Structural change in the world economy and the position of APEC

Regional Trade Agreements (RTA) have been increasing since the beginning of the 1990s, which symbolizes blooming multilateral trade institutions in the world. According to the World Trade Organization (WTO) Regional Trade Agreement database, 474 regional trade agreements for individual goods and services in total have been reported to GATT/WTO before July 2010. These include 351 agreements reported under the provisions of the 1947 GATT Article 24: 31 under the enabling clause, and 92 under the GATS Article 5. Currently, 283 agreements were in force.

However, this list of RTAs that should be reported to WTO does not include APEC (Asia-Pacific Economic Cooperation Conference), because it does not contain an institutional framework established through treaties, compared to, for example, the European Union (EU) and North American Free Trade Agreement (NAFTA). Established in 1989, APEC is categorized as a forum for regional cooperation with little institutional constraints on members' behavior. APEC's basic principles - free and open trade and investment, facilitation of business, and economic and technical cooperation - were agreed on in the Bogor Meeting in 1994.

Within the global economy, the collective size of the 21 APEC economies is larger than that of the EU in terms of population, GDP, and trade volume. While the EU has pursued regional integration through an institutional framework, In contrast, APECs members have relied on market-driven regional integration. However, while the trade of APEC member economies has grown very rapidly, the proportion of intra-regional trade has declined since 2000. What does this reduction in intraregional dependence mean? It indicates both exports and imports in the APEC region are highly dependent on the growth of external markets, especially those of North America and Europe. Economic interdependence within the APEC is not as deep as that in EU. This is probably because the external markets have stronger purchasing power and are competitive in industries that are complimentary to those of APEC economies.

Offshoring of businesses supports the world economic development

Patterns of global trade over the past four decades can be examined with the Grubel and Lloyd (GL) index, a measure of the degree of intra-industry trade in bilateral exports and imports. It indicates that while intra-industry trade is increasing for all it is particularly accelerating for intermediate goods. (World Bank, World Development Report 2009).

Intermediate goods trade, where enterprises purchase products supplied by other enterprises to add value to them, can be called B2B (Business to Business) transactions. Today, the proportion of B2B transactions in the world trade is increasing as the economy grows. The characteristics of B2B transactions can be observed on an industry basis through analysis using the part of intermediate goods on inter-industry relations tables.

OECD (Organisation for Economic Co-operation and Development) releases inter-industry relations tables that allow comparison based on internationally common industrial classifications. These tables can reveal that each country procures intermediate goods from overseas in what industries in what proportion during globalized business activities. This kind of transactions with foreign countries is called offshoring. A large portion of the world trade consists of B2B transactions, i.e. demand of intermediate goods such as materials and parts procured during industrial activities. The growth of offshoring in each country's economic activities can be shown by using the vertical specialization index, which is defined as the proportion of use of imported goods or services in goods or services exported from specific industries.

The United States, Japan and other larger economies tend to be vertically specialized to a lesser extent. Recently, it is known that enterprises in advanced industrial nations are driving rapid vertical specialization. Among OECD members, Japan is undergoing especially large change. Along with Japan, however, the U.S., major European industrial countries, and China have also experienced the same tendency. Vertical specialization is noticeable in the industries of petroleum processing, automobile, high technology, metal products, and so on.

Today, the proportion of B2B transactions across borders is rapidly growing. This kind of foreign transaction is often called offshoring. OECD releases tables that allow the analysis of inter-industry relations by industry based on internationally common industrial classifications. For each economy, these tables can reveal the extent, nature and growth of offshoring through a "vertical specialization" index, which is defined as the proportion of imported goods and services embodied in the goods or services exported by specific industries. In other words, it measures the extent to which a domestic industry specializes in a particular part of any given production process such as design, intermediate process, or final assembly. Specializing in one part of production implies that the domestic producer offshore the other processes.

These indexes show that the United States, Europe, Japan, and China and other larger economies have become much more vertically specialized over time. This trend has accelerated recently, as large multinational enterprises diversify their supply chains across economies. Among the OECD members, Japan is undergoing especially large change. Vertical specialization is especially noticeable in the industries of petroleum processing, automobiles, high technology, metal products, among others.

Decreased trade costs accelerate global offshoring

After the World War II, the world trade has grown at annual 6.2% on average. The interdependence in the world economy deepened by the growing world trade is called globalization.

The concentration of marine transportation routes shows how global companies are pursuing offshoring. While routes among developed counties in the north are highly concentrated, ones connecting developing countries in the south are scattered. What does this mean?

Trade costs are declining over the past half century. The trade costs include transportation and communication costs as well as traditional trade costs such as tariffs and nontariff barriers. An interesting characteristic of the declining transport costs is that costs for transportation to distant destinations are particularly decreasing.

Recent studies have stressed the importance of trade costs in determining specialization and patterns of trade. In new trade studies and economic geography, the size of trade costs is a key factor for selecting business locations.

Hummels observes based on long-term data worth 30 years that fares on marine and air transportation have improved significantly worldwide (Hummels, David, JEP, 2007).

Comparison of tariff rates and freights for trade in Asian economies between 2000 and 2005 reveals that they improved extensively. In addition, the average tariff rates as of 2008 in 13 economies that are covered by the APEC assessment in 2010 were generally lower than that in EU. According to WTO bound tariff rates and the tariff rates applied by APEC and EC member economies as of 2008, Japanese tariff rates are lower for non-agricultural products but much higher for agricultural products than those in European economies.

These additional costs are called trade costs, which constitute barriers against companies pursuing offshoring and selecting where to deploy production bases called global value chains. Now, are markets in Asian developing countries really attractive to globally operating companies? In fact, inadequately built social infrastructures in developing economies make such companies hesitate to enter those economies during their business activities beyond borders, even if those economies have valuable production resources or markets.

The role of Japan in improving infrastructures in Asia

A grand design for improving infrastructures in Asia is the Asian Highway project, which aims to standardize transportation routes across 155 countries ranging as long as 140,000 km throughout Asia. This project was launched by UNESCAP (United Nations Economic and Social Commission for Asia and the Pacific) in 1992 as one of three pillars in the initiative called the Asian Land Transport Infrastructure Development. Other two pillars are the Trans-Asian Railway project and the project for land transportation via intermodal transportation terminals that combine land, sea, and air transportation (dry and inland ports) (Asian Development Bank, Infrastructure for a Seamless Asia, 2009).

Along with these hardware infrastructures, a wide variety of other areas must be addressed for connecting markets beyond borders. WTO conducted international comparison of factors determining offshoring costs with respect to such matters as quality of transportation infrastructures, quality of communication infrastructures, quality of institutions for performing business activities, and barriers related to time. Countries with more income are evaluated better worldwide (WTO, World Trade Report 2008).

In addition, the World Bank database contains a country-by-country ranking of easiness of performing business activities. The indices include many factors such as start-up, construction permission, employment, registration of companies, financing, investor protection, tax, transborder transactions, enforcement of contract fulfillment, and termination of business, which are all related to business processes in economies in which international companies make investments. Incidentally, the U.S. and Japan are placed at fourth and fifteenth in the comprehensive world ranking in 2010, respectively. These evaluations are, not to mention, linked with expansion of the economies' trade and direct investment in the world.

Disparity of economic development levels among APEC members as measured by per-capita GDP can be regarded as disparity of infrastructure. Development requires not only improvement of hardware infrastructures but also software reforms in legal systems, employment, human resource development, and so forth.

The aggregate amount of inward direct investment as the ratio to GDP is also an indicator of openness of markets in each economy. While APEC economies have well succeeded in attracting foreign direct investment, comparison using this indicator shows that Japan, China, Korea, and Taiwan fall behind in efforts for opening markets compared with other member economies. Moreover, the openness level in APEC is lower than that in EU and the world average. Unfortunately, the market openness in Japan is ranked at the bottom in the APEC region. APEC and Japan in particular are strongly urged to make efforts for market reforms to invite business resources from vigorous foreign companies.

Economic prosperity in the Asia Pacific region requires establishing integrated seamless markets across Asia by improving infrastructures that reduce or remove barriers against economic activities. Until the APEC summit held in Yokohama in November 2010, Japan as the host must exercise effective leadership in building such seamless markets all over Asia.

The 21 APEC members actually include non-Asian countries. The U.S., for example, is attempting to enhance the institutional framework of TPP (Trans-Pacific Economic Partnership Agreement) as an FTA (Free Trade Agreement) involving Malaysia. As the APEC meeting is held in Japan, it is time for Japan to decide where to position themselves in Asia from a long-term perspective.

Click here for the culture program Corridor of Knowledge (The Changing World Economy and APEC-the Role Expected of Japan, Episode 74), edited by the author