EAST ASIAN ECONOMIC INTEGRATION BY MANUEL PANAGIOTOPOULOS A REPORT FOR THE AUSTRALIAN TRADE COMMISSION MARCH 2012

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EAST ASIAN ECONOMIC INTEGRATION

BY

MANUEL PANAGIOTOPOULOS

A REPORT FOR THE AUSTRALIAN TRADE COMMISSION

MARCH 2012

This information is provided on the basis that it carries no warranty of completeness, accuracy or suitability for any particular purpose. The Australian Trade Commission (Austrade) denies liability for any loss arising from reliance on such information, such reliance being entirely at the

users‘ discretion. In any business decision, independent professional advice should be sought.

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Key Questions:

Q 1: There is much discussion around East Asian regional integration (notably between and across China, Japan, Korea, the Association of Southeast Asian Nations -ASEAN and Australia). Is it regional integration or global integration centred on China?

Q 2: How is regional integration affecting importers and exporters and investors in the region by priority sector: construction, education, Information & Communication Technology (ICT), financial services, legal services, manufacturing (Elaborately Transformed Manufactures -ETMs and Simply Transformed Manufactures - STMs) and Mining Equipment and Technology Services (METs)?

Hypotheses:

That economic integration has been occurring at the regional level in East Asia, which is evident in the levels of intraregional trade, the expansion of intermediate goods trade and the coordination amongst fragmented parts of the production processes in the electronic and automotive sectors.

Further, while accepting the huge changes that have been created by China‘s entry in this process, it remains a regional integration, one amongst three (European Union - EU and the North

American Free Trade Agreement – NAFTA nations being the others).

The huge levels of foreign direct investment (FDI) in the region, coupled with the ability to finely slice the value-chain, should provide entry points for providers of goods and services to these producers and to the countries which host them.

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Conclusions and Recommendations

 The answer to Question 1 is that there is regional economic integration ongoing in East Asia largely driven by market forces but assisted by freer trade negotiations. While China is playing a key role, however, it is not the centre of globalisation. There are three regional hubs of globalisation: United States/NAFTA, Germany/EU and China-Japan/East Asia.

 The ongoing trend of regional integration will create opportunities for Australian

companies, primarily in the services and mining sectors and niche manufacturing, as the extensive production networks intersect with numerous demands for services and products that are outsourced.

 There is a complementarity between demographic factors, macroeconomic policies, trade and investment policies and positive externalities from extensive FDI. These will most likely result in a long-term rise in per capita gross domestic product (GDP) in the East Asia region such that consumer demand will become self-sustaining. There has been significant under-investment by Australian firms in the Asian region, although it has the highest growth rate of the regions reviewed in this study.

 Trade and investment policies continue to matter. There will be a critical role for the governments to promote further multilateral trade and investment liberalisation at the macro level and provide on the ground guidance and support to minimise the transaction and information costs of Australian companies that venture into the region.

 Regional and bilateral market intelligence and the search for appropriate partners are two key services.

 The mapping of significant regional value-chains in automotive, infrastructure, financial services, health, food and pharmaceuticals would provide valuable information for

Australian companies. The detailed maps of value-chains allows for the disaggregation of products and services into more discrete units. A variety of cost competitive models, locations, potential partners and the key Australian value-add will become clearer.

 Australian companies could expand their relationships with Japanese companies to enter the East Asian region. Japanese companies have been major investors in East Asia for four decades, with large production networks throughout the region. Japanese companies are also expanding their non-manufacturing investment into the region. Australian companies have many years of close collaboration with Japanese companies in Australia and Japanese companies have upgraded their perceptions of the capabilities of Australian firms. The recent example of joint business missions in infrastructure and public private partnerships (PPPs) in India and Indonesia could be repeated in other sectors.

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Chapter 13 Final demand patterns in Asia: includes contrasting perspectives on the level of dependence of East Asian growth on extra-regional demand, the impact of second and third-generation suppliers on technology upgrading and per capita income, long-term forecasts for the East Asian region, with special emphasis on the development of regional final consumption growth, urbanisation and the contribution made by the existing production networks of MNEs and local firms.

Chapter 14 Examples Australian and Japanese companies strategies in Asia.

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Chapter 1. Economic Integration

Discussion and analysis of economic integration, whether regional or global, is dominated by trade and investment. Essentially, though, these two are just different aspects of international

commercial transactions. Trade is usually the first activity to be undertaken by firms, for various reasons of production and transaction costs, followed by FDI, which, in turn, creates more trade.

This pattern is especially marked when FDI takes the form of the placement of distinct but connected parts of a production process in diverse geographic locations, which has been proceeding mainly during the past four decades in East Asia. The defining element is that the locations are in different countries, i.e., it is part and parcel of the rapid increase in the size, scale and scope of MNEs. Starting from the textile and clothing industries, this disaggregation process has moved into footwear, automotive, electrical equipment, electronics, precision goods,

publishing and others. This process has been given several labels, depending on the theoretical perspective of the analyst: production sharing; international production fragmentation; vertical specialization; slicing the value chain; and outsourcing. Each of these labels, in turn, influences the way trends and statistics are interpreted and policies are formulated.

In general, there are three factors that have supported this rapid transformation. ―First, rapid advancements in production technology have enabled industries to slice the value chain into finer, portable components. Second, technological innovations in communication and transportation have shrunk the distance that once separated the world‗s nations, and improved the speed,

efficiency, and economy of coordinating geographically dispersed production processes. This has facilitated the establishment of services links that combine various fragments of the production process in a timely and cost-effective manner. Third, liberalization policy reforms in both home and host countries have removed a considerable amount of barriers to trade and investment‖

(Athukorala, 2010).

As these processes have moved from single to multiple country locations, the causal and

reinforcing relationship between trade, FDI, technology transfer and capital flow has resulted in what is called regional economic integration. The regional aspect refers to the geographic

proximity of the various countries, although there remains a subjective element about the extent of the region. It also does not imply a lack of commerce outside the region.

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Japanese companies have been a driving force of the process since the 1960s, when Japan first emerged as a major exporter. Then the second generation, the NIEs (Hong Kong, South Korea, Singapore and Taiwan) followed in the 1970s. In the 1980s the third generation included

Malaysia, Thailand, Indonesia and the Philippines) and finally China and Vietnam, in the 1990s.

―While unilateral liberalizations by individual countries helped initiate export-led development in the region, the increasing economic integration of East Asia has been an important factor in sustaining the region‘s growth‖ (Haddad, 2007).

Since 2000, East Asia‘s trade expansion has been due to the processing of inputs goods or production sharing, with China as the main manufacturing and assembly centre importing

intermediate goods from neighboring countries. The massive movement of Asian firms into China has integrated China into the regional economy and the region into the global economy. ―The production networks that initially linked Japanese industry vertically with Korea and Taiwan (China) in low-skill assembly activities have gradually been transferred to lower-wage countries such as Malaysia, the Philippines, and Thailand. (Indonesia, however, has shown little success despite even lower wage levels.) These networks are also now being transferred to China and Vietnam‖ (Haddad, 2007).

The mechanism for this transformation has been the multitude of multinational national

corporations (MNCs), which mobilize resources across countries, regions and the world through vertical and horizontal networks of procurement, production, distribution and sales. ―As a result, regional economic integration has been brought forth into existence and the process of

globalization intensified. Thanks to the openness of global trade and foreign investments advocated by WTO and responded by national authorities, together with the advancement of transportation and communication technologies, MNCs are able to rapidly expand with much less obstacles than before‖ (Yang and Huang, 2011).

In general, the determinants of integration amongst different economies are proximity, market size, growth rate, trade and investment policies and corporations. ―International firms contribute to integration because their cross-border investments in affiliates and their joint ventures and

strategic alliances are trade promoting. MNE affiliates are more trade oriented than local firms, and the relationship between trade and their investments in local affiliates is increasingly complementary. Historically, the major foreign investors in East Asia have been Japanese and American firms. Since 1980, however, Taiwanese and Korean firms and, more recently, firms

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from Southeast Asia have become more significant sources of investment flows in China, Indonesia, Malaysia, Thailand, and the Philippines.‖ (Dobson, 1997).

There has also been investment by European firms, especially in Singapore and Indonesia.

Investment is distributed into natural resources, wholesale trade, services and manufacturing, which is ―concentrated in the electronics and electrical, textile and garment, chemical, and auto industries‖ (Dobson, 1997).

The impact of trade- and investment-friendly policies has been beneficial to East Asia, more so than other regions. ―Economic liberalization has provided low income economies with

opportunities to become integrated into the regional production network, enabling the sequential takeoff of industrialization in these economies‖ (Hamaguchi, 2007).

Definitions of economic integration include both process and structural elements. Lower barriers to trade and investment allow the more efficient use of economic resources, generate employment in less developed economies, narrow the gaps in development and sustain long-term regional economic growth. Economic integration in East Asia has already progressed in a de jure fashion, with bilateral and multilateral trade agreements. ―Most of the trade agreements in the region include elements that go beyond trade and look toward ‗deep‘ economic integration in the sense that virtually all of them intend to include provisions on trade facilitation, services liberalization, investment liberalization and facilitation, economic cooperation, and reforms and harmonization of domestic rules and regulations, in addition to the reduction and elimination of tariffs‖ (Corbett and Umezaki, 2009).

Another formulation of a definition: ―Economic integration generally refers to a staged process through which a group of countries gradually coordinate or merge their economic policies over time. This coordination may be bilateral or carried out through a multilateral organization such as ASEAN. The purpose of economic integration is to lower trade barriers and other economic obstacles between countries, thereby expanding markets and trade, lowering prices, and improving the competitiveness of trade partners through lower costs and economies of scale. For some

economic integration arrangements, the ultimate goal is a single market in which there is a free flow of goods, services, capital and labor, and harmonization of economic and monetary policies.

In other cases, member countries design the arrangement to be a free trade area, a customs union, or a common market, with no intentions to integrate further‖ (USITC, 2010).

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However, the wider aspect of the relationship of the region to the global economy and China‘s position also has to be addressed. One of the key questions of this project relates to the nature and extent of the transformation of world production with regard to China‘s impact. The question then becomes, is it regional integration or globalisation or globalisation centred on China?

China has loomed as the largest topic of interest since the decade beginning 2000. There is a tendency to see China as the hub of Asia and Asia as the hub of global manufacturing. A typical quote: ―The recent advent of free trade agreements (FTAs) will likely have a marked impact on Asia‘s trade policy and its cherished status as the global factory‖ (Kawai and Wignaraja, 2009).

(‗Global factory‘ is a loose usage, implying one hub, but see below for the counter argument.) The analyses of intermediate trade or production fragmentation are more nuanced, but still retain the focus on China: ―The progressive integration of world markets has led to the fragmentation of production across countries and the formation global supply chains…The evidence arising out of this literature points to a strong expansion of production sharing and vertical trade in the global economy, particularly since the 1990s. Nowhere has the expansion of vertical trade networks and supply chains been more pronounced than in Asia, largely in relation to the People‘s Republic of China‘s (PRC) ascension as a regional hub of assembly and global trade power.‖ (Ferrarini, 2011).

However, Ferrarini (2011) has carried out some recent careful analysis on the development and interaction of regional networks and how they connect to the global network using a ―measure of the direction and intensity of countries‘ network relations as providers and assemblers of parts and components within the international production networks. This is achieved through the Network Trade Index (NTI), which is defined…as a supplier country‘s share in parts imports by a

processing industry in the hosting country, weighted by that industry‘s share of total final goods exports. The index is computed at the level of industries, or sectors, and for each country pair in both directions—e.g., from Japan to the PRC and vice-versa—and is then averaged and

normalized to derive a more synthetic indicator for comparison across countries and industries‖

(Ferrarini, 2011).

Ferrarini‘s results show that there are three major regional hubs. The US is the centre of one hub, based on the automotive and electrical/electronic production network in NAFTA, plus its

connections to Asian electronics production. A second hub is Europe centred on Germany,

especially via the automotive production network. The third hub is the Asian network, ―especially in relation to trade in parts and components within the electric and electronics industries

surrounding the PRC–Japan axis, also involving a number of economies in East and Southeast

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Asia…Apart from Mexico—mainly because of its maquiladoras network ties to the US industries and markets—the analysis suggests that outside East and Southeast Asia, developing countries are not yet involved in global production networks to any substantial degree― (Ferrarini, 2011).

The final point made above is fundamental for this project, hinting at the more sustainable economic future of the Asian region.

Further analysis elaborated in Chapter 5, below, on value-added statistics, also does not support a China-centred globalisation.

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Chapter 2. De Facto and De Jure Integration

It is useful and instructive to distinguish between economic integration that occurs de facto and de jure. The former reflects the idea that the private sector reaches across national boundaries to expand and coordinate trade and investment in ways that create a larger, more integrated market without the mechanism of trade and investment agreements.

De jure integration is promoted by the use of formal treaties and legal instruments: ―There is no doubt that these two instruments of integration are very much related and indeed ultimately they are complementary. Integration of neighboring markets without formal regional trade agreements can create uncertainty among businesses since the institutional foundations may not be sufficiently clear and transparent. Integration by agreements can be vacuous if the underlying economic

factors are not favorable for integration‖ (Aminian et al, 2008).

Monetary union amongst countries within a region is often talked about as an advanced step in de jure integration. Although there have been some policies aimed at financial

cooperation, there has been little practical progress in this area. Most of the important legal accords have occurred in the real sector, with a rapid increase of FTAs in East Asia since the beginning of the 21^st century. “Perhaps this is due to a “natural” sequencing of economic integration, i.e., first the real sector and then monetary integration, which is the experience of, for example, the EU. Or perhaps it results from more coincidental factors, e.g., the global movement toward FTAs or the fact that, for whatever reason, there is a strong demand for economic cooperation, and the real sector is the easiest to negotiate in practice and is less compromising in terms of perceived national sovereignty. Is there a case for monetary union in East Asia? Is there a case for wider FTAs?” (Plummer & Wignaraja, 2007).

In the current and ongoing fiscal crisis in the EU, with the Euro under constant pressure of becoming obsolete, such questions must loom even larger in Asia than previous periods. It would be completely surprising if any moves towards currency union in Asia moved past the stage of rhetoric for the foreseeable future.

ASEAN’s first major economic integration initiative was the AFTA in 1992, which is effective in the original members. The transitional members (Vietnam, Laos, Myanmar and Cambodia) have additional time to fully comply. ASEAN also has formed the ASEAN Investment Area (AIA). “These efforts at industrial cooperation have been designed with essentially the same goal in mind as AFTA: reduce transactions costs associated with intraregional economic interaction‖

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(Plummer and Wignaraja, 2007).

The goal of an ASEAN Economic Community (AEC) was proposed at the ASEAN Heads of Government meeting in Phnom Penh in November 2002. Originally aimed for 2020, it was moved forward to 2015 in 2007. The AEC would crate a single market for goods and services and allow freer movement of capital and people. Although very ambitious for ASEAN, it remains a

challenge to be implemented in a context where tariff removal is the dominant instrument. In the past few years there has been a proliferation of FTA proposals in Asia, including an Asia Pacific Free Trade Area (APFTA), which would include all APEC members, an East Asian Free Trade Area, proposed by Japan, and a proposal to create an FTA between the ASEAN+3, New Zealand, Australia, and India (ASEAN+6).

―As the Doha Round of negotiations is currently indefinitely suspended, it is expected that regional and bilateral trade deals will become even more prevalent. The creation of Preferential Trade Agreements (PTAs) such as Free Trade Areas (FTAs) is by no means new. But the sheer number and the speed with which these agreements have been negotiated in the past ten years are simply astonishing. By 2005, all but one WTO member was trading under one or more PTAs‖

(Aminian et al, 2008).

The countries in East Asia, until very recently, have achieved market integration via the market rather than formal agreement. East Asian economic integration is much greater than Latin

America, which has used mainly the de jure process. ―Integration using the marketplace or via de facto agreements (together with business-friendly policies by individual countries) leads to more intense integration than de jure agreements… the proper sequencing of the two forms of

integration should first be the freeing of the domestic private sectors which allow them to mature and to use the international markets to integrate, before establishing legal treaties to further deepen the relationships…Trade agreements are both economic agreements as well as foreign policy agreements. Regional trade agreements can also be inward-looking or outward oriented. To keep the primary focus on the open-trade and economic objectives, it is thus important to first develop a thick market for exporters and traders, who can pressure the government to pay attention to the signals of the economic forces‖ (Aminian et al, 2008).

A number of factors have contributed to the recent proliferation of FTAs in the East Asian region.

Firstly, the establishment of NAFTA and the EU created the need for a response to the barriers erected by these FTAs and to the opportunities to expand exports within East Asia. Secondly, the stalled discussions of the Doha Round focused members‘ attention to smaller, more achievable

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agreements. Thirdly, the Asian financial crisis of 1997, which prompted more regional cooperation initiatives. Finally, ―rivalry among East Asian economies over leadership in the region has activated strategies involving FTAs‖ (Haddad, 2007).

The Asian financial crisis is probably the most important catalyst for the turn to de jure integration. Before that crisis, the East Asian countries had been convinced that the de facto, market-based approach they had used was the more successful. But the crisis and its rapid

movement throughout the region, plus the inadequate response by the SU and IMF ―demonstrated the weaknesses of informal regional cooperation and gave East Asians a strong impetus to search for a regional mechanism that could forestall future crisis…The crisis and its subsequent

contagion to a number of economies in Northeast and Southeast Asia painfully demonstrated that the East Asian economies were closely related and a resolution to the crisis could require a regional cooperation...The ASEAN+3 Summit in November 1999 released a ―Joint Statement on East Asian Cooperation‖ that covers a wide range of possible areas for regional cooperation‖

(Aminian et al, 2008).

Again it is worth remembering that trade integration within East Asia was high even before the Asian financial crisis. ―In 1995, 48.7% of East Asian exports were intra-regional… trade

integration among ASEAN countries (25.2% in 2005) is higher than the trade integration among ANDEAN community (8.2% in 2005) or MERCOSUR countries (12.9% in 2005)‖ (Aminian et al, 2008).

The de facto process of East Asia was more effective than the de jure process used in Latin America and it may be a better sequence for de jure to follow de facto ―because this sequence can enhance the internal bargaining power of the outward-looking trade interests first, which may tilt the implementation of the formal regional trade agreement to be more market-friendly‖ (Aminian et al, 2008).

The outward-looking trade interests should ideally be focused outside the region, too. Trade policies have been extensively studied because there is a danger that the progress made in successive multilateral trade negotiations to reduce barriers to trade and investment could be undone by preferential agreements that turn into trading blocs and a much lower level of economic welfare.

―Historically, preferential trading arrangements have not played much of a role in the integration of East Asian economies…Indeed, the fastest trade growth within the region has been the growth

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of trade with China since 1979, and this has occurred in the absence of formal trade-liberalization agreements. Such trends toward spontaneous regional integration result from progressive outward orientation of individual economies' trade and investment policies and unilateral liberalization of goods and capital markets‖ (Dobson, 1997).

On the contrary, the long period of economic growth called the East Asian miracle was due to

―macroeconomic stability, high investment in human capital, stable and secure financial systems, limited price distortions and openness to foreign technology‖ (Hamaguchi, 2007).

The general pattern is East Asia has been that wide disparity of income levels amongst different countries in close proximity has attracted investment from industries in the advanced economy, e.g., Japan, which are no longer competitive due to higher labour costs. Those host economies in turn have upgraded their own industries and moved production to even less-developed economies.

The result has been the current situation of fragmented production and high levels of intermediate goods trade. But this situation is still considered to entail some risk under a system of numerous bilateral preferential trade deals, which ―are neither disciplined by the WTO rules nor counts on the supra-national regional-level management body such as the case of the European Union, hence countries in the region should strengthen the de jure feature‖ (Hamaguchi, 2007).

It is noteworthy that ASEAN has been very active in FTAs in response to the rise of China, which competes for the inflow of resources and investment and there has been no real progress in trade agreements between the largest economies of Japan, China and South Korea.

East Asian integration has had both de facto and de jure elements, the former based on factor price differences and the latter being rather haphazard and unorganised but aimed at the large

multinational companies. ―These provisions have contributed to reduce setup cost of offshore factories and operational cost of linking various factories in different countries. Thus, trade integration also has strengthened the role of scale economies to shape the competitiveness of East Asian industries‖ (Hamaguchi, 2007).

The resulting integration, production networks and supply chains has created the need for more de jure action, more liberalization in trade and investment policies, harmonization of regulations, rules and standards. “East Asia’s policymakers are increasingly of the view that FTAs, if given wide scope, can support expanding trade and FDI activities through further elimination of cross-border

impediments, facilitation of trade and FDI, and other such harmonization efforts. Thus, FTAs can be regarded as part of a supporting policy framework for deepening production networks and supply

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chains formed by global MNCs and emerging Asian firms” ((Kawai and Wignaraja, 2009).

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Chapter 3. Trade Patterns

Analysis of East Asian economic integration is first approached through the dramatic rise in trade, both global and by Asian economies with those outside the region. Since 2000 these measures have both doubled but the striking feature is that ―intra-Asian trade has tripled, and regional trade involving emerging Asia, in particular, has increased even faster. As a result, Asian economies accounted for 35% of world exports in 2009, compared with 25% 10 years earlier, with the share of intraregional exports rising to 55% from 45% over the same period‖(IMF, 2011).

Furthermore, intraregional trade is most often indicated by the use of total merchandise exports.

According to WTO data, the share of intra-Asian merchandise exports in 2005 was 51% and was 53% by 2010 (cf www.wto.org/english/res_e/statis_e/world_region_export_10_e.pdf). These data include non-East Asia, so would underestimate the East Asian share. Similar figures are found in the International Monetary Fund statistics, as shown by the following chart. Despite slight

differences in the totals, both WTO and IMF data show a renewed increase in intra-regional trade.

(Shinohara, 2012)

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Starting in the 1970s and 1980s, when Japan accounted for more than half of the region‘s trade, there has been strong growth in trade over the past two decades by other Asian countries, including China, Taiwan, South Korea and ASEAN. These now account for more than 80% of regional trade.

China‘s rise especially has resulted in the relative decline of Japan, Taiwan and South Korea.

China‘s accession to the WTO in 2001 and the wide disparity of labour costs resulted in the mass movement of supply chains into China that produced for the US and EU markets, a redistribution of trade resources within the region. ―The redistribution of trade among Asian trading partners of the United States is typical of the surge in international and regional supply chains, with part of the production initially located in Japan or in other economies transferring to China. Usually, it has been the last stage of the supply chain, the assembly of the final products, which has relocated to China, with the production of the core components remaining within the original country‖

(WTO/IDE-JETRO, 2011).

―The share of Asia in world machinery and transport equipment exports increased from 14.5% in 1994/95 to 42.4% in 2006/7, with emerging East Asia accounting for over 80% of the increment.

By 2006/07, over 58% of total world ICT exports originated from Asia, with the PRC alone accounting for 23%. In electrical goods, the PRC‗s world market share increased from 3.1% to 20.6% between 1994/95 and 2006/07‖ (Athukorala, 2010). These statistics show how rapidly the East Asian region expanded its intermediate goods trade as an aspect of its integration into the global manufactured goods trade.

Proliferation of disaggregated production networks has resulted in faster growth of intra-regional trade compared to extra-regional trade and intra-industry trade growing faster than inter-industry trade. ―A dominant portion of the intra-industry trade takes the form of vertical intra-industry trade or production sharing networks. Indeed, the trade in parts within East Asia accounts for a large share of the total trade (that is, the trade in parts and finished products), and the share is

increasing: over 50 % of textiles and garments and over 80 percent of electrical machinery‖

(Haddad, 2007).

However, at this point it is critical to understand the differences between the use of total trade figures and intermediate goods trade and their effects on measures of integration:

―In 2006/7, intra-regional trade accounted for 55.1% of total manufacturing trade in East Asia, up from 53.2% in 1992/3. The level of intra-regional trade in East Asia was higher than that of

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NAFTA throughout this period and was rapidly approaching the level of the EU. For developing East Asia (Asia excluding Japan) and ASEAN+3, the ratios are lower than the aggregate regional figure, but they have increased at a much faster rate… However, the picture changes significantly when parts and components are netted out: the share of intra-East-Asian final trade (total trade – parts and components) in 2006/7 was 46.4%, down from 50.3% in 1992/3. The estimates based on unadjusted data and data on final trade are vastly different for East Asia, particularly for DEA and ASEAN. Both the level of trade in the given years and the change over time in intra-regional trade shares are significantly lower for estimates based on final trade. Interestingly, we do not observe such a difference in estimates for NAFTA and the EU‖ (Athukorala, 2010).

These different calculations point to asymmetry in imports and exports in the East Asian region.

―Unlike in EU and NAFTA, in East Asia the increase over time in the intraregional trade ratio (both measured using unadjusted data and data for final trade) has emanated largely from a rapid increase in intra-regional imports as the expansion in intra-regional exports has been consistently slower… This asymmetry is clearly seen across all sub-regions within East Asia‖ (Athukorala, 2010).

This asymmetry is due to the ―heavy component bias in Asian intra-regional trade and the multiple border-crossing of parts and components within regional production networks. On the export side, the intraregional share of final goods declined continuously from 46% in 1995 to 37% in 2007, whereas the intra-regional import share increased from 56% to 63% between these two time points. The observed asymmetry in intra-regional trade in East Asia reflects the unique nature of the involvement of Japan and the PRC in regional production networks‖ (Athukorala, 2010).

The implications of this asymmetry are that economic has not progressed as much as the total trade statistics would indicate and that the East Asian region may be unduly dependent on the economic demand emanating from the US and the EU. While these concerns are valid, recent developments in the East Asian region and the responses to the severe economic downturns of the US and EU suggest these fears can be discounted (see Chapter 12 below).

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Chapter 4. Investment Patterns

In general, multinational investment and disaggregation of the value chain have expanded due to the significant reductions in international communications and transport costs. For transport costs, geographic distance remains a key factor. These general factors complement the East Asian specific factors that have supported the strong growth in economic integration through the proliferation of production networks and the expanded trade that accompanies it.

―First, the region is well placed to benefit from fragmentation-based specialization countries in terms of relative wages. Second, relative cost advantages arising from these wage patterns seem to have been complemented by the quality of trade-related logistics. Third, ―first comer advantage and market thickness and agglomeration benefits evolved over a long period of time seem to have played a pivotal role. The latter two factors would have jointly brought about significant cost advantages in maintaining services links in production networks in the region‖ (Athukorala, 2010).

This pattern of production sharing or fragmentation is proceeding globally, but East Asia is the region that is preeminent in this activity. A fundamental factor is the great diversity of labor supply and costs, from Japan, to the NIEs and ASEAN members. ―Over the past two decades wages in Korea; Taipei, China; and Hong Kong, China have been rapidly approaching developed- country levels. But, despite rapid growth, manufacturing wages in the PRC and other latecomers to export-oriented industrialization in East Asia (Malaysia, Thailand, Viet Nam, and the

Philippines) remain lower than or comparable to countries on the European periphery and Mexico…Moreover, there are significant differences in wages among countries in the region, providing a basis for a shift in activities to lower-wage sources within the region and rapid expansion of intraregional product sharing systems‖ (Athukorala, 2010).

As a succinct summary, we could say that significant investments in ports and other logistics services and communications networks have complemented the historic pattern of early entry of MNEs and the close proximity of relative cost differentials amongst trade-oriented economies.

Factor costs differentials have been supported by policy choices and investments in ports and communications systems, which reduce the ―cost of maintaining services links in global production sharing…Singapore, by far the biggest transshipment hub in the region, tops the world‗s logistics quality ranking. The other major transshipment hub in the region, Hong Kong, China, is eighth in the global ranking‖ (Athukorala, 2010).

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The choice of location by MNEs is determined by the presence of the other market participants in the specific or neighboring countries. Over a long period of operating in the East Asian region, MNEs have invested in the capabilities and technology of their subsidiaries and affiliates, often to the extent of giving them responsibilities for regional or global production. In addition, there has been the emergence of China as a vast home to the assembly of electrical/electronic and other products, which has expanded the component industries in other countries in the region. ―For over 3 decades there has been rapid economic expansion in several countries in the region and this seems to have brought about market thickness, which refers to the diversification of the composition of the traded goods of a country as an outcome of rapid growth and structural

transformation, with a positive impact on the location of outsourcing activity‖ (Athukorala, 2010).

A further important factor that promotes the clustering activities in a region is the achievement of economies of scale. ―Scale economies create an incentive for firms to cluster spatially. If average production costs decline as the scale of production rises at the firm, industry, or regional level, then there are advantages to concentrating production in a particular location... Scale economies represent an incentive for the formation of regional production networks‖ (Haddad, 2007).

The Japanese MNEs have been major drivers of the growth of intraregional trade and integration through their development of highly disaggregated, region-wide production and distribution networks. ―Of the exports from the head offices of Japanese multinational corporations, 74 percent are destined to the overseas affiliates, while 56 percent of the imports come from overseas

affiliates‖ (Haddad, 2007).

We can distinguish foreign direct investment (FDI) in three ways. Firstly, horizontal FDI, in which operations are set up in host countries to supply that host‘s domestic market, not exports.

This type of FDI is considered in the literature to be export-substituting. Secondly, vertical FDI, in which operations are established in a low labor cost host and capital-intensive inputs are imported from the home base. Thirdly, there is export-oriented FDI, whose purpose is to serve third

markets. Vertical and export-oriented FDI form the basis for the development of production networks. ―In terms of affiliate numbers, in opposition to the theoretical literature in which horizontal FDI prevails, export-platform FDI holds the largest share for Japanese multi-national affiliates; in particular, in the textiles and precision machinery industries. Furthermore, complex vertical-FDI, in which a parent country invests in a particular host country with the intention of serving third markets with exports of final goods from an affiliate in the host country, and of procuring from the third country, accounts for a large share in the electronics, information and

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technology, and precision machinery industries‖ (Hiratsuka, 2011)

Rather than being substitutes, as traditional, constant returns to scale theory would suggest, FDI and expanded trade go hand in hand. ―FDI has been instrumental in the shift to international production networks, and economies that have experienced the largest FDI inflows have also seen the largest expansion in merchandise exports. The fragmentation of production presents producers in developing countries with a golden opportunity to widen their export markets. Indeed,

developing economies make up three of the top six destinations for FDI flows, with China moving up to become the second largest FDI recipient in 2009 behind the United States‖ (WTO/IDE- JETRO, 2011).

One example of the interplay between FDI, factor cost differentials, regional proximity,

economies of scale and production fragmentation is the hard disk drive (HDD) industry, itself a component of other industries (which is explored in more detail in Chapter 12). Originally, US HDD manufacturers set up facilities in Singapore and in time shifted various aspects of the process to other factories in Malaysia, Thailand and China to take advantage of labor cost

differentials. These latter hosts became major producers. ―Thailand had become the second largest exporter of HDDs behind the PRC. Thailand‘s trade share of HDDs accounted for 17% in 2007, compared with the PRC‘s 35%‖ (Hiratsuka, 2011).

The success of industries like HDDs in emerging economies has led to more confidence from MNEs in such investments, which in turn support the sustained growth in wealth in the region.

―TNCs‘ (Transnational Corporations) FDI plans are increasingly focusing on developing and transition economies, especially in South, East and South-East Asia, and, to a lesser extent, Latin America‖ (UNCTAD, 2011).

Asia has been the exemplary region in which a sequential upgrading has occurred in terms of industrial development. Global competition and freer markets has driven advanced economies to invest in higher value-added production and services, while relocating the more labor-intensive activities to less developed countries. This provides the latter with opportunities to engage in the regional and global economies and benefit from the import of capital and technology that

accompanies MNEs. ―FDI has played a crucial role in the process, serving as a vehicle for transferring technologies, ―recycling‖ comparative advantages and enhancing competitiveness.

For low income countries in the region, participation in TNCs‘ regional production networks has become an effective way to build productive capacities and promote exports, industrial

development and economic growth‖ (UNCTAD, 2011).

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The success of this process is highlighted by the more recent trends in FDI, with the investing firms being from inside the region. ―Intraregional FDI has made an increasing contribution to industrial upgrading. The relative weight of the region‘s FDI sources has shifted: while the United States played a leading role in the 1960s and 1970s, followed by Japan in the 1980s, their share has been declining since the early 1990s (table II.6 from the UNCTAD World Investment report 2010). Regional economic integration has boosted intraregional investment, which now accounts for around 40 per cent of the total FDI stock of the region…Following in the footsteps of Japanese TNCs, companies from NIEs have been relocating their production operations within the region to take advantage of lower costs, thereby enhancing their competitiveness and promoting industrial restructuring and upgrading in their home countries. Through this process, neighbouring host countries have gained increased access to capital, technology, productive capability and foreign markets.‖ 19

(Refer also to the chapter on final demand in Asia, below, for additional analysis on intraregional investment and its impact on economic growth).

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Chapter 5. Production Fragmentation and Intermediate Goods Trade

The vast networks of production and distribution managed by MNEs in Asia are also based on the low transport costs due to their proximity and low trade barriers due to policies. As a result,

―growth in one East Asian economy tends to favor an expansion in trade with other East Asian economies rather than with, say, Latin America. Low trade costs may magnify the advantages of fragmenting production, rendering the impact on trade of incremental reductions in trade barriers potentially large‖ (Haddad, 2007).

The resulting enormous intra-industry trade is vertical in two senses. Firstly, the trade in goods and services that is based on the differing levels of economic development. Secondly, as a feature of the fragmented production network as various components of final products move between different facilities. ―Production sharing, by definition, incorporates the back-and-forth nature of trade: the importation of inputs for assembly or additional processing, as well as the exportation of intermediate goods for assembly or additional processing by third countries. This is distinguished from pure intra-industry trade, one-way production sharing, and the trade in intermediate goods‖

(Haddad, 2007).

There has been a shift, not just from trade in consumer and capital goods but also from

intermediate goods, to trade in parts and components within the same industry. ―Trade patterns in today‘s global competitive climate where economies of scale strongly work are quite different from the traditional ones that are based on static comparative advantage. The whole production processes involve sequential production blocks located across countries. Different stages of production are shared by different suppliers located in different countries‖ (Lim, 2007).

The result of the development of the extensive networks of production in Asia has been that network trade (intermediate plus component goods) has more than doubled its share of total exports to about 50% by the end of the 2000s. The shift from mature to developing economies is also evident. ―The share of developing countries in total network exports increased from 22.0% in 1992/3 to 45.7% in 2005/6, driven primarily by the growing importance of East Asian countries in global production sharing. The share of East Asia (including Japan) increased from 32.2 % in 1992/93 to 40.3% in 2006/7, despite a notable decline in Japan‗s share, from 18.4% to 9.5%. The major driving force has been the PRC, whose share increased from 2.1% to 14.5%. Within East Asia, world market shares of ASEAN countries, with the exception of Singapore, have grown faster than the regional average‖ (Athukorala, 2010).

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There is a significant bias in the component trade of China: a much larger share of component imports compared to exports, which means that other countries in the East Asian region are providing parts and components for assembly in China. ―The share of components in the PRC‗s total manufacturing imports from East Asia increased from 16% in 1992/3 to 46% in 2006/7‖

(Athukorala, 2010).

Furthermore, there is no one-way flow towards a single destination. ―The intermediate good trade is multi-directional…the traditional image of the flying geese pattern which depicts international structure of trade within the framework of vertical division of labour does not fit well…more than 73% of VCR and DVD players and 80% of personal computers (PC) are made in China. On the other hand 62% of hard disk drives (HDDs) and 38% of DVD-ROM drives are produced in ASEAN countries. These products are used for assembling PCs, hence the production linkage between ASEAN and China is obvious (sic)‖ (Hamaguchi, 2007).

As mentioned previously, while China plays a key role as the final assembler in the region, Ferrarini‘s paper also shows that globalization is not centred on China but has at least three anchors. Furthermore, the changing demand dynamics in the US and EU after the severe downturns from 2008, will favour a shift of policies towards generating more regional demand.

―The economic integration of China has deepened production fragmentation in East Asia to an unprecedented level. The rapid integration of China into regional production networks has countered fears that China‘s global integration would crowd out the opportunities of other countries for international specialization‖ (Haddad, 2007).

Until recently, it could be said that ―intermediate goods exports have accounted for about 70 percent of the annual export growth in Asia over the last decade—more than double the

contribution of capital and consumer goods together. This has been particularly the case for the ASEAN-5, the NIEs, and Japan. Exports of intermediate goods have been particularly strong to other Asian economies, whereas consumer goods and intermediate goods have contributed

roughly equally to the increase of exports outside Asia…The average share of intermediate goods exports between Asian trading partners has increased to nearly 80 percent in 2009 from about 60 percent a decade earlier‖ (IMF, 2011).

If the expectations of shifting demand patterns are realized, these shares should converge somewhat, as the economies inside the Asian region become the final destination for more consumer goods. However, to a large degree, it is the previous dynamic trade performance which

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Evidence of the appearing shifts is the increasing importance of China as a destination for capital goods. ―For Japan and Korea, capital goods exports to China now account for 20 percent to 25 percent of their total capital goods exports (a fourfold increase from a decade earlier), making China by far their single most important capital goods export destination in Asia, and comparable to the United States or the European Union as export markets‖ (IMF, 2009).

At the same time, as shown by the major disruptions to regional and global supply chains after the tsunami in March 2011, Japan remains a key driver of economic growth in the East Asian region.

―For all major Asian economies, Japan remains the second most important source of intermediate inputs after China, and it remains the single most important supplier to China, where it accounts for 36 percent of all imported inputs sourced from Asia‖ (IMF, 2009).

As the Asian region continues to dominate the trade in intermediate goods and components and expands the trade of consumer goods, the advanced economies will focus more on diversifying their trade in services. Once again, some of these services can be called ―intermediate‖ because they could meet demand at various points of regional and global value-chains.

New theories have been formulated to understand the formation of international production networks. Firstly, new economic geography (NEG) ―attempts to explain the agglomeration and dispersion of economic activities in geographical space. The spatial structure of economic activities is considered to be the outcome of a process involving the opposing forces of agglomeration and dispersion…One important factor that subtly affects the balance between agglomeration and dispersion is the cost of transport, which includes freight costs, tariffs, non- tariff barriers, and the risk of exchange-rate variations‖ (Hiratsuka, 2011).

An allied approach, also using net cost analysis and comparative advantage, is fragmentation theory, which ―focuses on the location of production processes, and it suggests that production processes should be fragmented into several stages with separate production blocks being located at different sites, either domestic or international. By dividing the production process into separate blocks and situating each block in the most appropriate location, the total cost of production can be reduced‖ (Hiratsuka, 2011).

For example, in the case of capital intensive and labour intensive components of a product, marginal costs can be reduced by locating one component in a capital endowed country and the other in a labour endowed country. In addition, though, fragmentation theory also includes the calculation of the cost of ―incurring ‗setup cost‘ of establishing extra production plants and

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‗service link cost‘ for utilizing transportation and communication services in order to link the two operations. Firm‘s choice whether or not to split up the production depends on the balance of the marginal cost saving and the additional costs‖ (Hamaguchi, 2007).

The defining characteristic of NEG is its emphasis on the synergies that accumulate from

geographically adjacent economic activities that are also connected in a production process. Scale economies and the presence of skilled labour attract more capital and raise incomes. Production processes that are located in neighbouring countries likely face lower transport and transaction costs and more efficient use of inventories on a just-in-time basis. ―The positive feedback

mechanism leads to the self-organization of an agglomeration…A remarkable feature of the recent economic development in East Asia is not successive dispersion of industrialization but the

emergence of new agglomerations‖ (Hamaguchi, 2007).

The stress is on the plural. It may have begun as kind of flying geese pattern, starting with Japan, but the development of intermediate goods production and trade, especially in electronics and automobiles, has led to a new pattern. ―The region has multiple technological centres and co- agglomerations undertaking final-good and intermediate-good production, with intermediate goods moving bi-directionally between countries‖ (Hamaguchi, 2007).

A good example is the hard disk drive (HDD) industry, which has critical applications in both electrical/electronic and automobile sectors. The HDD sector has its own intermediate and final products. ―Due to the low cost of transportation, the HDD industry has developed a system of production fragmentation, where the production process is divided into several discrete stages and the separate production blocks are located in different countries‖ (Hiratsuka, 2011).

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(Hiratsuka, 2011)

We could say that in the East Asian region, from a value-chain perspective, national borders resemble notional borders. While remaining fully identical with sovereignty, borders are no longer impediments to trade and investment. The level and location of trade and investment are much more function of time, costs and scale. Trade and investment policies have achieved much,

although more could be done. There remain real regulatory and related mechanisms that add to the transaction costs between countries.

In this context, especially from the point of Australian opportunities, the following conclusion has important implications: ―Japanese firms investing in East Asia are likely to more flexibly de- internalize their production processes and conduct outsourcing activities than those going to other regions such as North America and Europe‖ (Hamaguchi, 2007).

In the East Asian region, there are more opportunities for Australian providers of goods and services to build on the extensive relationships they already enjoy with Japanese firms in the Australian and the Japanese markets. There are literally thousands of Japanese firms throughout the Asian region, deeply embedded in the industrial and consumer base.

As mentioned before, Ferrarini‘s research shows that there are three global hubs: the United

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States, China-Japan and Germany. Each hub has connections outside its own region with other hubs and networks. In East Asia, the China-Japan core is connected closely to several other countries as ―fragmented production activities scattered across the region typically involve the provision of high value-added parts and components by leading economies, such as Japan and the Republic of Korea, further processing in countries such as Malaysia and the Philippines, and final assembly in countries involving low labor costs and value added, predominantly in the PRC‖

(Ferrarini, 2011).

The East Asian region dominates the global electrical/electronic sector, with Japan in the core position. The global automotive industry networks are more evenly distributed, led by Germany and the US. ―By comparison, Asia‘s industrial network is relatively less developed… [but] Japan‘s automotive industry positions itself at the centre of Asia‘s networks, as a prime source of auto parts and components. Japan‘s strongest network partner is Thailand, which sources 67.5% of its automotive parts from Japan. Other relevant partners within the Southeast Asian region are Indonesia, and to a lesser extent the Philippines…The PRC has not yet reached a status of major influence in the regional automotive industries. Nevertheless, in 2006/2007 the country

represented the second-largest regional network leg, in connection with Japan, and also integrates strongly with the Republic of Korea‘s auto industry. The Republic of Korea itself represents a more significant element in the Asian networks, and also has significant relations to the German and the US hubs‖ (Farrarini, 2011).

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Chapter 6. Measurement Issues

There is a voluminous literature dealing with the growth of intra-regional trade and investment, typically in the context of economic integration. It is very common to find this type of statement:

―Asia is a highly integrated trading bloc, with buoyant intra-regional commerce (58 per cent of its trade in 2009). Furthermore, it has diversified its extra-regional markets to reach beyond its traditional partners, the European Union and the United States. The share of extra-regional trade excluding the European Union and the United States has increased from 12.9 per cent in 2001 to 18 per cent in 2009‖ (WTO and IDE-JETRO, 2011).

As useful as these statistics can be, they also suffer from serious deficiencies. When they are used in analysing international production networks, aggregated trade data can actually obscure those networks.

Global production sharing opens up opportunities for countries to specialize in different slices (tasks) of the production process depending on their relative cost advantage and other relevant economic fundamentals. In this context, the decisions of how much to produce and for which market have to be combined with decisions on where to produce and with what degree of intra- product specialization. ―Consequently, trade flow analysis based on data coming from a reporting system designed at a time when countries were trading only in final goods naturally distorted values of exports and imports, leading to a falsification of the nature of emerging trade patterns.

The degree of falsification is likely to increase over time as more complex production networks are created with an ever-increasing number of participants‖ (Athukorala, 2010).

―There is a vast literature on what may be termed standard trade data analysis based on the traditional notion of horizontal specialization in which trade is an exchange of goods that are produced from start to finish in just one country‖ (Athukorala, 2010). Such analysis does show an increase in intra-regional trade in Asia since the 1980s and forms the foundation for arguments in favour of regional trading agreements.

At the same time, there has been a concomitant expansion of international production

fragmentation, both regionally and globally. ―This phenomenon has been reflected in a growth in the trade in parts and components at a rate exceeding that of the trade in final goods because a good crosses multiple borders while it is involved in processing‖ (Haddad, 2007).

The driving force in the growth of production fragmentation and intra-industry trade has been

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foreign direct investment (FDI, i.e., the activities of multinational corporations (MNCs), including a significant amount of intra-firm trade. ―With the importance of MNCs in trade, the nature of MNCs‘ exports has been reconsidered. In the negotiations of US-China trade disputes, the

representatives of China have repeatedly pointed out that a large portion of its exports to the U.S.

was produced and traded by the MNCs of other countries in China and should be treated as the exports of these FDI source countries. The trade balances based on ownership should be a better revelation of trade relationship among countries. This point of view was recognized by the United States. Since 1995, the U.S. Bureau of Economic Analysis has annually published the report of An Ownership-based framework of the U.S. Current Account‖ (Yang and Huang, 2011).

―International trade statistics account for the gross cumulated value embodied in goods crossing international borders, not just the value added by the segment of the production process hosted by the exporting country and attributable to its resources‖ (Ferrarini, 2011). Aggregated data do not adequately reflect the distribution of value-added in the international value-chains and often include products that have been counted at least more than once as they travel across the same borders several times.

This characteristic of trade data has led to new methods of calculation, from looking at intra-firm sales of MNCs to the analysis of specific value-chains such as the iPhone, apparel or hard disk drives. ―A more comprehensive, economy wide approach to measuring value-added trade combines national input–output tables to identify the sources and destinations of value added as intermediate goods pass through global supply chains‖ (Farrarini, 2011).

More detailed disaggregated trade data has also been compiled, to identify the parts of parts of components of intermediate goods that are traded in production networks. ―Compared to input–

output analysis, this method is less comprehensive a gauge of processing trade and is limited to the subcategory of intermediates that are clearly recognizable as parts and components, thus disregarding processing and assembly activities characterizing vertical trade more broadly.

However, it offers the advantage of parsimony, in terms of both data requirements and the methodological complexities involved‖ (Ferrarini, 2011).

These various methods have arisen in specific policy contexts, such as economic integration or trade imbalances or development economics, etc. Each method has its uses and limitations, both in their original and additional contexts. Taken together they do provide a key insight, which is that vertical trade is but one aspect of economic integration. FDI and other capital flows are also

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The use of value-added or input-output analyses produces important insights for both policy formulation and corporate strategy. A good example is provided by looking at China, a key economy that is well integrated into global production networks. China has raw material and intermediate goods inputs and a large share of GDP as exports, much higher than other large economies. A detailed analysis of the imported inputs shows a much lower share of value-added generated in China.

Koopman, Wang and Wei (2008) modified existing methods of analysing value-added. ―By applying our methodology to Chinese data, we have found several interesting patterns. First, we estimate that the level of foreign content in Chinese exports is close to 50%, almost twice as high as what we calculate by using the HIY formula. Second, we find interesting heterogeneity across sectors: those sectors that are likely to be labelled as sophisticated or high-skilled, such as computers, electronic devices, and telecommunication equipment, tend to have especially low shares of domestic content.‖

―Conversely, many sectors that are relatively intensive in low-skilled labour, such as apparel, are likely to exhibit a high share of domestic content in China‘s exports. Finally, we find that foreign invested firms (including both wholly-owned foreign firms and Sino-foreign joint venture firms) tend to have a relatively low share of domestic content in their exports‖ (Koopman, Wang and Wei, 2008).

However, one of the consistent messages in this report is that the economic upgrading of the East Asia region, including of course China, is proceeding quickly, especially in the past few years.

Recently, Koopman et al (2011) updated their analysis of value-added in Chinese exports and found that domestic value-added had risen to 60.6% in 2007. By 2012 this figure is likely to be even higher; an indicator that value-added will support the future economic growth of the East Asian region.

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Chapter 7. Multinational Enterprise (MNE) Perspectives, Inter-firm and Intra-firm Transactions

Global Value chains, production sharing/networks/fragmentation are all driven by the international strategies of MNEs and the evolution of their choices between intra-firm and inter-firm

transactions (‗make‘ or ‗buy‘). Early on, the strategy might be to locate some parts of production in a lower cost market and –re-import the parts for final assembly. Later in the process, several countries could be engaged, with multiple export-import movements of parts before being assembled into an end product. ―As international networks of parts and comments supply have become firmly established, producers in advanced countries have begun to move the final assembly of an increasing range of consumer durables (e.g., computers, cameras, TV sets, and automobiles) to overseas locations in order to be physically closer to their final users and/or take advantage of cheap labor‖ (Athukorala, 2010).

Different industries have distinct internal-external transaction strategies. ―In the case of standard consumer goods such as clothing and footwear, global production sharing normally takes place through arm‗s length relationships, with international buyers playing a key role in linking producers and sellers in developed countries. On the other hand, production sharing within

vertically integrated global industries—such as electronics, electrical goods, and automotive—has evolved in a different manner‖ (Athukorala, 2010). Moving from an initial position in which a subsidiary performs the same operations as the home plant, a fully internal corporate operation, albeit in an overseas location (offshoring), eventually some activities or components are sourced from other suppliers. Some technology transfer would also occur.

In the East Asian region, MNEs pursue two different types of strategies. One rests on cost differentials and economies of scale to use networks for exports to final markets in the US and EU. The other is the production of goods for the local markets. ―The division between the two types of investment is not clear-cut, and many foreign affiliates operating in East Asia have

progressively adopted the characteristics of both vertical and horizontal multinationals‖ (WTO and IDE-JETRO, 2011).

The increasing complexity of multi-country production networks forces MNEs to redefine and concentrate on core activities. This leads to more extensive outsourcing, providing both technology transfer and opportunities for new firms to enter the network. ―A reliable and conducive international trading environment ensures the unhindered and efficient flow of

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GATT/WTO, trade barriers have been significantly reduced or eliminated and a stable, rules-based trading system has guaranteed and encouraged firms to engage internationally with confidence.

The availability of efficient and affordable logistics, transport and communication services supports this global production system‖ (WTO and IDE-JETRO, 2011).

The same considerations apply to services activities. Both manufacturing and non-manufacturing firms can and do outsource or offshore various types of services, from basic and routine to complex and customized, even R&D. ―Data processing, call centres, virtual assistance, legal support (legal transcription, drafting contracts, legal representation, etc), medical support (medical transcription, interpreting x-rays, etc), finance and accounting, software and applications

development and R&D are all activities that enterprises can assign to foreign firms. All these activities are designated as business process outsourcing (BPO) or information technology- enabled services (ITES). Of the Asian developing economies, it is India and the Philippines that are benefiting increasingly from offshored computer and IT-enabled business services‖ (WTO and IDE-JETRO, 2011). A general framework for understanding some of the issues related to intra- firm and inter-firm or ‗make‘ and ‗buy‘ decisions and the variations is provided by Gereffi‘s governance diagram:

(Gereffi, 2011)

EAST ASIAN ECONOMIC INTEGRATION BY MANUEL PANAGIOTOPOULOS A REPORT FOR THE AUSTRALIAN TRADE COMMISSION MARCH 2012