MANILA, Philippines?January 1 marked the implementation of the China-Asean Free Trade Agreement (Cafta) simultaneous with the setting up of the Asean Economic Community (AEC). Cafta represents the world?s third largest free trade agreement in terms of trade volume after the European Union and the North American Free Trade Agreement (Nafta), and the largest by population at 1.9 billion.

China and the Association of Southeast Asian Nations (Asean) have a combined gross domestic product (GDP) of $6.6 trillion and total trade of $4.3 trillion (13 percent of world trade). Foreign direct investment (FDI) in Asean and China amounted to $167.3 billion (10 percent of the total).

In the past decade, trade between the two exploded. Their total trade reached $192.5 billion in 2008 from $39.5 billion in 2000. To date, China accounts for 11.3 percent of Asean?s total trade, overtaking the United States as its third largest partner after Japan and the European Union. With its increasing presence, Cafta can help China counterbalance Japan?s political and economic power in the region.

With the slowdown in the United States and the European Union, Cafta shifts focus on Asean and China, a region with increasing growth potential. Cafta is a signal that Asean is open and together with the AEC, it can lay the foundation so the countries can trade more final goods with each other. This may also serve as a basis for future Asian integration.

Under Cafta, tariffs are expected to be eliminated on 90 percent of products ranging from textiles to rubber, vegetable oil and steel between China and the Asean 6 (Brunei, Indonesia, Malaysia, the Philippines, Thailand and Singapore). Cambodia, Laos, Myanmar and Vietnam will follow in 2015. Import duties will be removed on 6,682 Chinese products. Average tariffs are reduced to 0.6 percent (from 9.8 percent in Asean and 12.8 percent in China).

Trade between Asean and China consists largely of commodities, parts and components and intermediate and semi-finished products that China assembles for export to the United States and the European Union. With the latter?s weak recovery, the near-term benefits from cheaper imports and exports via the agreement might be limited.

However, many believe that after a year of sharp economic slowdown, Cafta will likely provide a strong boost to trade and investment in the region through China?s infrastructure spending along with the fiscal stimulus spending and improving domestic demand in the Asean countries.

Gains

The Asean countries are expected to gain from the export of cheaper intermediate goods and commodities to China in the short-run and export of final goods once China?s domestic consumption increases.

China will benefit by having a steady source of cheaper raw materials and commodities and exporting goods to the Asean countries. Asean will also benefit through China?s greater export-led FDI flows. At the same time, with integrated markets and lower market risks and uncertainty, more foreign investments are expected not only from China but also from the United States, Europe and Japan.

Not everyone is enthusiastic about the deal. The Economist (Jan. 7, 2010) sees the agreement as ?more breadth than depth.? The benefits might be exaggerated since tariffs have been falling for years and facilitating a brisk China-Asean trade. Trade in parts and components will not be greatly affected since tariffs on these products are already almost zero.

Exclusion list

Moreover, every country has an exclusion list in which tariffs can still apply such as hearses in Brunei, popcorn in Indonesia, snowboard boots in Thailand, motorcycles in Malaysia and toilet paper in China. Without a rigorous mechanism to settle disputes, there are doubts whether the trade deal will successfully deliver the promised gains.

China?s manufacturing accounts for 40 percent of its GDP. It exports mostly electronics, machinery, textiles, optical photographic and medical equipment, and furniture. It is also one of the world?s major producers of oilseeds, cotton and other fibers, rice, corn, wheat, soybeans, vegetables, tea and pork. With these strengths, many firms fear Chinese competition.

Opposition

Opposition to the trade deal has been loudest in Indonesia where pressures on the government to delay the implementation of Cafta have mounted.

How will the trade deal affect the Philippines? Our average tariffs are already low with manufacturing at 6.8 percent and agriculture at 11.2 percent. About 55 percent of our tariff lines are clustered around the 0- to 3-percent tariff levels and about 29 percent are found in the 5- to 10-percent levels.

These are the ones that will be exposed to immediate competition. The Philippines has continued to enjoy trade surplus with China. About 87 percent of our exports consist of parts and components whose tariffs are mostly zero. Likewise, 69 percent of our imports are manufactured goods and machinery equipment whose tariffs are also low. Hence, for these products, the short-term impact at the margin might be small.

The medium- to long-term impact is expected to be higher once the tariff walls on our highly protected sectors with tariffs from 30 percent to 65 percent come down. Currently, these goods are temporarily shielded from Chinese competition through the sensitive (SL) and highly sensitive (HSL) list track.

HSL products include hams, onions, garlic, cauliflowers, broccoli, carrots, turnips, cassava, sweet potatoes, rice, cane sugar, shutters, blinds, petrochemicals, hygienic, medical and surgical articles, motorcycles, motor vehicles and parts. SL products include pepper, ginger, cornstarch, carpets, stockings, hosiery, girdles, blankets, table linen, footwear, buses, sound signaling equipment, ignition wiring sets and other car parts.

Prepare for competition

Doing nothing and declaring at the 11th hour that we are not ready is not a good idea. The transition period must be used effectively and strategically to prepare our sensitive industries for future competition against China. We cannot forever shield them from competition through exclusion lists.

Free trade agreements (FTAs) are not all about import competition that we have come to fear. They are about the export incentives and higher profits that could arise from larger markets and removal of trade barriers.

FTAs will be beneficial to our industries only if they are able to take advantage of the market access opportunities offered.

Entering the export market is not easy and only the best firms can succeed. Hence, gearing our domestic firms for the export market will be crucial. We need government to play a more active role.

First, by providing all the necessary support to strengthen competitiveness and by lowering the cost of doing business.

Restructuring
Second, by getting ready for the restructuring process once firms are exposed to competition. This process will inevitably lead to temporary job losses from the death of inefficient firms. At the same time, new jobs will be created as new firms respond to the export incentives.

Protecting firms that have no chances of exporting or surviving domestic competition should be avoided. Policies and programs geared toward facilitating the exit of inefficient firms and entry of new ones should be prioritized. If strategically played and well coordinated by government, FTAs could bring gains through the creative destruction process that gives birth to more dynamic and competitive firms. Cafta could serve as a catalyst for the restructuring.

(Rafaelita M. Aldaba is a senior research fellow at the Philippine Institute for Development Studies.)

Asean trade with China 2004-2008
(Value in million US$)

Country 2004 2008
 Brunei
 Darussalam 243 0
 Cambodia 12 13
 Indonesia 4,605 11,637
 Lao PDR 1 15
 Malaysia 8,634 18,422
 Myanmar 75 499
 Philippines 2,653 5,467
 Singapore 15,321 29,082
 Thailand 7,098 15,931
 Vietnam 2,711 4,491

Asean Export 41,352 85,558
 Brunei
 Darussalam 87 171
 Cambodia 337 933
 Indonesia 4,101 15,247
 Lao PDR 89 131
 Malaysia 11,353 18,646
 Myanmar 351 671
 Philippines 2,659 4,250
 Singapore 16,137 31,583
 Thailand 8,183 19,936
 Vietnam 4,416 15,545
Asean Import 47,714 107,114
 Brunei
 Darussalam 155 (170)
 Cambodia (325) (921)
 Indonesia 503 (3,611)
 Lao PDR (88) (116)
 Malaysia (2,719) (224)
 Myanmar (277) (172)
 Philippines (6) 1,217
 Singapore (816) (2,500)
 Thailand (1,085) (4,005)
 Vietnam (1,705) (11,054)
 Balance of trade (6,362) (21,557)

Source: Asean Trade Statistics Database (Data as of July 2009) Website: http://www.aseansec.org/19105.htm