An Uncertain Future Together

A follow-up to the previous post (Prospects for a New Trading Bloc), I feel it is necessary to provide further analysis on the possible motives behind South Korea's acceptance of the joint declaration which underscored the possibility of forming a trilateral free trade agreement (FTA). This new position is different from the more skeptical position that South Korea took in December last year.

Looking at the timing of Seoul's negotiations with its neighbors, economic benefits from closer regional economic integration appear to be only one of the many objectives that President Lee Myungbak had under consideration. Although the finalization of the agreement between Seoul and Tokyo was recently put on hold, a bilateral agreement on sharing military intelligence and logistics was in its final stage before the trilateral negotiations began. Immediately following the summit in Beijing, South Korea approached China about establishing a similar arrangement. The timing of these meetings should be read as an expression of Seoul's foreign policy objectives.

It is likely that President Lee is attempting to achieve a definitive foreign policy victory before his term ends. The biggest challenge to Lee was not just the two North Korean attacks in 2010, but also the meek response he received from the regional powers when he sought to reprimand Pyongyang. In particular, China's lukewarm response has been blamed for encouraging North Korea to continue provocative actions along the Northern Limitation Line. Preventing future attacks will require establishing a diplomatic environment in the region that would deter North Korea from behaving belligerently - with China enthusiastic about the trilateral FTA, Seoul may be hoping to use it as leverage to more closely align Beijing to South Korea's interests.

Despite the efforts, China is unlikely to change its position on North Korea in the near future, especially when the Chinese Communist Party is preparing for its power transition later this year. Furthermore, China needs North Korea to resource the necessary raw materials for the development of the northeastern provinces.

This should also provide a stark reminder to the United States that some of South Korea's needs can only be satisfied by Chinese cooperation. Events this April proved that the United States can only do so much to convince the North Koreans not to do something. With this in mind, there is little reason to brashly pursue policy that will bring the two countries even closer together.  

Please read my article on Asia Times Online

Prospects for a New Trading Bloc

As the European Union teeters towards possible dissolution, a new trading bloc may emerge on the other side of the Eurasian landmass.

On May 12, 2012, Trade Ministers from Japan, South Korea and China agreed to propose to the leaders' summit (held in Beijing the next day on May 13, 2012) that the three countries should start FTA negotiations by the year’s end.

On the following day, Premier Wen Jiabao, PM Yoshihiko Noda, and President Lee Myungbak concluded the Fifth Trilateral Summit Meeting in Beijing and signed the Trilateral Agreement for the Promotion, Facilitation and Protection of Investment in which the three leaders pledged to work towards establishing a free trade agreement between the three countries. In a joint declaration, leaders of the three countries promised to further enhance the “future-oriented comprehensive cooperative partnership” to unleash vitality into the economic growth of the three countries, accelerate economic integration in East Asia, and facilitate economic recovery and growth in the world.

If the three countries are able to produce an exclusive free trade zone between the three countries, it will have a huge impact on the dynamic of the global market. According to the IMF, China, Japan and South Korea accounted for a combined 19.6 percent of global gross domestic product and 17.5 percent of world trade by value in 2010. In addition, the Japanese Ministry of Trade claimed that a trilateral free trade agreement would increase Japan's GDP by 0.3 percent, China's by 0.4 percent and South Korea's by 2.8 percent.

While both Premier Wen and PM Noda expressed enthusiasm for the potential trading bloc, President Lee showed a degree of reluctance during the negotiations. Many suggest that Seoul fears that a trilateral agreement will neutralize potential gains that could be gained through a bilateral FTA with China. Immediately following trilateral talks, South Korea and China held their first meeting on a bilateral FTA on Monday. Some observers say South Korea, which aims to expand its market share in China's automobile, TV, etc., intends to prioritize the bilateral negotiations over the trilateral talks. Sharing the Chinese market with Japanese corporations would not only reduce potential gains, but, according to Professor Kim Young Han, the country would also end up relying more on Japanese core components and other technology.

In addition, the domestic situation in South Korea could play a role in President Lee’s position. Following the ratification of the KORUS FTA in March, increasing number of people are voicing concerns regarding a possible FTA with Japan.

Japan would certainly greatly benefit from opening relations with both South Korea and China. According to Nomura Securities, establishing a bilateral FTA with China will raise Japan’s GDP by 0.68 percent, which is higher than the 0.35 percent growth expected with a bilateral FTA with the United States. Furthermore, the same study estimated that the trilateral FTA will boost Japan’s GDP by 0.74 percent (much higher than the Ministry of Trade estimate), exceeding the 0.54 percent increase offered by the Trans-Pacific Partnership. In a statement, PM Noda suggested that Japan would prefer to pursue both negotiations simultaneously.

From Yomiuri Shimbun Online

However, the trilateral free trade agreement will most likely not bear fruit in the near future. AEI’s Claude Barfield notes that while the ROK-PRC bilateral negotiations have placed pressure on Japan to advance negotiations, the political turmoil and uncertainty prevent Tokyo from moving forward with any regional economic integration.

China has been proposing an intra-regional free trade zone for the past decade. Several attempts at bilateral agreements have also already occurred. In 2003, Seoul and Tokyo attempted to negotiation a FTA, but broke down after the two governments were unable to resolve their differences regarding agricultural products.

Agricultural exports will undoubtedly become a focal point in negotiations between the three countries. Both Japan and South Korea maintain massive farm subsidies and high tariffs to agricultural imports. Even so, the value of Chinese agricultural exports to Japan and South Korea in 2011 was $10.99 billion and $4.17 billion respectively. A quarter of China’s agricultural exports go to Japan and South Korea, thus Beijing is actively negotiating for the reduction of tariffs. While China promises to strike a balance in exports, domestic agriculture remains an extremely sensitive issue for both Japan and South Korea.

Meanwhile, President Ma Ying-jeou suggested on May 16, 2012 that Taiwan should join the trade pact between the three countries. Alongside aspirations for the intra-regional trade bloc, Ma also reiterated his intent to join the Trans-Pacific Partnership (TPP) trade agreement within eight years and said he expected to resume negotiations on the Trade and Investment Framework Agreement (TIFA) with the US in the near future. At the same time, he pledged to complete follow-up negotiations under the cross-strait Economic Cooperation Framework Agreement (ECFA) with the PRC.

Taiwan is most likely prompted to jump start further negotiations on the ECFA and other FTAs because of the bilateral negotiations between the PRC and the ROK. Taiwanese manufacturers compete with South Korean corporations in electronics, steel, machinery, petrochemicals, plastics and textiles. Heavily dependent on exports to China, Taiwan’s competitiveness in the Chinese market relies heavily on the special economic status bestowed on Taiwanese corporations by Beijing. If South Korean firms were given a similar edge in the Chinese market, Taiwan’s industry could be under threat. Beijing has already stated that it expects the negotiations for PRC-ROK FTA to take no more than two years.

According to Liou To-hai, director of the National Chengchi University's Center for WTO Studies in Taipei, "should South Korea sign an FTA with China ahead of Taiwan and China completing agreements on trade in goods, trade in service and investment, all the dividend that Taiwan has gained from ECFA's early harvest program could be neutralized." In addition, foreign direct investment (FDI) in Taiwan would also be affected. Since the signing of the ECFA, Japanese companies have used Taiwan as a gateway into the Chinese market, but Taiwan's special role could end as Japan is likely to shift its investment to South Korea.

2013 will see several key negotiations take shape and their results will most likely establish norms in the political economy of the region for decades to come. Northeast Asia is yet unready to establish an economic zone like the European Union, but steps that Seoul, Beijing, and Tokyo (and possibly Taipei) take today will definitely set the stage for their future growth.

Putin’s Return to the Wild East

During a Russian Federation Security Council meeting in December 2006, the presidential envoy to the Russian Far East suggested creating a commission subordinate to the prime minister which would oversee all development projects in Eastern Siberia and the Russian Far East. Last month, the Economic Development Ministry drafted a bill that will establish a state corporation authorized to distribute licenses for mineral extraction in 16 administrative zones. Nicknamed the “Far Eastern Republic,” the corporation will be partially exempt from federal legislation, receive massive tax breaks, operate outside regional state control, and receive shares of other state companies as investment.

The idea behind the “Far Eastern Republic” is similar to the 2006 proposal - only this time the project is subordinate to the president who will have the power to appoint the head of the company and name the supervisory board. This constant proposal to present special economic authority to Putin (who would have been in charge of the project in 2008 as premier) represents a clear indication that Vladimir Vladimirovich is heavily invested in the development of the Far East. Indeed, he probably recognizes that domestic support for his administration rides on continued economic growth. For that to occur, Russia must tap into the vast natural resource reserves beneath its most underdeveloped regions.

Alongside exports to China, Russia has also opened up export opportunities to Japan and the Koreas. Earlier this month, Democratic Party of Japan policy chief Seiji Maehara and Alexander Medvedev, Vice President of Gazprom, agreed to study the possibility of laying a gas pipeline linking Hokkaido and Sakhalin Islands.

With all these opportunities, the biggest obstacle to Russia's development in the Far East will be the heavy handed involvement of the state in the region. The "Far Eastern Republic" is being heavily criticized by Russia's former finance minister Alexei Kudrin who recognizes that

the creation of such a market player capable of implementing any private project, considering the state's administrative resource and [special preferences], means that any other investor in this area must be aware that another player with special preferences, special administrative resources and special access to finances may come to the market at any moment

A supporter of privatization, Kudrin believes that Moscow's current policies are damaging to the investment climate in the country.

Indeed given the opportunity, enterprises in Russia appear ready to invest in assets in the Russian Far East. For example, when Vanino seaport in Khabarovsk Krai was privatized in May 2011, 73% stake in the seaport was bought for 10.8 billion rubles ($354 million) after the bid started at 934 million rubles ($30.6 million). Although the winning company is currently undergoing trial resulting from its failure to make the down payment on the seaport, it is an example of how much the assets in the Russian Far East are in demand.

The problem with privatization for the Kremlin is two things:

1. "Privatization" of the 1990s left a bad reputation for entrepreneurship; the Russian people only remember economic downfall, oligarchs and corruption - the Putin administration came to power in 2000 with the goal of cleaning up the socio-economic ramifications of the Yeltsin era, thus  openly endorsing privatization for the Far East is politically difficult
2. Privatization would mean letting go of control over major companies. This will in the short term decrease government revenue

Putin is intent on spearheading development in the Far East; however, beyond building some infrastructure in Vladivostok, the Russian state will not be able to sustain its investments in the region. President Medvedev’s administration had taken small steps towards lessening state control over energy companies, but Putin is unlikely to continue these policies with the "Far Eastern Republic."

While Putin will undoubtedly remain closely engaged in the Far East during his 6-year term, the efforts to develop the Russian Far East have already been sullied by heavy state control over the project. If Moscow desires a prosperous future for the Russian people, it really must consider a more effective and efficient means of access its mineral wealth.

Read my article on Asia Times Online

State of Play

General Martin Dempsey, the chairman of the US joint chiefs of staff, gave a presentation at the Carnegie Endowment for International Peace on May 1, 2012.

His main focus was on the method of implementing US foreign policy abroad and he underscored three elements:

• Re-balancing to the Asia-Pacific cannot be just about increasing military hardware. The “intellectual bandwidth” (i.e. the way we conceive of tactics) of policymakers must also adapt to the new era to apply "smart power."
• The US must work with others to respond to the security paradox; people live in a relatively safer era, but the capacity for individuals to commit violence has also increased in the last few decades -  contemporary threats operate in decentralized, syndicated (state, non-state, and criminal) and networked forms. In order to more effectively confront these issues on every level, the US government must not only establish inter-agency partnerships, but also network with other nations. 
• Policies must integrate new technological capabilities. Communication and cyberspace capabilities have evolved in the past decade; therefore, new strategies must likewise adapt to these new conditions to better prepare for challenges that will arise from these changes. 

According to Dempsey, this new strategic perspective targets threats that are projected to be more prominent in 2020. In particular, anti-access capabilities of rival states and belligerent actors are expected to become more refined. From carrier-killing missiles to IEDs, these new challenges reflect how the Powell Doctrine, based on wielding overwhelming force to achieve clear conventional objectives, is no longer applicable in modern strategic thinking. Focus on aerial and naval capabilities is a response to this development and will require a more efficient and targeted use of manpower and firepower.

The adaptation of these new concepts is going to be affected by the “sequestration” of the budget; therefore, Dempsey noted that specific strategic plans will not be considered until congress finalizes the budget.

Of course Dempsey made the usual caveat that these changes are not designed to be a tool for containing China. He emphasized that Washington must not fall into Thucydides' Trap where war becomes inevitable mainly because one party believes that military confrontation is inevitable.

At the same time, placing greater responsibilities and capabilities in the hands of US allies in the region could mean increasing space for a confrontation between Washington and Beijing. In particular, Japan and the Philippines are bent on deterring Chinese incursion into their (claimed) maritime territories - greater maneuver space and firepower for Manila and Tokyo open the possibility of those countries engaging in aggressive behavior that they otherwise may not have undertaken if the US was indisputably at the helm.

The policy of regional economic-defense cooperation is probably a good policy when the US is strapped for resources; however, the distribution of the security guarantees will not work unless the key issues themselves are first diffused. The US and PRC are both important to one another - a political, economic and diplomatic understanding should be reached before undertaking action that could be misinterpreted. It's still all about diplomacy.