to relate only to greater Certain services are fairly easy transparency. It would be useful to define to liberalize, e.g., in terms of a set of rules that would minimize the allowing for the movement of negative effects of FTAs and maximize professional persons, tourist- the positive effects. This is especially related services, and even high- important in the light of the FTA tech/knowledge-based services. movement in Asia, where policies, rather Others are extremely difficult. than being inward-looking, are directed Educational services tend to more toward efficiency goals. We might be highly protected. Financial call such rules “best practices” of FTAs. services are often the most difficult Below are 10 major areas that might be to include in any liberalization considered in this regard: 18 package. Still, the gains from trade in services are no less than those (i) Product coverage: Goods. from trade in goods, and yet there Comprehensive coverage is best, to be has been far greater attention included within a reasonable period to the latter in multilateral of time (defined as 10 years by the agreements and most FTAs. GATT/WTO). Article XXIV of the (iii) Rules of origin. Rules of origin GATT/WTO stipulates that, in should be as low as possible as well as an FTA or customs agreement, symmetrical. As noted above, abuses product coverage should include of ROOs in FTAs are problematic. “substantially all goods.” But the Stringent rules could have exclusion of individual products important trade-diversion and can be problematic on efficiency investment-diversion effects, with grounds, particularly when it a potentially high cost to non- involves products that are used partners and greater inefficiencies as inputs in the production chain. in partner countries. To avoid this, Thus, to the greatest extent generous and consistent ROOs are possible, the FTA should include of the essence. all goods. Some will no doubt be (iv) Customs procedures. To the greatest excluded either temporarily or extent possible, customs procedures should permanently, but such exemptions follow global best practices and GATT/ should be as few as possible WTO-consistent protocols. Customs and should take into account and related procedures are at the the important effects that they heart of “trade facilitation,” a key might have on the effective rate priority in the Doha Development Agenda. They are obviously

18 These best practices were developed by ADB; see closely related to ROOs, as one Plummer (forthcoming 2007) for details. of the key challenges of customs 24 | How to design, negotiate, and implement a free trade agreement in asia

officials is to clear countries (vii) Antidumping procedures. of origin of imports. Regional Antidumping procedures and dispute trading agreements can be used as resolution need to be transparent and instruments to modernize customs fair, and the process needs to be well laws, regulations, administrative specified and effective. Antidumping guidelines, and procedures. and countervailing duties, also (v) Intellectual property protection. IPR known as “administrative actions,” guidelines should be nondiscriminatory were discussed briefly above. They and consistent with TRIPS, TRIPS Plus, may or may not be stipulated and related international conventions. directly in an agreement; As will be noted later in this sometimes, the references may be reference book, the protection of exclusively directed to the WTO IPR is one of the most sensitive dispute resolution. Antidumping issues in negotiating FTAs. clauses in an FTA might be used Developed countries, having a to tighten antidumping evaluation strong comparative advantage procedures, promote transparency, in IPR-intensive products, want and expedite processes. But it to make sure that IPR is taken is also important that dispute seriously both de facto and settlement procedures are de jure. Developing countries clearly identified and respected. often criticize the IPR stance of Otherwise, confusion can follow. developed countries as being (viii) Government procurement. too severe and too favorable to Government procurement should innovators, e.g., granting patent be as open and nondiscriminatory, monopolies for an exaggerated and procedures as clear and open, length of time, or being too as possible. The size of the state insensitive in areas such as sector varies across the region pharmaceuticals. On the other and internationally, but in hand, it may be that stronger, most countries government more serious IPR protection procurement is a significant can actually be positive for the sector. There is a WTO Agreement development of a country’s own on Government Procurement, but innovative and artistic sectors, not all WTO member countries besides promoting more FDI and are signatories. 19 Moreover, the technology transfer. rules on market access in this (vi) Foreign direct investment. agreement are relatively limited. Investment-related provisions should The chapters on government embrace national treatment and procurement in the “deeper” nondiscrimination, shun performance FTAs tend to go much further. requirements, have a highly inclusive “Best practices” would require negative list, and provide the usual that the arrangement produce protection to foreign investors. In a transparent, open, and particular, national treatment nondiscriminatory regime that is critical in this regard, as it grants national treatment as much has important implications as possible to partner countries, for creating a competitive 19 In this sense this World Trade Organization (WTO) environment and a “level playing agreement is sometimes referred to as a voluntary or field.” plurilateral agreement. part I: Economics of a free trade agreement | 

with an excluded (negative) standards, however, are bound to list as short as feasible and the be general; FTAs, as they involve threshold-bid level as low as only a few or several countries, practical. can potentially achieve far (ix) Competition. Policies related to deeper means of integration and competition should create a “level progress in this area. What would playing field” for both locals and be critical for efficiency and partners, and they should not put non- outward orientation, therefore, partner competition at a disadvantage. would be TBT clauses based on Many countries in Asia do not international standards, having have a competition policy per high levels of transparency, se. But trade and investment embracing best practices, and liberalization is affected by eschewing discrimination against industrial organization at the outsiders as much as possible. domestic level, and this becomes an especially important area in In sum, by adopting best practices, countries having active state- FTAs can generate significant gains in owned enterprises. Hence, economic efficiency, well beyond the it follows that “deep” FTAs effects of traditional FTAs and, arguably, should have basic rules and beyond what any realistic multilateral procedures designed to prevent approach could possibly hope to generate. anticompetitive behavior from state-owned enterprises, quasi- state firms, privately owned Summary domestic monopolies/oligopolies, and the like, that would give them a competitive edge over foreign Trade policy is complicated. While competition. economic theory strongly supports (x) Technical barriers to trade. These free trade and outward-oriented trade should be kept to a minimum and agreements, trade policy is decidedly harmonized in a nondiscriminatory way, in the political realm and, hence, with clear and transparent mechanisms economic arguments constitute only for determining standards. The WTO one—albeit essential—dimension of Agreement on Technical Barriers trade negotiations. Still, it is important to Trade (TBT) attempts to that negotiators are aware of the “ensure that technical negotiations economic benefits of liberalization and and standards, as well as testing the economic costs to an economy of and certification procedures, do inward-looking policies. Rarely is the not create unnecessary obstacles most efficient outcome forthcoming from to trade.” TBT takes on particular any multilateral, regional, or bilateral significance at the global level, negotiation. The trick is to maximize as many of its aspects, including the efficient aspects of any given accord harmonization of standards, and minimize any potential negative “mutual recognition,” definition implications. of legitimate means of protecting This assessment of the costs and benefits animal and plant life and the of trade liberalization, at the global and environment, should have global bilateral/regional levels, was the main rules of conduct. International objective of Part I, which also considered 26 | How to design, negotiate, and implement a free trade agreement in asia

political determinants of trade policy. thumb that would be useful in creating Moreover, given that Asian economies such arrangements (or, perhaps, merging have explicitly expressed their desire for them in the future). In Parts II and III, we FTAs to be outward-looking rather than focus specifically on component parts of inward-looking, we considered rules of FTAs and practical issues. part I: Economics of a free trade agreement | 7

Appendix to Part I: application of a Computable General Equilibrium Model to FTAs

rade models have become have chosen the desired basket of goods increasingly useful tools for given their incomes, and firms have T analyzing the economic impact chosen production levels that maximize of trade agreements in recent years. their profits. Because an FTA introduces Advances in theory, analytical techniques, a set of policy changes in an economy, and data processing power of computers CGE models simulate an economy have enabled analysts to assess the impact where markets have adjusted and a new of trade agreements in quantitative terms equilibrium has been reached.The effect and compare the effects under different of an FTA can be estimated by comparing scenarios. For instance, an estimate of the incomes under the old equilibrium with impact of the Doha Round shows global those under the new equilibrium. gains of $68.6 billion to $155.2 billion by The attraction of a CGE model is that 2025 (ADB 2006). Another estimate shows it arrives at a numerically exact answer that full liberalization of merchandise (in the form of a change in income) trade would result in a $291 billion to while ensuring theoretically consistent $518 billion increase in world income by results. A CGE model identifies the 2015 (World Bank 2004). Meanwhile, sources of income gains or losses from bilateral free trade agreements (FTAs) like further opening up to trade and shows the Japan-Singapore Economic Partnership how these gains or losses are distributed Agreement have been estimated to across countries or regions. Hence, increase the income of Japan by $6.9 CGE simulations can be used in FTA billion and that of Singapore by $0.4 negotiations to highlight, for example, billion (Hertel et al. 2001). Given the wide the sectoral and production effects of range of estimates and possible impact some of the FTA provisions that could on developing member countries, it is hurt vulnerable groups in an economy. important to gain a basic understanding This would give a good idea of how the of the simulation models being used and government should target any assistance their strengths and weaknesses. designed to facilitate restructuring As noted in Box 1.4 above, the most and compensate the losers. Multiple common trade model is the global simulations can also be undertaken to computable general equilibrium (CGE) work out alternative scenarios that might model. The CGE model is based on turn national income losses from an FTA the concept of a general equilibrium, into gains. Because of the multiplicity of where supply equals demand in each links in an economy, a simple diagram market in the economy. The chart below may not show all the effects of an FTA, presents an overview of the elements of whereas CGE and other computer-based a typical CGE model and shows the links models allow systematic tracking of all between markets. To achieve market the interactions. equilibrium, prices are assumed to adjust The CGE models used in empirical until demand for factors of production studies vary somewhat in their underlying equals available endowments, consumers economic structure, behavior of agents, 28 | How to design, negotiate, and implement a free trade agreement in asia

and focus. Box 1.4 presents different (iii) Asia Pacific Economic Cooperation types of CGE models and their uses. With (APEC) FTA scenario: free trade a CGE model, simulation exercises can among APEC members; and be conducted to evaluate the welfare (iv) Global trade liberalization scenario: gains under different FTA scenarios. The complete abolition of import primary focus of such policy scenarios is tariffs and export subsidies. the removal of price distortions against imports that arise from trade barriers and The economic impact of these FTA other sources. An example of such an scenarios was estimated with the use approach might best illustrate the point. of ADB’s General Equilibrium Model A CGE model was used to evaluate gains for Asian Trade (GEMAT) (see Box 1.4 from the following Asian FTA scenarios: above). The results for gross domestic product (GDP) and welfare with (i) Fragmented scenario: a equivalent variation for the four policy continuation of the current wave scenarios are given in the table below. of bilateralism, where the region Expectedly, a fragmented reality of is fragmented by several bilateral multiple bilateral and regional FTAs is or small regional FTAs; the least attractive for all regions and (ii) ASEAN+3 FTA scenario: free trade countries. Among others, this scenario among Association of Southeast may give rise to the famous Asian Asian Nations (ASEAN) countries, “noodle bowl” effect, which refers to the the PRC (including Hong Kong, higher transaction cost from multiple China), Japan, and the Republic ROOs and standards in the growing of Korea; number of FTAs in East Asia.

Elements of a CGE Model: The Circular Flow in an Open Economy

International Sector Savings Investment

Consumption

Goods and Services

Households Capital Goods Firms

Factor Services of Production

Factor Incomes

CGE = computable general equilibrium. Source: Plummer and Wignaraja (2006); Kawai and Wignaraja (2007) part I: Economics of a free trade agreement | 9

Impact of Four FTA Scenarios, Change in Real Income (Equivalent Variation) Fragmented ASEAN+3FTA APEC FTA Global Free Region/ Scenario Scenario Scenario Trade Scenario Country In $ million (2001 prices) Northeast Asia (1,219) 21,724 56,734 72,944 ASEAN 8,869 10,375 8,341 11,319 Rest of Asia (101) (425) (1,560) 4,288 US (1,371) (2,362) 12,035 22,884 Europe (1,021) (904) (3,047) 25,325 Rest of the World (555) (464) 280 14,861 World 4,401 27,546 74,689 153,718 In % of GDP Northeast Asia (0.02) 0.37 0.96 1.23 ASEAN 1.72 2.02 1.62 2.20 Rest of Asia (0.01) (0.06) (0.22) 0.61 US (0.01) (0.02) 0.12 0.24 Europe (0.01) (0.01) (0.04) 0.30 Rest of the World (0.01) (0.01) 0.01 0.34 World 0.01 0.09 0.25 0.51 APEC = Asia Pacific Economic Cooperation, ASEAN = Association of Southeast Asian Nations, FTA = free-trade agreement, GDP = gross domestic product, US = United States of America. Source: ADB staff simulations.

Under the ASEAN+3 scenario, the While trade models like the CGE welfare of members increases, with model are useful in quantifying Northeast Asian GDP increasing by the impact of FTAs, the drawbacks 0.37% and ASEAN GDP by 2.02%, include their reliance on the quality of while nonmembers (the rest of Asia, US, information fed into the model and on Europe, and the rest of the world) incur the assumptions used in simulations. modest losses. An APEC FTA brings gains Data may not always be of high quality to Northeast Asia and the US but less and could be missing, links between gains to ASEAN than under a fragmented markets in the economy may not always scenario. The rest of Asia and Europe, be accurately specified, and different which would be excluded from an APEC scenarios and model specifications FTA, also lose relative to the first scenario. can mean different results. Moreover, Global free trade is the most attractive but existing CGE modeling frameworks unrealistic scenario since even the Doha do not include many aspects of trade Development Agenda process, which agreements—barriers to services, does not aspire to global free trade, has competition policies, investment rules, been beset by uncertainties regarding and other nontariff measures (e.g., the timing and depth of multilateral sanitary and phytosanitary standards agreements needed to reduce trade and technical barriers to trade), which barriers (see Plummer and Wignaraja are likely to afford more protection [2006] for an analysis of the impact of for domestic industries than tariffs. the different scenarios on East Asian Accordingly, the impact of these issues is economies). not reflected in the simulation results. 30 | How to design, negotiate, and implement a free trade agreement in asia

CGE models are best used in in the future, a gravity model shows conjunction with other empirical tools— the historical pattern of trade. The notably analysis of the complex structure findings from a CGE model could also of FTAs, econometric methods, country be supported by country or case studies or case studies, and policy analysis. For to highlight the possible microeconomic example, Gilbert et al. (2004) used both impact of FTAs not accounted for by the the CGE model and a gravity model to models. Nonetheless, the results of CGE analyze regional trade agreements in simulations are useful in giving a sense Asia. A gravity model seeks to explain of the order of magnitude that a change the pattern of bilateral trade and its in policy can mean for economic welfare. evolution over time in terms of certain Hence, CGE models are complements, not fundamental variables. While a CGE substitutes, for a thorough policy analysis model can show the effect of an FTA of FTAs. Part II: Coverage of a Free Trade Agreement

Trade in Goods

nder the WTO rules, a member may enter into a trade arrangement 20 with one or more other members under U which they grant more favorable access to exports from one another than to exports from other WTO members. As discussed in Part I, the basic rules governing this exception to the WTO’s MFN clause, or nondiscriminatory treatment for trade in goods, are found in the GATT Article XXIV. Under this article, a free trade agreement (FTA) binds a group of two or more concurring countries 21 to eliminate tariffs and other trade barriers on substantially all the trade between them in products originating in any of the member countries, within a reasonable length of time. Certain terms of Article XXIV are supplemented by the Understanding on the Interpretation of Article XXIV of GATT 1994 (hereafter, “Understanding”), which was endorsed as part of the Uruguay Round agreements. The Understanding, however, is more specific on some significant points. For instance, where Article XXIV indicates that tariffs should be eliminated within a “reasonable length of time,” the Understanding is more explicit, stating that an agreement allowing more than 10 years would require “a full explanation to the Council for Trade in Goods of the need for a longer period.” The Understanding is also more specific on the criteria and procedures for the required review of new or enlarged free-trade areas by the Council for Trade in Goods. For developing countries, the 1979 Decision on Differential

20 The WTO often uses the term “regional” to refer to FTAs and other integration arrangements even when the members involved are not part of the same region and are far apart geographically, as in the Republic of Korea–Chile and US-Australia FTAs. 21 Article XXIV refers to “customs territories”—territories with their own schedule of tariffs and other trade regulations. Thus, customs territories are usually countries. However, a country may have two or more distinct customs territories, as in the case of the PRC and Hong Kong, China. 32 | How to design, negotiate, and implement a free trade agreement in asia

and More Favorable Treatment, Box 2.1: WTO Disciplines in Reciprocity and Fuller Participation Trade-in-Goods Provisions of Developing Countries (hereafter, 22 Aside from compliance with the minimum “Enabling Clause”) gives these countries requirements of the exception to the most-favored nation more leeway in the time allowed for (MFN) clause, most free trade agreeents (FTAs) also adopt complying with the GATT requirements, or draw reference to WTO principles and disciplines. A including Article XXIV, and generally takes number of Asian FTAs have the following provisions: a more lenient stand on the review of National Treatment FTAs between such countries. “Each Party shall accord national treatment to the Provisions on trade in goods form goods of the other Party in accordance with Article III the heart of an FTA, and the mutual of the GATT 1994 and to this end Article III of the GATT desire to expand exports underlies every is incorporated into and made part of this Agreement.” agreement. An FTA is a way for like- The national-treatment clause affords no less favorable minded countries to reap the benefits treatment of the goods of the other Party than the most favorable treatment the Party accords to its own goods. of openness at a faster rate than is sustainable for the WTO, with its much Import and Export Restrictions larger and more diverse membership. “Each Party shall not institute or maintain any From the point of view of beneficial prohibition or restriction other than customs duties on expansion of trade in goods, potential the importation of any good of the other Party or on the exportation or sale for export of any good destined for partners may be compatible in several the other Party, which is inconsistent with its obligations ways. First, they may have significant under Article XI of the GATT 1994 and its relevant differences in comparative advantage, provisions under the WTO Agreement.” [emphasis usually indicated by internal relative supplied] prices. The Republic of Korea–Chile FTA Nontariff Measures illustrates (see Case Study 2.1) such “Each party shall not introduce or maintain any a pairing, with the Republic of Korea nontariff measures on the importation of any good enjoying strong comparative advantage in of the other Party or on the exportation or sale for manufacturing and Chile enjoying strong export of any good destined for the other Party which comparative advantage in agricultural are inconsistent with its obligations under the WTO Agreement.” [emphasis supplied] products. Moreover, each country is highly competitive in these sectors at the Source: Legal text of various FTAs. global level, suggesting that losses due to trade diversion will be small relative to trade creation. But potential partners may also be compatible because one or subject to tariffs. But, as elaborated in Part both need access to a larger integrated I, trade diversion also implies a terms-of- market to benefit from scale economies trade loss to the importing country. This in production or increased competition. constitutes an important incentive for In this case the dynamic gains may Asian countries to adopt “best practices” be important even if significant trade in FTA, as discussed at length above. That diversion implies losses in terms of the is, FTAs should seek to minimize trade static effects. diversion and maximize the potential The formation of an FTA may reduce gains from FTAs in terms of trade creation the welfare of excluded trading partners, and various dynamic effects. In addition, especially if significant trade diversion FTAs should be inclusive. For example, results, i.e., if tariff-free imports from APEC (2004) stresses that: “Consistent partners replace lower-cost goods still with Asia Pacific Economic Cooperation’s (APEC) philosophy of open regionalism 22 As part of the Tokyo Round agreements. and as a way to contribute to the part ii: coverage of a free Trade agreement | 

Case Study 2.1: Republic of Korea–Chile Free Trade Agreement In the mid-1980s, the United States began 2003, and entered into force on 1 April 2004. The to negotiate free trade agreements (FTAs) with agreement covers trade in goods, investment, trade economically or geopolitically significant partners in services, competition, government procurement, including Canada and Israel. However, Asian countries intellectual property rights, administrative issues, remained on the sidelines, with the most important and dispute settlement. countries refraining entirely from participation in For trade in goods, some tariffs were eliminated FTAs until after the Asian financial crisis.a While the immediately (e.g., in Chile for exports of autos, crisis itself had underscored the need for cooperation mobile phones, and computers from the Republic of among the interconnected East Asian economies, Korea), while most concessions were to be phased two other developments around the same time were in over as much as 13 years in the case of Chile’s arguably more important. First, as FTAs proliferated, imports of textiles and clothing. The Republic of excluded Asian exporters found themselves at a Korea likewise eliminated some restrictions on disadvantage relative to other suppliers not subject Chile’s exports of agricultural products immediately, to the same trade barriers. This created a strong but was to phase in other tariff concessions over incentive to form FTAs for “defensive” purposes. A a period of up to 16 years. Besides eliminating second concern was the People’s Republic of China’s tariffs on most goods, the agreement also called for (PRC) rapid integration into world markets, which eliminating quantitative restrictions not covered by translated into strong competition for established the General Agreement on Tariffs and Trade (GATT) export markets. By negotiating FTAs that excluded Article XI, as well as import licensing and other the PRC, other Asian countries hoped to gain a market nontariff barriers. Some sensitive goods were advantage over their powerful new competitor. exempted on each side—as noted above, In 1998, the Republic of Korea made plans to refrigerators and washing machines for Chile and negotiate its first FTA, which was also the first apples, pears, and rice for the Republic of Korea. trans-Pacific FTA. It chose Chile as its partner, even Under the agreement, global applied though the PRC, Japan, and the United States were must conform to Article XIX of the General Agreement each far more important in its trade. Two factors on Tarrifs and Trade (GATT) and the World Trade may have influenced the choice. First, while small, Organization (WTO) Agreement on Safeguards. Special Chile had already succeeded in negotiating FTAs safeguards may be applied to agricultural products; with several other countries. More importantly, the if no other mutually acceptable solution is reached, economy of Chile, whose exports were concentrated measures include stopping the reduction in agricultural products and minerals, was in the preferential tariff reduction or increasing the complementary with that of the Republic of Korea, tariff up to the most-favored nation (MFN) rate. This an exporter of manufactured goods. This meant that implies that other types of special safeguards, e.g., a reciprocal liberalization would most likely expand price floor or quantitative restrictions, can be applied trade along the lines of comparative advantage, with if both parties agree to the measure. Antidumping minimal impact on protected domestic producers. and countervailing duty actions must conform Yet each partner had sensitive sectors that were to Article VI of the GATT, the WTO Agreement on exempted from liberalization. The Republic of Korea Antidumping, and the WTO Agreement on Subsidies gained immediate tariff-free access for automobile and Countervailing Measures. exports to Chile while maintaining protection for Provisions on sanitary and phytosanitary (SPS) some agricultural products that competed with measures and on product standards build on the products from Chile (apples, pears, rice). Similarly, corresponding parts of the WTO Agreement, i.e., Chile gained greater access to its partner’s market such regulations should not constitute disguised for other agricultural exports, i.e., ones with little protection, should be based on scientific principles, impact on farmers in the Republic of Korea, while and should be applied in a way that does not maintaining tariffs protecting the local manufacture discriminate among suppliers. However, the SPS of washing machines and refrigerators. Agreement goes further, requiring each partner to The Republic of Korea–Chile FTA was completed accept the procedures and standards of the other if in October 2002, was formally signed in February those can be shown to achieve the required level of SPS protection. Both parties should base a The ASEAN Free Trade Area (AFTA) agreement, signed in 1992, their own product standards on existing expressed the intention of ASEAN members to establish a free international standards unless these can be shown trade area by 2008. The agreement, very brief by the standards of later fTAs, has since been amended to accommodate new to be ineffective or inappropriate in achieving the ASEAN members and to expedite the integration of the original country’s “legitimate objectives.” signatories. continued on next page... 34 | How to design, negotiate, and implement a free trade agreement in asia

Case Study 2.1 continued. Case Study 2.1: Republic of Korea–Chile Free Trade Agreement The FTA established a free trade committee to measures to stimulate investment by each party in monitor and evaluate the effects of the agreement. the other country and to expand trade in services. The agreement sets out procedures for dispute Other parts of the agreement deal with government settlement but defers to WTO dispute-resolution procurement, intellectual property rights, and rules of procedures regarding safeguard, antidumping, and origin. Preferential rules of origin are based on those countervailing duty actions taken under the GATT used in previous FTAs, including the North American provisions governing their use. Free Trade Agreement (NAFTA) and the FTA between Although expanding trade in goods by reducing the European Union (EU) and Chile. The Republic of applicable tariff rates was the paramount concern of Korea–Chile FTA calls for a single form, in English, to negotiators on both sides, the FTA also put in place establish compliance with rules of origin.

Source: Korea–Chile Free Trade Agreement; Chung (2003).

momentum for liberalization throughout Under Article XXIV, tariffs must the APEC region,” best-practice FTAs be eliminated on substantially all “are open to the possibility of accession traded goods. While the meaning of of third parties on negotiated terms and “substantially all” has yet to be clearly conditions.” 23 spelled out, 24 in practice FTAs usually A typical trade-in-goods agreement cover all but a few items (even though in FTAs primarily provides for tariff and in practice this has not always been the customs duty reduction and elimination, case 25 ). The Understanding notes that basic principles (including transparency, the value of an FTA is “diminished if any national treatment, and some reference major sector of trade is excluded,” and to WTO disciplines) (see Box 2.1), APEC best-practice guidelines call for nontariff and other measures (sanitary “liberalization in all sectors.” and phytosanitary, safeguards, emergency FTA concessions on trade in goods measures), rules of origin, customs include either reduction or elimination of procedures, general exceptions, and tariffs through (i) immediate elimination 26 institutional arrangements. 24 The interpretation of that expression has remained contentious. Two approaches, not mutually exclusive, TariffE limination and Reduction are typical in that respect: • The quantitative approach favors the definition of a In general, the provisions of an FTA must statistical benchmark, such as a certain percentage of the trade between regional trade agreement (RTA) indicate which goods will be included parties, to indicate that the coverage of a given RTA for elimination and reduction of tariffs fulfills the requirement. • The qualitative approach sees the requirement as as well as those to be excluded (i.e., meaning that no sector (or at least no major sector) sensitive products) from liberalization. It is to be kept out of intra-RTA trade liberalization. also must decide whether or not certain This approach is aimed at preventing the exclusion from RTA liberalization of any sector where the commodities should receive a longer restrictive policies in place before the formation of phase-in period (and, in some cases, the RTA hindered trade, as could well be the case if a quantitative approach were used (see WTO whether or not “special and differential Compendium of Issues Related to RTAs). treatment” will be granted to certain 25 For example, the European Community–European Free Trade Agreeent(EC-EFTA) FTA and the EC-Israel FTA member states). accord included only manufactured goods. 26 Even before the FTA negotiations are concluded, some 23 Asia Pacific Economic Cooperation (APEC). 2004. Best countries already provide and implement immediate Practice for FTAs/FTAs in APEC. 16th APEC Ministerial tariff reduction or partial tariff reduction in the form Meeting, Santiago, Chile, 17–18 November. of “early harvest schemes” for selected products. part ii: coverage of a free Trade agreement | 

upon the FTA’s entry into force; long as the partners specialize in different (ii) gradual and straight-line reduction segments of that category, as in the or elimination thereof; (iii) substantial exchange of small gas-efficient vehicles elimination in the first year, followed for luxury high-performance vehicles by gradual elimination or reduction (intra-industry trade). Intra-industry (particularly for sensitive products); or trade may also occur at successive stages (iv) an initial grace period of several years, of the value chain, as in the exchange of followed by elimination of tariffs. 27 computer disk drives or semiconductors In most FTAs entered into by the for assembled computers. member countries of the ASEAN, tariff Although exceptions to free trade or elimination follows certain modalities like slower phase-in for tariff cuts may help the normal- and sensitive-track approach. overcome political opposition to an In the case of the Asia Pacific Trade agreement that is beneficial overall, these Agreement (APTA), tariff concessions may tactics should be used sparingly. Cutting be negotiated (i) product by product, or eliminating tariffs on some goods at (ii) across the board, or (iii) for each a faster rate may actually raise rather sector. Concurrently, special concessions than reduce the amount of protection may be further granted to least-developed enjoyed by a domestic industry (“effective countries (LDCs) participating in the protection” of a productive activity 28 ). preferential arrangements (with respect to For example, reducing the tariff on cotton phasing or tariff elimination schedule and cloth more slowly than the tariff on raw rates). Under the bilateral FTA between cotton will increase the protection of Thailand and New Zealand, some goods cotton cloth production during the phase- were freed when the FTA took effect, in period. To the extent that the goal of while other tariffs are to be eliminated the FTA is to increase exposure to world either through progressive reduction or market forces at a manageable rate, through immediate zeroing after a period the effect is exactly the opposite of the in which duties are kept constant. policy’s goal. However, GATT Article XXIV does not require tariff elimination on the Product coverage date when the agreement takes effect, and most agreements allow tariffs and Success in negotiation requires each other barriers to be eliminated in stages. partner to be prepared to accept increased In such a case, the provisions of the imports of many types of goods. Thus, agreement must specify the schedule for from the standpoint of the negotiation, tariff reductions. Policy makers, therefore, success is most likely when the partners need to be aware of this phase-in problem do not hope to expand exports in the same industries, i.e., when the partners 28 The effective rate of protection (ERP) measures the differ in comparative advantage products, extent to which the overall structure of protection on giving rise to trade patterns such as goods raises the value added of a specific industrial activity relative to free trade. The ERP rises with the the exchange of manufactured goods tariff rate on the activity’s output but falls with the for agricultural products (interindustry tariff rate on the activity’s purchased intermediate inputs. If inputs are used in fixed proportions, the ERP trade), as in the case of the Republic of for the activity that produces good j expressed as a Korea and Chile. However, trade between fraction of value added under free trade is given by: (V − V ) / V = ( t − ∑a t ) / ( 1 − ∑a ), two partners may expand even if their T FT FT j ij i ij where VT and VFT are value-added in production of exports fall in the same broad category as good j under the current tariff structure and under free trade, the a --’s are the shares of each input i in the total cost of producing good j, and the t ’s are the 27 See METI (2007) and Lee et al. (2006). tariff rates on each good. 36 | How to design, negotiate, and implement a free trade agreement in asia

and the potential (short-run) distortions of tariff elimination is up to 20 years for in productive incentives. Thailand and 10 years for New Zealand. Members should keep in mind that a Phase-in period longer phase-in period means a longer wait until the full benefits of the FTA can As noted above, the time allowed for be achieved, and, of course, differences in phasing in often differs across product phase-in rates across goods may lead groups, with extra time allowed for to inappropriate increases in some sensitive products that are not excluded effective protection rates. Like the case of from preferential treatment. In the Thailand’s FTAs with Australia and New Republic of Korea–Chile FTA, some tariffs Zealand, the FTAs may provide further were eliminated immediately, while a that the elimination of customs duties may phase-in period of up to 16 years was be accelerated unilaterally or as a result of allowed for a few sensitive products. consultations requested by either party, to The NAFTA included phase-in times of provide flexibility in the tariff concessions up to 15 years. Such delays would be of the FTA. the exception in principle, given the 1994 Understanding, which insists on The Harmonized System a 10-year maximum except in special cases. Under the US-Singapore FTA, each Since each country is likely to trade party eliminated customs duties on all hundreds or even thousands of different originating goods of the other party when products, negotiations on tariff the agreement entered into force, but elimination typically identify goods will reduce the customs duties on some according to the Harmonized Commodity products under the US tariff lines over 4, Description and Coding System, usually 8, or 10 years, depending on the product. called the Harmonized System (HS). This The Enabling Clause allows an even is an internationally standardized method longer phase-in period for FTA members of classification developed by the World classified as developing countries. The Customs Organization (WCO). 29 Broad AFTA, as well as the ASEAN-plus FTAs categories of goods are first divided into with the PRC and the Republic of Korea sections, then into 97 chapters denoted by (which were notified, or are to be two digits, and then subheadings denoted notified, under the Enabling Clause), by four or six digits. For example, Section classifies the tariff items according to II (vegetable products) covers Chapters 6– their sensitivities under the normal- and 14. Chapter 10 (cereals) is further divided sensitive-track approaches. Under the into four-digit subheadings that include normal-track approach, some tariffs are 10.06 (rice) and then into four separate eliminated when the agreement takes six-digit subheadings that include 1006.20 effect and some others are eliminated (husked rice). Some countries expand this within specified time frames. Under the system to eight or more digits. However, sensitive track, on the other hand, items differences in treatment of goods within a protected or exempted by the member given broad category should be kept to a countries are classified into sensitive or minimum to prevent inefficiencies due to highly sensitive lists. In the New Zealand– the diversion of trade across subcategories Thailand Closer Economic Partnership or increases in effective protection rates. Agreement (New Zealand–Thailand 29 www.wcoomd.org/ie/en/topics_issues/ CEPA), no overall implementation period harmonizedsystem/DocumentDB/ is explicitly provided, but the schedule TABLE%20OF%20CONTENTS.html part ii: coverage of a free Trade agreement | 7

Positive-list or negative-list approach to the “free on board” (FOB) value of imports or, as is more usual, to the cost, A positive-list approach to trade in goods insurance, and freight (CIF) value. In enumerates specific tariff items to be the latter case, an ad valorem tariff rate included in the liberalization schedule, is applied to the value of insurance and while a negative-list approach identifies transportation costs, as well as to the cost selected tariff items to be excluded from of the goods themselves. negotiations for preferential tariffs. Most FTAs between developed and developing Treatment of Sensitive Products countries adopt a positive-list approach. For instance, the New Zealand–Thailand Because of the very large number of tariff CEPA takes a positive-list approach. Tariff lines to be included in an FTA negotiation, elimination schedules are then set item broad liberalization principles are by item. However, since an FTA must typically applied to most goods. For cover substantially all trade, it is more example, negotiators may agree that all convenient, though not popular, to use the tariffs already below a certain level will negative-list approach. be reduced immediately to zero when the agreement takes effect. However, the Which tariff rates? participants in any trade liberalization negotiation must take into account the Preferential tariffs are negotiated from existence of “sensitive products,” for certain base rates, which usually are which immediate adjustment or even the MFN tariff rates of the negotiating adjustment at the rate allowed for most parties. A procedural question regarding goods would cause severe problems in tariff rates in negotiations relates to a particular sector or region. Such a whether negotiations should take as a disruption could cause harsh political and starting point the current applied rates economic problems, at least in the short or the often higher bound rates of the run. These goods would be exempted participating countries (assuming the from the broad liberalization principles country does indeed bind its tariffs). 30 applied to most trade between the In order For real liberalization to begin partners. as soon as the agreement takes effect, In the interest of transparency, each current applied rates are the appropriate partner begins negotiations by presenting starting point. But where current applied a preliminary list of sensitive products. rates are already very low, negotiations Since WTO rules require an FTA to could focus on binding rates at similarly eliminate tariffs on substantially all low levels. Singapore began negotiating traded goods, these sensitive products the US-Singapore FTA with applied tariffs must be strictly limited in both number of of zero on most of its imports but agreed tariff lines and total value. 31 The impact to reduce bound rates to zero as well. of liberalization on domestic producers Another potential area of confusion of sensitive products may be mitigated by is whether a country’s rates are applied a later start to tariff cuts and extra time

30 Applied rates are those currently in use, while bound rates are the maximum rates to which WTO members have committed themselves in accession agreements or multilateral negotiations. Thus, countries may 31 A small value of current trade may not be relevant raise their applied rates unilaterally without violating because sensitive sectors are usually highly protected. their WTO obligations if bound rates are higher than Thus, the current trade value may be very low or even applied rates. zero. 38 | How to design, negotiate, and implement a free trade agreement in asia

allowed for tariffs to be eliminated. 32 The seasonal rates on imports of some fresh protocol for special treatment of sensitive agricultural products like tomatoes. products in ASEAN’s Common Effective Under NAFTA, the tariffs on out-of-season Preferential Tariff (CEPT) scheme 33 tomatoes were phased out over 5 years; includes flexibility in the starting date tariffs on in-season tomatoes were phased of the phase-in process, with a later out over 10 years, with a tariff quota in starting date and longer phase-in period effect during the transition period. for LDC members; rules for ongoing tariff cuts, with no rate change applied Trade Facilitation for more than 3 years, a reduction of at least 10 percentage points at each Nontariff market access provisions are adjustment, and a final tariff rate of no gaining wide attention in negotiations more than 5%; and scheduled elimination (multilaterally and bilaterally) and have of all quantitative restrictions and other become as significant as negotiations nontariff barriers. on tariff-related provisions. This is Imports of sensitive products are often because customs procedures and other restricted by a tariff-rate quota (TRQ) administrative hurdles can themselves rather than a simple ad valorem tariff. be significant barriers to trade. To Under a TRQ, imports up to a stipulated begin with, potential exporters and ceiling may enter at one tariff rate, while importers need information on their additional imports beyond that ceiling countries of origin and their partners’ are subject to a higher rate. During the laws and procedures that affect trade. phase-in period for such goods, scheduled And when trade is between FTA partners commitments should include gradual (or involves other kinds of preferential increases in the size of the lower-rate arrangements), compliance with rules quota, as well as reductions in the tariff of origin usually involves additional rates themselves. If tariff quotas are administrative procedures beyond those maintained, the agreement should be clear ordinarily required in trade transactions, on how the lower-rate quota will be filled. e.g., detailed production information in a An efficient option is for transferable specific format. Compliance with customs import licenses to be distributed through regulations requires time and effort, but a scheme that bases initial allocations on basing procedures on best practices will historical market shares. lead to efficiency and reduced transaction For sensitive agricultural products, costs. In a narrow sense, trade facilitation the applicable MFN tariff rate may be means applying customs procedures seasonal, with a higher rate applied predictably, consistently, and transparently, during the part of the year when imports by improving access to information and compete with a like product grown reducing the cost of complying with domestically. For example, the US, administrative procedures. In broader Canada, and Mexico all charge higher terms, trade facilitation includes reducing behind-the-border costs from inadequate 32 Because many goods are produced out of parts or or inefficient transportation, logistics, and intermediates imported from outside the FTA partner storage facilities. countries, the provisions include rules of origin (ROOs) that determine whether these goods are eligible for the preferential treatment (see the Rules of Multilateral negotiations Origin section in this chapter on page 49). In practice, restrictive rules of origin for particular products are also used to limit the impact on sensitive sectors. Multilateral negotiations on trade 33 ASEAN Protocol on the Special Arrangement for Sensitive and Highly Sensitive Products, Singapore, 30 facilitation are aimed at simplifying September 1999. cross-border procedures and increasing part ii: coverage of a free Trade agreement | 9

the capacity of developing countries to Trade facilitation provisions of FTAs participate in the global trade. Trade facilitation in the WTO context refers Trade facilitation provisions may be part to “simplification and harmonization of of the general principles, a section of international trade procedures including the the customs procedures chapter, or an activities, practices and formalities involved independent chapter in FTAs. They often in collecting, presenting, communicating specify measures, for example, simplified and processing data and other information requirements for documentation and required for the movement of goods in methods of determining compliance international trade.” The focus is thus with rules of origin (see the Rules of primarily on reducing the administrative Origin section on page 49). These trade costs 34 associated with trade. facilitation measures may be general or The WTO Ministerial Conference in specific—depending on factors like the Singapore in 1996 requested the WTO coverage of the FTA, geographic situation, Goods Council to begin exploratory work and institutional and technical capacity. to simplify trade procedures. Negotiations While the Agreement of the Bay of in the WTO on trade facilitation began Bengal Initiative for Multisectoral Techno- in 2004. 35 The negotiations are intended Economic Cooperation (BIMSTEC) to “clarify and improve relevant aspects does not specifically provide for trade of Articles V (transit of goods), VIII (fees facilitation, it nevertheless suggests and formalities affecting imports), and X the establishment of rules-of-origin (publication and administration of trade mechanisms and the simplification regulations) of GATT 1994 with a view to of import and export formalities. In facilitating trade among the members. 36 the case of the South Asia Free Trade Since then, a number of trade facilitation Agreement, provisions call for the prompt measures have been proposed by WTO publication of rules and regulations, the members. 37 identification of “inquiry points” for the Negotiators also examine ways of exchange of information, consultations providing technical assistance and on rules of origin, electronic means support for capacity building, taking of reporting and the identification of into account the differences in levels of low-risk and high-risk goods, customs development among WTO members. This cooperation, and technical assistance is being explicitly discussed at the Doha for LDCs. 38 Meanwhile, the CEPT Development Agenda under “aid for trade.” Agreement for AFTA provides that “Member States shall explore further 34 These costs include compliance with rules-of-origin measures on border and non-border procedures discussed in detail in the Rules of Origin section of this chapter. areas of cooperation to supplement and 35 The mandate for trade facilitation negotiations is set complement the liberalisation of trade.” out in Annex D (Modalities for Negotiations on Trade Facilitation) of the July Package. Since then, the ASEAN members have 36 www.wto.org/english/tratop_e/tradfa_e/tradfa_ agreed to implement a Harmonized Tariff negoti_e.htm Nomenclature as well as to establish and 37 The proposals involve (i) the publication and availability of information; (ii) the time period between implement the ASEAN Single Window publication and implementation; (iii) consultation and to expedite customs clearance through commenting on new and amended rules; (iv) advance rulings; (v) appeal procedures; (vi) measures enhancing single submission of information, impartiality, nondiscrimination, and transparency; documents, and formalities, single (vii) fees and charges connected with importation and exportation; (viii) formalities connected with processing, and single decision making. importation and exportation; (ix) consularization; (x) border-agency coordination; (xi) the release and clearance of goods; (xii) tariff classifications; and (xiii) 38 See Chaturvedi (2007) for the detailed stocktaking of matters relating to goods transit. trade facilitation provisions in South Asia FTAs. 40 | How to design, negotiate, and implement a free trade agreement in asia

The trade facilitation provisions also (v) Consistency and predictability; differ even for the same bilateral partner. (vi) Harmonization, standardization, For example, Japan’s bilateral agreements, and recognition; on one hand, include commitments (vii) Modernization and use of new to facilitate the transport of goods, technology; provide exporters and importers with (viii) Due process; and information regarding requirements for (ix) Cooperation. documentation, increase transparency, and build capacity through training, Some of these principles have been technical assistance, and exchange of introduced in a number of FTAs: experts. Agreements like the Japan- Singapore, Japan-Philippines, and (i) Customs cooperation. Cooperation Japan-Thailand Economic Partnership is promoted between customs Agreements (EPAs), on the other hand, authorities of FTA partners. It provide further commitments to improve may take the form of exchange the speed and efficiency of customs of information such as customs procedures through “paperless trading.” laws and procedures (especially for new and amended customs Evolution of best practices rules); establishment of joint in trade facilitation committees to discuss and address trade facilitation issues; mutual Existing mechanisms and instruments 39 administrative assistance and can provide for best practices in exchange of experts; and common trade facilitation. A case in point is customs declaration and joint the International Convention on the customs control at borders. Simplification and Harmonization of (ii) Release of goods. Principles like Customs Procedures (now commonly simplification and standardization referred to as the Revised Kyoto of procedures, risk management, Convention). The principles of the and post-clearance audit allow convention are explicitly recognized by customs to ensure the smooth and negotiators of the WTO and are being speedy flow of goods. Simplified incorporated in FTAs. 40 The Asia Pacific procedures reduce formalities Economic Cooperation (APEC) member and documentation requirements countries have also adopted the Trade to the minimum extent, aligned Facilitation Principles (applicable to both with international standards. Risk goods and services), namely: 41 management involves the selective inspection of traded goods on a (i) Transparency; scientific basis. Post-entry audit (ii) Communication and consultation; allows goods to be released first (iii) Simplification, predictability, and and documents reviewed, thereby efficiency; reducing the transaction costs of (iv) Nondiscrimination; physical examination at borders. (iii) Advance rulings. Also called 39 The World Customs Organization (WCO) website (www. “binding rulings,” these are issued wcoomd.org/home_about_us_conventionslist.htm) lists and contains the text of these instruments. at the request of an exporter or 40 See for example, Chapter 4 of the Singapore-Australia importer to customs authorities Free Trade Agreement. 41 See www.apec.org/apec/ministerial_statements/ to issue a decision relevant sectoral_ministerial/trade/2001_trade/annex_b.html to the application of customs part ii: coverage of a free Trade agreement | 1

procedures. Determining the these transit agreements requires tariff classification, customs partnership between government valuation, and applicable duties authorities, particularly customs and taxes on certain products, for and transport associations. example, would reduce clearance (vi) Technical assistance and capacity formalities and speed up the building. Trade facilitation release of goods. measures must be relevant and (iv) Use of information and must take into account the communication technology (ICT) resource constraints and needs and paperless trading. Modern trade of smaller countries that are facilitation measures like the use parties to FTAs. As part of the of electronic filing and the transfer aid-for-trade agenda, developed of trade-related information and countries could provide funding electronic versions of bills of and technical support 45 for the lading, invoices, letters of credit, implementation of multilateral and insurance certificates (a form or bilateral trade facilitation of electronic data exchange) programs. are alternatives to paper-based methods that enhance the Technical Barriers to Trade, and Sanitary efficiency of trade by reducing the and Phytosanitary Standards cost and time involved. Although ICT is not indispensable, it Regulations and standards often facilitates the implementation of serve legitimate objectives including a “single window” 42 in customs the protection of the environment; procedures. consumers; workers; national security; (v) Temporary admission of goods human, animal, and plant life or in transit. Most FTAs involving health; and the food and water supply. landlocked countries provide Nevertheless, regulations and standards for simplified procedures for the also have a darker side—they may be temporary admission of goods in employed as barriers to international transit. 43 Other FTAs (like those of trade. As tariffs have fallen, regulations Japan) provide for the application have increasingly been used as nontariff of existing customs conventions, 44 barriers to protect domestic producers. as well as Article V of GATT. Two WTO agreements—the Agreement The effective implementation of on Technical Barriers to Trade (TBT Agreement) and the Agreement on 42 A single window is commonly defined as “a facility Sanitary and Phytosanitary Measures that allows parties involved in trade and transport to lodge standardized information and documents (SPS Agreement), seek to balance the with a single entry point to fulfil all import, export, protection of legitimate objectives with and transit-related regulatory requirements.” the need to restrain nontariff barriers to (United Nations Economic Commission for Europe Recommendation on Establishing a Single Window: prevent protectionism. Following is Recommendation 33, ECE/TRADE/352) an introduction to the TBT and SPS 43 For example, the Kyrgyz-Kazakhstan FTA states that a “Party shall provide free transit via its territory, of goods Agreements, followed by an overview of originating in the customs territory of the other Party or TBT and SPS measures in FTAs. third countries and intended for the customs territory of the other Party or a third country.” (Article 10, para. 2) 44 Such as the Customs Convention on the ATA Carnet for the Temporary Admission of Goods (ATA Convention) and the Convention on the International Transport of 45 See Part 3 and Annex 1 of the Pacific Agreement for Goods under Cover of TIR Carnets (TIR Convention). Closer Economic Relations (PACER). 42 | How to design, negotiate, and implement a free trade agreement in asia

The TBT Agreement and conformity assessment procedures. The TBT Agreement is designed to • Avoidance of unnecessary obstacles protect human, animal, and plant life and to trade. WTO members must health in specific instances when the SPS ensure that adopting or applying Agreement does not apply. Legitimate technical regulations, standards, objectives for TBT measures include the and conformity assessment does protection of the environment, consumers not create unnecessary obstacles (prevention of deceptive practices), to international trade. 46 workers, national security, and human, • Harmonization. Members must animal, and plant life and health. WTO base technical regulations members also apply TBT measures to and standards on relevant ensure quality and to encourage product international standards. 47 If standardization. The TBT Agreement resources permit, members must applies to “technical regulations” (which participate fully in the preparation are mandatory), “standards” (which are of guides and recommendations voluntary), and “conformity assessment for conformity assessment procedures” (testing to verify whether by appropriate international a product meets a particular technical standardizing bodies. or standard). • Equivalence. Members are TBT measures relate to a product’s encouraged to accept foreign characteristics, packaging, marking, technical regulations fulfilling labeling, symbols, and terminology (among the same policy objectives, as other aspects). A typical example of a equivalent. technical regulation is a law requiring an • Mutual recognition of conformity automobile dealer to display the vehicle’s assessment procedures. Members fuel efficiency. Compliance is mandatory— must accept, whenever possible, the dealer may not sell the vehicle unless the results of foreign conformity its fuel efficiency is displayed. assessments, even when the Compliance with a standard is procedures differ from their own, voluntary and often gives a product a provided they are satisfied that marketing advantage. A standard might the procedures offer assurance set forth characteristics that a product of conformity with technical must meet before a government permits regulations and standards the manufacturer to use a particular equivalent to their own. symbol on the product’s label. A typical • Transparency. Members must example would be rules governing the provide information about use of a symbol showing that a product proposed and adopted technical is recyclable. If the product can be sold regulations, standards, and without the symbol, the measure is a conformity assessment procedures standard and not a technical regulation. through inquiry points, The TBT Agreement establishes the publication, notification, etc. following disciplines, some of which are familiar from the GATT Agreement: 46 The measures should be the least trade-restrictive measures reasonably available to fulfill a legitimate objective. • Nondiscrimination. WTO members 47 An exception exists when international standards must ensure MFN treatment and would be ineffective or inappropriate, for example, when fundamental climatic and geographic factors or national treatment with respect to fundamental technological problems make reliance on technical regulations, standards such standards inappropriate. part ii: coverage of a free Trade agreement | 

• Technical assistance. Upon request, (i) Science-based agreement. The members are required to provide SPS Agreement is a science- technical assistance on mutually based agreement; hence, SPS agreed terms. measures must be based on sufficient scientific evidence and The SPS Agreement on risk assessment. Precautionary measures must also be based on The purpose of the SPS Agreement is to some degree of scientific evidence. ensure that food and beverages are safe for (The science-based nature of the human and animal consumption (safe from SPS Agreement distinguishes it pesticide residues, additives, toxins, etc.), from the TBT Agreement.) and to prevent the spread of pests and (ii) Necessity. SPS measures must diseases (bacteria, viruses, invasive species, be necessary to protect human, etc.) among humans, animals, and plants, animal, or plant life or health while at the same time ensuring that (they must be the least trade- WTO members do not use SPS measures restrictive measures reasonably as disguised restrictions on international available to achieve the desired trade. Typical examples of SPS level of risk prevention). 49 measures are slaughterhouse inspection (iii) No arbitrary or unjustifiable requirements, quarantine requirements for discrimination. SPS measures sick animals, and pesticide and herbicide must not result in arbitrary or residue requirements. unjustifiable discrimination The SPS Agreement grants all WTO between countries with identical members the right to implement SPS or similar conditions. Measures measures to protect human, animal, must not be disguised restrictions or plant life or health from SPS risks on international trade. provided that the members comply with (iv) Harmonization. SPS measures the disciplines set forth in the Agreement. must be based on international Members that comply with the obligations standards, guidelines, and of the SPS Agreement are presumed to recommendations where they be in compliance with the obligations of exist, unless there is scientific GATT 1994, including its Article XX(b). 48 justification based on appropriate Unlike the TBT Agreement, the SPS risk assessment to use a higher Agreement does not classify trade standard. measures as technical regulations, (v) Equivalence. Members should standards, or conformity assessment accept as equivalent foreign SPS procedures. SPS measures nevertheless measures that provide the same function like technical regulations—to the level of protection. extent that compliance with SPS measures (vi) Transparency. Members must may be necessary to import or sell a provide information about their particular product. Some provisions of SPS measures through inquiry the SPS and TBT Agreements are similar. points, publication, notification, The most important provisions of the SPS etc. Agreement are the following: (vii) Technical assistance. WTO members have agreed to facilitate the 48 Article XX(b) provides a general exception for trade measures necessary to protect human, animal, or plant 49 Members must recognize the concept of disease-free or life or health. Some sanitary and phytosanitary (SPS) pest-free areas, and the possibility that the prevalence disciplines resemble those in the technical barriers to of pests and diseases could vary depending on trade (TBT) agreement. geography, ecosystems, etc. 44 | How to design, negotiate, and implement a free trade agreement in asia

provision of technical assistance cooperation with respect to trade in to other members, in particular goods by negotiating nontariff measures, developing countries. scientifically unjustifiable SPS measures, and TBT measures. 51 Treatment of SPS and TBT measures in FTAs WTO as a Basis for Agreement to Unlike customs unions, in which members Negotiate. The New Zealand–Thailand generally harmonize SPS and TBT rules, FTA reiterates the parties’ WTO FTAs have no single practice for the commitments with respect to nontariff treatment of these regulatory matters. barriers, and more specifically with Because of the sensitivity of agricultural respect to SPS and TBT measures. 52 and food safety issues, many FTAs contain The FTA endorses equivalence, few SPS provisions and leave it up to the harmonization, and mutual recognition, parties to apply the SPS agreement. 50 and sets up a joint SPS committee With respect to TBT matters, FTAs often to encourage consultations and contain stricter disciplines than those negotiations. It establishes a framework found in the TBT agreement. for addressing SPS and TBT issues, and FTAs take several different approaches for negotiating additional arrangements with respect to regulatory matters, in and annexes. 53 particular TBT. Some FTAs acknowledge the parties’ WTO obligations but create General Reaffirmation of the committees only to study SPS and WTO Agreement with Enhanced TBT problems. Other FTAs are moving Cooperation. The US-Singapore Free slowly toward mutual recognition of Trade Agreement (USSFTA) reaffirms conformity assessment procedures. A the parties’ WTO commitments and their third variant fosters greater integration shared commitment to facilitate bilateral by harmonizing certain regulations, trade by reducing or removing technical recognizing measures in various sectors and SPS barriers to the movement of as equivalent, and providing for a degree goods between the parties. 54 In Chapter 6 of mutual recognition of conformity the parties establish an enhanced assessment procedures—often on a cooperation and coordination procedure sectoral basis. Regardless of the approach for dealing with TBT issues. 55 The FTA taken, the starting point in FTAs is usually recognition that the parties’ WTO commitments remain binding. The WTO 51 See Articles 3.8(e) and 7.3(a), Framework Agreement Agreement thus serves as the lowest on Comprehensive Economic Co-operation between common denominator of commitments in ASEAN and the People’s Republic of China (Phnom Penh, 5 November 2002) (www.aseansec.org/13196. FTA agreements. The following examples htm). This agreement builds on the ASEAN-PRC FTA illustrate how SPS and TBT measures are signed on 6 November 2001. The goal of the parties is handled in selected FTAs. to create a free trade area by 2010. 52 See Articles 2.7 (nontariff measures), 6.4.1 (SPS agreement), and 7.3.3 (TBT agreement) of the Agreements to Strengthen Cooperation Thailand–New Zealand Closer Economic Partnership Agreement (www.thaifta.com/english/index_eng. and to Negotiate. ASEAN’s 2002 html). Framework Agreement with the PRC 53 See generally Chapters 6 and 7. 54 See www.iesingapore.gov.sg reaffirms relevant WTO commitments, 55 See page 1 of the introduction to the US-Singapore and provides for strengthened Free Trade Agreement, www.iesingapore.gov.sg/wps/ wcm/connect/resources/file/ebfe4f42743d685/FTA_ USSFTA_Agreement_Final.pdf?MOD=AJPERES. See 50 This assumes that the parties are WTO members. also Chapter 6, on technical barriers to trade. part ii: coverage of a free Trade agreement | 

contains provisions on the equivalence does not harmonize technical regulations, of mandatory requirements (particularly standards, and mutual recognition of in the sectoral annexes), 61 cooperative conformity assessment procedures, except activities in SPS matters, 62 and the in the area of telecommunications, where negotiation of improved conformity the parties agree to implement Phases 1 assessment procedures. 63 The agreement and 2 of the APEC Mutual Recognition also contains two important sectoral Arrangement for Conformity Assessment annexes providing for mutual recognition of Telecommunications Equipment. 56 of food products and horticultural goods. The agreement also establishes a medical The sectoral annex on food products products working group to provide a reaffirms WTO commitments under forum for cooperation on regulatory the SPS and TBT Agreements and is issues of mutual interest. 57 applicable to certain standards relating to food products exported from one party to Sectoral Harmonization of the other, and to conformity assessments Standards. ASEAN members have of manufacturers or manufacturing periodically selected sectors for processes of food products exported from harmonization. They agreed to harmonize one party to the other. 64 The sectoral standards in 20 priority product sectors in annex on horticultural goods reaffirms 1997 and completed the process in 2003. the parties’ obligations under the SPS They also agreed to harmonize electrical Agreement, 65 and provides for mutual safety standards for 71 additional recognition of certain phytosanitary products in 1999 and completed the certificates. 66 process in 2004. 58 In 2003, the ASEAN members agreed to harmonize cosmetic Safeguards, Antidumping Measures, and standards. 59 Countervailing Duties

Broad Mutual Recognition. The WTO rules indicate when members Singapore-Australia Free Trade may apply “trade remedies”— Agreement (SAFTA) builds on these safeguards, antidumping measures, and countries’ February 2001 mutual countervailing duties—in response to recognition arrangements for medicinal specified actions by trading partners. products, electrical and electronic While some FTAs merely indicate equipment, and telecommunications compliance with the relevant GATT equipment. It streamlines inspection articles, others modify these rules as and compliance procedures for certain they apply to trade among themselves. products, and commits the parties to For example, the Republic of Korea– harmonize their technical regulations Chile FTA simply indicates consistency with international standards. 60 SAFTA with the standard WTO treatment of

56 Article 6.3.1. 61 Article 5. 57 See Article 6.3.4 and Annex 6A of the US-Singapore 62 Article 6. Free Trade Agreement. Annex 6A, para. 1, provides 63 Article 7. for cooperation but excludes mutual recognition 64 www.dfat.gov.au/trade/negotiations/safta/annex_5_ agreements or other binding commitments. a.pdf, at Articles 1.1 and 1.2. 58 www.aseansec.org/15564.htm 65 www.iesingapore.gov.sg/wps/wcm/connect/ 59 www.aseansec.org/20607.pdf resources/file/ebc2d1418bb5162/Annex+5B+-+Se 60 See generally Chapter 5 on Technical Regulations ctoral+Annex+on+Horticultural+Goods-+SAFTA. and Sanitary and Phytosanitary Measures, and more pdf?MOD=AJPERES, at Article 1.3. specifically Article 4. 66 Article 5. 46 | How to design, negotiate, and implement a free trade agreement in asia

safeguards, antidumping measures, and relationship. In practical terms, without countervailing duties. a safeguard provision, it would be far The application of trade remedies more difficult to conclude substantive, may give rise to trade disputes among comprehensive trade agreements. The members. An FTA may specify additional key is to avoid abuse. dispute settlement processes beyond During the GATT era, safeguard those provided in the WTO through protection under Article XIX was used the creation of a regional body for only rarely. Some countries (notably this purpose (see Dispute Settlement the US and EC countries) applied “gray Mechanism section on page 92). Where area” measures to deal with domestic this is the case, the rules should establish adjustment problems. In cases including which parties have standing to bring footwear, autos, and steel, importing a dispute to this body, i.e., whether countries negotiated “voluntary” restraint individuals, firms, or nongovernment agreements with newer and highly organizations (NGOs) as well as countries competitive exporters like Japan and the may bring disputes for resolution. In the Republic of Korea. The WTO Safeguards WTO, member countries are the only Agreement revived interest in safeguards parties with such standing. by prohibiting the use of gray-area measures but also set a time limit for Global safeguards any safeguard action through a “sunset clause.” However, because Article XIX GATT Article XIX authorizes members requires safeguard-imposing countries to to use safeguard measures to provide provide compensation to countries whose temporary protection for a domestic exports are restricted, most safeguards industry when increased imports cause are eliminated before the required sunset or threaten to cause serious injury review of the measures. to the industry. In contrast to the While some FTAs simply indicate rules on antidumping measures and compliance with the relevant WTO rules countervailing duties (see pages 47 on safeguards, others modify these rules and 48), access to safeguard protection as they apply to trade among themselves. does not require evidence that exporters Under Article XIX, these safeguards— benefited from unfair trade practices. now often called “global” safeguards The inclusion in the WTO of safeguard to distinguish them from “special” provisions, which basically allow safeguards discussed below—are to be countries to raise protection in particular applied on a nondiscriminatory basis, sectors, is justified in terms of two i.e., according to the MFN principle of functions. First, by allowing a country to the WTO. But just as FTAs depart from pull back temporarily when liberalization MFN treatment in tariffs and other causes greater problems than anticipated trade barriers, they may accord each for domestic import-competing other special treatment in the case of industries, safeguards provide a form safeguards. For example, the Singapore– of insurance or safety net to countries New Zealand agreement specifies making liberalization commitments. that neither party will take safeguard Second, because internal political forces measures against goods originating in the may push a government to protect a other, i.e., the partner is to be exempted particular sector, safeguards offer a safety from any safeguard measure taken under valve for protectionist pressure and Article XIX. But, as noted earlier, the thus maintain the integrity of the larger Republic of Korea–Chile FTA provides no part ii: coverage of a free Trade agreement | 7

special status for partners when applying example, NAFTA included not only a long safeguard protection under Article XIX. transitional period (15 years) for sensitive The justification for exempting agricultural products but also special partners is that the aim of an FTA is to bilateral safeguards. These allowed the achieve a single integrated market, and tariff facing a partner to be snapped back restricting partner imports as tariffs are to the MFN level for a 3- or 4-year period being eliminated is a step backward from in the case of actual or threatened serious achieving that goal. On the other hand, injury as well as a “substantial” increase exempting FTA partners or other groups in imports from the partner. (often LDCs are exempted) means that Like product exceptions and slower the remaining suppliers outside these phase-in periods for sensitive products, preferred groups will be subject to an transitional and special safeguard even larger reduction in access to the provisions help achieve acceptance by safeguarded market, exacerbating the domestic import-competing industries but trade diversion. This spillover effect also reduce the likely benefits from the could thus give rise to frictions with other FTA once in force. Because safeguards, by important trading partners. their very availability, increase uncertainty about the actual terms of market access, Transitional and special safeguards they may reduce incentives for investors to make new commitments that help Like global safeguards, these “special partners to expand trade along the lines safeguards” permit access only when of comparative advantage. there is evidence of serious injury or threat of serious injury caused by Antidumping measures imports, i.e., there is no presumption that exporters have violated WTO norms. GATT Article VI and the Agreement Within the WTO, this type of safeguard on Implementation of Article VI of the has been associated with liberalization General Agreement on Tariffs and Trade in a particular sector, e.g., the phase-out 1994 (AD Agreement) allow countries of the Multi-Fiber Arrangement, or with to penalize imports sold in the domestic the entry of a new member, e.g., the PRC. market “at less than the normal value An FTA sometimes includes a transitional of the products” when there is evidence safeguard to provide a “safety net” in case that these imports are causing “material” the effect of regional liberalization on an injury to the competing domestic industry. import-competing sector is particularly Since antidumping complaints are severe. The injury test would then specific to particular exporting firms in require not only evidence of serious a particular country, the rules represent injury linked to increased imports but a departure from the principle of MFN also partner imports accounting for a treatment. In cases where dumping large part of the increase in imports. is found, import restrictions may be The Taipei,China–Panama and Thailand- enacted by levying a supplementary Australia FTAs both include transitional tariff (antidumping duty) based on the safeguard provisions allowing the relevant difference between the import price tariff to be returned (“snapped back”) and the normal value of goods from to the MFN level for a 2-year period to this source, or by negotiating a “price start with. Special safeguards, where undertaking” with the exporter, i.e., included, apply only to a particular sector, an agreement to raise the price of the often certain agricultural products. For product to an acceptable level. 48 | How to design, negotiate, and implement a free trade agreement in asia

Dumping occurs when the product is violated. Australia’s agreement with the sold at a lower price than at home or at US contains no chapter on antidumping a price below its cost of production, but measures, implying that WTO rules apply neither criterion is straightforward in without modification. Its agreements with its application. Moreover, the economic Singapore and Thailand refer explicitly to justification for antidumping measures in Article VI but impose additional limits on the absence of predation is at best weak; the use of such measures. almost all affirmative dumping cases involve pricing behavior that would be Subsidies and countervailing measures legal when practiced by a firm located in the domestic market. Many economists The WTO Agreement on Subsidies and feel that the main case for antidumping Countervailing Measures governs the policy is political rather than economic, use of countervailing measures when and that the beneficiaries are largely firms another country’s subsidies cause injury reluctant to compete with lower-cost to a domestic industry. As in the case of foreign producers. Moreover, in practice antidumping measures, WTO policy on antidumping measures often serve as an subsidies allows a departure from MFN attractive alternative to safeguard action. treatment. Here, however, the source of The injury criterion is less stringent the injury to a domestic industry arises (material versus serious injury), and no from a government’s action to provide a adjustment plan for the domestic industry subsidy rather than an exporting firm’s is required. Moreover, because the injury pricing practices. is attributed to unfair pricing on the Under the subsidies agreement, part of an exporting firm, antidumping subsidies requiring recipients to meet measures entail no compensation of specified export targets or to use domestic affected exporters and no limit to the inputs instead of imported inputs in length of time that the measures can stay production are prohibited because they in effect. 67 are designed to distort international Although many FTAs merely stipulate trade. 68 Outside of agriculture, most that partners retain their rights and export subsidies violate current WTO obligations under GATT Article VI and the rules and can be challenged in the WTO. 69 AD Agreement, some offer more favorable If a prohibited subsidy is not removed, treatment to their FTA partners. Since the complaining country can impose most alleged dumping would be legal an additional tariff (countervailing if the sale were carried out by a firm duty) based on the value of the subsidy in the domestic market, this favorable provided by the government of the treatment is consistent with the goal of exporting country. creating an integrated market. Notably, Most other subsidies are categorized EU members may not use antidumping as “actionable.” Here the complaining measures against firms in partner country must show that the subsidy is countries, though they may pursue complaints if EU competition policy is 68 The prohibition on export subsidies does not apply to least-developed countries (LDCs) and developing countries with per capita incomes below $1,000. 67 The Antidumping (AD) Agreement contains a “sunset” Developing countries and transition economies are requirement establishing that dumping duties should given extra time to eliminate export subsidies and be applied for no more than 5 years unless a review subsidies to import-substituting industries; LDCs are indicates that removing the duty would be likely to lead allowed an even longer period to comply. to the continuation or recurrence of dumping and injury. 69 A goal of the Doha Development Agenda is to phase out The sunset provision also applies to price undertakings. subsidies in agriculture as well. part ii: coverage of a free Trade agreement | 9

causing an adverse effect on its interests entering the customs territory of the by damaging (i) an import-competing member with the lowest tariff to the other industry, (ii) an export industry that members—a problem that is referred to competes in the subsidizing country’s in the literature of international trade domestic market, or (iii) an export as “trade deflection” (see Box 2.2 on the industry competing with firms in the economics of preferential rules of origin). subsidizing country for the same third- In essence, an FTA without ROOs would country markets. 70 Otherwise the subsidy be equivalent to a customs union with the is permitted. If a subsidy does have an external tariff being that of the member adverse effect, it must be withdrawn customs territory or country with the or its adverse effect removed. Again, if lowest MFN tariff, undercutting revenue domestic producers are hurt by imports collection in the members with higher of subsidized products, a countervailing MFN tariffs. duty can be imposed. 71 Alternatively, the It is important to recognize that subsidized exporter can raise the price of governments regard ROOs not simply as its products. a technical device to enforce preferential Many FTAs have no provisions trade agreements but also as commercial modifying the treatment of subsidies policy instruments. 72 provided in the WTO. However, Australia’s FTAs with Thailand and Singapore go Preferential Rules of Origin and the further than the WTO, prohibiting even World Trade Organization 73 agricultural export subsidies. This is in accord with APEC best-practice principles, The failure of the contracting members which call for FTAs that “go beyond of the WTO to complete the negotiations WTO commitments” by building on aimed at harmonizing non-preferential existing WTO obligations and exploring ROOs, as provided for in the Uruguay commitments in areas not yet fully Round Agreement (GATT 1994) on covered by the WTO. Rules of Origin, is an indication not only of the technical complexity of rules of origin but also of the members’ desire Rules of Origin to retain autonomy in setting product- specific ROOs to protect their industries. The refusal of contracting members Rules of origin (ROOs) are a necessity to even negotiate the harmonization in any preferential trade agreement, of preferential ROOs confirms the including all FTAs. Without ROOs it would reservation of such rules as commercial be impossible to distinguish products policy tools—indeed as tools of protection that are eligible for tariff preferences of special interests and “sensitive” from those that are not. Since FTAs products. allow members to set external tariffs Annex II (Common Declaration with independently, rules of origin are needed Regard to Preferential Rules of Origin) to to prevent the transshipment of imports the Agreement on Rules of Origin (GATT 1994) is a nonbinding statement that 70 An obvious example of this latter actionable subsidy WTO members shall clearly define would be the US’ (successful) complaint against the EU for its subsidies of soybean exports to third markets. 72 Vermulst and Waer (1990) provide examples of 71 Developing countries receive preferential treatment product-specific rules of origin from the EC that are, in if their exports are subject to countervailing duty effect, instruments of commercial policy. investigations. 73 This section draws on James (2005). 50 | How to design, negotiate, and implement a free trade agreement in asia

Box 2.2: Economics of Preferential Rules of Origin the ROOs in any contractual or autonomous trade regime that provides Rules of origin (ROOs) are needed in any preferential trade agreement to determine which goods are eligible for preferential tariff treatment beyond for preferential tariff treatment and which are not. the application of paragraph 1 of Without ROOs it would be difficult to maintain the Article I of GATT 1994 (principle of integrity of independent tariff regions in a free trade nondiscrimination). The Common agreement (FTA) because of “trade deflection,” or the Declaration also stipulates the timely transshipment of imported goods from nonmembers provision of preferential ROOs by through the member country with the lowest most- favored nation (MFN) tariff rates. There is likely to be a members to the WTO Secretariat and trade-off between prevention of trade deflection and the publication of such rules (and any trade creation, assuming that member countries are changes) by members as if they were able to administer ROOs effectively. The more restrictive subject to paragraph 1 of Article X of the ROOs, the less is the potential for trade deflection. GATT 1994. Upon request, members But this comes at a cost. Firms must choose whether or not to comply with ROOs, as documentation and must provide assessments of origin for accounting efforts may add the equivalent of 1.5–6.0% the purpose of obtaining preferences to of the ex-factory price, or production cost of the goods interested parties within a set period receiving preferential tariff treatment. If the difference (no longer than 150 days) and the between MFN and preferential tariffs (referred to in the assessments must remain valid for economics literature as the “margin of preference”) is 3 years. less than the cost of compliance, firms will simply ignore the ROOs and continue with shipments paying the MFN As the Interpretation and Application tariff, and the preferential agreement will be ineffective of Annex II finds “no jurisprudence or in boosting intra-FTA trade. decision of a competent WTO body,” One measure of the effectiveness of a preferential there are no binding disciplines over trade agreement is the extent to which member partners’ WTO members concerning preferential trade avails itself of the preferences or the utilization ratio (the volume of preferential trade divided by total ROOs. The APEC organization has intra-trade in an FTA). Typically, FTAs involving developed suggested the adoption of best-practice member countries such as the European Union or North principles in RTAs, FTAs, and other America Free Trade Agreement have higher utilization preferential arrangements. 74 APEC ratios than those involving developing countries (e.g., advocates the adoption of simple ROOs ASEAN). One must be cautious in interpreting the that facilitate trade. This implies that economic welfare effects of increased intra-regional trade, as they may be due to welfare-improving trade ROOs do not have high compliance creation or welfare-reducing trade diversion (see Part costs for business and that each APEC I). ROOs may also have an impact on firms’ investment member as far as possible adopts decisions in terms of choice of location for manufacturing consistent rules of origin across its own processes or sourcing decisions. This is a relatively new preferential agreements. The APEC also theme and is at the frontier of research pertinent to FTAs. The “spaghetti bowl” or Asian “noodle bowl” problem notes that ROOs should be designed arises when a country enters into numerous bilateral with a view to maximizing trade creation FTAs with inconsistent, complex, and overlapping and minimizing trade distortion so that ROOs. Firms wishing to take advantage of more than APEC members can promote regional one FTA may be faced with the difficulty of complying integration and not disrupt efficient with inconsistent rules of origin and may literally global production networks. have to invest in a separate production line for each FTA. Customs authorities may also have difficulty in administering multiple sets of ROOs in determining the eligibility of goods for reduced tariffs. The advantages provided by preferences dependent on customs rulings may encourage corruption and rent-seeking behavior. Hence, economists recommend that ROOs be consistent across agreements and be kept as simple and 74 APEC (2004) sets forth proposed best practices in transparent as possible (Part I). RTAs/FTAs that APEC members are party to. Source: James (1998); James (2006) part ii: coverage of a free Trade agreement | 1

Table 2.1: Product Origin—Wholly Obtained Principle Table 2.2: Tests for Determining Origin of Type of Tradable Principle/Criterion Processed or Manufactured Goods Primary Wholly obtained in a single Test for Processed/ Principle of Last Substantial customs territory/country Manufactured Goods Transformation Agricultural Goods Unprocessed and harvested Change in tariff heading (CTH) A change from any four-digit HS within customs territory/country or change in tariff subheading chapter to any other four-digit (CTSH) test HS chapter (six digits for CTSH) Marine Fisheries (outside Ownership of vessel/means territorial waters of member of catch Specified process test Any manufacturing process country) deemed to confer origin Forestry Products Unprocessed and harvested Value-added (percentage) test Minimum regional content or within customs territory/ maximum non-originating content country Mixed tests SP test and CTH test; CTH test or Mineral Products Extracted within territory or value added test, or both seabed in territorial waters Source: Author’s compilation. Scrap/Waste Products Collected within and fit only for recovery of raw materials Source: Author’s compilation. transformation” for determining product origin in the case of processed and manufactured goods. Three types of tests Methods of Determining Product Origin were agreed on as applicable in satisfying (potentially) the principle of a last The determination of product origin for substantial transformation. These are primary products and scrap or waste is (i) a change in tariff heading (CTH) test, fairly straightforward and is subject to the (ii) a specified process (SP) test, and criterion of being wholly obtained in the (iii) an ad valorem or percentage test. territory of the country in question (see These tests and their permutations are Table 2.1). Several caveats arise in marine shown in Table 2.2. fisheries and ocean-bed mining, however. Products obtained outside the territorial Examples of Alternative Tests for limits of a coastal entity may gain the Substantial Transformation origin of the vessel or platform that is used to extract, capture, or otherwise A CTH test is used to determine origin obtain the product in question. 75 if the manufacture or processing For manufactured and processed goods, undertaken results in a product coming the determination of origin is more under a four-digit HS number different complex and controversial, particularly from the numbers under which the non- for products with intermediate inputs and originating components or articles fall processing or manufacturing operations (Imagawa and Vermulst 2005: 607). For taking place in two or more countries or example, country A imports raw leather customs territories. The Kyoto Convention hide from country B (HS 41.01) and uses of the Customs Cooperation Council it to produce tanned leather hide (HS (now known as the WCO) of 1973 set 41.06), which it then exports to country forth the principle of a “last substantial C. Country B is the origin of the product imported by country C. When the test 75 Whether a territory is confined to the 12-mile limit or is applied at the six-digit HS code this to the extended limit provided for in the Law of the is known as a CTSH test. For example, Sea is disputed. Whether the flag of the vessel or its actual ownership and control confers origin is also in under the Canada-US Free Trade question (Imagawa and Vermulst 2005). Agreement of 1989, tomato paste (HS 52 | How to design, negotiate, and implement a free trade agreement in asia

2002.09) imported by Canada from Chile the following formula is applied in a and used to produce catsup (HS 2103.20) percentage test: that is later exported to the US originates in Canada and receives preferential QVC = [(FOB−VNM) / FOB)] * 100 treatment in the US. However, NAFTA adopted a rule of origin specifying that where: QVC is the “qualifying value catsup (HS 2103.20) obtains its origin content” of a good as a percentage of when transformed from any six-digit HS its FOB value of a good payable by chapter except from subheading 2002.09 the buyer to the seller regardless of (NAFTA Volume II, Annex 401-8, 1993). means of shipment (excluding taxes Hence, Canada can no longer import and duties), and VNM signifies the tomato paste from a source outside “value of non-originating material” NAFTA and receive preferential treatment used in the production of the good. under NAFTA rules of origin. The 13.6% US MFN tariff on tomato paste Item Origin Cost($) put Chilean tomato paste at a distinct Part A Japan 100 disadvantage versus Mexican tomato Part B Japan 100 76 paste. Part C Malaysia 400 The ad valorem or percentage criterion Part D India (non-originating) 300 test may take place in any one of three forms (Imagawa and Vermulst 2005: Part E Republic of Korea 500 (non-originating) 605): import content, domestic/regional content, or value of parts. The test Part F PRC (non-originating) 400 specifies a maximum non-originating Other Costs 200 content or a minimum regional or FOB Price 2,000 domestic content requirement as a percentage of the FOB or ex-factory $2,000 − $1,200 (Parts D, E, and F) price of the product that must be QVC = x 100 = 40% reached if a product is to satisfy the last $2,000 substantial transformation principle in the last territory where the product In the case of JMEPA, the QVC must was processed or manufactured. The be 40% or greater for the item to attain percentage test may or may not allow origin in the region. JMEPA allows cumulation among members, 77 but regional cumulation to reach the required allowance of cumulation is clearly more minimum QVC percentage. An example liberal than its disallowance. In the of the application of this rule to a color- case of the Japan-Malaysia Economic television receiver is given as follows Partnership Agreement (JMEPA), (JMEPA 2006: Operational Procedures): Thus, according to the JMEPA rules of origin, the color TV is eligible for 76 This example is originally cited in Vermulst, Waer, and Bourgeois (1994). preferential tariff treatment. 77 “Cumulation” allows value added for a group of A technical or specified process countries rather than just in the exporting country. For example, suppose that product A produced in test rounds out the acceptable criteria Singapore uses 50% of its inputs from Malaysia. under the WCO Kyoto Convention. This When exported to a country with which Singapore has an FTA, allowance for ASEAN cumulation would test provides a detailed description of suggest that 100% of the content would be accepted production or sourcing processes that (and, hence, the produce would certainly qualify for preferential treatment), whereas with no ASEAN do (positive test) or do not (negative cumulation only 50% would qualify. test) confer origin. In most cases, simple part ii: coverage of a free Trade agreement | 

packing and unpacking operations are not and non-originating material and clearly sufficient to confer origin. Normally such define the price being used as the negative test criteria are accompanied by denominator. The SP or technical test a positive test to provide more certainty criterion must be based on a positive to businesses. standard and must precisely set out the A technical test is frequently applied operation that confers origin (negative to preferential agreements in textiles standards may be set out to clarify the and apparel. For example, the Japanese positive standard). economic partnership agreements with Malaysia, the Philippines, Thailand, and Administrative Requirements Singapore apply a “double jump” or two-stage processing test requiring that It is quite useful for an FTA to include apparel be produced either from fabric an annex with examples and guides that is first dyed or printed in a member for firms and traders. These may be set (stage 1), and then assembled into an out in an operational manual on rules article of apparel (stage 2). Alternatively, of origin containing illustrations and if originating yarn is used to produce practical examples of the application fabric, then even if dyeing and printing of each type of test and any supporting processes are carried out in a nonmember, documentation that the customs requires. the test is satisfied, provided that the The manual should have specimens of the fabric is also woven and assembled into required documents, including certificates a garment article in a member country. of origin. JMEPA provides a detailed The double-jump requirement in Japan’s annex with administrative procedures agreements is applied in a way that is for obtaining and completing certificates rather liberal in that the processes need of origin (COOs) including procedural not be completed in only one country but matters with regard to administration may occur in both members. Furthermore, and enforcement of ROOs. The annex Japan allows any process occurring within gives detailed information on seven ASEAN to count toward the double- rules associated with COO modification jump test (i.e., “cumulative origin”). For and minor errors, loss, or theft, as well example, if yarn from outside the region as related provisions with regard to is woven into cotton cloth in Malaysia shipments that may pass through a third and the cloth is then cut and assembled party. Four rules are also set forth to into garments in the Philippines, the clarify administration and enforcement, article becomes eligible for preferential including offices responsible, stamps and treatment. specimens of signatures and stamps used There is no perfect or universal test by the administering authorities, offices for determining the origin of a good responsible for advance customs rulings, produced in two or more locations. and matters pertaining to communication For this reason, it is important that between responsible authorities. agreements provide clear definitions of The annex also contains appendixes rules of origin and publish these rules. with specimens of the COOs and The CTH or CTSH criterion must clearly instructions for completing the COO specify the HS chapter tariff headings forms, examples of the calculation of the or subheadings that are addressed by percentage of qualifying value content, the rule. The percentage or ad valorem and a clarification of product-specific criterion must indicate the formula for ROOs including de minimis provisions; calculating the percentage of originating examples of documents required when 54 | How to design, negotiate, and implement a free trade agreement in asia

using ASEAN cumulation provisions; provided that these are listed and are and a description of operations for consistent with conditions set forth in the dyeing or printing processes for textiles Annex to Article II. and clothing items (HS 50–63). In The principle of last substantial general, the inclusion of such a detailed transformation, which is used to provide annex on administrative aspects of a basis for the tests used to determine ROOs greatly increases transparency the origin of manufactured goods, and facilitates the use of agreements by is irrelevant to international service private enterprises. transactions (Kingston 1994). This problem results from the difficulty in Rules of Origin for Services evaluating the different components that make up a service and the fact that the FTAs are increasingly providing nationality of a service-providing firm or preferential access for commercial services entity may not reflect the ownership and in addition to goods. While there are no control of the firm or entity. generally accepted principles or criteria Of the six possible ways of for identifying the origin of a service, six determining the origin of a service types of tests tend to be used: nationality outlined above, most countries adopt an of service provider or service-providing ROO based on residency or ownership entity, residency test, value-added test, and control of the service-providing ownership test, intellectual input control entity or, in cases where establishment test, and “mixed” tests. 78 is unnecessary, on the control of In general, service agreements the essential input without which (notified under Article V of GATS) may the service cannot be provided. The extend preferences to any or all four latter is simple in the case of services modes of supply of commercial services provided by natural persons. In contrast, (see Trade in Services section below). determining non-originating value added The ROOs for services would have to take of a service is likely to be extremely into account which of the four modes of difficult. Similarly, if foreign investment supply is relevant in the provision of the is required to provide a service through service. establishment, the origin rule by Setting rules for determining the residency test is rather straightforward. country of origin of an internationally Residency is simply the place where the traded service is essential for the service firm is incorporated, provided the implementation of an FTA notified under firm has a substantial presence in that Article V of GATS. To the extent that location (Hufbauer and Schott 1993: countries demand reciprocity in extending 61). Selecting the origin of cross-border MFN treatment to services (implying services, particularly network services, discriminatory barriers to countries presents a difficulty similar to that not providing reciprocal access to their encountered in determining the country markets 79 ), ROOs are again necessary. of origin of a good produced in several Article II of GATS codifies unconditional locations in a global production and MFN treatment but allows members distribution network. In general, simple to maintain discriminatory measures, and transparent ROOs based on the residency test or ownership and effective 78 This section draws on James (1998). 79 This is known as “conditional MFN treatment” (Grey control of the service are desirable on 1990). efficiency and fairness grounds. part ii: coverage of a free Trade agreement | 

Costs of Compliance and Preferential The costs of ROOs can be conceived of Rules of Origin as being a direct addition to a firm’s costs in the sense of requiring the firm wishing Compliance with ROOs imposes costs to avail itself of tariff preferences to incur on firms and traders. Firms must decide added costs. For example, keeping records whether the benefits of receiving of all shipments of inputs and their prices preferential tariff treatment are greater in production is necessary to establish than the costs of complying with the compliance with a value-added rule. ROOs. 80 Costly and complex rules of However, the costs may also be indirect. origin are an important consideration. For example, if firms are required to make This is accentuated when a large and fabric from originating yarn and to cut, important economy such as Japan, the trim, and assemble garments within the EU, or the US negotiates numerous member territories under the SP test for separate bilateral FTAs with differing sets textiles and apparel, this will discourage of rules of origin. Development of “hub them from locating production outside and spoke” systems of FTAs, where the the FTA, even if certain processes could hub economy has preferential access to be done at lower cost. Indeed, ROOs each spoke but spokes lack connection, may discourage firms from undertaking can isolate spokes, divert trade and outward processing arrangements in investment, and raise trade costs (ADB locations that would otherwise benefit 2006). Consistent and clear ROOs are them through low-cost, labor-intensive desirable in avoiding the development operations. of hub-and-spoke systems but such The CTH test is widely adopted as the an outcome is unlikely when industry basis for ROOs for processed primary interest groups lobby for ROOs designed goods and manufactured products in the to protect their interests. Indeed a review WTO. However, the test is not perfect. of ROOs in bilateral agreements involving First of all, the HS tariff classification major Asian hub economies (Japan, was not designed with ROOs in mind, Republic of Korea, PRC, Singapore, and nor has any other tariff classification Thailand) revealed that ROOs vary not system been so designed. This means that only across hubs but even within hub- products may undergo a last substantial and-spoke systems (James 2006). The transformation without changing tariff “spaghetti bowl” problem of complex, heading, particularly within machinery inconsistent, and overlapping ROOs is sectors where assembly is a very therefore on the rise and is likely to get substantial transformation but does not worse before it gets better. constitute a CTH. In such cases, a CTSH rule may be used at the HS six-digit level, but this is usually supplemented by a minimal regional content or value-added 80 There are few ex post studies of the costs of compliance with rules of origin. See, for example, rule. The value-added requirement is Productivity Commission (2004). The study usually set high enough to discourage estimated that costs of compliance with ROOs in the Australia–New Zealand Closer Economic Relationship firms from production to (CER) were about 1.5–6.0% of the ex-factory price of lower-cost non-members, thus indirectly manufactured goods. Herin (1986) reports that the costs of compliance with EC ROOs led one fourth of adding to production costs. Second, export firms in the EFTA to simply forgo attempting to tariff schedules used for purposes of CTH comply. Palmeter (1993) finds the cost of compliance with EC rules of origin to be equivalent to 5% of become obsolete and must be constantly production costs. revised and updated every 5 years. 56 | How to design, negotiate, and implement a free trade agreement in asia

Countries often exercise large amounts of (see Box 2.3) clothing items must be cut discretion in applying the CTH test and and assembled from fabric that contains in selecting processed or manufactured only yarn originating within the member products with rules of origin that are countries, subject to a maximum of 7% exceptions to a CTH or CTSH test. by weight non-originating fabric or yarn. The value-added test is widely regarded The exemption of the 7% is under the de as the most objective test, but this is the minimis provision that allows a certain case only if clear accounting principles exemption by weight of various types are applied uniformly. The test sets a of non-originating material (such as minimum threshold for regional content certain types of fabric or fiber in textile necessary to confer origin but may also set fabric and clothing that are not produced a maximum threshold for non-originating within the FTA), but careful and costly content as a percentage of the good’s accounting is required of firms in price. Price itself is variously defined as complying with these requirements. ex-factory, FOB, and CIF price in codes of rules of origin. The lack of precision Cumulation and Flexibility in Satisfying of CTH-based rules often leads to the Rules of Origin in PTAs application of the value-added test as a supplement or as an alternative to the For developing countries to enjoy the CTH rule for manufactured products. benefits of preferential market access One drawback to the value-added rule is under unilateral preference schemes like that higher value-added requirements are the Generalized System of Preferences more difficult for less-developed countries (GSP) and other preferential trade to achieve than for more-developed schemes, the EU, Canada, and Japan countries, particularly where the former have modified their ROOs to allow are engaging in labor-intensive activities “cumulation” between developing using imported intermediate products. countries, in the form of value-added The SP test is used in cases where (as in Canada’s GSP) or cumulative product value chains are complex and operations (as in the double-jump or operations take place in two or more two-stage processing ROOs in Japan’s countries. The SP rule is supposed to be and EU’s GSP). The US has also shown based on a positive standard, that is, a some flexibility in allowing apparel from statement of operations or processes that sub-Saharan African countries to use do confer origin, and not of those that non-originating fabric up to a limit under do not. 81 However, in many cases the SP the African Growth and Opportunity Act. test can be used as a commercial policy Japan allows ASEAN cumulation in its instrument designed to protect domestic GSP rules of origin (that is, operations producers rather than as an objective within ASEAN countries count toward test of rule of origin. The SP test is used regional content requirements) and its often in HS Chapters 50–63 covering economic partnership agreement with textiles and apparel and may involve a Malaysia also allows operations that take two-step (“double jump” such as fiber place in another ASEAN country to count to fabric or yarn to clothing) or even a toward the double-jump rule for textiles triple transformation. For example, to and clothing. The EU has adopted a Pan- comply with the NAFTA rules of origin European Cumulation System (PECS) that permits inputs from any territory

81 However, the latter may be used to clarify a positive with an association agreement to be standard. added to inputs from within the EU in part ii: coverage of a free Trade agreement | 7

Box 2.3: NAFTA Product-Specific Rules of of shipments within a specified time Origin—Textiles and Apparel frame (say, 1 year) rather than requiring every individual shipment to satisfy the The North American Free Trade Agreement (NAFTA) of 1993 provides for special rules of origin (ROOs) for value-added test. intra-NAFTA trade in fibers, yarns, textiles, and clothing. The agreement states that it takes precedence over all other agreements members have with regard to Trade in Services trade in textile products (including the Multi-Fiber Arrangement). Stipulating the immediate elimination of US import quotas on textile products from Mexico, NAFTA prohibits the imposition of new quotas on such While various models exist in FTAs goods, except as provided for in the safeguard provision pertinent to liberalizing trade in services, during a “transition period.” there is broad convergence on concepts, One of the most interesting and most restrictive approaches, and disciplines. Many of provisions of the NAFTA special ROOs is the adoption of these find their origin in the GATS but a “yarn-forward” rule for most textile products. This rule requires textile and clothing products to be produced there has also been much experimentation from yarn that originates within NAFTA member over the last 10 years. A key element countries to benefit from preferential treatment. For that distinguishes preferential trade in clothing made from cotton or man-made fiber yarns, services is the approach to liberalization. however, the rule is “fiber-forward.” For such clothing Distinctions tend to be drawn, depending articles a “triple transformation” is required: from cotton or man-made staple fibers to yarn, from yarn to fabric, on whether a GATS-type or a NAFTA-type 82 and from fabric to clothing or made-up articles of approach has been followed. This section textiles. For certain types of imported fabrics that are explains the key concepts and approaches not produced within the NAFTA textile industry or that in both models (including various hybrids). are deemed to be in short supply (particularly silk, linen, It begins by explaining how trade in and certain shirting fabrics) exceptions are allowed. A services occurs and the types of preferences de minimis provision also allows clothing using no more than 7% by weight of non-originating fabrics to qualify that can be negotiated through an FTA. It for preferences. then examines the conformity requirements Source: NAFTA; James (2006). of Article V of the GATS and the usual provisions that are contained in the services chapter of an FTA. This provides meeting the value-added criterion for the basis for explaining the various duty-free access. approaches used in FTAs to negotiate Allowing firms to choose between and schedule market access and national complying through a CTH or CTSH test treatment commitments on services. or meeting a minimal regional content requirement is an innovation in Japan’s Preferential Trade in Services: economic partnership agreements with Key Questions and Concepts Indonesia, Malaysia, the Philippines, and Singapore (see Appendix to Part II for How are services traded across borders? Malaysia and the Philippines). Firms may comply through either type of test; this Understanding the different ways by arrangement is more flexible than the “all which services are traded internationally or nothing” approach to rules of origin. is a fundamental starting point. For An additional bit of flexibility could be trade in goods, the exchange is relatively gained in the case of value-added rules if straightforward since goods are tangible the rule could be satisfied by taking the 82 See Organisation for Economic Co-operation and average percentage of regional content or Development (OECD) (2002), Stephenson (2002), and of non-originating content over a number Marconini (2005). 58 | How to design, negotiate, and implement a free trade agreement in asia

Box 2.4: How Services are Traded— and the consumer of that service have to The Four “Modes of Supply” in the GATS meet for the transaction to take place. This is because the service is often not Virtually all free trade agreements (FTAs) follow created until it is delivered. To achieve this the General Agreement on Trade in Services (GATS) definition of trade in services. The GATS does not define proximity, either the producer has to move what services are but defines instead the four modes of to the consumer, or the consumer has to service delivery. move to the producer (see Box 2.4 for the four modes of supply under the GATS). Mode 1: Cross-Border Supply While the four modes of supply The service itself crosses the border, rather than the producer or consumer. Examples include services defined in the GATS have been criticized provided via post or the Internet. for not necessarily reflecting transactions in real life, where a service may be Mode 2: Consumption Abroad delivered through more than one mode, The service consumer crosses the border to where most FTAs still use them as the basis the service supplier is located to purchase and consume services. Examples include holidays abroad, foreign for scheduling commitments. The share education, and overseas health care. of individual modes in world trade in services has been estimated at: 40% Mode 3: Commercial Presence each for modes 1 and 3, 20% for mode The service supplier establishes a commercial 2 (mainly tourism), and less than 2% presence through a foreign-owned affiliate, subsidiary, or 83 representative office in the country where the consumer is for mode 4. Mode 3 trade, mostly located. Examples are a French bank operating in Thailand, combined with FDI, has been the most or a Malaysian telecommunications company in Malawi. dynamic component in recent years. The advantage of distinguishing Mode 4: Movement of Natural Persons between the four modes of supply is A service supplier, in the form of a person, enters a foreign market to supply a service. The service supplier that it gives flexibility to negotiators to can be an independent supplier (e.g., a consultant, a liberalize only a certain type of activity health worker) or an employee of a service supplier (e.g., within a sector. The existence of four a consultancy firm, a hospital, a construction company). possible ways of delivery, however, makes A nurse from the Philippines working on a contract the structure and content of the services in Japan, for instance, would be a natural person who chapter of an FTA more complex than that moves to another country to supply a service for a defined period of time. of the goods chapter.

Source: World Trade Organization (WTO) website. Available: www.wto. org; author’s compilation. What are barriers to trade in services and how are preferences granted?

objects that can be stored, packaged, Unlike trade in goods, preferential and transported across borders. Services, treatment in services is granted not on the other hand, are by definition through tariffs but through the removal intangible and can be transacted and of regulatory restrictions on foreign traded in more ways than goods. Some services and service suppliers. 84 Many services can be exchanged across a restrictions on foreign services and border without either the producer or service suppliers typically occur in consumer moving. Examples are the use of the Internet to provide online services 83 WTO Secretariat. like distance learning, e-banking, hotel 84 See Sauve and Mattoo (2003) for a discussion of reservations, telemedicine, as well as many preferences in regional trade agreements that cover services. See also Goode (2005) for an explanation of other Internet-based services. However, the difference between eliminating discrimination and for some other services, the producer liberalizing trade. part ii: coverage of a free Trade agreement | 9

technical regulations, licensing, and regulatory regimes for suppliers from qualification requirements. Some of these different countries. 86 This means that restrictions may be discriminatory, with many service sector reform measures, foreign providers having to fulfil more agreed to in the context of an FTA, could demanding or burdensome requirements be relatively easy to “multilateralize” than domestic providers. Others may (that is, extend to all partners). It would, be non-discriminatory since they apply of course, generally increase economic equally to both domestic and foreign benefits to do so. providers. Preferences are granted when discriminatory restrictions, such Conformity with Article V of the GATS as national treatment restrictions on foreign ownership, the type of legal entity When negotiating preferences in the allowed, branching rights, performance context of an FTA, the parties need requirements, 85 nationality, or citizenship to be mindful of the requirements of requirements for managers, are eased Article V (economic integration) of the or removed for an FTA party but not for GATS (see Box 2.5). Article V, formally non-parties. Similarly, preferences may speaking, refers to economic integration occur when quantitative restrictions on arrangements and, unlike the counterpart service output or on the number of service Article XXIV provision of GATT, does not suppliers are completely removed, or a distinguish between customs unions and larger quota is allocated, but only for an free-trade areas. FTA party. Article V does not define what might An important feature of reducing constitute “substantial sectoral coverage.” barriers to trade in services is that, unlike It simply notes that the phrase is to be reducing barriers to trade in goods, it does understood in terms of the number of not lead to a loss of tariff revenue. The sectors, volume of trade, and modes of removal of discrimination usually happens supply, and that there should be no a through a change in domestic legislation, priori exclusion of any mode of supply. the conclusion of mutual recognition “Absence or elimination of substantially agreements, or the harmonization of all discrimination” requires the parties national laws and regulatory practices. to an FTA to remove measures, usually Hence, implementing preferences in contained in laws and regulations, that services may not always be easy or discriminate against foreign services feasible. The nature of service regulations and suppliers. This condition is to is such that many service restrictions, be satisfied through the removal of once removed for one country, may not existing discriminatory measures or the continue to be applied to others, given prohibition of new or more discriminatory the difficulty of putting in place different measures, or both. It is important to note that what is being required is the removal 85 Performance requirements are measures that impose of discriminatory treatment arising from certain requirements on the way investors operate their business. These can include the proportion of the regulation and not the regulation output that must be exported, the amount of inputs itself. A timetable can be established that must be sourced locally, or requirements related to the transfer of technology. These measures, which for removing discrimination. Measures affect trade in services, are typically prohibited in the concerning payments and transfers, the investment chapter of an FTA. The WTO Agreement on Trade-Related Investment Measures also prohibits many safeguarding of the balance of payments, of these measures. Under the General Agreement on Trade in Services (GATS), performance requirements, 86 See Roy, Marchetti, and Lim (2006) for a discussion if they are to be maintained, have to be scheduled as of why preferential arrangements could potentially be market access or national treatment limitations. less harmful in services than in the goods trade. 60 | How to design, negotiate, and implement a free trade agreement in asia

Box 2.5: Meeting the Requirements general exceptions, and security of GATS Article V exceptions may be maintained. While an FTA lowers barriers between Article V of the General Agreement on Trade in the parties to the agreement, it must not Services (GATS) permits World Trade Organization (WTO) member countries to conclude free trade agreements at the same time raise the overall level of (FTAs) provided that certain requirements are met. The barriers faced by nonparties as compared FTA has to provide for with the situation before the agreement. If significant changes occur, WTO (i) substantial sectoral coverage; members affected by them may seek (ii) the elimination of substantially all discrimination in compensation or even withdraw some of the sense of national treatment; and their MFN commitments. (iii) not raising barriers against nonmembers as result Article V is meant to ensure that the of the agreement. FTA, although it may be discriminatory, All three conditions are cumulative and have to be contributes to further liberalization at the satisfied concurrently. multilateral level. In practice, assessing conformity with Article V is difficult for Rules of Origin and Developing-Country Flexibilities a number of reasons. For one, there are Also contained in Article V is a liberal clause on rules severe data limitations on the service of origin and additional flexibilities for developing countries. A service supplier from a third country trade, making it almost impossible to incorporated in one of the parties to the FTA must be accurately assess the volume of trade allowed to enjoy preferential treatment within the FTA covered by an FTA on services. 87 There as long as it engages in substantive business operations is also no agreement on the meaning within the territory of the parties. of “substantial sectoral coverage” and Developing countries have more flexibility in fulfilling the conditions of substantial sectoral coverage and “substantially all discrimination.” eliminating discriminatory measures. a In agreements Moreover, since Article V allows consisting entirely of developing countries, more discrimination to be eliminated within favorable treatment may continue to be given to firms a reasonable time frame, questions may owned or controlled by their own nationals. arise as to what is “reasonable.” These Notification Requirements same questions have emerged in the WTO members concluding FTAs in services context of the GATT/WTO Article XXIV must notify these agreements, and any subsequent in the context of goods. However, one enlargements or significant changes, to the WTO Council should not make too much of these for Trade in Services. While the council is mandated difficulties. An ordinary reading of the to examine these notifications for their conformity to word “substantial” indicates that the FTA Article V it has, to date, not launched any conformity examinations. Under current practice, notified FTAs are should be comprehensive in its coverage forwarded by the Council for Trade in Services to the (not exclude sectors) and should remove Committee on Regional Trade Agreements (CRTA) for nearly all discrimination between any eventual examination. With the adoption of a new the parties. An FTA that reproduces regional trading agreement transparency mechanism commitments in the GATS with only by the General Council on 14 December 2006, the WTO Secretariat is mandated to submit a factual report for a limited number of improvements discussion by WTO members in the CRTA. b would, on the face of it, not qualify. A “reasonable” time frame should also be a It is not clear from GATS Article III(a) whether that flexibility also one where phaseout periods are kept to a extends to developed countries that enter into agreements with developing countries, though the presumption is that it applies only strict minimum. to parties that are developing countries. b The transparency mechanism is implemented provisionally. Members are to review, and if necessary modify, the decision, and replace it with a permanent mechanism adopted as part of the

overall results of the Doha Round. The decision is available at www. 87 wto.org/english/news_e/news06_e/job06_59rev5_e.doc See Fink and Warren (2000). Source: WTO website. Available: www.wto.org. part ii: coverage of a free Trade agreement | 1

Contents of a services chapter: scope, General Disciplines. After specifying coverage, general disciplines, market access, scope and coverage, FTAs tend to and national treatment contain a common set of general disciplines, usually derived from the There is a strong degree of convergence GATS, on MFN treatment, transparency, between FTAs and the GATS in scope, payments and transfers, monopolies and coverage, and general disciplines. FTAs exclusive providers, domestic regulation, also tend to follow the GATS structure of safeguards, subsidies, government a framework of rules and disciplines and procurement, recognition, rules of origin, individual schedules of commitments. and general exceptions. Apart from a few In some FTAs, additional sectoral innovations, there is often little difference commitments are taken in financial between the FTA and GATS provisions on services, telecommunications, and the these general disciplines. temporary movement of natural persons. It is also increasingly common for service- (i) Most-favored-nation clause. All related disciplines to be found in separate FTAs tend to contain an MFN chapters on investment, competition clause, which usually requires policy, and government procurement. the parties to the FTA to provide In FTAs that follow a “negative list” treatment no less favorable than approach (see below the discussion of that accorded to non-partners. scheduling approaches), the schedule The purpose of this clause is to of commitments typically includes ensure that no party to the FTA reservations on existing and future will be disadvantaged if any other nonconforming measures. party to the FTA negotiates better concessions in another agreement Scope and Coverage. Many FTAs follow with a nonparty. This is an the GATS and exclude air traffic rights interesting clause, as it essentially and services supplied in the exercise ensures that whenever an FTA of governmental authority from the commitment is negotiated, the agreement. Following GATS Article 1(3), parties can avail themselves of the governmental authority is defined as best preferential treatment that its services provided neither on a commercial FTA partner is providing or may basis nor in competition with other provide in any of its subsequent suppliers. Other common exclusions are FTAs. There may, however, be government procurement, subsidies, legal and operational issues and grants. Similar to the GATS, the to consider when negotiating norm is also for FTAs to cover all such clauses, since they may be measures affecting trade in services at all providing a guarantee that extends government levels including sub-federal beyond what the party originally authorities and nongovernment bodies intended. There is also the issue of exercising delegated authority. the feasibility and consistency of There are some exceptions. In the extending MFN treatment between NAFTA-type FTAs, measures taken by local FTAs that may have significant governments (municipal level) are usually differences in structure and excluded, and air transport, although content. carved out of the services chapter, is (ii) Transparency. As is the case under covered by the investment chapter as far the GATS, FTAs typically contain as mode 3 is concerned. obligations to publish relevant 62 | How to design, negotiate, and implement a free trade agreement in asia

measures and notify new (or (v) Recognition. An increasingly changes to existing) measures important feature of FTAs is affecting trade in services and to mutual recognition agreements establish national inquiry points to (MRAs) for professional services. provide information on measures An example of an MRA is the affecting the service trade upon requirement in FTAs following request. An innovation in FTAs the NAFTA model under which involving the US is a clause the parties are required to give requiring the opportunity for prior equal opportunity to members comment on proposed changes in of the agreement and eliminate service regulations. citizenship or residency (iii) Monopolies and restrictive business requirements for recognition practices. Since some services or licensing within 2 years. are supplied by a monopoly AFTA allows for the recognition provider in many economies, of equivalency in educational the FTA usually needs to specify requirements or experience what these services are and the in the granting of licenses or extent to which competitors may certifications. GATS Article VII on supply ancillary services. It is also MRAs requires WTO members that common to guarantee foreign have either begun or concluded service providers access under negotiations to notify the Council nondiscriminatory conditions for Trade in Services and to to the services provided by provide adequate opportunity a monopoly. There may also to any other WTO member to be additional transparency negotiate its accession to such requirements including the an agreement. In practice, many obligation to provide additional countries appear to have taken information on the request of a the line that MRAs negotiated as party. In some FTAs, disciplines part of an FTA are exempt from on monopolies and restrictive the Article VII requirement. It business practices are contained in is argued that as the MRA was a separate chapter on competition negotiated in the FTA, it falls policy. under the Article V exception and (iv) Transfers and payments. It is usually Article VII does not apply. On the standard for FTAs to contain a other hand, since the GATS does clause that prohibits restrictions not explicitly provide for a link on transfers or payments subject between economic integration to prudential exceptions. However, agreements and recognition, it FTAs following the NAFTA model could also be argued that Article and AFTA, for instance, allow V does not exempt WTO members restrictions in the event of serious from their Article VII obligation. balance of payments and external (vi) Rules of origin. Unlike trade-in- financial difficulties. This is goods, FTAs usually have liberal similar to GATS Article XII. In ROOs for services (reflecting the the Australia-Thailand FTA, the requirement in Article V). prohibition is restricted only to the Third-country investors, extent that the restrictions would provided they have substantial affect scheduled commitments. business operations in one of part ii: coverage of a free Trade agreement | 

the FTA parties, benefit from domestic regulation. Exceptions include the preferential treatment. More additional disciplines on financial services details were covered in the Rules and telecommunications, additional of Origin section above. transparency provisions, as well as some (vii) Domestic regulation. The provisions sector-specific provisions relating to the are often the same as those of the temporary movement of natural persons GATS. There has been no progress and recognition. The most significant made in FTAs on sensitive issues variance between FTAs and the GATS, as like the “necessity test.” well as between FTAs themselves, tends to (viii) Safeguards, subsidies, and government come in their liberalization commitments, procurement. In general, there which are discussed below. has been little progress in FTAs on “unfinished” rule items like Market Access and National Treatment. emergency safeguard measures The degree of liberalization that and subsidies. The safeguard occurs in an FTA depends on the clause in FTAs typically refers commitments made in respect to to negotiations in the WTO. market access and national treatment. Negotiations on emergency Article XVI of the GATS allows WTO safeguard measures in the WTO members when making commitments have, however, been inconclusive to schedule four types of quantitative so far. On subsidies, with the restrictions and limitations on the form exception of the EU and the of legal establishment and foreign equity Australia–New Zealand Closer participation. In general, FTAs using a Economic Relations, FTAs have positive list tend to include a GATS-like not established any dedicated market access provision, while those using disciplines on subsidies. 88 a negative list normally require only the Moreover, subsidies and grants are notification of quantitative restrictions typically carved out from the scope (see explanation of positive and negative of the general disciplines. There lists below). It should be noted that the has been relatively more progress GATS market access provision does not on government procurement, appear in FTAs that follow the NAFTA though this tends to feature in a model. In that connection, GATS goes separate chapter on government further than NAFTA-based FTAs, as procurement rather than as part of Article XVI includes nondiscriminatory services per se. 89 quantitative restrictions. (ix) General exceptions. A feature of all A key element of all FTAs is the FTAs is general (i.e., public morals, provision on national treatment, which is human, animal, or plant life or the building block of any agreement on health) and security exceptions services. The national treatment provision similar to those contained in Articles of the GATS is found in Article XVII. The XIV and XIV bis of the GATS. provision contains the notion of treatment no less favorable than that accorded to Overall, FTAs do not go further than locally owned service suppliers. The the GATS with respect to the rules benchmark for national treatment in the area, e.g., safeguards, subsidies, or GATS is not identical treatment but treatment that does not modify the

88 See OECD (2002). conditions of competition in favor of 89 OECD (2002). national services and service suppliers. 64 | How to design, negotiate, and implement a free trade agreement in asia

Unlike market access, there is no no limitations. National schedules list exhaustive listing of limitations that can service sectors and modes of supply be scheduled. Most FTAs have adopted that enjoy market access and national the national treatment provision of the treatment, subject to limitations. GATS. In FTAs that contain a separate Countries are at liberty to impose trade- investment chapter, there is usually a restrictive measures in all nonscheduled national treatment provision similar to sectors, although those measures may that found in the services chapter. still be subject to an agreement’s general It should be noted that FTAs following disciplines. The use of a positive list has the NAFTA model usually have an various pros and cons. important provision regarding the Countries may prefer a positive “standard of treatment” that does not find a list because its use in the GATS has parallel in the GATS. 90 Under the provision, already made them familiar with the the service suppliers of all parties must approach. A positive list may also be enjoy the better of national treatment and easier to handle for countries that feel MFN treatment. In other words, if the PRC less confident about their regulatory gets better MFN treatment in a particular regime and wish to have more time state of Australia than Australian service before committing an existing regulatory providers, then Singaporean or Chilean situation through a negative list. 92 The service providers should also get MFN and pace of liberalization is likely to be slower not national treatment. under such an approach, since progress is to be made through rounds of request- Positive versus Negative List offer negotiations. Such negotiations typically take a longer time to reach a A key element that distinguishes between “critical mass.” A major problem with a GATS-type and NAFTA-type models is positive list is that it does not provide the way commitments are scheduled. any information on services that are not The GATS uses a positive list of specific included in the schedule or the actual commitments that are in turn subject to regime since economies may choose not limitations or conditions inscribed. This to bind at the status quo. is in contrast to a NAFTA-based negative An example of a positive list used in list, where all services covered by the FTA the Singapore-India FTA is provided in are considered liberalized unless indicated Box 2.6. The example is a pure GATS- otherwise through lists of reservations. 91 style positive list with a listing of services in the far left column and a breakdown Positive list of commitments into the four respective modes of supply. The commitment is In a positive list, only services included subject to limitations on market access in the schedule will enjoy preferential and national treatment. There may also treatment to the extent that there are be limitations in the horizontal section that are not shown in this example. The term “None” refers to a situation of 90 Marconini (2005) discusses the North American Free Trade Agreement (NAFTA) inspired approach in some full liberalization with no limitations. detail. “Unbound,” on the contrary, means that 91 NAFTA-type and GATS-type agreements also differ in that the former deal with different modes of supply no commitment is provided and any in different chapters: disciplines for modes 1, 2, and 4 in a chapter on cross-border trade in services, and 92 This point is observed by many commentators disciplines relating to mode 3 as part of a chapter on including Goode (2005), Marconini (2005), investment. Stephenson (2002), and Sauve and Mattoo (2002). part ii: coverage of a free Trade agreement | 

Box 2.6: A Traditional GATS-Style Positive List This example is taken from Singapore’s schedule of commitments in its free trade agreement with India. Modes of supply: (i) Cross-border supply, (ii) consumption abroad, (iii) commercial presence, (iv) presence of natural persons Limitations on Limitations on Additional Sector or Subsector Market Access National Treatment Commitments SECTOR-SPECIFIC COMMITMENTS 1. Business Services A. Professional Services Legal consultancy services (i) Unbound (i) Unbound for Indian law (861**) (ii) none (ii) none (iii) unbound (iii) unbound (iv) unbound except as (iv) unbound indicated in the horizontal section Accounting, auditing, and (i) None (i) None bookkeeping services, (ii) none (ii) none except for financial (iii) none (iii) none auditing services (862**) (iv) unbound except as (iv) unbound indicated in the horizontal section limitation can be imposed. It is common considerable confusion. 94 Merging the in a positive list in mode 4 to refer to the market access and national treatment horizontal section for the commitments. columns into one removes the problem of This is because mode 4 commitments tend how to treat overlaps. not to be sector-specific but to apply to Not specifying how the service is all sectors (see explanation of horizontal delivered arguably does little to reduce commitments below). the complexity of scheduling, since the parties still remain free to schedule Variations on the positive-list approach limitations by mode of supply. On the other hand, having only one column for Some innovation has taken place limitations is an interesting innovation, as among FTAs using the positive-list a two-column schedule poses the typical approach to simplify the schedule. These problem of distinguishing between market include removing the need to schedule access and national treatment. 95 Still, commitments by mode of supply, and despite these attempts to simplify the reducing market access and national schedule, very few GATS-plus concessions treatment limitations to one column were actually granted in the Thailand- (see Box 2.7). 93 This is an interesting Australia FTA. simplification of the schedule, since overlaps between market access and 94 The convention in the GATS is to schedule limitations national treatment often give rise to that relate to both market access and national treatment, in the market access column only. 95 The guideline in the GATS is to schedule limitations in the market access column if there is an overlap with 93 Also discussed in Goode (2005). national treatment. 66 | How to design, negotiate, and implement a free trade agreement in asia

Box 2.7: A Simplified Positive List a This example is taken from Thailand’s schedule of commitments in its FTA with Australia. The market access and national treatment measures listed in the limitations column condition all the sector-specific commitments. Sector or Subsector Limitations HORIZONTAL COMMITMENTS ……. Local Government Measures Thailand reserves the right to adopt or maintain any measure administered at the local government level unless that measure is applied on a discriminatory basis with the intention of nullifying or impairing the benefit accruing to Australia under the terms of the Agreement. SECTOR-SPECIFIC COMMITMENTS Notes: (i) Commitments in this schedule are subject to the general limitations contained in the “Horizontal Commitments” section of this schedule. (ii) The (*) indicates that the sector-specific commitment for cross-border supply is unbound because of the lack of technical feasibility. b (iii) The (**) indicates that the service specified constitutes only a part of the total range of activities covered by the Provisional Central Product Classification (CPC) concordance. 1. Business Services General management consulting services Equity participation of up to 100% by Australian (CPC 86501) provided exclusively investors/service suppliers is allowed. through regional operating headquarters, its associated company, or a foreign branch. Convention services (CPC 87909**) Total area of not less than 4,000 square meters; and excluding catering and beverage services total area of the largest hall must not be less than 3,000 square meters. International exhibition services Total area of not less than 50 rai (80,000 square (CPC 87909**) meters) with an indoor exhibition area of not less than 25,000 square meters. a With one column for market access and national treatment limitations and no modes of supply specified. b The entry “unbound because of the lack of technical feasibility” is a convention borrowed from the General Agreement on Trade Services (GATS). Although reference is made to it in the Thailand-Australia FTA, it is not used in the schedule.

The Japan-Philippines Economic feature that is normally found only in Partnership Agreement (JPEPA) negative-list FTAs (see Appendix to Part II introduces an interesting innovation: an for an example). additional column (Stand Still [SS]) in which parties can specify whether the Negative list limitation is an existing nonconforming measure. This is a helpful innovation, NAFTA pioneered the use of a negative since it clarifies current measures and list, where all services are considered also encourages the parties to bind the liberalized unless otherwise indicated status quo, if not to liberalize. Binding through lists of reservations. In other existing nonconforming measures is a words, all measures and sectors are part ii: coverage of a free Trade agreement | 7

Box 2.8: An Annex 1 Reservation List Box 2.9: An Annex 2 Reservation on This example is taken from the Australia-US FTA. “Future Measures” Sector Telecommunications This example is taken from the US-Chile FTA. Obligations National Treatment (Article 11.3) Sector Social Services Concerned Senior Management and Boards of Obligations National Treatment (Articles 10.2, 11.2) Directors (Article 11.10) Concerned Most-Favored-Nation Treatment Level of Central (Articles 10.3, 11.3) Government Local Presence (Article 11.5) Performance Requirements (Article 10.5) Source Telstra Corporation Act of 1991 Senior Management and Boards of ofMeasure Directors (Article 10.6) Description Investment Description Investment and Cross-Border Services The maximum aggregate foreign The United States reserves the right ownership allowed in Telstra is 35% to adopt or maintain any measure of the Telstra shares that are not with respect to the provision of law Commonwealth-held. The maximum enforcement and correctional services, individual foreign ownership allowed and the following services to the extent in Telstra is 5% of the Telstra shares they are social services established or that are not Commonwealth-held. The maintained for a public purpose: income Chairperson and a majority of directors security or insurance, social security of Telstra must be Australian citizens, or insurance, social welfare, public and Telstra is required to maintain its education, public training, health, and head office, main base of operations, child care. and place of incorporation in Australia.

considered free of restrictions unless liberalization to all FTA parties. The there is a reservation listed in the ratchet mechanism thus automatically “nonconforming measures” annex. The binds any liberalization within the FTA. absence of any reservations indicates Clearly, countries that feel confident that the sector is fully liberalized. about their regulatory regime and have Reservations are typically for existing relatively few discriminatory measures nonconforming measures (Annex 1) and tend to favor a negative-list approach. 96 for future measures (Annex 2). Negative Otherwise, countries would resort to using lists have been used in all NAFTA-type the Annex 1 and Annex 2 reservation FTAs. Such an approach can potentially lists, and thus defeat the point of using provide a high degree of transparency a negative-list approach. There is also since, subject to the number of Annex sometimes fear that a negative list would 1 and Annex 2 reservations, the actual bind the hands of governments, since it level of openness is spelled out, along cannot possibly be known what services with an indication of the legal/regulatory might be developed over time. However, framework in place. it is worth bearing in mind that all FTAs, FTAs using a negative-list approach also as with the GATS, recognize the right to typically include a ratchet mechanism, regulate. What is required in a schedule is whereby any future liberalization the removal of discriminatory measures, of Annex 1–type reservations is not necessarily deregulation. automatically locked in. In other words, A negative list has no schedules of whenever an FTA member removes any commitments with sectors, modes of restriction, even without any negotiation, it must extend the benefit of that 96 Marconini (2005). 68 | How to design, negotiate, and implement a free trade agreement in asia

supply, and limitations, since all services It should nonetheless be kept in mind by definition are liberalized. The annex that a certain degree of self-selection of the agreements contains lists of may be involved in these results, since “nonconforming measures,” i.e., those countries with the greatest motivation measures that for the time being continue to liberalize may have chosen to use to discriminate against foreign service a negative-list approach. More recent suppliers. Box 2.8 gives an example of an studies are also starting to show that the Annex 1 list of existing “nonconforming choice of a negative-list or positive-list measures” from the Australia-US FTA. approach does not always indicate the By expressing a reservation in Annex extent of liberalization, contrary to what 1, the party exercises its right under is sometimes argued. 98 For instance, some the FTA to maintain the discriminatory FTAs that are following a negative-list measure in its current form, and is bound approach exclude a high number of sectors not to make the measure more restrictive in their specific commitments. 99 Ultimately, at a later date. The format of an Annex what matters more is what is committed 1 listing is fairly straightforward: in the individual schedules rather than the virtually all FTAs using a negative list form these commitments take. follow the NAFTA template. It is also possible to pre-commit in Annex 1 by Making Horizontal Commitments setting a timetable for the lifting of the reservation. Since reservations are based There is often considerable confusion on existing nonconforming measures, about the status of horizontal such precommitments to phase out commitments in a schedule. To clarify, restrictions are a good indication of actual horizontal commitments in a GATS-type liberalization (for examples of phase-out positive list bind all sectors listed in the commitments in various FTAs, see Matrix schedule unless stated otherwise. 100 1 in the Appendix to Part II). Essentially a formatting convention that A second type of reservation—on removes the need to repeat the same “future measures”—allows parties to binding in all the subsectors that follow, reserve the right to adopt new or more horizontal commitments are thus normally restrictive measures. In a sense, this is used for measures of general application somewhat equivalent to the “unbound” that apply to all sectors (see Box 2.7: situation in a GATS positive list. Annex 2 the limitation placed by Thailand on reservations on “future measures” provide local government measures binds all the important exceptions to the sweeping sector-specific commitments that follow). coverage of a negative list. Box 2.9 gives Neither horizontal commitments nor an example from the US-Chile FTA. sector-specific commitments rank higher; Whether negative-list FTAs liberalize 98 See Ochiai, Dee, and Findlay (2007); and Lesher and more than positive-list FTAs depends on Miroudot (2006). what is reserved in Annex 1 and Annex 2. 99 See Ochiai, Dee, and Findlay (2007); and Lesher and In principle, it is possible to arrive at the Miroudot (2006). Percentages of sectoral exclusions in negative-list FTAs: Chile–Republic of Korea, 46.4%, same level of liberalization with either Japan-Mexico, 53.3%, US-Singapore, 59.4%, Republic a negative or a positive list. In practice, of Korea–Singapore, 59.8% (from Ochiai, Dee, and Findlay [2007]). however, FTAs using a negative list tend to 100 The use of horizontal commitments in relation to show a significant degree of improvement mode 4 (refer to Box 4) sometimes creates confusion. The GATS convention is for members to specify in the over commitments taken in the GATS, horizontal section the market access and national compared with FTAs using a positive list. 97 treatment they grant for mode 4, but not for the other modes of supply. Entries like “Unbound except as indicated in the horizontal section” are thus common 97 See Roy, Marchetti, and Lim (2006). in the sector-specific section. part ii: coverage of a free Trade agreement | 9

the two need to be read together. The is greater emphasis in FTAs on addressing horizontal section in a negative list follows nondiscriminatory measures, licensing a similar logic. It contains reservations of requirements, transparency, efficiency a general nature, which do not need to of the administrative process, and be repeated in all following subsectors. In competitive safeguards. terms of good practice, only commitments or reservations that are truly horizontal, in Telecommunications the sense that they bind all sectors, should be included in this section. An increasing number of FTAs have a separate chapter dealing with the unique Sector-SpecificD isciplines characteristics of the telecommunications services sector. It is also worth bearing Other interesting innovations in FTAs in mind that in the extended GATS are found in sector-specific disciplines Telecommunication Services negotiations, and liberalization modalities in financial which concluded in February 1997, services, telecommunications, and the many WTO members committed to open temporary movement of natural persons. 101 their national markets to international competition, thus removing the more Financial services important barriers to market access. While there is no single approach Financial services tend to be heavily to a telecommunications chapter, regulated for prudential reasons. The it is clear that the value added for sector is also characterized by a large telecommunications services for many number of diverse services that are FTAs comes in further developing the defined in the GATS Annex on Financial regulatory disciplines. NAFTA-type FTAs, Services. Many of the standard provisions especially those involving the US, for of a typical FTA could, of course, easily example, combine elements of the NAFTA, apply to financial services as well. the GATS Annex on Telecommunications, However, there is clearly a distinct and the WTO Reference Paper, to form preference for a separate chapter because a comprehensive set of regulatory of the unique characteristics of the disciplines, which are GATS-plus. Other financial services sector. Box 2.10 lists FTAs, such as Thailand-Australia, Japan- typical contents of a financial services Singapore, New Zealand–Singapore, chapter and approaches taken. Philippines-Japan, do not have a separate In general, in developed and advanced chapter on telecommunications services. developing countries, market access and Network issues set telecommunications national treatment restrictions in financial apart. Without access to the essential services have been substantially reduced facilities of the network, it is impossible through domestic reform, and most of to provide telecommunication services. the progress, especially for commercial There is also a need to separate policy presence, is reflected in the commitments and regulation. A separate independent made in the GATS 1997 Round of regulator must be established to ensure a financial services negotiations. As a result, transparent approach to the players in the when it comes to financial services, there market as well as regulatory certainty. Provisions on telecommunications 101 The examples given here of typical provisions in the services are intended to ensure access to telecommunications and financial services chapters of and use of the services without undue FTAs are drawn mainly from unpublished research by the Institute for International Trade. See also Goode (2005) discrimination against service providers. for examples of typical provisions in these two sectors. This is important because public 70 | How to design, negotiate, and implement a free trade agreement in asia

Box 2.10: Typical Features of Financial Services Provisions of FTAs Scope and Coverage New Financial Services Financial services are defined in the same way as An interesting issue that arises in FTA in the Annex on Financial Services. Typical exclusions negotiations is how to treat “new financial services,” are government procurement of financial services, that is, those services that are likely to be developed and activities or services forming part of a public in the future and are unknown to the negotiators at retirement plan or statutory system. the time the FTA is finalized. In cautious agreements, the approach taken is for the parties to consult on Liberalization the possibility of covering new financial services The chapter specifies the approach—whether at the request of one party. In more ambitious positive- or negative-list—to market access and agreements, FTA parties already agree at the time national treatment. In all its free trade agreements the FTA enters into force. (FTAs), the US combines positive- and negative-list approaches for financial services. On market access, Transparency the provision is modeled on General Agreement on In addition to the usual transparency obligations, Trade in Services (GATS) Article XVI, but applies only each party is required to publish in advance any to mode 3. Liberalization is subject to the traditional regulations of general application relating to negative-list approach (establishment is allowed in financial services. An important innovation is the all financial service activities unless a reservation requirement to provide interested persons and the is made). However, cross-border trade (modes 1 other party a reasonable opportunity to comment and 2) is subject to a different approach, similar to on such proposed regulations. the one adopted in the World Trade Organization’s (WTO) Understanding on Commitments in Financial Financial Services Committee Services, i.e., a positive list of commitments. NAFTA-type FTAs form financial services committees to supervise the implementation of Regulation and Supervision the chapter and its further elaboration, to consider The need for effective prudential regulation issues regarding financial services that are referred is well established in all FTAs. For instance, all to the committees, and to participate in dispute prudential measures taken by central banks and settlement process. monetary authorities are typically carved out of the FTA. The main principle as regards regulation Dispute Settlement Provisions and supervision, while recognizing the need Some FTAs lay down a distinct set of dispute for prudential regulation, is nondiscrimination. settlement provisions for financial services. These If the regulation is needed for prudential emphasize the need for panelists to have financial purposes, normally there is little justification for services expertise and confine retaliatory measures, discrimination between domestic and foreign if applicable, to the financial services sector. There is suppliers. also a procedural requirement for investor disputes on financial services to be referred to the financial services committee for decision. Source: Institute for International Trade, unpublished case studies.

telecommunications services are often parties to develop mutually beneficial provided by a monopoly or under interpretations of the general principles conditions where a former monopoly still laid down in the GATS Annex on dominates the market. As shown in Box Telecommunication Services. The key 2.11, the telecommunications chapters challenge in developing such also have provisions pertaining to the interpretations is that markets in an FTA behavior of regulatory bodies, especially are usually very different in nature, size, with respect to decision making, and stage of development. A regulatory transparency, and technical standards. issue that is important in one market Including a telecommunications might be less so in another. services chapter in an FTA allows the part ii: coverage of a free Trade agreement | 71

Box 2.11: Typical Features of Telecommunications Services Provisions of FTAs Free trade agreement (FTA) provisions on treatment. FTAs (e.g., US-Peru) typically require the telecommunications services typically follow telecommunications regulatory body to be separate the structure and content of the World Trade from and not accountable to any supplier of public Organization’s General Agreement on Trade in telecommunications services. All decisions by the Services (GATS) Telecommunications Reference regulatory body must be impartial and must not Paper, with details added. accord more favorable treatment to a supplier owned by the government. Universal service Scope and Coverage obligations must be administered transparently, The chapter usually applies to (i) measures relating fairly, and with competitive neutrality. to access to and use of public telecommunications services, (ii) obligations of suppliers of public General Competitive Safeguards and telecommunications services, (iii) measures relating Interconnection to public telecommunication networks, and (iv) Competition policy is vital to telecommunications measures relating to the supply of value-added services. FTAs generally include safeguards against services. Other provisions include no requirement anticompetitive practices such as anticompetitive for an enterprise to construct a network or provide horizontal arrangements, misuse of market a service not generally supplied by a public entity power, anticompetitive vertical arrangements, or for a broadcaster to make available its facilities and anticompetitive mergers and acquisitions. as a public telecommunications network. Normally Public telecommunications services must provide excluded from coverage are measures relating to interconnection at reasonable rates and protect broadcast or cable distribution of radio or television the confidentiality of commercially sensitive programming. information.

Regulatory Transparency Obligations of Major Suppliers A set of good practices, such as in US-Oman, A major supplier is typically defined as a supplier include prompt publication of the rules issued by the of public telecommunications services that can telecommunications regulatory body, an opportunity materially affect price and supply. FTAs, such as US– to comment on rules, and the availability to the Central America Free Trade Agreement, oblige major public of information and measures relating to the suppliers not to discriminate against unrelated provision of telecommunications services. Licensing suppliers (i.e., not their own subsidiaries and must be fair and nondiscriminatory. affiliates); to charge reasonable rates; to unbundle network elements; and to provide fair treatment Actions of Independent Regulators in interconnection, co-location, and rights-of-way. The independence of the regulatory authority Major suppliers are also subject to anticompetitive is central, as it affects market access and national safeguards, including anticompetitive cross-subsidy.

Source: Institute for International Trade, unpublished case studies.

Temporary movement of natural persons (including intra-corporate transferees). Most NAFTA-type negative-list FTAs Given the sensitivities surrounding the have a separate chapter on the movement of labor, only very limited movement of natural persons, which progress has been made in the GATS on establishes disciplines for the entry of mode 4 (the temporary movement of businesspersons active in the goods and natural persons to supply a service). 102 services sectors. Also common is a review These sensitivities are also present in mechanism, which gives persons denied FTAs, though there have been some entry an opportunity to have their claims interesting innovations with respect considered by an independent person or to professionals and business visitors tribunal. The substantive disciplines and depth of commitments in these chapters 102 Most FTAs apply the GATS definition of mode 4. vary from agreement to agreement (see 72 | How to design, negotiate, and implement a free trade agreement in asia

Box 2.12: Movement of Natural Persons— the progress made has come in the form Provisions on Business Visitors of mutual recognition agreements. To be able to supply a service in a foreign Sometimes a free trade agreement (FTA) will address business mobility issues for investment and services market, professionals need to either have in separate chapters. As there is usually considerable the mandated local qualifications or have overlap between the business mobility provisions their foreign qualifications recognized. in these chapters, it would seem appropriate (where Nonrecognition of qualifications is thus an possible) to combine relevant provisions in one chapter. important barrier to mode 4 access. The In that case, the main provisions would tend to govern approach in many FTAs is to encourage the following matters: their competent regulatory bodies to (i) a statement that the agreement does not apply negotiate and conclude MRAs. Some FTAs to measures regarding nationality or citizenship, identify specific professions for MRAs permanent residence, or permanent employment; and establish negotiating time frames. A (ii) a listing of the chapters of the agreement to which detailed examination of MRAs is beyond the provisions on entry apply; the scope of this chapter but it is clearly (iii) the conditions under which temporary entry for an area that holds much promise for the short-term business visitors and intra-corporate movement of natural persons. An example transferees may be granted; of an easing of restrictions on certain (iv) the conditions under which temporary entry may categories of mode 4 is given in the be denied; following case study (Case Study 2.2) (v) an agreement that the parties retain the right to regulate the entry of natural persons and to ensure of the Japan-Philippines Economic the orderly movement of natural persons across Partnership Agreement. their borders; (vi) a provision enabling online lodgment of visa Summary applications and their processing; (vii) the exclusion of labor market testing in any of the There is no one single FTA model to parties; liberalizing trade in services that can be (viii) an undertaking to exchange information on domestic prescribed. Indeed, much will depend laws and policies governing temporary entry; on the objectives and individual (ix) an undertaking to handle appeals against decisions circumstances of the parties involved. This by immigration authorities expeditiously; and chapter provides an overview of some key (x) a description of the extent to which the issues that need to be considered when agreement’s dispute settlement provisions apply to the chapter. negotiating the services chapter of an FTA. It examines some of the key approaches Source: Institute for International Trade, unpublished case studies. used and the potential issues that may arise. In doing so, some examples of innovative practice that have arisen over recent years are illustrated and discussed. Box 2.12 for some typical provisions The increasing popularity of some of these on business visitors). All such chapters innovations, such as in the scheduling of include a GATS-style carve-out on access commitments or the treatment of specific to the domestic employment market and sectors like telecommunications and the regulation of the entry of natural financial services, is giving rise to what persons. appears to be a body of prevailing, if not On the whole, most FTAs do not go of best, practice. beyond improving conditions of entry It is, however, difficult to generalize. for business visitors and intra-corporate The FTAs that have been concluded in transferees. With respect to professionals, the recent past, not least the services part ii: coverage of a free Trade agreement | 73

Case Study 2.2: Specific Commitments for the Movement of Natural Persons under the Japan-Philippines Economic Partnership Agreement (JPEPA) JPEPA is a General Agreement on Trade in Qualification Requirements Services (GATS)-type positive-list agreement with Legal, accounting, or taxation service suppliers the innovation of binding limitations at the level of need to be qualified under Japanese law. In terms of existing nonconforming measures. In JPEPA, Japan service suppliers possessing advanced skills, there took a number of significant commitments to ease is a minimum requirement of having completed the entry of Filipino mode 4 service providers. college education (i.e., bachelor’s degree) or higher education, or have at least 10 years’ experience in Categories the area of speciality. For nurses and caregivers, Annex 8 of JPEPA defines the various categories qualifications obtained in the Philippines are included in the commitment on mode 4 and sets recognized according to the following criteria: out the respective terms and conditions for the (i) a qualified nurse under Philippine law with at entry of short-term business visitors; intra-corporate least 3 years’ work experience; and (ii) caregivers transferees; investors; and natural persons who must have graduated from a 4-year program of engage in professional services (legal, accounting, or at higher-education institution and be a certified taxation services), those who possess advanced or caregiver in the Philippines, or have graduated specialized skills, and nurses or certified careworkers. from a nursing school authorized by the Philippine In terms of the last two categories, activities are to Government. Japanese language proficiency is also be conducted on the basis of a personal contract. required to satisfy the requirements for entry and stay as a qualified nurse (kangoshi) or caregiver Lengths of Stay Granted (kaigofukushishi). Short-term business visitors (90 days, which may be extended), intra-corporate transferees, investors, Immigration Laws and Procedures natural persons who engage in professional services, All commitments on temporary entry and stay for specialized/skilled workers (1 to 3 years, which natural persons are still subject to immigration laws may be extended), and nurses or caregivers (1 to 3 and procedures. In other words, service providers years; depending on whether stay was linked to the may be required to obtain an appropriate visa or its purpose of obtaining a qualification and on the type equivalent prior to entry. of service provided, period may be extended). Source: Extracted from the text of the Economic Partnership Agreement between Japan and the Republic of the Philippines. Available: www.mofa.go.jp/region/asia-paci/philippine/epa0609/index.html

component of such agreements, are seem to be an obvious question highly complex in architecture and are but the reasons why economies still evolving. But the race to conclude choose to conclude FTAs will FTAs, and the inclusion of services as a be critically important in the central component, is showing no signs selection of the approach. Indeed, of slowing down. It would thus seem an assessment of existing polices important to provide some normative and circumstances may well guidance to those who may be involved in reveal that a preferential deal such negotiations. By way of conclusion, may not be the best option. After several points are worth reiterating: all, if the objective of service liberalization is to reduce the (i) Before embarking on mastering costs of service inputs and to the technicalities and intricacies attract FDI, this may well be of negotiating services in an FTA better served by undertaking it is important to ask: what are multilateral commitments. the ultimate goals that are to be Moreover, for practical reasons served by the agreement? This may it is often difficult for economies 74 | How to design, negotiate, and implement a free trade agreement in asia

to have separate regulatory understanding of the regulatory regimes for different supplier regime in question. This does countries. If preferences cannot be not mean that a positive list implemented in practice, would does not require a similar level it not be better to liberalize at of preparation, if an ambitious the multilateral level where, it is outcome is sought, but since generally agreed, gains would be market access and national greater than through preferential treatment apply only to scheduled deals? Good policy should guide sectors there is less pressure to negotiating form and not the other do so. In terms of outcomes, it way around. cannot be assumed that a negative (ii) If the decision is taken to negotiate list will be far superior to a an FTA, in the context of services, a positive list. This is an empirical primary starting point is to ensure question that can be answered compliance with Article V of the only by a thorough reading of GATS. The substantive conditions the reservations in a negative-list of Article V are designed with schedule and of limitations in a the objective of ensuring that positive-list schedule. when economies depart from (iv) Given that there is usually less MFN treatment to negotiate familiarity with concepts and preferential trade agreements, approaches used in FTAs as they do so in a way that minimizes compared with those in the GATS, trade distortions and harm to it is important to pay attention to the multilateral trading system. definitions. Some key concepts The conditions of Article V can that are found in FTAs do not be met, for instance, by not have exactly the same objective excluding modes of supply or as in the GATS. For instance, in taking large sectoral carve-outs, FTAs, the MFN clause acts as an and by substantially eliminating “insurance policy” against an FTA discrimination on national party providing better treatment treatment. to a third party. NAFTA-inspired (iii) Much has been made of whether a FTAs also often require the better positive- or negative-list approach of MFN or national treatment. In should be adopted. While both some cases, domestic suppliers approaches have their pros and cons, actually get worse treatment it is possible to arrive at the same than that given on an MFN basis, level of liberalization, whichever since the government’s policy is approach is taken. What is perhaps to provide incentives to foreign more critical is a thorough investors. understanding of the implications (v) Particular attention needs to be and consequences of either given to ensuring coherence and approach, since this will have consistency between the various an important bearing on how to chapters of the FTA that deal with prepare for the negotiations. A trade in services. NAFTA-inspired negative list, since it automatically FTAs typically contain disciplines binds all sectors and measures for modes 1, 2, and 4 in the unless reservations are taken, “services” chapter, while mode requires a thorough review and 3 is covered by a chapter on part ii: coverage of a free Trade agreement | 75

“investment,” which covers both Hong Kong, China and Singapore, FDI in goods and services. There may services is also a growing phenomenon. also be an additional chapter on The developing countries in East Asia certain categories of mode 4, such and beyond compete with one another as business visitors. Managing for FDI and try to improve their overall overlaps and avoiding conflicts investment climate. The positive effects become an important challenge. of FDI are being increasingly appreciated For instance, in many NAFTA-type because of, among others, its ability to FTAs, core air transport services enhance productive capacity leading to are carved out of the services higher incomes and employment, the chapter. However, the investment building of manufacturing capabilities, chapter, which applies to mode 3, and the upgrading of technological levels. does not exclude any particular However, countries remain concerned service sector and would therefore over the perceived negative effects, which apply to all air transport services. include the “crowding out” by foreign It then becomes necessary for a investment of domestic entrepreneurship specific reservation to be taken in in strategic and sensitive sectors of the the relevant annex for the sectoral national economy. This has resulted carve-out to apply. in a broadly open national FDI policy coexisting with sectoral limitations on FDI entry and operations. Investment In this section, we first consider the FDI aspects of FTAs in the broader context of multilateral rules and approaches and International investment flows have other forms of cooperation. Then we grown more rapidly than international consider best-practice approaches to FDI trade in goods or world GDP. A major policies in FTAs. contributing factor is the liberalization of FDI policies around the world and the FTAs and FDI Inflows global fragmentation of production. While the bulk of direct investment flows is still Location-specific factors contribute to the between developed countries, there is also overall investment climate. These factors a growing volume of direct investment include an established legal framework flows to the developing economies. and economic fundamentals. FTAs have In recent decades, FDI has been different investment provisions reflecting increasingly regarded as an important differences in various location-specific instrument for accelerated economic factors. Investment provisions include development. In East Asia, FDI has been pre- and post-establishment treatment used as an instrument to jump-start of foreign investors and their differences export manufacturing. It has led to the with actual national investment rules, establishment of regional production and the availability of effective dispute networks and has been instrumental settlement mechanisms. Empirical studies in linking the region to global supply show that investors want a predictable chains. For some economies in East investment climate. Predictability may Asia, multinational corporation affiliates be enhanced when domestic policies established via FDI account for over half and regulations are enshrined or locked of manufactured exports. In the more into regional and bilateral treaties and advanced East Asian economies, such as agreements. It should also be noted that 76 | How to design, negotiate, and implement a free trade agreement in asia

trade rules (tariffs, nontariff measures, most cheaply through exports from the rules of origin) could affect investment single regional location, thereby realizing flows. FTAs have different effects on economies of scale. The tariff-jumping extra-regional and intra-regional sources motive favors FDI over exporting; the of FDI. higher the external tariff and the lower the fixed costs of a new plant, the greater FDI from extra-regional sources the incentive for tariff-jumping FDI. On the other hand, FTAs may encourage The lowering of regional tariffs may “export platform” intra-regional FDI, create incentives for extra-regional because lower trade costs favor the investors to establish a presence in the establishment of production networks region to take advantage of the larger and an efficiency-seeking subsidiary in a integrated market (horizontal market– member country as it becomes cheaper seeking FDI). If individual member to reexport regional production. There countries of the FTA were previously is likely to be more intra-regional FDI served through trade, this may then in countries with few manufacturing raise inward FDI. If individual member capacities and when flexible rules of origin countries were already served through allow for diagonal or full cumulation to MNC subsidiaries, this may induce FDI enable non-members to supply the country flows to the least-cost location in the FTA. that attracts intra-regional FDI. Further, as noted in the Rules of Origin section above, when the FTA has strict Competition for FDI rules of origin, the extra-regional investor may need to set up manufacturing An FTA could result in a highly uneven and processing operations in several distribution of FDI among member member countries in the region. When economies. While increased intra-regional most inward FDI is from extra-regional FDI enhances the regional integration sources, the attractiveness of the enlarged process, competition for FDI between market size depends also on the margin member states could be divisive and of preference between the MFN-applied costly if fiscal incentives are involved. tariffs and the FTA tariff preferences. For To minimize such competition, ASEAN, example, ASEAN is heavily dependent on for example, emphasizes investment FDI from extra-regional sources, yet these cooperation among its members. It investors at present are not accorded the has organized ministerial-level joint same treatment as investors from within investment promotion activities in major ASEAN. A further concern arises when developed economies promoting ASEAN some national FDI policies are more as an investment region (the “ASEAN generous than the regional ASEAN FDI Road Show”). The ASEAN Secretariat policy. has also undertaken several investment facilitation activities, including providing FDI from intra-regional sources information through portals, databases, publications, and statistics. FTAs may discourage horizontal “tariff jumping” FDI because it becomes cheaper WTO Provisions on Investment to serve member countries through trade rather than by establishing a subsidiary While trade in goods and services is and incurring plant-level and firm-level covered by WTO rules, there are no costs. The FTA region could be served corresponding rules on international part ii: coverage of a free Trade agreement | 77

investment flows. A number of efforts requirements, with transition to establish international rules on periods of 2 years for developed investment have failed. The latest is the countries, 5 years for developing abandonment after the 2003 Cancun countries, and 7 years for LDCs. meeting of the Doha Development Agenda 3. The Agreement on Trade-Related to establish a multilateral agreement on Aspects of Intellectual Property investment (MAI). The MAI was perceived Rights (TRIPS) sets minimum as unbalanced and unacceptable to many standards of protection for specific developing countries since it sought categories of intellectual property to protect investors and there were and includes national treatment, no provisions on investor obligations. MFN treatment, domestic Developing member countries of the WTO enforcement procedures, and were concerned that this would prevent international dispute settlement. or reduce their policy space to determine It builds on existing conventions their own investment policies. like the Berne Convention, Without an overarching MAI, foreign the Paris Convention, and the investment provisions are dealt with in Washington Treaty on Intellectual a fragmented fashion in several existing Property in Respect of Integrated WTO Agreements. Circuits. 4. Under the Government 1. In the General Agreement on Procurement Agreement (GPA), Trade in Services (GATS), FDI tenders may not discriminate is covered under supply mode against foreign products and 3 (commercial presence). GATS foreign suppliers and locally adopts a positive-list approach, established suppliers that are that is, countries can decide which foreign-affiliated or foreign- service sectors to commit. Once owned. The GPA disallows a sector is committed, horizontal “offsets” in the evaluation of (all sectors) market access and tenders and award of contracts. national treatment principles 5. The Agreement on Subsidies and apply, unless otherwise notified. Countervailing Measures (ASCM) 2. Under the Agreement on prohibits the use of investment Trade-Related Investment incentives that fall under the Measures (TRIMS), countries definition of a “subsidy” and cannot impose trade-related cause “adverse effects.” Subsidies performance requirements on contingent on the exportation of firms that are inconsistent with goods produced are prohibited. the national treatment principle. Adverse effects are defined in The annex to TRIMS contains terms of distortions in the trade an illustrative list of prohibited flows of subsidized goods. performance requirements. Many governments have used local Investment Provisions of FTAs content requirements in the past to promote backward integration The investment provisions of FTAs are and domestic value added, such aimed at giving investors in the FTA as in the automobile industry. member countries better market access TRIMS provides for the phasing and right of establishment and national out of prohibited performance treatment, as well as restraint in the use 78 | How to design, negotiate, and implement a free trade agreement in asia

of performance requirements. However, Box 2.13: Bilateral Investment Treaties there are still substantial safeguard Investment provisions can be contained in bilateral measures in the FTAs and in the national investment treaties (BITs) as well as free trade agreements laws that restrict FDI. The investment (FTAs). Without an overarching multilateral agreement provisions of FTAs usually go beyond on investment (MAI), BITs remain the main instrument for those in the WTO, particularly the negotiating investment rules between countries. There are provisions on the right of establishment. currently well over 2,100 BITs in existence. They are usually Three categories of FTAs may be designed to protect foreign direct investments (FDIs) from expropriation and ensure certain standards of treatment distinguished in this regard: by the host country. The actual contents of BITs can vary. US BITs often include pre-establishment rights, while (i) Those that do not have European BITs usually focus on post-establishment rights. investment-related provisions Most developed investing countries have already except for trade rules. This is the signed many BITs with developing host countries. They seek diplomatic protection of their nationals and case with most FTAs between their assets, and guarantees regarding repatriation of developing countries. revenues earned. In particular, BITs are useful in ensuring (ii) Those that include comprehensive FDI flows to developing countries that lack sufficient investment provisions from the national legal safeguards for the protection of assets start, including pre-establishment and property rights. ASEAN countries have entered national treatment and into BITs that facilitate post-establishment rather than pre-establishment rights. Singapore’s FTA investment effective investor-state dispute chapters, however, tend to cover pre-establishment mechanisms, such as NAFTA. rights as well. There are even many BITs between ASEAN (iii) Those that evolved toward a member countries. common approach over time, Source: ADB staff. introducing new provisions to promote regional investment cooperation and grant national and equipment, to intangible assets treatment and MFN treatment to such as patents, know-how, and other foreign firms, as is the case with intellectual properties, as well as the ASEAN’s AIA agreement, signed licenses and permits needed to carry out in 1998. the investment. Usually what results is a combination of both definitions. Some The investment provisions of FTAs agreements cover only FDI and specifically can be categorized under definitions of exclude portfolio investment, such as the investment and investors, treatment of AIA. This reflects ASEAN’s aversion to investments and investors, and dispute portfolio investments after the 1997 Asian resolution and settlement. financial crisis. Some agreements include concession agreements and the right to Definition of investment and investors search for natural resources. In ASEAN, only investments “approved in writing” Investment. Investments are usually are protected under the AIA, while other defined to be broader than FDI flows. investments are protected either by There are two principal ways of defining the national laws of the host country, investments. The enterprise-based BITs (see Box 2.13), or the principles of method defines the enterprise that is to international law on state responsibility. be covered and then defines the assets of the enterprise to be included. The assets- Investor. Foreign investments can be based method (NAFTA-type) itemizes the made by natural persons or by corporate types of assets to be included, ranging entities. Usually investment protection from physical assets such as machinery is confined to citizens, although the part ii: coverage of a free Trade agreement | 79

Malaysia and Singapore agreements, and finance, transportation, power for example, also include permanent and energy generation, media and residents. In common-law countries telecommunications, land and natural (such as Brunei Darussalam, Malaysia, resources, real estate, small-scale and Singapore) the concept of corporate agriculture, and small and medium nationality is based on incorporation, so enterprises. Most agreements confine that any company that is incorporated national treatment to the post- in the country assumes its nationality. establishment phase only. Many However, in civil-law countries (like the agreements also exclude state enterprises Philippines and Thailand), nationality from the national treatment rule. In is based on the location of the effective addition, most agreements reserve the management of the company. right to implement future measures concerning the limitation of national Treatment of Investors and Investments. treatment to several sectors, especially in While many FTAs would include “fair the service sectors. and equitable treatment,” others provide national treatment and MFN treatment for Flexibility in National Treatment pre-establishment and post-establishment. Provision. Some agreements seek to Some investment provisions apply to postpone national treatment to reflect the listed sectors only (positive approach), lower level of economic development of while others apply to all sectors with the host country, while other agreements listed exceptions (negative approach). confine national treatment only to those in “like circumstances.” Some agreements National Treatment. National treatment provide for national treatment “as far means that the foreign investor should as possible.” In the APEC Non-binding be treated on equal terms with local Investment Principles, the national investors. National treatment is desired by treatment provision states that such foreign investors, but some host countries treatment is “subject to the exceptions as are reluctant to give it, preferring provided for in domestic laws, regulations instead to support local firms. National and policies.” treatment at the pre-establishment stage refers to the right of establishment or Fair and Equitable Standard. This foreign ownership of corporate equity, usually means that certain rights and other assets, and land. At the extreme, privileges usually regarded as having been foreign ownership is prohibited from accepted in customary international law certain sectors and enterprises, while in should be accorded the foreign investor. most cases majority foreign ownership is As discussed below, Urata and Sasuya controlled. (2007) conducted a recent study of seven bilateral FTAs, covering the US, Canada, Exceptions to National Treatment. Many Mexico, Japan, Singapore, and Australia, host countries, both developed and and found that Canada, Mexico, and developing, impose sectoral limitations Australia have highly restrictive screening on foreign ownership and control to and approval of FDI projects. Under the shelter their strategic and sensitive Investment Canada Act, Canada requires sectors from foreign investor competition a review of all acquisitions of Canadian and on national security grounds. businesses, with the value of the assets Excluded sectors are commonly found and the control being acquired. Japan in the land and natural resource and highly restricts the movement of foreign service sectors and include banking investors. Australia, Canada, Chile, the 80 | How to design, negotiate, and implement a free trade agreement in asia

Republic of Korea, and Mexico are very could cover a percentage of firm restrictive in their service sectors. In the production that has to be exported, the transportation sector, there are limitations purchase of local products and services, on foreign ownership especially of and the employment of local labor. Unlike oceangoing vessels and airlines; TRIMS, which prohibits only trade- often, concessions for the domestic air related performance requirements, FTAs transportation sector are provided only to seek to prohibit them altogether in their domestic companies. In information and investment provisions. communications, Mexico, the Republic of Korea, and Singapore limit foreign (i) NAFTA forbids the use of ownership in newspaper publishing. performance requirements. Japan limits foreign ownership in Nippon Developed countries argue that Telegraph and Telephone Corporation performance requirements distort (NTT) to less than one third of total share international trade. First, their capital, and does not allow foreigners imposition may result in the to serve as directors or auditors. The foreign investor using inefficient financial sector of Japan also has inputs or production processes, or limitations on foreign ownership and both. Second, they may influence market access. Singapore restricts foreign the type of investment, as they bank provision of retail customer services could affect the quality of inputs such as the establishment of automated used and, hence, investment teller machine (ATM) networking, but profitability. relaxes the restriction under the (ii) In the past, ASEAN countries, US-Singapore FTA. except Singapore, linked investment incentives to performance Most-Favored-Nation Treatment. MFN requirements. However, net clauses are commonly found in trade incentives matter to investors, and agreements. The foreign investor the performance requirements desires national treatment between could negate the positive effects himself and the local investors, as well of investment incentives. TRIMS- as nondiscriminatory treatment with inconsistent performance other foreign investors. This means requirements have been removed that privileges created in other future under the WTO Agreement. agreements will automatically flow to It should be noted, however, nationals of the first agreement. For that abolishing performance example, privileges accorded to US requirements alone is unlikely investors in the US-Singapore FTA would to attract FDI if other positive also be accorded to Japanese investors elements of the investment climate even though they were not included in the are absent. earlier Japan-Singapore FTA. However, privileges given by Singapore in the Expropriation and Nationalization. context of ASEAN do not automatically International law and regulations flow to Singapore’s bilateral FTA partners. normally allow expropriation of foreign assets only when it is in the public Performance Requirements. These are interest, is nondiscriminatory, and is imposed by host developing countries made with adequate compensation. FTAs to ensure that the foreign investor with such provisions aim at reducing contributes to expected benefits. They the noncommercial risks of foreign part ii: coverage of a free Trade agreement | 1

investment. Home countries require or in other exceptional circumstances payment of prompt, adequate, and in which capital movements could effective compensation. result in serious economic and financial Most agreements favor the “full disturbance.” There are agreements that compensation” formula. However, some refer explicitly to the right of a country developing countries seek an alternative under the IMF Agreement to impose flexible formula that would enable them exchange restrictions. Also, GATS (Article to pay compensation within a flexible XII) provides that repatriation may be time frame in times of balance-of- stopped in the event of serious balance- payments difficulties. Many investment of-payments and external financial agreements have also addressed the issue difficulties. that the protection of the environment or other interests of the state should Use of Investment Incentives. Developing not be construed as amounting to host countries, including many in ASEAN, expropriation. For example, the side letter often use a variety of fiscal and non-fiscal in the US-Singapore FTA reads: “Except incentives to attract FDI. These incentives in rare circumstances, nondiscriminatory are largely given at the discretion of regulatory actions, designed and applied host governments and are normally not to protect public welfare objectives, included in the investment provisions of such as public health, safety and the FTAs or in BITs. Their use is controversial, environment do not constitute indirect as is the case with the use of performance expropriation.” requirements. Critics point to lack of evidence of their efficacy in attracting Repatriation of Profits and Other FDI, their distortionary effect on resource Proceeds. Some countries insist on allocation, and their negative effect on guarantees in agreements that assure tax revenues. the ready repatriation of profits as well as the proceeds of liquidated assets in Responsibilities of MNCs. One major a freely convertible currency and at reason why the MAI failed to find the prevailing exchange rate. However, acceptance among developing countries strong repatriation provisions may be is its failure to incorporate the interests resisted by host developing countries of developing host countries by also that face balance-of-payments problems, requiring investing MNCs to meet particularly occasioned by sudden standards of performance. BITs and flights of capital such as those that the investment provisions of FTAs also triggered the Asian financial crisis in generally make no express reference to 1997. Some safeguard provisions in the responsibility of MNCs, particularly investment agreements may provide for toward the environment. However, in such situations. For example, Chilean Indonesian agreements, a foreign MNC agreements generally contain the that pollutes the environment would not provision that “equity capital can only be acting in accordance with Indonesian be transferred one year after it has laws and would not enjoy investment entered the territory of the Contracting protection. Additionally, the Indonesian Party unless its legislation provides investment agency (BKPM) could for a more favorable treatment.” The introduce conditions on foreign investors Japan-Singapore FTA provides for the at the time of entry and the granting of suspension of repatriation rights “in the license to operate. event of external financial difficulties 82 | How to design, negotiate, and implement a free trade agreement in asia

Dispute resolution and settlement economic stability, a well-established and transparent legal and regulatory Investment rules, including those on framework (including protection of expropriation, need to be backed by an intellectual property), and availability effective dispute settlement mechanism. of cost-effective physical infrastructure This can be state-to-state or investor-to- and human resources. Countries that state. Some host countries are averse to wish to attract FDI in high-tech activities investor-to-state dispute settlement built have to ensure a favorable environment into investment agreements. Disputes can for research and development, while be settled by national or regional courts, countries that wish to attract FDI primarily or referred to international arbitration for employment creation have to ensure under the Convention of the Settlement a favorable labor market. Likewise, to of Investment Disputes (ICSID) or the UN be effective, provisions on investment Commission on liberalization and protection have to (UNCITRAL). be buttressed by liberal trade rules, fair competition laws, and protection of FDI Strategy and Best Practices intellectual property rights (IPR). National treatment and MFN treatment The investment provisions of FTAs are are the cardinal principles desired by aimed at liberalizing the regulations and foreign investors. FTAs seek to enshrine protecting investments to encourage these principles. Nonetheless, economic freer and greater cross-border flows of and policy space will ultimately be investment, particularly of FDI. These necessary to enable the host country provisions have to be negotiated, taking to protect key and sensitive sectors into account the laws, regulations, and and businesses from free and open policies governing foreign investment competition from foreign investors. in the FTA partner countries. Often, However, these temporary and permanent investment commitments in FTAs require exclusions from national treatment should corresponding changes in national laws, not be lengthy and should be time-bound; regulations, and policies, which take time otherwise, the liberalizing principles to put in place. lose their meaning. Nondiscriminatory There is growing recognition that FDI treatment of investments and investors can contribute to a country’s economic would enable a country to attract development, more particularly to investment from the best sources participation in regional production and assure a level playing field to all networks and global supply chains, and investors. technological and marketing capabilities An equally important principle sought in manufacturing. This benefit is strongly by foreign investors is the protection exemplified by the role of FDI in the rise of of their investments from arbitrary the PRC as a manufacturing power in the and unjustified expropriation and past decade. Global competition for FDI nationalization. However, host countries has intensified as FTAs have become more need to negotiate safeguard measures global in reach and as individual countries to cover themselves in “emergency have unilaterally liberalized. Besides situations.” Dispute resolution could be liberalizing their policies and regulations, undertaken under the impartial ICSID and host countries must also ensure that other UNICTRAL. key elements of a favorable investment In the final analysis, the investment climate exist, that is: political and provisions of FTAs represent a fine part ii: coverage of a free Trade agreement | 

balancing act between a country’s lowers trade barriers in government economic, political, and social benefits procurement through a framework of and the perceived costs of FDI. For common procurement procedures, example, ASEAN would do better to have transparency at all stages of the a common template when negotiating procurement process, and the opportunity the investment chapters in FTAs with its for aggrieved private bidders to challenge various dialogue partners. This would procurement decisions and obtain help ensure coherence among the various redress. At the 1996 Singapore Ministerial agreements and attract more external FDI. Conference, the WTO working group was mandated to look into the “transparency” aspects of government contracts. Many FTA-Plus Chapters developing countries objected to a WTO agreement on government procurement covering national treatment, as they Traditional FTAs as defined by economists provide preferential treatment to national focused almost exclusively on tariffs. firms, suppliers, and contractors. The Even the EC, which began as a customs procurement issue was removed from the union and ultimately evolved into an Doha agenda in 2004. , had diverse commercial policies (e.g., independent nontariff Government procurement in FTAs barriers and lack of national treatment in certain areas) even three decades Government procurement is a key feature after its foundation. It is clear from this of many FTAs. This reflects the failure to reference book that modern FTAs are secure an agreement at the multilateral complicated; in certain areas they even level and the recognition that foreign go beyond what the EC included. In this suppliers of goods and services require section, we consider four additional key not only nondiscriminatory market access features typically included in modern but also transparent and fair procedures FTAs, particularly in the context of FTAs that allow them to compete on a level in which at least one developed country playing field. is a party: government procurement, APEC developed a set of voluntary, intellectual property protection, nonbinding principles on government competition policy, and environmental procurement. The principles, intended to and labor standards. promote the liberalization of government procurement markets and transparency, Government Procurement cover value for money, open and effective competition, fair dealing, accountability Government procurement in the WTO and due process, and nondiscrimination. FTAs have gone beyond the GPA and The WTO Government Procurement include many developing (and some Agreement (GPA) is a plurilateral developed) countries that did not sign agreement among 27 WTO members the plurilateral GPA. They are more that include the EU; the US; Japan; Hong comprehensive in coverage, involving Kong, China; the Republic of Korea; and transparency and information access, Singapore. Few developing countries market access and national treatment, are members, and some OECD countries various tiers of government and various have not signed the GPA. It is essentially types of government business, and lower a market access agreement because it monetary thresholds for contracts. 84 | How to design, negotiate, and implement a free trade agreement in asia

Nondiscriminatory Treatment. The Singapore–New Zealand FTA, for Nondiscrimination requires each example, commits to implement the government to accord the suppliers, APEC nonbinding principles relating goods, and services of its FTA partner the to transparency, value for money, open same treatment that applies to domestic and effective competition, fair dealing, suppliers, goods, and services. Like the accountability and due process, and GPA, these agreements explicitly prohibit nondiscrimination. The US-Singapore offsets. FTA also makes reference to applying the APEC nonbinding principles. Thus, Transparency. FTAs promote transparency the APEC nonbinding principles appear through the collection and dissemination to offer a common template for bilateral of all relevant information by electronic FTA negotiations on government means. For example, the e-ASEAN procurement. Framework Agreement calls for the use of electronic means in the procurement of Intellectual Property goods and services by members. NAFTA adopts lower thresholds and a Intellectual property provisions of FTAs negative-list approach to service coverage. compared NAFTA seems to have influenced several bilateral agreements involving The starting point for intellectual property the US. In the US-Australia FTA, the (IP) rules in FTAs is the network of procurement chapter sets out specific existing IP treaties 103 that bind almost rules, procedures, and transparency all trading nations. Many provisions of standards to be applied in the conduct these treaties are incorporated into the of government procurement. Australia WTO TRIPS Agreement (discussed in becomes a “designated country” under the Investment section above), which is the US Trade Agreements Act and, hence, applicable to all WTO members. Together, enjoys a waiver from the Buy American these rules form the lowest common Act, which enables Australian suppliers to denominator of IP obligations. They bind compete in the US procurement market both developed and developing countries, on equal terms with American suppliers although LDC members of the WTO and suppliers from other “designated Agreement enjoy a waiver until 1 January countries.” In the negotiations for the US- 2016 before they must provide patent Malaysia FTA, government procurement protection for pharmaceutical products. has been one of the sticking points. In FTAs often strengthen IP protection Malaysia, government procurement is beyond that required by the WTO TRIPS a key pillar of affirmative action policy, Agreement. Such provisions are called and a nondiscriminatory government procurement policy would undermine 103 The WTO incorporates parts of the Paris Convention such affirmative action. for the Protection of Industrial Property (governing patents, trademarks, service marks, industrial designs, There are no government procurement and utility models); the Berne Convention for the provisions in AFTA nor in the FTAs that Protection of Literary and Artistic Works (Copyright and Related Rights); the International Convention for ASEAN has concluded with the PRC the Protection of Performers, Producers of Phonograms and the Republic of Korea. However, and Broadcasting Organisations (Rome Convention); and the Treaty on Intellectual Property in Respect there are government procurement of Integrated Circuits (IPIC, or Washington Treaty), chapters in Singapore’s FTAs with which governs layout designs/topographies). The text of these World Intellectual Property Organization New Zealand, Japan, the Republic of (WIPO)–administered treaties can be found at: www. Korea, India, Australia, and the US. wipo.int/treaties/en/ part ii: coverage of a free Trade agreement | 

“TRIPS-plus” provisions, since they exceed identified with well-known trademarks; the minimum obligations contained in the and protect new types of marks such as TRIPS Agreement. TRIPS-plus provisions scent and sound marks. include (i) the implementation of higher The IP provisions of FTAs differ, IP protection than that required in the depending on the level of development TRIPS Agreement, or (ii) an agreement of the parties to an FTA. FTAs between to forgo transition periods and privileges developed countries frequently contain that developing countries and countries provisions requiring the ratification in economic transition negotiated during of post-TRIPS IP agreements, and and after the Uruguay Round of GATT. cooperation in the implementation The US and the EU in particular use of TRIPS provisions, including the FTAs as a vehicle for negotiating TRIPS- enforcement of laws protecting foreign plus commitments. Typical commitments intellectual property. The Singapore- include agreements to accept the Australia Free Trade Agreement (SAFTA) patentability of plants and animals provides a good example of an FTA other than microorganisms; 104 join the between a developed country and International Union for the Protection an advanced . 109 of New Varieties of Plants (UPOV) Section 13 deals explicitly with IP Convention; 105 grant additional protection protection. Article 2 of Section 13 to geographic indications beyond the reconfirms each party’s commitment to weak protection granted in TRIPS Articles the TRIPS Agreement (a common FTA 22–24 (particularly in the alcoholic provision) and obligates the parties beverage sector); 106 limit parallel imports; to accede or ratify several post-TRIPS extend industrial design, patent, and IP agreements: the World Intellectual copyright protection; 107 limit compulsory Property Organization (WIPO) Copyright licensing, particularly in the public health Treaty, the WIPO Performances and field; 108 increase penalties for breaches of Phonograms Treaty, and the Geneva Act IP rights (IPR), increase IPR enforcement of the Hague Agreement Concerning the rules; expand the scope of trademark International Registration of Industrial protection to cover dissimilar goods Designs. Article 5 requires the parties to “cooperate with a view to eliminating 104 See The Agreement on Trade-Related Aspects of trade in goods infringing intellectual Intellectual Property Rights (TRIPS) Article 27.3(b). property rights, subject to their respective 105 www.upov.int/en/publications/conventions/index. html. laws, rules, regulations, directives or 106 TRIPS Articles 22–24 apply to “geographical policies.” In Article 6 the parties agree to indications”—a term defined in Article 22 of the TRIPS Agreement as “indications which identify a cooperate on education and the exchange good as originating in the territory of a Member, or of information on the protection, a region or locality in that territory, where a given quality, reputation or other characteristic of the good management, and exploitation of IPR. is essentially attributable to its geographical origin.” More stringent IP obligations are found in 107 The minimum periods of protection in the TRIPS the US-Singapore FTA. 110 Agreement for protection are 10 years for industrial designs (Article 26([3)]), 20 years for patents (Article 33), and 50 years for copyrights (Article 12). 109 www.dfat.gov.au/trade/negotiations/safta/full_safta. 108 Compulsory licensing is a decision by a government to pdf allow the use of the subject matter of a patent without 110 Chapter 16 (Articles 16.1–16.10) of the US-Singapore the right holder’s consent. Compulsory licensing is Free Trade Agreement contains a large number of permitted by Article 31 of the TRIPS Agreement, in TRIPS-plus provisions, including the ratification of particular with respect to certain pharmaceutical many additional IP Agreements, and a considerable products, subject to recent disciplines agreed on by number of provisions directed at the enforcement WTO members. See generally the WTO instruments of IP obligations. See www.ustr.gov/assets/Trade_ dealing with TRIPS and Public Health: www.wto. Agreements/Bilateral/Singapore_FTA/Final_Texts/ org/english/tratop_e/trips_e/pharmpatent_e.htm asset_upload_file708_4036.pdf 86 | How to design, negotiate, and implement a free trade agreement in asia

Chapter 13 of the Thailand-Australia investigate allegations of patent and FTA 111 provides a more typical example of trademark infringement. the IP protection found in an agreement Best practices also include fulfilling between a developed and a developing any TRIPS-plus obligations FTA members country. IP obligations are not as strong have accepted. The more a country as those in either the SAFTA or the US- develops and trades, the more pressure Singapore FTA, but are nevertheless the developed world will place on it to present. In general, cooperation with meet its IP commitments, and to accept respect to existing IP obligations is the TRIPS-plus commitments. The fulfilment theme. Article 1302 requires the parties of IP commitments, in turn, requires to observe the TRIPS Agreement. Article educating the private sector, civil society, 1303 requires the parties, upon receipt enforcement agencies, and the judiciary of information or a complaint, to take about IP protection. Good governance, measures to prevent the export of goods including an effective judiciary, is that infringe copyright or trademarks, in necessary for an effective IP regime. accordance with its laws, regulations, or The priority a country places on IP policies. Likewise, Article 1304 requires protection will depend on its level of the parties to cooperate on enforcement, development, as well as demand from and Article 1305 requires cooperation on its own business, scientific, and cultural educational activities. community. LDCs almost never receive serious foreign pressure to enforce Framework of best practices and practical IP rules. They also benefit from the approaches to intellectual property temporary waiver of patent protection for pharmaceutical products enacted in the Developed countries and advanced course of the Doha Development Agenda. developing countries are expected to This point should be considered by LDCs conform to IP best practices. This means seeking to negotiate an FTA. fulfilling their international IP obligations arising under the WTO Agreement and Policy recommendations and strategy for international IP treaties, in particular civil negotiating IP provisions in FTAs and criminal enforcement obligations. 112 Enforcement issues are a sensitive subject The advanced developed countries in many ADB member countries, as a already have solid IP protection in place result of the large number of TRIPS and are important beneficiaries of the requirements concerning enforcement, IP system. Their business interests are the stringent enforcement provisions the main proponents of TRIPS-plus present in the US-Singapore FTA, and commitments. Because of the market legislation such as Section 337 of access opportunities that developed the of the US Tariff Act of 1930 (19 countries can offer to developing U.S.C. §1337), which empowers the countries, they are in a strong negotiating US International Trade Commission to position vis-à-vis the developing world when they negotiate IP issues. Nevertheless, developing countries 111 www.dfat.gov.au/trade/negotiations/aust-thai/tafta_ toc.html have historically been hesitant to tighten 112 Unlike many of the WTO’s covered agreements, IP protection, both in the WTO and in Articles 41–61 of the TRIPS Agreement require members to establish fair and equitable procedures for FTAs. IP protection is generally viewed the enforcement of intellectual property rights (IPR). in developing countries as favoring part ii: coverage of a free Trade agreement | 7

developed countries and their business provide an indication of a country’s interests. IP protection is, however, real ambitions in the negotiations. of increasing importance to certain (iii) A developing country should developing countries, in particular study matters being discussed those that (i) seek to attract FDI (see and negotiated in the WTO, the Investment section above); (ii) have including the review of Article innovators in particular technology 27.3(b) of the TRIPS Agreement sectors; or (iii) seek to protect their film, on the patentability of plant print, and music industries. and animal inventions, and the Developing countries that negotiate negotiations on the protection of TRIPS-plus commitments with the traditional knowledge, folklore, developed countries should evaluate the and biodiversity. merits of more stringent IP protection. In (iv) If an FTA includes two or more particular, they should look at access to developing-country members, technology, health issues (in particular the developing countries should access to medicines), the protection of consider working together to domestic innovation, and the protection negotiate with prospective of domestic artists, software producers, developed-country members. etc. They should also evaluate the Economic blocs, like the EU, have relative strength of their negotiating stronger negotiating power than position in light of their existing TRIPS individual countries. Likewise, commitments; the economic importance developing-country blocs are of the FTA, either directly or as a vehicle beginning to enjoy greater to attract FDI and increase development; negotiating strength. Some and the positive and negative effects developing countries are already of strengthened IP commitments on beginning to work together on disadvantaged members of society. TRIPS-plus issues. 113 Developing countries should also consider (v) Prospective FTA partners from IP commitments that they would like to the developed world may expect receive from prospective FTA partners, at least minimal IP concessions such as the protection of traditional from developing-country partners. knowledge and folklore (including Developing countries should medicinal plants) and biodiversity. identify the sectors in which There are strategies for strengthening a they want market access or other developing country’s negotiating position concessions, in return for IP when negotiating IP commitments in an concessions. FTA, such as the following: (vi) If IP concessions are inevitable, the developing country should (i) A developing country should enter seek in return exemptions for FTA negotiations knowing what it sensitive sectors, long transition wants to gain. periods, technical assistance, (ii) A developing country should study other FTAs that prospective FTA 113 For example in 2005, 10 Latin American health partners have signed, particularly ministers issued a joint declaration calling for FTAs signed by countries at a avoidance of TRIPS-plus provisions. (See Third World Network Info Service on WTO and Trade Issues. 2006. similar level of development. More South American Ministers Vow to Avoid TRIPS Plus recent FTAs are more likely to Measures. 1 June. Available: www.twnside.org.sg) 88 | How to design, negotiate, and implement a free trade agreement in asia

infrastructure (computers, Provisions on competition in the WTO etc.), and training programs for authorities working on Competition-related provisions have IP-related issues, including been incorporated in the GATT and training programs in developed subsequent WTO agreements in a countries. piecemeal manner. It appears in GATT (vii) The developing country should Article VI on antidumping measures consult IP and FTA specialists and countervailing duties; GATT Article at ADB, WTO, the United XVII on state trading enterprises; GATS Nations Conference on Trade Article VIII on monopolies and exclusive and Development (UNCTAD), service suppliers; GATS Article IX on the World Health Organization business practices; and agreements on (WHO), and other international TRIPS, TRIMS, Safeguards, Technical organizations before entering FTA Barriers to Trade, Application of negotiations. Sanitary and Phytosanitary Measures; (viii) The developing country Preshipment Inspection, Government should consult other relevant Procurement, and Trade in Civil Aircraft. stakeholders and groups, Proposals have been made to extend including businesses, trade the WTO rules to include multilateral associations, chambers of disciplines in competition policies. A commerce, and NGOs, before WTO working group has been mandated entering FTA negotiations. to focus on clarifying certain core principles, including transparency, Competition Policy nondiscrimination, procedural fairness, and provisions on hardcore cartels’ Hoekman (1998) distinguishes modalities for voluntary cooperation, and competition policies in general from support for the progressive reinforcement antitrust or . Competition of competition institutions in developing policy refers to the broad set of countries through capacity building. measures and instruments pursued by governments to enhance the contestability Provisions on competition in FTAs of markets, of which antitrust law is a subset. Competition policy is directed Competition-related provisions are in at both government and private sector widespread use in FTAs and they expand actions and includes privatizing state- on the WTO disciplines. For example, owned enterprises (SOEs), deregulating APEC has produced a set of nonbinding activities, cutting firm-specific subsidies principles on competition. The objective (), and reducing policies is to introduce and maintain “effective that discriminate against foreign products or adequate competition policy and/or and suppliers. Antitrust laws are directed laws and associated enforcement policies, at private sector behavior. They involve ensuring the transparency of the above, instruments that control or regulate and promoting cooperation among APEC the permissible behavior of private economies, thereby maximizing, among firms or natural persons. They prohibit other things, the efficient operation of anticompetitive practices like price fixing, markets, competition among producers collusion between firms to restrict output, and traders, and consumer benefits.” or abuse of a dominant position. The principles cover nondiscrimination, part ii: coverage of a free Trade agreement | 9

comprehensiveness, transparency, and In the Australia–New Zealand CER accountability. (ANZCEFTA), complaints about the Typically the competition chapter in misuse of substantial market power an FTA would contain several important may be filed, heard, and enforced in obligations, e.g., commitments to ensure either jurisdiction. These are buttressed that (i) anticompetitive business practices by a separate bilateral enforcement are proscribed, (ii) monopolies do not agreement with extensive investigatory abuse their powers, (iii) there are avenues assistance and exchange of information. for complaints of unfair practices to be ANZCEFTA phased out the application initiated, and (iv) the relevant authorities of antidumping remedies. In the US- commit to cooperate and consult one Singapore FTA, the US was interested another to facilitate enforcement and in how Singapore’s SOEs competed and share best practices. Competition policy in interacted with other companies and how FTAs is generally of two types: (i) supra- they were regulated, particularly in view national coordination of specific of their significant role in the Singapore competition rules, and (ii) general economy. The Competition Policy chapter obligations against anticompetitive ensures that Singapore SOEs are subject conduct. to the same rules of fair competition as other companies, and that US companies Supranational Coordination of in Singapore would be guaranteed a level Specific Competition Rules. In the EU, playing field. The Singapore Government enforcement of competition rules falls also committed to continue its policy on the supranational institutions. At the of not intervening in the commercial same time, EU member states maintain operations of SOEs, reduce its stake in separate and distinct national competition SOEs over time, and enact a competition laws and national competition authorities. law by 2005. The EU also has trade agreements with third countries that call for the adoption Environmental and Labor Standards and coordination of specific competition standards and rules. Almost every country adopts laws intended to maintain socially mandated General Obligations against environmental and labor standards. Anticompetitive Conduct. These are However, these standards vary across general obligations to take action against countries as a consequence of historical anticompetitive business conduct. NAFTA developments as well as economic and Chapter 15 on competition policy, social factors. Standards tend to rise monopolies, and state enterprises requires with per capita income; at higher income member countries to “adopt or maintain levels, citizens’ demands move beyond measures to proscribe anticompetitive basic necessities and begin to focus business conduct and to take appropriate on issues like clean air and water and action with respect thereto.” FTA members elimination of child labor that may have are to consult and cooperate on the no direct effect on their personal living effectiveness of their national competition conditions. Differences across countries in laws and to cooperate on the enforcement environmental standards may also reflect of those laws via mutual legal assistance, climate and geographic factors. notification, consultation, and the Some FTAs include provisions on exchange of information. environmental or labor standards. 90 | How to design, negotiate, and implement a free trade agreement in asia

Specific terms may arise from one Environmental standards or more of three concerns. First, and especially when partners are at different While the Marrakesh Agreement stages of development, the partner with establishing the WTO begins with a higher standards may fear that a trading commitment to optimal use of the world’s partner’s lower standards may translate resources, sustainable development, into a cost advantage in production and and environmental protection, WTO thus a competitive advantage in trade rules place few restrictions on the (“social dumping”). Second, partners may environmental policies of its members. fear that FTA commitments may restrict The basic principle underlying WTO a member’s ability to regulate activity, rulings on disputes arising from national including FDI, within its borders so as environmental policies is that such to maintain its own desired standards. policies should not be applied in a way Finally, developing countries may seek that distorts trade by discriminating technical or financial assistance in raising between domestic and foreign producers standards at home through participation or between different trading partners. in the agreement. Countries are free to use subsidies to Some agreements, such as the Republic achieve environmental objectives, and of Korea–EFTA FTA, have no provisions WTO agreements dealing with such issues regarding environmental and labor as product standards, food safety, and IP standards. The Republic of Korea–Chile protection acknowledge their relevance FTA does not provide for labor standards, to environmental goals. Ongoing efforts but its provision on environmental in the WTO to reduce agricultural standards reserves the right of either party subsidies are likely to have important to set appropriate standards for investment environmental benefits in addition within its boundaries and warns against to their primary goal of removing an encouraging investment through the important source of distortion in world relaxation of domestic health, safety, trade flows. or environmental measures. Beginning The official stance of the WTO and of with NAFTA, all free-trade negotiations many WTO members is that the setting between the US and partner countries of international rules for environmental have incorporated provisions on both protection should be left to environmental environmental and labor standards. 114 agencies and conventions. While there Typically these oblige each country to are potential conflicts between terms of enforce its own environmental and labor multilateral environmental agreements laws, address consistency with multilateral (MEAs) and the WTO over the use environmental agreements, and affirm of trade policies such as sanctions or obligations under the International Labour other import restrictions to enforce an Organization (ILO) (e.g., Australia-US FTA environmental agreement, in practice no and Singapore-US FTA). such conflict has arisen. Most FTAs have no provision dealing specifically with environmental issues. 114 The Canada-US FTA dealt only with potential conflicts with parties’ trade obligations under various A few others explicitly address the international environmental agreements. In NAFTA, environment in chapters on other environmental and labor provisions appeared as side agreements added late in the negotiation to subjects. For example, the ASEAN-PRC overcome domestic political resistance in the US. FTA includes environment, fishery, and Subsequent FTAs negotiated by the US have included environmental and labor clauses in the body of the forestry among a large number of policy agreement. areas in which the parties commit to part ii: coverage of a free Trade agreement | 91

extend cooperation. The investment financing environmental infrastructure chapter of the Taipei,China–Panama FTA projects along the border. includes a section on environmental The US-Singapore FTA is representative measures, which affirms that the of environmental terms included in agreement should not prevent the parties other US FTAs. The agreement includes from adopting and enforcing appropriate a chapter (18) specifically dealing with measures to protect the environment. It the environment. However, the main also recognizes that “it is inappropriate terms generally call for each party to to encourage investment by relaxing enforce its own environmental laws and domestic health, safety or environmental to avoid using reduced environmental measures.” protection to promote exports or to attract A major exception would be FTAs investment. The environmental chapter negotiated by the US, all of which include also proposes the formation of a joint explicit sections dealing specifically with committee to deal with environmental environmental issues. (These illustrate matters, and calls for each country to the propensity of the US to use FTAs to encourage public participation. achieve a variety of non-trade objectives.) Provisions of the Canada-US FTA (Articles Labor standards 104 and 105, Annex 104.1) indicate that, where the agreement conflicts with trade Labor standards are norms for the way that obligations under specified MEAs, the workers are treated, including child labor latter will prevail. Where a country can and forced labor, the right to organize trade choose among equally effective means unions and to strike, minimum wages, of complying, it will choose the one that health and safety conditions, and working conflicts least with its commitments hours. All WTO member governments under the agreement. NAFTA was one of are committed to a narrow set of the first international trade agreements to internationally recognized “core” standards: include a full treatment of environmental freedom of association, no forced labor, issues and thus set a precedent for no child labor, and no discrimination in the treatment of environmental issues the workplace. Beyond that agreement on in future agreements negotiated by core standards, the primary international the US. Although the NAFTA text organization dealing with labor issues is addresses environmental concerns the International Labour Organization in several places, including a section (ILO) rather than the WTO. 115 Nonetheless, on MEAs with language similar to some groups, especially in wealthier that in the agreement with Canada, countries with higher wages and higher additional environmental provisions labor standards, assert that the much lower are contained in a side agreement. wages in developing countries constitute a The North American Agreement on form of unfair competition. For their part, Environmental Cooperation calls for developing countries understandably see trilateral cooperation on environmental the emphasis on common labor standards matters and includes provisions regarding as a form of protectionism intended to the parties’ responsibility to enforce their keep their goods out of the markets of the environmental laws. The US and Mexico developed countries. agree to establish a bilateral commission to promote cooperation in achieving 115 At the 1996 Singapore Ministerial Conference, WTO members identified the International Labour environmental goals and a North Organization (ILO) as the competent body to negotiate American Development Bank to assist in labor standards. 92 | How to design, negotiate, and implement a free trade agreement in asia

As with environmental issues, most feature in the relevant article of the US- FTAs contain no provisions on labor Jordan agreement (Article 6) subjects standards. FTAs negotiated by the US are compliance with labor laws to the same the principal but not the only exception. dispute settlement process as other While ASEAN FTAs contain no labor provisions of the agreement. However, standards provisions, Malaysia’s FTA with the agreement only requires the parties Japan includes provisions on encouraging “to strive to ensure that domestic laws human resource development and are consistent with “internationally implicitly commits Japan to share the recognized labor rights… and to improve cost. Although the Republic of Korea’s those standards.” other FTAs contain no labor provisions, the agreement with Singapore does include a commitment to promote human Dispute Settlement Mechanism resource development through such activities as exchange of government Scope of the WTO Mechanism officials, cooperation between educational institutions, and special training programs WTO dispute settlement is state-to-state, (Article 18.10). rule-based, and binding, and takes place In contrast, all US FTAs beginning within strict time limits. The Dispute with NAFTA have included special Settlement Understanding (DSU) is provisions on labor standards. The illustrated in a flowchart in Figure 2.1. NAFTA labor provisions are included in The scope of the DSU is set forth in a side agreement, the North American its Appendix I. The DSU applies to the Agreement on Labor Cooperation. agreement establishing the WTO; the Each party commits to “the freedom multilateral trade agreements on trade of association, the right to bargain in goods, trade in services (GATS), and collectively, the right to strike, prohibition trade-related aspects of IPRs (TRIPS); of forced labor, restrictions on labor by the DSU; and two plurilateral trade children and young people, minimum agreements still in force that cover employment standards, elimination trade in civil aircraft and government of employment discrimination, equal procurement. pay for men and women, prevention As the flowchart suggests, WTO of occupational accidents and diseases, disputes may have up to four phases: compensation in case of work accidents (i) mandatory consultations; (ii) in the or occupational diseases, and protection event of unsuccessful consultations, an of migrant workers” consistent with its arbitral procedure in which disputes own domestic laws. The agreement also are heard by a panel, composed usually creates a tri-national labor commission to of three persons serving as finders of facilitate the achievement of its objectives fact and law; (iii) an appellate system and “to deal with labor issues in a under which the finding of the panel cooperative and consultative manner that (the panel report) can be appealed to an duly respects each nation’s sovereignty.” appellate body; and (iv) an enforcement Subsequent FTAs place labor provisions in mechanism according to which the the main text but are similar in requiring winning party may impose sanctions each country to enforce its own labor (withdraw trade concessions) until the laws without regard to whether those losing party brings its trade measures into laws are consistent with internationally conformity with the recommendations of recognized labor standards. A new the WTO Dispute Settlement Body. parT ii: Coverage of a free Trade agreemenT | 9

figure 2.1: WTO Dispute Settlement Flowchart

Consultations 60 days (Art. 4)

During all stages Panel established good offices, conciliation, by 2nd DSB by Dispute Settlement Body (DSB) (Art. 6) or mediation (Art. 5) meeting

0-20 days Terms of reference (Art. 7) Composition (Art. 8) NOTE: a panel can be ‘composed ’ 20 days (+10 if (i.e., panelists Director-General chosen) up to asked to pick panel) Panel examination Expert review group about 30 days Normally 2 meetings with parties (Art. 12) (Art. 13, Appendix 4) after its 1 meeting with third parties (Art. 10) ‘establishment’ (i.e., after DSB’s decision to have a panel) Interim review stage Review meeting Descriptive part of report with panel sent to parties for comment (Art. 15.1) upon request Interim report sent to parties for comment (Art. 15.2) (Art. 15.2)

6 months from panel’s ... 30 days for composition, Panel report issued to parties appellate report 3 months if urgent (Art. 12.8; Appendix 3 par 12(j))

up to 9 months Panel report issued to DSB from panel’s (Art. 12.9; Appendix 3 par 12(k)) establishment Appellate review max 90 days 60 days for panel (Art. 16.4 and 17) TOTAL FOR report unless DSB adopts panel/appellate report(s) REPORT appealed... including any changes to panel report made by appellate report (Art. 16.1, 16.4, 17.14) ADOPTION: Usually up to 9 months (no appeal), or 12 months ‘REASONABLE Implementation (with appeal) from PERIOD OF TIME’ report by losing party of proposed establishment determined by: implementation within ‘reasonable period of of panel to member proposes, time’ (Art. 21.3) Dispute over adoption of DSB agrees; or parties implementation: report (Art. 20) in dispute agree; Proceedings possible, or arbitrator including referral to (approx 15 months In cases of non-implementation initial panel on if by arbitrator) parties negotiate compensation pending full implementation (Art. 21.5) implementation (Art. 22.2) 90 days

Retaliation if no agreement on compensation, DSB Possibility of arbitration authorizes retaliaton pending full on level of suspension 30 days after implementation (Art. 22) procedures and ‘reasonable Cross-retaliation: principles of retaliation period’ expires same sector, other sectors, other agreements (Art. 22.6 and 22.7) (Art. 22.3)

source: world Trade organization (wTo) website. available: www.wto.org/english/thewto_e/whatis_e/tif_e/disp2_e.htm

The WTO Agreement also provides for under it since 1995. WTO dispute good offices, mediation, conciliation, and settlement stands in strong contrast to the an independent arbitral system. But WTO GATT dispute settlement system, where the members rarely use these procedures. losing party could block the adoption of a The WTO DSU has been a tremendous panel report (the findings of the arbitral success. It is widely used by WTO members, process), delay was common, and the which have lodged more than 300 disputes enforcement mechanism weak. 94 | How to design, negotiate, and implement a free trade agreement in asia

Despite the success of the WTO system, under ASEAN economic agreements, however, certain questions remain. Should including AFTA. The protocol is based WTO panels have exclusive jurisdiction almost entirely on the WTO DSU. Like the in trade disputes, or can a panel decline WTO system, it provides for consultations, jurisdiction when an FTA tribunal is a panel process, appellate review, and seized with a dispute? The Appellate Body suspension of concessions, under terms ruled in the Mexico–Soft Drinks dispute that are almost identical to those of that Articles 3, 7, 11, 19, and 23 of the the DSU. Minor differences do exist: DSU require WTO panels to take certain panel reports are adopted at the Senior actions and that a “decision by a panel Economic Officials Meeting (SEOM). The to decline to exercise validly established SEOM plays a role similar to that of the jurisdiction would seem to ‘diminish’ WTO Dispute Settlement Body. Like the the rights of a complaining Member to WTO, a reverse-consensus rule applies in ‘seek the redress of a violation of [WTO] the SEOM. Appeals are made to a seven- obligations….” 116 The Appellate Body’s member Appellate Body appointed by the decision in Mexico–Soft Drinks would ASEAN economic ministers, with three appear to restrict the right of a WTO members designated to hear a proceeding. panel to determine freely whether or not Article 1:3 of the protocol allows ASEAN it can exercise jurisdiction. In instances members to resolve a dispute involving when WTO rights and obligations are fellow members in other dispute at issue, particularly rights affecting settlement forums (e.g., the WTO) at any “third parties,” it is possible that the stage before a party has made a request WTO dispute settlement mechanism may to the SEOM to establish a panel. This be elevated above dispute settlement clause implies that the protocol becomes mechanisms in FTAs. the exclusive means of resolving disputes between members once a request is made Institutional structures of FTA dispute to the SEOM to establish a panel. 117 settlement mechanisms compared Japan-Singapore Economic Partnership FTA dispute settlement mechanisms vary Agreement. As is clear from the above considerably, yet almost always have discussion, economic partnership several points in common with the WTO agreements that incorporate FTA system. A few examples drawn from FTAs agreements have become relatively involving ADB members will demonstrate common in East Asia. Singapore has some of the similarities and differences in entered into several such agreements dispute settlement provisions, and better that provide for state-state dispute illustrate the jurisdictional question posed settlement, require consultations as above. a first step in the dispute settlement process, and provide for an arbitration ASEAN Free Trade Agreement. AFTA was the first major FTA in the East and 117 The decisions of the Appellate Body in Mexico–Soft Southeast Asian region. The ASEAN Drinks and the WTO Panel in Argentina–Definitive Protocol on Enhanced Dispute Settlement Anti-Dumping Duties on Poultry from Brazil (Argentina–Poultry), WT/DS241/R, bring into Mechanism governs disputes arising question when or even whether WTO rules would permit a panel to decline to hear a case pending or 116 Appellate Body Report, Mexico–Tax Measures on Soft decided under the Protocol or other FTA mechanisms, Drinks and Other Beverage (Mexico–Soft Drinks), and whether the doctrine of estoppel might be applied WT/DS308/AB/R, paras. 48–53 (quoting para. 53). to prevent the WTO from hearing such a dispute. part ii: coverage of a free Trade agreement | 95

mechanism if consultations prove Singapore-Australia Free Trade unsuccessful. Investor-state disputes are Agreement. Again, consultations usually regulated under separate dispute followed by arbitration are used in the settlement provisions. For example, the SAFTA. In the event of any inconsistency Japan-Singapore Economic Partnership between this agreement and any other Agreement (JSEPA) is an FTA with a agreement to which both are parties, dispute settlement mechanism that the countries are required to consult provides for general consultations to with each other with a view to finding avoid recourse to the dispute settlement a mutually satisfactory solution in system. Like the WTO Agreement, accordance with customary rules of it makes arbitration, mediation, and public international law. conciliation available as options for settling a dispute. If the parties are North American Free Trade unable to settle their dispute through Agreement. Chapter 20 of the agreement means short of formal dispute settlement is applicable to NAFTA disputes not proceedings, JSEPA provides for “special involving investment, antidumping consultations” as the first step in its measures, or countervailing duties formal dispute settlement process, before (which fall under other NAFTA dispute arbitration. JSEPA permits the parties settlement rules). NAFTA members to have recourse to other international are required to try to resolve Chapter dispute settlement agreements (such 20 disputes through government- as the WTO) to which they are parties. to-government consultations. If Starting an action under one agreement consultations are unsuccessful, the makes that agreement the exclusive parties may request a meeting of forum for the dispute unless “substantially the NAFTA Free Trade Commission separate and distinct rights or obligations (comprising the trade ministers of the under different international agreements parties). If the commission cannot resolve are in dispute.” the dispute, a party may call for the establishment of a five-member arbitral Comprehensive Economic Cooperation panel, which is entitled to seek assistance Agreement between the Republic of India from scientific experts (“scientific review and the Republic of Singapore. This boards”). NAFTA permits parties to agreement also provides for choose whether to resolve trade disputes consultations, followed by arbitration through arbitration within the FTA or to resolve disputes arising under it. It before the WTO. Disputes like the long- incorporates many WTO obligations. The running Softwood Lumber case have been parties affirm their rights and obligations heard in both forums. under existing bilateral and multilateral In summary, the above examples are agreements to which both are parties, representative of FTA dispute settlement including the WTO Agreement, but what provisions. They suggest that FTA dispute is to be done in the event of a conflict settlement systems between agreements is left vague. The agreement only provides that, in the (i) are state-to-state; event of an inconsistency, the parties (ii) require consultations; should immediately consult with each (iii) usually make available good other with a view to finding a mutually offices, mediation, and satisfactory solution. conciliation; and 96 | How to design, negotiate, and implement a free trade agreement in asia

(iv) provide for some form of arbitration (i) Work within WTO rules. Many if consultations are unsuccessful. FTAs draw inspiration from the WTO dispute settlement system In addition, FTA agreements generally and this is a good place to use an enforcement mechanism similar to start when analyzing practical that of the WTO Agreement (but based approaches and best practices on the withdrawal of FTA, and not, WTO in FTA dispute settlement concessions). 118 mechanisms. The success of the One area where FTAs differ is in forum WTO dispute settlement system selection between the FTA and the WTO has served as an inspiration for in the event of overlapping obligations. many FTAs. AFTA presents the Various options exist: clearest example of an FTA with dispute settlement provisions (i) Refrain from taking a position on modelled on the WTO system. The this point and simply require the framework applies consultations, parties to consult. a panel process (arbitration), (ii) Make the FTA the exclusive forum and an appellate process. for the resolution of a trade Enforcement is generally well dispute involving FTA members. understood by trading countries, (iii) Allow FTA members to choose and commonly used in FTAs, with whether to have a dispute heard the exception that FTA dispute before an FTA tribunal or before settlement mechanisms do not the WTO (make the first forum always have an appellate stage of before which the dispute is dispute settlement proceedings. brought the exclusive forum). At a minimum, FTAs should be in (iv) Allow the exercise of concurrent accord with WTO rules, including jurisdiction. dispute settlement practices. (ii) Place importance on The WTO Appellate Body decisions in consultations. The importance the Mexico–Soft Drinks case (discussed of consultations as a first step above) raises questions concerning FTA in dispute settlement must be provisions aimed at limiting an FTA stressed. A large number of trade member’s recourse to WTO dispute disputes are resolved either settlement when WTO obligations are at bilaterally through informal issue, though the decision will not be the consultations, or through last word on the subject. formal consultation procedures. Likewise, although good offices, Framework and Practical Approaches conciliation, and mediation are for Best Practices in Dispute Settlement options that are only infrequently Mechanisms used, their inclusion in an FTA costs the parties nothing and their occasional use by the parties Some salient recommendations of realistic may, in certain cases, help to best practices in dispute settlement would avoid recourse to formal dispute include the following: settlement proceedings. Resolving a trade dispute at an early stage, 118 The effectiveness of this remedy may be tempered by the existence of any bound concessions a party has before the initiation of formal made under the WTO Agreement. dispute settlement procedures, is part ii: coverage of a free Trade agreement | 97

cost-effective and efficient, draw on WTO principles and often the best solution for and practices. The result is a maintaining harmonious trade framework of obligations that relations among FTA parties. is familiar to the parties and (iii) Develop a choice of law strategy may result in fewer disputes. between WTO and FTA Likewise, FTAs frequently draw procedures. Owing to the almost on the dispute settlement rules universal nature of the WTO of the WTO as a model for their Agreement, and overlapping own rules. The familiarity of obligations in the WTO and FTA trading countries with these rules, Agreements, FTA members may and the relative success of the find themselves in situations WTO dispute settlement system, where the rules of both the FTA supports this choice, and may and the WTO apply. They must result in a desirable degree of decide under which rules they harmonization among FTA dispute want to seek relief. Dispute settlement systems. settlement proceedings might be (v) Provide technical assistance on dispute heard under one or both systems, settlement to developing-country and the potential for inconsistent FTA members. Economically results exists. Parties negotiating more advanced FTA members FTAs frequently insert a clause should recognize the importance providing that initiation of an of strengthening capacity and action under the FTA excludes institutions in less-developed commencement of the same members. Capacity constraints action in the WTO. Two WTO can limit the ability of developing decisions have examined this countries, in particular LDCs, to type of clause, 119 and in each case participate successfully in FTA WTO panels assumed jurisdiction dispute settlement proceedings. despite the clause. Nevertheless, Technical assistance regarding these two rulings, for a number dispute settlement practices of technical reasons, are not the and procedures is important in final word on the question. FTA maintaining an equitable dispute drafters should therefore continue settlement system. More broadly, to insert a provision on how investment in education in poorer conflicts between the two sets of member countries can help rules should be managed, with improve the success of the FTA in the expectation that members will general, and its dispute settlement operate in good faith and not seek system in particular. recourse in a second forum if they (vi) Emphasize good governance fail to prevail in the first forum. principles, including transparency, in (iv) Use WTO dispute settlement FTA dispute settlement procedures rules as a model for FTA dispute and practices. Factors like good settlement provisions. Because governance and transparency of their common goals (trade will influence the success of an liberalization), FTAs frequently FTA and will provide greater legitimacy for its dispute

119 See the Mexico–Soft Drinks and Argentina–Poultry settlement system. The free flow decisions (discussed above). of goods, services, investment, 98 | How to design, negotiate, and implement a free trade agreement in asia

and capital can contribute to fair and efficient procedures and regional growth and development, practices is one way to lock in as well as stability and prosperity. those gains. A dispute settlement system with Appendix to Part II:

Rules of Origin in Japan’s Economic Partnership Agreements (EPAs) with Malaysia and the Philippines Chapter EPA with Malaysia EPA with the Philippines 16 Preparations of Fish CTH or WO CTH or WO (or wholly obtained in ASEAN) (or wholly obtained by authorized vessel under Indian Ocean Tuna Commission) 18–20 Preparations of Cocoa, Cereals, CTH or WO CTH (19) or WO Vegetables (or wholly obtained in ASEAN) (or for Chapters 18 and 20 wholly obtained in ASEAN) 28–38 Chemicals CTH or VA (regional, 40%) CTH or VA (regional, 40%) 40 Rubber and Articles of Rubber CTH or VA (Regional, 40%) CTH or VA (Regional, 40%) 50–60 Textiles CTH and two-step SP CTH and 2 Step SP (or two-process SP in ASEAN) (or two-process SP in ASEAN) 61–63 Clothing and Articles of Textiles CTH and two-step SP CTH and two-step SP (or two-process SP in ASEAN) (or two-process SP in ASEAN) 64 Footwear CTH CTH 84–85 Electrical Machinery CTSH or VA (regional, 40%) CTH or VA (regional, 40%) 86–89 Transport Equipment CTH or VA (regional, 40%) CTH or VA (regional, 40%) 94 Furniture and Bedding CTH or VA (regional, 40%) CTH or VA (regional, 40%) ASEAN = Association of Southeast Asian Nations, CTH = change in tariff heading, SP = specified process, VA = value added, WO = wholly obtained. Source: Compiled from the World Trade Organization (WTO) regional portal. Available: www.wto.org

Binding Nonconforming Measures, Japan-Philippines Economic Partnership Agreement (JPEPA) Modes of supply: (i) Cross-border supply, (ii) consumption abroad, (iii) commercial presence, (iv) presence of natural persons Sector or Subsector SS Limitations on Market Limitations on National Additional Commitments Access Treatment C. Telecommunication Services Basic telecommunication SS (i) None (i) None Japan undertakes the services: (ii) none (ii) none additional commitments Voice telephone services (7521); (iii) none except that (iii) none except below. Packet-switched data foreign capital that board transmission services (7523**); participation, members and Circuit-switched data direct and/or auditors in NTT transmission services (7523**); indirect, in and the regional Telex services (7523**); Nippon Telegraph companies must Facsimile services (7521**, and Telephone be Japanese 7529**); Corporation nationals. Private leased circuit services (NTT) 23 must be (iv) none (7522**, 7523**); and Other less than one third. (iv) none SS = subsector. 100 | How to design, negotiate, and implement a free trade agreement in asia and China ingapore Partner Country acao Hong Kong, M US and S US and E C US US US US US US US US US US US 2005.

and 2005. arch ecember D 31

municipal, by financial auditing ctober 2011.

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to

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telecommunication as of be allowed funds to capital investment and foreign engineering, integrated

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ebruary 2009. of

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supply of portfolio services cross-border management provide to to be allowed also to Companies existing

in architectural, operations holly owned mutual funds, by sset management 2007. beby permitted to traffic telecommunications esale of international of the after entry than 4 years force no later into establish branches to be allowed to inancial companies of the agreement. of entry the date force from into be phased out within 3 years to requirements ocal presence operators, agencies and tour travel for requirements ocal presence requirements, ocal presence of the agreement of entry the date force from into be phased out within 3 years to requirements ocal presence licenses, insurance new nonlife acquire will be able to insurers oreign branches. operate to will be allowed insurers life oreign supply marine, to be allowed to companies insurance oreign of after the date than 4 years no later in Chile establish branches to be allowed to companies insurance oreign of the agreement. of entry of date force be phased out within 5 years into of the agreement. of signature of the date years of the agreement. of entry force into of the agreement. of entry the date force from into within 3 years and bookkeeping, 31 O and in no case beyond expire those levels at concessions the current district once levels services television national on weekends/ on free-to-air programming of locally produced broadcasting Quotas for 1 F 30% by 50% to from be reduced to holidays F F agreement. of the agreement. after entry than 4 years force schemes no later into investment collective the zonal, at will be no restrictions concessions on the number There of subscription television of the agreement. of entry the date force from into within 3 years The L L L R servicesarchitectural beas of D permitted to W F L advertising, for F basis. on a cross-border of the agreement force into F of the agreement. entry force into A of the agreement, entry force into Matrix 1: Examples of Commitments Providing for the Phase-out of Restrictions in Various FTAs Various of Restrictions the Phase-out for in Providing of Commitments Examples 1: Matrix Sector servicesudiovisual usiness services servicesrofessional inancial services inancial services inancial services inancial services F F A Telecommunications Construction Tourism Transportation Telecommunications F B F P Country Australia Bahrain Chile China, People’s Republic of Colombia part ii: coverage of a free Trade agreement | 101 Partner Country alvador l S E US US US US US US US US US US US US

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Community, uropean education, Sector E C = inancial services F transport and maritime Tourism, and L im (2006). archetti, M oy, R Country machine, teller M = automated T ource: S Thailand A part ii: coverage of a free Trade agreement | 103

Matrix 2: Key Approaches and Provisions of FTAs Involving East Asian Countries Agreement Scheduling MFN Clause Sectoral Carve﷓Outs Rules of Origin for Approach Judicial Persons* ASEAN Framework Positive MFN between ASEAN None** Yes. As far as services are Agreement on members subject to concerned, benefits are Services ASEAN-X formula*** also extended to juridical persons with substantial business operations in the territory of any party. Australia-Thailand Positive More favorable None ** Yes (for chapter on treatment of promotion and protection non-parties to be of investments) extended to parties, but nonbinding. India-Singapore Positive More favorable Core air transport Yes (for services supplied treatment of services cross﷓border and through non-parties to be consumption abroad, extended to parties, although benefits can but nonbinding. be denied). Several Singaporean banks are expressly listed as beneficiaries. Japan-Malaysia Positive More favorable Core air transport Yes (parties can deny treatment of services and FTA benefits to service non-parties to be cabotage in maritime providers from non-parties extended to FTA transport with which a party does parties, subject to not maintain diplomatic a negative list of relations or where certain reservations. trade sanctions apply). The investment chapter of Japan-Malaysia does not extend benefits to branches of enterprises of third states. Japan-Singapore Positive More favorable Core air transport Yes. As far as services are treatment of services and concerned, benefits are non-parties to be cabotage in maritime also extended to juridical extended to parties transport persons with substantial (but nonbinding). business operations in the territory of any party. Australia-Singapore Negative None Core air transport Yes services Chile–Republic of Negative None Core air transport Yes. But parties can deny Korea services and financial FTA benefits to service services providers from non-parties with which a party does not maintain diplomatic relations or where certain trade sanctions apply. Japan-Mexico Negative More favorable Core air transport Yes. But parties can deny treatment of services, cabotage in FTA benefits to service non-parties to be maritime transport, providers from non-parties extended to FTA and financial services with which a party does parties, subject to not maintain diplomatic a negative list of relations or where certain reservations. trade sanctions apply. 104 | How to design, negotiate, and implement a free trade agreement in asia

Agreement Scheduling MFN Clause Sectoral Carve﷓Outs Rules of Origin for Approach Judicial Persons* Viet Nam–US Positive MFN obligation None ** Yes. But parties can deny FTA benefits to investors from third country if the denying party does not maintain normal economic relations with the third party (investment chapter only). Singapore-US Negative, except for Better treatment of Core air transport cross-border trade in non-parties to be services financial services, for extended to FTA which a positive list is parties, subject to adopted. a negative list of reservations. Singapore-Panama Negative, except for Better treatment of Core air transport cross-border trade in non-parties to be services financial services, for extended to FTA which a positive list is parties, subject to adopted. a negative list of reservations. ASEAN = Association of Southeast Asian Nations, FTA = free trade agreement, MFN = most-favored nation, US = United States. * Extended to juridical persons constituted under domestic laws and having substantial business operations in the domestic territory. ** No explicit sectoral carve-out in the text of the agreement; coverage of the sector depends on what has been committed in the schedules of specific commitments (in the case of a positive-list approach) or what is included in the reservations list (for negative list FTAs). *** ASEAN-X formula as described in Fink and Molinuevo (2007) is a 2003 amendment to the ASEAN Framework Agreement on Services that allows for the departure from MFN if two or more members agree to liberalize trade in services faster than the remaining ASEAN members.

Source: Compiled from tables in Fink and Molinuevo (2007).

Examples of Investment settlement mechanism for state-to-state Agreements and investor-to-state disputes, including access to international arbitration through Key NAFTA Investment Provisions. Chapter the International Centre for Settlement of 11 contains the most established regional Investment Disputes (ICSID) and the UN investment regime. Investment is defined Commission on International Trade Law through a broad list of assets, along with (UNCITRAL). a negative list of certain claims to money. Although investment provisions are (i) The obligations of the investment applicable to all sectors in principle, each chapter in US FTAs go far beyond country has identified key sectors that are the provisions proposed at the exempted. National treatment and most- WTO. For example, they require favored nation (MFN) treatment are granted US investors and investments to for the establishment (market access), be treated at least equally with acquisition, expansion, management, locals (national treatment), in conduct, operation, and sale or other preestablishment rights and other disposition of investments. In addition, matters, unless the exceptions there are prohibitions on restrictions on are listed in the FTA (negative- ownership and on use of performance list approach). Performance requirements, and there are guarantees requirements such as transfer of on free transfer of funds and protection technology are also prohibited from expropriation and nationalization. except in certain circumstances or There is also a comprehensive dispute for listed exceptions. part ii: coverage of a free Trade agreement | 105

(ii) US FTA negotiations with may also be brought before the ICSID, some ASEAN countries on UNCITRAL, the Regional Centre for the investment chapter have Arbitration in Kuala Lumpur, or any other met with various difficulties. regional center. ASEAN has likewise The expropriation provision entered into economic partnership requires compensation, including agreements with its dialogue partners interest, for direct or indirect (the PRC, Japan, the Republic of Korea, expropriation of an investment. the Australia–New Zealand FTA, India, As “investment” is defined very and the EU). The investment chapter in broadly to include tangible each agreement is aimed at promoting and intangible property, loans, liberalization, transparency, facilitation, shares, intellectual property, and protection of cross-border investment. etc., investors can directly sue A concern, however, is the lack of the state at an international coherence and consistency among the tribunal for violations of the different agreements. investment chapter, including the expropriation provision. Key Investment Provisions of the “Indirect investment” could mean Japan-Singapore Economic Partnership losses resulting from government Agreement (JSEPA). In recent years regulation or policy. The Singapore has been prolific in signing investment chapter could affect a bilateral trade agreements. The investment partner country’s ability to put in provisions of JSEPA (Chapter 8) are place capital controls and other examined below. policies such as those used during the 1997 Asian financial crisis. (i) Investment vs. Enterprise. “Investment” is very broadly defined Key ASEAN Investment Provisions. These to cover every kind of asset owned are contained in the 1987 ASEAN or controlled, directly or indirectly, Agreement on the Promotion and by an investor. It also includes profit, Protection of Investment, and the 1998 interest, capital gains, dividends, Framework Agreement on the AIA. The royalties, and fees. “Investor” latter introduced the concept of the covers nationals of Japan, nationals “ASEAN investor” and covers investments of Singapore, and permanent from sources within and outside the residents of Singapore. “Enterprise” ASEAN region. It provides for national means any legal person/entity and treatment for ASEAN investors by 2010 includes government-owned and (later advanced to 2003) and non-ASEAN government-controlled corporations. investors by 2020 (later advanced to An enterprise is defined as “owned” 2010) with respect to investments that by non-parties if more than 50% are specifically approved in writing of the equity interest is owned by and registered by the host country; for non-parties, and “controlled” by preestablishment rights subject to a non-parties if such persons have negative list of temporary and sensitive the power to name a majority of exclusions from each ASEAN state; its directors or otherwise to legally and for state-to-state and investor-to- direct its actions. state dispute settlement at the national (ii) National treatment (Article 73): and regional (meetings of the ASEAN Each party must accord investors/ economic ministers) levels. Disputes investments of its FTA partner 106 | How to design, negotiate, and implement a free trade agreement in asia

national treatment with regard (b) Singapore has listed the to the establishment, acquisition, following exceptions: expansion, management, horizontal exceptions on operation, maintenance, subsidies and incentives for all use, possession, liquidation, sectors; company registration sale, or other disposition of formalities for all sectors (also investment. National treatment exceptions to performance also extends to access to its courts requirements); ownership of of justice and administrative residential land and property; tribunals and agencies. National regulations on Singapore- treatment applies as well to any dollar transactions; and restitution or compensation to privatization (also performance investors that have suffered loss requirements). Sectoral or damage to their investments exceptions cover investments due to armed conflict or in services; the printing and revolution, insurrection, and civil publishing sector; the arms and disturbance. explosives sector; and certain (a) Japan has listed the following industries/products in the exceptions: horizontal manufacturing sector. exceptions on land transport; (iii) Performance requirements: These prior notification requirement are prohibited, with exceptions. in some sectors; public (iv) Expropriation and compensation monopoly and state enterprises; (Article 77): Investments/ subsidies designated for investors must be accorded investments in research and fair and equitable treatment development; and permanent and full protection and residents of Singapore. security. Expropriation and Sectoral exceptions cover nationalization can be undertaken agriculture (plant breeder’s only for a public purpose, on rights); the mining industry, a nondiscriminatory basis, in including oil and natural gas accordance with due process exploration and development; of law, and upon payment of the water transport industry; compensation. Compensation financial services; and the must be equivalent to the fair telecommunications industry. market value of the expropriated National treatment and investments, must be paid without prohibition of performance delay, and must be effectively requirements do not apply to realizable, freely transferable, fisheries within the territorial and freely convertible at the seas, internal waters, and market exchange rate prevailing exclusive economic zones; the on the date of the expropriation, manufacture of explosives; and into freely usable currencies the nuclear energy industry; defined in the International the aircraft industry; the arms Monetary Fund (IMF) Articles industry; the space industry; of Agreement. Investors have the electric utility industry; the the right of access to the courts gas utility industry; and the of justice or the administrative broadcasting industry. tribunals or agencies of the part ii: coverage of a free Trade agreement | 107

partner making the expropriation, (vii) Intellectual property rights (Article to seek a prompt review of the 86): National treatment applies investor’s case or the amount only to the extent provided for of compensation that has been in TRIPS Annex 1C to the WTO assessed. Agreement. (v) Settlement of state-investor disputes (viii) Joint Committee on Investment (Article 82): Such investment (Article 88): This committee disputes must, as far as possible, will review and discuss the be settled amicably through implementation and operation of consultations between the this chapter, review the specific disputing parties. If an investment exceptions in Article 76, and dispute cannot be settled through discuss other investment related such consultations within 5 issues. months, and if the investor has not submitted the dispute for resolution under administrative Investment Provisions of or judicial settlement, or in Selected FTAs Compared accordance with any agreed dispute settlement procedures, that investor may either request The Urata and Sasuya (2007) study of the establishment of an arbitral seven FTAs involving the US, Australia, tribunal or submit the investment Japan, Singapore, Republic of Korea, and dispute to the ICSID or UNICTRAL Chile reached the following conclusions: for conciliation or arbitration. (vi) Temporary safeguards (Article 84): (i) The Japan-Mexico and Chile– A party may adopt or maintain Republic of Korea agreements measures inconsistent with its are the most restrictive to foreign obligations on national treatment direct investment (FDI). In the and on transfers in the event of Japan-Mexico agreement, Mexico serious balance of payments or has more restrictions on FDI than external financial difficulties, Japan. In the Chile–Republic or where, in exceptional of Korea agreement, the two circumstances, movements of countries are almost equally capital result in serious economic restrictive. Restrictions cover and financial disturbance in the foreign ownership and market FTA partner. The measures must access, national treatment, be consistent with the IMF Articles composition of management, of Agreement, must not exceed performance requirements, entry those needed to deal with the of investors and businesspeople, circumstances, must be temporary and right to implement future and must be eliminated as soon as restrictive measures. conditions permit, must promptly (ii) The North American Free Trade be notified to the FTA partner, Agreement (NAFTA) is also must be nondiscriminatory, and restrictive to FDI. Canada and must avoid unnecessary damage Mexico maintain a high degree to the commercial, economic, of restrictions. The US, while and financial interests of the FTA relatively more open, requires partner. reciprocity from its FTA partners— 108 | How to design, negotiate, and implement a free trade agreement in asia

it opens up only those sectors security sectors. The Japan- that its FTA partner also opens Singapore agreement is more up to US investors. Canada and restrictive than the Japan-Mexico Mexico have very high restrictions agreement, reflecting the fact on agriculture and mining. All that the former is Japan’s first three NAFTA countries maintain bilateral agreement and Singapore high restrictions on the financial, has limited bargaining leverage transportation, and information “because Japan had to ask more and communications sectors. In from Mexico than it did with contrast, the US agreements with Singapore, such as opening of the Australia and Singapore are less automobile market, Japan also restrictive than NAFTA. had to give more.” (iii) Of Singapore’s bilateral agreements with Japan, the US, The seven countries, ranked from and the Republic of Korea, the the most to the least restrictive in the agreement with the Republic of investment provisions of their FTAs, are Korea is most restrictive because Canada, Mexico, Chile, Republic of Korea, of the latter’s restrictions. In Japan, Australia, Singapore, and the all sectors, the Republic of US. The restrictions examined pertained Korea reserves the right to to foreign ownership and market prohibit or restrict ownership access, national treatment, screening in state enterprises, to prohibit and approval, corporate directorships, or limit the right of Singapore movement of people, and performance investors to control a company requirements. The US is the most open or investment created in the to FDI; its restrictions usually follow the transfer or disposal of state reciprocity principle. It is relatively open assets, and to adopt or maintain in the primary, manufacturing, and most any measure with respect to service sectors, except for the financial land acquisition by foreigners. and transportation sectors. Singapore Singapore restrictions are found is relatively open to FDI, but imposes in the financial sector and in its limitations on foreign ownership in state requirement for investments to enterprises, certain types of housing, and have local managers. Both the financial services. Foreigners who wish Republic of Korea and Singapore to register a business firm in Singapore have high restrictions on the need to have a local manager, and a local electricity sector, transportation, resident for at least one of the directors, information and communications, while all branches of foreign companies education, public administration, should have at least two local agents. defense, and compulsory social Part III: Negotiating, Implementing, and Evaluating Free Trade Agreements

Introduction

country’s participation in a free trade agreement (FTA) does not begin and end with the actual A negotiations. The FTA trail entails various pre-negotiation procedures and extends until its enforcement and evaluation. Understanding the whole process will assist the negotiators, implementers, and evaluators in effectively delivering their duties and properly coordinating their functions. Part III 120 provides a general understanding of the entire FTA process, discusses the procedures and experiences at each step, and identifies good practices and practical approaches to the issues and challenges that face government officials and staff working on FTA and other FTA-related matters. A model FTA process is shown in Figure 3.1. Except for the substantive and procedural requirements established under the WTO framework, there is no firm sequence of events in preparing for,

120 Part III is based on inputs from concerned ministries and agencies of ASEAN member countries, the Republic of Korea, and Australia. The authors are grateful to the ASEAN Secretariat for circulating the questionnaire to ASEAN member countries, and to the FTA training course speakers and participants for their valuable comments. Good practices and experiences especially from developed countries are incorporated. 110 | How to design, negotiate, and implement a free trade agreement in asia

Figure 3.1 Model FTA Process

INITIATION PRE-NEGOTIATION CONSULTATION Joint Statement • Legislative Notification MANDATE to pursue FTA • Presidential/Ministerial Directive to launch Negotiation PRE-NEGOTIATION CONSULTATION • Cabinet Approval • National Feasibility Studies or • Resolution by Member States Impact Assessments • Public Hearing • Critical issues consultation • Legislative reports/notices NEGOTIATION Acceptance of CONSULTATION/ JSG Report INFORMATION GATHERING FTA DRAFT DOMESTIC/NATIONAL • Public and • Initialing by Conduct of Joint Private negotiators Feasibility Study ORGANIZATION • Legal scrubbing Stakeholders • National Advisory Council and translation Framework • Interagency Committee • Cabinet approval of Agreement/ • Negotiating Team Terms of Negotiation • Public disclosure EXTERNAL • Joint Study Group (JSG) • Chief Negotiator Joint Coordinating • Plenary Sessions Team • Working Groups Interagency or committee consultation

RATIFICATION IMPLEMENTATION AMENDMENT FTA • Legislative • Exchange of diplomatic ENFORCEMENT REVIEW and • Protocol SIGNING • President notes and MONITORING ASSESSMENT • Side Agreements • Legal enactments • Directives, issuances, and regulations • Information campaign • Public Notice • Treaty Publication and Registration with UN • Notification to WTO

FTA = free trade agreement, JSG = Joint Study Group, UN = United Nations, WTO = World Trade Organization. Source: ADB Staff.

negotiating, and implementing FTAs. The and timely, the country that conducted procedures, however, are usually the same the feasibility studies proposes FTA and are more often dictated by national negotiation. FTA initiation therefore laws and practices. involves an active player (the country that The starting point of an FTA process has determined the relevance of entering varies between countries. While most into an FTA and thereby proposes FTA developed countries and some newly negotiations with another party) and a industrialized economies (NIEs) in Asia passive player (the country that accepts begin with pre-negotiation consultations the proposal from a prospective FTA or exploratory works, most developing partner to negotiate). countries (e.g., member countries In many countries, the decision to of the ASEAN) begin with high-level enter into an FTA is politically motivated government-to-government initiatives. and is sometimes determined by At the pre-negotiation consultation the head of state. In this case, FTA stage, national feasibility studies, initiation precedes the pre-negotiation domestic sensitivity analysis, scoping consultations. The idea of entering into studies, or public hearings assess the an FTA is usually introduced in bilateral desirability and viability of the proposed meetings (such as state visits) to further FTA and identify sectoral difficulties. the economic relations between the When the FTA is found to be appropriate parties involved. ASEAN, for instance, has part Iii: negotiating, implementing, and evaluating free trade agreements | 111

typically acceded to FTA talks initiated A joint study group (JSG) (which will by its external dialogue partners in the conduct the joint feasibility study) and a ASEAN-plus FTAs. joint coordinating team (JCT) (which will After the initiation or pre-negotiation agree on the terms of the negotiation) are consultation, the prospective FTA partners organized on both sides of the negotiating issue a joint statement declaring formally table as part of the broader consultation their intention to negotiate and enter and information-gathering stage. If the into an FTA. Joint statements usually JSG report recommends entering into an contain the rationale or significance of FTA and this recommendation is accepted the FTA, its broad coverage, the target by the leaders of the prospective partner date of implementation, and sometimes countries, a framework agreement is a reference to the country’s WTO signed or formal negotiation ensues. commitments. The framework agreement specifies Some pre-negotiation procedures the outline or coverage of the proposed are then required and preliminary agreement, including areas for possible government-to-government contact economic cooperation and possibly “early- is made. These internal government harvest schemes.” 121 With or without a procedures are a precursor to launching framework agreement, the JCT agrees on FTA negotiations, which include the terms of the negotiation and moves on legislative notification (especially where to the negotiation. the parliament has a strong role in or FTA negotiation (which takes 1–2 influence on executive policies), the years, depending on the issues covered circulation of presidential or ministerial and the depth of the proposed agreement) directives (as in most ASEAN countries), occurs at two levels—externally with the the submission of the overall FTA negotiating counterparts, and domestically objectives and strategy to the cabinet for with national stakeholders. External approval (as in the Republic of Korea), negotiations are conducted between or formal adoption by member states chief negotiators (especially on sensitive (as in the case of the Australian Federal issues) and between sub-teams at plenary Government and the EU). In the process, sessions and at working group level the mandate to negotiate is obtained. (for specialized or technical matters). At the organization stage or as early Domestic negotiations take place with as the pre-negotiation stage, several stakeholders from both the public sector bodies may be organized or convened— (e.g., policy makers, cabinet members, national advisory committees (with and regulatory bodies) and the private representatives from the public and sector (e.g., business or industry groups, private sectors); legislative-executive NGOs, workers’ unions, environmental and interagency committees (composed lobbyists, civil society, and consumer of public stakeholders, regulators, and groups). Part of the negotiator’s task at policy makers); and the negotiating team this stage is therefore balancing external (at the working and support levels). The and domestic interests. While domestic committees (which are either decision- negotiations are an integral part of the making or consultative bodies) will whole negotiation process in advanced oversee and coordinate the policy aspects of the FTA and ensure that they are 121 A term used in trade negotiations for agreeing to aligned with the national objectives of the accept the results of a portion of the negotiations before the rest of the negotiations are completed (e.g., country. The negotiating team is tasked to early implementation of tariff liberalization of selected carry out their negotiation mandate. goods). 112 | How to design, negotiate, and implement a free trade agreement in asia

countries, external negotiations are still Box 3.1: How the US Negotiates a at the center of the process in many Trade Agreement developing countries. Concurrently, coordination and Before negotiations, the administration notifies the Congress, consults with relevant congressional consultation with the interagency committees and the Congressional Oversight Group committee, the national advisory council, (COG), and complies with additional consultation and the cabinet, and the legislative body 122 assessment requirements (for negotiations in the continues. While some practical issues are agriculture, textiles and apparel, and fish and shellfish addressed through meetings among the sectors). The Congress then considers implementing legislation for a trade agreement under expedited ministries concerned (at the director or procedures. director-general level depending on the During the negotiations, the Office of the US Trade level of authority needed to resolve the Representative (USTR) consults closely with the COG and issues), critical issues are often elevated to all committees of jurisdiction. the interagency committee, the national Before signing the agreement, the President reports advisory council, or the cabinet. Highly to the revenue committees the proposed amendments to the US’ trade remedy laws and then notifies Congress. critical issues that dictate the destiny of Private sector advisory committees will thereafter submit the whole negotiation are sometimes reports to Congress, the President, and the USTR. taken up at the level of the head of Within 60 days from entering into the agreement, state, usually at the final stage of the the President submits to the Congress a list of the negotiation. In some countries, regular required amendments to US law. The International Trade Commission submits to the President and Congress an legislative reports or notices provide an assessment of the impact of the FTA on the US economy opportunity to discuss critical issues, and the industrial sectors. arrive at new bargaining positions if necessary, and minimize possible conflicts Source: US Trade Representative website; Pregelj (2005). or obstacles during ratification. Sometimes the text of the agreement is based on previously signed agreements (e.g., agreements entered into by the US, negotiators. 123 The initialled text then Japan, and ASEAN) to which one of the undergoes “legal scrubbing” to ensure countries is a party. This process, called that it reflects or is consistent with what “docking,” saves time, as negotiators no was agreed on and intended during longer need to renegotiate areas that do the negotiations. Consistency with not present any material issue to either and adjustments of domestic laws and side. Docking may even result in more regulations are taken into consideration. consistent or harmonized FTA agreements Legal scrubbing takes time: although (especially in the matter of rules), the main agreement may not exceed a lessening the so-called “spaghetti bowl hundred pages, the appendixes could effect” of FTA proliferation. have thousands of pages. 124 Instances of After the negotiation but before the ambiguity or oversight may have to be signing of the agreement, the text of renegotiated. Negotiators must therefore the agreement is initialled by the chief be good drafters in the legal as well as the practical sense, since careful drafting

123 Chief negotiators of Japan’s FTAs sign what is called 122 During FTA negotiations, US negotiators are mandated an “agreement in principle.” to coordinate at length with congressional committees. 124 For example, the draft US–Republic of Korea FTA, After the negotiations, the Congress examines the deemed the most voluminous FTA entered into in the draft FTA text in the light of the negotiating mandate region, had 1,300 pages in Korean and 1,400 pages in and either approves or vetoes the text but does not English, 280 pages of reference materials, and a 30- propose amendments. page terminology guidebook. part Iii: negotiating, implementing, and evaluating free trade agreements | 113

(coupled with skillful legitimation) international instrument at the United makes ratification and efficient Nations. 126 implementation more likely. The pre- A note verbale or diplomatic note, signing stage may also involve translation from each of the parties notifies the other if the official language of one country party that all domestic requirements for is different from the common language implementation (including ratification) used by the parties. have been complied with. 127 The date the The full text of the FTA, as well as FTA takes effect depends on the domestic its annexes and list of commitments, laws of the member country or the may or may not be made available to agreement of the parties. the public at this stage. However, public The implementation stage consists of disclosure before signing promotes (i) the passage of laws or amendments transparency and provides an opportunity to domestic laws and regulations to to clarify the contents of the agreement comply with the countries’ commitments to the stakeholders. In some countries in the FTA, and (ii) the issuance of (e.g., Singapore), cabinet approval is directives and rules by the implementers mandatory before the FTA is signed. or regulators (e.g., agencies dealing with The signing of the agreement makes the tariffs, customs, or tax collection). Lack of FTA internationally binding between the proper legal and administrative measures parties involved. or their delay could undermine the Whether or not the agreement is effectiveness of signed FTAs. already in effect or enforceable depends The FTA is enforced and monitored by on the domestic laws of each country. implementing and regulatory agencies After the agreement is signed, it is made within the country with the assistance of available to the public and notified to overseas trade promotion offices (which the WTO. 125 Where required in some collect information and concerns from countries, legislative ratification precedes traders and private sector groups abroad). the notification to the WTO. Reports from these agencies and offices Ratification may or may not follow the are useful in evaluating FTAs. signing of the agreement. Some countries Most FTAs provide for their (interim or classify FTAs as executive agreements, and midterm) evaluation. On the basis of the thus binding and effective once signed assessments made by a review committee, by the president or the trade minister. the FTA may be revised or amended Most countries’ laws, however, require through protocols to the agreement. ratification by the legislature or approval The amendment may require the same by the president (if the latter did not procedures as those carried out when sign the FTA) for FTAs to be enforceable, negotiating an FTA, or a simple addendum particularly when they are classified or side letters to the agreement signed as treaties. As a treaty, the FTA is also by the trade ministers, depending on recorded, published, and deposited as an the nature and coverage of the proposed changes.

125 The WTO Negotiating Group on Rules requires “Member parties to a newly signed RTA [to] convey to the WTO, in so far as and when it is publicly available, information on the RTA, including its official name, 126 In Australia, after an agreement enters into force, it scope and date of signature, any foreseen timetable for is recorded, archived, and published in the Australian its entry into force or provisional application, relevant Treaty Series and registered with the United contact points and/or website addresses, and any Nations (UN). other relevant unrestricted information.” [emphasis 127 This notification is different from that made by a WTO supplied, Annex 1.b] member to the WTO. 114 | How to design, negotiate, and implement a free trade agreement in asia

Preparing for FTA Negotiations Box 3.2: US Trade Strategy

Countries, at least in principle, have Competitive liberalization is the core strategy of US trade policy. The US gives priority to the multilateral established systematic criteria for entering system but conducts parallel talks with global, regional, into an FTA and selecting an FTA partner. and bilateral partners to generate constructive In most cases, the decision to enter into liberalization. The main objective of negotiation is the an FTA is primarily motivated by political removal of trade barriers in goods, services, and foreign rather than economic considerations. investment, as well as the extension of the rules-based trading system. This broad objective is accompanied by Nevertheless, each country needs a a range of policy priorities, including the protection of well-defined FTA strategy to maintain intellectual property, the enhancement of transparency, a consistent negotiating position and to support for e-commerce, and the continued guide its negotiators, especially where incorporation of government procurement, labor, and the negotiating mandate is insufficient or environmental issues into US trade agreements. ambiguous. While trade is not an immediate objective of some US initiatives and foreign policy considerations largely account for others, certain standards are nevertheless General FTA Strategy established. The US considers it a matter of utmost importance that its free trade agreements set the gold The need for an FTA strategy cannot be standard for free trade, investment, and economic reform.

overemphasized. For active FTA players, Suggested Readings: the strategy states their primordial goal Bergsten, C. Fred. 1996. Competitive Liberalization and Global Free and approach to FTAs. For countries that Trade: A Vision for the Early 21st Century. Working Paper 96-15. Washington, DC: Peterson International Institute for Economics. passively enter into FTAs, it provides a Schott, Jeffery J., ed. 2004. Free Trade Agreements: US Strategies framework for negotiating agreements and Priorities. Washington, DC: Peterson International Institute for Economics. that achieve the country’s national economic development objectives, and ensures the effective management of scarce resources and skills in trade negotiation. The FTA strategy may be approaches of (i) negotiating globally general (as in the case of the US, Japan, through the WTO, (ii) cooperating with Australia, and the Republic of Korea) or other countries in the region (e.g., the specific to the FTA partner (as in the case Asia Pacific Economic Cooperation), and of most developing countries). (iii) negotiating with important trading The US puts forward its competitive partners including FTAs. 128 liberalization strategy in its bilateral, regional, and multilateral agreements (Box Formulation of FTA Negotiation Strategy 3.2). Japan’s FTA approach, on the other hand, is two-track: it negotiates regionally The creation of a viable free trade area with ASEAN as a whole, and bilaterally is a complex legal and economic process with individual member countries. that requires strategic planning. Before Japan’s economic partnership agreement beginning FTA negotiations, a country strategy is likewise dual, providing for should consider its economic, political, trade liberalization and facilitation, on and legal objectives—its reasons for one hand, and economic partnership wanting to join an FTA. enhancement (through cooperation Is it seeking to join an FTA because of and FTA-plus provisions), on the other other FTA negotiations in their region? (Box 3.3). Meanwhile, Australia pursues There may be a defensive need to opportunities to negotiate better trade negotiate an FTA with a major trading and investment conditions through the mutually reinforcing and complementary 128 www.dfat.gov.au/trade/fta/fta-guide.pdf part Iii: negotiating, implementing, and evaluating free trade agreements | 115

partner if other countries in the region and losses from the FTA, and to shape an (competitors) have done so already. appropriate negotiating strategy. Is it seeking to join an FTA to increase market access, perhaps to increase its Determining the scope and coverage market for a particular product or group of the agreement of products? Is it joining to cement a political relationship or gain a preference Consistency with WTO Rules. Almost vis-à-vis a competitor? Which market all trading nations are either WTO sectors will benefit from an FTA? Which members or in the accession process; market sectors may lose? What are the hence, WTO rules also influence the economic results? choice of strategies in trade negotiations. To answer these questions, a country WTO rules provide opportunities for FTA should: members to protect key sectors. Members can seek to exclude products from the (i) Develop an economic model of agreement, or to liberalize the covered the economy in its present state products through gradual or transitional and project the economic results arrangements. A country must, however, of commitments made in various strike an agreement on exemptions and sectors. phase-in periods in its FTA negotiations, (ii) Consult industry and trade and must bear in mind that sectoral associations, consumer groups, omissions and phase-in periods could farmers and farm groups, jeopardize the success of the negotiations NGOs, and other stakeholders, and could have diverse short- and long- and ascertain their FTA needs, term economic implications. objectives, and concerns. The WTO rules that are applicable (iii) Examine the objectives in terms to free-trade areas serve as minimum of the country’s trade relations requirements that all FTAs should with other countries, the needs meet, and specific WTO disciplines are of stakeholders, and the country’s a starting point for determining the WTO obligations. scope and coverage of FTAs. The WTO (iv) View objectives from an economic Agreement permits FTAs, but subjects perspective: them to conditions designed to ensure (a) Can the FTA be used to that any free-trade area formed by promote domestic economic the parties has substantial coverage— reform and competition? sufficient to justify the discrimination (b) Will exempting sectors from and trade distortion that is likely to result coverage (protectionism) from the FTAs. 129 make a domestic sector Specifically, GATT Article XXIV sets inefficient? forth rules for the formation of an FTA (c) Will exemptions raise the price for trade in goods. Many of the same of certain inputs and diminish competitiveness? 129 As illustrated in Part I and II, the GATT and the (d) Will exemptions protect Understanding provide that (i) a free trade area should facilitate trade between the constituent infant industries? Should long territories and not raise new barriers to trade with transition periods be used to other WTO members outside the FTA; (ii) an FTA must eliminate duties and restrictive commercial regulations protect such industries? on “substantially all the trade” between its members with respect to products originating in their territories; and (iii) an interim agreement to establish an FTA In effect, this exercise is a cost-benefit must include a plan and schedule for the formation of analysis to evaluate the potential gains the FTA within a reasonable length of time. 116 | How to design, negotiate, and implement a free trade agreement in asia

Box 3.3: Japan’s FTA Strategy Japan views free trade agreements (FTAs) as a means of broadening the scope of its economic relationships with other countries while maintaining its commitment to the World Trade Organization (WTO). It considers economic, political, and diplomatic factors when promoting FTAs, and is guided by the principle of conformity with WTO agreements. Japan aims for a comprehensive agreement, based on its first bilateral FTA with Singapore. It maintains flexibility by considering “Singapore-plus” or “Singapore-minus” options. A selective approach is also possible, for advance agreement in specific areas such as investment and services. Japan has strategic priorities in determining which FTAs to negotiate, and has established specific objectives in each case. Negotiations with ASEAN countries, for example, should offer a broad range and high degree of liberalization to ensure economic integration comparable with that of other regions. Japan also uses FTAs to promote economic development by incorporating aspects of development assistance in FTAs with developing countries. Template of Japan’s Economic Partnership Agreements Chapters Objective Trade in goods Investment Liberalization and Rules of origin Movement of natural facilitation Customs procedures persons Paperless trading Intellectual property Mutual recognition Government Trade in services procurement Competition Financial services Trade and investment Economic partnership cooperation promotion and enhancement ICT Small and medium Energy enterprises Science and technology Broadcasting Human resource Tourism development Source: Ministry of Foreign Affairs of Japan. 2002. Japan’s FTA Strategy. October. Available: www.mofa.go.jp/policy/economy/fta/ strategy0210.html

rules are applicable to customs unions, taken at the start of service negotiations. and WTO decisions interpreting the In particular, the parties must decide rules applicable to customs unions may whether to use a “positive-list approach” have relevance for the negotiation of an like the WTO, or a “negative-list FTA since both forms of regional trade approach.” (See extensive discussions in agreements are often couched in similar Part II of this reference book.) language. GATS Article V, on the other hand, sets Complementing Economic and forth rules for the scope and coverage Development Strategy. An FTA should of an FTA for trade in services. 130 be viewed as part of a country’s overall Fundamental decisions regarding the political, economic, and development modality of service commitments must be strategy. The FTA may strengthen a political relationship. It may also secure 130 An economic integration agreement liberalizing trade an economic advantage vis-à-vis other in services among its members must have substantial WTO members, or implement a regional sectoral coverage, and eliminate substantially all discrimination between or among the parties, in the development strategy. For example, sectors covered by (i) eliminating discriminatory Mexico’s membership in the NAFTA measures; and/or (ii) prohibiting new or more discriminatory measures, either when the agreement secured preferential market access for takes effect or within a reasonable time frame. Mexican exports to both the Canadian part Iii: negotiating, implementing, and evaluating free trade agreements | 117

and US markets, and resulted in FDI in development aspects into consideration, Mexico from Canadian and US investors the negotiations may result in exceptions as well as from non-member country that are broader and more favorable to investors. developing countries seeking to enter Japan decides to enter into an FTA on into FTAs. the basis of (i) economic, (ii) geographic, (iii) political and diplomatic, Understanding the political and (iv) feasibility, and (v) time-related administrative process criteria. Similarly, US key trade agencies hold discussions with potential FTA The political and administrative process partners with six broad factors in mind: implicit in the negotiation of an FTA will (i) country readiness, (ii) economic and differ for each country. Many countries commercial benefits, (iii) benefits to the follow the traditional route of granting broader trade liberalization strategy, power to government officials in FTA (iv) compatibility with US interests, negotiation, signing, ratification, and (v) congressional and private sector implementation. Other political and support, and (vi) resource constraints administrative mechanisms, however, of the US Government. Australia’s FTA exist. For example, internal policy papers policy allows the country to negotiate an and guidelines are developed at relevant FTA only if it (i) will deliver substantial ASEAN forums to guide ASEAN-plus economic benefits including commercial FTAs. In the case of the EU, the member gains for Australian businesses, (ii) will states have granted the EC authority deliver benefits more quickly than to negotiate FTAs, and are not directly multilateral efforts, (iii) is comprehensive involved in ratification (in contrast to in scope, (iv) is consistent with Australia’s ASEAN FTAs, where negotiations and WTO commitments and objectives, implementation are primarily country-to- and (v) will significantly enhance the country). country’s broader economic, foreign policy, and strategic interests. 131 Identifying the lead agency

Awareness of Ongoing Negotiations to The legislature or the constitution in Clarify and Improve FTA Disciplines. The many countries vests the authority Doha Declaration mandates negotiations for developing trade policy in the aimed at “clarifying and improving president or prime minister, subject to disciplines and procedures under the parliamentary approval. At the same existing WTO provisions applying time, the formulation of FTA negotiation to regional trade agreements. The strategy may be lodged with the president negotiations shall take into account or executive department (e.g., in the the developmental aspects of regional Republic of Korea and the Philippines), a trade agreements.” The clarification and specialized body (in Brunei Darussalam), improvement of disciplines may make or a national or ministerial team it more difficult to negotiate WTO- comprising representatives of all consistent FTAs (perhaps by specifying government ministries (in Indonesia). what constitutes “substantially all In Australia, the Federal Government the trade”). Alternatively, by taking executive (the cabinet) decides the overall FTA negotiation strategy, and 131 See www.mofa.go.jp/policy/economy/fta/ strategy0210.html, US Government Accountability also sets the guidelines for each FTA Office (2004), and www.fta.gov.au negotiation. 118 | How to design, negotiate, and implement a free trade agreement in asia

Box 3.4: Useful Information and Sources for Negotiators Economic analysis and country trade Multilateral institutions (such as UNCTAD, IMF, and World performance Bank) and regional organizations like ADB and ASEAN Secretariat; national sources like the national statistics office and trade and finance ministries; private sector data providers (e.g., JP Morgan and Bloomberg); and various research institutions Sector/Industry information, measures affecting International Trade Center, UN Commodity Trade Statistics trade, and nontariff barriers database, UN Trade Analysis and Information System, WTO Trade Policy Review Reports, EU Market Access Sectoral and Trade Barriers database, ASEAN Nontariff Measures database, and USTR National Trade Estimate Report on Foreign Trade Barriers FTA trends and useful resources ADB ARIC FTA database, UNESCAP Asia Pacific Trade and Investment Agreements database, WTO RTA gateway, Tuck Trade Agreements database Domestic and FDI policies and regulations National legislation, finance and customs regulations Domestic and trade priorities of the FTA partner National development plans, FTA strategies Sensitive issues including trade remedies filed WTO, World Trade Law website, tariff commissions and raised in dispute settlement mechanisms against prospective FTA partner

ADB = Asian Development Bank, ARIC = Asia Regional Integration Center, ASEAN = Association of Southeast Asian Nations, EU = European Union, IMF = Integrated Monetary Fund, FDI = foreign direct investment, FTA = free trade agreement, RTA = regional trade agreement, UN = United Nations, UNCTAD = United Nations Conference on , UNESCAP = United Nations Economic and Social Commission for Asia and the Pacific, USTR = United States Trade Representative, WTO = World Trade Organization.

Source: ADB staff.

The FTA negotiation strategy is arises during implementation, and when implemented by the agency that takes a change in the circumstances of the the lead in trade and FTA matters. 132 US parties requires a new agreement. The lead trade agreements are negotiated and agency also takes the role of intermediary implemented by the President through between the regulatory agencies that the Office of the US Trade Representative administer the implementation of the FTA. (USTR). In other countries, the legislature These duties are performed by an FTA takes a stronger role. Member states of staff ranging in size from 10 to 15 officers the EU have delegated most trade policy (as in international trade departments competence to the European Commission. of some ASEAN countries) to 100 staff The lead agency exercises general (as in the FTA Bureau of the Republic of supervision and management over trade Korea). Of the staff complement of 45 in negotiations. It plays a major role from the the authorized department of one of the time the FTA is initiated, when a dispute advanced countries in the region, around 15 are involved full time in a particular FTA. 132 The ministries or departments of foreign affairs and trade (in Australia, Brunei Darussalam, Republic of Using information as a negotiation tool Korea, and New Zealand); the department or ministry of (international) trade and industry (in Malaysia, Philippines, Singapore, and Viet Nam); the economic, Effective negotiation depends on the trade and industry, and foreign affairs ministries (in Japan); and the ministry of (foreign) commerce (in availability of essential data and the the PRC, Pakistan, and Thailand). quality of the impact analysis of the part Iii: negotiating, implementing, and evaluating free trade agreements | 119

proposed FTA. Trade officials must be Analysis Project (GTAP) simulations. To equipped with this information to make supplement the quantitative analysis informed decisions in the negotiations. of the impact of FTAs, some type of Negotiators are not expected to be qualitative evaluation may be required. technical experts in all FTA aspects. In some countries, a domestic sensitivity But they must at least have at hand the analysis is performed to assess the relevant information, such as economic or likely impact of the FTA on producers, trade indicators and regulations not only consumers, and regulators before going of their country but also of the other party through negotiation. Other types of (see Box 3.4). 133 studies are sectoral impact studies, political and social impact analyses, Conducting a feasibility study to assess environmental impact assessments, and the prospective FTA review of laws and regulations that are related to or that may be affected by The feasibility study assessing the the FTA. Econometric modeling may be prospective FTA is conducted either commissioned by the government through internally (within the ministry) or external consultants, along with other externally (with the assistance of an qualitative assessments of the costs and independent government think tank or benefits of the proposed FTA. a private consulting firm). The study is The breadth and relevance of the carried out at the national level in the feasibility study, which takes from 6 pre-negotiation stage or jointly with months to a year to complete for bilateral the FTA counterpart through a joint FTAs (1–2 years for ASEAN-plus FTAs), study group (JSG). The JSG, which depend on the scope and coverage of is composed of government officials, the proposed FTA and the length of its economists, and business sector negotiation. The feasibility study may be representatives, is gathered to examine conducted once at the pre-negotiation potential complementarities between the or joint feasibility study stage, and again negotiating countries in terms of further during the negotiation process to gauge trade and economic cooperation through the impact of the scenario presented at the FTA. The report and recommendations the negotiation table. of the JSG are reviewed and studied The results of the feasibility studies are closely by a joint task force or joint useful but sometimes do not provide the coordinating team (usually composed of depth of sectoral or industry analysis and members of the negotiating committee) detailed information required during the for negotiation purposes. negotiations. In this regard, the in-house Feasibility studies are conducted by capacity of the trade teams or FTA units to government, members of the academe, deliver up-to-date information at various or groups of eminent persons endorsed stages of negotiations is crucial in coming by the government. In most countries, up with appropriate bargaining positions. research institutions, law firms, and The trade negotiators may also tap the scholars are selected through private resources of other government agencies tendering to perform feasibility or (through interagency cooperation) and econometric studies including CGE industry and consumer groups (through model analysis based on Global Trade public-private partnership) on specific issues and technical matters. The 133 Also to avoid being surprised or embarrassed at having negotiating team, however, must have to face a counterpart negotiator who knows more about the laws and regulations of a particular country sustained competence and diligence to than the country’s own negotiators. arrive at an independent and credible 120 | How to design, negotiate, and implement a free trade agreement in asia

Figure 3.2: Three Levels of FTA Committees

National Advisory Council

Legislative-Executive Public-Private

Joint Study Interagency Group Committee

FTA Support

Negotiating Team Joint Coordinating Team

Sub-teams/ Working Chief Negotiator Co-chairpersons Group FTA = free trade agreement. Source: ADB.

negotiating position based on their own and national priority issues related to FTAs assessment of facts and in accordance are discussed. The council may comprise with their mandate. public-private representatives, a legislative- executive committee, or a combination of the two. At the second level is the Structuring the interagency committee, which is composed Negotiating Team of the cabinet members and agencies affected by and involved in the FTA negotiations. Other countries may provide Organizing a negotiating team involves for a subcommittee (for example, the FTA not only enlisting those who will be at support committee in Thailand) to oversee the negotiating table but also forming FTA implementation, economic adjustment, an advisory committee, an interagency and restructuring. Wide consultation is committee, and other committees to managed or conducted at these first two guide and give technical support to the levels. Some members of these committees negotiators. The negotiators must be (together with distinguished members of equipped with appropriate skills and the academe) are assigned or appointed to information to be effective as mediators the JSG to identify the benefits and losses rather than mere messengers in the from the proposed FTA, and recommend negotiation. A clear reporting line is also the type and coverage of the agreement, if important for effective decision making deemed desirable. during the negotiations. At the third level is the negotiating team, composed of the chief negotiator, Organizational Structure co-chairpersons, and several sub-teams or working groups to negotiate with Most countries establish committees at their government counterparts. In three levels when entering into an FTA some countries, a task force for each (Figure 3.2). At the highest level is the FTA negotiation is created, to conduct national advisory council, 134 where policy all aspects of research, analysis, and consultation and even actual negotiations.

134 Steering committee on international trade negotiations Key members of each party’s negotiating (Thailand) or ministerial or national team (Indonesia). team together compose the JCT. Before part Iii: negotiating, implementing, and evaluating free trade agreements | 121

Box 3.5: Typical Composition of Working Groups in the Negotiating Team

Chapter/Provision Ministry/Agency (as chair) Goods (other than agriculture) Trade and industry/Foreign affairs/Tariff commission Rules of origin Trade and industry/Customs Agriculture and sanitary and phytosanitary Agriculture measures Services and investment Finance/Economic affairs/Investment Competition policy Competition bureau/ commission Technical barriers to trade Standards, industry regulators Trade rules and facilitation Trade/Customs Government procurement Finance Cooperation and development Foreign affairs Dispute settlement, institutional provisions, Attorney general/Justice department/ and intellectual property International law/Intellectual property bureau

Source: Authors’ compilation.

the negotiations, the JCT presents the Government, representatives of the negotiating foci, discusses the items for state governments are also part of the negotiation, and agrees on an indicative negotiating team. Similarly, if negotiations timetable for the negotiation. are held abroad the negotiating team The chief negotiator or head of is supported by ambassadors and trade delegation usually comes from the lead attachés assigned thereto. FTA agency (e.g., USTR in the US, the The sub-teams or working groups hold Ministry of Foreign Affairs and Trade in specific and focused negotiations on each the Republic of Korea, and the Ministry chapter or sector of the proposed FTA of Foreign Affairs in Japan). In ASEAN- before these provisions are considered plus FTA negotiations, the organization by the joint negotiating committee at the structure is similar, with at least one lead plenary. The members of each working negotiator from each member country group and their number vary depending assigned to each dialogue partner. on the resources of the negotiating The chief negotiator is assisted by the governments (in size, most negotiating co-chairpersons (director level), who teams from developing countries stand head the sub-teams or working groups. in a 1:2 to 1:4 ratio vis-à-vis their The co-chairpersons usually come from counterparts from developed countries). ministries and regulatory agencies with Government officials in the legal responsibility for each chapter of the FTA, departments undoubtedly play a crucial and may also be technical government role in the negotiating team. Aside from experts (see Box 3.5, for example). In handling or co-chairing working groups the case of Japan, the co-chairpersons on dispute settlements, competition come from the Ministry of Foreign policies, intellectual property rights, and Affairs, to ensure a unified and consistent institutional provisions, lawyers or the perspective during the negotiations. In legal team warrant that the mandate to federal governments like the Australian negotiate and the conduct of negotiation 122 | How to design, negotiate, and implement a free trade agreement in asia

is sanctioned by their constitution and instance, while the Republic of Korea is consistent with domestic laws; ensure or Japan may assign a team of around that FTA provisions are carefully drafted 50 persons to each FTA negotiation, the (consistent with the agreement and developing country negotiating team flexible enough for situations that are is often less than half that number. not or could not have been reasonably Moreover, negotiators from developing foreseen during the negotiations); countries handle more than one important undertake proper and legal scrutiny area of negotiation or even several FTA of the complete draft; and classify the negotiations, thereby causing conflicts agreement and render a legal opinion on and problems of overlapping sessions. the need to have it ratified. Although the size of the negotiating team could prove valuable in the The Negotiators’ Mandate negotiations, the quality of the negotiators (i.e., the appointment of After the pre-negotiation consultations, the right persons) and the consistency a mandate in the form of directives or of the core team members are much negotiating instructions is issued. In more important concerns. First, the some countries, government departments negotiators in each working group must prepare a submission to the cabinet, be capable of aligning the sectoral (or and the cabinet, after considering the their agency’s) position with the national options and recommendations, decides to negotiating position by interacting negotiate. In the US, the Bipartisan Trade regularly with other working groups Promotion Authority Act of 2002 serves and consulting with the interagency as the President’s official mandate to committee through the co-chairpersons or negotiate FTAs. The negotiation mandate the chief negotiator. The core negotiating contains government approval to proceed team must be retained as much as with the formal negotiations, grants possible for consistency and faster authority to represent the government, resolution of outstanding issues. This and delimits the negotiating team’s will make the negotiation process more authority (in terms of coverage of the efficient and serve the national interest. agreement, negotiating position, and so Lastly, the members of the negotiating on). The negotiators’ mandate may change team must have adequate technical, from time to time. Negotiators need a clear communication, and negotiating skills 135 mandate from their ministries or at least to be effective negotiators and not mere a channel through which they can obtain emissaries every time a negotiating the mandate promptly. In some cases, the issue is presented at the table. Access to lack of authority of negotiators drags out information and support from various the negotiation process. Regular meetings sectors are also essential. involving all sectoral bodies may be conducted to guide the negotiating team and clarify or strengthen their mandate.

135 Training and capacity building in the following areas Quantity and Quality of the would be useful to negotiators: (i) formulation of international trade negotiation positions and strategy; Negotiating Team (ii) trade regimes and negotiation of international trade agreements; (iii) trade diplomacy and advocacy; In a negotiation between a developed (iv) policy and research analysis; (v) rules of WTO and other international agreements; and (vi) the art and a developing country, the latter is of managing political pressure and stakeholders’ faced with negotiating constraints. For agenda(s). part Iii: negotiating, implementing, and evaluating free trade agreements | 123

Box 3.6: ASEAN Approaches to Negotiation Box 3.7: Negotiation Approach under the GATS Association of Southeast Asian Nations (ASEAN) free Trade in services under the World Trade Organization trade agreement (FTA) negotiations are characterized by (WTO) has quite different negotiation dynamics in terms a sectoral approach to negotiations—first, agreement is of commitments and rules. On one side is the bilateral reached on trade in goods, followed by trade in services negotiation of specific national commitments, which and investment liberalization. Even though the dialogue takes the form of a bilateral bargaining process based partners are supposed to negotiate with ASEAN as on requests and offers, and on the other the multilateral a whole, negotiating with ASEAN involves bilateral (i.e., collective) negotiation of the governing rules, which negotiations between each ASEAN member country involves an effort to build consensus on broad principles and the dialogue partner. This type of negotiation is among member countries. crucial in cases of modalities and coverage of FTAs, particularly provisions on sensitive sectors. The process, The steps in negotiating a proposal under the General however, tends to drag out the negotiation because the Agreement on Trade in Services (GATS) are as follows: negotiators, having to weigh national versus regional (i) develop requests under the request or offer objectives, find it difficult to reach consensus. procedure in the WTO. Source: ADB staff. (ii) formulate negotiating proposals on rules in the GATS negotiation. The Negotiation Process (iii) negotiate sectoral and functional agreements.

Source: Monning and Feketekuty (2003). Laying Out the Negotiation Rules and Timetable to take delays into account, especially Unlike multilateral negotiations (i.e., in the negotiation of modalities (where within the WTO framework), FTA the number of tariff lines is negotiated negotiations follow no established or separately from the list of products; see internationally accepted procedure. They Figure 3.3 and discussions under trade differ from country to country and may in goods in Part II), sensitive sectors, be deduced from past practices, protocol, and exclusions. It must also provide for or prior agreements entered into by adequate consultation with domestic the negotiating countries. At the very stakeholders and significant committees least, the JCT must agree on the rules when critical issues are considered. There of proceeding with the negotiations. In is no universal deadline for negotiation of terms of sequencing, the negotiators may FTAs. However, in the US the time limit adopt a sectoral approach (see ASEAN set for the trade promotion authority example in Box 3.6), a dual approach serves as deadline for its FTA negotiation. (i.e., the modalities-and-rules approach The election cycle in many countries may in the GATS, Box 3.7), or a gradualist also be a deadline for FTA negotiations. approach (from simpler to more complex Negotiators are likewise faced with issues). These are not the only options— resource constraints (especially when negotiators sometimes agree to adopt a some agencies are unable to attend template FTA (another FTA previously negotiation meetings) and strong pressure signed by a party to the negotiation) to conclude the negotiations quickly. and no longer negotiate items that are acceptable to both parties or are not Interagency Coordination otherwise disputed. The sequence of negotiations Aside from providing a venue for logically affects the preparation of the government departments to balance indicative timetable for negotiations. national interests and industry- and The timetable must be flexible enough sector-specific concerns, interagency 124 | How to design, negotiate, and implement a free trade agreement in asia

Figure 3.3: Tariff Elimination Modalities for Negotiating FTAs

MODALITIES

Early-Harvest Scheme Normal Track Sensitive Track

Immediate Elimination Gradual/Phase-in Sensitive List Highly Sensitive Elimination List/Exclusion

Source: Author’s compilation from various free trade agreements (FTAs).

coordination facilitates at least two proven to be practicable and effective. In significant processes that are useful in some countries, junior trade officers learn negotiating and implementing FTAs. by observing actual negotiations. Exposure First, interagency coordination enables to FTA issues and involvement in actual the consolidation of all the sectoral FTA negotiations are effective ways of consultations of the different departments developing negotiation skills. Whatever or agencies. Formal hearings are the strategy or approach adopted by a sometimes selective and infrequent, so negotiating team, certain guidelines and the national advisory council or trade protocols must be followed to achieve negotiation team can base its assessment smooth and successful negotiations (see only on sectoral information provided by Box 3.10). The chief negotiators on both the ministries or agencies. sides must ensure this. Second, interagency coordination Most countries appoint a separate provides the necessary link in FTA chief negotiator for each FTA rather than enforcement and monitoring. For endorsing one for several FTAs. The chief instance, the effective implementation negotiator must be clear about the of the trade facilitation provisions country’s national trade interests, maintain of an FTA requires interconnectivity a strategic and holistic framework in the and coordination among all cross- negotiations, and ensure that the country’s border agencies (customs, sanitary and negotiating position is clearly understood phytosanitary, inspection, and quarantine by the counterpart. However, simply agencies). In most cases, interagency sticking to a predetermined negotiating coordination is required before FTA position may drive the negotiating process implementation (to itemize the products to an impasse; hence, negotiators are to be included in each modality of quite often advised to focus more on tariff liberalization). The interagency interest than on standing positions. 136 committee may be ad hoc and organized Unlike negotiations for private issues, FTA for each negotiation or may already be negotiations bind government officials embedded in the government structure more strongly to their mandates. Given (see Boxes 3.8 and 3.9 for an overview that the ultimate goal of FTA negotiations of the interagency mechanisms in the US is to maximize national interests, however, and the Republic of Korea). positions need to be properly adapted to changing negotiating conditions to Negotiation Techniques, Habits, and Role best serve the national interest. The of the Chief Negotiator chief negotiator must, among others, possess credibility, patience, and sincere There are various negotiation techniques, commitment to negotiate and arrive at an most of which can be learned through practice. Simulation exercises have been 136 Fisher and Ury (1988). part Iii: negotiating, implementing, and evaluating free trade agreements | 125

Box 3.8: US Interagency Structure Box 3.9: Interagency Coordination Mechanism in the Republic of Korea The Office of the US Trade Representative (USTR) is the lead agency in formulating and coordinating US Interagency coordination is either managed by an trade policy, negotiating trade agreements such as free ad hoc or permanent centralized interdepartmental trade agreements, and enforcing these agreements. committee, led in many cases by the ministry of foreign It consists of three tiers of committees—the National affairs. Some countries (e.g., the Republic of Korea) have Security Council (NSC) and the National Economic a committee consisting of the ministers for international Council (NEC), the Trade Policy Review Group (TPRG), economic affairs and chaired by the . and the Trade Policy Staff Committee (TPSC). The Sub-teams or back-office members working on different presence of the NSC shows that security issues are aspects of the free trade agreement meet when considered in US trade policy. necessary with colleagues in other relevant agencies. The Office of the USTR consults with other While certain issues are discussed bilaterally between the government agencies on trade policy matters through lead agency and the agencies concerned, most issues the TPRG and the TPSC. These groups, administered and are dealt with in committee meetings. The committees chaired by the Office of the USTR and composed of 19 effectively coordinate different agency positions, although federal agencies and offices, make up the sub-cabinet- critics decry the frequent use of the process to share level mechanism for developing and coordinating US responsibility for certain sensitive issues among agencies. government positions on international trade and trade- related investment issues. Source: ADB staff. If agreement is not reached in the TPSC, or if significant policy questions are being considered, then issues are taken up by the TPRG (deputy USTR and undersecretary level). The final tier of the interagency trade policy mechanism is the NEC, chaired by the (BATNA) and considering the partner’s President. The NEC deputies committee considers BATNA are also very important in memorandums from the TPRG, as well as important or strengthening bargaining power during controversial trade-related issues. negotiation and strategizing the options 138 Sources: US Trade Representative website; US Government available. Accountability Office Report (2005).

Managing Consultations

agreement; maintain a good working relationship with the counterpart chief Building domestic consensus in FTAs is negotiator; have the ability to manage always difficult. A common issue raised conflicting interest and views; employ against FTA negotiators is their failure sound judgment on the pace and rhythm to consult all stakeholders. Getting of the negotiation; be able to effectively stakeholders to participate in consultation coordinate the team; and have the meetings may also be difficult. Managing ability to energize domestic processes. consultations involves providing a The chief negotiator should also be able venue for discussing the stakeholders’ to communicate with the media since concerns and issues and sustaining such a progress briefings are frequent. If the mechanism. parties cannot reach a mutually beneficial agreement and the negotiations fail, it Subjects and Types of Consultation is crucial for the chief negotiator to be prepared with a best alternative to an The overall objective of consultation is agreement. 137 Developing one’s best to consolidate varied interests, assess alternative to a negotiated agreement the country’s FTA objectives, and build national consensus on the proposed FTA. 137 Using a “cost-benefit” analysis of the negotiating team’s options, strategy, or plan for solving the trade problem. 138 See Fisher and Ury (1988). 126 | How to design, negotiate, and implement a free trade agreement in asia

Box 3.10: Negotiating Skills and Good Consultation involves two types of Negotiating Habits subjects. Public stakeholders who define national policies, implement government Listen Actively Place information provided by other negotiators in programs and measures in all sectors, the proper context. When in doubt, confirm what you and deliver services to the public are thought you heard. subjects of the first type. They are the members of the parliament, the cabinet, Ask Questions and regulatory agencies. In the second The negotiation setting is an opportunity to learn about counterpart interests and determine where trade- group are the private stakeholders, offs or compromise might be appropriate. comprising chambers of commerce, trade groups, sector or industry Tactical and Timely Use of Silence representatives, consumers, labor groups, Information or compromise may be provided to fill NGOs, and the general public. The level the vacuum. of participation of these groups varies Take Breaks from the Negotiating Table (and existing mechanisms tend to be “Going to the balcony” to review an oral or written biased in favor of big pressure groups). proposal, develop or formulate a response, and regain At the very least, all of these sectors your composure is important. should be well represented during the Organize Brainstorming Sessions negotiations. Brainstorm to elicit reactions, ideas, and Consultation mechanisms may be counterproposals. “What if” questions give the team or formal or informal. Formal consultations counterparts the power of choice and make acceptance are institutionalized and involve the of the proposal more likely. membership and participation of public Use Objective Criteria and private stakeholders in the advisory Introduce fair standards and persuade the other council as well as in the interagency party to support an argument or proposal by submitting committee’s FTA policy debates. Some evidence from independent experts. countries convene public hearings Practice Role Reversal before the official negotiation. Informal Discuss what would work for the other party and consultation is done through sectoral why, to understand that party’s bargaining position. public hearings, opinion surveys, outreach and regional seminars, and other means Listen to and Record All Proposed Options (e.g., through invitations for comments on Preserve the proposal for ongoing review and comment by creating a record of the session. government websites). Contrary to common perception, Be Sensitive to Cross-Cultural Dynamics, consultation is not a stumbling block but Gender, and Language rather a building block (by providing Diplomacy and careful use of language will inputs and outputs) in the negotiation determine the success or failure of the negotiation process. process. In terms of inputs, consultation serves as a venue for discussing the Build a Reputation issues and concerns of various sectors, Rapport and good working relationships with identifying the key sensitive sectors, counterparts will generate long-term benefits. and managing conflict arising from the Create a Win-Win Mentality resistance posed by civil society and Aim to arrive at a mutually acceptable agreement other vested groups. In some cases, such that both sides feel they have won. strong opposition from interest groups is

Source: Monning and Feketekuty (2003). a defensive tool used to protect certain industries during the negotiation. In terms of outputs, consultation becomes an instrument of advocacy for parT iii: negoTiaTing, implemenTing, and evaluaTing free Trade agreemenTs | 17

the negotiators, not only in disseminating figure 3.4: When Consultation Should information on the FTA at various stages, Be Conducted but also in soliciting stakeholder support (thereby assisting in the legitimation of the FTA), understanding technical Pre-negotiation Consultation Joint Feasibility information, and drafting effective Studies and non-trade-restricting measures to implement the FTA. Although the type of consultation may Assessment and Consultation Amendment during Negotiation vary in the stage of the FTA process, it should nonetheless be conducted from pre- Enforcement and Monitoring negotiation to amendment (Figure 3.4). During pre-negotiation, public hearings are source: adb staff. conducted to make a general assessment of the impact of the FTA. When feasibility studies are conducted, economic scholars, technical experts, and the business sector down approach, where those at the provide specific and quantitative analyses higher levels (e.g., ministries, chief of the FTA. Politically sensitive items executive officers) steer the flow of and other critical issues are discussed consultation and, ultimately, decision with the various stakeholders through making. Developed countries, however, available channels during the negotiation. have established a bottom-up approach Consultations during the implementation to consultation (beginning broadly of the FTA assist the regulators as well with the general public and concerned as end users of government and trade sectors). Various stakeholders’ views are services in improving the FTA-established constantly obtained through submissions mechanisms and in assessing whether or and industry feedback (e.g., the Australia, not the objectives of the FTA have been New Zealand, and Singapore FTA websites achieved. elicit such feedback). The choice of the The resources needed and the system usually takes into account the manner of consultation depends on political, economic, and institutional the value accorded to the process by a circumstances of the country as well country. To attain the expected effects as the time and resources available. In described above, the consultation should any case, the design of the consultation be sufficient to help the stakeholders mechanism should be systematic, understand what is being presented at continuous, and transparent. The amount the negotiation and consult with their and quality of information provided by constituencies on the pros and cons of the negotiators will determine and sustain the proposals from their own perspective. the stakeholders’ active participation in This guarantees representation of the consultation. all interests in policy debate and formulation. imPlemenTing an fTa consultation mechanisms

There are various models and ways of After an FTA is signed, it undergoes managing consultations on FTAs and several internal pre-implementation trade-related issues (refer to Box 3.11). procedures such as ratification and Most developing countries adopt a top- legislative enactment to ensure that the 128 | How to design, negotiate, and implement a free trade agreement in asia

Box 3.11: Examples of Consultation Mechanisms Agency-Led Consultations prepare a report on proposed trade agreements The Republic of Korea (through the Ministry of for the Administration and Congress and make Foreign Affairs and Trade) consults all private and it public on the website of the Office of the US public stakeholders before and during negotiation, Trade Representative (USTR). The USTR’s Office thus giving them ample opportunity to voice of Intergovernmental Affairs and Public Liaison their concerns and opinions. Consultations are administers the federal trade advisory committee conducted through public hearings, private sector system and provides outreach to, and facilitates advisory meetings, and online channels to gather dialogue on trade policy issues with, state and industry views. local governments, the business and agricultural communities, and labor, environmental, consumer, National Trade Consultations and other domestic groups. Australia’s national trade consultations provide a forum for consultation, coordination, and Evaluation and Advisory Consultations collaboration on trade and investment issues Australia’s Productivity Commission (PC) is the between the federal and state and territory Government’s principal evaluation and advisory governments. Once or twice a year, the trade body on microeconomic policy and regulation. Once minister chairs a meeting with state and territory authorized to conduct an inquiry, the PC collects ministers who are responsible for trade issues. public opinions through hearings, submissions, Additional issue-specific meetings are arranged as and feedback on draft reports. Final findings and necessary. Explicit consultation guidelines have been recommendations are based on extensive public issued by the Council of Australian Governments, the input and feedback, which, in some cases, differ agency that facilitates consultation, cooperation, and substantially from initial positions. This open policy coordination. process helps reduce the possibility of unexpected responses, which could lead to policy reversals. Industry-Based Consultations In India, extensive consultation is conducted Technology-Based Consultations by at least two major industry associations—the International Enterprise Singapore is an Confederation of Indian Industry (with over agency under the Ministry of Trade and Industry 4,800 company members) and the Federation that is spearheading the development of of Indian Chambers of Commerce and Industry. Singapore’s external economy. It maintains a free These associations play an active role in delivering trade agreement portal providing information industry views and providing critical inputs to the to Singapore-based companies exporting to Government on trade issues. Singapore’s FTA partner countries, and collects industry feedback (through online surveys) to help Public-Private Advisory Consultations the government negotiate FTA provisions that cater Established in 1974, the private sector advisory to the needs and interests of business. committee system in the US is aimed at providing information and advice with respect to negotiating Sources: Australian Trade Commission; FTA and Commonwealth- objectives and bargaining positions before trade State Consultation on Treaties websites; International Enterprise Singapore website; Office of the US Trade Representative website; agreements are negotiated. Under the Trade Act and Gallagher (2006). of 2002, each advisory committee is required to

signed FTA is within the mandate of concerned, if only to comply with the the government. 139 These procedures, country’s FTA commitments and gain from however, often unduly delay the FTA’s new market opportunities. implementation and, hence, also the attainment of its expected benefits. The Pre-implementation implementation stage requires the active involvement of all government agencies The effectivity of an FTA depends on (i) the “entry into force” provision in the 139 This presupposes that the agreement is in accord with the country’s constitution or requires no constitutional FTA, and (ii) the internal or domestic change. procedures of the signatories. Depending part Iii: negotiating, implementing, and evaluating free trade agreements | 129

on the nature of the agreement, the FTA member countries. Indonesia considers may take effect on the date it is signed, or FTAs and all other international on the date one party gives notice to the agreements (e.g., the WTO Agreement) other party that it has complied with all as presidential decrees, thereby requiring the legal requirements such as ratification in most cases, only the signature of the (or the number of days after that notice President. The Philippines, on the other is received by the other party), or on hand, makes a distinction: agreements the date the FTA becomes effective and that primarily involve the reduction of binding as domestic law. 140 The date of tariffs are executive agreements and need effectivity may also be agreed upon by the not go through legislative ratification, signing parties. but FTAs that are comprehensive in scope In the case of AFTA, member countries (covering items that could be subject to have different procedures for the FTA legal enactments or are constitutionally to be effective. While the act of signing mandated) require legislative by authorized officials (which could concurrence. Still, even if legislative be the president or the trade minister ratification is not required, strong as the president’s alter ego) would political pressure would necessitate “prior make the AFTA effective in Brunei endorsement” of the legislature if only to Darussalam, Malaysia, and Viet Nam, legitimize the FTA (as in the case of the other ASEAN countries have additional New Zealand–Singapore FTA). 142 requirements: a letter of acceptance In Japan, executive agreements can signed by the President in the Philippines be concluded by the executive under and Indonesia, and ratification by the its power to manage foreign affairs. legislature in Thailand. In Singapore, all However, treaties that require the necessary approval is obtained before maintenance or adoption of legislative signing; hence, no ratification is needed. measures for their implementation or In the US, after an agreement is deal with financial matters require the concluded, the US President is required approval of the Diet. 143 In the same vein, to submit its final text to Congress other Asian countries like Georgia have together with the draft implementing bill, made it obligatory to ratify international a statement of any administrative action treaties and agreements that require proposed to implement the agreement, a change in domestic legislation or and other supporting information. the adoption of laws and acts with the Failure to comply with this submission force of law to honor the international requirement would prevent the agreement obligations undertaken. 144 If an from entering into force. 141 agreement requires no change in domestic legislation, it may be accepted without Ratification parliamentary ratification. In the US, Congress has delegated The AFTA requirements, however, do the tariff-negotiating authority to the not apply to ASEAN-plus agreements or President and authorized the latter to bilateral FTAs entered into by individual suspend existing duty-free treatment. By virtue of this delegation and the doctrine 140 For example, when the FTA has provisions affecting the rights and obligations of citizens or imposes 142 The New Zealand Constitution provides that the penalties, due process requires notice or publication. Parliament has no power to delay or alter an The FTA takes effect only after the publication international agreement or ratify one. The Parliament requirements have been complied with. In this only takes into consideration the FTA to identify and case international agreements have the standing of provide for necessary changes to law. domestic law. 143 Japan’s two-house Parliament. 141 Pregelj (2005). 144 Article 65, Constitution of Georgia. 130 | How to design, negotiate, and implement a free trade agreement in asia

Box 3.12: Australia’s Treaty Approval Process WTO notification The Australian treaty approval process involves the following steps for all treaty actions (negotiating a new A mandatory action for WTO members treaty, amending an existing one, or abrogating a treaty): signing an FTA is to notify the agreement to the WTO. The following rules govern (i) The preparation of a national interest analysis (NIA), the notification procedure: which sets out the advantages and disadvantages to Australia of becoming, or not becoming, a party (i) The Decision on the Transparency to the treaty, including the significant quantifiable Mechanism for Regional Trade and foreseeable economic and environmental Agreements, which calls for effects of the treaty. Among several other points, an early announcement by the NIA must detail the consultations that have members participating in FTA taken place with the states and territories, and with 146 community and other interested partners. negotiations; and (ii) The preparation of a regulatory impact statement, (ii) GATT Article XXIV:7; the including an assessment of the impact of the Understanding; and GATS proposed regulation (i.e., the treaty) and its Article V:7, which provides that alternatives on different groups and the a member must notify the WTO community as a whole. and submit details to the WTO (iii) The tabling of the treaty before Parliament for 20 regarding FTAs and interim sitting days and consideration of the proposed agreements that the member is treaty action by the Joint Standing Committee on joining or intends to join. Treaties. (iv) The preparation and passage of the enabling Notification under the WTO may legislation. be under the Enabling Clause, GATT Source: Goode (2005). Article XXIV, or GATS Article V, 147 and may be made to the WTO’s Committee on Regional Trade Agreements (those of political agency, negotiators (with the FTAs falling under GATT Article XXIV approval of the President and designated and GATS Article V) or to its Committee political appointees of the President) on Trade and Development (FTAs falling can commit to an executive agreement under the Enabling Clause). The types without the approval of the Congress, of agreements notified are preferential but not to a treaty or an agreement that arrangements, free-trade agreements, changes US law. An agreement classified customs unions, service agreements, and as a treaty must be ratified by two thirds accession to any of these agreements. of the US Senate, while an agreement that After the required notification, a working changes US law must be approved by a 145 majority of both houses of Congress. 146 It also requires parties to specify the provision(s) of FTAs are considered as treaties in the WTO Agreement under which the FTA is notified, Australia, so the FTA must undergo treaty and to provide the full text of the FTA and any related schedules, annexes, and protocols, in one of the WTO approval (see Box 3.12). After treaty official languages (English, French, and Spanish). approval and when the agreement enters 147 WTO rules for trade in goods are found in Article XXIV of the GATT, and for trade in services, in into force it is recorded, archived, and Article V of the GATS. The Enabling Clause allows published in the Australian Treaty Series developed countries to accord more favorable treatment to developing countries without according and registered with the UN. such treatment to other countries. It also applies to preferential trade arrangements (PTAs) or FTAs between developing countries but not PTAs and FTAs 145 Monning and Feketekuty (2003). See also Grimmett between developed and developing countries. See (2004) and Pregelj (2005). Fiorentino et al. (2007). part Iii: negotiating, implementing, and evaluating free trade agreements | 131

Figure 3.5: New RTA Transparency Mechanism

Early Formal Factual Review Notification Announcement Notification Presentation by WTO of Members Change

RTA = regional trade agreement. Source: World Trade Organization (WTO) website. Available: www.wto.org. party is convened to examine the notified enactment or amendment of laws may be FTA, verify consistency with the WTO made by the president’s office. Agreement, and make appropriate The laws to be passed or amended recommendations. Furthermore, are those covered by the FTAs that affect periodic reports on the operation of the rights and obligations of the citizens the FTAs, including significant changes of the FTA member country. These and developments in the agreements, laws either translate the international are required. A new regional trade agreement into domestic law or clarify the agreement (RTA) transparency issues presented in the new arrangement. mechanism was adopted on a provisional This is especially the case where some basis in 2006. This refers to the early restrictions are lifted or foreign entities announcement of RTA and notification to are given preferential treatment by the WTO (see Figure 3.5 for the major steps FTA (see Box 3.13 for an example of legal involved). changes adopted as a result of entering into an FTA). These new or amended laws Implementation are complemented by implementing rules and regulations, as discussed in the next Legislative enactments and amendments section.

Most countries pass new legislation or Directives, issuances, and regulations amend existing laws to comply with their FTA commitments or to extend Even after an FTA takes effect (and the preferential treatment to traders from FTA requisite laws are passed or amended), countries. These procedures are necessary some administrative procedures still for FTAs to be effective as domestic laws need to be carried out to fulfill the and to fill the gaps left by the general requirements of the FTA. Some FTAs provisions and even the implementation draw out uniform operational guidelines arrangements provided in the FTAs. in implementing the customs procedure The legislative enactment presupposes and rules of origin mechanism. In the that the FTA is consistent with the Philippines, the executive order from the constitution and has passed the President is followed by issuances from ratification stage. It is worth noting that the finance department and guidelines the procedure and voting requirement from the customs bureau. In Malaysia, when ratifying an FTA may be different a directive from the finance ministry from the requirement for passing would suffice. Meanwhile, in Indonesia, legislation to implement the FTA. In a decree from the finance ministry and some countries where the president has an issuance from the customs agency legislative powers, the requisite legislative on the procedures are mandatory. These 132 | How to design, negotiate, and implement a free trade agreement in asia

Box 3.13: Legal Changes Made in Singapore Box 3.14: Examples of FTA Websites

Singapore has entered into a number of free trade Australia www.fta.gov.au/ agreements (FTAs) with its trading partners. As a Japan www.mofa.go.jp/policy/economy/fta/ result, Singapore laws have been amended to reflect index.html commitments made under the various FTAs. Customs Singapore www.iesingapore.gov.sg/wps/portal/ legislation has been amended to accord preferential FTA tariff treatment and provide procedures for the issuance Thailand www.thaifta.com/english/index_eng. of preferential certificates of origin. Following the html US-Singapore FTA (USSFTA), Singapore legislation United States www.ustr.gov/Trade_Agreements/ has permitted the importation of chewing gum “with Section_Index.html therapeutic value.” Likewise, under the new Singapore import/export law, where any part of the manufacture Source: Author’s compilation. of textiles and clothing products covered under the USSFTA is carried out or procured by any person in Singapore, to be exported to the US, that person must Public information be registered. As a result of Singapore’s FTA commitments (namely, USSFTA, the Republic of Korea–Singapore FTA, and the Information dissemination has always Transpacific Strategic Economic Partnership concluded been crucial in the implementation of an by Singapore with Brunei Darussalam, Chile, and New agreement. For instance, many observers Zealand), it now offers its FTA partners a more attractive have attributed the low utilization of procurement environment, particularly in relation to the preferential tariff rates to the lack of threshold values of procurement contracts. Singapore 148 passed the Competition Act of 2004 and established information on the AFTA tariff scheme. the Competition Commission in 2005. Changes have The fact that the newly signed FTA been made as well in the regulation of entry into and will not impose any undue burden on activities in various service sectors such as banking exporters who value the reduction or and legal practice. The Trade Marks Act, the Patent Act, elimination of nontariff barriers more and the Copyright Act have been amended to reflect Singapore’s FTA commitments. than differential tariff rates should also be highlighted. Source: Hsu (2006). Information dissemination is traditionally conducted through brochures, newspapers and other are common steps in implementing tariff publications, seminars, road shows, and reduction schemes. The procedures are trade discussions. However, there are more complex (where implementing rules modern approaches to introducing FTA and regulations follow a law that has to the public, including disseminating been passed or amended) to implement information through FTA websites (see the nontariff provisions of the FTA (e.g., Box 3.14 for a list of FTA websites). services or investment liberalization These sites are useful not only in provisions). providing one-stop online resource The directives, issuances, or sites on the FTAs entered into by the regulations should serve as essential country but also in soliciting feedback guides for regulators as well as traders/ or conducting public consultation individuals especially in availing on proposed FTAs. FTA sites may themselves of the preferences given also provide additional assistance by under the FTA. They should not be too publishing the names of those who stringent or complicated so as to restrict or discourage the business sector from 148 Other reasons given for the low utilization rate are the minimal margin between WTO or MFN rates and taking advantage of what the FTA has common effective preferential tariff (CEPT) rates, and to offer. the additional procedures required. part Iii: negotiating, implementing, and evaluating free trade agreements | 133

can render expert advice to exporters For example, although valuable, data on (e.g., in Singapore and Australia). In the actual utilization of the FTA are not Australia, an FTA export advisory panel always readily available. The directive to has been established to promote the be issued by the customs or tariff agency benefits of FTAs, by offering advice could require traders that avail themselves on implementation and market access of preferential rates under the FTA to issues, and by identifying specific trade report such use on the specified form and investment opportunities created by directly to a specific unit or agency, to such agreements. The panel is made up facilitate recording and monitoring. Such of senior representatives from a range of information will be handy in evaluating industry groups and includes input from the impact of FTAs on traders. a cross-section of specialists, business Other possible mechanisms for organizations, and community groups. monitoring and compliance are regular consultations with the private sector and full use of the technology (such as the Evaluating an FTA internet and available mobile services) to gather comments from other sectors including consumers. The review clauses of FTAs provide an opportunity to identify areas Assessment and Evaluation where the agreements can be further improved. This stage, however, requires Some FTAs provide review clauses to proper mechanisms for monitoring analyze the impact or progress of their and evaluation to assess whether the implementation. Most countries use objectives of the FTA have been met in general indicators to assess the economic the first place and whether the scope of impact of FTAs, from macroeconomic the agreement can be expanded and its indicators (in the Republic of Korea) terms improved. to industry utilization indicators (in Singapore). The review, however, is often Monitoring and Enforcement limited to analyzing whether tariff cuts have been made or whether the FTA has Compliance monitoring requires resulted in an increase in trade volume resources and intensive effort not only or growth in market shares between the from the lead agency but especially FTA partners. The use of these indicators from the implementers and regulators. should be approached with caution since In the US, monitoring is primarily done trade expansion need not be a direct by the same agency that negotiates FTA, result of the tariff liberalization and may although several other agencies, both be caused by other factors beyond what domestic and overseas, are likewise is covered by the FTA. There is also a involved (see Box 3.15). growing interest in assessing FTAs by In most countries, monitoring is examining the existence or nonexistence lodged with the implementing agencies. of nontariff barriers to trade. Coordination among agencies is essential Another important aspect is identifying especially between those agencies that the proper agency to evaluate the will put into operation the provisions FTAs. While some countries designate a of the agreements and those that will specialized body, in others trade-related eventually review the agreements and institutes or other organizations conduct provide for the necessary amendments. annual studies on the economic effects of 134 | How to design, negotiate, and implement a free trade agreement in asia

Box 3.15: US Monitoring and Enforcement System The monitoring and enforcement of trade agreements of the US involves four agencies and several units within each agency. Each agency has both domestic and overseas components, as well as several geographic, industry, and issue-specific units involved in monitoring and enforcement. The agencies coordinate monitoring and enforcement activities through an interagency network for trade policy development led by the Office of the US Trade Representative and involving at least 17 federal agencies. To improve interagency coordination, a regular forum is provided to allow federal agencies to share and discuss information, set priorities, assign responsibilities, and design and implement strategies. Trade agencies take advantage of technology (through e-mail and videoconferencing) to communicate information on trade compliance issues.

Agency Main Unit at Headquarters Overseas and Other Units Involved US Trade Monitoring and Enforcement Unit US Mission to the World Trade Organizations Representative (WTO); trade policy officers; WTO and multilateral affairs; region-specific offices Commerce Market Access and Compliance Trade promotion agencies; Foreign Office Commercial Service; market access and compliance officers overseas; Manufacturing Services; Import Administration; Patent and Trademark Office State Trade Policy and Programs Economic section of embassies; country desk staff; issue-specific task forces Agriculture Foreign Agricultural Service Animal and Plant Health Inspection Service; Food Safety and Inspection Service

Source: US Government Accountability Office (2005).

FTAs. Often the foreign affairs ministry Amendment Procedures is responsible for both implementing and evaluating FTAs. The frequency of Like the review clauses, most FTAs have reviews depends on each specific FTA. sections on amendments and modification. For example, the joint committee under These amendments may take the form the Australia-US FTA is supposed to of exchanges of notes and protocol meet annually to supervise the overall agreements. Where no substantial change implementation of the agreement. is introduced, these protocols require Even if the importance of this stage only the endorsement of the parties (i.e., is well recognized among the countries, the signature of the trade ministers). manpower and other resources are There are countries that require cabinet often limited. With this constraint, it is approval, depending on the changes to important to remember that there should be introduced. Some FTA amendments be an independent assessment of the FTAs. undergo the same domestic procedure At the very least, those who were directly as treaty amendments. In certain cases, involved in the negotiations should not be amending FTAs involves ministerial the ones who evaluate the FTAs. approval and legislative change. Appendix to Part III: sample Questionnaire on the Negotiation, Implementation, and Evaluation of Free Trade Agreements

Preparing for FTA Negotiations that most affect—or would affect— your country’s choice of FTA partner (1) Please choose the kind of FTA and arrangement, with the factor negotiation strategy that you use and ranked “1” being the most significant identify its main components: and the factor ranked “4” the least significant. Type Main Components General Economic objective Previous/ FTA Current Future Political consideration negotiation Factor FTA FTA strategy Coverage of FTA FTA Partner Different Sensitive sectors to be Type of FTA (regional or strategy protected bilateral) per FTA/ Sequencing of Scope and Coverage of FTA partner negotiation* Time Frame of FTA Others (please specify) * E.g., trade in goods first, then trade in services and investment. (5) Is there an agency designated to conduct feasibility studies on your (2) Who is responsible for formulating your prospective FTAs? If so, please identify trade (or FTA) negotiation strategy? the agency and the type of feasibility studies conducted (for example, CGE Legislature modeling, sectoral impact studies). President/Executive department ______Specialized body (such as trade representative office) (6) Please describe your general FTA Others (please specify) negotiation cycle,* including the sequencing of political or (3) Do you have written laws, directives, administrative procedures for initiating guidelines, or policies regarding your and implementing FTA negotiations, FTA negotiation strategy? Please and the usual time spent on each step. enumerate: ______* E.g. , feasibility study, public hearing, cabinet decision, consultation with the legislature, organization of the (4) In your previous/current and negotiation team, consultation with stakeholders (interest prospective FTA negotiations, please groups), drafting of laws, legislative approval, implementation rank in descending order the factors and review procedures. 136 | How to design, negotiate, and implement a free trade agreement in asia

Organizing the negotiating team Managing Consultations and FTA Implementation and Monitoring (7) Which ministry/agency is the lead agency in FTA negotiations in your (12) To what extent and at what stage country? ______Please identify do public/private stakeholders the lead department/office in that participate in the negotiation process? ministry and the total number of staff of that department. ______Stakeholders/Sectors Stage of Major Negotiation Input (8) Please describe the composition Trade groups of your trade negotiating team in Business sector previous FTA negotiations (name, Consumer groups actual number of members, and Sensitive industries composition of each sub-team (please specify) or committee, and actual tasks performed). Marginalized sectors Others (please specify) Sub-team/ Number and Tasks Committee Composition (13) What are the advantages (or of Members limitations) of your current system of managing consultations? ______

(14) Please describe the procedures after the FTA is signed (including (9) Please enumerate the strengths legislative approval) and before it and weaknesses of interagency takes effective. coordination in the negotiation process. Mandatory Optional Procedures ______Procedures ______(i) (i) (ii) (ii) (10) Please describe the constraints on your negotiating team in previous/ current FTA negotiations. (15) What are the mechanisms used ______in disseminating information on ______the signed FTAs? Please tick all the applicable mechanisms. (11) Do you have one chief negotiator for all FTA negotiations? _____What FTA webpage do you think are the most important Government websites characteristics and roles of the chief Newspapers or other publications negotiator? Brochures and FTA guides ______Seminars and trade discussions TV and radio Others (please specify) part Iii: negotiating, implementing, and evaluating free trade agreements | 137

(16) Who is responsible for evaluating (17) What indicators do you use in the implemented FTA? How often are assessing FTAs? the reviews conducted? ______Legislature President/Executive department Specialized body (e.g., trade representative office) Others (please specify)

References

Trade Trends: Regionalization vs. Regionalism

Asian Development Bank (ADB). 2006. Asian Development Outlook 2006. Manila. ______. 2007. Free Trade Agreements Database for Asia. Asia Regional Integration Center. Available: www.aric.adb.org/ftatrends.php Gilbert, J., R. Scollay, and B. Bora, 2004 New Regional Trading Developments in the Asia-Pacific Region. In Global Change and East Asian Policy Initiatives, edited by S. Yusuf, N. Altaf, and K. Nabeshima. Washington, DC: World Bank. Hertel, T. W., T. Walmsley, and K. Itakura. 2001. Dynamic Effects of the “New Age” Free Trade Agreement between Japan and Singapore. Journal of Economic Integration 16 (4; December): 446–484. Kawai, Masahiro. 2005. East Asian Economic Regionalism: Progress and Challenges. Journal of Asian Economics 16 (January): 29–55. Kawai, Masahiro, and Ganeshan Wignaraja. 2007. ASEAN+3 or ASEAN+6: Which Way Forward? Prepared for Ten Years After the Crisis: Evolving East Asian Financial System and Challenges, a conference jointly organized by the Ministry of Finance of Japan and the Asian Development Bank Institute, Tokyo, 12 June. ______. 2008. Regionalism as an Engine of Multilateralism: A Case for a Single East Asian FTA. OREI Working Paper Series on Regional Economic Integration, No. 14 (February). Krueger, A.O. 1974. The Political Economy of the Rent- Seeking Society. American Economic Review, vol. LXIV: 291–303 Kuroda, Haruhiko. 2007. Realistic Possibilities for Regional Economic Integration. Speech delivered at the Asian Business Conference, 1 March, Makati City, Philippines. Available: www.adb.org/Documents/ Speeches/2007/ms2007012.asp Lee, Jong-Wha, and Innwon Park. 2005. Free Trade Areas in East Asia: Discriminatory or Nondiscriminatory? World Economy 28(1): 21–48. Plummer, M., and G. Wignaraja. 2006. The Post-Crisis Sequencing of Economic Integration in Asia: Trade as a Complement to a Monetary Future. Economie Internationale 107: 59–85. World Bank. 2004. Global Economic Prospects: Realizing the Development Promise of the Doha Agenda. Washington, DC. ______. 2005. Global Economic Prospects: Trade, Regionalism, and Development. Washington, DC.

Why Enter into an FTA?—Politics and Economics

Corden, W. M. 1972. Economies of Scale and Customs Union Theory. Journal of Political Economy 80 (3): 465–475.

Economics of Consolidation/Harmonization

Frankel, Jeffrey A. 1997. Regional Trading Blocs in the World Economic System. Washington, DC: Institute for . Plummer, Michael G. 2007. Best Practices in Regional Trading Agreements: An Application to Asia. The World Economy 30 (12; December): 1771–1796.

Trade in Goods

ASEAN Protocol on the Special Arrangement for Sensitive and Highly Sensitive Products. Singapore, 30 September 1999. Available: www.aseansec. org/1207.htm Asia Pacific Economic Cooperation (APEC). 2004. Best Practice for RTAs/FTAs in APEC. 16th APEC Ministerial Meeting, Santiago, Chile, 17–18 November. Available: www.apec.org/etc/medialib/apec_media_library/ downloads/ministerial/annual/2004.Par.0004.File. tmp/04_amm_003.pdf Australian Department of Foreign Affairs and Trade. Free Trade Agreements. Available: www.dfat.gov.au/trade/ negotiations/wto_agreements.html Chaturvedi, Sachin. 2007. Trade Facilitation Measures in South Asian FTAs: An Overview of Initiatives and Policy Approaches. Asia-Pacific Research and Training Network on Trade (ARTNet) Working Paper Series, No. 28. January. Chilean General Directorate of International Economic Affairs. FTA Chile–South Korea. Available: www. direcon.cl/index.php?accion=tlc_corea Chung, Hae-kwan. 2003. The Korea-Chile FTA: Significance and Implications. East Asian Review 15 (1; Spring): 71–86. Available: www.ieas.or.kr/vol15_ 1/15_1_5.pdf Duval, Yann, et al. 2006. An Exploration of the Need for and Cost of Selected Trade Facilitation Measures in Asia-Pacific in the Context of the WTO Negotiations. ARTNet Working Paper Series, No. 14. June. Feridhanusetyawan, Tubagus. 2005. Preferential Trade Agreements in the Asia-Pacific Region. IMF Working Paper WP/05/149. July. Available: www.imf.org/ external/pubs/ft/wp/2005/wp05149.pdf Goode, Walter. 2005. Negotiating Free-Trade Agreements: A Guide. Australian Department of Foreign Affairs and Trade. Available: www.wto.org/english/tratop_e/ region_e/regrul_e.htm. Lee, Chang Jae, et al. 2006. From East Asian FTAs to an EAFTA: Typology of East Asian FTAs and Implications for an EAFTA. Korea Institute for International Economic Policy. Ministry of Economy, Trade and Industry (METI), Japan. 2007. Report on Compliance by Major Trading Partners with Trade Agreements: WTO, FTA/EPA, BIT. Plummer, Michael. 2007. “Best Practices” in Regional Trading Agreements: An Application to Asia. In The World Economy. Forthcoming. United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP). 2006. A Comparative Analysis of Trade Facilitation in Selected Regional and Bilateral Trade Agreement. ARTNet Working Paper Series, No. 17. August. ______. 2007. WTO Negotiations on Trade Facilitation: Update. Available: www.unescap.org/tid World Bank. 2005. Global Economic Prospects 2001: Trade, Regionalism, and Development. Washington, DC. World Customs Organization (WCO). Harmonized Commodity Description and Coding System. Available: www.wcoomd.org/ie/en/topics_ issues/harmonizedsystem/DocumentDB/ TABLE%20OF%20CONTENTS.html World Trade Organization (WTO). 1996. Singapore Ministerial Declaration. WT/MIN(96)/DEC. 18 December. ______. 2006. Compilation of Members’ Proposals. TN/TF/W/43/REV.10. ______. Compendium of Issues Related to Regional Trade Agreements. Available: http://docsonline.wto. org/DDFDocuments/t/tn/rl/W8R1.doc ______. (n.d.) Regionalism: Friends or Rivals. Available: www.wto.org/english/thewto_e/whatis_e/ tif_e/bey1_e.htm. ______.(n.d.) The WTO’s Rules. Available: www. wto.org/english/tratop_e/region_e/regrul_e.htm

Online Resources

Asian Development Bank (ADB). Free Trade Agreements Database for Asia. Available: www.aric.adb.org/ ftatrends.php Asia Pacific Economic Cooperation (APEC) www.apec.org Tuck Trade Agreements Database. Available: http://cib. tuck.dartmouth.edu/trade_agreements_db/ World Customs Organization (WCO) website. Available: www.wcoomd.org

Rules of Origin

Asian Development Bank (ADB). 2006. Asian Development Outlook 2006. Manila. Grey, Rodney de C. 1990. Concepts of Trade Diplomacy and Trade in Services. Thames Essay No. 56, London: Trade Policy Research Centre. Herin, Jan. 1986. Rules of Origin and Differences between Tariff Levels in EFTA and in the EC. European Free Trade Association Occasional Paper No. 13. Geneva. Hufbauer, Gary C., and Jeffrey Schott. 1993. NAFTA: An Assessment. Rev. ed. Washington, DC: Institute for International Economics. Imagawa, Hiroshi, and Edwin Vermulst. 2005. The Agreement on Rules of Origin. In The World Trade Organization: Legal, Economic and Political Analysis, Vol. 1, edited by Patrick F.J. Macrory, Arthur E. Appleton, and Michael G. Plummer. New York: Springer. James, William E. 1998. Extending ASEAN Preferential Trade to Commercial Services: Regulatory and Policy Issues. Working Paper Series Vol. 98-13, June. International Centre for the Study of East Asian Development, Kitakyushu. ______. 2005. Rules of Origin and Rules of Preference and the World Trade Organization: The Challenge to Global Liberalization of Trade. In The World Trade Organization: Legal, Economic and Political Analysis, Vol. 2, edited by Patrick F. J. Macrory, Arthur E. Appleton, and Michael G. Plummer. New York: Springer. ______. 2006. Rules of Origin in Emerging Asia- Pacific Preferential Trade Agreements: Will PTAs Promote Trade and Development? ARTNet Working Paper Series, No. 19. August. Kingston, E. Ivan. 1994. The Economics of Rules of Origin. In Rules of Origin in International Trade: A Comparative Study, edited by Edwin Vermulst, Paul Waer, and Jacques Bourgeois. Ann Arbor: University of Michigan. Palmeter, N. David. 1993. Pacific Regional Trade Liberalization and Rules of Origin. Paper presented at the Pacific Economic Cooperation Council Trade Policy Forum VII. June. Panagariya, Arvind. 1999. Regionalism in Trade Policy: Essays on Preferential Trading. Singapore: World Scientific. Productivity Commission. 2004. Rules of Origin under the Australia–New Zealand CER Trade Agreement. Canberra. June. Vermulst, Edwin, and Paul Waer. 1990. European Community Rules of Origin as Commercial Policy Instruments? Journal of World Trade 24(3). Vermulst, Edwin, Paul Waer, and Jacques Bourgeois, eds. 1994. Rules of Origin in International Trade: A Comparative Study. Ann Arbor: University of Michigan. Viner, Jacob. 1950. The Customs Union Issue, New York and London: Carnegie Endowment for International Peace.

Trade in Services

Crawford, Jo-Ann, and Roberto Fiorentino. 2005. The Changing Landscape of Regional Trade Agreements. WTO Discussion Paper No. 8. World Trade Organization, Geneva. Available: www.wto.org/ english/res_e/booksp_e/discussion_papers8_e.pdf Findlay, Christopher, and Tony Warren. 2000. Impediments to Trade in Services: Measurement and Policy Implications. London and New York: Routledge. Fink, Carsten, and Martin Molinuevo. 2007. East Asian Free Trade Agreements in Services: Roaring Tigers or Timid Pandas? First draft. Unpublished. Goode, Walter. 2005. Negotiating Free-Trade Agreements: A Guide. Australian Department of Foreign Affairs and Trade. Available: www.dfat.gov.au/publications/ negotiating_ftas/index.html Hoekman, Bernard. 2006. Liberalizing Trade in Services: A Survey. WPS 4030. Washington, DC: World Bank and the Centre for Economic Policy Research (CEPR). Available: http://econ.worldbank.org/external/ default/main?ImgPagePK=64202990&entityID=0000 16406_20061006151055&menuPK=64210521&page PK=64210502&theSitePK=544849&piPK=64210520 Lesher, Molly, and Sebastien Miroudot. 2006. Analysis of the Economic Impact of Investment Provisions in Regional Trade Agreements. OECD Trade Policy Working Paper No.36. Available: http://caliban. sourceoecd.org/vl=2754750/cl=17/nw=1/rpsv/ workingpapers/18166873/wp_5l4vwbdwmcmx.htm Marconini, Mario. 2005. Regional Trade Agreements and Their Impact on Services Trade. Paper presented at the Regional Conference on Trade and Sustainable Development, 30–31 May, Cartegena, Colombia. Available: www.ictsd.org/dlogue/2005-05-30/Docs/ Regional%20Trade%20Agreements%20and%20their %20Impact%20on%20Services%20.pdf Mattoo, Aaditya, and Carsten Fink. 2002. Regional Agreements and Trade in Services: Policy Issues. Policy Research Working Paper 2852. World Bank, Washington, DC. Available: http://econ.worldbank. org/external/default/main?pagePK=64210502&theSi tePK=544849&piPK=64210520&menuPK=64210521 &entityID=000094946_02062104102344 Ochiai, Ryo, Philippa Dee, and Christopher Findlay. 2007. Services in Free Trade Agreements. Paper prepared for REITI Policy Symposium, Assessing Quality and Impacts of Major Free Trade Agreements, 22 and 23 March. Organisation for Economic Co-operation and Development (OECD). 2002. The Relationship between Regional Trade Agreements and the Multilateral Trading System: Services. TD/TC/WP (2002) 27/FINAL. Working Party of the Trade Committee, 9 October, Paris. Available: www.olis.oecd.org/olis/2002doc.nsf/LinkTo/td-tc- wp(2002)27-final Roy, Martin, Juan Marchetti, and Hoe Lim. 2006. Services Liberalization in the New Generation of Preferential Trade Agreements (PTAs): How Much Further than the GATS? Staff Working Paper ERSD-2006-07. Geneva: World Trade Organization. Available: www.wto.org/ english/tratop_e/serv_e/serv_e.htm Sauve, Pierre, and Aaditya Mattoo. 2003. Regionalism in Services Trade: A Teaching Module. Prepared for the World Bank Institute, Paris and Washington, DC. September. Available: http://siteresources.worldbank. org/INTRANETTRADE/Resources/Topics/Services/ SauveRegionalism1622.pdf-Paper.pdf Stephenson, Sherry. 2002. Regional versus Multilateral Liberalization of Services. World Trade Review 1(2): 187–209. Available: http://ideas.repec.org/a/cup/ wotrrv/v1y2002i02p187-209_00.html Stoler, Andrew. 2006. Regionalism v. Multilateralism: A View for the Asia-Pacific Region. Paper presented at the Conference on Regional Integration at the crossroads, sponsored by the EU, UNECLAC, Observatorio Relaciones EU-America Latina, Santiago, Chile, 21–22 November. United Nations Conference on Trade and Development (UNCTAD). 2007. Trade in Services and Development Implications. TD/B/.1/85, 2 February, Trade and Development Board, 19–23 March, Geneva. Available: www.unctad.org/en/docs/c1d71_en.pdf Warren, Tony, and Christopher Findlay. 2000. Measuring Impediments to Trade in Services. In GATS 2000: New Directions in Services Trade Liberalization, edited by Pierre Sauvé and Robert M. Stern. Washington, DC: Brookings Institution Press.

Investment

Kenworthy, James. 2004. Free Trade Agreements: Key Negotiating Issues, Substantive Provisions and Major Considerations. Monograph. Te Velde, Dirk Willem, and Miatta Fahnbulleh. 2003. Investment Related Provisions in Regional Trade Agreements. Paper prepared for the (UK) Department for International Development (DFID)–funded Regional Integration and Poverty project. October. Urata, Shujiro, and John Sasuya. 2007. An Analysis of the Restrictions on Foreign Direct Investment in Free Trade Agreements. RIETI Discussion Paper Series 07- E-018. March.

FTA-Plus Chapters

Government Procurement

Heydon, Kenneth. 2003. Regulatory Provisions in Regional Trade Agreements: The Singapore Issues. Paper presented at the International Conference on Trade and Investment: Maximising the Benefits for Africa, Dakar, Senegal, 23–26 April. Intellectual Property

Berne Convention for the Protection of Literary and Artistic Works. Available: www.wipo.int/treaties/en/ip/berne/ trtdocs_wo001.html Hague Agreement Concerning the International Registration of Industrial Designs. Available: www.wipo.int/ treaties/en/registration/hague/ International Convention for the Protection of New Varieties of Plants (UPOV Convention). Available: www.upov. int/en/publications/conventions/index.html Paris Convention for the Protection of Industrial Property. Available: www.wipo.int/treaties/en/ip/paris/ Rome Convention for the Protection of Performers, Producers of Phonograms and Broadcasting Organizations. Available: www.wipo.int/treaties/en/ ip/rome/ Washington Treaty on Intellectual Property in Respect of Integrated Circuits. Available: www.wipo.int/treaties/ en/ip/washington/ World Intellectual Property Organization (WIPO). Copyright Treaty. Available: www.wipo.int/treaties/ en/ip/wct/ ______. Performances and Phonograms Treaty. Available: www.wipo.int/treaties/en/ip/wppt/

WTO Instruments Dealing with TRIPs and Public Health

Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs Agreement). Available: www.wto.org/ english/docs_e/legal_e/27-trips.pdf Decision on Least-Developed Country Members: Obligations Under Article 70.9 of the TRIPS Agreement with Respect to Pharmaceutical Products, adopted by the General Council on 8 July 2002, WT/L/478, 12 July 2002. Available: www.wto.org/english/tratop_e/trips_e/ art70_9_e.htm Decision on the Amendment of the TRIPS Agreement, adopted by the General Council, adopted on 6 December 2005, WT/L/641, 8 December 2005. Available: www.wto.org/english/tratop_e/trips_e/ wtl641_e.htm Decision on the Implementation of Paragraph 6 of the Doha Declaration on the TRIPS Agreement and Public Health, adopted by the General Council on 30 August 2003, WT/L/540 and Corr.1, 1 September 2003. Available: www.wto.org/english/tratop_e/trips_e/implem_ para6_e.htm Declaration on the TRIPS Agreement and Public Health, WT/MIN(01)/DEC/2, 20 November 2001 (adopted on 14 November 2001). Available: www.wto.org/english/ thewto_e/minist_e/min01_e/mindecl_trips_e.htm Doha Declaration, adopted on 14 November 2001 by the Fourth WTO Ministerial Conference, Doha, Qatar, WT/MIN(01)/DEC/1, 20 November. Available: www. wto.org/english/thewto_e/minist_e/min01_e/ mindecl_e.htm#trips Hong Kong Ministerial Declaration, Paragraph 40 on TRIPS and Public Health, adopted on 18 December 2005, WT/MIN(05)/DEC, 22 December 2005. Available: www.wto.org/english/thewto_e/minist_e/min05_e/ final_text_e.htm#public_health

Competition Policy

Heydon, Kenneth. 2003. Regulatory Provisions in Regional Trade Agreements: The Singapore Issues. Paper presented at the International Conference on Trade and Investment: Maximising the Benefits of Globalisation for Africa, Dakar, Senegal, 23–26 April. Hoekman, Bernard. 1998. Competition Policy and Preferential Trade Agreements. World Bank EDI Working Paper 18875. ______. 2002. Economic Development, Competition Policy and the WTO. World Bank Policy Research Working Paper 2917. October.

Dispute Settlement

Macrory, Patrick F. J., Arthur E. Appleton, and Michael G. Plummer, eds. 2005. The World Trade Organization: Legal, Economic and Political Analysis. Vol. 1, Chapters 25–32, pp. 1197–1458. New York: Springer. World Trade Organization (WTO). 1995. Analytical Index: Guide to GATT Law and Practice (Updated). 6th ed. Geneva. ______. 2002. Analytical Index: Guide to WTO Law and Practice. Geneva.

WTO Documents on Dispute Settlement

Understanding on Rules and Procedures Governing the Settlement of Disputes. Available: www.wto.org/english/ docs_e/legal_e/28-dsu.pdf WTO Dispute Settlement Flow Chart. Available: www.wto. org/english/thewto_e/whatis_e/tif_e/disp2_e.htm GATT and WTO Dispute Settlement Reports

Agreement between the EFTA Countries and Spain. BISD 27S/127. Argentina: Definitive Anti-Dumping Duties on Poultry from Brazil (Argentina–Poultry). Report of the Panel. WT/DS241/R (2001). Canada: Certain Measures Affecting the Automotive Industry. Report of the Panel. WT/DS139/R, WT/ DS142/R (2000). Mexico: Tax Measures on Soft Drinks and Other Beverage (Mexico–Soft Drinks). Report of the Appellate Body. WT/DS308/AB/R (2006). Turkey: Restrictions on Imports of Textile and Clothing Products. Report of the Appellate Body. DS34/AB/R (1999).

Free Trade, Partnership and Cooperation Agreements

ASEAN Free Trade Area (AFTA) Protocol on Dispute Settlement Mechanism. Available: www.aseansec. org/16654.htm ASEAN Protocol on Enhanced Dispute Settlement Mechanism. Available: www.aseansec.org/16754.htm ASEAN Secretariat. 1998. The Sixth ASEAN Summit and the Acceleration of AFTA (Volume V). Available: www. aseansec.org/viewpdf.asp?file=/pdf/aftaVOL5.pdf India-Singapore Comprehensive Economic Cooperation Agreement (CECA). Available: www.iesingapore.gov.sg Japan-Singapore Economic Agreement for a New Age Partnership (JSEPA). Available: www.iesingapore.gov.sg North American Free Trade Area (NAFTA). Available: www.nafta-sec-alena.org/DefaultSite/index_ e.aspx?DetailID=78 Singapore-Australia Free Trade Agreement. Available: www. dfat.gov.au/trade/negotiations/safta/full_safta.pdf Thailand-Australia Free Trade Agreement. Available: www. dfat.gov.au/trade/negotiations/aust-thai/tafta_toc. html United States–Singapore Free Trade Agreement. Available: www.ustr.gov/assets/Trade_Agreements/Bilateral/ Singapore_FTA/Final_Texts/asset_upload_file708_ 4036.pdf.

WTO Agreements

Agreement on Government Procurement (AGP). Available: www.wto.org/english/docs_e/legal_e/gpr-94_e.pdf Agreement on Trade-Related Investment Measures. Available: www.wto.org/english/docs_e/legal_e/18- trims.pdf Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs Agreement). Available: www.wto.org/ english/docs_e/legal_e/27-trips.pdf Doha Declaration, adopted on 14 November 2001 by the Fourth WTO Ministerial Conference, Doha, Qatar, WT/MIN(01)/DEC/1, 20 November 2001. Available: www.wto.org/english/thewto_e/minist_e/min01_e/ mindecl_e.htm#trips General Agreement on Tariffs and Trade 1947 (Article XXIV). Available: www.wto.org/english/docs_e/legal_ e/gatt47_e.pdf General Agreement on Trade in Services (GATS Articles V, XI, XII, XIV, and XIV bis). Available: www.wto.org/english/ docs_e/legal_e/26-gats.pdf Transparency Mechanism for Regional Trade Agreements. WT/L/671, 18 December 2006. Available: http:// docsonline.wto.org/DDFDocuments/t/WT/L/672.doc

Negotiating, Implementing, and Evaluating FTAs

Asia Pacific Economic Cooperation (APEC). 2004. Best Practice for RTAs/FTAs in APEC. 2004/AMM/003, Agenda Item: V.2. Available: www.apec.org/etc/ medialib/apec_media_library/downloads/ministerial/ annual/2004.Par.0004.File.tmp/04_amm_003.pdf Fiorentino, Roberto V., Luis Verdeja, and Christelle Toqueboeuf. 2007. The Changing Landscape of RTAs: 2006 Update. WTO Discussion Paper No. 12. Fisher, Roger, and William Ury. 1991. Getting to Yes: Negotiating Agreement without Giving In. Penguin Books. Gallagher, P. 2006. Trade Policy Consultative Mechanism in Pakistan: An International Comparative Study. International Trade Centre. Goode, W. 2005. Negotiating Free Trade Agreements: A Guide. Australian Department of Foreign Affairs and Trade. Grimmett, J. 2004. Why Certain Trade Agreements Are Approved as Congressional-Executive Agreements Rather Than as Treaties. CRS Report for Congress. Hsu, L. 2006. Free Trade Agreements: Singapore Legal Developments. Chapter 7–An Overview of the Singapore Legal System. Available: www. singaporelaw.com.sg/content/FreeTrade.html (last accessed 06 June 2007) Monning, W., and G. Feketekuty. 2003. A Practical Guide to Negotiations Module 9. Instructional Modules. International Commercial Diplomacy Project. Institute for Trade and Commercial Diplomacy. Available: www.commercialdiplomacy.org/manuals/mudule9. htm#_ftnref1 and http://siteresources.worldbank. org/INTRANETTRADE/Resources/Topics/Services/ GezaPracticalGuides0822f-Paper.pdf (both accessed 06 June 2007) Pregelj, V. 2005. Trade Agreements: Procedure for Congressional Approval and Implementation. CRS Report for Congress. US Government Accountability Office (GAO). 2004. International Trade: Intensifying Free Trade Negotiating Agenda Calls for Better Allocation of Staff and Resources, GAO-04-233. Available: www.gao.gov/ new.items/d04233.pdf ______. 2005. Further Improvements Needed to Handle Growing Workload for Monitoring and Enforcing Trade Agreements. GAO-05-537. Available: www.gao.gov/new.items/d05537.pdf

Online Sources

ASEAN Secretariat—www.aseansec.org Asia Regional Information Center—www.aric.adb.org Australia Department of Foreign Affairs and Trade—www. dfat.gov.au Australia FTAs website—www.fta.gov.au Council of Australian Governments—http://coag.gov. au/meetings/140696/attachment_c.htm European Commission—http://ec.europa.eu India Ministry of Commerce and Industry—http:// commerce.nic.in/ Institute for Trade and Commercial Diplomacy—www. commercialdiplomacy.org International Enterprise Singapore—www.iesingapore. gov.sg Japan Ministry of Foreign Affairs—www.mofa.go.jp Korea Ministry of Foreign Affairs and Trade—www.mofat. go.kr Malaysia Trade and Industry—www.miti.gov.my New Zealand Ministry of Foreign Affairs and Trade—www. mfat.govt.nz Thailand Department of Trade Negotiations—www.thaifta. com/english/index_eng.html US Trade Representative Office—www.ustr.gov World Trade Organization—www.wto.org

About How to Design, Negotiate, and Implement a Free Trade Agreement in Asia

This reference book, intended to complement the training courses on free trade agreements (FTAs) conducted by ADB, aims to increase the knowledge and capacity of officials who are actively involved in designing, negotiating, and implementing FTAs. Building on international trade theories and good practices and FTA experience of countries worldwide, the book explains important facts and benchmarks to be How to Design, Negotiate, and Implement a considered when preparing, negotiating, and enforcing FTAs in Asia. How Negotiate, to Design, and Implement a About Asian Development Bank Free Trade Agreement in ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries substantially reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to two thirds of the world’s poor. Nearly 1.7 billion people in the region live on $2 or less a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. In 2007, it approved $10.1 billion of loans, $673 million of grant projects, and technical assistance amounting to $243 million. ASIA Free Trade Agreement in Asia

Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org Publication Stock No. BBK-119108 ISBN: ISBN 978-971-561-684-3 Printed in the Philippines