Engaging East Asian Integration: States, Markets and the Movement of People

3. Building a Neighbourhood — One Policy at a Time: The Case for Deeper Economic Integration in East Asia

46 3 Building a Neighbourhood — One Policy at a Time: The Case for Deeper Economic Integration in East Asia1 Hamid Alavi Ralph Van Doorn Vikram Nehru I. INSIGHTS ON THE BENEFITS OF EAST ASIAN INTEGRATION The benefits of regional integration are greater than previously realized. This section summarizes the main benefits of regional integration as documented in the literature on this, and discusses recent work that suggests that regional integration can be even more beneficial than previously realized, especially if the potential associated risks of integration are managed properly.2 Building a Neighbourhood, One Policy at a Time 47 The Benefits of Regional Integration Conventional Analysis Stresses Specialization as the Driver of Benefits The conventional analysis of the benefits of regional integration focuses on trade in goods and emphasizes trade and location effects. The preferential reduction in tariffs through regional agreements induces a shift in demand towards exports from partner countries at the expense of domestic production (trade creation) and away from exports from non-member countries (trade diversion). According to this view, trade creation improves welfare, trade diversion reduces it.3 Changes in trade flows induce changes in the location of production between member countries of a regional agreement based on static comparative advantage (specialization). New Insights Identify Economies of Scale and Agglomeration Economies as the Key Driver The new economic literature — sometimes called the “new international trade theory” — summarized in An East Asian Renaissance (Gill and Kharas 2007) and World Development Report (World Bank 2009), emphasizes the increasing role of economies of scale and agglomerations economies as central forces driving international trade, the geographical concentration of economic activity, and economic growth. While this theory was developed in the late 1970s (Krugman 1979), empirical support has been more recent. The premise of the new thinking is that when trade barriers fall, firms gain access to bigger markets, allowing them to expand production and reap economies of scale. But openness also exposes them to competition from rival foreign firms, paring their margins. As such, some firms may go out of business, but between the domestic survivors and the foreign entrants, consumers will have more variety of goods to choose from. Thus the main gains from trade arise not from specialization, but from economies of scale, fiercer competition, and increased consumer choice that regional integration and, eventually, globalization provide. These economies of scale are usually of three kinds — the internal economies of scale within a plant or factory, localization economies of scale that arise from a large number 48 Hamid Alavi, Ralph Van Doorn, and Vikram Nehru of firms in the same industry and the same place, and urbanization economies that arise from a large number of different industries in the same place (Krugman 1991). Features of East Asia’s Experience4 Regional Integration Has Spurred East Asia’s Growth The region’s GDP has climbed on average 8 per cent a year for over two decades, higher than any other region in the world (Figure 3.1). At the same time, intraregional trade has increased by almost 12 per FIGURE 3.1 Growth of Regional GDP per Capita (index = 100 in 1990) 0 50 100 150 200 250 300 350 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 South Asia Middle East & North Africa Latin America & Caribbean Europe & Central Asia East Asia & Pacific Sub-Saharan Africa Note: These numbers refer to low- and middle-income countries only according to The World Bank’s country classification. In this chart and the next few charts, East Asia & Pacific (EAP) includes the ASEAN+3 countries, Hong Kong, Mongolia and Papua New Guinea. Source: World Development Indicators. Building a Neighbourhood, One Policy at a Time 49 cent annually, growing faster than trade with the world, which grew only 9 per cent annually in the same period. Figure 3.2 shows a strong correlation between intraregional trade flows and regional GDP per capita growth. In fact, East Asia’s intraregional trade as a share of total trade is far above that of any other developing region, and is closer to that of high-income countries. The region has overtaken NAFTA in terms of intraregional trade as a share of total trade of the region with the world, and has been catching up with the European Union (Figure 3.3). Within the East Asian region, all countries with a few exceptions (notably Papua New Guinea) have...