53244 China`s New Trade Issues in The Post-WTO Accession Era Poverty Reduction and Economic Management Unit East Asia and Pacific Region World Bank Table of Contents Foreword i Acknowledgments ii Glossary of Abbreviations and Acronyms iii Introduction and Overview 1 Part I Guideline to Free Trade Agreement Negotiation 11 1 Status Quo of The Development of China`s FTAs 11 2 Market Access Provisions 19 3 Rules of Origin 25 4 Disputes Settlement in Free Trade Agreements 32 5 Managing Multiple Trade Negotiations in Services 39 6 FTAs in Services--Positive vs Negative List Approach 44 7 Labor Mobility Provisions in FTAs: Lessons for China 52 8 Competition Provisions in FTAs: Lessons for China 67 9 Environment Provisions in FTAs: Lessons for China 76 Part II China Options in The Post-WTO Accession Era 88 10 Tariff Policy for Cotton Imports in China 88 11 Rethinking Trade and Poverty Linkages: Implications of the Doha Round Negotiations for China`s Agriculture 97 12 Trade and the Environmental Debate 114 Part III Promoting Trade in Services 127 13 Trade in Services Overview 127 14 Lessons From Leaders In Services Trade 132 Korea 132 India 136 European Union 140 United States 144 Japan 150 China, Hong Kong Special Administrative Region 156 15 Promoting Trade in Services: Case Studies 166 Information technology services 167 Transport 179 Animation 192 Tables: Table 1.1 Status of China`s regional trade agreements by end-October, 2008................. 18 Table 3 A.1 Rules of Origin in East Asian FTAs ............................................................. 31 Table 4.1 Key Elements to be Considered while Designing Dispute Settlement Provisions of RTAs............................................................................................................................. 37 Table 4.2 Choice of Forum Clauses in RTAs ................................................................... 38 Table 6.1 Scheduling approaches in East Asian FTAs ..................................................... 46 Table 10.1 Key statistics on cotton production and trade in China, marketing years....... 88 Table 10.2 Applied over-quota tariff generated by the 2007 formula .............................. 90 Table 10.3 China`s Net Exports of Processed Cotton, 2006............................................. 91 Table 10.4 China: Cotton Production, Trade and Disappearance ..................................... 91 Table 10.5 Tariff bindings on selected cotton products and substitutes ........................... 93 Table 11.1 Comparisons between China`s import tariff and external tariffs in 2006 ...... 98 Table 11.2 Proposed tariff reductions of agricultural commodities ................................ 99 Table 11.3 Comparisons of USA, G20 and EU proposals on agricultural domestic support policy............................................................................................................................... 100 Table 11.4 The macro impacts on China under EU, G20 and USA proposals in 2015 .. 102 Table 11.5 Impacts on China`s import of major agricultural commodities .................... 103 Table 11.6 Impacts on China`s export of major agricultural commodities .................... 104 Table 11.7 The impacts on production in China under different scenarios in 2015 ....... 106 Table 11.8 The impacts on per capita agricultural income in rural area by income groups ......................................................................................................................................... 108 Table 11.9 Shares of output values for competitive and noncompetitive agricultural products for different groups of farmers under baseline in 2015.................................... 109 Table 11.10 Impacts on per capita agricultural income of different farmers by province ......................................................................................................................................... 111 Table 12.1 Top Chinese Climate-Friendly Exports..................................................... 119 Table 12.2 Impact of a US trade-related climate measure on Chinese exports .............. 121 Table 13.1 Examples of Restrictions on Trade in Services ............................................ 129 Table 14.1 Leading Exporters of Other Commercial Services for 2006 ........................ 132 Table 14.2 Korea's Focus on Transparency in the Marketplace ..................................... 134 Table 14.3 Korea's Focus on Competition Policy........................................................... 135 Table 14.4 Examples of Korean Service Industry Policy Tools ..................................... 136 Table 14.5 Impact of Poor Regulatory & Administrative Quality on Service Firms ..... 139 Table 14.6 Leading Exporters of Trav., Transport., Other Commercial Services 2006 . 143 Table 14.7 Gross Value Added Growth and Contributions ............................................ 145 Table 14.8 Capital Inputs to the Knowledge Economy .................................................. 145 Table 14.9 US Commercial Service Activities ............................................................... 147 Table 14.10 Examples of Singapore Service Industry Policy Tools .............................. 150 Table 14.11 Policies to Address Service Industries Weaknesses ................................... 153 Table 14.12 Competition in Wholesale & Retail ............................................................ 153 Table 14.13 Primary Practices for Service Export Success ............................................ 154 Table 14.14 Examples of Japan Service Industry Policy Tools...................................... 155 Table 14.15 Hong Kong SAR Services % of GDP ......................................................... 157 Table 14.16 Trade Barriers to Environmental Service Industries................................... 158 Table 14.17 Examples of HKSAR Service Industry Policy Tools ................................. 160 Table 15.1 Sample Factors Influencing Export of Computer and Information Services 168 Table 15.2 Average Annual IT Salary in Dollars for Selected Countries, 2006 ............ 171 Table 15.3 Favorable Labor Pool Attributes for IT firms ............................................... 172 Table 15.4 The Philippines BPO Industry Overview 2005/2006 ................................... 176 Table 15.5 Percentage of Total Software Revenues Spent on Pirated Software, 2006 .. 179 Table 15.6 Sample Industry Value Chain ....................................................................... 195 Table 15.7 Sample Internet Interests of Conglomerates ................................................. 196 Table 15.8 Sample Animated Feature Filmsure Films ................................................... 196 Figures: Figure 2.1 Distribution of Liberalization by RTA ............................................................ 23 Figure 2.2 Distribution of Liberalization by RTA Parties in Chapters, Year 10 .............. 23 Figure 2.3 Coverage of Agricultural Provisions in Selected RTAs .................................. 24 Figure 2.4 Coverage of Textile Provisions in Selected RTAs .......................................... 24 Figure 3.1 ROOs are not cheap! ....................................................................................... 28 Figure 3.2 Trade impact of preference margins ................................................................ 28 Figure 4.1 Main Steps in Dispute Settlement ................................................................... 34 Figure 12.1 Comparison of Import/Export Ratios in Climate Friendly Technologies ... 118 Figure 13.1 Services Value Added (% of GDP) ............................................................. 127 Figure 13.2 Services Policy Dialogue in a Supportive Environment ............................. 131 Figure 14.1 Korea % Value Added by Activity .............................................................. 133 Figure 14.2 2006 Commercial Services Exports ............................................................ 140 Figure 14.3 Service Industry Clusters ............................................................................. 148 Figure 14.4 Magnets to Attract Service Industry Talent................................................. 149 Figure 14.5 Services Productivity and Enabling Environment ....................................... 151 Figure 15.1 Major Exporters & Importers of Cmp. & Inf. Services, 2005 ..................... 168 Figure 15.2 Worldwide Services Spending by Foundation Market ................................ 172 Figure 15.3 Worldwide Services Spending by Foundation Market ................................ 173 Figure 15.4 Worldwide IT Spending by Vertical Market ............................................... 173 Figure 15.5 Structure of Transportation Services Exports Extra-EU (25), 2005............ 181 Figure 15.6 Structure of Transportation Services Exports United States, 2005 ............. 181 Figure 15.7 Trade in Transportation Services with China in 2005 ................................. 182 Figure 15.8 Development of Intl. Seaborne Trade, Selected Years ................................ 183 Figure 15.9 Destination of 05` US Exports of Audiovisual & Related Services ............ 193 Boxes: Box 8.1 Models of Competition Regimes in RTAs .......................................................... 70 Box 9.1 Provisions on Environment in U.S. RTAs .......................................................... 82 Box 9.2 Environment Related Rights and Obligations under EU RTAs .......................... 85 Box 12.1 Chinese Submission to the WTO on Common` and Development` Lists .... 117 Foreword The past eight years witnessed China`s phenomenal growth and integration into the world economy, expedited by its accession to the WTO in 2001. The accession greatly accelerated China`s domestic reforms. By the end of 2007, China was ranked the second largest exporter and third largest trader in the world after its exports grew at over 20 percent per year for the sixth year in a row. The increasing competitiveness of China has been driving the efficiency of production, innovation and growth of global exports to new heights. Regional production networks in East Asia grew substantially in the past few years and were largely centered on China. From China`s perspective, accession to the WTO means more than the secure and nondiscriminatory access to the world market and gains in export. The accession provides China the platform and incentives to make more decisive strides in its already progressive reform. It lays a single multilateral basis for the country to develop trade relationships with its partners where openness can go further. It also puts the country at an international level to fulfill its legal and regulatory commitments, among others, in a transparent and rule-based global trading system. As China continues its trade reform process, its focus has shifted to the second generation issues that are now emerging. Like other countries, China has embarked on a series of Free Trade Agreements negotiations, including with Chile, Singapore, Australia, New Zealand, Norway, and Peru. China is also gearing up towards expanding its services trade, which now account for about 20 per cent of global trade. Environmental protection are high on China`s agenda, especially in the context of the WTO where issues such as environmental products are being negotiated. This volume aims to help guide policymakers in assessing the second generation trade issues and their development impact on China by presenting lessons from other countries and policy options. Trade is a strategic area in which the World Bank has been working closely with China with the aim to promote the country`s participation in the multinational economic institutions, to reduce its barriers to trade and investment, and to involve it more in global development and cross-border learning initiatives. This volume would not have been possible without collaboration with the Chinese Ministries of Finance, Commerce, and Agriculture. It has also incorporated valuable contributions from Chinese researchers in the trade area. Studies in this collection have been disseminated in a series of workshops and learning events co- organized by the World Bank and the Chinese counterparts in Beijing, which served as a forum for policy dialogue among the Chinese policy makers, trade negotiators, and scholars from development and international perspectives. We sincerely hope that the publishing of this collection in Chinese will extend this forum as it reaches a wider Chinese audience. James W. Adams Vice President The World Bank i Acknowledgments This book of selected papers is based on a series of workshops held during 2006-2009 in Beijing. These workshops were co-organized by the Ministry of Commerce and the World Bank to discuss the preliminary findings of the studies undertaken under the Trade and Poverty Project. The project was supervised by a core team led by Min Zhao (Task Team Leader) and including Mona Haddad and William Martin. Throughout the implementation of the project, we cooperated with the U.K. Department for International Development (DFID), which generously supported the research and other activities financially and intellectually. It would not have been possible without the work and contributions of a large number of friends and colleagues. We would like to thank the speakers and authors, who gave their time and energy to prepare their papers: Frederick Abbott (Florida State University College of Law), Guobin Cui (Tsinghua University School of Law), Kamala Dawar (independent consultant), Henry Gao (University of Hong Kong), Gary Hufbauer (Peterson Institute for International Economics), Jinkun Huang (Center for Chinese Agriculture Policy), Martin Molinuevo (World Trade Institute), Linda Schmid (independent consultant), Anuradha R.V. (independent consultant), Gregory Sergi (Duke University School of Law), Lanye Zhu (East China University of Politics and Law), as well as Silja Baller, Olivier Cattaneo, Jean-Pieer Chauffour, Carsten Fink, Muthukumara Mani, and Constantinos Stephanou from the World Bank. This book was prepared under the overall guidance from Bert Hofman (ex-Lead Economist) and Ardo Hansson (Lead Economist). David Dollar (Country Director) and Vikram Nehru (Sector Director) provided oversight. We would like to thank the Ministry of Commerce, People`s Republic of China, in particular, Vice Minister Yi Xiaozhun and Deputy Director-General Zhu Hong, for their guidance, support and cooperation during the implementation of the project, and the more than 200 participants in these workshops whose lively engagement prompted challenging discussions and offered comments and suggestions. Finally, we deeply appreciate the cheerful and dedicated assistance of Jianqing Chen and Zijing Niu of the World Bank Beijing Office for their excellent support. The findings, interpretations and conclusions expressed herein are those of the author(s) and do not necessarily reflect the views of the Board of Executive Directors of the World Bank or the governments they represent, or of the UK Department for International Development. ii Glossary of Abbreviations and Acronyms ACFTA ASEAN-China FTA ADR American Depository Receipt AEO Authorized Economic Operator AFTA ASEAN Free Trade Area AKFTA ASEAN-Korea FTA ANZCEFTA Australia New Zealand Closer Economic Relations Trade Agreement ASEAN Association of South East Asian Nations BEA Bilateral Emergency Actions BIS Bank for International Settlements BPO Business Process Outsourcing CACM Central American Common Market CBD Convention on Biological Diversity CEPA Closer Economic Partnership Arrangement CGI Computer Generated Imagery COMESA Common Market for Eastern and Southern Africa CPRC Competition Policy Review Committee CTC Change in Tariff Classification CTE Committee on Trade and Environment C-TPAT Customs-Trade Partnership Against Terrorism DDA Doha Development Agenda DDR Doha Development Round DFID U.K. Department for International Development DSB Dispute Settlement Body EBS Equitable Benefit Sharing EFTA European Free Trade Association EGS Environmental Goods and Services EPA Economic Partnership Agreement EPPs Environmentally Preferable Products ERC Economic Review Committee EU European Union FDI Foreign Direct Investment FTAs Free-Trade Agreements GAQSIQ General Administration for Quality Supervision, Inspection and Quarantine GATS General Agreement on Trade in Services GATT General Agreement on Tariffs and Trade GCC Gulf Cooperation Council GDP Gross Domestic Product GHG Greenhouse Gas GI Geographical Indication GLCs Government Linked Companies IP Intellectual Property iii H5N1 Avian Flu Virus IAIS International Association of Insurance Supervisors ICAC International Cotton Advisory Committee ICT Information Communication Technology ICTSD International Centre for Trade and Sustainable Development ILO International Labor Organization IMF International Monetary Fund IMHGR Interim Measures on Human Genetic Resources IMO International Maritime Organization IOSCO International Organization of Securities Commissions IPR Intellectual Property Rights ISM Code International Safety Management Code ISPS International Ship and Port Security Code JETRO Japan External Trade Organization JFTC Japan Fair Trade Commission JMEPA Japan- Malaysia Economic Partnership Agreement JSEPA Japan-Singapore Economic Partnership Agreement KFTC Korea Fair Trade Commission KSFTA Korea-Singapore FTA LDCs Least Developed Countries MEAs Multinational Environmental Agreements MERCOSUR Southern Common Market METI Ministry of Economy, Trade and Industry MFN Most-Favored-Nations MNP Movement of Natural Persons MSC Maritime Safety Committee NAFTA North American Free Trade Agreement NGO Nongovernmental Organization NRA Nominal Rate of Assistance NTM Non-tariff Measures OECD Organisation for Economic Co-operation and Development PIC Prior Informed Consent PPM Processes and Production Methods PTA Preferential Trade Agreement R&D Research and Development RFID Radio Frequency Identification ROO Rules of Origin RTAs Regional Trade Agreements RVC Regional Value Content SAAS Software as a Service SACU Southern African Customs Union SAFTA Singapore-Australia FTA SAIC State Administration for Industry and Commerce SMEs Medium-sized Enterprises SOLAS Safety of Life at Sea SPARTECA South Pacific Regional Trade and Economic Cooperation Agreement iv SSGs Special Safeguards SSM Special Safeguards Mechanism TAFTA Thailand-Australia TCM Traditional Chinese Medicine TEUs Twenty-Foot Equivalent Units (intermodal shipping container) TFP Total Factor Productivity TK Traditional Knowledge TNZCEP Thailand-NZ TR Technical Requirement TRANSEP Trans-Pacific TRIPS Trade-Related Aspects of Intellectual Property Rights TPLs Tariff Preference Levels TRQs Tariff Rate Quotas UNCTAD United Nations Conference on Trade and Development UNCLOS UN Convention on the Law of the Sea UNFCCC United Nations Framework Convention on Climate Change US-CAFTA-D R Central America-Dominican Republic-United States FTA VC Value Content WCO World Customs Organization WIPO World Intellectual Property Organization VP Value of Parts WTO World Trade Organization v Introduction and Overview Min Zhao China`s successful economic development has rested on expanding external trade. After nearly 30 years of economic reform, China`s external trade grew rapidly and accelerated following its accession to the WTO in 2001. By 2008, China`s annual goods exports and imports had reached US$1429 billion and US$1133 billion, respectively, making China the second largest exporter and the third largest importer in the world. China`s total trade volume is now sixty-seven times that of 1980 1 , and the trade surplus amounted to US$295.5 billion in 2008. The liberalization brought about by WTO accession was substantial. The average tariff rate dropped from 43.2% in 1992 to around 9.8% in 2008. Trade openness, as measured by the ratio of goods trade to GDP, is nearly 60%. China also made unprecedented commitments in service trade liberalization in the WTO`s General Agreement on Trade in Services (GATS). The ambition of China`s liberalization program in services manifests itself especially in commercial presence. Clearly, external trade has contributed to China`s economic development by enhancing the efficiency of resource allocation, expanding the supply of some natural resources needed for production, and transferring technological know-how via imports of capital goods. And trade liberalization has catalyzed China`s economic reform. As a result, China was able to maintain a record-high average GDP growth rate of 9.5 percent during 1980-2006. The growth in trade has contributed strongly to the creation of non-farm jobs, rural economic development, and rural poverty reduction. China`s experience demonstrates the importance of trade liberalization in facilitating the change in economic structure toward more competitive sectors. It also validates the significance of trade for growth and development. So Why Is Trade Policy Still Important for China? With China`s adoption of an open trade regime, one could argue that there is limited room to further cut tariffs or remove barriers to service trade. If so, why do we still need to be concerned about trade policy? We argue that trade policy is still important because of the Doha Round of multilateral negotiations at the WTO and because of the multiple Free Trade Agreements (FTAs2) that China is negotiating. To begin with, China`s WTO accession was mainly a unilateral liberalization; in contrast, the trade liberalization in the post-WTO accession era is multilateral in the case of Doha Round or bilateral and regional in the case of China`s FTA negotiations. While China`s average tariff is low, China may still gain from dismantling of trade barriers in other economies. For instance, Huang et. al. find that China would gain from agricultural trade 1 Data source: CEIC 2 Free Trade Agreements are used interchangeably with Regional Trade Agreements in this book. 1 liberalization in the Doha Round. Also, Mani finds that China stands to gain from less stringent trade policies on environmental products as an emerging exporter. Moreover, its growing reliance on international trade gives China an interest in international trading rules. In many ways, the content of trade liberalization has shifted from reduction in tariffs to many aspects of trade supervision. One notable extension of the content is the increasing inclusion of regulatory issues, concerning areas as varied as intellectual property rights, competition, investment, environment, and labor. This is not only reflected in the WTO Doha Round, but also in most FTA negotiations. 1 Finally, China can gain from further increases in services trade. Despite rapid growth, there is still much room for expansion. Services now consist of 20 percent of global trade, but only account for 11 percent in China`s external trade. The expansion of services trade may well serve the change in China`s development agenda by diversifying its export base and providing producers with necessary service imports, especially in backbone services. China`s New Trade Objectives in The Post-WTO Accession Era As China`s development objectives change, so must its objectives for the trade agenda. A country with a savings ratio as high as China`s does not need a large trade surplus to support its balance of payments. The domestic savings rate topped 51.2 percent of GDP 2007, whereas investment reached 42.3 percent of GDP--a level that was only exceeded by Singapore in its rapid growth phase in the 1970s and 1980s.2 China has used exports to drive growth, but this strategy has its price in terms of environmental sustainability as well as its limitations in terms of growth. An export-oriented growth strategy for a large country like China can create trade tensions going forward. Moreover, in the long run, China`s exports will only be able to grow with the expansion of world trade. Finally, China could face the unattractive prospects of permanently declining terms of trade, as it tries to sell more goods on the international market. A key implication of the changing development objectives is to narrow the trade surplus. But China would face a short-term problem going down this path: a decline in the trade surplus may lead to less non-farm job creation and lower economic growth with falling external demand. There are two solutions to this problem. First, China`s growth could rely more on services, which are generally more labor intensive and can generate more jobs than export industries, cater to domestic demand, and require less capital investment. Second, China`s growth could rely more on productivity increases rather than capital inputs as it has done in the past. China can learn lessons from its own success in promoting industrial growth. Trade liberalization in services could bring benefits in 1 These Issues except trade facilitation were later dropped from the Doha negotiations. 2 Indeed, the large balance of payments surpluses resulting from high trade surplus has become an emerging issue for macroeconomic management: trade surplus together with capital inflows have led to a rapid build-up of foreign exchange reserve, which has complicated monetary policy. By end-2008, China's foreign exchange reserves stood at US$1946 billion, equivalent to 19 months of imports of goods and services. 2 several ways: it would induce more investment in this sector; it would encourage innovation and technological improvement among service providers; it would dismantle the uncompetitive firms, and it would allow more competition in sectors previously closed for entry. The challenge for the authorities is to create a regulatory environment that is conducive to investment and operation of the services sectors. A second implication of China`s emerging development goals for trade policy relates to inequalities.1 China`s income inequality as measured by the Gini coefficient has been rising rapidly since the mid-1980s. From being one of the more equal countries in the world in the early 1980s, China has become one of the more unequal ones. While trade liberalization is often welfare improving, benefits may not be evenly distributed and some may even incur a loss. A solution to this uneven distributional impact of some trade measures is not to defer the needed reform, but rather to complement trade policy with social protection measures. The changing development objectives require a rigorous pre-assessment of trade policies on income distribution so as to target the groups that could suffer. A third implication of China`s emerging development goals for trade policy relates to the environment. Air quality, water sanitation and land degradation have become an emerging concern for people. China`s exports have been relatively energy-intensive and pollution intensive. About 40 percent of China`s gross consumption of energy is directly or indirectly used for the purpose of export production. However, there is no easy solution. While shifting exports from industrial goods to services reduces China`s energy consumption and emissions among other pollutants, the production of energy and pollutant intensive goods may simply be transferred to other countries, and most likely to countries which have lower energy efficiency and low capacity of pollutant treatment. Thus any trade measures that have environmental consequences should be assessed in the global context. Over the 11th Five Year Plan (FYP) and beyond, China will focus on a more balanced development, as captured in the Five Balances emphasized since the 3rd CPC Plenary Session of the 16th Party Congress in October 2003. The Five Balances call for growth that is more focused on domestic development, that is more evenly shared, and that is more environmentally friendly. The challenge for policy makers is to align external trade with these government-wide objectives. For China`s trade policies, this would imply that greater attention should be given to a more balanced growth in exports and imports, to the expansion of trade in services as a vehicle to promote the development in the services sector, and to the assessment of the poverty and environmental impact of trade policies. 1 Inequality can affect growth and development through various channels: (i) high inequality in income can lead to inequitable access to public services, and production inputs such as credits. In turn this may lead to inefficient growth--the smarter kids do not go to school, and the more capable entrepreneur does not get resources to grow. Second, those that have benefited from growth in the past may capture the political process to protect their privileges, which could also lead to lower growth. Third, large inequalities could lead to social unrest that may affect growth. At the same time, too much focus on growth could lead to inefficient policies that could undermine growth--for instance highly redistributive taxes, or subsidies for agricultural production, which increase taxes on the rest of the economy. 3 China`s New Trade Policy Tool in the Post-WTO Era While trade liberalization has been widely recognized in the global development agenda, it takes long and arduous negotiations to reach a multilateral agreement. The Doha Round has progressed very slowly. The impasse in the Doha Development Agenda (DDA) negotiations has led to a flurry of new initiatives for Regional Trade Agreements (RTAs). Regional trade agreements are fundamentally altering the world trade landscape. The number of agreements in force by end August 2008 was 213, rising six fold in just two decades. Today, more than one-third of global trade takes place between countries that have some form of reciprocal RTA. As the surge in RTAs is fast reshaping the architecture of the world trading system and the trading environment of developing countries, China has made RTAs a policy tool to pursue its trade liberalization agenda further. China proposed its first regional trade agreement with ASEAN in November 2001. In the subsequent eight years, China has launched a flurry of RTA negotiations that ­ counting those completed or in the process of negotiation ­ cover trade with more than 30 economies, accounting for about one- fourth of its trade. In October 2007, China announced a strategy to promote the establishment of free trade areas and to further promote trade liberalization and economic development. What Questions Are Addressed in This Study As China continues its trade reform process, its focus has shifted to the emerging second generation issues. Like other countries, China has embarked on a series of Free Trade Agreements negotiations, including with Chile, Singapore, Australia, New Zealand, Norway, and Peru. China is also gearing up towards expanding its services trade, which now accounts for about 20 percent of global trade. In the context of a changing international trade landscape and development agenda for China, the World Bank and China`s Ministry of Commerce jointly carried out a series of studies on leading issues of trade during 2006-2009. During the course of the studies, we devoted ourselves to exploring answers to the following questions: How to design the architecture of FTAs and how to manage multiple FTA negotiations? What are the economic and development implications of some key provisions in FTAs? How to assess the impact of tariff cut with the binding constraints of trade obligations early committed in China`s WTO accession and concluded FTAs? What are China`s interests in the Doha Round in agriculture, non-agriculture market access, geographic indication, bio-diversity and environment? What is the overall economic impact, and what are the impacts on poverty among other development objectives? 4 What can we learn from other leading economies on how to promote the expansion of trade in services? What Have We Learned--Key Findings and Policy Implications It is in China`s interest to actively participate in multilateral and regional trade negotiations and further promote trade liberalization. While China`s trade regime is already quite open and enhances efficiency in resource allocation, China can still gain from improving access to other economies` markets and from a better trade environment with stringent international rules. The trade agenda in the post-WTO accession era should be realigned with China`s development agenda, including the building of a harmonious society. While China generally benefits from trade liberalization, benefits are not distributed evenly among different income groups and regions. Impact assessments of trade policies should take into account binding obligations and should go beyond the effects on the macroeconomy. FTAs have become an important trade policy tool for China in pursuing trade liberalization. The significance of this phenomenon should not be overlooked since it will ultimately influence the nature of international trade relations and the policy choices and behavior of the operating actors. China needs to build up a coherent strategy to coordinate the multiple FTA negotiations so as to maximize the benefits. Using trade barriers to serve some other policy objectives (poverty reduction or environment protection) may not be desirable. Policies that address these problems directly, by improving productivity in agriculture, or reducing the barriers to mobility out of agriculture are much more likely to be successful in dealing with such problems. Lessons from leading economies in services trade are consistent with lessons from China its own success in promoting industrial goods exports. The key for promoting services trade is a more attractive environment for service industry investment and innovation, including improved competition policy, enhanced intellectual property protection, open market access, a transparent regulatory regime and sufficient supply of skill labors. What the Subsequent Chapters Contribute These findings and policy implications are described more fully in the following chapters. Those chapters are grouped under three themes-- (i) regional trade negotiations, (ii) 5 multilateral trade issues, and (iii) policy options for promotion of services trade. A brief description of key aspects of each chapter`s analysis is given here. Guidance to FTA Negotiation Part I, collecting eight policy notes, deals with issues emerging from China`s regional trade negotiations. It provides an overview and suggestions on selected essential provisions in FTAs ranging from market access provisions, rules of origin, and dispute settlement mechanisms, to key considerations in managing multiple service trade negotiations, positive and negative lists as architectural choices, and labor mobility. Chapter 1 provides an overview of China`s development in FTAs. It shows that China has actively pursued regional trade agreements in recent years, with some success. FTAs have been good complements to multilateral trade arrangements, have covered a substantial share of China`s external trade, and have made great contributions to expanding China`s external trade. Chapter 2 summarizes the key features of market access provisions based on a survey of 20 RTAs. The chapter on market access is central to RTAs. The coverage and schedule for tariff liberalization programs vary across RTAs, and Agreements also differ in the trajectories of tariff reductions. While RTAs are aligned with WTO standards and many are WTO+, many RTAs also contain provisions that could be labeled as other restrictive regulations of commerce such as TRQs, special safeguards, and stringent rules of origin. Market access has to be evaluated according to product coverage, the pace and extent of tariff reductions, and parties` trade policies with respect to third parties. Chapter 3 analyzes the pros and cons of different rules of origin (ROO) contained in FTAs. While ROO are necessary to avoid trade diversion associated with preferential trade liberalization, FTAs with considerably different or overly restrictive rules of origin are likely to increase administrative costs for traders as well production costs for firms, thus reducing their competitiveness. The costs of rules of origin are likely to be higher for small producers than for large producers. Policymakers should ensure that rules of origin are simple and extend the same commutation and origin determination across FTAs. Large countries like China bear a particular influence and responsibility with regard to the rules of origin, especially in a region with substantial differences in country size and incomes. Chapter 4 deals with dispute settlement in regional trade agreements. Dispute settlement mechanisms play an important role in the effective implementation of international commitments, including in the context of global and regional trade integration. Many RTAs include provisions on dispute settlement. There is no single model of dispute settlement mechanism; sophistication can vary with different factors, such as the scope/level of trade integration or the number of contracting parties. This chapter provides a comprehensive summary of key features of disputes settlement mechanisms and points out key issues policy makers should pay attention in designing such mechanisms in RTAs. 6 Chapter 5 analyzes the implication of interrelationships between different agreements in trade in services and provides suggestions on how to manage multiple trade negotiations. Many countries--including China--are engaged in multiple trade negotiations in services. The true extent of trade preferences created by FTA commitments depends crucially on the rules of origin and the so called non-party MFN clause that requires automatic extension of benefits granted to non-parties. Liberal rules of origin reduce the preferential nature of FTA commitments, and thus may undermine some of the bargaining advantages of FTA negotiations. The inclusion of non-party MFN clauses in FTAs will, on balance, strengthen incentives to negotiate at the WTO. It is important that governments develop a coherent negotiating strategy that enables them to strike the best bargains. Chapter 6 compares the positive list approach and negative list approach in service FTAs. The study shows that negative lists and positive lists can achieve similar openness outcomes depending on how the agreements are actually written. However, a negative list approach typically entails more transparency and credibility, while a positive list approach may provide more flexibility to accommodate political economy constraints. Chapter 7 assesses the potential of RTAs in promoting labor mobility. Trade agreements increasingly seek to promote the mobility of labor. The note shows that while the world economy stands to gain massively from liberalization in the mobility of labor, adverse popular reaction to the economic and social impacts of immigrants has kept progress in enhancing global labor mobility well below progress in trade and capital liberalization. Addressing cross-border labor mobility in the context of RTAs has recently emerged as a promising avenue. Given the limited commitments made under GATS, developing countries such as China, which want to expand openness to include semi-skilled workers and movement unrelated to a specific commercial presence, may find that broader RTA provisions are of interest. Win-win results can be achieved if China focuses on areas of employment shortage in the other countries. Chapter 8 review the international experience with competition provisions in RTAs with a view to drawing some possible lessons for China as it pursues its regional trade strategy. Competition laws and policies are increasingly being established at the regional level, as they could be instrumental in supporting the benefits of trade and investment liberalization. Competition laws in RTAs fall in the 4 models, ranging from fully centralized to fully decentralized. Their impacts have been mixed, because of institutional and behavioral reasons, relating to lack of competition culture or political will to promote implementation domestically. So far RTAs in China have not included competition policy. Competition policy could be included in China's future RTAs, but through the decentralized model, with a focus on cooperation. China may want to use the opportunity of these negotiations to (1) further discipline its state-owned enterprises; (2) carefully consider the possible role of antidumping policies; and (3) promote and lock-in domestic reforms aimed at improving its domestic competition policies. Chapter 9 reviews the experience of advanced economies in the treatment of environmental provisions in the context of RTA negotiations. A key question is whether 7 trade agreements should address environmental issues or whether they should stay separate. International experience shows that what matters is how these agreements are written. Notwithstanding the political sensitivity of the trade-environment nexus, integrating environmental concerns into the trading system seems now an almost irreversible trend. With a shift of the development agenda from primarily pursuing growth to achieving a more balanced and sustainable development and taking into account China`s high reliance on trade, it may be increasingly in China`s interest to pro- actively engage its partners on environmental issues in its regional trade agreement (RTA) negotiations. In its future RTA negotiations on environment policy, China may take into account its level of development and enforcement capacity. To facilitate the policy making process, China could consider conducting a comprehensive pre-RTA assessment, and one of the key components is environmental impact assessment. China could probably take a pragmatic approach--being flexible towards different negotiating partners, and a phased-in approach in dispute settlement mechanism. Trade Policy Options in the Post-WTO Accession Era Part II collects three papers. These papers assess the impact of some key multilateral trade issues China faces in post-WTO era, in particular those emerging from the Doha Development Round negotiations (DDR) of the WTO. Chapter 10 assesses the impact and effectiveness of raising the cotton import tariff on its domestic price and cotton producers` income. Intuitively, a higher domestic cotton price would benefit cotton producers in China. A policy option of raising tariffs on cotton imports thus arises against the backdrop of the government`s allowance of imports at a rate well below the bound tariff rate despite the fact that imports substantially exceed the quota. Under WTO rules, China would be permitted to impose a tariff of up to 40 percent on over-quota imports. The study however finds two fundamental problems arise with raising this tariff. First, China remains a net exporter of cotton when exports of cotton in the form of fibers, yarns, textiles and apparel are compared with imports of cotton in all forms. Second, whether or not China remains a net importer of cotton, the ability to import cotton products at low duties, such as 5 percent for yarns, means that the tariff on cotton is unable to have more than a small impact on the domestic price of cotton. Moreover, the combination of a high tariff on cotton and a low tariff on yarn would have a sharply adverse impact on early stage processing activities such as spinning of cotton yarn, for which raw cotton inputs account for a large share of total costs (reportedly 70 percent of the cost of yarn production). Chapter 11 analyzes the potential impacts of the Doha trade proposals (those of the USA, EU and G20) on agricultural production and incomes of China`s farmers by region and income group. This study suggests that China`s economy will benefit from the Doha Round--though overall the impacts are small--since it is mainly focused on the agricultural sector. A more liberalized trade reform proposal would bring more gains to China, although the impacts do not differ significantly among the three proposals. Importantly, China`s food security improves under the Doha proposals. Although farmers as a class will benefit, the gains among farmers vary largely by income group, province and the type of crops which they produce. Some, such as farmers in Guangxi 8 and Yunnan, may even suffer due to the large negative effects on sugar. Therefore, policy makers should be concerned about the poverty and equity effects. Chapter 12 focuses on the current state of debate surrounding environmental goods negotiations under the WTO in the context of Chinese exports and imports. The trade and the environment debate which has been mainly focused on the impact of trade on local pollution and on cross-border measures to address transboundary pollution has resurfaced again--this time strongly in the climate change arena. Global climate change awareness and discussions surrounding clean energy technologies offer an economic opportunity as China is emerging as a major producer and exporter of these technologies. Any efforts to liberalize trade in these technologies would give a further boost to Chinese exports. It thus becomes important that China closely participates in the WTO and other forums such as UNFCCC where these issues are being debated to ensure that its interests are taken into account. Chapter 12 also looks at some recent proposals (in the US and EU) which call for increased trade barriers against imports from countries which have less stringent carbon policies and then draws implications for China. While developed countries remain the largest per capita emitters of greenhouse gases today, the growth of carbon emissions in the next decades will come primarily from developing countries, which are following the same energy- and carbon-intensive development path as did their rich counterparts. Among the developing countries, the main growth in carbon emissions will emanate from China and India because of their size and growth rates.1 Strong economic growth and heavy dependence on coal in industry and power generation contribute to this trend. There will be thus increasing pressure on the trade front to redress any competitiveness pressures. While it is debatable as to what extent these measures are WTO compatible, China should be prepared to deal with the issue both within and outside the country as the economic and regional impacts could not be understated. Promoting Services Trade In light of China`s opening up of its services sector, Part III of the book addresses policies and issues that are key to services trade expansion. The overview chapter (Chapter 13) explains the role of services in an economy, how firms trade, and common capacity issues faced by services firms when expanding internationally. It details the fundamental policy environment that enables growth in trade in services. Many governments improved competition policy and intellectual property protection to create a more attractive environment for service industry investment and innovation. They focused on financial sector reform to increase access to finance and venture capital. They used export and incentive programs to support entry into new markets. China can use a combination of such policy tools to improve the quality, cost, and scope of services in the economy and to enable firms to compete internationally. 1 More than 70 percent of the world emissions increase from 2020­30 according to the International Energy Agency is projected to come from non-Annex I (developing) countries. China alone will contribute about a quarter of the increase in CO2 emissions, or 3.8 Gt, reaching 7.1 Gt in 2030. Its emissions will overtake those of the United States by 2010. 9 Chapter 14 explores how a variety of governments use different policy tools to improve productivity and trade in services. It examines how countries have succeeded in developing their services trade, identifying common and unique measures they use in enabling firms to compete in the global services economy and growing export of services. Korea offers lessons in reenergizing growth with a revised market access stance, improved regulatory transparency, and refined competition policy. India's exceptional success in the export of business services demonstrates the return on investment in tertiary education as well as the effect of lifting traditional industrial restrictions. The EU offers practical approaches to minimize regulatory and administrative process barriers to trade within an economic entity. Examining services trade between the European Union and the United States identifies regulatory cooperation as a means to facilitate trade and growth. The United States demonstrates how widely available market information and a constellation of other factors foster service industry innovation. Singapore demonstrates the value of efficient government, industry clusters, and means to attract service professionals. Japan provides insight into boosting productivity in services with investment in human resources, improvements to the business environment, and recognition of successful service exporters. Hong Kong SAR shows the value of an open foreign direct investment regime to service industries. The establishment of the Closer Economic Partnership Arrangement confirms the parties' recognition of the key tenets of services trade policy. . Chapter 15 provides trend analysis of developments in global services trade and country competition in the transportation, software, and animation industries. These are sectors of special export interest for China. For each sector, leading exporters are identified, industry trends are explored, and strategies China can use to improve market conditions are suggested. China has significant competitors operating globally in each industry. Chinese policymakers and industry leaders can improve prospects for Chinese firms with attention to particular factors influencing global competition in each sector. Although information technology, transport, and animation are very different industries they share common industry trends. Each is experiencing exceptional trade growth and emerging markets are significant providers in each sector. Deployment of technological innovation can be a competitive advantage for firms operating in each industry. Management's ability to respond to competition, orchestrate strategic alliances, and anticipate challenges and opportunities on the horizon is also a determinant of export success. Information technology and animation firms are particularly reliant on a vibrant venture capital market and robust protection of intellectual property. Changing regulations in transport require astute engagement by Chinese policymakers and proactive leadership from industry captains. Firms from each sector also gain from accessing quality and skilled professionals from around the world. 10 Part I Guideline to Free Trade Agreement Negotiation 1 Status Quo of The Development of China`s FTAs Department of International Economic and Trade Relations, Ministry of Commerce, People`s Republic of China In recent years, along with the deepening development of economic globalization, regional economic integration has witnessed tremendous development, with regional trade arrangements predominantly in the form of FTAs emerging one after another. Major economies and regional groupings around the world have both sped up their development of FTAs and ushered in a new wave of free trade worldwide. Following this new trend, China has also made new headway in its efforts to promote the negotiation and establishment of FTAs. In October 2007, for the first time, the 17th National Congress of the Communist Party of China expressly made clear the need to implement the FTA strategy. Establishing FTAs has become a new platform and mode for China`s efforts to promote reform and development through reform since its accession to the WTO. In recent years, with the deepening development of economic globalization, regional economic integration has witnessed tremendous development. By the end of August, 2008, regional trade arrangements notified to the WTO, still in force and dominated by FTAs had already reached 213 in number, accounting for over half of global trade in goods. Under the leadership and deployment of the CPC Central Committee and the State Council, China has proactively flowed with the tide of regional economic integration and steadily moved ahead with its efforts to establish FTAs. At present, FTAs have become a new form and mode of China`s reform and opening-up drive since its accession to the WTO and a new channel and platform for mutually-beneficial and win- win cooperation with other countries. Overview of FTAs A free trade area is defined as a specific area formed through an agreement that is signed between two or more countries or territories, in which members further open up their markets to each other on the basis of most-favored nation treatment, phase out the vast majority of tariff and non-tariff barriers to trade in goods and improve market access conditions in the services field, as a result of which trade and investment liberalization is achieved and all the customs territories of all the members are covered. It is fundamentally different from a specific zone that a certain city or region establishes by setting aside a piece of land for purposes of implementing preferential economic and 11 trade policies such as an economic development zone, export processing zone or bonded zone. An FTA, as an arrangement, is an exception to WTO rules (WTO plus). WTO rules permit members of an FTA to accord to each other more preferential treatment without according it to other WTO members. It is both in-depth opening that goes beyond WTO rules and a supplement to the WTO-based free trade regime. It both follows the basic principles of the multilateral trading regime and provides freer economic and trade space for mutually-beneficial cooperation between and among partner countries. Take Mexico as an example. In the wake of the establishment of the North American Free Trade Area (NAFTA), Mexico`s global export ranking rose to No. 13 in 2005, up from No. 21 in 1996, replacing Japan as the second largest exporter to the United States and replacing China as the largest textiles exporter to the United States. There is one saying in South Korean media to the effect that, in response to the global trade warfare without gunshots, the only way to survive is to sign free trade agreements. Global Development Trends of FTAs By the end of August, 2008, regional trade arrangements notified to the WTO, still in effect and dominated by FTAs had reached 213 in number. WTO experts estimate that over half of global trade at present occurs among various kinds of regional groupings and under terms and conditions more preferential than the most-favored nation treatment as provided for by the WTO. In particular, at a time when the Doha Round of WTO talks is not progressing smoothly, many countries have shifted the focus of their economic and trade policies away from the WTO to FTAs. Since the year 2007, a host of heavyweight free trade agreements and ideas have sprung into existence, such as the Free Trade Agreement between the United States and South Korea, the Economic Partnership Agreement between Japan and the ASEAN, and the Transatlantic Free Trade Area (EU-North American Single Market) initiative. The tremendous development of FTAs around the globe has generated a profound impact upon the present pattern of the world economy. According to USTR statistics, as a totality, the countries with which the United States has signed, or is in the process of signing, a free trade agreement have become the world`s third largest economy, occupying 14% of global GDP excluding that of the United States, absorbing 42% of U.S. exports, with U.S. exports to these countries growing at a speed twice that of exports to other countries. In 2007, intra-NAFTA trade represented 60%, intra-EU trade stood as high as 70%, and trade among East Asia, as a percentage, also jumped above 50% in 2007, up from 43% in 1990. New Progress in China`s Efforts to Establish FTAs Since the year 2003, China started from scratch in its efforts to establish FTAs and laid down a good foundation. Up to now, China has established 14 FTAs with 31 countries and territories in Asia, Oceania, Latin America, Europe and Africa, covering one-fourth of China`s total trade volume in the year 2008. The following is a description of the main developments: 12 Closer Economic Partnership Arrangement (CEPA) as well as its supplementary agreements between the Mainland and Hong Kong and between the Mainland and Macao. Following the signing of the CEPA in 2003, four supplementary agreements were signed and implemented. In July 2008, the Mainland signed the fifth supplementary agreement with Hong Kong and Macao respectively. In connection with trade in goods, as of January 2006, the Mainland has accorded zero tariff treatment to all goods originating from Hong Kong and Macao. In terms of trade in services, the Mainland has further relaxed market access restrictions on Hong Kong and Macao in 40 sectors such as legal and accounting services. Cooperation has been conducted in nine fields such as trade and investment promotion and customs clearance facilitation. The implementation of the CEPA and its supplementary agreements has promoted stable economic growth in Hong Kong and Macao. China-ASEAN FTA Series Agreements. In November 2002, at the 6th China- ASEAN Leaders` Meeting, leaders from China and ten ASEAN countries signed the Framework Agreement on Comprehensive Economic Cooperation between China and the ASEAN. In November 2004, jointly witnessed by Premier Wen Jiabao and leaders from ten ASEAN countries, China and the ASEAN signed the Agreement on Trade in Goods, the implementation of which started in July 2005, leading to the gradual reduction and elimination of tariffs on over 7,000 tariff items. By the year 2010, the tariffs of the vast majority of goods among China and six old ASEAN members will be eliminated, and four new ASEAN members will basically eliminate their tariffs by the year 2015. Since the reduction of tariffs, trade between China and the ASEAN has been booming in terms of both imports and exports, and trade and economic cooperation has been developing rapidly. In 2007, the two sides became each other`s fourth largest trading partner, with bilateral trade going beyond US$ 200 billion for the first time in history. In January 2007, the two sides signed the Agreement on Trade in Services, with commitments of further liberalization made in 67 sub-sectors in 12 services sectors in ten ASEAN countries and 26 sub-sectors in 5 sectors in China and implementation scheduled for July in the same year. Premier Wen Jiabao pointed out that [t]he signing of this agreement is another major outcome between China and the ASEAN in the field of trade and economic cooperation, a symbol of a crucial step ahead made by the China-ASEAN FTA, and the groundwork laid down for the establishment of the FTA according to schedule. At present, the two sides are continuing to move ahead with negotiations in the field of investment. China-Chile Free Trade Agreement: In November 2005, President Hu and former Chilean President Lagos jointly witnessed the signing of the China-Chile Free Trade Agreement, the implementation of which started in October 2006. According to the agreement, the tariffs of products accounting for 97% of all the tariff items will be reduced to zero by phases within 10 years` time. The two 13 countries also further intensified exchanges and cooperation in the fields of economy, SMEs, culture, education, science and technology, environment and so on. Up to now, China and Chile have implemented three rounds of tariff reductions. China has reduced or eliminated tariffs on 7,336 kinds of products that account for 97.2% of China`s total tariff items, among which tariffs on 4,795 kinds of products have been reduced to zero. Chile has also reduced or eliminated tariffs on 7,750 kinds of products that account for 98.1% of Chile`s total tariff items, among which tariffs on 5,891 kinds of products have been reduced to zero. By the year 2015, China and Chile will complete the process of tariff reduction. Over the past two years since the comprehensive reduction of tariffs between China and Chile, bilateral trade has been booming in terms of both imports and exports and, in 2007, met the target of US$ 10 billion ahead of schedule. In the first year (October 2006 to September 2007) and the second year (October 2007 to September 2008) of the implementation of the Agreement, bilateral trade amounted to US$ 13.2 billion and US$ 17.6 billion respectively, rising by 59% and 33% year on year respectively. In a breakdown, China`s imports from Chile amounted to US$ 9.2 billion and US$ 11.6 billion respectively, increasing by 68% and 26% year on year respectively, and China`s exports to Chile rose to US$ 4 billion and US$ 6 billion respectively, up by 41% and 49% year on year respectively. Over the past two years, China`s exports of mechanical and electronic products to Chile registered tremendous growth. Cars were first exported in 2007, and by now seven Chinese car brand names have made their way into the Chilean market. In the first nine months of this year, 9,138 cars worth US$ 48.38 million have been exported, jumping by 369% and 335% year on year respectively; electrical appliances and electronic products worth US$ 720 million have been exported, a rise of 51%; and exports of machinery and equipment amounted to US$ 500 million, an increase of 40%. Chilean agricultural products such as salmon and fruits have entered the Chinese market for the first time since the implementation of the agreement. At the same time, Chinese imports from Chile of copper, copper ore, pulp, iron ore, fish meal, wine and other primary processed products rose to record highs too. During the first year of the agreement`s implementation, copper imports rose by 83% year on year to US$ 700,000 tons; wine imports amounted to US$ 49.51 million, rocketing by 307%. According to Chilean statistics, China has now replaced the United States as Chile`s biggest trading partner. Enterprises in the two countries have all along paid attention to the Agreement, are enthusiastic about making use of preferences, and have reaped a lot of benefits from therein. Over the past two years, China has in total signed and issued 196,000 rules of origin certificates in regard to preferences under the Agreement, and US$ 8.4 billion worth of exports have benefited from such preferences. Exports by Chinese enterprises benefiting from preferences have accounted for 90% of exports to Chile. In 2007, bilateral trade stood at US$ 14.7 billion, rising by 65% year on year. In a breakdown, Chinese imports from and exports to Chile amounted to US$ 10.3 billion and US$ 4.4 billion, up by 79% and 42% 14 respectively. China has replaced the United States as Chile`s largest export partner. In addition, China and Chile signed in April 2008 the Supplementary Agreement on Trade in Services for the Free Trade Agreement between China and Chile. On the basis of gradual liberalization of trade in goods between the two countries, this agreement will provide enterprises from the two countries with more trade and investment opportunities, reduce transaction costs and expand revenues on the part of enterprises. China-Pakistan Free Trade Agreement: In April 2005, during Premier Wen`s visit to Pakistan, the two sides announced the launch of negotiations. In November 2006, the two countries signed the free trade agreement as a major outcome of President Hu`s visit to Pakistan. According to the agreement, the two sides will implement tariff reductions on all the products in two phases. In the first phase, within five years after the entry into force of the agreement, the two sides will reduce tariffs by different margins on 85% of each other`s tariff items. The second phase starts from the 6th year after the entry into force of the agreement, with the objective of tariff-free products representing 90% of each other`s tariff items and also bilateral trade. In addition, the agreement incorporated provisions in regard to investment promotion and protection. Since its entry into force in July 2007, various quarters of society have responded positively, and the outcome of implementation has been good. President Hu indicated that [t]he agreement will surely raise the level of Sino-Pakistan trade and economic cooperation and create conditions for more Pakistan commodities to make their way into the Chinese market. At present, the two sides are moving ahead with the negotiations on trade in services. China-New Zealand Free Trade Agreement: On April 7th, 2008, jointly witnessed by Premier Wen and New Zealand Prime Minister Clark, the Free Trade Agreement between the Government of the People`s Republic of China and the Government of New Zealand was signed in Beijing and scheduled to enter into force on October 1st, 2008. The Agreement is a comprehensive free trade agreement that encompasses trade in goods, trade in services and investment and also the first free trade agreement signed by China with a developed country. In addition to its possible, direct economic interests, the inspiring role in China`s further opening up also deserves attention. The signing of the agreement has attracted wide-ranging attention from international media, with various mainstream media reporting it as breaking news. The Forbes magazine ran an editorial in which it stated that China and New Zealand had reached a milestone trade agreement, which enabled China to win its first important individual gold medal in the Olympics of free trade, and that China was catching up with the United States by establishing a club with its own trading partners. China-Singapore Free Trade Agreement: On October 23, 2008, jointly witnessed by Premier Wen Jiabao and Singaporean Prime Minister Lee Hsien Loong, the 15 Free Trade Agreement between the Government of the People`s Republic of China and the Government of the Republic of Singapore was signed in Beijing. The negotiations started in August 2006 and, after eight rounds of hard but frank consultations, the two sides successfully completed negotiations in September 2008. Encompassing a host of fields such as trade in goods, trade in services, movement of personnel and customs procedures, the Agreement is a free trade agreement comprehensive in coverage. On the basis of the China-ASEAN free trade area, the two sides further accelerated the pace of trade liberalization and extended the depth and width of the bilateral free trade relationship and trade and economic cooperation. According to the Agreement, the Singaporean side pledges to eliminate tariffs on all the products imported from China before January 1, 2009, and the Chinese side pledges to offer tariff-free treatment to 97.1% of products imported from Singapore before January 1st, 2010. The two sides made WTO plus commitments in the field of trade in services such as healthcare, education and accounting. China-Peru Free Trade Area: On April 28th, 2009, jointly witnessed by Vice President Xi Jinping and Peruvian Vice President Luis Giampietri Rojas, the Free Trade Agreement between China and Peru was signed in Beijing. The China- Peru FTA is the first package free trade agreement between China and a Latin American country and a new milestone in the development of the bilateral relationship. The China-Peru free trade agreement is wide-ranging in coverage and high in the level of openness. In relation to trade in goods, China and Peru will offer tariff-free treatment by phases to over 90% of each other`s products. A vast array of Chinese products such as light industry, electronics, household electrical appliances, machinery, automobiles, chemicals, vegetables and fruits and Peruvian products such as fish meal, mineral products, fruits and fish products will all benefit from tariff reduction arrangements. In connection with trade in services, the two sides will, on the basis of each other`s WTO commitments, further open up services sectors to each other. In respect of investment, the two sides will offer each other`s investors and investment post- establishment national treatment, most-favored nation treatment and fair and equitable treatment, encourage cross investment and provide facilitation. At the same time, the two sides have reached wide-ranging consensus on a large number of fields such as intellectual property rights, trade remedies, rules of origin, customs procedures, TBT and SPS measures. Meanwhile, China is moving ahead with negotiations to varying degrees with Australia, the Gulf Cooperation Council (including Saudi Arabia, Kuwait, United Arab Emirates, Oman, Qatar and Bahrain), Iceland, Norway, Costa Rica and Southern African Customs Union, and conducting FTA joint feasibility studies with India and the Republic Korea, with positive progress recorded. Practice has borne out that China`s efforts to establish FTAs have generated good economic and political impacts at home and abroad and should become an important aspect of China`s bid to implement a mutually-beneficial and win-win opening up 16 strategy and to build a harmonious world. In the days to come, China will continue to proactively make use of the new platform of FTAs, constantly raise the level of opening up, push ahead with reform and development, and promote the building of a harmonious world. 17 Table 1.1 Status of China`s regional trade agreements by end-October, 2008 RTA Negotiations Initiated Current Status CEPA Mainland ­ June 29, 2003 CEPA III came into full implementation on January 1, Hong Kong 2006 CEPA Mainland - October 17, 2003 CEPA III came into full implementation on January 1, Macau 2006 Implemented China-ASEAN November 1, 2002 Agreement on Trade in Goods effected in July 2005 Agreement on Trade in Services effected in July 2007. Agreement on Investment under negotiation. China-Chile November 18, 2004 Agreement on Trade in Goods came into full implementation on October 1, 2006 Agreement on Trade in Services signed on Apr 13, 2008 Free Trade Agreement (goods) came into full China-Pakistan April 1, 2005 implementation in July 2007. Free Trade Agreement in Services signed in Febrary 2009. China-New Zealand November 22, 2004 Agreement on Trade effected on Oct 1, 2008 China-Singapore August 25, 2006 A full-fledged Free Trade Agreement was signed on Oct 23, 2008 China-Peru September 7, 2007 Agreement on Trade in Goods signed in April 2009 China-Iceland July 10, 2006 4th round negotiation closed on Apr 30, 2008 Agreement of Trade in Goods agreed; China-GCC July 1, 2004 Agreement of Trade in Services under negotiation Under China-SACU June 2004 Under negotiation negotiation China-Australia April 18, 2005 12th round negotiation closed on Sept 26, 2008 China-Norway September 18, 2008 First round negotiation closed on 2008. China-India Feasibility study completed in Oct, 2007 Prospective China-South Korea Feasibility study started in early 2007 partners China-Costarica Feasibility study completed in July 2008 18 2 Market Access Provisions Silja Baller1 The chapter on market access is central to RTAs. Market access is evaluated according to product coverage (comprehensiveness), pace and extent of tariff reductions (depth), and parties` trade policies with respect to third parties (to provide an indication of the actual preferences granted). WTO Disciplines The market access provisions in RTAs are closely governed by WTO disciplines. RTAs between two developing countries are subjected to slightly less stringent criteria in that partial liberalization is allowed under the 1979 WTO Enabling Clause. Art XXIV GATT prescribes three key conditions for trade liberalization in RTAs: The liberalization effort must cover substantially all trade. A number of definitions of what substantially all trade have been used, including: percentage of trade between the parties, commonly 90, 85 and 80%; no (major) sector must be excluded from liberalization; percentage of tariff lines being liberalized as a benchmark (generally 95% of all HS tariff lines at the 6-digit level). Liberalization must take place within a reasonable length of time. The 1994 Understanding on the Interpretation of Article XXIV states that the length of time in question should exceed 10 years only in exceptional cases, while there is no guidance, however, on what constitutes an exceptional case. There are no conditions on the trajectory of liberalization, i.e. liberalization could be linear or concentrated around certain points during the transition period. Besides tariffs, RTAs should eliminate other restrictive regulations of commerce on substantially all trade. The debate turns around which trade policy instruments should be regarded as restrictive regulations. These could include tariff rate quotas (TRQs), special safeguards (SSGs), non-tariff measures (NTM) and rules of origin (ROO). 1 Source: This note was prepared by Silja Baller based on an IDB report 19 Market Access Features of RTAs Market access features in a sample of about 20 RTAs show the following:1 The coverage and schedule for tariff liberalization programs vary across RTAs. Agreements differ in the number of product groups subjected to liberalization, as well as the years to full liberalization: in some cases all tariffs are eliminated upon the entry into force of the agreement (e.g. agreements involving Singapore), while in others, transition periods stretch over a 20-year horizon, with some concessions withheld in perpetuity. Agreements differ in the trajectories of tariff reductions. Some parties use a linear trajectory, while others employ a non-linear trajectory that often involves back-loading, i.e. larger reductions are left to the latter part of the transition period (e.g. EU Agreements with South Africa, Morocco and Lithuania). In some cases, a grace period of up to 10 years before reductions begin is granted as in the case of the EU-South Africa RTA for example. Most RTAs respect GATT Art XXIV guidelines. They commit to liberalization of 90% of tariff lines by year 10 into the agreement. Coverage of products tends to become homogenous towards the end of the 10 years. There are exceptions in the case of developing countries and sensitive products (agriculture, textiles and apparel, and footwear). On a chapter level, parties liberalize more than 80% of tariff lines by year 5 and more than 90% by year 10 for the bulk of chapters. The fastest and deepest liberalization takes place in non-sensitive products such as ores (ch.26), fertilizers (ch.31), pulp of wood (ch.47) and some base metals (ch.81). The extent of liberalization is not undermined on a trade-weighted basis. Bottom-line results remain if the tariff line indicator is replaced by a trade-weighted tariff line measure: most RTA partners still liberalize 90% or more by year 10. Most RTAs are aligned with WTO standards and many are WTO+. Many RTAs, and increasingly so, incorporate a larger number and/or more specific provisions than are currently in force under the WTO. However, many RTAs also contain provisions that could be labeled as other restrictive regulations of commerce such as TRQs, special safeguards, and stringent rules of origin. Measures Accompanying Tariff Liberalization Restrictive measures Beyond the exclusion of few items from the general liberalization schedule, RTAs have relied on provisions for Bilateral Emergency Actions (BEA), Special Safeguards Mechanisms (SSG), and Tariff Rate Quotas (TRQs) to provide additional protection. 1 The sample includes: Australia-Thailand, China-Hong Kong (China), Japan-Singapore, New Zealand- Singapore, Singapore-Australia, Chile-Korea, Mexico-Japan, US-Singapore, US-Chile, Chile-Mexico, CAFTA (Central-America FTA), Canada-Chile, Canada-Costa Rica, US-Jordan, US-Morocco, EFTA- Mexico, EC-South Africa, EC-Lithuania, EC-Morocco. 20 Both BEA and SSG are safeguards mechanisms. BEA requires demonstration of significant injury to domestic industry; while SSG simply operates on the basis of a price or quantity trigger. BEAs generally remain available after full liberalization has been reached, while SSGs cease to apply after the phase-in period (such as in the case of Thailand-Australia and Thailand-New Zealand RTAs). In the case of US-Australia, the SSG mechanism remains in force for beef and certain other agricultural products even after the end of the phase-in period. Japan-Singapore is an exception in that both types of emergency measures are available only during the implementation period. Tariff liberalization is often accompanied by quantitative restrictions in the form of tariff rate quotas. TRQs are used to give a certain degree of tariff concessions, while at the same time retaining control over quantities. The quotas within which tariff concessions apply are generally expanded during the transition period and cease to exist once phase-in is completed. An exception is the US-Australia agreement where Australian dairy products remain subject to TRQs in the indefinite future. Liberalizing measures Provisions that are more liberalizing include Tariff Preference Levels (TPLs) which provide access at preferential rates for specified quantities of non-originating products that fail to meet rules of origin criteria. They are found for example in the Canada-Chile and Canada-Costa Rica agreements regarding textile and clothing products. Restrictions and extended phase-in periods as substitutes Countries generally use various restrictions and extended phase-in periods as substitutes for one another. For example, EU-Morocco, EU-Czech Republic and EU-Lithuania all have phase-in periods of less than 10 years, but exclude large parts of the agricultural sector from complete tariff elimination. Singapore-Japan phases in almost all commitments immediately, but has an overall exclusion rate of more than 5% of tariff lines due to Japan`s exclusion of almost 10% of their products. No permanent exclusions are contained in the Australia-Thailand, New Zealand-Thailand, and US-Chile agreements; however, the percentage of trade subject to TRQs, special safeguards or bilateral emergency measures is significant. Canadian RTAs (with Chile and Costa-Rica) also use a mix of prolonged phase-in periods with TRQs and BEAs applicable during the transition period. RTA Market Access Families RTAs cluster into families by world region (Asia, Europe, the Americas) and trade hubs (US, EU, Singapore) when it comes to coverage of main market access disciplines. In US RTAs, all products are assigned into a set of distinct categories for the purpose of tariff elimination, with a time-frame and trajectory toward complete elimination (rather 21 than just fixing an end-point). These categories include TRQs (typically in the appendix) as well as exceptions to preferential treatment. In EU RTAs, all industrial products are subjected to a general tariff elimination schedule. Agricultural and/or fish and/or processed agricultural products are governed by a separate list of exceptions and separate annexes or protocols; protocols tend to be quite complex, featuring different types of regimes such as end-point preference margins (a preference tariff defined in relation to the MFN tariff rather than in absolute terms), TRQs, reference quantities, and a phased reduction of tariffs to a final level (often non-zero). EFTA agreements follow the EU model in having separate schedules for fish and agriculture next to the general tariff elimination schedule. The EU-Chile agreement is a move away from the typical EU model in that it establishes a single schedule for each party which contains all products. However, some of the complexity remains in that the schedule still contains measures such as TRQs, the elimination of only the ad-valorem component of a mixed duty; and cases where no liberalization takes place. Special Products: Agriculture and Textiles Tariff treatment The sectors subject to the greatest numbers of exceptions are agricultural and fisheries products as well as textiles and apparel. Only about 10% of RTAs have sectoral measures besides agriculture and textiles. Agricultural chapters (1-8) generally see the least liberalization on average and have the highest dispersion of liberalization across RTAs. Liberalization is particularly slow in dairy produce (ch.4), sugars (ch.17), cocoa (ch.18), cereals (ch.19), and footwear (ch.64). Countries liberalize 60% or less of tariff lines by the fifth year and 65% or less by the tenth year after entry into force of the RTA. There is considerable movement in the textile chapters between the 5- and 10-year benchmarks, while dairy and sugar see little additional liberalization. Differences across parties in agriculture, textiles, and apparel largely disappear 10 years after entry into force of the agreement. 22 Figure 2.1 Distribution of Liberalization by RTA Figure 2.2 Distribution of Liberalization by Parties in Chapters, Year 5 RTA Parties in Chapters, Year 10 0.5 Ch 62 Ch 61 0.45 Ch 60 Ch 42 Ch 57 Ch 63 Ch 19 Ch 64 Ch 11 Ch 20 Ch 52 0.4 Ch 04 Ch 65 0.5 Ch 17 Ch 18 Ch 58 Ch 02 Ch 55 Ch 24 Ch 08 Ch 07 Ch 54 0.35 Ch 21 Ch 10 Ch 09 Ch 83 Ch 46 0.45 Ch 16 Ch 56 ChCh 39 Ch 06 StDev of Agreements 01Ch 94 Ch 22 Ch Ch 73 43 Ch 48 Ch 03 Ch 68 Ch 04 Ch 11 Ch 15 Ch 19 0.3 Ch 59 Ch 72 0.4 23 ChCh 69 Ch 17 Ch 02 Ch 41 Ch 18 Ch 35 ChCh Ch 33 4440 Ch 20 Ch 95 67 Ch Ch 07 Ch 60 0.25 Ch 12 Ch Ch 70 Ch 3482 Ch 66 51 Ch 0.35 Ch 10 Ch 24 Ch 08 Ch 96 Ch Ch 13Ch 7674 Ch 45 Ch 93 Ch 16 Ch 64 Ch 49 Ch 36 Ch 42 62 StDev of Agreements Ch 61 Ch 53 Ch 32Ch 14 Ch 87 Ch 37 Ch 30 Ch 21 Ch 01 Ch 03 Ch 38 Ch 28 Ch 15 Ch 06 Ch 46 Ch 63 0.3 0.2 Ch 78 Ch Ch 80 Ch 79 29 Ch 27 Ch 84 Ch 92 Ch 54 Ch 09Ch 55 Ch 52 Ch 43 Ch 05 Ch 23 Ch 85 Ch 22 Ch 65 Ch 97 Ch 89 Ch 57 0.25 Ch 12 Ch 69 0.15 Ch 91 Ch 35 Ch 94 Ch 56 Ch 58 Ch 50 Ch 86 Ch 44 14 Ch 13 Ch Ch 66 67 Ch 0.2 Ch 30 Ch 48 83 0.1 Ch 71 Ch 90 Ch 53 Ch 68 Ch ChCh 70 93 59 73 Ch 25 Ch 41ChCh Ch 45 33 ChCh 95 39 ChCh 72 Ch4034 Ch 05 Ch Ch 96 87 ChCh 88 75 0.15 Ch 51 Ch 80 0.05 Ch 47 Ch 81 Ch 50 49 Ch Ch Ch 27 74 Ch 31 ChCh 8986 Ch 76 36 Ch 26 0.1 82 ChCh 0 Ch 32 Ch 91 Ch 85 Ch 38 79 Ch 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1 0.05 Ch 37 Ch 71 Ch 8428 Ch 25 Ch 90 Ch Ch 29 Average of Agreements Ch 47 31 Ch 78 88 Ch 92 0 75 81 26 Ch 97 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1 Average of Agreements Source: IDB (2006) The observed persistent variation in agriculture is due mostly to the EU Agreements where liberalization is postponed--sometimes to perpetuity, as for example for certain live animals, meat, dairy and sugar products originating in South Africa in the EU-South Africa RTA. Agriculture was a major issue in the Australia-US RTA. Both countries had already committed to substantial liberalizations under the WTO, such that further concessions were difficult to come by. On the US side, the most sensitive product, sugar was completely excluded from the agreement, while two others, beef and dairy products, will be subject to TRQs for a period of 18 and 17 years, respectively. Further, beef will benefit from special safeguards even beyond the transition period. Australia`s sensitive goods, on the other hand will not benefit from any exclusions, and only a small percentage of other goods qualify for bilateral emergency actions. Special Provisions The coverage of special provisions for agriculture and textiles is high: of the 42 RTAs in the sample, 32 have special provisions on agriculture and 16 on textiles. While RTAs in the Americas tend to include many special provisions for agriculture, EU agreements contain fewer, but importantly have separate tariff liberalization protocols for agricultural goods. Except for the EU agreements, most RTAs contain prohibitions on agricultural export subsidies. Asia-Pacific agreements tend to have less special disciplines on agriculture, generally containing only a provision (often a prohibition) on export subsidies as well as stipulations on cooperation among the parties. Domestic support is covered in Mexico`s RTAs only, mostly requiring adherence to WTO rules on agricultural subsidies. 23 Regarding textiles special disciplines are less common and are generally only found in US, Canadian and EU RTAs. Next to specific protocols or sections, they often contain provisions on safeguards and emergency actions. Further, liberalization in textiles is limited in US RTAs by stringent ROO provisions. Figure 2.3 Coverage of Agricultural Provisions in Figure 2.4 Coverage of Textile Provisions in Selected RTAs Selected RTAs NAFTA NAFTA Comesa Anzcerta 100% US-Austr. US-Chile Comesa Anzcerta 100% US-Austr. US-Chile EU-Lithuania CAFTA EU-Lithuania CAFTA EU-Romania US-Sing EU-Romania US-Sing EFTA-Singapore US-Jordan EFTA-Singapore US-Jordan EFTA-Mexico US-Israel EFTA-Mexico US-Israel EU-Morocco 50% US-Bahrain EU-Morocco 50% US-Bahrain EU-South Africa US-Morocco EU-South Africa US-Morocco EU-Chile US-Peru EU-Chile US-Peru EU-Mexico Canada-Chile EU-Mexico Canada-Chile 0% 0% Hong Kong-China Canada-Israel Hong Kong-China Canada-Israel Thailand-Australia Mexico-Nicaragua Thailand-Australia Mexico-Nicaragua New Zealand-Thailand Mexico-Japan New Zealand-Thailand Mexico-Japan New Zealand-Singapore Mexico-Bolivia New Zealand-Singapore Mexico-Bolivia Singapore-Australia Mexico-Costa Rica Singapore-Australia Mexico-Costa Rica Japan-Singapore Mexico-Israel Japan-Singapore Mexico-Israel Chile-NZ-Sing-Brunei Mexico-Northern Triangle Chile-NZ-Sing-Brunei Mexico-Northern Triangle Cent. Am.-DR Mexico-Uruguay Cent. Am.-DR Mexico-Uruguay Cent. Am.-Chile Korea-Chile G3 Chile-Mexico Cent. Am.-Chile Korea-Chile G3 Chile-Mexico Canada-Costa Rica Canada-Costa Rica Source: IDB (2006) 24 3 Rules of Origin Mona Haddad1 The proliferation of preferential trade agreements in East Asia containing different rules of origin has important implications for economic integration in the region and for trade between the region and the rest of the world. Free Trade Agreements with considerably different rules of origin or with overly restrictive rules of origin are likely to increase administrative costs for traders as well production costs for firms, thus compromising their competitiveness. The costs of rules of origin are likely to be higher for small producers than for large producers. Policymakers should ensure that rules of origin are simple and extend the same cumulation and origin determination across FTAs. Rules of origin (ROO) are necessary to avoid trade deflection associated with preferential trade liberalization. Without ROO third countries outside an FTA could avoid the country with higher outside tariffs by trans-shipping its goods through the country with the lower tariff (this does not concern customs unions as they have a common outside tariff). If the rules are too stringent or complex, however, the resulting compliance costs can neutralize any preference margin granted and lead to low utilization of tariff preferences. Types of Rules of Origin Preferential rules of origin can either apply to a trade regime as a whole (regime-specific ROO) or to an individual product (product-specific ROO). Product specific rules define origin according to one of two broad criteria. In order to qualify for origin status, products must either: be wholly obtained or produced, i.e. they do not contain any second-country components or materials. have gone through a substantial transformation. This has to involve at least one of four main components, i.e. these components can be used as stand- alone or in combination with each other: Change in tariff classification (CTC): this requires the product to alter its chapter (corresponds to 2 digits in the HS classification), heading (4 digits), sub-heading (6 digits) or item (8 digits) in the exporting country. Value content (VC): this requires that the product acquire a certain minimum local value in the exporting country (regional value content ­ RVC); alternatively, it is sometimes also defined as remaining below a 1 Source: Note prepared by Mona Haddad based on Silia Baller, A Negotiator`s Guide to FTAs, 2007; and Miriam Manchin and Annette Pelkmans-Balaoing, Rules of Origin and the Web of East Asian FTAs, 2007 (background papers) 25 ceiling value of inputs from non-member countries (import content ­ MC) or a ceiling value of parts (VP). Technical requirement (TR): this requires a product to undergo certain manufacturing operations in the originating country and is often used for apparel products and chemicals. It has been shown that the TR criterion generally has the highest cost of compliance compared to VC and CTC. In addition to product-specific criteria, rules of origin can contain two types of regime- wide provisions (i) leniency provisions; and (ii) provisions that make the agreement more stringent. There are three types of leniency provisions: De minimis or tolerance principle: a maximum percentage of non- originating inputs which can be used without affecting origin is determined, thereby inserting leniency into origin determination that uses the CTC or TR criteria. The tolerance rule under NAFTA allows non-originating inputs to be used even if the rule on sufficient processing is not satisfied provided their value does not exceed 7 percent. All EU FTAs contain de minimis rules, at 10 percent for most agreements. MERCOSUR and the African and Asian FTAs generally do not include a de minimis provision. Roll-up/absorption principle: materials, which have acquired origin by meeting specific processing requirements, will be considered as originating when used as an input in a subsequent transformation. Therefore, non- originating materials are no longer taken into account in the calculation of the value-added of the subsequent transformation. Roll-up is used across all FTAs. Cumulation principle: producers of one FTA member are allowed to use materials from another FTA member as if they were their own, thereby preserving the preferential status of the final product. The cumulation principle can be applied in three ways: Bilateral cumulation: permits two FTA partners to use inputs originating in the other partner as if they were their own. Diagonal cumulation: permits countries tied by the same set of preferential origin rules to use materials originating in any part of the area as if they were their own. Diagonal cumulation is generally only found in EU-FTAs. Full cumulation: an extension of diagonal cumulation, full cumulation permits countries tied by the same preferential rules of origin to use materials even in advanced stages of processing, from any part of the area even if these were not originating. While other forms of cumulation 26 require that the goods be originating before being exported from one party to another for further working or processing, this is not the case with full cumulation. Full cumulation simply demands that all the working or processing in the list rules must be carried out on non-originating materials in order for the final product to obtain origin. The EEA Agreement, EU-South Africa, AFTA and ANZCEFTA allow for full cumulation, while Canada-Israel allows for cumulation with the US. Regime-specific criteria that increase the stringency of a given rules of origin regime include: A separate list specifying operations that are considered insufficient to confer origin. A prohibition of duty drawback, i.e. tariffs on non-originating inputs that are subsequently included in a final product exported to a FTA partner market cannot be refunded. EU FTAs and FTAs in the Americas in most cases explicitly exclude drawback, though some allow for a transition period. AFTA, ANZCEFTA, SPARTECA, US-Israel, CACM and MERCOSUR on the other hand, explicitly permit drawback. Compliance and Administrative Costs, and Their Impact on Utilization of Preferences Firms need to overcome several hurdles in order to be able to benefit from preferences. First, firms need to satisfy the rules of origin in terms of meeting the technical requirements. Given the complexities of ROO, satisfying origin requirements could involve important production costs. In the globalized world economy it is important that firms have access to the most appropriate inputs at world prices. The rules of origin will be restrictive if they limit the choices of firms in sourcing inputs. Firms that are forced by the rules of origin to use higher cost local or regional inputs will find it more difficult to compete and may lose the opportunity to exploit scale economies if they have to produce essentially different products for the global and for the FTA partners market. Second, actually proving origin compounds these costs and involves maintaining systems that accurately account for imported inputs from different sources to prove consistency with the technical rules. The ability to prove origin may require the use of sophisticated and expensive accounting procedures (by the standard of small firms in developing countries). Third, following specific administrative procedures are required to provide the necessary documentation. Administrative costs can vary with different documentation and certification methods. Depending on the provisions in the agreement, certification can either take the form of self-certification by exporters--the least stringent method--or be done by an industry umbrella group, or by the exporting country government. The EU 27 requires a movement certificate issued by the exporting government, but allows an alternative certification method--the invoice declaration--for approved frequent exporters. NAFTA, FTAs in the Americas and Chile-Korea allow self-certification, while all others require certification by a public body or a private organization approved by the government. Figure 3.1 ROOs are not cheap! Figure 3.2 Trade impact of preference margins trade impact of preference margin (%) ACP 1.2 (administ rat ive) PANEURO 1 (administ rat ive) 0.8 PANEURO (compliance) 0.6 NAFTA (administ rat ive) 0.4 NAFTA (compliance) 0.2 Mexico t o US (compliance) 0 EFTA t o EU 0 5 10 15 20 25 30 35 40 45 50 55 60 (administ rat ive) -0.2 0 2 4 6 8 administ rat ive or compliance cost s of ROO as percent of value -0.4 preference margin (%) Source: Cadot, et.al. 2007 Empirical assessment of the potential impact of preferences on trade flows under the Asean Free Trade Agreement (AFTA) shows that preferential tariffs are typically exploited when the preference margins (the difference between MFN and preferential tariffs) are higher than 10-25%. Below that level, the costs involved in obtaining the preference--such as administrative costs and the costs of complying with the rules of origin requirements of the preferences--are higher than the benefits from obtaining preferential treatment. Moreover, preference margins above 80% also have a significant negative effect on trade flows. This is due to the larger incidence of non-tariff measures (NTMs) in these products that have a high preference margin. Choosing Between Basic Regimes: RVC vs. CTC In the past, the value-added approach enjoyed great popularity, mainly due to its: simplicity (the same rule can be applied to all traded products) neutrality (the rule is not affected by the sensitivity of the products in question and is not subject to political concerns over specific industry policies). Although seemingly simple, the value added criterion has proven burdensome in practice. The calculation of costs is time-consuming and administratively onerous in many cases. Manufacturers must maintain records of all production activity and costs. Disagreements often arise over what are allowable costs and how they should be distributed across traded and non-traded goods. Shifts in exchange rates and fluctuations in international 28 prices of materials can significantly affect an exporter`s costs, causing uncertainty as to whether a given product will qualify as originating under the value added approach. Almost all FTAs being negotiated by the US adopt the product-specific CTC methodology and this approach is increasingly being passed on to other countries in the Asia-Pacific region. The main benefits of the CTC approach are: objectivity: there is a single, clear rule for each tariff line. Thus, uncertainty with respect to exchange rates and fluctuating world prices as well as debates at customs over allowable and non-allowable costs, price mark-ups or allocation of operating overheads across production is avoided ease of managing for small and medium-sized enterprises (SMEs): The CTC approach requires less record keeping and calculations. In cases where the CTC may not be sufficient to confer origin, it is usually supplemented with a value added criterion or the requirement of a specific manufacturing operation. However, a CTC criterion with product-specific supplement conditions becomes receptive to industry pressures (e.g. as has happened with yarn and textiles in US FTAs). Allowing producers to choose between alternative criteria (CTC and RVC) for the same product could be a good solution. Ways of Simplifying ROO Regimes: Harmonization and Cumulation The current tangle of different, overlapping ROO regimes that came in the wake of the proliferation of preferential trade agreements imposes many costs on trading partners, including administrative costs to producers, inefficiencies in sourcing, and increased lobby activity. Harmonization among preferential ROO regimes would avoid the spaghetti bowl effect. Maximizing consistency in the ROO used in FTAs would reduce costs in several ways: for firms in organizing their production processes to meet the ROO requirements under the different FTAs for all involved in the trade process in familiarizing themselves with the ROO requirements in different FTAs for exporters in requiring the establishment of only one set of administrative procedures of ROO compliance (e.g. record keeping and verification processes) for producers and manufacturers in allowing them to take advantage of economies of scale by being able to more easily supply a range of FTA partners 29 In order for future preference schemes in the region to deliver improved market access and regional integration a careful design of rules of origin aiming at less restrictive rules would be essential. A number of factors could lessen the negative effects of restrictive rules of origin schemes: reviewing rules of origin requirements in terms of substantial transformation to make them less restrictive (for example, can a value-added requirement be reduced without compromising trade deflection) and to ensure they are consistent with the new global economy and development objectives (for example, do they facilitate production sharing networks in East Asia) allowing firms flexibility by specifying a choice of regime-wide rules of origin (for example, satisfying either a value-added requirement or change of tariff heading) allowing for common cumulation rules across agreements (such as diagonal or full cumulation) allowing more trader friendly` approaches, such as using self-certification methods, to reduce administrative costs. The Role of China Large countries like China bear a particular influence and responsibility with regard to the rules of origin, especially in a region with substantial differences in country size and incomes. In an era of rising FTAs, restrictive ROO can lead to particularly damaging effect. First, restrictive rules of origin with limited opportunities for cumulation may reinforce a hub and spoke pattern in which activity becomes more focused on the hub (China) with little interaction between the various spokes. Second, small low income countries may become increasingly marginalized in the world economy as large countries seek improved market access to each others` markets through FTAs. Third, FTAs may not only divert trade away from excluded countries but also undermine intra-regional trade flows if they include restrictive rules of origin. China has a particular opportunity, through its size and economic importance, to ensure that other countries in the region, especially the low-income partners, are not disadvantaged by the FTAs it signs. This can be pursued through common rules of origin across different agreements, realistic processing requirements, and full cumulation amongst all partners to existing trade agreements. 30 Table 3 A.1 Rules of Origin in East Asian FTAs Change of Tariff Value-added Specific Manufacturing Cumulation Tolerance Classification Domestic or Import Content Process ASEAN FTA (AFTA) Yes Regional (40%) full 10% ASEAN-China Yes Regional (40%) full 10% (ACFTA) ASEAN-Korea Yes Regional (40%) full 10% (AKFTA) Singapore-Japan Yes Domestic (60%) Yes Bilateral Product specific (JSEPA) Singapore-New Domestic 40% Bilateral 10% Zealand (ANZSCEP) Singapore-Australia Domestic 50% (30% for some 3% (SAFTA) products) Singapore-Korea Yes 45-55% Bilateral 10% (KSFTA) Thailand-Australia Yes 40-45% Yes Bilateral 10% (TAFTA) Thailand-NZ Yes, product Yes Bilateral 10% TNZCEP specific Malaysia-Japan Yes, product Domestic 40% (product specific) Bilateral Only from ASEAN (JMEPA) specific (product specific) Trans-Pacific Yes 45-50% Yes Diagonal 10% TRANSEP Australia-NZ 50% Bilateral 2% (ANZCER) 31 4 Disputes Settlement in Free Trade Agreements Mona Haddad & Olivier Cattaneo 1 Dispute settlement mechanisms help ensure an effective implementation of international commitments. Dispute settlement mechanisms in RTAs do not follow a single model, and many are inspired by that of the GATT/WTO. The WTO has remained the main forum to settle trade-related disputes. However, the evolving nature of RTAs--which increasingly include WTO+ provisions--reinforces the need for dedicated dispute settlement mechanisms. Recent RTAs have also tended to bolster their dispute settlement mechanisms with tougher measures such a shorter delays and monetary compensation. Dispute settlement mechanisms play an important role in the effective implementation of international commitments, including in the context of global and regional trade integration. The success of the GATT and the WTO could be partially explained by its dispute settlement mechanism that made trade sanctions credible and reinforced the security and predictability of trade transactions. Many regional trade agreements (RTAs) include provisions on dispute settlement that are inspired by the GATT/WTO. There is no single model of dispute settlement mechanism; sophistication can vary with different factors, such as the scope/level of trade integration or the number of contracting parties. Some agreements--like the European Union (EU), the Common Market for Eastern and Southern Africa (COMESA), the Southern African Customs Union (SACU), and the Andean Community--have dedicated tribunals/courts. Most bilateral free-trade agreements (FTAs) provide for the use of non-jurisdictional procedures and ad hoc panels. The settlement of disputes is narrowly defined as the settlement of disputes between states. However, some RTAs--unlike the WTO--authorize private parties to file claims against governments (e.g., Chile-Korea FTA) and/or other private parties, for some part or all of the disciplines covered by the agreement. For example, Chapter 20 of NAFTA only applies to intergovernmental disputes, but investors may submit claims to arbitration under Chapter 11. These disparities in scope and realm--for both the dispute settlement provisions and the RTAs themselves--explain the uneven use of dispute settlement mechanisms in RTAs. For example, the ASEAN dispute settlement mechanism has yet to hear its first case. Indeed, the WTO has remained the prime place to settle trade-related disputes. However, the evolving nature of RTAs--to include more WTO+ provisions--reinforces the need for dedicated dispute settlement mechanisms. 1 Source: Note prepared by Mona Haddad and Olivier Cattaneo based on Gregory Sergi, A Negotiating Guide for Regional Trade Agreements: The Legal Aspects, Background paper, 2007; comments were provided by Daria Goldstein. 32 The GATT/WTO and RTAs provide for dispute settlement mechanisms that combine both non-jurisdictional (e.g., mediation, conciliation) and jurisdictional (e.g., panel procedure) features. The balance of these diplomatic and legal features varies from agreement to agreement. Recent RTAs have tended to reinforce the teeth of their dispute settlement mechanisms (e.g., shorter delays, introduction of monetary compensation). Survey of dispute settlement provisions in some recent bilateral FTAs. This note presents some of the key features of dispute settlement mechanisms included in recent bilateral trade agreements in East Asia and other parts of the world. While not fully representative of RTAs, this sample survey gives a brief overview of issues related to dispute settlement mechanisms and provides some guidance to governments negotiating new agreements. It focuses on three main aspects of dispute settlement: scope; procedures and enforcement; choice of forum. Scope of Dispute Settlement The scope of dispute settlement is defined both by (i) the RTA obligations subject to dispute settlement, and (ii) the type of cases that may be brought to dispute settlement. FTAs can exclude certain sections of the agreement from dispute settlement. This is common for: issues the parties agree to resolve through the WTO--e.g., anti-dumping and countervailing duty actions in the Chile-China and many US agreements; commitments to cooperate in areas such as education, environment, or labor standards; topics that are somewhat novel and untested in international trade law, or relate to a state`s enforcement of its own laws and raise serious sovereignty issues--e.g., commitments in the field of competition policy in the Australia- Thailand FTA. FTAs can specify whether a complainant may challenge proposed as well as actual measures and whether non-violation complaints are allowed: in some rare instances, FTAs (e.g., US-Colombia) allow challenges of government measures that have not yet come into force. Aimed at preventing damage and promoting ex ante consultations, this process could be unduly time-consuming and burdensome, with increased risk of premature and unjustified cases. Non-contentious procedures (e.g., judicial review or 33 consultations, like in Chile-EC) could achieve the same end at a lower political cost; some FTAs allow non-violation complaints,1 often for a limited number of specific provisions (e.g., goods, rules of origin, cross-border services trade in Korea-Singapore or Chile-Korea; the same plus textiles, government procurement, and intellectual property in US-Colombia). Similarly allowed in the GATT/WTO, these complaints have remained, however, very rare, controversial, and never successful. Therefore, many recent RTAs, including those of China and Japan, excluded non-violation complaints. Procedural Aspects in the Main Phases of Dispute Settlement In line with public international law practice, most RTAs offer a choice, or a sequence, of non-jurisdictional and jurisdictional dispute settlement procedures. Often inspired by the GATT/WTO, and sometimes by commercial arbitration, RTAs usually distinguish the following main steps in dispute settlement: consultation (and sometimes mediation) phase; establishment of a panel; panel proceedings; enforcement of decision. Figure 4.1 Main Steps in Dispute Settlement Types of Dispute Settlement Tracks WTO China - Chile Australia - US EU - Chile Japan - Singapore Consultations Consultations Consultations Association Consultations Committee Panel Commission Joint Committee Panel Panel Appellate Panel Panel Body The Consultation (and Mediation) Phase: 1 Non-violation cases allege a benefit the complainant reasonably expected to receive from the agreement is being nullified through some action of the respondent that is not inconsistent with any specific obligation in the RTA. For example, tariff concessions could be easily frustrated by measures that the trade agreement did not regulate, such as domestic taxes, subsidies and product regulations serving legitimate public policy goals. 34 Initiation of consultations. Most RTAs require that, before resorting to further action, parties enter in good faith into formal consultations with a view to reaching a mutually satisfactory solution. In the WTO, about one half of the disputes are settled at this stage. Some RTAs include more precise obligations with regard to provision of information or confidentiality. Minimum time for consultations. RTAs typically set a minimum time for consultations. Most often, this period is of 60 days (like at the WTO), but has tended to be shortened in some recent RTAs (e.g., 45 days in Chile-Korea). Also, shorter delays were authorized in matters regarding perishable goods. Alternative dispute resolution mechanisms. The WTO and most RTAs allow parties to request good offices, conciliation, or mediation (e.g., of the WTO Director General or an RTA`s administrative body) that may begin and be terminated at any time, without prejudice to the rights of parties for further proceedings under the regular dispute settlement mechanism. In some instances, like Chile-EC, the mediation of an RTA`s administrative body shall precede any panel procedure. Establishment of a Panel: If consultations fail, parties typically have the right to request the establishment of a(n) (arbitral) panel which comprises three or five (e.g., in NAFTA, Canada-Chile) members. RTAs provide further guidance with respect to: the choice of panelists; the ways to avoid that a party blocks the procedure; the compliance with a certain timeframe. Choice of panelists. Like the WTO, most RTAs establish an indicative roster of individuals nominated by their government, willing and able (qualification requirements apply) to serve as panelists. In the WTO, panelists are chosen by the Secretariat among nationals of members with no interest in the dispute; this method cannot apply where all the parties to an agreement (obviously always the case for bilateral FTAs) have an interest in the dispute. When it comes to choosing one of their own national expert, governments usually prefer not to delegate this task (there are some exceptions, like in Chile-EC, where an institutional body of the agreement selects the panelists by lot from a pre-established list). In other terms, RTAs usually allow each party to choose an equal number of panelists (one or two), and the third (or fifth) panelist (the chairperson in most cases) is selected either by agreement of the parties or by the first two or four panelists. Avoiding deadlocks. In order to avoid that one party totally blocks the establishment of a panel, for instance by refusing to nominate a panelist or to establish a contingent list, or by failing to agree on the nomination of the chair, some RTAs have designed contingency procedures. For instance, Chile-China and Japan-Malaysia provide for the WTO Director General to appoint the chair where other methods have failed. In Japan-Singapore, panelists could ultimately be chosen among members of an institutional body (Consultation Committee) of the agreement, and the chair person by random drawing. 35 Timeframe. Similarly, to avoid unreasonable procedural delays, RTAs commonly require panelists to be appointed in a specified timeframe. In the WTO, panelists shall be appointed within 10 days (up to 30 days if the parties did not agree on the composition of the panel). By contrast, the timeframe specified in RTAs varies from 3 days in Chile-EC to 90 days in Australia-Thailand. Panel Proceedings: RTAs typically contain some description of the procedures to be followed by a panel. Frequently, however, it refers to more detailed rules of procedures to be separately negotiated. Procedural issues that sometime appear in RTAs` dispute settlement provisions include: Interim report. While at the WTO panels issue a preliminary report and parties are given an opportunity to submit comments, some RTAs ­ inspired by commercial arbitration ­ have suppressed this procedural step. Others, e.g., US-Colombia, Canada-Chile, or Chile-Korea, maintained interim reports. Amicus curiae briefs. Like the WTO, most RTAs are silent as to unsolicited amicus curiae briefs, but allow the panels to seek information or technical advice from experts. Some agreements, however, explicitly allow panels to consider requests from NGOs to provide written views regarding the dispute, e.g. Korea-Singapore, or US-CAFTA-DR. Publicity of the proceedings. While the WTO is moving toward more transparency, trade disputes remain largely confidential: only two proceedings (in 2005 and 2007) have so far been opened to the public upon the parties` request. RTAs are no exception to the rule, and provide for the confidentiality of the panel proceedings, although some recent US FTAs require that each party`s submissions, statements, and responses to the panel be made public. Time to issue a report. In most RTAs, panels are given a specific timeframe to issue their ruling to the parties ­ usually between 120 and 150 days (compared to 180 days in the WTO). Some RTAs dramatically reduced this timeframe ­ e.g., to 60 days in India-Singapore. Additional provisions can address the case of perishable goods or other urgent cases to be settled more rapidly. Enforcement of the decision: The WTO has experienced a high rate of voluntary compliance with decisions of its Dispute Settlement Body (DSB). However, a reluctant respondent can use several procedures to prolong noncompliance, including arbitrations with regard the length of the implementation period, the satisfaction of the DSB`s recommendations, or the level of suspended concessions ­ some of which can be appealed. Given that retaliation is always 36 forward-looking, and that the complainant is not entitled to retroactive damages, a reluctant respondent has an incentive to fully utilize each of the steps in this process. Many RTAs have adopted similar provisions. However, some RTAs allow that the original panel makes more precise recommendations (including on the manner and the timeframe for implementing its recommendations, e.g., Chile-Korea), and makes findings as to the degree of adverse trade effects of any measure found in violation of the agreement (e.g., Canada-Chile). In line with the GATT/WTO, RTAs allow retaliation where a party has not satisfactorily implemented a panel`s recommendations. Retaliation consists of the suspension of benefits to the level of the prejudice (either mutually agreed or determined by arbitration). The effectiveness of this threat depends, however, on the relative size of the two parties. Some RTAs have introduced the possibility of paying an annual monetary assessment in lieu of the suspension of concessions (e.g., US-Colombia). Table 4.1 Key Elements to be Considered while Designing Dispute Settlement Provisions of RTAs Pre-panel phase Time allowed for consultations Role of mediation and other alternative dispute settlement mechanisms Establishment of a panel Timeframe for selection of panelists Use of a panelist roster/indicative list Selection process for panelists and panel`s chairperson Contingency options for panelist selection if parties do not agree The panel proceedings Timeline for panel`s report Requirement for an initial and final report Consideration of amicus curiae submissions Transparency (panel proceedings and parties` submissions) The post-panel Temporary suspension of benefits or monetary compensation (compliance) phase Recommendations by the original panel on the manner and timeframe for implementation Findings by the original panel on the level of adverse trade effects Choice of Forum Because of substantial overlap between RTA and WTO obligations, countries may have a choice of two or more forums that have subject matter jurisdiction over a dispute. This could open the door to a sort of forum shopping, with the following risks: creating a dispute in the dispute with regard the choice of forum; running two parallel (or successive) disputes ­ with the risk of duplication, conflicting rulings, and exhaustion of the resources (human and monetary) of the poorest party. With a view to avoid these problems, most RTAs contain a choice of forum clause, that either: 37 allows the complainant to select the forum in which to settle the dispute, but once that choice is made, excludes the possibility to later resorting to another forum to settle the same dispute (e.g., Chile-China); or requires that the complainant uses the WTO system to seek redress of a violation of an obligation that is equivalent in substance in the WTO and the regional agreements (e.g., Chile-EC); or requires that the complainant uses the RTA system to settle disputes arising under certain provisions of the RTA ­ often because it is considered that these provisions are substantially different from others found in the WTO agreements (e.g., NAFTA, Japan-Singapore) Some RTAs, e.g., Australia-Thailand, extend the scope of this clause to possible choice of forum conflicts with international agreements other than the WTO. These clauses are essential, although they do not fully suppress the risk of a dispute in the dispute on the choice of forum, e.g., when parties cannot agree on whether an RTA obligation is substantially equivalent to another obligation in the WTO. The WTO does not object to the settlement of trade disputes in other forums, to the extent it is a mutually agreed solution. Absent such agreement, the WTO would ultimately have to decide. Table 4.2 Choice of Forum Clauses in RTAs 1. Chile­China: Where a dispute regarding any matter arises under this Agreement and under another free trade agreement to which both Parties are parties or the WTO Agreement, the complaining Party may select the forum in which to settle the dispute. Once the complaining Party has requested a panel under an agreement . . . the forum selected shall be used to the exclusion of the others. 2. NAFTA: In any dispute... that arises under (the articles or chapters on environment, SPS measures, standards-related measures)... the complaining party may, in respect of that matter, thereafter have recourse to dispute settlement procedures solely under this Agreement. 3. Japan-Singapore: However, this does not apply if substantially separate and distinct rights or obligations under different international agreements are in dispute. 4. Chile­EC: a) When a Party seeks redress of a violation of an obligation under the WTO Agreement, it shall have recourse to the relevant rules and procedures of the WTO Agreement, which apply notwithstanding the provisions of this Agreement. b) When a Party seeks redress of a violation of an obligation under this Part of the Agreement, it shall have recourse to the rules and procedures of this Title. c) Unless the Parties otherwise agree, when a Party seeks redress of a violation of an obligation under this Part of the Agreement which is equivalent in substance to an obligation under the WTO, it shall have recourse to the relevant rules and procedures of the WTO Agreement, which apply notwithstanding the provisions of this Agreement. d) (d) Once dispute settlement procedures have been initiated, the forum selected, if it has not declined its jurisdiction, shall be used to the exclusion of the other. 5. Australia­Thailand: Once a dispute settlement procedure has been initiated between the Parties with respect to a particular dispute under this Chapter or under any other international agreement to which the Parties are parties, that procedure shall be used to the exclusion of any other procedure for that particular dispute. This paragraph does not apply if substantially separate and distinct rights or obligations under different international agreements are in dispute. 38 5 Managing Multiple Trade Negotiations in Services Carsten Fink Many countries--including China--are engaged in multiple trade negotiations in services. All members of the World Trade Organization (WTO) participate in the services negotiations of the Doha Development Agenda (DDA). In addition, many countries have embarked on the negotiation of bilateral and regional free trade agreements (FTAs) covering services. The latter have increased rapidly over the past decade and it is not rare to find governments negotiating five or even more FTAs in parallel. Often different agreements are negotiated by different negotiating teams. At the same time, there are important interrelationships between different agreements, which governments need to take into account in their overall trade negotiating strategy. This note seeks to highlight several of these interrelationships and suggests ways in which governments can promote greater coherence from the top. What are trade negotiations all about? Trade negotiations are mercantilist in nature. Governments exchange concessions, whereby own market opening is sold for improved market access abroad. Mercantilism has little economic rationale. As Paul Krugman (1997) famously pointed out, the economist`s case for open markets is essentially a unilateral case. If trade liberalization brings about economic benefits and governments are convinced of these benefits, market opening should be pursued regardless of what other countries may do. However, mercantilism serves a useful political economy purpose. Suppose that a government is convinced that certain liberalization measures will generate overall economic benefits, but those measures are opposed by vested interests that stand to lose from foreign competition. Negotiated as part of a package of trade commitments, a government may be in a better position to proceed with market opening, because it can muster support from those constituents that stand to gain from improved market access abroad. Regardless of the forum, trade negotiations in services almost always proceed on a request and offer basis. In other words, country A submits a wish list of market opening it would like country B to undertake, on the basis of which country B considers making an offer. The final negotiating outcome then depends on the overall balance of commitments--not just within services but across all areas negotiated in a given forum. Even though the modalities are largely the same, there is a key difference between WTO negotiations and FTA negotiations. Multilateral services liberalization under the WTO`s General Agreement on Trade in Services (GATS) takes place on non-discriminatory terms. The Agreement`s most-favored-nations (MFN) principle requires members of the multilateral trade body to extend any trade benefit immediately to all other members. By 39 contrast, FTAs seek the liberalization of trade in services among a small number of countries--often only two trading partners. FTAs are thus preferential in nature. Only parties to an agreement benefit from the trade commitments negotiated under an FTA. Service suppliers from non-parties are discriminated against. This difference carries an important implication. The WTO now has 150 members (and the few large economies that are still not members are in the process of acceding to the organization). Most FTAs that are being negotiated involve existing or prospective WTO members. Thus, for a bilateral or regional FTA to be meaningful, its parties need to commit to additional market opening beyond their liberalization undertakings under the GATS. Bargaining considerations Multilateral negotiations offer the benefit of large country coverage. At the end of the negotiations, each member will experience improved market access in up to 149 economies. At the same time, bargaining may actually be more effective in FTAs. At the WTO, requests and offers are exchanged on a bilateral basis, but eventual commitments are made on an MFN basis. Thus, even though one WTO member may be interested in improved market access in another member, it may be reluctant to engage in reciprocal bargaining if there are third members interested in the same market access. The end result may be a less ambitious negotiating outcome. In principle, FTAs offer a way out, as the smaller number of players reduces the scope for free-riding on the bargaining efforts of others. There is an additional reason why bargaining may be more productive in FTAs. Under preferential liberalization, domestic service providers exporting or investing in the FTA partner country would not face any competition from service suppliers outside the FTA area. In other words, the value of an FTA partner`s market opening may be higher if it is done on a preferential rather than non-discriminatory basis. In the end, governments may be willing to pay more for preferential market access abroad, leading to deeper exchanges of market opening commitments. However, the story is more complicated than that, for two reasons. First the true extent of trade preferences created by FTA commitments depends crucially on the rules of origin adopted by an FTA. Second, many of the recently negotiated FTAs feature so- called non-party MFN clauses that ratchet up an FTA commitment to the highest level of market opening ever granted. We will discuss the influence of these two factors in turn. Rules of origin FTAs extend trade benefits to signatory parties only. Yet what exactly constitutes trade between parties that is eligible for preferential treatment? Suppose countries A and B take part in an FTA to which country C is not a member. Suppose further that a service provider from country C has established a commercial presence in country B. Under 40 which circumstances, if any, would this service provider be allowed to export services to country A? That question is resolved through so-called rules of origin. In a nutshell, the vast majority of FTAs have adopted a liberal rule of origin, extending benefits to non-party service suppliers established in one of the FTA parties and showing substantive business operations there. Only few agreements--notably Australia-Thailand and India-Singapore--have opted for a more restrictive rule of origin, limiting FTA benefits to domestically owned and controlled service suppliers.1 The choice of rule of origin has important bargaining implications. Returning to the above example, suppose that country A also negotiates an FTA with country C, after the conclusion of the FTA between A and B. If rules of origin in the latter agreement are liberal, country A may not be able to sell the same market opening measure to country C. Since country C service suppliers are already able to access country A through their established affiliates in country B, the government of C may not be willing to pay the full mercantilist price for making the same commitment. (The same is true for negotiations between A and C at the WTO, after the conclusion of an FTA between A and B). In reality, country C will still have an interest in country A committing the market opening measure in question in its own FTA with A, for three reasons. First, it may be costlier for a country C service supplier to enter the market in A through country B rather than directly from its home base in country C. Second, small and medium-sized service suppliers may not have a presence in country B and they would benefit from accessing country A`s market directly. Third, unless the market opening measure is committed in the FTA between A and C, the government of C will not be able to challenge country A`s actions pertaining to the market opening measure through the FTA`s dispute settlement mechanism. However, the basic point remains. Liberal rules of origin reduce the preferential nature of FTA commitments. Even though they are desirable from an economic perspective, they undermine some of the bargaining advantages of FTA negotiations outlined above. At the extreme, if FTA commitments do not grant any real trade preferences, why negotiate FTAs in the first place and not confine services trade negotiations to the multilateral level? Non-party MFN clauses Many of the recently negotiated FTAs in services feature provisions that require the automatic extension of benefits granted to non-parties. For example, the MFN obligation of the Japan-Malaysia Economic Partnership Agreement reads: 1 For a more detailed discussion of the rules of origin provisions in East Asian FTAs see Fink and Molinuevo (2007). 41 Each Country shall accord to services and service suppliers of the other Country treatment no less favourable than that it accords to like services and service suppliers of any third State.1 What are the bargaining implications of such an obligation? To begin with, for any given FTA, each country has an incentive to ask its trading partner for MFN treatment, as it ensures that domestic service providers benefit from current and future trade preferences extended to non-parties. However, a country bound by many non-party MFN obligations faces a less favorable bargaining situation in future FTAs. A new FTA partner knows that any negotiated preference will be extended automatically to others. Thus, service exporters and investors from that partner will not have exclusive access to the domestic market, reducing the value of a future FTA commitment. Consequently, the willingness of a new FTA partner to pay for additional market opening may be reduced. In addition, to the extent that FTA negotiations run in parallel, the free-rider problem described above for WTO negotiations re-emerges. If country C knows that any FTA preference granted by country A to country B will be automatically extended to C through a non-party MFN clause, C may hold back from paying for the same negotiated commitment in its own FTA negotiations with A. Overall, a country that has concluded FTAs with non-party MFN clauses covering all its major trading partners will find itself in a situation where the difference between a new FTA commitments and a WTO commitment is minor. To put it differently, the inclusion of non-party MFN clauses in FTAs will, on balance, strengthen incentives to negotiate at the WTO. Multiple trade negotiations: key considerations for governments From a trade ministry`s perspective, managing multiple FTA negotiations is a challenging task. The sequence of trade negotiations and the choice of FTA partners are influenced by a variety of factors, not just mercantilist priorities. Trade negotiations in services require careful coordination among different ministries and regulatory agencies. Multiple negotiations make the coordination task even more complex. Notwithstanding these challenges, there are a number of guiding principles that emerge from the interrelationship of different trade negotiations: The desirability of including a non-party MFN provision in an FTA depends, in part, on the balance of offensive versus defensive negotiating interests. Countries with liberal services policies and substantial export and investment interests in the FTA partner are likely to gain from a non-party MFN clause. The reverse holds for countries that maintain important trade barriers in 1 See Article 101 of the Japan-Malaysia Economic Partnership Agreement. In the East Asia region, twelve out of twenty-five services FTAs feature a non-party MFN clause (see Fink and Molinuevo, 2007). In addition to FTAs, many bilateral investment treaties provide for non-party MFN, with equivalent effects to the ones described here. 42 services and wish to sell them for market opening in future FTA or WTO negotiations. In evaluating the mercantilist bargain entailed in a particular FTA, a government needs to take into account the implications of that FTA for parallel and future trade negotiations. If rules of origin are liberal, certain non-party service suppliers may be granted access to the domestic service market. That possibility may impact on the mercantilist equilibrium in other FTA negotiations or at the WTO. A government needs to study the identity of service suppliers present in the market of an FTA partner. Are these suppliers ultimately owned and controlled by domestic persons or third parties? Similarly, a government needs to study whether domestic service suppliers can already take advantage of trade preferences that an FTA partner has with a third country. If so, would domestic service suppliers still value having the partner`s preferences extended, so that they can directly access the partner`s market? As pointed out above, these bargaining considerations are not rooted in an economic logic. However, if mercantilism is to serve its political economy function to the fullest, it`s important that governments develop a coherent negotiating strategy that enables them to strike the best bargains. 43 6 FTAs in Services--Positive vs Negative List Approach Mona Haddad1 A negative list approach typically entails more transparency and credibility than a positive list approach in services Free Trade Agreements (FTAs). A positive list approach may replicate most of the openness benefits of a negative list approach. In addition, a positive list approach may provide more flexibility to accommodate political economy constraints. Trade agreements promote international commerce in three ways: by reducing barriers to foreign participation, by making trade policies more transparent, and by enhancing the credibility of the trade regime. Architectural choices can make an important difference in this respect. A critical question in the design of an FTA is how exemptions and limitations to liberalization are inscribed into an agreement. Most FTAs allow for sectoral carve-outs that exempt one or more activities from the scope of the agreement. Activities falling under such an exemption are not subject to any of the disciplines established in the agreement. The most frequently encountered carve- outs pertain to air transport, cabotage in maritime transport, and financial services The liberalization content of services FTAs is detailed in country-specific schedules which involve two dimensions: listing of service activities subject to liberalization commitments listing of levels of openness Lists can be done: on a positive basis: identifying what is covered or allowed on a negative basis: identifying what is not covered or not allowed through mixed (hybrid) approaches In practice, the possible combinations of lists are as follows: Sectors Openness Positive list Positive list Hybrid list Negative list Negative list 1 Source: Carsten Fink and Martin Molinuevo, 2007, Background Paper for EASPR. 44 Agreements with positive list of sectors In a positive list approach, only the sectors that parties have expressly identified are subject to market opening undertakings. Countries are free to maintain or impose trade- restrictive measures in all non-scheduled sectors, although those measures may still be subject to an agreement`s general disciplines (such as on transparency). Once a sector is scheduled, the next step is to set the level of openness in that sector. This is done through pure positive lists (which are rarely used)1 or GATS-style hybrid lists. Under a GATS-style hybrid list, parties are free to describe either how trade is restricted or what typeof services transactions are allowed in a listed sector. In a GATS schedule, an entry that takes the form None, except ... signifies a negative list of trade-restrictive measures, whereas an entry that takes the form Unbound, expect ... signifies a positive list of market-opening concessions.2 Key features of GATS-style hybrid list approach: First, schedules of commitments specify: market access terms, limitations and conditions; and national treatment conditions and qualifications. Second, commitments in each listed sector are made with respect to four different modes of supply: cross-border trade (mode 1), consumption abroad (mode 2), commercial presence (mode 3), and movement of natural persons (mode 4).3 Eleven of the twelve East Asian hybrid list FTAs follow the structure of the GATS by distinguishing between four modes of supply and between market access and national treatment measures. The only exception is the Australia-Thailand FTA where commitments neither distinguish between modes of supply nor between market access and national treatment measures. To which mode and to which class of measures a particular commitment applies is determined by the nature of the scheduled entry. Compared to the GATS, this scheduling approach appears to reduce difficulties in scheduling measures that may be inconsistent with both market access and national treatment obligations.4 1 Under a pure positive list, parties to an agreement specify for each listed service sector the level (and type) of foreign participation that is allowed. Only two East Asian FTAs follow this approach: the Mainland- Hong Kong and the Mainland-Macao CEPAs. 2 A negative list of trade-restrictive measures also prevails, when a scheduling member does not explicitly indicate None, except ..., but inscribes one or more limitations applying to a listed sector. For further details on the scheduling of GATS commitments, see WTO document S/CSC/W/19. 3 In actual GATS schedules, most entries for modes 1, 2, and 3 set the level of openness on a negative list basis, whereas the great majority of entries for mode 4 are made on a positive list basis. 4 The relationship between the GATS market access and national treatment disciplines has been subject to conflicting legal interpretations. See Mattoo (1997). 45 Third, several GATS-style hybrid list agreements adopt an MFN obligation which is subject to the scheduling of reservations. MFN reservations are always inscribed on a negative list basis in relation to both service activities and trade openness measures. Fourth, GATS-style schedules allow for horizontal commitments. Measures scheduled in these horizontal commitments apply to all listed service sectors, unless the wording of a sectoral commitment unambiguously indicates otherwise. In assessing the level of openness of specific service sectors, it is therefore critical to take these horizontal commitments into account. Sometimes they can be far-reaching--for example, a joint venture requirement with foreign equity participation limited to 49 percent, or an entry that limits the movement of individual service providers to specific types of intra-corporate transferees. In such cases, they effectively fix a low level of openness across all sectors. Some East Asian countries have reduced horizontal limitations in their FTA schedules relative to the GATS, whereas others have reproduced entirely what they committed horizontally under the GATS. Table 6.1 Scheduling approaches in East Asian FTAs Agreement(s) sectors openness 1. Lao PDR-US BTA P n.a. 2. Mainland-Hong Kong CEPA P P 3. Mainland-Macao CEPA P P 4. ASEAN Framework P H 5. Agreement on Services P H 6. ASEAN-China FTA P H 7. Australia-Thailand FTA P H 8. India-Singapore ECA P H 9. Japan-Malaysia EPA P H 10. Japan-Philippines EPA P H 11. Japan-Singapore EPA P H 12. EFTA-Korea FTA P H 13. EFTA-Singapore FTA P H 14. Jordan-Singapore FTA P H 15. New Zealand-Singapore FTA P H 16. Vietnam-US BTA P H 17. Australia-Singapore FTA N N 18. Chile-Korea FTA N N 19. Guatemala-Taiwan (China) FTA N N 20. Japan-Mexico EPA 21. Trans-Pacific EPA N N 22. Panama-Taiwan (China) FTA N N N N 23. Nicaragua-Taiwan (China) FTA N1 N 24. Singapore-Panama FTA 25. Singapore-US FTA N1 N N1 N 256. Korea-Singapore FTA N2 N3 P=positive list; N=negative list; H=hybrid list 1/ except for cross border trade in financial services for which a positive list is adopted; 2/ except for financial services for which a positive list is adopted; 3/ except for financial services for which a hybrid list is adopted; n.a.= not applicable (as no trade-restrictive measures are scheduled) 46 Fifth, GATS-style hybrid list agreements typically do not require signatories to make bindings at the level of actual openness. A gap between bound and actual policies--a so- called binding overhang--may introduce uncertainty, because governments at any point can restrict foreign participation in their domestic service markets, as long as they stay within their trade commitments. The East Asian hybrid-list FTAs similarly do not impose any requirement to bind at the actual level of actual openness. To reduce the uncertainty associated with a binding overhang, the Japan-Malaysia EPA offers parties the possibility to identify in their schedules those service sectors in which a party agrees to bind status quo policies. In addition, the identified service sectors are subject to upward ratcheting: once a party eliminates a trade-restrictive measure, policy will automatically be bound at the more liberal level.1 Negative list agreements Negative listing generally applies to both sectors and openness measures: trade is unrestricted across all service activities (except where a sectoral carve-out applies), unless scheduled limitations indicate otherwise. The 1994 North American Free Trade Agreement (NAFTA) was one of the first to adopt the negative list. In East Asia, Singapore was the first country to adopt a negative list agreement in its FTA with the United States in 2003. Singapore has since pursued the negative list model in four other agreements, including its FTA with Korea. Japan adopted a negative list in the Japan-Mexico EPA in 2003. Korea`s first negative list agreement was concluded with Chile in 2004--after Chile had concluded a negative list FTA with the United States in 2003. Countries that conclude one negative list agreement typically seek to promote this model in subsequent agreements. Key features of negative list agreements: First, these agreements typically establish separate disciplines for cross-border trade and investment in services. Cross-border trade in services in the negative list model covers the GATS equivalent of modes 1, 2, and 4, although commitments do not formally distinguish between these three modes of supply. The GATS equivalent of mode 3 is covered by a horizontal investment chapter that applies to both goods and services, though the typical investment disciplines go beyond those established by the GATS. Second, trade in financial services receives separate treatment in several of the negative list FTAs. The Nicaragua-Taiwan (China) FTA, the Panama-Singapore FTA, and the 1 Article 99.3 of the Japan-Malaysia EPA provides that [w]ith respect to sectors or sub-sectors where the specific commitments are undertaken [...] and which are indicated with SS, any terms, limitations, conditions and qualifications [...] other than those based on measures pursuant to immigration laws and regulations, shall be limited to those based on non-conforming measures, which are in effect on the date of entry into force of this Agreement. 47 Singapore-US FTA adopt a positive list of sub-sectors for cross-border trade in financial services, but trade openness measures continue to be scheduled on a negative list basis. The Korea-Singapore FTA extends the positive list of sub-sectors to investment in financial services and allows parties to determine the level of openness in each sub-sector through a hybrid list approach. Four negative list FTAs--the Guatemala-Taiwan (China) FTA, the Japan-Mexico EPA, the Korea-Chile FTA, and the Trans-Pacific EPA--carve out trade in financial services entirely from the scope of the agreement, leaving the Australia-Singapore FTA and the Panama-Taiwan (China) FTA as the only agreements for which the negative list applies, in principle, to financial services.1 Third, negative list agreements establish additional classes of openness measures for the scheduling of specific commitments (beyond national treatment limitations and market access obligations). New classes of measures in East Asian FTAs include: For cross-border trade in services: local presence requirements.2 For investment: performance requirements and limitations on the nationality or residency of senior managers and boards of directors. For financial services: scheduling of limitations on cross-border purchases of financial services (Singapore`s FTAs with Panama and the United States). Fourth, negative list agreements require binding the existing policies at the status quo level (existing non-conforming measures), with possible exceptions (future measures). Existing non-conforming measures include all current laws and regulations that a country seeks to maintain. Moreover, FTAs provide for an upward ratcheting mechanism of policy bindings: once a trade-restrictive measures identified in this category is eliminated (on a unilateral basis), the new measure is automatically bound at the more liberal level (in the FTA). In East Asia, all seven FTAs provide for upward ratcheting of policy bindings. Future measures are reservations that allow exceptions to the status quo binding of current policies. They do not necessarily relate to existing laws and regulations, and they allow a country to introduce new measures in the relevant sectors at any point after an agreement enters into effect. The scope of future measures is defined through their sectoral coverage and the description outlining the reserved policy actions. Broad future measures can de facto exclude full sectors from an agreement`s market opening obligations--equivalent to not listing a sector or inscribing unbound` for one or more modes of supply under a positive list scheduling approach. Under the Korea-Singapore FTA, for instance, Korea scheduled a future measure under which the government reserves the right to adopt or maintain any measure with respect to (a) broadcasting services [...] (b) foreign investment in the broadcasting services sector. 1 However, under the Australia-Singapore FTA, Singapore scheduled several broad future measures in financial services, substantially limiting the scope and depth of its liberalization undertaking. 2 This additional class of measure is due to negative list agreements not separately identifying the GATS equivalent of mode 1. 48 Positive or negative list? A negative list approach may provide greater transparency and credibility to services trade policies than a positive list approach. Knowing what is not allowed--rather than what is allowed--may help service providers better understand how they can do business in a foreign country. Because non-conforming measures reflect status quo policies, businesses are better informed about the actual level of openness in an FTA partner and are directly pointed to the laws and regulations affecting their ability to contest the FTA partner`s market. Status quo bindings also maximize the credibility value of trade commitments, as foreign service suppliers are assured that current policies will not become more restrictive. A negative list approach may be more pro-liberalization. Governments need to reveal existing non-conforming measures in the course of FTA negotiations and, if they wish to maintain those restrictions, defend their rationale. This process may create greater incentives for eliminating unwarranted restrictions. Negative list agreements apply to future service activities. New service activities may emerge from technological progress or new ways of organizing business and an automatic commitment to free trade may pre-empt protectionist pressures. Liberalization benefits of negative list agreements depend crucially on the nature of non- confirming and future measures scheduled. Reservations that exempt a broad range of measures can seriously reduce the liberalization content of trade commitments. In the Singapore-US FTA, the United States scheduled a non-conforming measure that effectively exempts [a]ll existing non-conforming measures of all states of the United States, the District of Columbia, and Puerto Rico. No state law or regulation is explicitly listed under this reservation, making it difficult for a Singaporean service provider to assess possible US trade barriers at the state level.1 In the same FTA, the United States scheduled a non-conforming measure under which it [...] reserves the right to adopt or maintain any measure that is not inconsistent with the United States' obligations under Article XVI of the General Agreement on Trade in Services.2 This limitation appears to nullify all market access concessions that the US 1 The Japan-Mexico EPA recognizes the burden of collecting information on all trade-restrictive measures applied at the sub-federal level. But instead of scheduling a single reservation like the one for the US, Mexico committed to list all non-conforming measures applied by Mexican states within one year after entry into force of the FTA. 2 See Annex 8A of the Singapore-US FTA. 49 offered to Singapore and that go beyond the US GATS commitment.1 The possibility of scheduling future measures opens the door for excluding certain service activities from liberalization undertakings and binding policy above status quo levels in negative list agreements--diluting the difference between hybrid list and negative list agreements. In the Japan-Mexico EPA, Mexico scheduled a future measure under which it [...] reserves the right to adopt or maintain any measure relating to the supply of services in any mode of supply in which those services were not technically feasible at the time of entry of force of this Agreement. This reservation effectively denies the application of the agreement to future service activities--one of the supposed benefits of negative listings. A positive list approach may replicate much of the benefits of a negative list approach. It is in principle possible to replicate every negative list schedule with a positive list schedule. In addition, GATS-style hybrid list agreements allow for the scheduling of measures on a negative list basis, preserving possible transparency benefits associated with negative listing.2 The benefits associated with status quo bindings are not necessarily limited to negative list agreements. In the Japan-Malaysia EPA a requirement to schedule at the level of existing policies was incorporated into a positive list agreement. Three of the East Asian negative list FTAs have partially or fully reverted to a positive list in scheduling commitments for financial services--a sector where regulatory sensitivities towards foreign participation are common. Three of the remaining four negative list FTAs have carved out the financial service sector altogether, leaving the Australia-Singapore FTA as the only agreement in which the negative list applies to financial services.3 A positive list approach may provide more flexibility to governments and may be more conducive to market opening of sensitive sectors. A positive list of sectors combined with the possibility of binding above status quo policies may provide important breathing room to governments. Such breathing room 1 The transparency of the US commitment in the Singapore-US FTA is reduced by another provision of this agreement. Schedules of non-conforming measures contain both a description of the relevant measures and a reference to the relevant laws and regulations. Article 2(g) of Annex 8 of the Singapore-US FTA provides that description, for Singapore, sets out the non-conforming aspects of the measure for which the entry is made; and description, for the United States, provides a general, non-binding, description of the measures. 2 In principle, a positive list of sectors can even apply to future service activities by covering residual service sectors, such as other business services,` other financial services,` or other services not included elsewhere.` 3 However, Singapore scheduled several broad future measures under this FTA, preserving its freedom to maintain or impose restrictions on the supply of financial services by Australian institutions. For example, one such future measure reserves Singapore`s right [...]to adopt or maintain any measure affecting the supply of services by foreign full banks or in relation to Qualifying Full Bank licenses. 50 may be needed in cases where governments have limited administrative capacity to compile an inventory of all trade-restrictive measures, including at the sub-federal level, or in sectors where there are sensitivities towards foreign participation. Positive list agreements seem to afford governments the ability to tailor commitments to political economy constraints. They may thus give governments the confidence to embark on some liberalization rather than fully excluding sensitive sectors. In sum, negative lists generally bring about greater transparency than positive lists. Negative lists and positive lists can achieve similar openness outcomes depending on how the agreements are actually written. 51 7 Labor Mobility Provisions in FTAs: Lessons for China Min Zhao & Jean-Pierre Chauffour Labor mobility issues are more contentious than either trade or capital liberalization. Large wage differences between countries give rise to pauper labor fears ­ the apprehension that immigration from poor countries will sharply drive down wage levels and create unemployment in the destination country. During the previous era of globalization in the late 19th century, visas and work permits were not required for people to move between countries. At its historic peak, migration accounted for about 70% of the observed international convergence of the ratio between the real wage level and the rental value of capital. Today, adverse popular reaction to the economic and social impacts of immigrants has kept progress toward global labor mobility well below progress toward trade and capital liberalization. In 2000, only 3% of the world`s population (175 million persons) lived outside their country of birth, but global exports of goods and services represent more than one third of world GDP, and the ratio of the stock of world foreign direct investment stock to world GDP is almost as large. Both developed and developing countries stand to gain from liberalization in the mobility of labor. The OECD estimates that further liberalization, to the extent of 3% of the workforce of OECD countries, could result in significant global welfare gains of up to $156 billion per year. 1 Other estimates indicate that a complete liberalization of Mode 4 would lead to gains ranging from nearly 10% to 67% of world GDP. 2 Interestingly, 70% of the potential gains from further labor liberalization are attributed to the possibility of greater mobility for unskilled workers (worth an estimated $110 billion annually). Despite the size of potential gains, as estimated by economists, most countries are wary of liberalizing labor mobility. Unlike free movement of goods, services and capital, which have been promoted by trade agreements, meaningful provisions on labor mobility are hardly found in those same agreements, and very few such international accords exist. In most countries, the movement of labor remains the subject of national determination and falls within the jurisdiction of the immigration authority, whose main concern can be to regulate and restrict, not promote. Services liberalization has not made much progress at the multilateral level, but the members of some of the recent regional trade agreements (RTAs) have accepted greater labor mobility at the regional level. While the WTO GATS does not define specific categories of labor, WTO members have accepted four widely used categories of 1 See OECD (2004), and Strutt, Poot and Dubbeldam (2008). In this paper, the OECD assesses the gains from complete liberalization of merchandise trade at $104 billion per year. However, this OECD estimate of gains from trade liberalization is far smaller than the estimate made by the Peterson Institute. According to Bradford, Grieco and Hufbauer, the US economy was approximately $1 trillion richer in 2003 due to past globalization ­ the payoff both from technological innovation and from policy liberalization ­ and could gain another $500 billion annually from future policy liberalization. See Bradford, Grieco and Hufbauer (2005). 2 See Hufbauer and Stephenson (2009). 52 skilled professionals for the purpose of inscribing commitments under Mode 4, both in the GATS and in regional trade agreements (RTAs). 1 Given the impasse in the Doha Round and the lack of any progress on services in the multilateral negotiations for the past several years, it is hard to expect great progress on the labor mobility through WTO negotiations. A large number of RTAs, however, have incorporated Mode 4 as part of the package, and interesting initiatives have been taken. Several free trade agreements have been entered into by developing countries in the Americas and in Asia containing provisions that facilitate procedures for temporary labor movement and open up market access opportunities. Some agreements include guaranteed numerical quotas for certain categories of skilled labor. Given the limited commitments made under GATS, developing countries such as China, which want to expand openness to include semi-skilled workers and movement unrelated to a specific commercial presence, may find that broader FTA provisions are of interest. International experience In international services trade, labor mobility is conceptualized as the temporary movement of natural persons or Mode 4. The WTO GATS defines it as the supply of a service by a service supplier of one Member, through presence of natural persons of a Member in the territory of any other Member. The four traditional Mode 4 categories are (1) Business visitors and salespersons (BVs); (2) Intra-corporate transferees (ICTs); (3) Independent professionals (IPs) and (4) Contractual services suppliers (CSSs). 2 WTO agreements have no general provisions for labor mobility. Since 2000, however, the temporary movement of certain types of workers ­ namely, service suppliers ­ has been negotiated to a very limited extent under WTO GATS Mode 4. Mode 4 is designed to facilitate the movement of people in a way analogous to the movement of goods and capital. Movement associated with Mode 4, however, covers a very small share of annual cross-border movements of people and accounts for less than 2% of the total value of services trade. In particular, Mode 4 narrowly targets highly skilled workers that are often subject to an economic needs test on the part of the employer, intra-corporate transferees and business visitors, and specialized labor for which it is hard to find substitutes (e.g., medical and construction services). Other limitations of Mode 4 liberalization include: general reluctance by governments to make international commitments that limit their sovereign right to control immigration and determine labor market conditions; commitments that require openness to all countries on a most-favored-nation (MFN) basis that would undermine preferential migration schemes 1 All WTO members are signatories to GATS, which does not cover permanent migration. GATS is based on four key elements, identified as Modes 1 to 4: Mode 1 relates to cross-border supply; Mode 2 focuses consumption of services abroad; Mode 3 covers the commercial presence of foreign firms; and Mode 4 deals with the movement of natural persons. The WTO approach is limited to the temporary movement of workers, as opposed to permanent emigration 2 Mode 4 of GATS is defined as the "supply of a service... by a service supplier of one Member, through presence of natural persons of a Member in the territory of another Member". This includes independent service suppliers and the self-employed, as well as foreign employees of foreign companies established in the territory of a Member. See World Bank Global Economic Prospects (2004). 53 negotiated at the bilateral and regional levels; and the exclusion from Mode 4 of labor provisions related to permanent employment, citizenship or residency. Given the restricted scope of Mode 4 in GATS, most countries adopt labor provisions in their bilateral and regional RTAs. A collateral benefit is that the RTA may also include labor mobility provisions beyond what is covered by GATS, such as the right of establishment and full national treatment (non-discrimination) for service suppliers based in the partner country; commitments on visas; and chapters that spell out the rights of investors. A comparison of labor provisions reveals other common characteristics: (1) labor mobility does not typically replace general migration legislation; (2) a right of labor mobility does not automatically entail the right to practice a certain profession as national regulations for licensing and qualifications usually apply; (3) some agreements are limited to specific sectors (e.g. manufacturing); and (4) some agreements move beyond the WTO General Agreement on Trade in Services (GATS) to cover intra-corporate transferees and investors in a separate chapter on general movement of natural persons. While most RTAs focus almost exclusively on professional service providers, distinct progress has been made with respect to professional services. Many go beyond the WTO GATS in providing access for a greater number of categories of professional services, either with expanded numbers of covered categories or in providing unlimited access. For example, in some RTAs, the coverage of labor categories is expanded to include technicians, trainees, nurses, caregivers, installers, spouses and dependents. Differences between developed countries` approach to Mode 4 liberalization are striking: time limits, numerical limits, range of professionals, and their imagination in creating innovative categories. They also often offer the possibility of long-term visa renewals once professionals are settled in the country. Very recent development shows a few developed countries have been willing to go beyond the expansion of access for professional service providers. This includes notably Canada, in the two recent FTAs negotiated with Colombia and Peru: the FTAs extend access to the Canadian market to 50 categories of technicians. The innovative category also includes the EPA of the EU with CARIFORUM that has extended market access to contractual service suppliers and independent professionals (for 6 months) and to graduate trainees (for 1 year). Japan has moved to liberalize access to its labor market for the categories of nurses and care workers in its recent EPAs with Indonesia and the Philippines. Finally, both Australia and New Zealand have expanded the categories of labor in their RTAs to include both contractual service suppliers and installers (for New Zealand) in their recent agreement with ASEAN members and in the New Zealand RTA with China. The New Zealand RTA with China also has novel provisions for artisans that are proficient in Chinese cultural occupations, such as theater, language, and medicine. Australia has innovated in its very recent RTA with Chile to cover the spouses and dependents for ICTs and CSSs residing in the country longer than one year. Thus Trade agreements have moved over the past two years beyond the purely professional 54 categories of labor to include CSSs, semi-professionals and technicians, nurses, care workers ­ and even spouses and dependents ­ within their scope. The trading partners that have been the most willing to open their markets wider for foreign workers from developing RTA partners have been countries that face considerable labor shortages. Canada has shown itself the most generous in this respect, with Japan being selective and sector-specific in responding to its labor market needs. Australia has been willing to consider family dependents as part of the labor categories defined under its most recent RTA. The United States and the European Union who have both faced heavy inward migration flows ­ both documented and undocumented ­ from Latin America (in the United States) case and from North Africa and Eastern Europe (in the EU case), are less willing to contractually bind greater market openness for foreign workers in their RTAs.1 Nonetheless, the European Union did expand its coverage of labor categories in the recent EPA with CARIFORUM members. However, in the United States official and public attitudes have turned sour, and no agreements have been negotiated with Mode 4 coverage since 2002. Against this background, there is scope for further expanding opportunities in RTAs. The story of labor mobility within trade agreements continues to evolve. Developing countries who are able to pro-actively define and push their interests with developed-country trading partners should find opportunities that did not exist in the past. To this end, developing countries need a well-designed strategy. It would be advisable to develop local training programs for the specific skills required in the target market. Bilateral labor agreements (BLAs) are alternative instruments to the more legalistic and rigid RTAs, in particular in promoting mobility of semi-skilled and unskilled labors. The first and foremost advantage of BLAs or Temporary Worker Programs is that they provide considerably more flexibility with respect to the management of the labor market by the countries involved. Such agreements can be negotiated in response to the economic cycles of the market. Importantly, monitoring of such agreements can be carried out on both sides as a joint responsibility, rather than putting the burden entirely on the destination country to determine the legality of the worker. Guarantees can be designed and written into the agreements in the form of bonds or fines for non- compliance, to encourage the respect for the provisions by private parties. Of course the disadvantage of bilateral labor agreements is that they are single-issue instruments, unlike RTAs. This limitation means that developing country partners do not have the scope, within a BLA, to trade off their offensive interests in labor mobility for the offensive interests of their developed country trading partners. Possible lessons for China 1 Indeed, a very recent RTA between the EFTA members and Colombia, signed on November 25, 2008, does not even include an Annex on Professional Service Suppliers and contains no mention of the movement of natural persons other than their definition as Mode 4 in the body of the agreement. The EFTA members ­ Iceland, Liechtenstein, Norway and Switzerland ­ are not facing labor shortages, and in the current hostile economic climate did not feel any pressure to include liberalization of labor mobility as part of their agreement with Colombia. See www.sice.oas.org. 55 Given that low-skilled workers account for the majority of Chinese seeking employment abroad (estimated about 75% of total labor exports in 2004), the prospects for liberalizing labor mobility along the outlines of GATS Mode 4 may not resonate strongly with Chinese RTA interests. Liberalization under Mode 4 is oriented to highly skilled service suppliers, as well as executives, managers, and other intra-corporate transferees. Like most developing countries, such as Thailand and Philippines, China has expressed its interest in better opportunities abroad for middle- skill groups, including semi-skilled and even unskilled workers.1 So far, China has only reached agreement on limited labor mobility and some facilitation. Until recently, China addressed labor mobility through stand-alone bilateral cooperation agreements or MOUs rather than in PTAs. 2 In 2008, one of the more ambitious and comprehensive labor agreements was reached with New Zealand. Annexes 10 to 12 of the China-New Zealand PTA permit temporary labor mobility, including unique bilateral commitments to allow up to 800 skilled workers from China in specific cultural sectors (e.g., Chinese medicine, martial arts) and a maximum of 1,000 skilled workers for up to three years in specified occupations where New Zealand faces a shortage of skills. Facilitation clauses call for improved processing and transparency of visa requirements, and extended work permits for senior and intra-corporate transferees. Following the framework used with New Zealand, labor mobility for business visitors and intra-corporate transferees were also included in recent Chinese trade agreements with Singapore and Peru.3 When China is interested in pursuing bilateral trade agreements with the major developed trading partners (other than the United States at the present), there is a chance to obtain an expanded market access. Labor markets worth exploring are opportunities for firms and individuals that bring unique cultural talents or specialized skills, some independent professionals, and niches of the industrialized developed economies with labor shortages ­ geographic locations or particular occupations. If developing countries such as China wish to promote exports of service providers in the health services, this is certainly an area that offers a large potential for expansion. For this market, it might be advisable to develop local training programs for the specific skills required in the target market, in the way that the Philippines has done and Indonesia is currently doing. In the case of workers with lower skill levels and less formal educational training, the best vehicle for promoting greater labor mobility is not that of formal RTAs, but rather the more flexible instrument of temporary worker programs (TWPs). 1 China is also interested in labor mobility under Mode 4, including under the categories of intra-corporate transferees and business visitors because China has become a platform for many multinational companies. Relative to its population size, Chinese labor migration is small, contributing about 540,000 compared with 9 million from the Philippines. See Shin-yi Peng, (2006), Hufbauer and Stephenson (2009), and Gao (2009), 2 China has signed 10 bilateral labor cooperation agreements with 10 countries, including the UK, Russia, Jordan, Malaysia, Korea, Mauritius, Saipan, Bahrain, Australia and UAE. See Gao (2009) 3 The China-Singapore PTA also included labor mobility for contractual service suppliers. While the China-Chile PTA includes an annex on temporary movement of business persons, it does not contain substantive commitments. See Gao (2009). 56 Nevertheless, given the super political sensitivity of labor mobility, labor mobility negotiations will be a long, persistent, and patient search for niches in the labor markets of development countries where greater entry of migrants is not only tolerated but welcomed. To better serve the negotiations, policy makers and negotiators may bear the following six precepts in mind: Negotiators should approach the discussions of labor mobility with a positive attitude and emphasize gains to the destination country. The economic gains are invariably large, and the political costs are often exaggerated, but it is helpful when negotiators from developing countries can research particular labor markets and lay the facts on the table. To better serve their negotiators, government should conduct in-depth research on the labor markets of potential destination countries. The goal is to discover promising niches. This will require specialized officers or contractors working in the destination countries. Likewise, country specialists should work with educational and credentialing authorities in the developed countries to lay the groundwork for mutual recognition agreements for the benefit of their independent professionals and other highly skilled workers. Also, China could push for the formulation of international standards based on its own domestic standards in sectors in which China has special advantage, such as TCM, Chinese chef, Mandarin language teacher, martial arts instructors, etc. When Chinese firms are seeking to expand their operations abroad, whether in a developed or developing country, government negotiators should team up with the firm to ensure agreement on the requisite number of visas for ICTs and CSSs to support the new operation. This needs to be done whether or not an RTA is in place. Negotiators should seek agreement on the status of Mode 4 workers, meaning their rights as to visas, working conditions, social security contributions, unemployment compensation, and ability to remit funds. For example, quota designations for certain cultural occupations, and artisans and workers in short supply, may be feasible, especially if there is some provision for flexibly adjusting the quotas on an annual or biennial basis to reflect labor market conditions. Above all, senior officials must mind the image of their migrants abroad ­ doing whatever is possible to ensure that their migrants are seen as hard- working, law-abiding, respectful people. When adverse incidents happen, as they will, the government should cooperate as appropriate, including revocation of visas and other measures. 57 References Gary Hufbauer and Sherry Stephenson (2009) Increasing Labour Mobility: Options for Developing Countries, background paper Gary Hufbauer and Yee Wong (2009) China`s Trade Agreements: Lessons from Other Countries, background paper Henry Gao (2009) Supporting China`s Regional Trade Agenda: China`s Strategies on Negotiating Competition, Environment, and Mode 4 Provisions in its RTAs, background paper 58 Annex 7.1 Comparison between WTO and RTA Provisions This annex will provide a brief overview of the nature and type of provisions for labor mobility in developed countries` RTAs as they are compared with WTO GATS Mode 4. United States NAFTA predated and informed the development of GATS by providing the language for temporary labor mobility, defined as the temporary movement of business persons without the intent to establish permanent residence. Under NAFTA, a separate side agreement for labor, the North American Agreement on Labor Cooperation (NAALC) emphasized that each Party had a commitment to enforce its domestic labor laws but also addressed questions beyond the standards articulated in conventions of the International Labor Organization (ILO).110 The inclusion of internationally recognized labor rights, especially minimum wage provisions that potentially have the greatest impact on trade, goes beyond core ILO standards; this has become standard fare in nearly all US RTAs.2 Specifically, the NAALC adopted clauses to prevent occupational injuries and illnesses; to provide compensation in cases of occupational injuries and illnesses; to protect migrant workers; and to ensure labor rights related to minimum wages. In NAFTA, labor mobility provisions were limited to higher skilled workers in four business categories: business visitors, professionals, intra-company transferees; and traders or investors (including those in the agriculture and manufacturing sectors). To facilitate temporary labor mobility, Chapter 16 of NAFTA also allowed renewable Trade NAFTA (TN) visas for professionals that lasted up to one year and are now uncapped for both Canadians and Mexicans. Besides NAFTA, agreements with Chile and Singapore expanded labor mobility for professional workers, and created a path for H-1B1 visa that included the possibility of unlimited extensions. Unfortunately, these provisions sparked a strong backlash from the US Congress, which objected to trade agreements that seemed to infringe on immigration policy. Since 2002, no trade agreements have included a chapter on temporary entry. Instead, RTAs with Morocco, DR-CAFTA and Peru, include an Annex on Professionals with similar objectives as the NAFTA Annex. While NAFTA provides the most comprehensive example of US legal provisions for labor in a RTA context, all US RTAs include at least one reference to labor standards in 1 It is important to emphasize, however, that NAFTA does not embrace ILO conventions, since few of them have been accepted by the United States. 10 It is important to emphasize, however, that NAFTA does not embrace ILO conventions, since few of them have been accepted by the United States. 2 These international labor standards reflect domestic US concerns about trade policy and they include: the right of association; the right to organize and bargain collectively; prohibition of forced or compulsory labor; minimum age for employment of children; and acceptable conditions of work with respect to minimum wages, hours of work and occupational safety and health. See Grynberg and Qalo (2007). 59 the preamble. Examples of stronger labor clauses include the US-Jordan, US-Chile and US-Peru RTAs, which emphasize commitments to international labor standards and domestic labor laws, and encourage cooperation to improve basic worker`s rights. In particular, the US-Jordan RTA goes a step further to ensure that parties meet obligations on labor standards, subjects not included under NAFTA. The US-Jordan RTA stipulates that each Party shall not fail to effectively enforce its domestic labor laws in a manner affecting trade between the Parties. Labor standards were mentioned in RTAs with Australia and Singapore, but negotiations leading to the US-Peru RTA provided a new template, in accordance with a US Congressional mandate for language on fundamental labor rights. This template has now been applied to recent RTAs with Colombia, Panama, Peru and South Korea. In particular, the Peru RTA forbids governments from waiving or otherwise derogating from fundamental labor rights (a term that was not further defined).1 As a result, the United States is now an advocate for stronger set of international legal responsibilities, such as the obligation to adopt and maintain labor rights. European Union Except for the founding European agreement, the Treaty of Rome (ratified in 1957) and non-reciprocal RTAs with African and Caribbean countries, the EU has shown less appetite for including labor standards in bilateral and regional association agreements. Under Article 18 of the Treaty of Rome, Europe took a very liberal approach to labor mobility that extended to all categories of citizens and includes immigration rights. However, this single country approach only applies to the core EU 15 members; free immigration from the newer 10 members, admitted in 2004 is supposed to be a reality by 2011. European RTAs with non-member countries are more restrictive, partly because the European Commission does not yet have negotiating authority from EU member states in all of the service areas. Accordingly the RTAs reserve to each party the discretion to grant, refuse and administer residence permits or visas. The Euro-Mediterranean agreements explicitly state that labor mobility provisions cannot be used to challenge an immigration decision that refuses entry. Unlike US RTAs, European labor provisions are not collected in a single chapter or article, but instead are referenced in other provisions. For example, the EC-Chile RTA addresses labor standards in Article 44, within the context of a general provision on social cooperation that mentions a commitment to relevant ILO conventions. Other trade agreements, such as the Euro-Mediterranean RTAs with Morocco and Tunisia, stipulate non-discriminatory conditions for workers beyond service suppliers. 1 See Article 17.1 of the US-Peru RTA, available at: http://www.ustr.gov/Trade_Agreements/Bilateral/Peru_TPA/Section_Index.html. The interpretations of other key provisions, such as "freedom of association" and "collective bargaining," are likewise undefined. The United States has not ratified the ILO convention on freedom of association, which dates to 1949. As a result, the US government has adopted labor provisions in its RTAs that go beyond its acceptance of ILO declarations, opening the possibility that US federal and state labor laws will need to be changed or be subject to trade sanctions. See Charnovitz (2008). 60 Japan and New Zealand Japanese and New Zealand RTAs do not explicitly address labor provisions.1 Instead, in cases where RTAs do not contain labor-related provisions, Japan or New Zealand is expected to observe the fundamental principles stated in the ILO Declaration on Fundamental Principles and Rights at Work (1998). Key ILO labor rights enumerated in the Declaration and other conventions include: freedom of association, right to organize and bargain collectively, non-discrimination, freedom from forced labor, minimum age of employment for children, and elimination of the worst forms of child labor. In some cases, Japanese RTAs outline a narrow application of labor standards. For example, Article 103 of the Japan-Philippines RTA emphasizes that both parties should not weaken domestic labor laws to attract investment: Parties recognize that it is inappropriate to encourage investment by weakening or reducing the protections afforded in domestic labor laws.2 1 The same practice is followed in RTAs negotiated by EFTA. 2 Bourgeois, Dawar and Evenett (2007). 61 Annex 7.2 Scope of Labor Mobility in RTAs Countries in geographic proximity to one another and with similar levels of economic development ­ such as within the European Union or the Australia-New Zealand Trans- Tasman Travel Arrangement (TTTA) ­ are likely to follow a more liberal approach to labor mobility. United States NAFTA is the only US RTA that offers full mobility of labor in designated categories, albeit temporary, and in the case of Mexico with numerical limits (since relaxed). All other trade agreements start with the GATS framework (constructed after NAFTA had been signed), and then add additional elements. The US-Jordan RTA, for example, extends GATS labor mobility by specifying visa commitments for both independent traders and persons linked to investment beyond service suppliers. European Union Under the Treaty of Rome, the original European Community guaranteed comprehensive rights of labor mobility, allowing every EC citizen the fundamental right to move freely between the territories of member states. This, of course, is the general practice within single nations. No visas or work permits were necessary to move from one EC member state to another, although sometimes residence permits were required. Despite this liberal foundation, progress still remains to be made in relaxing restrictions on movement of labor within the enlarged European Union. Workers in the new Central and Eastern Europe (CEE) member states are not yet able to move freely. For example, CEE workers face sectoral exclusions and a horizontal transition period of ten years. When the European Union expanded from 15 to 25 member countries in 2004, only the United Kingdom, Ireland and Sweden waived the opportunity to impose immigration restrictions lasting up to seven years. But the United Kingdom allowed unskilled workers from Bulgaria and Romania in just two sectors: food processing and agriculture. Bilateral European RTAs have very limited labor mobility provisions, based primarily on the GATS framework with specific carve-outs. For example, the EU-Mexico RTA only provides labor mobility through trade in services, and specifies a ten-year transition period. Under the Mexico trade agreement, certain sectors are excluded (e.g., audio- visual, air transport) and both parties can regulate the entry and stay of individuals. The EU-Chile RTA, however, is broader in scope and covers Mode 4 as well as 33 categories of professional service providers that it accepts from Chile without numerical limit. Similarly, the EU-CARIFORUM Economic Partnership Agreement expanded the coverage of workers to include contractual service suppliers, independent professionals and graduate trainees. 62 Japan Despite its tradition of a highly restrictive policy towards foreign labor, Japan is one of the few Asian countries that made large commitments under GATS. In particular, as part of its Mode 4 negotiations, Japan offered to increase market access for natural persons that are not related to establishing a commercial presence under Mode 3; moreover, Japan offered a generous time limit of three years for most categories. While none of the Japanese RTAs provide full labor mobility, some include provisions on the ability of companies to bring key personnel under the investment chapter. For example, Chapter 9 of the Japan-Singapore RTA includes specific commitments for movement of persons related to business purposes and investment that outlines short-term visitors and intra- corporate transfers. There are also provisions and a joint committee devoted to mutual recognition of professional qualifications. Two recent RTAs moved beyond the Singapore RTA and indicate an innovative approach that has not yet been seen in other trade agreements. Agreements with Indonesia and the Philippines, for example, are unique in covering specific categories of nurses and care workers with annual quotas and training requirements. New Zealand The combination of the Australia-New Zealand CER and the Trans-Tasman Travel Arrangement (TTTA) allows for full market access, mobility and national treatment for all service suppliers. First established in 1923 and formally codified in 1973, the TTTA was developed through a series of immigration accords between the two countries. Although some sectors under the CER are excluded (e.g. air services, broadcasting, postal services), the TTTA provided complete labor mobility by allowing a person to register an occupation and practice that profession if he is so registered in his home country.1 After the CER, the second most comprehensive labor provisions are articulated in Chapter 11 of the New Zealand-Singapore RTA. Both parties agree to review commitments every two years and expand on initial commitments to meet the APEC objective of free and open trade in services by 2010. While the trade agreement largely mirrors the GATS framework, there are a few features that go beyond GATS: service exporters from New Zealand will have better access to the Singapore market in specific areas such as architecture, engineering, telecommunications, finance, education and environmental services. In addition, business and intra-corporate transferees can enter both countries more freely (up to one month with a possible extension for another two months). Besides the CER and the Singapore RTA, other New Zealand trade agreements, such as the New Zealand-Trans Pacific Strategic Economic Partnership and the Thailand RTA, narrowly focus on steps that will facilitate labor mobility. Examples of labor facilitation include streamlined immigration clearance procedures, increased recognition of qualifications and registration systems for certain professions, and work permits and temporary entry for intra-corporate transferees or senior managers. By contrast, more 1 In 2001, Australia modified the agreement by excluding social security eligibility from New Zealanders who are not permanent residents. 63 substantive commitments under the ASEAN-Australia-New Zealand RTA include a chapter on temporary entry that allows New Zealand managers one of the longest time stays for intra-corporate transferees (3 or 4 years). Recent RTAs with both ASEAN members and China suggest that New Zealand is moving beyond the expansion of access for professional service providers to include both contractual service suppliers and installers. 64 Annex 7.3 Institutions and Enforcement of Labor Provisions in RTAs Most RTAs do not establish a separate institution to enforce national labor laws and regulation commitments. European RTAs, for example, do not create institutions to manage implementation of labor standards. A few US trade agreements create institutions, but and they are usually subsumed within a general institutional structure spelled out in the RTA. Labor provisions are also rarely enforced with a formal dispute settlement mechanism. Instead, most RTA partners agree to hortatory commitments with few enforcement mechanisms, beyond encouraging both parties to comply with their own domestic labor laws. In some trade agreements, such as the Euro-Mediterranean Association Agreements, dispute settlement procedures are simple and vague. The Euro-Med RTAs allow both parties to use Joint Committees to arbitrate any disputes and take any measures deemed appropriate if either signatory fails to fulfill its obligations. These decisions are made on a consultative basis, are non-binding and have no provisions for trade sanctions. Within NAFTA, the United States created a complex consultation mechanism, deliberately designed not to lead to binding arbitration. The Peru RTA establishes a Labor Affairs Council and formal dispute settlement procedures to ensure that both parties effectively enforce their own domestic labor laws; penalties are possible, but as a last resort. Japan established an arbitration panel covering labor issues in just one of its RTAs. Under the Japan-Philippines RTA, labor provisions are addressed in the investment section, and any disputes can be brought to a general dispute settlement mechanism. To forestall a race to the bottom in labor standards (which in any event is unlikely), if one party considers that another has weakened domestic labor laws to encourage investment, it can request consultations with the other party. United States NAFTA, US-Chile, US-Peru and US-CAFTA-DR RTAs are the few trade agreements that established labor-specific regulatory authority to monitor implementation of labor provisions. Under NAFTA, the NAALC cannot enforce labor laws in the territory of a party but it does provide the equivalent of a supranational labor affairs council. Under Article 4, any entity with a legally recognized interest can access NAALC tribunals for evaluating the enforcement of a party`s domestic labor laws. NAALC is unique in being the first regional labor side agreement containing economic sanctions for labor rights violations, following an arbitration process. In theory, fines can be levied to redress persistent non-enforcement, and if fines are not paid the other NAFTA parties can then impose trade sanctions. However, these measures have never been invoked. The NAALC framework has several limitations. For example, although NAALC emphasizes signatories commit to enforce their own national labor laws, NAFTA parties are not committed to observe the ILO Declaration on Fundamental Principles and Rights 65 at Work. The dispute settlement mechanism is cumbersome, and the lengthy process for issuing reports averages more than 30 months. Since 2002, the United States has amplified the possibility of enforcing labor standards in its bilateral RTAs. Some recent RTAs, such as US-Australia and US-Morocco, explicitly include the option of WTO dispute resolution on labor standards issues. The US-Peru RTA strengthens labor provisions by mandating both parties to enforce domestic labor laws through a mechanism that includes monetary penalties, transparent domestic legal procedures and openness (e.g., a public hearing). The Peru RTA also creates a labor cooperation and capacity building mechanism to promote cooperation on labor-related issues such as fundamental rights to work, the worst forms of child labor, and occupational safety.1 Besides NAALC and the Labor Council under the Peru RTA, a few other US RTAs incorporated labor-related institutions under the umbrella of Joint Committees that oversee the general implementation of the trade agreement. For example, the US-Jordan RTA allows the possibility for an independent supranational dispute settlement mechanism and grants non-binding dispute panel proceedings for the violation of labor provisions.2 However, there is a high threshold to meet before initiating a review of labor rights issues. Unlike the NAFTA, the parties to the US- Jordan RTA agreed in an exchange of letters not to impose trade sanctions for labor disputes. By contrast, sanctions under RTA with Chile, Peru and Singapore are allowed, though the possibility is remote and a cap of $15 million annually is imposed. The weakest institutional mechanism to oversee labor provisions is the voluntary option, where both parties designate a domestic representative at the national level within the labor ministry to consult on labor affairs. For example, the US-Morocco RTA only encourages parties to commit to provisions and, if necessary, convene a national labor advisory committee or publish any relevant reports. 1 See Villarreal and Bolle (2006); and Everett Eissenstat, Assistant USTR, Testimony before House Committee on Ways and Means, July 12, 2006. 2 By contrast, NAFTA only allowed complaints to be submitted on three key labor provisions: child labor, minimum wage and technical labor standards, and occupational safety and health. 66 8 Competition Provisions in FTAs: Lessons for China Jean-Pierre Chauffour The costs imposed by anti-competitive practices were recognized by Adam Smith more than two hundred years ago. Today, countries widely appreciate Smith`s insights and the potential for anti-competitive practices to undermine the benefits of trade liberalization. Even though the Doha round negotiators under WTO auspices have no mandate to negotiate a multilateral framework on competition policy, individual countries have signed rules on competition policy in at least one quarter of all bilateral and regional trade agreements (RTAs) in force or under negotiation. The inclusion of competition-related policies are part of the growing agenda on behind the border measures, ­ the effort to deepen trade agreements to cover liberalization in services, investment and labor markets, government procurement, monetary and financial integration, and environmental issues. Competition policies may play a significant role in supporting the benefits of trade and investment liberalization. They prevent the economic and consumer welfare gains anticipated from liberalizing markets from being undermined by cross-border anticompetitive practices (e.g., cross-border mergers and acquisitions that could monopolize the domestic market). Competition provisions also tend to reduce collateral distortions from other policies, for example anti-dumping measures implemented with price or volume undertakings. They support region-wide competition policy institutions, and ensure that foreign firms can access open and competitive markets. Competition provisions could be particularly useful for dynamic emerging countries such as China. Commitment to sound competition policies can help developing countries overcome powerful domestic constituencies that would otherwise block the reform process and carry on their cartel practices. Recent empirical evidence suggests that competition provisions are welfare enhancing in the long-term; the research takes issue with the view raised by some countries that competition provisions will compromise their development efforts. The main challenge facing developing countries such as China seems to be the cost to effectively enforce competition-related policies. Among China`s existing RTAs, none includes special chapters or side agreements on competition. To the extent that some of China`s RTAs contain isolated provisions addressing competition policy, they are usually rather general and do not create specific legal obligations. Moreover, they often do not go beyond the existing WTO provisions. For example, Articles 69 and 70 of China`s RTA with Singapore address monopolies and exclusive service suppliers and restrictive business practices, respectively. However, closer examination reveals that the two articles simply copied the language of Articles VIII and IX of the GATS without adding anything new.1 1 Similarly, the language on the rejection of practices abusing intellectual property rights in Article 111.1(e) of the RTA with Chile simply reiterates the principles in Article 8 of the TRIPS. 67 The scarcity of competition provisions in China`s existing RTAs does not necessarily mean that China is reluctant to engage in international cooperation on competition policy. Instead, during both the drafting and the enforcement of the Anti-Monopoly Law (AML), China has been cooperating with foreign competition authorities at both the formal and informal levels. This implies some interest by China to consider competition policy in its future RTAs. Several countries, such as Australia, New Zealand and Iceland, have made demands to China on competition provisions in their RTA negotiations. This policy note will review the international experience with competition provisions in RTAs with a view to drawing some possible lessons for China as it pursues its regional trade strategy. International experience The scope of the competition provisions in existing RTAs around the world range from a comprehensive regional competition law to a minimal regime encouraging cooperation in preventing anti-competitive practices. A comprehensive regional law would usually address issues related to cartels and abuse of dominance, state aid and inter-agency cooperation, as well as procedural and transparency requirements. Some regional competition regimes incorporate consumer law to address cross-border consumer protection issues. This can complement competition policies` economic efficiency and social welfare objectives. However, the application of binding judicial dispute settlement mechanisms to support the implementation of competition law and policy is uncommon. With or without a regional competition regime, provisions with competition objectives are often introduced in RTAs without negotiating a competition chapter. These provisions include the principles of non-discrimination and national treatment as well as competition related provisions in other areas, such as intellectual property and services. Nevertheless, these provisions do not present a comprehensive commitment from the parties to create an independent framework to tackle harmful cross-border restrictive business practices or to enable private parties to seek redress against such practices. A useful taxonomy to understand the scope of competition provisions in RTAs would differentiate between substantive and procedural provisions, and between cooperative versus unification models. The cooperative model would promote separate, independent laws with information exchange, while the unification model would tend to harmonize the parties` substantive rules and institutions. Using this taxonomy, one could distinguish between four basic models of competition law, ranging from a fully centralized regional competition law, to the fully decentralized model (see Box 1). Both developed and developing countries have experienced all four models, with varying degrees of success. However, due to the relative immaturity of these regimes, there is still little evidence available on the impact of these provisions to make definitive conclusions about their effects. 68 While most RTA competition regimes focus on the supply side behavior of firms, it is also important to consider the possible demand-side market imperfections. Preventing barriers to market entry, cartels, monopolies, and other restrictive business practices works to protect both consumers and firms. Yet, dealing with these barriers does not directly address demand-side market imperfections caused, for instance, by lack of consumer information or the inability to switch suppliers. Enhancing notification, information sharing, and investigative assistance among the Member States can work to protect foreign consumers from domestic anti-competitive businesses practices and to protect domestic consumers from foreign anti-competitive business. It can also help to prevent inappropriate consumer policies becoming unnecessary barriers to trade. A number of RTAs have explicitly mainstreamed their consumer law provisions within or alongside the competition regimes to address the legislative and enforcement gaps in cross-border trade relating to consumer welfare. For instance, the Australian regional competition agreements with the United States, South Korea and Papua New Guinea incorporate consumer policy provisions. The COMESA treaty also addresses consumer welfare from within its competition regime. While including competition provisions in a RTA makes sense in theory, implementation based on limited evidence from US and EU experience has proven difficult. One feature that clouds an evaluation is that the level of ambition of competition policies varies depending on the level of economic development among the signatories and the extent that its regulatory structure is shaped by the rule of law. The United States and the European Union have been most active in advocating ambitious models for competition provisions; Japan and New Zealand have taken a less comprehensive approach. Implementation records have been particularly poor in developing countries. Lack of effective implementation and enforcement is more common for RTA members that did not possess a national competition law prior to accepting regional commitments; or in those RTAs with members at very different stages of competition regime development. This is partly due to lack of knowledge and experience of competition policies. But without an effective domestic law in all the member states of an agreement, there can be no legal basis for a member to take any action against practices organized in another member state in respect of the effects upon its own territory. And where regional regimes establish measures such as cooperation, notification, consultations to generate regional benefits, they are of little use nationally without the human resources and expertise to absorb or respond to the information. 69 Box 8.1 Models of Competition Regimes in RTAs Full Centralization. The most comprehensive regional competition regime consists of a supra-national law with a distinct regional jurisdiction. While the regional and domestic laws can overlap, the regional laws only address competitive practices taking place in the regional territory that is beyond the jurisdictional boundaries of just one member of the RTA. These competition laws are directly applicable within the territory of a Member and superior to any national law or judgment that is inconsistent with the regional law. Regional competition laws may also have direct effect` in the Members` jurisdictions, providing firms or citizens the right to invoke the regional law in the domestic courts of the member countries. To fully centralize the regional competition law, a complementary regional institutional mechanism is established to conduct investigations, enforce actions and assess and levy penalties. Examples of this model include the competition laws established in the EC Treaty, the COMESA, UEMOA and the Andean Pact. Partial Centralization. The less centralized competition model establishes a regional competition law, but supports this with only a partially centralized agency. As with the fully centralized regional regime, the independent regional law has direct applicability and superiority over inconsistent national laws. However, although the central agency has the mandate to receive complaints and initiate independent investigations, it must work with the Member State competition agencies and national courts to process case actions leading to enforcement and remedies. Examples of this model include ANZCERTA and CARICOM. Partial Decentralization. Further down the scale of centralization are regional regimes which are not buttressed by a regional authority. While a regional law is established, different means of intergovernmental cooperation are responsible for promoting the regional law. There is no independent regional body with powers of investigation and enforcement. Thus, the application of the law is left entirely to the Members States. National competition authorities have the jurisdiction to bring cases and they are also the recipients of complaints addressed at any violation of the regional competition law. Mercosur is an example of this model. Fully Decentralized. The least centralized regional regime identified in a regional competition regime exists where the Members do not create a regional law but rather set out the necessary criteria for national law and cooperation principles to address anti- competitive practices that are detrimental to the functioning of the RTA. These provisions require the implementation of or maintain measures to proscribe The reasons for the poor members to adopt regional competition provisions are anticompetitive business conduct and to take relating to action, competition out any both structural/institutional, and behavioral, appropriate lack of but do not setculture or more specific competition rules. The provisions formalize consultation and co-operation political will to promote implementation domestically. Relying on bottom-up between the initiatives the enforcement of those is less appropriate when both a implementation parties on in south-south agreements laws via mutual legal assistance, notification, consultation and the exchange of and institutions are absent. A well competition culture and buttressing regional lawsinformation. Examples of this model include regional competition agreement Canada-Costa Rica and SACU. designed NAFTA Chapter 15, Canada-Chile, needs to takes account of these local circumstances and act as a policy tool to create the national structural and behavioral environment necessary to benefit from regional competition provisions. 70 North-south agreements have better implementation records when the more developed party offers appropriate technical assistance, capacity building and ability to the less developed regional partner. For those members with nascent or non- existent competition regimes, technical assistance provisions should be designed to impart the necessary expertise and experience over the long term. This will assist in inculcating the necessary behavioral reforms. While RTA competition provisions can offer the legislative push and policy lock-in necessary for sustained reform, initially a more appropriate key objective may be to focus on establishing a culture that values competition at the national or sub regional level in the region. In RTAs involving members with no or little experience of applying competition policy, the provisions should focus primarily on the exchange of information, technical assistance and capacity building. Subsequent negotiations can expand the agreement. More general commitments should only be implemented after the necessary expertise and cooperation mechanisms have been developed. Provisions could be included that oblige members, over a specified period of time, to adopt competition laws that can address the full range of private and government sanctioned anti-competitive practices and outcomes. Regional laws can also act as a temporary alternative to the expense of establishing and implementing domestic competition laws. Soft law can be more appropriate if governments are uncertain of the underlying technical issues and judicial consequences of the provisions. If competition regimes are at an early stage of implementation, other non-judicial mechanisms may also be more appropriate, including voluntary peer review, consultations on implementation issues and informal diplomatic methods. These can subsequently be complemented by a non- binding competition policy review mechanism and non-binding consultations, promoting voluntary implementation of competition policy obligations and ultimately harmonization. Mainstreaming consumer law within competition regimes can help to address the legislative and enforcement gaps in cross-border trade relating to consumer protection. This complements and advances the economic and social welfare objectives of competition policy. Transition economies and other countries with a legacy of heavily state-led economies may find it more beneficial to include effective regulation on state aid and antidumping policy to address government created trade distorting practices. Also, in highly centralized regimes that establish a regional authority to assist implementation, the authority must be endowed with strong investigative powers, adequate resources and expertise, cease and desist orders, as well as the power to collect fines if it is to avoid becoming a paper tiger. Possible lessons for China As China becomes more integrated, cross-border market failures can emerge to undermine the benefits of its increased liberalization. These could include regional cartels, cross-border predatory pricing, restrictive vertical marketing agreements 71 establishing price discrimination, and mergers designed to create regionally dominant positions. Unilateral competition measures undertaken by national governments cannot address such negative cross-border anti-competitive practices adequately unless there is some mechanism to promote inter-governmental cooperation. In principle, implementing effective regional competition law and policy can be used to address these negative practices and generate more efficient markets offering better quality goods for cheaper prices, and encourage investment. Further benefits may also be achieved from mainstreaming consumer policy into regional competition laws to develop the effective demand for competition. The option for cooperation to deal with cross-border consumer protection issues complements both economic and social development objectives. China can draw on the international experience to maximize the benefits of negotiating competition provisions in its future RTAs. While more cost-benefit analyses of the different regimes and provisions discussed above are required to craft appropriate regional competition regimes addressing both the institutional and behavioral factors obstructing successful implementation, a number of preliminary conclusions can be drawn as below. Negotiating appropriate competition provisions in an RTA necessarily need to take account of the local institutional and developmental context. Given China`s development status, the rest of this policy note will review possible avenues for China in its future negotiations of competition provisions in RTAs, before providing some possible recommendations to further improve its domestic competition law regime. First, with regard to the overall structure of the competition policy provisions in RTAs, as the competition regime of China is still very young, it is probably better to start with isolated competition provisions for selected sectors (such as services or IPR) and gradually move to broader chapter or side-agreement on general competition issues later. In this regard, China might want to start including such provisions in its RTAs with partners with similar background and experiences (e.g., Singapore) or those with higher integration levels (e.g., Hong Kong), then move on with other partners as it has built up sufficient experience. Second, China could carefully balance its defensive and offensive interests on competition policy. On the one hand, as the factory of the world, China wields considerable influence on the prices of industrial and consumer products. While such market power generally means more profits, it can also raise concerns from third countries` competition authorities.1 On the other hand, due to the growing importance of its domestic market, many multinational corporations (MNCs) are interested in increasing their market shares in China, at times using their dominance in the international market to gain unfair advantage in the Chinese market either by dumping their products at extremely low prices or by raising their prices to generate large profits. Therefore, for the dual purposes of protecting the legitimate interests of Chinese firms in the foreign market 1 As illustrated by the recent cases of antitrust actions against Chinese Vitamin C manufacturers and magnesite producers, compliance with foreign competition regulations have become a major challenge for some Chinese firms. 72 and ensuring effective enforcement of China`s own competition laws in the domestic market, China might consider including provisions on notification, negative comity, positive comity, coordination, and joint investigation in its RTAs. Third, in its future RTA negotiations, China could usefully put the focus on the procedural provisions such as cooperation, consultation and information exchange, rather than substantive provisions that aim to harmonize or coordinate competition standards or rules. Due to its unique historical experience, the challenges facing the competition regime in China are rather different from those in other countries. At one end of the spectrum, because many sectors are still in early stages of development and the entry barriers are very low, these sectors are highly fragmented and even the market leaders only have very small market shares. Thus, the regulators have historically been focusing on the unfair competitive behaviors of small players and lack experience in dealing with monopolies. At the other end of the spectrum, administrative monopolies pose real problems in the Chinese market. Because these administrative monopolies are typically affiliated with government ministries and regulated by special laws and regulations, the reach of the AML is greatly limited. As the main reason for both problems is the legacy of planned economy in China, there is limited relevant international experience on how to handle these problems. Fourth, China may want to use the opportunity of its future RTA negotiations to further discipline its state-owned enterprises (SOEs). Because of the dominance of SOEs in certain sectors, foreign negotiating partners might request China to include in future RTAs special provisions on SOEs, monopolies and enterprises with special and exclusive rights. While China might be reluctant to agree to such provisions in the short term, including these provisions is in China`s long-term interest as competition from foreign firms is usually the only way the SOEs could be made to follow competition disciplines in practice. Fifth, in a similar vein, China may want to consider the strategic use of antidumping measures for its own benefit. For a long time, Chinese firms have been the prime targets of antidumping actions. Indeed, some commentators even argue that, in some cases, the main reason that the Chinese firms form cartels to fix prices is to avoid accusations of dumping. While RTA provisions prohibiting the application of antidumping measures seem to be in the short-term interest of Chinese firms, it is unclear whether such provisions serve its long-term interest as China itself has been increasingly resorting to antidumping investigations and measures. In this regard, further study and better coordination between the antidumping and competition authorities in China would help formulate and establish a common position. As China has adopted a rather critical approach to the existing antidumping regime in the Doha negotiations, China should also coordinate its negotiating positions in both regional and multilateral settings if it decides to adopt a different approach on antidumping measures in future RTA negotiations. Sixth, as the competition issues facing developed and developing countries are rather different, China might consider taking different approaches in RTA negotiations with different countries. Generally speaking, the competition laws and regulations in developing countries are less developed. Thus, in RTAs with developing countries, China might focus on information exchange or joint studies on issues such as 73 the relationship between industrial policy and competition rules, regulations of SOEs, or unfair competition among smaller firms. Moreover, depending on the willingness of the other country, there might not be any competition provision at all in the RTA. In RTAs with developed countries, especially when the other country demands the inclusion of competition policy in the negotiations, China might consider requesting for transition periods, technical assistance, or even exemptions from particular obligations to soften the impact of over-ambitious competition provisions. Finally, competition provisions in RTAs also provide the opportunity to promote and lock-in domestic reforms aimed at improving competition policies domestically. To reap the maximum benefits from the market access opportunities created by RTAs, China might wish to consider further improving its competition law regime as follows: Better coordinating China`s industrial, competition, and trade policies. Industrial policy typically involves fostering a few national champions in a sector to the detriment of the interests of other firms. For competition policy, the interests of consumers are the main concern. For trade policy, the interests of exporting firms and import companies usually take priority. Because of their different focus, these policies might well run into conflicts. For example, when the state decides to merge several firms together to promote the development of certain industry, such action might run afoul to the competition obligations in RTAs. Similarly, when several exporters decide to raise prices together to deal with anti-dumping investigations, they might violate the anti-trust laws of the importing countries. Coordination among various ministries involved in competition is important but not always easy; similarly for coordination between central government and local government; and among local governments themselves. One way to mitigate the problem is to have joint meetings between the different agencies at regular intervals, or at least require an agency to notify and consult the other agencies when it makes changes to its policies. Further improving the legislative framework. While the enactment of the AML is a great achievement, further improvement can be made to make it more effective. Clarification is needed on what industries include in the Article 7, which stipulates that the state protects the lawful operations of industries which are crucial to the well-being of the national economy and dominated by SOEs. The ambiguity may lead to the abuse of this clause. For instance, as many commentators argue, while the telecommunication sector should be included, it is doubtful that value-added telecom services should be accorded the same importance as basic telecom services. Moreover, China may consider enhancing the effectiveness of the AML and furthering empowering the competition authorities to allow them to effectively deal with administrative monopolies. Article 51 states that, when dealing with administrative monopolies, the anti- monopoly enforcement agencies do not have power to sanction the administrative bodies directly. Instead, they may only make recommendations to the relevant bodies at a higher level. Doubt casts on the willingness of the supervising bodies to punish their subordinates. The same article also provides that, in the case that any other relevant laws and regulations have different provisions on 74 administrative monopolies, the provisions in those laws should prevail over the AML. Again, this greatly reduces the effectiveness of the AML. Streamline the competition enforcement process by further delineating the jurisdictions among different competition authorities. In the existing competition regime in China, the enforcement power is shared by several agencies with potentially over-lapping jurisdictions. While this could be justified by the need to develop expertise between agencies, the current practice of giving the jurisdiction to a case to the agency that first gets its hands on the case does not take the relative expertise of the agencies into consideration. In this regard, one possibility is to specify a clear job division and have a one agency in charge of certain subject matters. References Gary Hufbauer and Yee Wong (2009) China`s Trade Agreements: Lessons from Other Countries, background paper Henry Gao (2009) Supporting China`s Regional Trade Agenda: China`s Strategies on Negotiating Competition, Environment, and Mode 4 Provisions in its RTAs, background paper Kamala Dawar (2009) Competition Provisions in Regional Trading Agreements, background paper 75 9 Environment Provisions in FTAs: Lessons for China Jean-Pierre Chauffour & Min Zhao The trade and environment linkage is a sensitive and controversial issue for many countries. While it is true that trade, like any other economic activity, has environmental implications, there are no unanimous views on whether trade as a policy instrument should address environmental concerns. Putting aside the debate about whether environmental issues should be addressed in trade agreements or in stand-alone environmental agreements, the purpose of this policy note is to identify the main contours of the trade and environment debate in the context of Regional Trade Agreements (RTAs). At the multilateral level, international trade law and international environmental law have traditionally been viewed as independent disciplines, and have been dealt with under different international instruments. The agreements of the World Trade Organization (WTO) recognize certain broad principles relating to the environment. The Doha Declaration also mandates countries to examine this linkage closely. WTO`s jurisprudence on the subject of trade and environment recognizes that WTO law does not exist in clinical isolation of international law and developments, including environmental concerns. However, it emphasizes that environmental measures to restrict trade can be adopted only under certain strict conditions. As the Doha round stalls, trade-related environmental concerns are increasingly being integrated in trade deals at the bilateral and regional levels. Three key reasons for adding environmental provisions in RTAs include: (1) enthusiasm for sustainable development; (2) worries that weak environmental enforcement can create unfair competitive advantages; and (3) efforts to advance the international environmental agenda by using sanctions that are not agreed on a multilateral basis. While most countries recite environmental cooperation among the goals of their RTAs, the scope of environmental provisions in RTAs varies significantly, even among developed countries. While RTAs signed by the United States, the European Union and New Zealand contain some of the most comprehensive environment provisions, Japan has taken a less ambitious approach. Overall, there has been an increased awareness of the possible benefits of environmental provisions in RTAs. The widespread worry that stricter implementation of environmental rules would undermine national competitiveness in the context of free trade has proven to be unfounded. Empirical research suggests that the costs of compliance with environmental regulations have had little or no impact on the overall competitiveness of countries. In fact, some economists advance a trading up hypothesis of liberalization, the idea that trade leads to upward convergence towards more stringent environmental policies. However, it remains to be seen whether the trading up hypothesis will apply to climate change measures, which are likely to be far more costly than past efforts to better the environment. 76 As China shifts its development agenda from primarily pursuing growth to achieving a more balanced and sustainable development, the experience of advanced economies in the treatment of environmental provisions in the context of RTA negotiations could provide valuable insights and lessons. International experience Developed economies such as the United States, Canada, the European Union and New Zealand, have been using progressively elaborate environmental provisions in their recent RTA negotiations. However, the approach of each country is different, and the depth and scope of RTAs entered into by them varies. RTAs entered into by the United States have the most elaborate and sophisticated provisions on environment so far, most of which are worded as legally binding provisions. The EU RTAs with Chile and the Mediterranean countries concluded in the early 2000s did not have elaborate provisions on environment. The European Union, however, seems to be approaching far more complex provisions since its agreement with the Cariforum countries in 2008, and in its current negotiations with ACP countries. Among other developed countries, the approach taken by Japan and Australia is less ambitious. Environmental considerations are mentioned in all Japanese trade agreements and Japan discourages investments that waive or relax environmental standards. However, its emphasis has been on principles of cooperation to achieve certain environmental objectives. Australia has not been a proponent of environmental provisions in RTAs. Its 2004 agreement with the United States reflects environmental provisions to the extent that they reflect the approach taken by the United States in its RTA negotiations. Australia has however not replicated such provisions in any of the other RTAs entered into by it. A strong political commitment, reflected in parliamentary resolutions, legislative mandates, or declared trade strategies seems to be a critical precursor for including environmental provisions in trade agreements. Environmental mandates were legislated under the US Trade Act (2002), in the context of trade negotiating objectives laid down by the US Congress. Specifically, the Congress declared that trade agreements should strengthen the capacity of trading partners to protect the environment through the promotion of sustainable development; should provide market access for US environmental technologies, goods and services; and should ensure that environmental policies abroad do not discriminate against US exports or serve as disguised barriers to trade. In 2001, the New Zealand government adopted a Cabinet mandate for harmonizing trade policy objectives with environmental goals. Under the Framework for Integrating Environment Standards and Trade Agreements, New Zealand emphasized that environmental provisions should not be misused for protectionist reasons nor should they lower environmental standards. In contrast, Japanese government does not have a mandate to advance environmental goals in RTA negotiations. A number of important considerations can be drawn from international experience in terms of environmental provisions. They include the role of pre-RTA environmental 77 impact assessments, the location of the provisions in a side agreement or in the main text of the agreement, and the exact nature of environmental provisions. Pre-RTA Environmental Impact Assessments are required in some countries. The United States, Canada, the European Union and New Zealand regularly conduct impact assessments of the RTAs they are negotiating on the environment. The focus of such assessments by the United States, Canada and New Zealand is on the impact on the environment within their countries, although a few recent U.S. RTAs have reflected on potential impact in the trading partner as well. The European Union`s approach is to conduct Sustainability Impact Assessments` that focus on the economic, social and environmental assessments in both the European Union and the trading partner. Environmental Provisions can be incorporated in Side Agreements to RTAs or in Main Text of RTAs. Neither approach is necessarily superior to the other, since the legal implications of the approaches depend first and foremost on the nature of the provisions that they reflect. Side agreements do not necessarily imply that environment is only an incidental issue. Some of the strongest provisions on environment are reflected in North American Agreement on Environmental Cooperation, which was concluded between the United States, Canada and Mexico as a side agreement` to the North American Free Trade Agreement (NAFTA). RTAs commonly include environmental provisions in the body of the agreement, but the level of commitment varies depending on several key factors. These include whether environment is only recited in the preamble or separately detailed in a chapter on the environment; the types of institutions, including dispute settlement mechanisms, created to facilitate cooperation and monitor enforcement of environmental laws; and the types of capacity building and technical cooperation offered. Once provisions are written into the text, perhaps the most important step is to agree on effective enforcement mechanisms. So far, no RTA has adopted an enforcement mechanism for environmental issues that has the same bite as, for example, enforcement of tariff bindings. Nature of Environmental Provisions in RTAs: Environmental provisions used in U.S. and EU RTAs typically reflect a blend of legally binding and non-binding provisions. Environmental provisions in RTAs entered into by Japan have so far reflected mainly non-binding principles. Several of the binding obligations pertain to the high standards that a party is required to ensure in its domestic environmental laws. The terminology used in most U.S. and EU RTAs tries to achieve a balance between sovereign decision-making in enacting suitable provisions, and a commitment to exercise such decision-making in a manner consistent with achieving high environmental standards. Environmental provisions in RTAs entered into by several countries also focus on specific areas for cooperation between the parties to achieve environmental objectives. Technical Assistance and Capacity Building: The need for technical assistance and capacity building is recognized in most RTAs that incorporate environmental provisions, in respect of compliance with environmental requirements and standards. In addition, incorporation of environmental standards in product standards aimed at sanitary and phytosanitary requirements, and technical 78 regulations, are also areas where technical assistance and capacity building is often required for developing countries, in order to ensure adequate market access for their exports. However technical assistance and capacity building are not worded in legally binding terms. Several important initiatives have been undertaken under both U.S. and EU RTAs towards fulfilling the obligations of technical assistance and capacity building. Elements of cooperation to achieve specific environmental objectives are also enumerated in RTAs entered into by the United States, the European Union, and Japan. Dispute Settlement and Remedies: Dispute settlement provisions in RTAs typically consist of consultations, followed by formal dispute settlement. Most U.S. RTAs prescribe remedies in the form of monetary compensation for non- compliance with environmental provisions. In the event such compensation is not paid by a party, then as a last resort, there can be tariff suspensions. EU RTAs leave open the issue of compliance measures` to the judicial mechanism hearing the dispute, which may include monetary compensation, but not suspension of concessions. However, since environmental provisions in RTAs are of fairly recent origin, there is little jurisprudence currently to assess the impact of such provisions, since no formal state-to-state disputes have been raised as yet under existing RTAs. A few RTAs also comprise provisions on public submissions` to the Environmental Committee constituted under the RTA. Such submissions result in fact-finding` reports, but do not result in any binding conclusions. Possible lessons for China While China has shifted its development objectives from primarily focusing on growth to pursuing a more balanced and sustainable development, environmental concerns have not, so far, been a high priority on the Chinese RTA agenda. China has acceded to more than 50 international conventions on environmental protection, including two landmark accords, the Kyoto Protocol and the Montreal Protocol. Most of China RTAs contains clauses on environmental cooperation. However, in China`s existing RTAs, environmental provisions are typically limited to the mentioning of the principle of sustainable development in the preamble, the recognition of the possibility to use environmental measures as an exception to the general trade obligations, and general language on environmental cooperation among the parties. In addition, some RTAs include liberalizations on environmental goods and services in the respective schedules. For example, in the RTA with Chile, China agreed to partially liberalize the environmental services sector. In some of the most recent RTAs, however, China seems to lean toward a more active approach to environmental considerations. This is consistent with the shift of China`s development objective. For example, in the RTA with Singapore, China agreed to cooperate with Singapore on the Tianjin Eco-city project and enhance cooperation on environmental protection and energy and resource conservation. Another example is the RTA with New Zealand, which includes a side agreement on environmental cooperation. This agreement uses only best-endeavor language and does not create any binding 79 obligations. The RTA with Chile also mentions a possible side environmental cooperation agreement. It may be increasingly in China`s interest to address more provisions on environment in RTA negotiations. The inclusion of more environmental provisions in RTAs and the resulting pressure from foreign governments and firms will provide China with the necessary impetus to carry out domestic environment policy reforms. As most of the environmental provisions in the existing RTAs focus on information exchange, cooperation and dialogue, it is unlikely that binding environmental obligations will be included in China`s RTAs for the foreseeable future. Yet, environmental provisions could usefully help trigger domestic reforms to enhance the institutional capacity of the environmental protection agencies, revamp the existing legislative framework, and strengthen the enforcement mechanism in China. From this perspective, China may wish to consider having a governmental mandate to explicitly address environmental issues in its PTA negotiations. Nevertheless, negotiating appropriate environment provisions in an RTA necessarily needs to take account of the local institutional and developmental context. The agenda on environment by a developing country like China needs not to be reactive` in all cases. China should carefully consider its interests, which include both offensive and defensive interests. Examples of offensive interests include limitations on green barriers such as trade-protectionist measures disguised as environmental protection measures. Defensive interests, on the other hand, include the affirmation of China`s right to set and maintain any WTO-consistent environmental protection measures that corresponds to the level of economic development. China might also be interested in making explicit climate change commitments that could mitigate potential carbon tariffs imposed by its trading partners. An appropriate environment policy cannot be made without a comprehensive pre- RTA assessment. The pre-RTA assessment often include the following elements: 1) environmental assessment of RTA; 2) economic Costs assessment of Environmental Provisions, which is required to understand the actual economic costs of implementing the contemplated environmental provisions; 3) regulatory inventory through which identifying legislative changes at the domestic level required by proposed provisions; and 4) capacity assessment of local institutions which can be adapted so as to ensure compliance with the proposed environmental provisions. Based on the assessment results, policy makers can align the environment provisions in RTAs with China`s overall development strategy. In terms of the negotiating strategy, China might wish to take a pragmatic approach--being flexible towards different negotiating partners. When negotiating with countries with similar levels of economic development and environmental protection, China might wish to include clauses on joint study, joint action, or even harmonize environmental standards, laws and regulations in particular areas of mutual interest. The harmonized standards and rules are particularly important as they not only address problems in the region, but also may form the basis of global rules that could be used as an alternative to those reflecting mainly developed country interests. If carefully coordinated, the rules and standards developed at the regional setting can also be used to 80 buttress China`s position on the relevant issues in other international organizations, such as the WTO. When negotiating with the other countries at different stages of economic development, China might wish to include more provisions on technical assistance, cooperation or technology transfer. In the case where pre-RTA environmental assessment is requested, technical assistance and capacity building from the party that has more experience in the matter could be a part of the RTA process. Technical assistance and capacity building may also be required if the RTA requires adherence to specific environmental regulatory norms. Take an example of SPS-TBT Standards. Adequate information and dissemination systems should be built into RTAs in respect of SPS & TBT requirements in the export market, e.g., measures such as eco-labeling, packaging and recycling requirements for achieving environmental objectives, and SPS requirements in relation to plants, plant products, and food products. Adequate provisions for technical and financial assistance for compliance with such measures should also be built into the RTA. Specific obligations on enacting and maintaining environmental regulations could even be made conditional on actual development assistance and capacity building. Benchmarking and monitoring provisions relating to cooperation, technical and financial assistance and capacity building is often a means to maximize the benefits of such cooperation. Provisions requiring cooperation to reach certain environmental goals should be built into the RTA as essential conditions. Clear benchmarks for monitoring implementation of such provisions are necessary. Specific areas in which cooperation, technical assistance and capacity building is required should be prioritized and work programs around these need to be monitored. As including environment provision in RTAs is still new, China may consider a phased-in approach in dispute settlement mechanism. In the initial few years, dispute settlement mechanisms emphasizing consultation and cooperation may be a better option than binding dispute settlement and sanctions resulting from non-compliance with environmental requirements. When China gains more experience with environmental provisions under the RTAs and builds a strong enforcement capacity, dispute settlement with stronger remedies, such as monetary compensation or trade sanctions, could be considered. References Anuradha R.V. (2009) Environmental Provisions In Regional Trading Agreements: Overview of RTAs entered into by US, EC, Japan and Australia, background paper Gary Hufbauer and Yee Wong (2009) China`s Trade Agreements: Lessons from Other Countries, background paper Henry Gao (2009) Supporting China`s Regional Trade Agenda: China`s Strategies on Negotiating Competition, Environment, and Mode 4 Provisions in its RTAs, background paper 81 Annex 9. 1 Environment in RTAs by U.S., EC, Japan and Australia This annex will provide a brief overview of the nature and type of environmental provisions in different RTAs. United States NAFTA, entered into between the U.S., Canada and Mexico in 1994, was the first RTA to reflect environmental provisions. A side agreement to NAFTA- the North American Agreement on Environmental Cooperation (NAAEC) provided for several innovative features, such as a separate Commission for Environmental Cooperation, public consultation and enforcement mechanisms for environmental provisions. US RTAs since 1994 have consistently reflected several environmental provisions, either in an independent chapter devoted to Environment`, or in a side agreement on environment. The range of environmental provisions and practices in the context of RTAs entered into by the U.S. can be summarized as follows: 1. Environmental Review of RTAs: Environmental Reviews are mandated under U.S. laws, as a necessary pre-condition prior to conclusion of any RTA. Such reviews predominantly focus on environmental impact of any proposed RTA on the economy and the environment in the U.S. However, some Environmental Reviews, such as those of U.S.-Colombia and U.S.-Morocco, have also highlighted environmental impacts in the trading partners. 2. Provisions in the Preamble: The Preamble emphasizes principles of environmental protection and sustainable development. 3. Environment` is dealt with either in a chapter under the RTA, or under a side agreement,1 or both. The Chapter or side agreement, as the case may be, typically include the following provisions: Box 9.1 Provisions on Environment in U.S. RTAs A. General Principles Obligation of both parties to cooperate in the field of environment. Obligation to ensure that trade and environmental policies are mutually supportive of each other. B. Right to Establish Levels of Environmental Protection Right of each party to establish its levels of environmental protection and environment development policies. 1 Apart from the NAAEC, other side agreements on the environment entered into by the U.S. include Environmental Cooperation Agreements with Chile and Korea. A Joint Statement on Environment Cooperation accompanies the RTA between U.S. and Australia, and U.S. and Singapore RTA has a Memorandum of Intent on the Environment. 82 C. Provisions with respect to Domestic Environmental Laws Obligation on each party to strive to ensure that its laws and policies provide for and encourage high levels of environment protection. Right of each party to retain discretion with respect to investigatory, prosecutorial, regulatory, and compliance matters and to make decisions regarding the allocation of resources to enforcement with respect to other environmental matters determined to have 1 higher priorities. Commitment by each party to strive to ensure that, in the process of encouraging trade and investment, it does not waive or derogate from its environmental laws in a manner that weakens or reduces the protections afforded in those laws. Obligation to ensure availability of judicial, quasi-judicial, or administrative proceedings for the enforcement of its environmental laws are fair, equitable, transparent, and provide for appropriate administrative and procedural protections in accordance with its law. The RTAs with Chile and Korea clarify that the Chapter on Environment shall not be construed to empower a Party's authorities to undertake environmental law enforcement activities in the territory of the other Party. The RTA with Peru allows for such enforcement only in the context of the Annex on Forest Governance. D. Environmental Cooperation, Technical Assistance, Capacity Building: US RTAs differ in terms of the scope and content of provisions dealing with environmental cooperation. Environmental cooperation typically pertains to provisions for technical assistance and capacity building in relation to environmental standards. Provisions on environment cooperation in NAFTA's side agreement on environment- the North American Agreement on Environment Cooperation (NAAEC), for instance, focuses on environmental impacts on trade, and labeling, financing, purchasing of environmentally friendly products, etc. Provisions on Environmental Cooperation under U.S.-Peru pertains to protection of biological diversity and indigenous knowledge. Provisions on Environment Cooperation under U.S.-Chile RTA highlights the following areas in which the U.S. is committed to cooperate with Chile: Develop a Pollutant Release and Transfer Register (PRTR) in Chile which is a publicly available database of chemicals that have been released to air, water and land or transferred off-site for further waste management. Reducing Mining Pollution in Chile. Improving Environment Enforcement and Compliance through training and exchange of information. Training to help reduce pollution from agricultural practices in Chile. Cooperation to reduce methyl-bromide emissions. Improving wildlife protection and management in Chile. E. TBT & SPS- Product Standards Most U.S. RTAs contain provisions relating to formation of a specific committee to oversee implementation of SPS and TBT standards, and assist in trade facilitation. CAFTA-DR and the RTAs with Panama and Peru also comprise provisions on the responsibility of the committee to make recommendations for trade capacity building and designing 1 This discretion however is not unfettered. It is circumscribed by words to the effect that a party is in compliance with this provision provided the exercise of discretion is "reasonable" or the exercise of discretion results from "a bona fide decision regarding allocation of resources." 83 programmes for technical assistance, in relation adherence to SPS and TBT standards. There are however no references to financial assistance in such provisions. U.S.-Korea RTA has a separate provision dealing with automotive standards and regulations which may be adopted, inter alia, for environmental reasons. F. Public Participation: Most U.S. RTAs also have fairly detailed provisions on `public participation'. These can range from obligatory provisions to those requiring `best efforts'. For example, U.S.-CAFTA-DR mandates each Party to provide for the receipt and consideration of public communications on matters related to the Chapter on Environment. Each Party is also required to convene a national consultative or advisory committee, comprising members of its public, to provide views on matters related to the implementation. On the other hand, U.S.-Morocco, and U.S.-Singapore refer to a lesser onerous obligation for putting in place `procedures' for dialogue with the public, and make `best efforts' to respond to requests by members of public with regard to implementation of environmental provisions. G. Institutional arrangements: All U.S. RTAs have a separate committee, such as a Joint Committee or an Environmental Affairs Council, responsible for overseeing implementation of the provisions of the agreement, and provide recommendations for implementation H. Dispute Resolution: State-to-State Consultations: All U.S. RTAs, except for U.S.-Jordan RTA, provide for a separate dispute resolution mechanism with regard to enforcement of provisions regarding domestic environmental laws in each Party to the RTA. If consultations between the parties fail, the RTAs provide for engagement of experts to advice on the matter. If this cannot lead to resolution of the dispute, formal dispute settlement proceedings under the RTA can be commenced. Remedies for non-compliance with domestic environmental obligations can include monetary compensation which is required to be deposited in a fund for environmental initiatives. If the losing Party does not provide such compensation, then as a matter of last resort, the other Party can suspend tariff concessions. Such provisions have not been resorted to under any of the U.S. RTAs. There is as yet no experience with the possible outcome of these provisions. Public Submission Process: NAFTA, CAFTA-DR, US-Panama and US-Peru have detailed provisions allowing for submissions by members of the public to the Environmental Commission or Secretariat, with a complaint on non-compliance with environmental obligations. The Commission/Secretariat is required to prepare a factual record and provide this to the Environment Affairs Council (EAC) constituted under the RTA. The EAC can make recommendations. These are however not binding on the state Parties to the RTA. European Union EU`s approach towards environmental provisions in RTAs is part of its broader agenda towards sustainable development`. It mandates as a necessary pre-condition, Trade Sustainability Impact Assessments` of the parties involved in the RTA, which highlight, among other aspects, environmental impacts of the proposed RTA on the environment of both the EU and the trading partner. The RTAs attempt to address the issues raised in the SIA primarily through provisions dealing with principles of environmental cooperation. EU RTAs also typically emphasize on technical and financial assistance to developing country partners in relation to the environmental provisions of the RTAs.1 1 See for example, EU-Chile, EU-Cariforum and EU-Mexico. 84 EU`s approach in most of its RTAs has been one that incorporates elements of broad cooperation. Its recent Economic Partnership Agreement (EPA) with Cariforum countries contains the most elaborate chapter on environment so far that it has incorporated in any RTA. The scope and depth of the provisions of this chapter, while similar to the provisions in U.S. RTAs, are not as elaborate as the provisions used in U.S. RTAs. Early RTAs entered into by the EC, such as EC-Chile and EC-Mexico, have limited provisions on environment. The EU-Cariforum Economic Partnership Agreement (EPA) has more detailed provisions. Some key features of the EU-Cariforum EPA are summarized below. Box 9.2 Environment Related Rights and Obligations under EU RTAs Some Key Provisions of the EU-Cariforum EPA include the following: A. General Principles Emphasis on the Objectives of Sustainable Development and protection of the Environment. B. Provisions with respect to Domestic Environmental Laws Right of the Parties to regulate in order to achieve their own level of domestic environmental and public health protection and their own sustainable development priorities, and to adopt or modify accordingly their environmental laws and policies. Obligation on Parties to seek to ensure that its own environmental and public health laws and policies provide for and encourage high levels of environmental and public health protection and shall strive to continue to improve those laws and policies. Recognition of the "the special needs and requirements of CARIFORUM States shall be taken into account in the design and implementation of measures aimed at protecting environment and public health that affect trade between the Parties". Obligation not to encourage trade or foreign direct investment to enhance or maintain a competitive advantage by: (a) lowering the level of protection provided by domestic environmental and public health legislation; and (b) derogating from, or failing to apply such legislation. C. Obligations for Technical Assistance and Capacity Building The EU-Cariforum EPA as well as EU's Agreements with Chile and Mexico, have provisions on efforts towards cooperation and ensuring technical assistance for implementation of the provisions of the agreement, including the provisions relating to environmental obligations. The EU-Chile agreement also emphasizes on cooperation in relation to projects to reinforce Chile's environmental structures and policies. The EU-Cariforum's provisions are the most detailed in this regard. Some examples include: - Capacity building for environmental management in tourism areas at the regional and local level; - Technical assistance to producers in meeting relevant product and other standards applicable in markets of the EC Party - Technical assistance and capacity building, in particular to the public sector, in the implementation and enforcement of multilateral environmental agreements. - Facilitation of trade between the Parties in natural resources, including timber and wood products, from legal and sustainable sources - Assistance to producers to develop and/or improve production of goods and services, which the Parties consider to be beneficial to the environment; and - Promotion and facilitation of public awareness and education programmes in respect of environmental goods and services in order to foster trade in such products between the Parties. 85 D. TBT & SPS- Product Standards - EU's RTAs with Chile, Mexico and the recently with the Cariforum countries, include provisions for technical assistance for producers in meeting relevant product and other standards. - The EU-Cariforum Agreement has detailed provisions with specific relevance for environmental standards. (a) Technical assistance to producers in meeting relevant product and other standards applicable in markets of the EC Party; (b) Promotion and facilitation of private and public voluntary and market-based schemes including relevant labelling and accreditation schemes E. Dispute Resolution - EU RTAs emphasize on Consultation and Cooperation in Environmental Matters - The Cariforum EPA provides for Consultations. - If consultations fail, the matter can be referred to a Committee of Experts formed under the EPA - Findings of Committee will be provided to Consultative Committee responsible for Implementing EPA. - There are no provisions for fines or suspension of tariff concessions in the event of non- compliance Japan RTAs entered into by Japan have recently started reflecting environmental provisions. All RTAs entered into by Japan emphasize commitment not to lower environmental standards to attract investment. Provisions on environmental cooperation are included in Japan`s RTAs with Mexico, Malaysia, Thailand, Philippines. The Japan-Philippines RTA specifically refers to cooperation on compliance with Environmental Standards` for exports. Japan`s agreements with Switzerland and Mexico have two distinct environmental provisions, worded as soft law obligations to achieve certain specific environmental objectives. This approach is noteworthy because it seems to provide room for specific action points based on a country`s requirements. Under the Japan-Switzerland agreement: Parties agree to encourage trade and dissemination of environmental products and environment-related services in order to facilitate access to technologies and products that support environmental protection and development goals. Under the Japan-Mexico agreement: Parties agree to cooperate in the field of environment with a view to ensure environmental preservation and improvement to promote sound and sustainable development, shall cooperate in the field of environment. Australia Australia has consistently emphasized on principles of sustainable development and environmental protection in international negotiations. However, it has not taken 86 initiatives to link trade and environmental provisions in any substantive way. Australia`s agreement with Chile has a provision in the Preamble which states that implementation of the agreement will be done consistent with environmental protection and sustainable development. Environmental objectives are also referred to only in the chapter on Technical Barriers to Trade and Sanitary and Phytosanitary Measures, in the agreements that Australia has entered into with ASEAN and Singapore. The text however does not add anything further to the WTO obligations. Australia`s agreement with Thailand refers to the parties` commitment to international environmental and conservation agreements. Australia`s RTA with the U.S. however incorporates environmental provisions similar to the ones summarized in Box 1 above. These provisions do not find reflection in other Australian RTAs. 87 Part II China Options in The Post-WTO Accession Era 10 Tariff Policy for Cotton Imports in China William Martin A key challenge in China, as it has been in other rapidly developing economies, is a substantial gap in incomes between urban and rural areas, and between farm and non- farm families. This problem, often called the farm problem is frequently used to justify protection to import-competing farming activities. China is currently a large importer of cotton, which it imports under a tariff-quota regime. Despite the fact that imports substantially exceed the quota, the government has continued to allow imports at a rate well below the bound tariff rate. Under WTO rules, China would be permitted to impose a tariff of up to 40 percent on over-quota imports. Given the large gap between incomes in urban and rural China, the question of whether tariffs on over-quota cotton imports should be raised nearer to the out-of-quota tariff has been asked. The purpose of this note is to take cotton trade as an example and to assess the effectiveness of trade protection policy in raising the income of poor farmers. Developments in China`s Cotton Production and Trade China is an extremely important participant in world raw cotton production, utilization and trade. China alone produces around a quarter of world cotton, much more than any other country. Table 10.1 presents some key figures on China`s production, mill consumption and trade in cotton since marketing year 1980-1. A key feature of the table is that production has grown quite strongly over the period, a period that corresponds roughly with the reform period in China. Despite strong growth of cotton production, China`s net trade position in raw cotton has turned to deficit since 1998-99, driven largely by rapid growth in mill consumption of cotton. Cotton mill consumption had been relatively stable in the 15 years leading up to 1999, at around its 1999 level of 4.3 million tonnes. Since then, however, mill consumption of cotton in China has more than doubled, rising to 9.6 million tones in 2005-6, probably as a consequence of expansion in textile production following the abolition of the export quotas on textiles and clothing formerly imposed under the Agreement on Textiles and Clothing. The impact on China`s trade position in cotton has been quite dramatic, turning China from a net exporter in the three years to 2000/01 into a large net importer of raw cotton. Table 10.1 Key statistics on cotton production and trade in China, marketing years. Mill Area Yield Prodn Imports Exports Consumption 000 Ha Kgs/Ha 000 Metric Tons 88 1980/81 4,921 550 2,707 773 3,300 1 1981/82 5,187 572 2,969 478 3,546 0 1982/83 5,828 618 3,601 236 3,641 16 1983/84 6,076 764 4,640 145 3,421 165 1984/85 6,921 904 6,260 18 3,484 214 1985/86 5,140 807 4,146 0 4,117 607 1986/87 4,305 823 3,542 3 4,567 690 1987/88 4,843 877 4,246 19 4,369 506 1988/89 5,534 750 4,148 315 4,376 356 1989/90 5,203 728 3,789 408 4,150 188 1990/91 5,588 807 4,508 480 4,225 202 1991/92 6,540 867 5,672 355 4,250 131 1992/93 6,837 660 4,510 53 4,600 149 1993/94 4,985 750 3,739 176 4,600 166 1994/95 5,528 785 4,342 884 4,400 40 1995/96 5,422 879 4,768 663 4,350 5 1996/97 4,722 890 4,203 787 4,450 2 1997/98 4,500 1,023 4,602 402 4,350 6 1998/99 4,250 1,059 4,501 78 4,300 148 1999/00 3,726 1,028 3,829 30 4,834 370 2000/01 4,041 1,093 4,417 52 5,259 97 2001/02 4,810 1,107 5,324 98 5,869 74 2002/03 4,184 1,175 4,916 682 6,602 164 2003/04 5,109 954 4,871 1,929 7,224 38 2004/05 5,693 1,111 6,324 1,394 8,239 7 2005/06, 5,062 1,129 5,714 4,200 9,617 8 est. Source: International Cotton Advisory Committee (ICAC). Applied Tariff Policy for Cotton in China As part of her WTO commitments, China agreed to a Tariff Rate Quota on raw cotton of 894 thousand tonnes. Imports under the quota are subject to a 1 percent tariff, while over-quota imports are subject to a bound tariff of 40 percent. China`s actual tariff policy in recent years has been consistent with, but quite distinct from tariff bindings. In December 2006, the Ministry of Finance announced a sliding scale of the cotton import duty for over-quota cotton (Cotlook, 2006). This import duty is determined by the formula: Ri = INT(Pt/(Pi*E)) +a*Pi*E -1)*1000 +0.5)/1000 where Ri is the duty rate, with a maximum of 40 percent; Pt is a constant 8.8 yuan per kilo; Pi is the cif price in US$ per kilo; E is the exchange rate relative to the US$; and a is a constant of 2.526 percent. If the cif price is at or above a reference price of 11.397 yuan per kilo (around 66 cents per lb), the tariff is 6 percent. As the cif price falls below the reference price, the tariff rises to a maximum of 40 percent. Examination of the cif import 89 values for China`s cotton imports reveals that the price of imported cotton rarely fell below the reference price on a country-wide basis during the period 1995 to 2005. Had the tariff formula in equation (1) applied during the past decade, and had imports exceeded the quota in all of those years, the tariffs that would have been generated by equation (1) are given in Table 10.2. From the table, it is clear that the minimum out-of- quota tariff of 6 percent would have applied in eight of the 11 years considered. In the lower priced years of 1999, 2001 and 2002, a higher tariff would have applied. Table 10.2 Applied over-quota tariff generated by the 2007 formula Import Unit Value Exchange Rate Tariff US/kg Y/US$ % 1995 1.86 8.35 6.0 1996 1.84 8.31 6.0 1997 1.77 8.29 6.0 1998 1.66 8.28 6.0 1999 1.34 8.28 7.4 2000 1.48 8.28 6.0 2001 1.26 8.28 10.5 2002 1.22 8.28 12.8 2003 1.67 8.28 6.0 2004 1.63 8.28 6.0 2005 1.50 8.19 6.0 Sources: Cotton unit values (Huang, Liu, Martin and Rozelle (2007) Whether to raise the tariff? Since 2004, China`s imports of cotton have substantially exceeded the quota level, permitting China to impose a tariff of up to 40 percent. It is clear that the applied tariff rate on cotton imports can be raised by a big margin. Whether to raise the tariff depends on the impact of a higher tariff on households and particularly on the income of poor households. The usual approach would be to assess the impact of the tariff on the domestic price, and then to assess the impact of the higher cotton price on households. The cash-crop nature of cotton implies that an increase in the price of cotton translates directly into an increase in the incomes of cotton farmers--an increase of ten percent in the price of cotton increases cotton farmers` revenues by ten percent. Moreover, cotton makes up a relatively small share of the spending of the poor in China, so there would be few direct adverse impacts on the incomes of the poor. Therefore, a key question that needs to be addressed is how effective a higher tariff on cotton would actually be in raising the price of raw cotton in China. Two fundamental problems arise. One of the constraints on using tariffs to redistribute income is that they can only be effective in raising the prices of imported goods. If a 90 standardized commodity like cotton is an exportable, then a tariff is unlikely to be successful in raising its domestic price since prices paid for an exportable good are determined by returns in export markets, rather than by the cost of imported goods. Another constraint on the effectiveness of tariff policy is the possibility that tariff increases on one product will cause importers to substitute away from the product with the increased tariff, towards imports of related goods. These might be goods that are substitutes in consumption, such as synthetic fibers, or goods that are closely linked through vertical production linkages--such as cotton yarns and fabrics. Although China is a net importer of raw cotton, China remains a net exporter of cotton when net exports of cotton in the form of textiles and clothing are factored in. MacDonald (2007) estimates that net exports of cotton were roughly 15 million bales of cotton out of total mill use of 55 million bales in 2006. As is evident from Table 10.3, most of the exports of processed cotton are in the form of apparel. Table 10.3 China`s Net Exports of Processed Cotton, 2006, million bales Exports Imports Net Exports Yarn 3 4 -2 Fabric 11 3 8 Clothing 27 1 26 Total 41 8 32 Source: MacDonald (2007). More detailed data on production and net trade in cotton for the August-July marketing years from 1995/96 to 2005/06 further confirm China is a net exporter of cotton. The cotton contained in textile and apparel exports from China1, presented in Table 10.4, is estimated based on the data on the cotton equivalents of imported and exported textiles and clothing. These numbers show a dramatic increase in China`s net imports of raw cotton since 2004-05 consistent with the ICAC numbers presented in Table 10.1. In addition, they show a quadrupling of China`s exports of cotton in the form of textiles (including garments) during the decade. The final column of the table indicates that net exports of cotton in raw and processed form have risen quite substantially. Except in 2005/06, the data in Table 10.4 suggest that exports of cotton in all forms were substantially greater than domestic final consumption. Table 10.4 China: Cotton Production, Trade and Disappearance, '000 tonnes Mkt yrs Prodn Net Exports Dom Disappearance Net Exports Aug-July As Cotton As Textiles w/- Stock Change all forms 1995/96 4,768 -629 1,752 2,347 1,123 1996/97 4,202 -758 1,857 2,351 1,099 1997/98 4,594 -370 1,915 2,102 1,545 1998/99 4,507 75 1,915 1,998 1,990 1999/00 3,832 343 2,481 1,999 2,824 2000/01 4,420 46 2,628 2,314 2,674 1 Macdonald (2007) provides an example of women`s sweaters classified as other fibers containing a total of 0.4kg of fiber, of which he assumes 45 percent is cotton. After allowing for waste, he assumes that such sweaters (HS 6110909026) contain 0.22 kg of cotton. 91 Table 10.4 China: Cotton Production, Trade and Disappearance, '000 tonnes Mkt yrs Prodn Net Exports Dom Disappearance Net Exports Aug-July As Cotton As Textiles w/- Stock Change all forms 2001/02 5,312 -23 3,187 2,327 3,164 2002/03 4,921 -517 4,218 2,080 3,701 2003/04 4,855 -1885 4,763 1,986 2,878 2004/05 6,314 -1384 5,599 2,511 4,215 2005/06 5,704 -4191 6,461 2,575 2,270 2006/07 6,700 Source: Cotton-USDA PSD Online; Textiles-Scott MacDonald, personal communication. 2006/07 estimate from NBS, China. If correct, these numbers would have important implications for the effectiveness of tariff policy for cotton in China. As long as China remains a net exporter of cotton, including processed cotton, the effectiveness of a tariff on cotton in raising domestic prices is likely to be subject to serious question. If a tariff were imposed on imports of cotton destined for domestic final consumption, processors would substitute domestic cotton for imported cotton in these uses. However, in this situation, the domestic market would not be large enough to absorb all production of cotton. Under these circumstances, the price of cotton would be determined not by the tariff-inclusive price of cotton, but by the returns obtainable on export markets. Attempts to sell cotton at a price based on the tariff- inclusive price of imported cotton would encounter the fundamental problem that it would not be possible to sell all of the domestically-produced cotton in the domestic market at this price. The trade impact of a higher tariff also depends on whether the tariff applied to cotton destined for the export market. China`s duty exemptions for inputs used in the production of exports have typically accounted for approximately half of China`s total imports, including raw materials, intermediates and final goods. For a good like cotton, which is rarely consumed as a final good, one might expect a higher than average fraction to be imported for use in exports. China customs data show that the fraction of China`s cotton imports entering China under processing trade arrangements has been around 75 percent in most years since 1997. Because domestic production of cotton exceeds domestic final demand, some domestic cotton would have to be used for export production. Domestic prices would need to remain at a low level to allow domestic cotton to be competitive with zero-duty imported cotton in the production of exports. Under these circumstances, an increase in the tariff on cotton is unlikely to be successful in substantially raising the price of domestic cotton. If the usual duty exemption arrangements did not apply for cotton, the situation would be slightly different. Processors would still substitute domestic cotton for imported cotton in goods destined for the domestic market. Assuming the domestic market does not absorb all domestically-produced cotton, however, some would need to be sold through incorporation in exported products, and the need to allow these exports to be profitable would drive domestic cotton prices down to something close to the levels obtainable from export markets. 92 Even if China may become a net importer of cotton at some point with the rapid increase in domestic consumption, the ability to import cotton products at low duties, such as 5 percent for yarns, under a duty bound at the WTO, means that the tariff on cotton is unable to have more than a small impact on the domestic price of cotton. The applied tariffs and the tariff bindings applying on some key cotton-containing products, and competing products, are given in Table 10.5. The combination of a high tariff on cotton and a low tariff on yarn would, however, have a sharply adverse impact on early stage processing activities such as spinning of cotton yarn, for which raw cotton inputs account for about 70 percent of total costs (China Cotton Textile Association 2007). This adverse impact arises with any duty over 5 percent, and would increase sharply, reducing output and employment in early-stage cotton processing in China. The binding of 5 percent on cotton yarn also insulates the downstream textile and clothing industry from any changes in the price of cotton. As long as these producers can access cotton yarn internationally at a 5 percent tariff, they are not affected by higher prices for imported cotton. This policy approach would appear to be a serious risk of destroying the cotton spinning industry at the expense of cotton yarn imports, without significantly improving the well being of cotton farmers. Table 10.5 Tariff bindings on selected cotton products and substitutes, % Cotton, not carded or combed 40.0 Cotton, carded or combed 40.0 Uncombed single cotton yarn 5.0 Yarn of other vegetable textile fibres 6.0 Filament yarn of polyesters 5.0 Unbleached woven cotton fabrics 10.0 Bleached plain cotton weave 14.0 Unbleached woven fabric, <85% polyester staple 16.0 Men's or boys' shirts of cotton, knitted or crocheted 16.0 Women's or girls' blouses of cotton 16.0 Men's or boys' trousers of cotton 16.0 Conclusions The concerns that rural people are falling behind urban people are real and important, and policy action is needed to address them. However, it is generally the case that trade policy measures are not the best for addressing problems of the distribution of income1. As we have seen, tariff policy measures have difficulty assisting export oriented sectors such as cotton production, even if these are the ones in which the income gap is most serious. And protection, or other price policies, in one industry have adverse impacts on other sectors by pulling resources away from the unprotected sectors, and raising the costs of the unassisted sectors. In the case of cotton, such a policy is made more difficult by the adverse impacts of such a policy on the processing sector. 1 Most other market failures, such as externalities in production or consumption, are related to levels of output or consumption, or the use of particular inputs, rather than to the level of trade. In these cases also, policy measures that directly target the source of the problem are likely to be superior to trade measures. 93 Another commodity price policy option that might have been considered as a means to raise the price of cotton is something like the US Step 2 program (see OXFAM 2002), officially described as a domestic support measure, under which a subsidy is paid both on exports and on domestic consumption of cotton in an attempt to offset the cost-raising impact of the export subsidy on domestic users of cotton.. A key difficulty with this approach is that it would be extremely costly in budgetary terms, because it involves payment on all cotton, not just on the export component. Further, the recent Brazilian cotton case has resulted in it being found to contravene WTO rules. A wide range of other policies, that address income distribution problem directly, appear to be both strongly welfare increasing and consistent with WTO commitments and of high rates of return. These include research and development, which is typically under- provided by private markets; improvements in transport, electrification and other infrastructure in rural areas; improving the availability and lowering the cost of education in rural areas. Many of these investments have been shown to have extremely high rates of return in rural areas (World Bank 2008). The marginal return on rural research and development appears to be extremely high1, with benefit cost ratios frequently exceeding 10, while subsidies for output have benefit cost ratios well below unity. Other measures include increase investments in public goods in rural areas, including in infrastructure, rural education and health services, and removal of barriers for the mobility of farm labor into non-farm activities. These direct policies are much more likely to be successful than policies that attempt to work indirectly through the prices of particular commodities, such as cotton. 1 Alston et al (2000) examine well over a thousand studies of the benefits from rural research, and find an average rate of return of 81 percent per year. 94 References Alston, J., Chang-Kang, C., Marra, M., Pardey, P., and Wyatt, T. (2000), A Meta-Analysis of Returns to Agricultural R&D: Ex Pede Herculem, IFPRI Research Report 113, International Food Policy Research Institute, Washington DC. Baffes, J. (2003), Cotton and developing countries: a case study in policy incoherence`, World Bank Trade Note 10, Washington DC. www.worldbank.org/trade China Cotton Textile Association (2007), Analytical Report on Industry Performance in 2007, China Cotton Textile Association. Cranfield, J., Preckel, P. and Hertel, T. 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Shi Jianwei, (2007), CCA: 2006 China cotton production underestimated`, http://www.cncotton.com/encotton/News/CottonNews/200709/t20070906_144663.html 95 Sicular, T., Yue, Ximing, Gustafsson, B. and Li, Shi (2006), The Urban-Rural Income Gap and Inequality in China` Research Paper No. 2006/135, UN-WIDER, Helsinki. World Bank (2004), Implications for Pakistan of abolishing textile and clothing export quotas, Policy Note, World Bank Resident Mission, Islamabad, April 30. World Bank (2008), World Development Report 2008, World Bank, Washington DC. WTO (1995), The Results of the Uruguay Round of Multilateral Trade Negotiations: the Legal Texts. World Trade Organization, Geneva. Zhao, Y. (1999), Leaving the countryside: rural--to-urban migration decisions in China` American Economic Review 89(2):281-86. Zhai, Fan and Hertel, T. (2006) Labor market distortions, rural-urban inequality and the opening of China`s economy` Mimeo, www.gtap.org 96 11 Rethinking Trade and Poverty Linkages: Implications of the Doha Round Negotiations for China`s Agriculture1 Jikun Huanga2 , Jun Yanga, Ninghui Lib, Scott Rozellec, Will Martind While the overall effects of trade liberalization often were generally expected to be positive, there is still concern about the impacts that additional trade liberalization--such as, the new round of the Doha negotiations--might have on China`s agricultural production and rural poverty. Specifically, since households in most parts of China are fairly well integrated into national markets, the effects of trade liberalization that start at China`s ports--both those that raise and lower domestic prices--are transmitted rapidly throughout the economy (Huang et al., 2003b). Hence, while producers of exportable commodities will gain if trade volume rises due to a new trade agreement, if a group of farmers is producing a product that is imported in greater quantities due to trade liberalization, the price that the farmers would receive would have been higher had there been no trade liberalization. It is important, then, to identify those groups of farmers that gain and those that lose from trade liberalization--at least in the short run. A careful analysis of the trade impacts on poverty is particularly needed in the light of the ongoing Doha negotiations. The overall goal of this paper is to improve our understanding of how policies, especially moves toward trade liberalization, affect China`s agricultural development. More specifically, in this paper we seek to examine the impacts of Doha Round negotiations on the income of farmers, and particularly the income of the poor, in different regions of China. China`s agricultural trade policies Since its accession to the WTO, the agricultural trade regime has become relatively open. For key products, such as rice, wheat and maize, the assessed tariffs have been low because the in-quota tariff rates have generally been the ones that have applied (Table 9.1). For many other products, such as fish products, oilseeds, pork, poultry, sugar and dairy products, protection rates are relatively low and higher out-of-quota rates are not applicable. 1 This note is edited by Ms. Min Zhao based on Huang etal. (2009)`s background paper. 2 a Center for Chinese Agricultural Policy, Institute of Geographical Sciences and Natural Resource Research, Chinese Academy of Sciences, Jia 11 Datun Road, Anwai, Beijing 100101, China b Institute of Agricultural Economics and Development, Chinese Academy of Agricultural Sciences, Beijing, China c Freeman Spogli Institute for International Studies, Stanford University, USA d Development Research Group, World Bank, USA 97 While China`s own agricultural trade barriers are relatively low, it faces relatively high barriers in export markets. Table 11.1 presents estimates of the tariffs levied by China on a range of products, particularly agricultural products, world average tariffs for those products and the tariff rates applied against China`s exports. The tariffs imposed on imports are in some cases above world average tariff rates and in others below them. As noted above, the tariffs listed for China on key products such as wheat and rice are in- quota rates, and higher tariffs can be levied if imports exceed quota levels. While this is a fairly well known story, perhaps the most striking fact that can be seen from the numbers in the table is that the tariffs on exports from China (that is, the rates imposed on China`s food exporters) are above the world average rates. This pattern of distortions--that is unfavorable to China--may mean that China can most likely best address this set of systematic inequalities through negotiations under the WTO. Table 11.1 Comparisons between China`s import tariff and external tariffs in 2006 (%) China's import World average Import tariff levied on Tariff Tariff China's commodities Rice 1 8.7 131.09 Wheat 1 4.3 3.89 Coarse grain 2.94 8.2 190.85 Vegetable & fruit 6.54 3.0 22.55 Oilseeds 2.88 3.4 50.28 Sugar 12.74 9.3 36.21 a Plant fiber 1(5) 0.8 6.44 Other crop 3.34 2.3 8.31 Cattle &mutton 9.65 3.6 4.25 Pork & poultry 7.72 3.7 9.35 Milk 8.66 3.3 3.23 Fish 7.48 1.0 6.11 Processed food 8.77 3.1 10.03 Natural resources 0.27 0.7 1.98 Textile & apparel 8.96 3.4 11.23 Resources industries 5.88 1.6 3.33 Metal & machinery 5.41 1.5 2.82 Transport equipments 8.09 1.6 3.63 Electronic products 2.31 0.8 1.14 Manufactures 14.46 1.8 2.68 Source: estimation based on China`s WTO commitment, GTAP tariff database, China and ASEAN free trade agreement, EU enlargement etc. a China adopts TRQ management on import of Cotton. The in-quota tariff is only 1%; the out-of-quota tariff is 40% in 2006. However, China took a much low sliding tariff (beginning around 5 percent, shown in bracket) instead of a prohibitive out-of-quota tariff. Main proposals in the Doha Round Negotiations The WTO negotiations under the Doha agenda will not reduce agricultural protection to zero; rather, what is envisaged is reduction in tariff rates using a so- called tiered-formula approach that makes larger cuts in higher tariffs. The specific approach to be used has been the subject of great disagreement, with a wide range of proposals advanced as the negotiations have continued. One relatively early point of 98 agreement, however, was that the all proposals for negotiation would use four tiers. For the industrial countries, some of the key proposals have included those offered by the USA and the EU. The proposal that is supposed to reflect more of the developing countries point of view is the one developed by the G-20. Building on the G-20 proposal, Falconer (2007) subsequently suggested a range of possibilities for cuts in each tier. Each of these proposals is set out in Table 11.21. Table 11.2 Proposed tariff reductions of agricultural commodities (%) EU proposal G20 proposal US proposal Falconer Tiers Cut Tiers Cut Tiers Cut Tiers Cut For industrial countries 1 <30 35 <20 45 0<20 65 < 20 48 to 52 2 30-60 45 20-50 55 20-40 75 20-50 55 to 60 3 60-90 50 50-70 65 40-60 85 50-75 62 to 65 4 >90 60 >70 75 >60 90 >75 66 to 73 Cap 100 100 75 No Cap For developing countries 1 <20 37 to 43 <30 25 <30 25(1-40) <30 32 to 34.6 2 20-40 43 to 50 30-80 30 30-80 30 30-80 36.6 to 40 3 40-60 50 to 57 80-130 35 80-130 35 80-130 41.3 to 43.3 4 >60 57 to 60 >130 40 >130 40 >130 44 to 48.6 Cap 112 150 150 No Cap Source: Hanrahan and Schnepf (2005), Sharma (2007) and Falconer (2007). The US proposal was by far the most ambitious, with a ceiling tariff after cutting of 75 percent, and cuts of 90 percent in tariffs above 60 percent. The G-20 proposal, which has been the basis for most of the discussion in recent years, involved a tariff cap of 100 percent, and cuts of 75 percent in tariffs above 75 percent. The most recent proposal, by Crawford Falconer, the chairman of the agricultural negotiations, removes the explicit cap on tariffs, and lowers the cuts in the highest tariffs, while raising the cuts in the lowest tariffs. Since the G-20 proposal captures the broad nature of the policy changes involved in the subsequent proposal, and because the Falconer proposal provides only ranges (and these ranges seem likely to change in the future), we focus primarily on the G-20 proposal in our analysis. As is clear from Table 11.2, the proposed tiers for developing countries are wider than those for the industrial countries. This means that in the case of developing countries, the stiffest tariff cuts do not apply except for the higher rates of tariffs (when compared to the case of industrial countries). For example, under the G-20 formula, the largest cuts are in tariffs above 130 percent for developing countries, rather than those above 75 percent for the industrialized countries. In addition, the largest cuts only reach 1 There are many explanations of why the proposals are different. One explanation is that the fundamental differences among the proposals reflect the differences of the interests in the agricultural sectors of the various countries. Each country is trying to maximize its gain or minimize the loss of producers and consumers in their own food economies. 99 40 percent for these tariffs (in the case of developing countries), rather than 75 percent as in the case of industrialized countries. The Falconer proposal also eliminates the tariff cap. For developing countries, it raises the tariff cuts on both the lowest and the highest tariffs relative to the G-20 formula. The formulas applicable to developing countries are important, both because they will influence the adjustments that China needs to make in its own tariff bindings, and because these tariff formulas are applicable in export markets, such as that in the Republic of Korea, which are eligible for developing-country treatment under WTO rules. Since these tariff formulas are to be applied to bound, rather than applied tariffs, their ultimate effect on applied rates will depend upon the gap between bound and applied tariff rates. It will also depend upon the extent to which some countries are excluded from the formula cuts, and particular products are selected for more flexible treatment than is allowed under the formula. In this stage of our analysis, we focus on the impacts of formula cuts to provide a benchmark against which these questions of flexible treatment can be addressed in future research. Table 11.3 Comparisons of USA, G20 and EU proposals on agricultural domestic support policy Highest Tier 2nd Tier 3rd Tier USA proposal EU, Japan U.S. Other Developed Amber Box Cuts 80% 60% 37% De Minimis cuts Bound at 2.5% of TVP Bound at 2.5% of TVP Bound at 2.5% of TVP Blue Box Ceiling Bound at 2.5% of TVP Bound at 2.5% of TVP Bound at 2.5% of TVP G20 proposal EU, Japan U.S. Other Developed Amber Box Cuts 80% 70% 60% EU proposal EU, Japan U.S. (or Japan+) Other Developed Amber Box Cuts 70% 60% 50% De Minimis cuts Bound at 1% of TVP Bound at 1% of TVP Bound at 1% of TVP Blue Box Ceiling Bound at 5% of TVP Bound at 5% of TVP Bound at 5% of TVP Source: Hanrahan and Schnepf (2005) Besides the market accession negotiations, export competition and domestic support are other two important aspects in the Doha trade negotiations. Correspondingly, the three proposals (USA, EU and G20) also include sets of criteria on these two issues. In addressing the issue of export subsidies, the three proposals commit all WTO members to eliminating all forms of agricultural export subsidies. Although there was relative consensus on export subsidies, the negotiations are more complicated when discussing issues of the reduction of domestic support. As shown in Table 11.3, the reductions are measured by the rate by which aggregate measures of support (AMS) are cut.1 Domestic support calculations also include bounding levels of De minimis support and Blue Box payments. Although all proposals agree on the fact that for the reductions of AMS must be greatest for those countries with higher levels of AMS, the exact schedule of cuts differs among the proposals. The G20 proposal is most aggressive when addressing AMS cuts. It suggests that the EU and Japan must reduce the AMS by 80%. The G-20 proposal 1 Amber box supports include domestic programs that do impact on production and trade, as defined by the Aggregate Measure of Support (AMS), such as the output price support and input subsidy. 100 also asks the USA to cut domestic support by 70% as well as requesting that other developed countries make reductions of 60%. As to the De minimis and Blue Box payments, the USA proposal suggests that the bounding levels of the two items be restricted to no more than 2.5% of the total value of agricultural production. In contrast, the EU proposes that De minimis and Blue Box payment are bounded at 1% and 5% respectively. Methodology and Scenarios To understand the impacts of different proposals for trade liberalization in the Doha Round WTO negotiations, we use two models, the Global Trade Analysis Project (GTAP) and the Chinese Agricultural Policy Simulation and Projection Model (CAPSiM). The national-level economic impacts of Doha are assessed with the GTAP model. The simulated price changes of international agricultural products are then fed into CAPSiM in order to analyze the potential impacts of a Doha agreement on China`s agricultural production. A module embedded in CAPSiM then allows us to study the effects of trade policy changes on the incomes of farmers and other households by region and by income group. In this study, four scenarios are considered in assessing the impacts of Doha on China`s agriculture at the national, regional and household levels. The four scenarios include one baseline scenario and 3 alternative Doha policy scenarios. The Doha policy scenarios include one to simulate the USA proposal; one to simulate the EU proposal; and one to simulate the G20 proposal. In the analysis we are going to assume that all of the parts of the Doha agreement are realized by 2015. As such, we estimate the impact of Doha by comparing the baseline results with those under Doha policy scenarios in 2015. Baseline scenario. In the baseline scenario, there are several key assumptions. First, we assume that there is no Doha agreement. Instead, every country will continue operating under their existing policies. If there are major trade agreements that affect agriculture, they are not due to the Doha Round. Therefore, our scenario embodies the effects of important known policies related to international trade, such as the continued implementation of the Uruguay Round commitments, China's WTO accession promises (which continue to take effect through 2010), the phase-out the Multi-fiber Agreement (MFA--by January 2005) and the implementation of the Agreement of Free Trade Areas between China and ASEAN member countries. Doha policy scenarios. Doha negotiations mainly focus on three so-called pillars (i.e., market access, export competition (subsidies) and domestic support). If a Doha agreement is reached, there is a consensus that it will include elimination of export subsidies. However, the proposed reductions in import tariff and domestic support vary significantly between the EU, G20 and USA proposals. The major proposed policy commitments that are parts of the EU, G20 and USA proposals are summarized in Table 11.2 and Table 11.3. In short, the policy shifts described in these tables constitute the major inputs into the scenario formulations. 101 In the process of modeling the proposed provisions, as only the applied tariffs are available in GTAP database, the tariff cuts in our research are based on the applied tariffs. Using applied tariffs, however, implies that the estimated impacts that are simulated in this study should be considered as upper bounds. In other words, if we had used bound tariffs, we would have found lower estimated impacts--and probably substantially smaller impacts given the large degree of binding overhang in many markets. To simplify our analysis, we will also assume that countries only must cut their Amber Box support. Their initial levels of De minimis and Blue Box support remain unchanged. In order to simulate the reduction of Amber Box subsidies, we cut down the output subsidies and intermediate subsidies in GTAP according to the ratios presented in Table 11.3. Potential Impacts of the Doha Round Negotiations Macro and Sector-wide Impacts Table 11.4 The macro impacts on China under EU, G20 and USA proposals in 2015 EU Proposal G20 Proposal USA Proposal EV(million USD) 3479 3361 3413 Real GDP growth (%) 0.05 0.05 0.05 GDP price index (%) 0.99 0.98 0.97 Total income (%) 1.08 1.07 1.06 Term of trade (%) 0.46 0.43 0.44 Total export (%) 3.89 3.92 4.01 Total import (%) 5.56 5.60 5.70 Trade balance(million USD) 2293 2286 2492 Agricultural income (%) 2.04 2.05 2.24 Agricultural export (%) 10.31 10.99 19.89 Agricultural import (%) 6.83 7.41 9.08 Source: GTAP simulation results Regardless of which of the three scenarios that is simulated, a Doha agreement would improve China`s economic welfare and stimulate domestic economic growth--although the impacts would not be large. According to our analysis, if any of these three agreements were implemented, China`s welfare would increase by about 3.4 billion US$ (Table 11.4). Real gross domestic production would rise by 0.05% when comparing the results of the scenario analyses to the baseline1 (Table 11.4). At the same time, international trade would also expand--including both imports and exports. Since the export price rises higher than the import price, China`s terms of trade would improve. While the overall impacts are minor, individuals associated with China`s agricultural sectors would benefit from the adoption and extension of the proposed trade liberalization changes being discussed under the Doha negotiations. As shown in Table 9.3, the rise in income in agriculture is about two times that of the national 1 It is common to get quite small effects on real gross domestic production (GDP) using GTAP model to analyze the trade policy change, as the change just captures the improvements of allocation efficiency of primary factors. 102 average. Similarly, the increases of agricultural exports and imports are also larger than those of the national average. Moreover, the growth of agricultural exports is higher than that of imports (Table 11.4). This relatively higher rate of rise in exports implies that the agricultural sector as a whole will enjoy more trade benefits from Doha trade liberalization. The relatively minor variations among the results of the different scenarios (that is, the EU versus the G20 versus the US proposal) are explained by two factors. First, all of the proposals largely limit the Doha proposals to the agricultural sector; there are few significant policy differences in non-agricultural sectors (NAMA) among three proposals. Since, agriculture is a relatively small sector of the economy, its overall impact is relatively small (and differences among the proposal are even smaller). Second, prior to the Doha round (that is, after the accession of China to the WTO), China`s agriculture was already largely liberalized. The Impact on China's International Prices and Trade Doha Round liberalization would have larger impacts on the international prices faced by China and international trade of agricultural commodities (and these impacts will vary significantly among commodities). China`s imports of grains and soybean will fall, while its exports will increase and China will gain in net export of these crops in Doha Round. The nature of impacts is the result of how China`s trade responds to the changes in the international prices of these commodities due to trade policy changes. Table 11.5 Impacts on China`s import of major agricultural commodities Impacts under difference scenarios Baseline (thousand EU Proposal G20 Proposal USA Proposal ton) Quantity Price Price Quantity Price Quantity (%) (%) (%) (%) (%) (%) Milled Rice 995 -0.1 1.5 -0.9 1.9 -1.2 2.1 Wheat 1096 -25.0 3.2 -26.8 3.6 -27.4 3.8 Maize 1813 -26.7 6.0 -26.8 6.1 -26.4 5.6 Other Grain 3099 -8.5 6.0 -8.5 6.1 -7.8 5.6 Soybean 41271 -0.7 1.4 -1.0 1.8 -0.6 1.2 Cotton 7490 17.6 3.8 17.4 4.0 17.2 3.9 Oil Crop 6744 -0.9 1.4 -1.3 1.8 -0.8 1.2 Sugar Crop 3286 15.6 -2.9 17.2 -3.7 20.6 -5.7 Vegetable 406 31.5 -0.8 34.3 -1.3 42.0 -2.5 Fruit 2878 20.4 -0.8 22.9 -1.3 30.0 -2.5 Pork 839 3.2 -1.6 4.3 -2.3 6.7 -3.9 Beef 378 65.3 -0.8 68.0 -1.5 72.6 -2.9 Mutton 199 55.7 -0.8 58.2 -1.5 63.1 -2.9 Poultry 505 0.6 -1.6 1.6 -2.3 3.9 -3.9 Milk 5847 -1.7 1.9 -0.8 1.2 0.3 0.6 Fish 3289 7.4 -2.2 8.6 -2.9 11.4 -4.4 Source: CAPSiM simulation results 103 Table 11.6 Impacts on China`s export of major agricultural commodities Impacts under different scenarios Baseline EU Proposal G20 Proposal USA Proposal (thousand ton) Quantity Price Quantity Price Quantity Price (%) (%) (%) (%) (%) (%) Milled Rice 1873 47.7 12.1 57.5 14.5 72.6 18.1 Wheat 594 8.2 -6.3 6.7 -6.6 5.5 -7.0 Maize 81 34.9 11.4 55.8 17.2 88.4 25.7 Other Grain 48 21.4 11.4 42.9 17.2 71.4 25.7 Soybean 1042 36.0 18.2 27.4 15.1 38.6 19.0 Cotton 11 -23.1 4.8 -23.1 5.6 -15.4 7.0 Oil Crop 21 42.9 18.2 35.7 15.1 50.0 19.0 Sugar Crop 163 21.1 1.5 22.7 1.5 27.3 1.4 Vegetable 8957 22.3 5.4 28.1 6.6 50.2 11.1 Fruit 5324 27.2 5.4 32.2 6.6 51.2 11.1 Pork 977 0.6 0.2 -0.9 -0.3 -2.3 -0.8 Beef 29 11.5 2.5 11.5 2.1 11.5 2.0 Mutton 4 33.3 2.5 33.3 2.1 33.3 2.0 Poultry 1146 0.8 0.2 1.1 0.3 2.8 0.8 Milk 157 9.4 4.4 11.6 4.8 13.8 5.5 Fish 4601 10.7 1.2 11.8 1.5 13.7 1.9 Source: CAPSiM simulation results For the three scenarios simulated, compared to the baseline in 2015, the Doha Round will raise China`s import price of grain by about 2 percent for rice, 3-4 percent for wheat, about 6 percent for maize and other coarse grains, and 1-2 percent for soybean (Table 11.5). Rising import prices will lead to corresponding declines in the imports of these commodities. The largest declines in imports, about 25- 27 percent, will occur in the case of wheat and maize (Table 11.5). On the other hand, all export prices of grain and soybean will rise. The rise in these export prices will range from 6-7 percent for wheat, to 12-17 percent for rice, and to 15-19 percent for soybean ( Table 11.6). With the negative impacts on imports and positive impacts on exports of grain and soybean, China`s trade balance (or net exports) of these commodities would rise by about 500 thousand tons for rice, more than 400 thousand tons for wheat and about 500-700 thousand tons for soybean and maize. The Doha development agenda tends to improve China`s food security. In contrast, the situations will be different for the cases of sugar and cotton. Compared with the baseline in 2015, China`s imports of sugar will rise by about 15-20 percent (Table 11.5). Although China`s export of sugar will also increase, exports will be minimal and China`s net import will increase by about 400-500 thousand tons because of much higher volume of imports in the baseline scenario. The Doha round trade liberalization shifts will further raise this expected volume of imported cotton by about 1.3 million tons (or about 17 percent, Table 11.5). Moreover, the findings also differ between these two commodities. Although China`s agriculture has been largely liberalized, sugar is still relatively heavily protected by the nation`s border policies. The average import tariff on sugar in 2006 was about 12.7 percent, which is higher than the worlds` average tariff, 9.3 percent (Table 11.5). Although Doha trade liberalization will 104 raise the world price of sugar, China`s sugar import price is expected to fall by 2.9-5.7 percent (under the different scenarios). This fall will occur because the tariff reduction in China is scheduled to be more than the increase in the world price of sugar. Impacts on the cotton sector are interesting because a large part of the impacts are not due to changes in the international price of cotton, but are due to the booming demand for cotton from factories in the textile and apparel industries. Therefore, there is supposed to be raising relative prices of domestic and imported cotton. Both the import and export of vegetables and fruit will expand in China, however, the positive impact on China`s horticulture product exports under the Doha Round proposal will be more than its impacts on import`s increase; this shift, of course, means that China`s trade surplus in the vegetable and fruit sub-sectors will rise (Table 11.5, and Table 11.6). China has a strong comparative advantage in the production of vegetables and fruit since this is one of China`s more labor-intensive cropping sub-sector. Moreover, China`s vegetables and fruit have great potential to expand if the Doha Round (or future rounds of trade liberalization) talks can reduce the high import tariffs levied by other countries on China`s horticultural exports. The exports of many livestock products will rise with Doha Round (Table 11.6). However, China has also imposed relative higher tariffs on livestock imports, especially beef, mutton and milk (Table 11.6). Rising imports in the case of most livestock products will be more than the rise in their exports under all scenarios (Table 11.5 and Table 11.6). The Impacts on Agricultural Production in China The impacts of the Doha Round on the domestic production inside China are fully consistent with the impacts of the Doha Round on trade. First, the production of many grains (e.g., rice, wheat, maize, potato and other coarse grains) will increase (Table 9.7). Because sweet potato is mainly used for feed, its demand will decrease with the moderate decline in animal production. Moreover, the growth rates of milled rice, wheat, potato and other coarse grains will rise in the more liberalized proposals. Taking milled rice as an example, its output will rise by 0.07%, 0.12% and 0.20% respectively according to the EU, G20 and US proposals (Table 9.7). However, the growth of maize is different from the case of other grain commodities. The ranking of it growth will be the opposite, increasing by 0.05%, 0.02% in the EU and G20 proposals and decreasing by 0.03% in US proposal. The reason for this reverse is mainly due to the fact that in the more liberalized proposal (i.e., the US one) the production of animal products gradually decreases. Since most of China`s domestically produced maize is used for feed, the drop in the demand for feed will dominate and maize production will decrease slightly under the US proposal. 105 Table 11.7 The impacts on production in China under different scenarios in 2015 Impacts under difference scenarios Baseline (thousand EU proposal G20 proposal USA proposal ton) (thousand (thousand (thousand % % % ton) ton) ton) Milled Rice 123130 82 0.07 149 0.12 248 0.20 Wheat 98643 79 0.08 88 0.09 84 0.09 Maize 181251 88 0.05 32 0.02 -54 -0.03 Sweet potato 22596 -48 -0.21 -53 -0.23 -58 -0.26 Potato 19084 44 0.23 46 0.24 53 0.28 Other Grain 15735 248 1.58 248 1.58 228 1.45 Soybean 20396 382 1.87 408 2.00 366 1.79 Cotton 9144 153 1.67 156 1.71 155 1.70 Oil Crop 9658 26 0.27 36 0.37 20 0.21 Sugar Crop 11909 -289 -2.43 -318 -2.67 -370 -3.11 Vegetable 464688 128 0.03 384 0.08 1490 0.32 Fruit 153826 86 0.06 172 0.11 569 0.37 Pork 58465 -204 -0.35 -220 -0.38 -240 -0.41 Beef 5905 -82 -1.39 -85 -1.44 -90 -1.52 Mutton 3481 -40 -1.15 -41 -1.18 -45 -1.29 Poultry 19292 -30 -0.16 -42 -0.22 -55 -0.29 Egg 23707 -88 -0.37 -90 -0.38 -93 -0.39 Milk 45709 51 0.11 25 0.05 5 0.01 Fish 33815 65 0.19 69 0.20 66 0.20 Source: CAPSiM simulation results The production of other land-intensive commodities, such as soybean, oil crops and cotton, will also increase. The growth rates of soybean and cotton are the highest among all the crops. The production of soybeans will increase by 1.9%, 2.0% and 1.8% respectively in the EU, G20 and US proposals (Table 11.7). At the same time, the output of cotton will rise by about 1.7% in all three proposals. The higher growth indicates the farmers that plant these corps will gain under the Doha trade liberalization scenarios. Horticultural farmers should gain from trade liberalization. According to our model, the output of labor-intensive vegetables and fruit will increase. This is especially true in the more liberal US proposal. The production of vegetables are projected to rise by 0.03%, 0.08% and 0.32% respectively under the EU, G20 and US proposals (Table 11.7). Correspondingly, the output of fruit also will rise--by 0.06%, 0.11% and 0.37%. Since the tariffs of vegetables and fruit decrease sharply in US proposal, if that proposal were to be realized, China would be able to further exploit its comparative advantage in labor- intensive vegetables and fruit. China`s production of many animal products (i.e., beef, mutton, pork, poultry and eggs) will fall under the Doha trade scenarios. This is especially true for beef and mutton. Although the output of these animal products will decrease relatively more in the liberalized proposals, the differences among the three proposals are trivial (Table 11.7). The production of beef and mutton will drop from between 1.2% to 1.4%. This level is 106 much larger than the projected falls for pork, poultry and eggs. China`s production of pork, poultry and eggs will drop by 0.4%, 0.2% and 0.4% respectively. Since pork dominates China`s livestock industry in terms of quantity of production, under the Doha round, the reduction of production in absolute value terms (about 0.2 million tons) is the largest of all livestock commodities. In summary, then, the impacts of the Doha trade liberalization scenarios have a number of regular characteristics. First, the production of grains will increase. This means that, ceteris paribus, under trade liberalization, self-sufficiency in grains actually will improve. Second, the output of soybeans and cotton also will rise. In fact, although these are land intensive commodities, their growth rates are the highest among all the crops. Third, the projected fall in China`s production of sugar under Doha Round compared with the production under baseline scenario is the greatest challenge to China`s producers. Its production is shown to be projected to decrease in all, and especially in the more liberalized proposals. Fourth, trade liberalization, as might be expected, will promote China`s production of vegetables and fruit. This result is most obvious in the US proposal. When other nations liberalize their horticultural sectors, China gains and it is able to further exploit its comparative advantage in labor-intensive products. Fifth, China`s production of beef, mutton, pork, poultry and egg will decrease. This is especially true in the case of the production of mutton and beef. They drop significantly in terms of percentage change. Sixth and finally, the production of fish will increase. The Impacts on Farmer Agricultural Income in China Doha trade liberalization will help China`s farmers increase their income. The contribution to income growth, however, will be limited. As shown in Table 11.8, the per capita income of farmers, on average (for the nation), will rise by 1.07% (or about 22 yuan), 1.12% (about 23 yuan) and 1.17% (about 24 yuan), respectively, in the EU, G20 and US proposals. The results also indicate that the gains of farmers will increase under the more liberalized proposals. 107 Table 11.8 The impacts on per capita agricultural income in rural area by income groups Absolute change (yuan) Relative change (%) EU G20 USA EU G20 USA proposal proposal proposal proposal proposal proposal National average 22.06 23.05 24.02 1.07 1.12 1.17 Under poverty 8.29 8.72 9.21 1.00 1.06 1.11 Income group 1 15.41 16.06 17.19 1.11 1.16 1.24 Income group 2 23.45 24.19 25.47 1.28 1.32 1.39 Income group 3 38.45 39.76 41.30 1.62 1.68 1.74 Income group 4 54.15 55.73 56.51 1.77 1.82 1.85 Income group 5 69.55 71.38 71.62 1.64 1.68 1.68 Farmers in plain area 33.72 34.99 35.68 1.38 1.43 1.46 Farmers in hill area 18.74 19.93 21.45 0.98 1.05 1.13 Farmers in mountain area 9.32 9.59 10.07 0.59 0.61 0.64 Farmers: Han 22.30 23.32 24.37 1.08 1.13 1.18 Farmers: Minority 8.40 7.48 3.71 0.44 0.39 0.20 Note: The group under poverty includes all households with per capita income of less than 872 yuan in 2001, which accounted for about 10% of rural population. Per capita income of groups 2, 3, 4, 5 and 6 were in the ranges of 872- 1300, 1300-1700, 1700-2300, 2300-3300 and above 3300 yuan, respectively. The groups 2, 3, 4, 5 and 6 accounted for about 15%, 15%, 20%, 20% and 20% of rural population in 2001. Source: CAPSiM simulation results. While the gains are positive (albeit small), on average, they vary by income groups, topography and by minority status. Although per capita incomes in all income groups will be improved, the benefits increase gradually from the lowest to the highest income groups. As the shown in Table 11.8, the per capita income of those farmers under poverty will increase by 1.00% (or 8.3 yuan), 1.06% (8.7 yuan) and 1.11% (9.2 yuan) in the EU, G20 and US proposals. Correspondingly, the increase in per capita agricultural income of those farmers in the top income group (i.e., income group 5 in Table 11.8) will rise by 1.64% (or 69.6 yuan), 1.68% (71.4 yuan) and 1.68% (71.6 yuan). This rate is higher than that of the group farmers that earn incomes under the poverty line. In this way, we can not say the trade liberalization is progressive. Like the differences among income groups, income improvements also differ among households that live in villages that have different topography. In short, farmers living in plains areas will gain more. The average per capita income of farmers that live in villages that are located on a plain will rise by 1.38% (33.7 yuan), 1.43% (35.0 yuan) and 1.46% (35.7 yuan) in the EU, G20 and US proposals (Table 11.8). However, income increases by only 0.59% (9.3 yuan), 0.61% (9.6 yuan) and 0.64% (10.1 yuan) when farmers live in mountainous villages (Table 11.8). Our results also indicate ethnicity matters. The per capita income of Han farmers is shown to rise more than that of those that live in minority villages. The average per capita income of Han farmers will rise by 1.08% (22.3 yuan), 1.13% (23.2 yuan) and 1.18% (24.4 yuan) in the EU, G20 and USA proposal (Table 11.8). Correspondingly, the income 108 growth of minority farmers is much lower. In fact, under the most liberal proposals (the US), the increase will reduce a little bit. Table 11.9 Shares of output values for competitive and noncompetitive agricultural products for different groups of farmers under baseline in 2015 Share of non- Share of neutral Share of competitive competitive agricultural products agricultural products agricultural products (those that did not (those that benefited (those that lost from gain nor lose from from Doha) Doha) Doha) (1) (2) (3) National average 62 11 27 Under poverty 53 10 37 Income group 1 58 12 30 Income group 2 60 13 27 Income group 3 61 12 27 Income group 4 63 11 26 Income group 5 67 11 22 Farmers in plain area 61 8 31 Farmers in hill area 68 15 17 Farmers in mountain area 57 18 25 Farmers: Han 63 12 25 Farmers: Minority 46 24 30 Note: Based on the analysis of the impacts on trade and production, the potential benefit agricultural products under column 1 include rice, wheat, soybean, cotton, oil crops, vegetables, fruits and fish; the potential lost products under column 2 include sugar, beef, mutton, pork and poultry; the neutral products include maize, milk, potato and some minor crops (e.g. other grains). There are many factors leading to the different gains among groups. However, among all of the differences, the most important is the differences among the groups in terms of their farming structure. In other words, richer Han farmers living in plains village benefit more because of the nature of the crops and livestock that they are producing. In order to clearly show the difference in farming structure among the groups, we classify agricultural commodities into three groups based on our analysis of production and trade. The first group is composed by those commodities that are discovered by our analysis to produce benefits for farmers. The set of goods include rice, wheat, soybean, cotton, oil crops, vegetables, fruit and fish. We call these benefiting commodities. The second group includes those that when produced under the Doha round proposals will lead farmers to incur a loss (relative to the baseline). These activities include sweet potato, sugar, beef, mutton, pork and poultry. We call these non-benefiting commodities. The remaining agricultural commodities are not affected significantly. These activities include maize, milk, potato and some minor crops (e.g., other grain). We call these neutral commodities. Through the comparison of farming structures-- benefiting versus non-benefiting--we seek to explain the reason why different groups enjoy/suffer different impacts. The farming structures of different groups help explain the nature of their benefits. As shown in column 1 of Table 11.9, the different income groups that gained the most 109 from the Doha round also produced more benefiting commodities. Specifically, farmers that were under the poverty line only had 53% of their output from benefiting commodities. In contrast, those in the top decile had 67% of their output in benefiting commodities. Although the share of the non-benefiting commodities to total production was almost the same (there is a difference in products that are neutral), the difference between the propensity of higher income groups to produce relatively more benefiting commodities explains a great deal of our results among income groups. The same is true when explaining the differences between the groups based on the topography and ethnicity. As seen in Table 11.9, the larger share of benefiting commodities (the smaller share of non-benefiting commodities), the farmers will gain (lose) more. These farmers that live in villages that are located on plains and farmers that live in Han villages gain more since they have more of their output in benefiting commodities. The Impacts on Farmers' Agricultural Income by Province Although we show that at the national level households in all income groupings gain from trade liberalization, this result does not hold for every province (Table 11.10). At the national (aggregated) level, the overall impact on farmer`s per capita income is small. The main reason is that there are offsetting effects among provinces. But from Table 6 it can be seen that the impacts differ significantly across provinces even for the farmers in the same income categories. Because trade impacts are more commodity-specific, and because farmers in different income groups in different provinces grow different sets of commodities, we can see that there actually are much sharper regional and income class-specific impacts (Table 11.10). It also means that such impacts may have implications for equity. In the case of China, while nearly all farmers in all provinces, except Guangxi and Yunnan, can be seen to benefit from trade reform, liberalization generally hurts producers in Guangxi and Yunnan provinces. The reason, of course, is clear when we consider that farmers in Guangxi and Yunnan provinces are primarily producing sugar, which is the commodity most hurt by Doha trade liberalization. 110 Table 11.10 Impacts on per capita agricultural income of different farmers by province (yuan/person) Farmers under poverty The richest (top 20%) of Average farmers in 2001 farmers in 2001 EU G20 USA EU G20 USA EU G20 USA Beijing 17.9 19.7 25.9 0.0 0.0 0.0 30.8 30.6 29.4 Tianjin 22.4 22.9 25.4 3.4 3.3 2.8 74.4 70.9 60.0 Hebei 30.7 31.9 33.8 8.5 8.7 8.6 81.2 78.5 67.9 Shanxi 15.4 16.2 18.1 7.7 7.8 7.9 37.5 35.9 31.0 Inner Mongolia 27.8 27.9 19.5 11.6 11.4 9.3 172.5 166.2 152.7 Liaoning 36.6 37.4 38.3 12.4 12.4 12.1 198.3 193.0 169.6 Jilin 80.4 80.7 77.2 15.6 15.5 14.6 374.2 365.0 326.1 Heilongjiang 65.5 67.3 60.9 13.1 12.8 11.4 144.1 136.6 126.6 Shanghai 19.1 20.9 24.0 5.3 5.7 5.7 14.0 14.5 17.5 Jiangsu 32.0 34.2 35.9 10.0 10.5 11.2 35.7 34.9 33.0 Zhejiang 23.4 25.9 33.7 0.5 0.5 0.7 26.3 29.1 40.0 Anhui 28.9 30.9 30.7 14.1 14.8 14.6 41.0 39.7 37.1 Fujian 22.3 24.3 31.0 2.3 2.5 3.2 46.1 50.1 65.3 Jiangxi 23.8 25.6 27.8 10.0 10.7 12.0 45.8 48.7 57.9 Shangdong 37.1 38.7 41.0 25.7 26.1 25.7 86.1 84.2 75.8 Henan 39.4 41.1 40.7 16.9 17.5 17.8 80.8 77.6 67.3 Hubei 44.6 48.0 50.4 13.3 14.0 14.5 82.3 85.6 93.5 Hunan 21.9 23.6 27.0 8.5 9.3 11.3 18.0 18.1 21.1 Guangdong 21.4 22.5 25.4 4.8 5.0 5.1 43.8 46.9 58.3 Guangxi -13.6 -16.6 -24.5 -24.5 -26.7 -33.0 44.2 47.5 55.3 Hainan 22.8 24.6 28.9 9.3 9.9 11.4 45.2 49.3 68.0 Chongqing 20.0 21.5 26.1 9.3 10.0 12.3 48.6 47.9 45.8 Sichuan 17.4 18.6 22.1 8.9 9.4 11.1 45.3 45.0 44.4 Guizhou 12.0 12.5 13.6 6.5 6.5 6.9 76.1 74.4 67.5 Yunnan -3.1 -4.7 -8.4 -16.7 -17.7 -20.0 24.7 28.0 34.9 Tibei 38.5 38.5 33.9 32.9 32.9 29.5 34.7 30.0 18.6 Shaanxi 15.1 15.9 17.8 8.6 9.0 10.1 49.2 48.3 48.3 Gansu 36.0 36.8 36.4 11.4 11.7 11.4 199.1 200.2 188.5 Qinghai 9.4 9.5 6.4 12.1 13.2 13.2 -8.7 -10.9 -15.8 Ningxia 16.1 15.6 15.0 4.5 4.5 4.1 85.9 81.2 66.7 Xinjiang 74.9 75.8 70.6 48.3 49.4 47.5 224.1 234.9 254.2 Source: CAPSiM simulation results Interestingly, not all the poor will gain or lose in terms of production with trade liberalization. Our analysis shows that the poor (and more significantly for richer farmers) in the poor provinces (in the western and northern provinces) gain more from trade liberalization, while the poor (and richer farmers) in the eastern and southern provinces gain relatively less or are hurt (Table 11.10). Therefore, according to these results, Doha trade reform will contribute to poverty alleviation in some parts of China. However, at the same time it may lead to greater poverty and worsening income distribution problems in other regions. 111 The other important finding is that the poor in all provinces, except Qinhai and Tibet1, will gain less (or lose absolutely more) than the rich in each sector. This results occurs because, despite the differences in planting structure (of benefiting versus non-benefitting commodities), the quality of land in poorer areas means that the poor produce less (or are less productive) than farmers in the richer categories. While, in fact, it is unclear if the lower productivity is due to lower quality of land or inability to apply sufficient inputs (or both), it is clear that there is a role of the government in improving the ability of the poor to increase productivity (through more R&D extension, investment and credit). It also is worthy to note that farmer incomes in some regions may become worse under the more liberalized proposals. As shown in Table 11.10 farmer per capita incomes, on average (at the national level), will increase under the more liberalized proposals. However, it is not always true when looking at the differences among farmers in different provinces. Our results show that per capita incomes in Guangxi and Yunnan fall gradually from 13.6 yuan and 3.1 yuan under the EU proposal, to 16.6 yuan and 4.7 yuan under the G20 proposal, to 24.5 and 8.4 under the US proposal (Table 11.10). Therefore, one implication of this finding is that the national government needs to put effort into designing a way to compensate farmers that suffer relatively more pain (in certain types of villages in certain provinces) than those in others (that gain). Concluding Remarks After nearly 30 years of economic reform, China`s agriculture has grown rapidly and has been gradually liberalized. Today, China has become home to one of the most liberalized agricultural economies in the world. The growth in agricultural output has contributed strongly to rural poverty reduction. China`s experience also demonstrates the importance of trade liberalization in agricultural development and in facilitating its agricultural structure`s change toward more competitive sectors. This study shows that China`s economy will benefit from the Doha Round--though overall the impacts are minor--since the Doha Round is mainly focused on the agricultural sector. Therefore, in percentage changes, the gains in agriculture would be greater than gains to the rest of economy (and, agriculture is making up an increasingly smaller part of China`s overall economy). We also found that a more liberalized trade reform proposal would bring more gains to China, although the impacts, in fact, do not differ significantly among three proposals (USA, EU and G20). In analyzing the impacts of the Doha Round on China`s agriculture and poverty, we conclude that the positive impacts are more than the negative ones, though most of the impacts will be small in terms of their share of domestic production. Although other 1 It is mainly caused by the differences of income structures among income groups. Taking Qinghai for example, the share of potential benefit agricultural commodities by top income group is 43% with the share of potential loss agricultural commodities of 20%. Contrarily, the share of the potential benefit by farmers under poverty is 60% with the share of the potential loss only 7%. Therefore, the farmers under poverty in Qinhai will gain, with the farmer in the top income groups hurt. 112 effects on the rural economy from other subsectors may be equally large or even larger, this study`s focus on the agricultural sector shows that there will be an impact and the net impacts are positive for the average farmer in China. This implies that China may want to take a more active role in pushing forward the Doha Round negotiations, reducing high tariffs imposed on China`s products in the rest of world. The results of this study also show that the impacts of a Doha Round will differ significantly from the impacts of China`s WTO accession. The Doha Round is an exercise in multilateral trade liberalization; in contrast, China`s WTO accession was mainly a unilateral liberalization. Because of this the set of benefiting commodities may not exactly correspond to the set of commodities in China`s global competitive sector. Whether or not farmers that are engaged in agricultural production are gainers or losers due to the Doha Round will highly depend on the relative changes in China versus the changes of trade policies in other countries. Our findings have important implications not only to China`s position in Doha negotiation, but also for its domestic grain security. Importantly, China`s food security improves under the Doha proposals. We demonstrate that although the absolute effects of trade liberalization will not be very large, policy makers should be concerned about the poverty and equity effects. We show this through several findings. First, according to the analysis, while most farmers will gain from the Doha Round, the degree of the gain will differ largely among farmers with different levels of incomes and among farmers living in different locations (e.g., on the plain versus in mountainous areas). Second, although on the average farmer at the national level will benefit from the Doha Round, this finding does not hold for all provinces. The typical farmer in some provinces, such as Guangxi and Yunan, will not gain from the Doha Round mainly due to the large negative effects on sugar. While the average farmer does gain in other provinces, those that are producing benefiting commodities will gain more than those producing non-benefiting commodities. As a consequence of these equity issues, policy makers need to take several actions. First, officials need to try to encourage farmers in poorer areas to shift their production decisions (where appropriate) to more competitive and benefiting products that will gain from Doha Round. Second, officials may also need to take other, non-trade actions to increase the livelihood of farmers in these areas. In many areas, farmers do not have an advantage in any farming activity. In such areas rural education, better communications and other policies that might facilitate their shift into the non-farm sector may be the most beneficial policy. Third, there is a role for government for improving agricultural productivity through more research, R&D extension and agricultural infrastructure investment, particularly in poor areas. Last, but not least, there is also a role of government to make effort in compensate farmers that suffer relatively more lose or less gains than those in others. 113 12 Trade and the Environmental Debate Muthukumara Mani Background There has been much debate over the last two decades on the role international trade plays in determining environmental outcomes. This has led to both theoretical work identifying a series of hypotheses linking openness to trade and environmental quality, and empirical work trying to disentangle some of the suggested linkages using cross- country or within-country data. Much of the focus, has been on looking at how changes in production and trade flows have altered the pollution intensity of production (composition effect) in both developed and developing countries, and/or how trade flows may themselves be affected by the level of abatement costs or strictness of pollution regulation in the trading partner countries.1 In the policy arena, the importance of establishing coherent relationships between the trade obligations set out in various bilateral/multilateral trade agreements and environmental policies of countries is now well-recognized. Environmental provisions under the WTO`s General Agreement on Tariffs and Trade (GATT) allow adoption of product-related measures in certain situations if they are necessary to protect human, animal or plant life or health, or relate to the conservation of exhaustible natural resources. In addition, other trade agreements--such as NAFTA, CAFTA and MERCOSUR--include provisions that directly address environmental concerns. The Doha round of the WTO also provided the scope for expanding environmental provisions in the context of the WTO negotiations. Specific issues currently tabled relate to: The relationship between existing WTO rules and specific trade obligations set out in multinational environmental agreements (MEAs). The reduction or, as appropriate, elimination of tariff and non-tariff barriers to environmental goods and services (EGS). Clarification and improvement of WTO disciplines on fisheries subsidies, taking into account the importance of this sector to developing countries. Clarification of environmental labeling (including ecolabeling) policies. While reasonable progress has been made on a number of fronts, the EGS mandate and proposals, which call for the "reduction or, as appropriate, elimination of tariff and non- 1 The issue of trade and the environment has surfaced at the Bank from time to time. There were two edited volumes (1992, 1999) focusing on issues such as pollution havens, race to the bottom, FDI inflows, etc. These were quite useful in informing the broader discussion in the area at that time. 114 tariff barriers to environmental goods and services", has received relatively greater attention recently leading up to the recent UN Conference on Climate Change in Bali. This policy note focuses on the current state of debate surrounding environmental goods negotiations under the WTO in the context of Chinese exports and imports.1 The note also looks at some recent proposals (in US and EU) which call for increased trade barriers against imports from countries which have less stringent carbon policies and then draws implications for china. Environmental goods negotiations--what are the pros and cons? Proponents of the negotiations to liberalize trade in certain environmentally-friendly technologies believe that increasing access to and use of these technologies can contribute to improving environmental quality and pollution abatement in both developed and developing countries. This has now been extended to address climate change concerns given the general global urgency surrounding the issue. Trade in these sectors is also seen as a potentially powerful tool for economic development by generating economic growth and employment and enabling the transfer of valuable skills, technology and know-how. On the other hand, the negative impacts of liberalization on vulnerable industries in developing countries -- in particular fledgling small and medium- sized enterprises, have often been cited. This has led to calls among some stakeholders that liberalization should be gradual or carefully qualified and in certain cases that countries should be able to stop or roll back liberalization that may have these negative impacts. What are environmental goods? There is no broadly agreed definition of environmental goods. But environmental goods have been conceptualized in two ways. The first is the narrow, conventional view that focuses on treating a specific environmental problem through the end-use of a particular good. This includes goods such as wastewater treatment or air pollution control equipment. The second is a broader view and includes environmentally preferable products (EPPs). In this case, the primary purpose of the product is not to remedy an environmental problem but environmental benefits may arise from the production method, during the course of its use, or during the disposal stage of the product. A wide array of products--ranging from hybrid cars to energy-efficient light bulbs--could all conceivably be classified as EPPs. Most WTO Members, however, have sought to avoid including products that were deemed environmentally preferable based on their process and production methods (PPMs).2 1 The trade issues concerning environmental services are of a different nature and often involve domestic regulatory issues as well. The note therefore focuses only on environmental goods. 2 Differentiating goods on the basis of production would also potentially throw up challenges with regard to classification of products for the purpose of trade under the existing Harmonized Commodity Coding and Description System (HS), as well as require labeling or certification introducing additional complexities of standard-setting, recognition, and acceptance. 115 Approaches taken for the negotiations in the WTO The approaches taken to liberalizing environmental goods under the Committee on Trade and Environment (CTE) has especially proved a major cause of deadlock in the WTO negotiations. Some countries (mostly developed) have proposed a list approach` to negotiations similar to that adopted for industrial goods; that is, focusing on identifying and submitting specific lists of goods and then negotiating the elimination or reduction of bound tariffs (and nontariff barriers) permanently and on a most-favored-nation (MFN) basis. A number of developing countries, however, are concerned about the impact of liberalization on existing domestic industries and in some cases on tariff revenue. As an alternative, some developing countries (e.g., India, Argentina) have proposed a project approach to liberalization. Under this approach the liberalization of any good or service (including dual-use` ones) would be linked to specific environmental projects approved by a designated national authority. According to some WTO members, the project approach has two drawbacks: (a) it lacks binding and predictable market access offered on a permanent basis; and (b) is inconsistent with WTO rules. Concerns have also been raised regarding the time taken to develop multilateral criteria, as well as dispute-settlement proceedings relative to the duration of a project. China in its submission proposed a common list that would include environmental goods of export and import interest to developing countries and a development list that would be derived from the common list and comprise goods eligible for special and differential treatment in the form of lower levels of reduction commitments for developing countries (see Box 12.1). No formal list, however, was submitted by China for discussions. 116 Box 12.1 Chinese Submission to the WTO on Common` and Development` Lists China in its submission (TN/TE/W/42) to the WTO Committee on Trade and Environment recognized that special and differential treatment to the developing and least-developed Members is a must in the process of liberalizing trade on environmental goods. It therefore proposed a two pronged approached consisting of liberalizing on the basis of a: Common List for which comprises specific product lines on which there is consensus that they constitute environmental goods. The products included in this list should reflect the interests of both developed and developing Members. Priorities should be given to products of export interest of developing and least- developed Members in order to enhance the export capacity building on environmental goods in real terms. For the products in the common list, Members are committed to reduce or eliminate tariff and non-tariff barriers. The specific modality of trade liberalization on environmental goods shall be developed by the NAMA negotiating group according to the Doha mandate. Development List is a list for special and differentiated treatment born from the common list, which comprises those products selected by developing and least-developed Members from the common list for exemption or a lower level of reduction commitment, with a view to reflecting the principle of less than full reciprocity, taking into consideration the needs of their economic development and the vulnerability of their relevant domestic industries in the area of environmental goods. China also stressed the need and importance of facilitation of technology transfer to the developing and least-developed Members when working on trade liberalization on environmental goods. Consolidated list of Submissions In all nine members tabled submissions containing their lists of environmental goods (see Annex-Table 12A.1 for a list of submissions) for consideration. This included submissions from Canada, the European Communities, Japan, Korea, New Zealand, Qatar, Switzerland, Chinese Taipei and the United States. To facilitate broader discussions, the CTE in 2005 created a consolidated common list from these submissions. The list contained 480 products covering areas of waste water management, solid and hazardous waste management and renewable energy plant. Potential convergence set Owing to a general lack of traction within the EGS negotiations, in May 2007, a group of 9 countries (comprising Canada, the EU, Japan, Korea, New Zealand, Norway, the separate customs territory of Taiwan, Penghu, Kinmen and Matsu, Switzerland and the United States of America) proposed a list of 153 goods with a view to provide a more focused engagement in a fewer goods (within CTE) and to spur some momentum in the negotiations. The cosponsors of this potential convergence set suggested that this list by taking into account discussions in CTE surrounding the bigger list including and addressing concerns of some developing countries offers potential for a high degree of convergence among members. The US-EU Proposal 117 A recent US-EU proposal made at the WTO a few days prior to the crucial Bali climate change meetings suggests that the WTO Members agree to eliminate tariffs and identified non-tariff barriers to trade in 43 climate friendly products, building on the analysis done earlier by the World Bank (see Annex-Table 12A. 2). The proposal is open to special and differential treatment for developing country Members, including longer phase-in periods. The objective is to have a zero tariff world for climate friendly goods in the near future and no later than 2013. Except for opposition from countries like Brazil (for not including ethanol) and India, the proposal has received support from a number of countries. The US expects to pursue this further in the next meeting of the leading greenhouse gas emitting countries to be held in Hawaii in February 2008. Chinese trade in climate-friendly technologies When we look at the Chinese exports in this list of proposed climate-friendly technologies, we find that it has increased multi-fold in the last five years--from $2.2 billion in 2002 to almost $10 billon in 2006. On the other hand, imports also continue to increase but at a much slower rate--imports almost doubled in the last five years. When we compare similar numbers for both the US and EU we get somewhat striking results for China. While the import/export ratios for these technologies remains more or less constant in the US and EU, it is declining steadily in China suggesting that China is exporting more than it is importing and emerging as major exporter in this area (Figure 12.1). Any efforts to liberalize trade in these technologies would give further boost to Chinese exports. Figure 12.1 Comparison of Import/Export Ratios in Climate Friendly Technologies 3.0 2.5 2.0 China 1.5 US 1.0 0.5 EU 0.0 2002 2003 2004 2005 2006 In terms of bilateral trade flows, both the US and EU are increasingly becoming major importers of these technologies from China. For the US, the imports have gone from $0.4 billion in 2002 to $1.4 billion in 2006 and for the EU the imports have gone from $0.3 to almost $3 billion during the last five years. The US is in fact become a net importer of these technologies from China. Analysis undertaken for this paper suggests that liberalization of trade as per the WTO proposal would increase the Chinese exports of climate friendly technologies to the US by about 8.4 percent. This only takes trade creation effects into account. The net impact of trade creation and trade diversion from other producers could be much higher. Table 12.1 gives the top Chinese exports in this area by HS code and volume of exports. 118 Table 12.1 Top Chinese Climate-Friendly Exports HS Description Net Code Exports ($millions) 732111 Solar driven stoves, ranges, grates, cookers (including those with subsidiary 579 boilers for central heating), barbecues, braziers, gas-rings, plate warmers and similar non-electric domestic appliances, and parts thereof, of iron or steel. 732190 Stoves, ranges, grates, cookers (including those with subsidiary boilers for central 266 heating), barbecues, braziers, gas-rings, plate warmers and similar non-electric domestic appliances, and parts thereof, of iron or steel. - Parts. 841581 Compression type refrigerating, freezing equipment incorporating a valve for 302 reversal of cooling/heating cycles (reverse heat pumps) 841861 Compression type refrigerating, freezing equipment incorporating a valve for 919 reversal of cooling/heating cycles (reverse heat pumps) 848340 Gears and gearing and other speed changers (specifically for wind turbines) 340 850720 Other leadacid accumulators 935 853710 Photovoltaic system controller 738 854140 Photosensitive semiconductor devices, including photovoltaic cells whether or 2460 not assembled in modules or made up into panels; light emitting diodes 900190 Mirrors of other than glass (specifically for solar concentrator systems) 659 900290 Mirrors of glass (specifically for solar concentrator systems) 441 Source: WITS database Use of trade restrictive measures for environmental purposes Countries vary with respect to their vulnerability to climate change and their willingness to pay to avoid any future damage. Because of the difficulties associated with attaining the international cooperation that will be needed for effective policies to address climate change, there is a widespread concern that countries might start using unilateral measures to address differential attitudes, perceptions, and policy standards. Such unilateral measures may take the shape of trade measures," such as tariffs or quotas against countries that do not adhere to similar standards. Under the WTO, members can adopt measures to protect the environment and human health and life as long as such measures comply with GATT rules. Articles XX(b) and (g) allow WTO members to justify trade measures if these are either necessary to protect human, animal or plant life or health, or if the measures relate to the conservation of exhaustible natural resources, respectively. Moreover, the chapeau of Article XX requires that these measures not arbitrarily or unjustifiably discriminate between countries where the same conditions prevail, nor constitute a disguised barrier to trade. While no such measures are in place anywhere in the world, two such proposals are already getting lot of traction and attention both in the EU and the US. The recent European Commission`s plans to tighten Europe's greenhouse gas reduction regime, also recognizes the risk that new legislation could put European companies at a 119 competitive disadvantage compared to countries with less stringent climate protection laws, such as the US, China and India. According to the Commission, this situation could cause large "carbon leakages", whereby companies move their activities to other regions of the world in order to keep costs down. To address this threat, the draft legislation includes proposals to impose restrictions on imports unless an international agreement subjecting all industrialized countries to similar climate change mitigation measures is reached. According to the proposal, such a "carbon equalization system" could take the form of an obligation for foreign companies doing business in Europe to obtain emissions permits alongside European competitors. There are similar proposals in the U.S. Congress attached to future GHG emissions cap- and-trade legislative proposals.1 If passed in their current form, these bills would require purchases of greenhouse gas emission allowances in order for imported goods to be allowed to enter the U.S. from countries that are not making satisfactory efforts to mitigate greenhouse gas emissions. The requirement for such purchases would be an alternative to offsetting border measures in the form of tariffs. In both the US bills, the proposal is to require U.S. importers in some circumstances to purchase GHG emission allowances. Such a measure could be less vulnerable than a tariff to challenge in the WTO, because it could more clearly be considered an environmental measure that would qualify as an exception under GATT Article XX(g), which allows measures relating to the conservation of exhaustible natural resources. The offsetting border provisions in both bills have been carefully crafted to avoid - or survive if necessary - any challenges in the WTO dispute settlement process.2 There are provisions, for instance, that would require the U.S. government to enter into negotiations with foreign governments in an effort to resolve international competitiveness issues and in advance of any actual imposition of the allowance purchasing requirement. Legal experts remain divided on whether the EU or the US proposed measures would be compatible with international trade regulations, as the WTO has no clear provisions on the subject. On the one hand, border adjustment measures could be considered to contravene WTO rules prohibiting discrimination between countries or between "like products." A particularly thorny issue in assessing the compatibility of trade measures with climate change policy may arise with the application of PPM (Processes and Production Methods)-based measures. These are measures that may be targeted at the way products are produced, as opposed to the inherent qualities of the product itself. Since most climate change measures do not directly target any particular products, but rather focus on the method by which greenhouse gases may be implicated related to production, PPM issues are critical for the compatibility analysis. However, the recent experience of the Shrimp-Turtle dispute suggests that the WTO Dispute Panel and the 1 Two of the many legislative proposals introduced during 2007 are relevant. One is Senate bill 1766, introduced by Senators Bingaman and Specter; the other is Senate bill 2191, introduced by Senators Lieberman and Warner. 2 Brewer (2008). Climate Change Policies and Trade Policies: The New Joint Agenda. Georgetown University. Draft. 120 Appellate Body may have opened the doors to the permissibility of trade measures based on PPMs. Nonetheless, both the EU and the US proposals could have significant implications for China`s manufacturing trade--especially what can be classified as energy intensive. If we look at Chinese trade in some of the mostly commonly identifiable energy-intensive industries-- pulp and paper, industrial chemicals, iron and steel, nonmetallic mineral products, and nonferrous metals--we find that both the imports and exports have increased considerably over the last ten years and especially in the last five years. While imports have increased from $65 billion in 2002 to $142 billion in 2006, exports have increased from $22 billion to $101 billion. While both reflect China`s status as one of the fastest growing manufacturing economies during the last decade, the import-export ratio is rapidly declining suggesting that China is now exporting more than it is importing. It also suggests the possibility that some industries may have relocated to China from countries with more stringent climate policies. The ratio is still, however, less than 1 which suggests that it continues to be a net importer. This could change as countries in the EU ratchet up their carbon standards to comply with or in anticipation of any post-Kyoto deal. In terms of bilateral trade the US and EU account for a large share--the US accounting for a 13 percent of Chinese exports and EU accounts for 15 percent of its energy intensive exports. For this report, we did some rough calculations on the impact of the proposed US measure on Chinese exports. If we assume that proposed measure which requires US importers to purchase carbon offsets translates into tariff equivalents it will roughly be a function of the global price of carbon. Assuming a 10, 20, and 30 percent tariff equivalent (based on $per ton carbon) of the proposed measures we estimate the impact on both Chinese exports and exports of energy intensive commodities. We find that such a measure could significantly impact China`s exports in energy intensive sector from 10- 30 percent. While this may deliver some local environmental benefits, the impact on labor, ancillary industries and regional development could not be understated. For example, this could impact adversely major steel producing provinces such as Sichuan, Hebei, and Liaoning. The calculation does not take into account the trade diversion effects and the impact of a similar EU measures. Hence the net impact on Chinese exports could be much higher than projected here. Table 12.2 Impact of a US trade-related climate measure on Chinese exports Tariff Equivalent 10% 20% 30% Energy Intensive 9.9 22.8 31.7 Exports (% loss) Total Exports (% 0.4 1.0 1.4 loss) 121 Way forward The trade and the environment debate which has been mainly focused on the impact of trade on local pollution and on cross-border measures to address transboundary pollution has resurfaced again--this time strongly in the climate change arena. This is mainly in the context of trade in clean energy technologies and on the use of trade measures to combat competitive pressures in developed country industries. The recent proposals that have surfaced in the European Parliament and the US Congress are a sign that the issue will remain alive in the global discussions surrounding any future climate regime. While developed countries remain the largest per capita emitters of greenhouse gases today, the growth of carbon emissions in the next decades will come primarily from developing countries, which are following the same energy- and carbon- intensive development path as did their rich counterparts. Among the developing countries, the main growth in carbon emissions will emanate from China and India because of their size and growth.1 Strong economic growth and heavy dependence on coal in industry and power generation contribute to this trend. There will be thus increasing pressure on the trade front to redress any competitiveness pressures. While it is debatable as to what extent these measures are WTO compatible, China should be prepared to deal with the issue both within and outside the country as the economic and regional impacts could not be understated. At the same time, the global climate change awareness and discussions surrounding clean energy technologies also offer an incredible economic opportunity as China is emerging as a major producer and exporter of these technologies. It thus becomes important that China closely participates in the WTO and other forums such as UNFCCC where these issues are being debated to ensure that its interests are not compromised. 1 More than 70 percent of the world emissions increase from 2020­30 according to the International Energy Agency is projected to come from non-Annex I (developing) countries. China alone will contribute about a quarter of the increase in CO2 emissions, or 3.8 Gt, reaching 7.1 Gt in 2030. Its emissions will overtake those of the United States by 2010. 122 Annexes: Table 12A.1 List of Submissions to the WTO Environmental Goods and Services Negotiations Symbol Date Subject/Title Member TN/TE/W/6 6 June 2002 Environmental Goods New Zealand Negotiations on Environmental TN/TE/W/8 9 July 2002 United States Goods 9 October TN/TE/W/14 Environmental Goods Qatar 2002 TN/TE/W/17 (and 20 November Market Access for Non-Agricultural Japan Corr.1) 2002 Products TN/TE/W/19 ­ Negotiations on Environmental 28 January TN/MA/W/24 (and Goods: Efficient, Lower-Carbon Qatar 2003 Corr.1) and Pollutant-Emitting Fuels and TN/TE/W/27 ­ Technologies Harmonized System (HS) 25 April 2003 Qatar TN/MA/W/33 Classification Codes of Gas-Related TN/TE/W/34 ­ Goods Liberalizing Environmental Goods TN/MA/W/18/Add. 19 June 2003 in the WTO: Approaching the United States 4 Definition Issue TN/TE/W/38 ­ Contribution on an Environmental TN/MA/W/18/Add. 7 July 2003 United States Goods Modality 5 Statement on Environmental Goods TN/TE/W/42 6 July 2004 at the CTESS Meeting of 22 June China 2004 TN/TE/W/44 (and 7 October Proposed Initial List of Chinese Taipei Corr.1) 2004 Environmental Goods 10 February TN/TE/W/46 Environmental Goods New Zealand 2005 17 February Market Access for Environmental TN/TE/W/47 European Communities 2005 Goods Market Access for Environmental TN/TE/W/47/Add.1 27 June 2005 European Communities Goods - Addendum 18 February Initial List of Environmental Goods TN/TE/W/48 Republic of Korea 2005 Proposed TN/TE/W/49 26 May 2005 Environmental Goods New Zealand TN/TE/W/49/Suppl. Environmental Goods, Statement at 16 June 2005 New Zealand 1 the CTESS Informal Meeting of 10 June 2005 - Supplement List Canada's Initial of TN/TE/W/50 2 June 2005 Canada Environmental Goods TN/TE/W/50/Suppl. Canada's Initial List of 1 July 2005 Canada 1 Environmental Goods - Supplement An Alternative Approach for TN/TE/W/51 3 June 2005 Negotiations under India Paragraph 31(iii) TN/TE/W/52 1 July 2005 Initial List of Environmental Goods United States 123 Symbol Date Subject/Title Member Structural Dimensions of the TN/TE/W/54 4 July 2005 India Environmental Project Approach TN/TE/W/55 5 July 2005 Environmental Goods Cuba TN/TE/W/56 5 July 2005 EC Submission on Environmental European Communities Goods TN/TE/W/57 6 July 2005 Environmental Goods Switzerland Environmental Goods for TN/TE/W/59 8 July 2005 Brazil Development 14 September TN/TE/W/57/Corr.1 Environmental Goods Switzerland 2005 Procedural and Technical Aspects 19 September TN/TE/W/60 of the Environmental Project India 2005 Approach 12 October Revised New Zealand Provisional TN/TE/W/49/Rev.1 New Zealand 2005 List of Environmental Goods Integrated Proposal on 14 October TN/TE/W/62 Environmental Goods for Argentina 2005 Development 20 February Continued Work Under Paragraph TN/TE/W/64 United States 2006 31(iii) of the Doha Declaration Environmental Project Approach - TN/TE/W/67 13 June 2006 India Compatibility and Criteria The Development Dimension as an Integral Part of the Negotiations On TN/TE/W/69 30 June 2006 Cuba Environmental Goods: The Principle of Special and Differential Treatment Market Access for Environmental TN/TE/W/49/Rev.2 30 June 2006 New Zealand Goods: Revised New Zealand List Canada's Revised List of TN/TE/W/50/Rev.1 4 July2 006 Canada Environmental Goods Canada, the European Communities, Japan, Korea, New Zealand, Norway, the Separate Continued Work Under Para 31 (iii) JOB (07)/54 27 April 2007 Customs Territory of of the Doha Ministerial Declaration Taiwan, Penghu, Kinmen and Matsu, Switzerland and the United States of America 1 October Environmental Goods for JOB (07)/146 Brazil 2007 Development-Paragraph 31 (iii) 30 October Environmental Goods and Services JOB(07)/161 Peru 2007 for Development 124 Symbol Date Subject/Title Member Proposal for a Result Under 30 November United States and the JOB(07)/193 Paragraph 31 (iii) of the Doha 2007 European Communities Ministerial Declaration Table 12A.2 List of Climate-Friendly Technologies HS Code Product Description 392010 PVC or polyethylene plastic membrane systems to provide an impermeable base for landfill sites and protect soil under gas stations, oil refineries, etc. from infiltration by pollutants and for reinforcement of soil 560314 Non-wovens, whether or not impregnated, coated, covered or laminated: of manmade filaments; weighing more than 150 g/m2 for filtering wastewater 701931 Thin sheets (voiles), webs, mats, mattresses, boards, and similar nonwoven products 730820 Towers and lattice masts for wind turbine 730900 Containers of any material, of any form, for liquid or solid waste, including for municipal or dangerous waste. 732111 Solar driven stoves, ranges, grates, cookers (including those with subsidiary boilers for central heating), barbecues, braziers, gas-rings, plate warmers and similar non-electric domestic appliances, and parts thereof, of iron or steel 732190 Stoves, ranges, grates, cookers (including those with subsidiary boilers for central heating), barbecues, braziers, gas-rings, plate warmers and similar non- electric domestic appliances, and parts thereof, of iron or steel--Parts 732490 Water saving shower. 761100 Aluminium reservoirs, tanks, vats and similar containers for any material (specifically tanks or vats for anaerobic digesters for biomass gasification) 761290 Containers of any material, of any form, for liquid or solid waste, including for municipal or dangerous waste 840219 Vapor generating boilers, not elsewhere specified or included hybrid 840290 Super-heated water boilers and parts of steam generating boilers 840410 Auxiliary plant for steam, water, and central boiler 840490 Parts for auxiliary plant for boilers, condensers for steam, vapor power unit 840510 Producer gas or water gas generators, with or without purifiers 840681 Turbines, steam and other vapor, over 40 MW, not elsewhere specified or included 841011 Hydraulic turbines and water wheels of a power not exceeding 1,000 kW 841090 Hydraulic turbines and water wheels; parts, including regulators 841181 Gas turbines of a power not exceeding 5,000 kW 841182 Gas turbines of a power exceeding 5,000 kW 841581 Compression type refrigerating, freezing equipment incorporating a valve for reversal of cooling/heating cycles (reverse heat pumps) 125 841861 Compression type refrigerating, freezing equipment incorporating a valve for reversal of cooling/heating cycles (reverse heat pumps) 841869 Compression type refrigerating, freezing equipment incorporating a valve for reversal of cooling/heating cycles (reverse heat pumps) 841919 Solar boiler (water heater) 841940 Distilling or rectifying plant 841950 Solar collector and solar system controller, heat exchanger 841989 Machinery, plant or laboratory equipment whether or not electrically heated (excluding furnaces, ovens etc.) for treatment of materials by a process involving a change of temperature such a heating, cooking, roasting, distilling, rectifying, sterilizing, steaming, drying, evaporating, vaporizing, condensing or cooling. 841990 Medical, surgical or laboratory stabilizers 848340 Gears and gearing and other speed changers (specifically for wind turbines) 848360 Clutches and universal joints (specifically for wind turbines) 850161 AC generators not exceeding 75 kVA (specifically for all electricity generating renewable energy plants) 850162 AC generators exceeding 75 kVA but not 375 kVA (specifically for all electricity generating renewable energy plants) 850163 AC generators not exceeding 375 kVA but not 750 kVA (specifically for all electricity generating renewable energy plants) 850164 AC generators exceeding 750 kVA (specifically for all electricity generating renewable energy plants) 850231 Electric generating sets and rotary converters; wind-powered 850680 Fuel cells use hydrogen or hydrogen-containing fuels such as methane to produce an electric current, through a electrochemical process rather than combustion 850720 Other lead acid accumulators 853710 Photovoltaic system controller 854140 Photosensitive semiconductor devices, including photovoltaic cells whether or not assembled in modules or made up into panels; light emitting diodes 900190 Mirrors of other than glass (specifically for solar concentrator systems) 900290 Mirrors of glass (specifically for solar concentrator systems) 903210 Thermostats 903220 Manostats 126 Part III Promoting Trade in Services Linda Schmid1 13 Trade in Services Overview Services industries are an increasingly important component of domestic economic development and international trade. In developed and developing economies, services represent, on average, a substantial proportion of employment and GDP as illustrated in Figure 13.1. As incomes rise and basic needs are met, individuals generally spend a greater amount of their income on services. In addition, the division of economic production processes into discrete activities has given rise to specialized intermediate services that represent crucial inputs to agricultural and manufacturing as well as services production. The cost and quality of services influence the productivity of all sectors of the economy including the efficacy of the public sector as a significant user of services. Figure 13.1 Services Value Added (% of GDP) Source: World Bank world development indicators database http://www.worldbank.org Increasing international trade in services Services have become a valuable component of international trade consistently representing approximately 1/5 of world trade. In 2006, world commercial services exports including transportation, travel and other commercial services totaled $2.7 trillion with other commercial services representing almost 50% of the total. 2 Technological 1 Linda Schmid is an independent consultant on international trade policy and development. She served as the Trade in Services Officer, International Trade Centre, Geneva. She acted as Trade Director, Caribbean Trade and Competitiveness Program, Barbados. She is a contributing author to Managing the Challenges of WTO Participation, Cambridge University Press 2005. E-mail: Lschmiddc@gmail.com. 2 Other commercial services encompass communications, construction, insurance, financial, computer and information, royalties and license fees, other business services and personal, cultural, and recreational 127 progress has boosted trade in communication, construction, insurance, financial, computer, business, and personal services. The advent of the Internet, lower costs of travel, and more open investment regimes have allowed commercial service firms to find, market and serve clients around the world. This is reflected in the services proportion of global foreign direct investment (FDI) stock, which stood at 61% in 2005 with inward flows focused on finance, business activities, and trade.1 Means of trading services A commercially valuable means of trading services is via establishment.2 According to the WTO, trade in commercial services provided through establishment surpasses all other modes of supply.3 In part, this is due to the nature of services and the importance of language in services development and delivery, "geographic and linguistic proximity are key determinants of the level of services trade between two countries."4 The business return on familiarity with clients draws firms close to their customer base. "Customers constitute the single most important source of information for innovative ideas" according to representatives from communications, financial, and technical business service firms. 5 Services are also generally considered intangible and difficult to evaluate before their delivery. As a consequence, successful service providers work hard to establish their credibility, build their reputation, and effectively communicate with clients. Establishing in a market of export interest is a practical means of deepening commercial relationships with clients. The business case for establishing locally is also a reflection of remaining constraints to trade in services. Legislation, government rules, and administrative procedures remain the most significant barriers to trade in services and establishing a local office is a viable way to manage regulatory requirements. Those sectors that are heavily regulated, for example, banking, insurance, securities, telecommunications, and professional services may earn a greater return from familiarity with local laws and administrative procedures. Local qualification requirements, joint venture rules, and residency stipulations also propel local establishment. Pragmatic service firms recognize these obstacles and many work through them by establishing a local office, in conjunction with providing services online, via consumption abroad, and through temporary movement of people. State of the art services firms employ all modes of supply in the intricate value chain of developing, marketing, and delivering services. For example, outsourcing firms may use services reflecting IMF Balance of Payments categorization. World Trade Organization (2007) International Trade Statistics 1 United Nations Conference on Trade and Development (2007) World Investment Report 2 The 4 modes of supply of services include: mode 1: cross-border, mode 2: consumption abroad, mode 3: commercial presence also known as establishment, and mode 4: movement of natural persons. For a comprehensive explanation see World Trade Organization (2005) A Handbook on the GATS Agreement 3 World Trade Organization (2007) 4 Janet Ceglowski (2006) "Does Gravity Matter in a Service Economy?" Review of World Economics Vol.142, No. 2, p 307-329 5 Guy Gellatly, Valerie Peeters (1999) Understanding the Innovation Process: Innovation and Dynamic Service Industries Statistics Canada 128 an online presence to market to clients, provide services, and deliver after sales service. They will also invite clients to visit services facilities and monitor operations over the life of the contract. As another example, educational providers and tourism establishments will attract customers to university and hotel locations, and use other modes to initially reach clients, provide information, and obtain payment. Engineers and accountants may travel abroad to meet clients and deliver services electronically. Policymakers interested in expanding service exports can work to reduce trade restrictions in export markets of interest in all modes of supply. Examples of common restrictions are presented in table 13.1. Table 13.1 Examples of Restrictions on Trade in Services Administrative rules and procedures that are difficult to obtain and understand Limitations on the geographic scope of operations of the firm Limitations on the percentage of foreign ownership of the firm Restrictions on the availability of foreign currency to purchase services abroad Requirements for the formation of a joint venture or specific corporate structure Limitations on firm's ability to use its company name Requirements that local marketing and advertising firms be used Prohibitions on the provision of a service by a foreign firm Restrictions on foreign participation in government procurement processes Unduly burdensome limitations on movement of natural persons across borders Source: World Trade Organization (2005) A Handbook on the GATS Agreement Key factor inputs to services production Service industries are reliant on key inputs that public policy can foster. In general terms, labor, technology, finance, and energy are critical factors of production in service industries. In high-growth value added services the level of education and expertise of employees is a significant input needed to deliver professional, medical, and research services, for example. The scope and quality of primary, secondary and tertiary education is therefore important to producing a pool of well-qualified individuals capable of working in a variety of services fields. Furthermore, the ability to provide adult education to enhance skills and provide retraining in support of labor flexibility also accommodates the comparatively rapid business life cycles of service industries where employee turnover and dislocation is prevalent. Related to the importance of education is the ability to attract and facilitate the movement of service industry experts across borders, particularly in those service sectors where a domestic competence does not exist or would take many years to develop. A supportive policy environment can facilitate trade in key inputs to ensure quality and competitively priced technology products, communications, energy, and financial services. Service firms use technology to produce and deliver services. As a consequence, service firms require access to economically priced and high-quality information technology products as well as robust communications infrastructure. 1 1 The General Agreement on Trade in Services (GATS), under the WTO, recognizes telecommunications as a conduit for international services and as an important service. WTO members` commitments in the 129 Given their reliance on technology and dependence on communications, service firms need consistent and economically priced energy services. In terms of finance, service firms in emerging markets consistently bemoan the inability of financial institutions to understand their business model and offer financial products that do not rely solely on the possession of physical assets. Service firms require appropriate financing that values forward contracts and unique methods of services production. Economies that facilitate trade in service inputs can help eliminate potential constraints to service industry expansion. The condition of domestic institutions also influences the scope and depth of the services economy. Fundamental policy environment There is a fundamental policy environment that supports the development of service industries. Its foundation is a functioning judicial infrastructure that enforces the validity of contracts and fair play in the marketplace. Regulatory institutions sit on top of this foundation. Whether regulatory institutions are sector specific or provide supervision across services sectors, they are critical for market oversight, to protect against market failures, ensure corporate behavior, and achieve societal objectives. Regulatory institutions must also be free from undue political interference that would prejudice their treatment of firms in the marketplace. Their integrity and ability to carry out their duties efficiently and without favoritism toward one firm or another provides predictability and confidence in market operations for service industry investors and users. The ability of regulatory institutions to oversee a market with transparency and restraint will also influence the fluidity and ease of doing business in the services economy. Regulatory institutions must also keep pace with the constant evolution of service industries, increased international trade, and changing market dynamics. Regulatory institutions require staff with industry expertise, adequate financing to carry out regulatory duties, and appropriate enforcement powers to discipline actors in the marketplace. Globalization is propelling regulatory institutions to cooperate across borders and work together in international forums to keep pace with ever evolving rules. Developed and emerging economies must also guard against capture of regulatory institutions by industry interests. For example, the recent fallout in the sub-prime lending market, in the United States, due to lax state and federal oversight of lending standards, risk assessment, and securitization processes exemplifies the constant struggle to maintain expert and vigilant regulatory institutions even in developed economies. Transparency, competition, & innovation Judicial and regulatory institutions are responsible for creating an environment that is conducive to service industry development. This environment is defined by transparency and crafted with policies that support investment, competition, and innovation. Transparency in the development and implementation of rules helps service firms to GATS, Annex on Financial Services, and Annex on Telecommunications, as well as support of the Information Technology Agreement facilitate trade in service industry inputs. 130 understand and plan for government measures that will bear on operations. The provision of information about laws, regulations, and procedures directly affecting service industries reduces uncertainty, risk, and lowers investment costs. Transparency extends to information about market participants and disclosure requirements reflect the value information holds for entities operating in the marketplace. Coupled with comprehensive and quality economic data, market information contributes to stability and service industry growth. Service firms thrive when they understand rules, their position in the -vis marketplace vis-à other firms, and the economic variables in the market. Governments use a variety of means to promote transparency including legislating and implementing administrative procedures that ensure that information is available to market participants and that their service industry knowledge is integrated into the formulation of rules governing the sector. Governments publish notices of rule makings, formally request public input, and hold hearings, for example, to gather information, and make informed policy decisions. Governments maintain and enforce disclosure requirements and support comprehensive and quality economic data collection. They facilitate a robust services policy dialogue by providing transparent rulemaking procedures, mandating corporate disclosure, and supporting the collection of comprehensive and quality data and its timely release. Services policy dialogue Services policy dialogue and information flow contribute to the development of rules for a variety of service industry sectors. The rapid development of service industry products makes it difficult for regulators to understand the nuances of service industry production and delivery and the consequent implications for public policy. For example, information technology services exemplify a rapidly developing sector with domestic and international policy implications in many cases uniquely identifiable by information technology providers. As participants in the market, information technology providers can identify production constraints, business models, and delivery systems, for example, important to policymakers. Consistent and comprehensive services policy dialogue, as illustrated in Figure 13.2, enables the government to stay abreast of evolving service industries. Figure 13.2 Services Policy Dialogue in a Supportive Environment 131 14 Lessons From Leaders In Services Trade The leaders in trade in services offer insight into the development and oversight of services economies. Trade in communication, construction, insurance, financial, computer, business, and personal services is led by selected economies. For example in 2006, as illustrated in table 14.1, the European Union (25) exported the greatest share of other commercial services at 49.6%, followed by the United States at 15.4%, Japan at 5%, India at 4.2%, and Hong Kong at 2.8 %. Singapore exported a share of 2.3% and the Republic of Korea exported a share of 1.4%. Each economy offers important insight into the development of their services economy, important policy trends, and lessons to learn. Table 14.1 Leading Exporters of Other Commercial Services for 2006 (billion dollars and percentage) Value Share 2006 2000 2006 European Union (25) 683.7 45.7 49.6 United States 211.9 19.5 15.4 Japan 69.0 5.9 5.0 India 58.3 4.2 Hong Kong, China 39.0 3.3 2.8 China 36.5 1.5 2.6 Switzerland 34.0 2.4 2.5 Canada 32.4 3.1 2.3 Singapore 31 1.7 2.3 Korea, Republic of 19.2 1.4 1.4 Source: WTO1 Korea Korea offers lessons in how an economy that experienced exceptional success in export manufacturing revisits its policy environment to re-energize growth through the correction of weaknesses in its services economy. Despite its manufacturing prowess, Korea has a low productivity rate in services relative to other developed economies. Korea implemented a strategy to open the economy to attract service industry expertise, improve the regulatory environment, and increase competition in the domestic market. The government created targeted incentive programs to strengthen tourism, logistics, engineering, and manufacturing assisting services. Korea is also poised to reformulate its approach to financial services regulation to broaden and deepen its capital markets. These measures indicate that government can work on a variety of fronts to develop services market. 1 World Trade Organization (2007) 132 Korea has historically had relatively low productivity in the services sector compared to other economies of its stature due to several factors. In contrast to many OECD countries, Korea had low labor productivity in services, less service exports, and negative to minimal total factor productivity growth in certain service sectors due to the regulatory environment. 1 Starting a business in Korea took time and administrative dexterity, which increases the cost of investment and administrative overhead. 2 A variety of government supports delayed closure of unprofitable firms, which reduced competitive pressure to improve processes and use of resources. 3 Government measures also limited competition in the domestic market by favoring national champions and restricting foreign providers.4 In addition, in Korea, services represent a low percentage of total value-added as exhibited in Figure 14.1. These challenges in the domestic market inhibit the ability of service firms to achieve a competitive posture necessary for export growth. Figure 14.1 Korea % Value Added by Activity 25 construction 20 transport, trade, 15 hotels and restaurants 10 banks, insurance, real estate, other 5 business services government, health, 0 education, and other 2001 2002 2003 2004 2005 personal services Source: OECD country statistical profiles 2007 http://stats.oecd.org Market access stance To attract service industry expertise, lower costs, and improve efficiency, Korea is using trade arrangements to signal to investors that expanded investment in a wide variety of services is welcome. For example, Korea's Revised Offer on Services conveyed to WTO members in May of 2005 proposes to eliminate substantial limitations on market access and national treatment and provides additional commitments in a wide array of service sectors. Korea's proposed removal of equity limitations across sectors, additional commitments on legal, accountancy, and architectural services, and new bindings in research and development attest to Korea's willingness to lift barriers that inhibited investment and movement of people in the services sector.5 Korea is also using bilateral 1 International Monetary Fund (2006) Korea's Transition to a Knowledge-Based Economy: Prospects and Challenges Ahead Republic of Korea: Selected Issues 2 International Monetary Fund (2006) 3 International Monetary Fund (2006) 4 International Monetary Fund (2006) 5 World Trade Organization (2005) Republic of Korea Revised Offer on Services 133 arrangements to affirm its resolve to provide transparency in the development and implementation of government measures that influence service industries.1 Regulatory reform Korea simplified administrative procedures and increased transparency to improve the environment for service industries. Korea established a Regulatory Reform Committee, which cut regulations in half and refined the remaining rules in 1998.2 Korea now uses the Internet to make regulations available and speed application processes.3 Table 14.2 identifies how Korea improved transparency. Korea's exceptional broadband 4 deployment and its electronic government initiative will reduce administrative and transaction costs for service firms. Table 14.2 Korea's Focus on Transparency in the Marketplace Refined rules Increased availability of rules Established electronic processes to easily adhere to rules Expanded corporate disclosure requirements Expanded consultation with market participants Strengthened independence of auditors Source: OECD5 Competition policy Korea refined competition policy to curb anti-competitive practices and improve the cost and quality of services. Korea amended the 1980 Monopoly Regulation and Fair Trade Act in 20026 prohibiting collusive fee setting arrangements in nine professional service sectors, reduced the market position of "Chaebols", and expanded investigatory and enforcement authority of the Korea Fair Trade Commission (KFTC). 7 With the 2002 amended Act, competition oversight activities have included examination of specific service sectors, for example, construction, media, education, banking, insurance, and real estate. 8 These changes illustrated in table 14.3 helped create a more competitive environment for service industries. According to the World Economic Forum's Global Competitiveness Index, Korea's 2007/2008 ranking rose to 11 from a previous rank of 23. 1 Korea US Free Trade Agreement (2007) Chapter 12 Cross-Border Trade in Services http://www.ustr.gov 2 Organization of Economic Cooperation and Development (2007) Korea: Progress in Implementing Regulatory Reform. 3 Organization of Economic Cooperation and Development (2007) 4 The ITU ranks the Republic of Korea just behind Denmark, the Netherlands, Iceland, and Switzerland in broadband penetration at 29.27%. International Telecommunication Union Economies by Broadband Penetration 2006 http://www.itu.int 5 Organization of Economic Cooperation and Development (2007) 6 World Trade Organization (2004) Trade Policy Review Republic of Korea Report by the Secretariat 7 World Trade Organization (2004) 8 World Trade Organization (2004) 134 Table 14.3 Korea's Focus on Competition Policy Reassessed structures and activities of conglomerates* Prohibited specific cartels in services* Increased penalties for anti-competitive practices* Clearly defined and expanded business misconduct* Strengthened oversight of mergers and acquisitions* Expanded authority of KFTC to investigate, penalize, and refer for criminal prosecution* Organized KFTC by investigative function* KFTC regularly hosts academic and business sectors to study competition issues+ KFTC regularly cross trains officials through "case study presentations" to expand competence across the Commission+ KFTC regularly works with international counterparts in developed economies+ Source: *WTO1 & +International Competition Network2 Incentives Korea maintains targeted incentive measures to boost productivity in service sectors. These are primarily tax incentives and lower minimal investment levels for greenfield investments in tourism, logistics, and engineering services. 3 Korea also offers incentives to attract experts from abroad. In the past, Korea worked to attract service industry expertise in telecommunications. A retired AT&T executive related the experience of Korean telecom officials visiting the US and meeting with telecommunications technicians who were Korean expatriates. The Korean officials offered the expatriates attractive incentives to return home to help build Korea's telecommunications infrastructure.4 In 2003 and 2004, Korea established free economic zones to welcome foreigners with specialized skills with comfortable living conditions in Incheon as well as the Busan and Gwangyang ports.5 Finance Korean firms have had difficulty accessing finance given strict collateral requirements and limited availability of venture capital, which constrained the growth of service firms and the creation of new service enterprises. 6 Financing constraints also limited investment in technology important to service sector efficiency. 7 To alleviate these constraints, Korea is emulating London's deregulation of its financial sector with the Korean Capital Markets Integration Act. The Act will change Korea's supervisory approach from a prescriptive to a more principles-based system. The purpose of the restructuring is to help raise the standards of the capital market and expand the types of financial services products available to investors and service industries. The Act is also intended to better position Korea as a regional financial services hub and propel its 1 World Trade Organization (2004) 2 International Competition Network (2003) Capacity Building and Technical Assistance: Building Credible Competition Authorities in Developing and Transition Economies 3 World Trade Organization (2004) 4 Interview (February, 2008) Retired AT&T Executive 5 World Trade Organization (2004) 6 International Monetary Fund (2006) 7 International Monetary Fund (2006) 135 economy into higher value-added services. 1 Table 14.4 captures tools to improve the services economy and trade. Table 14.4 Examples of Korean Service Industry Policy Tools Korea, Domestic Competition Investment Service sectors Trade promotion Regulation Trade Republic of Capacity policy & IPR Environmrnt arrangements Services are a Preeminent Legislation Lowering FDI Historically low Tax, credit & Established Affirmative rising share of in amended 02' restrictions to productivity in equity support Regulatory market access employment broadband increase services due to Reform stance at 72.1% in deployment Limiting competition and market entry Working to attract Committee to 03' position of boost domestic barriers, slow service industry reduce Proposed Privatizing "Chaebols" productivity in corporate exit experts from unnecessary multilateral & services from markets , abroad regulation bindings unbundling, The Korea Fair limited energy Trade competition Revised Services sector Commission - (OECD) administrativ provisions in staff structure e rules to bilaterals Significant adjusted for increase reform in new priorities transparency the banking sector Source: WTO2 India India maintains a global footprint in information and business processing outsourcing, however, bottlenecks in infrastructure services create constraints across agriculture, manufacturing, and service industries. India's dramatic emergence in the global information technology services market highlights the benefit of investment in education as a fundamental element of trade capacity building. In 2005, behind the European Union, India was the largest exporter of computer and information services valued at $16,091 million.3 At the same time, the stark differences in the development of India's service sectors and their impact on the larger economy illustrate the importance of attending to growth in all services. Furthermore service firms expend excessive resources working to navigate regulatory procedures and corruption. Weaknesses in service infrastructure and poor performance in the public sector has left many Indian citizens behind economically, "India still has the highest concentration of poor people in the world."4 The boom in India's information technology service sector is attributed to high returns on educational investment in tertiary education. India's establishment of institutes of 1 Anna Fifield, Seoul looks to echo London 'big bang' Financial Times London (UK): 26 June, 2007 p. 10. . 2 World Trade Organization (2004) 3 World Trade Organization (2007) International Trade Statistics 4 International Monetary Fund (2008) Inclusive Growth India: Selected Issues 136 technology focused on engineering and science created a large pool of technical workers prepared for the dynamic growth in services outsourcing and off-shoring. English language capability was particularly beneficial in tapping into the global market. "India boasts the largest pool of English-speaking knowledge workers in the world after the USA."1 Enterprise zones at the state level lifted the traditional Indian industrial "license, permit, quota" regime that had severely depressed economic productivity in the past.2 In 1991, India also reduced trade barriers, lowered tax rates, lifted many investment restrictions and liberalized currency controls to engage internationally. 3 Investment in submarine cables for digital transmission of data helped position India for service outsourcing. All of these factors enabled Indian information-technology firms to take advantage of the business opportunity offered by Y2K adjustments to computer systems around the world. Indian entrepreneurs successfully executed Y2K modifications for multinationals and established a reputation in business process outsourcing.4 Education Despite this success in computer and information services, severe shortcomings in service infrastructure leave many behind. Recent studies identified educational attainment, access to infrastructure, and financial sector development as influential in creating inclusive growth.5 In the education sector, India invested heavily in tertiary educational institutions. The initial Indian Institute of Technology was established in 1950 in West Bengal, eight years later a second was established in Bombay, other institutes followed in Madras (1959), Kanpur (1960), Delhi (1961), and Guwahati (1995).6 Yet dismal delivery of primary and secondary education limited educational attainment for many. The illiteracy rate in India stands at just under 40%7 making it difficult for these individuals to move into jobs in industry or services. Although the government is working to improve delivery of educational services and public expenditure on education represents 3.8% of GDP, the combined gross enrollment ratio for primary, secondary, and tertiary education stands at a comparatively low 63.8%.8 Furthermore, press reports suggest that education reform remains stymied by discriminatory attitudes.9 Infrastructure bottlenecks India has used a spectrum of approaches to improve service infrastructure. A more open investment environment in telecommunications and air transport has decidedly improved quality, cost, and scope in both sectors. In 1994, India ended the state monopoly in air 1 Sanjay M. Nadkarni, (June 2005) "The Knowledge Economy in India" Asian Business & Management Vol. 4, Iss. 2; p. 213 2 Gurcharan Das, July/August (2006) The India Model Foreign Affairs 3 Das, (2006) 4 Interview (January, 2008) Representative US India Business Council 5 International Monetary Fund (2008) Inclusive Growth India: Selected Issues 6 Indian Institutes of Technology Alumni ITT History http://www.iit.org 7 United Nations (2008) UN Human Development Report 2007/2008 8 United Nations (2008) 9 Somini Sengupta, (17 January, 2008) Education Push Yields Little for India's Poor The New York Times 137 transport services, opened it to competition, and lowered explicit market entry restrictions and pricing controls. 1 These reforms effectively reduced costs and increased penetration rates in air transport. 2 With a similar approach, India experienced dramatic improvements in telecommunications infrastructure. 3 India's "telecommunications network has become the third largest in the world;" with greater competition, penetration of broadband could expand.4 India is working to reduce bottlenecks in road, rail, and maritime with public private partnerships. "The lack of adequate ports, roads and power supplies are one of the main obstacles hindering India's economic development."5 The government promotes private- public partnerships to leverage investment in road transport using a build, operate, transfer format.6 In railway, the government maintains a monopoly, however, welcomes public private partnerships in ancillary freight operations. 7 In shipping, India allows 100% foreign investment, yet restrictions remain on carriage of public cargo. 8 The government is also using public private partnerships to upgrade port facilities and operations. 9 Public private partnerships are enmeshed with the traditional Indian regulatory regime and implementation hurdles include overlapping regulatory mandates, convoluted approval processes, and opaque government procurement processes. 10 Financial infrastructure India's government is committed to building on the substantial expansion of the financial sector in the last decade. In 2006, public-sector banks controlled 72% of total assets and the government maintains lending requirements for agriculture and small-scale industries. 11 Micro-credit is also widely available for production including retail. 12 Private and foreign banks are present in the market and bank credit grew at a 31% rate in 2005/06.13 Although the government recognizes that the corporate debt and bond market are underdeveloped, "little progress has been made because of the multiplicity of agencies that need to agree to move the market forward." 14 In addition, although disclosure requirements are substantial, data is sometimes difficult to obtain. India marginally lifted foreign investment restrictions in banking and is working to improve 1 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 2 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 3 Asia-Pacific Telecommunity Yearbook 2006 4 Organization for Economic Cooperation and Development (2007) Economic Survey of India 2007: Removing Infrastructure Bottlenecks 5 India Turns a Corner Trade Finance January (2007) 6 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 7 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 8 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 9 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 10 Organization for Economic Cooperation and Development (2007) 11 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 12 Palaniappan Chidambaram, Finance Minister of India, (September 25, 2007) Remarks on India's Economic Growth and Outlook before the Peterson Institute for International Economics 13 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 14 Geraldine Lamb, (January 1, 2008) Davos: Indian Capital Markets The Banker 138 corporate governance and transparency. The Government is amending prudential requirements in view of international standards to strengthen the sector.1 Regulatory environment Regulatory oversight and administration remain problematic in India. For example in 2007, India ranked 48.3 on a scale of zero to 100 in regulatory quality according to Governance Indicators of the World Bank. 2 India scored 3.5 on Transparency International's Corruption Perceptions Index on a scale of one to 10 signifying a low level of confidence in the public sector.3 For service industries, the practical effect of poor regulatory and administrative quality is the use of service industry resources for opaque and questionable compliance requirements rather than service industry production. This opportunity cost is at the expense of investment in new product development or technology, for example. Furthermore, service firms competing internationally are at a disadvantage, when their domestic regulatory environment remains at a sub optimum level. Table 14.5 indicates the effects of an opaque regulatory environment. Table 14.5 Impact of Poor Regulatory & Administrative Quality on Service Firms Unnecessarily absorbs service industry productive resources time capital management expertise Raises costs of market entry to new firms subdues competition slows rate of innovation Deters new or additional investment raises initial capital investment required due to excessive compliance activities above the norm of gathering data, record-keeping, supplying information to authorities Depresses total factor productivity growth Source: Regulation and Productivity Performance 20064 India's ability to free computer and information services from the historically burdensome Indian regulatory regime has made service exports an engine of growth and catalyst for reform. Indian service firms expanding capabilities into different services sectors also provide returns. For example, Reliance Industries is using its business acumen gained in telecommunications and financial services and applying it to energy services. 5 Indian services firms are also using overseas expansion to acquire new skills and reach more clients. Within the private sector, India maintains the expertise to rapidly institute electronic government to ease the process of doing business across the rest of the 1 World Trade Organization (2007) Trade Policy Review Report by the Secretariat India 2 World Bank (2007) Governance Indicators Regulatory Quality 3 Transparency International (2007) Corruption Perceptions Index http://www.transparency.org 4 Nicholas Crafts, (2006) Regulation and Productivity Performance Oxford Review of Economic Policy Vol. 22 No.2 5 Sundeep Tucker, (13 January, 2008) Reliance Can Do No Wrong in the Eyes of Indians Financial Times 139 economy. India's exceptional success in export of computer and information services has delivered employment, growth in associated sectors, and a rationale for the government to reassess its handling of infrastructure and regulatory oversight. European Union The EU offers practical approaches to minimize obstacles to growth in trade in services within an economic entity, which are possibly applicable to potential constraints to trade in services among provinces in China. The European Union taken as a block of 25 members represents the largest services exporter in the world as illustrated in Figure 14.2. The variation in government policies among the 25 members and the EU's continued drive towards integration offers practical approaches to strengthening services trade within an economic entity and with the rest of the world. The scope of the EUs Services Directive is particularly instructive in identifying important issues originating from services trade. Furthermore, the scope and depth of the EUs services trade with the United States and the efforts they are now making to integrate their services economies exemplifies the key issues facing the growth of developed services economies. Figure 14.2 2006 Commercial Services Exports (Million US$) Transportation Travel Other Commercial Services 600,000 500,000 400,000 300,000 200,000 100,000 0 China EU (25) Hong Kong India Japan Korea, Singapore United SAR Republic of States Source: WTO1 Process barriers The EU is using a Services Directive to ameliorate barriers to services trade through pragmatic and practical means in professional, business, distribution, tourism, construction, education, and real estate services. The European Union identified obstacles that are impeding service firms within the 25 member countries from trading with each other. For example, in some cases, companies wait months or years to obtain the licenses and permits required to open a new office. Companies who submit such 1 World Trade Organization (2007) International Trade Statistics 140 applications may never receive any response from officials. Service firms are sometimes subject to "economic needs tests" to demonstrate their business will not upset local competitors. The EU recognizes that such tests enable government officials to make arbitrary perhaps discriminatory decisions and noted that a single firm seeking to enter 22 EU services markets spent 5.9 million in application fees. As another example of the obstacles inhibiting services trade, the EU identified inadequate cooperation among regulatory authorities, with regard to sharing basic corporate registration information.1 These examples demonstrate the importance of working with regulatory and administrative authorities to reduce "process" barriers. Regulatory barriers In the case of cross-border trade, the EU found that firms had spent as much as "3% of annual turnover" examining the scope of legal stipulations of two countries of export market interest. Firms from the EU found other EU markets maintained capital adequacy requirements in combination with stipulations for personal guarantees so excessive that the companies decided to enter non-EU markets. Recreational access fees were also discriminatory to EU citizens from different countries. The EU also assessed the cost of determining the "legal and administrative formalities" in one market from 80,000 to 160,000. These examples illustrate the need to review specific rules to determine their purpose, if they are achieving that purpose, and if a less trade restrictive rule could be used. Practical tools The Services Directive uses practical tools to streamline regulatory processes and reduce barriers. To track implementation, the EU will use "implementation tables" identifying specific objectives public officials must achieve by a designated time. For example, by a certain time public officials are responsible for establishing "points of single contact" which are web enabled, for service industry providers to determine in one location all of the requirements for establishing an office and for requirements through the life of the service firm. To ensure objectives are achieved, the EU has also identified "follow-up measures", for example, a requirement that public officials explicitly "notify" and post changes to service industry rules and regulations through the points of single contact. Simplifying administrative procedures The Services Directive will help simplify administrative procedures. A program to review procedures and requirements governing service sectors will be undertaken to eliminate those procedures and requirements that are not necessary and simplify those that are unduly complex. This review extends to all administrative procedures and requirements that are imposed across the life of a service industry, for example, reporting requirements. EU efforts will focus on simplifying administrative procedures to make information available to service firms and service users, aggregate all requirements in one 1 European Commission (2005) Examples of Problems the Services Directive Would Help Solve. http://ec.europa.eu 141 place, and enable applicants to fulfill administrative requirements online. The EU will use electronic government to reduce time, and administrative overhead required for registering and carrying out service industry activities. Helping public officials to work together to facilitate services trade The Services Directive will help public officials in different markets work together to improve the services environment. The initiative will require different agencies to cooperate to reduce the burden of multiple applications with the same information. Officials will also have to accept documents from other officials which contain the same material. The initiative will eliminate duplicative procedures, lower the cost of requirements and improve the "clarity and accessibility" of such processes. Under the initiative, officials are also obligated to help service firms by proactively informing them of all the steps necessary to complete procedures. Officials must also be communicative about the processing of applications and other requirements. The Directive also requires that "conditions for granting authorizations be clear and unambiguous, objective, transparent and accessible, and made public in advance."1 The Services Directive will help service firms outside of the EU access the EU market. Under the Directive, administrative processes for service industries should be the same for domestic and foreign firms. The initiative will require review and assessment of "authorization schemes" or the systems by which a public official determines and grants qualifications and licenses to ensure they are nondiscriminatory. The Services Directive is instructive because of its practical approach to facilitating services trade within the EU and with foreign service providers. EU US regulatory cooperation to facilitate trade in services Examining services trade between the European Union and the United States pinpoints the services trade issues at the forefront of concern in developed economies. The scope of the EU US services trade, the shape of that trade, and how the EU and the US are working together to facilitate trade provides insight into developed services economies. In 2006, the European Union (25) was the world's leading exporter of travel, transportation, and other commercial services followed by the US as illustrated in table 14.6. 1 Commission of the European Communities (2007) Handbook on Implementation of the Services Directive 142 Table 14.6 Leading Exporters of Trav., Transport., Other Commercial Services 2006 (Billion dollars & percentage) Travel Value Share European Union (25) 312.5 41.8 United States 106.7 14.3 Transportation Value Share European Union (25) 280.5 44.4 United States 70.3 11.1 Other commercial services Value Share European Union (25) 683.7 49.6 United States 211.9 15.4 Source: WTO1 Foreign Direct Investment through the establishment of affiliates is a significant conduit for services trade between the EU and the US. The largest proportion of the EU US services trade is conducted by EU service firms established in the US and US firms established in the EU. For example in 2004, European sales through affiliates to the United States represented well over $250 billion, almost double EU cross-border trade to the United States. Similarly in the same year, US services sales through affiliates to Europe represented well over $250 billion, almost double US cross-border trade to Europe.2 The volume of transatlantic trade in services demonstrates the practical results of establishing in export markets of interest. At the same time, European and US regulators work closely to improve trade and service industries across all modes of supply. They use practical cooperative methods to ease regulatory burdens. Regulatory counterparts review regulatory approaches including governance and specific rules and regulations. 3 They identify conflicts in approach, principles, or implementation and seek to reduce frictions that result from different practices. EU US regulators consider respective legislative and regulatory developments and establish systems to facilitate mutual recognition of regulatory criteria. They may exchange experts, create tools to ease review of foreign investors, and share application data. Regulators share information on new developments in the markets related to new products or corporate and consumer behavior, for example. They also compare the implementation of international standards within their respective markets. 4 Through dialogue and consistent engagement EU and US regulators improve transatlantic services trade. The EU and the US are very active in international bodies that influence standards for service industries. For example, the EU and the US support the participation of their regulators in entities such as The Bank for International Settlements (BIS), 5 the 1 World Trade Organization (2007) International Trade Statistics 2 US Bureau of Economic Analysis (2006) US International Services Cross-Border Trade in 2005 and Sales through Affiliates in 2004 3 European Commission. (2005) Commission Non Paper for the FSC-Meeting http://ec.europa.eu/internal_market 4 Office of United States Trade Representative (2004) EU US Financial Markets Regulatory Dialogue http://www.USTR.gov 5 http://www.bis.org/ 143 International Organization of Securities Commissions (IOSCO), 1 and the International Association of Insurance Supervisors (IAIS).2 These and other service industry bodies facilitate exchanges between regulators around the world and shape international regulatory standards. In the face of globalization, the EU and the US are taking an active role in formulating the global regulatory environment for trade in services. United States Behind the European Union, the United States is the largest service exporter in the world and has experienced exceptional productivity growth in service industries in the last decade. The vibrancy of the United States services economy reflects a constellation of factors that create innovation and enable US firms to leverage traditional and "intangible" factors of production. The United States puts a heavy emphasis on the quality and availability of market information to investors, citizens, and the government. This extends to requirements for financial reporting and public sector collection of data on economic activity. As such, the US is a leader in the collection of trade in services data at the international, national, and state level. This information is critical to inform policymaking and drives the market access stance of the United States. The United States also has a well-developed export promotion regime that supports its services industries. US export promotion methods offer insight into tools the public sector can use to improve services trade. Productivity growth in service industries The US has experienced exceptional productivity growth in a scope of service industries due to the value-added contribution of labor, Information Communication Technology (ICT) capital, non-ICT capital, and multi-factor productivity from 1995 to 2004.3 During this time, the largest contributor to productivity in financial and business services was a combination of labor composition and hours worked. In these sectors, investment in ICT capital or computer hardware, telecommunications infrastructure, and software contributed 1.2% of value-added growth. Overall multifactor productivity contributed .9% of value-added growth as illustrated in table 14.7. Non-ICT capital contributed .7% of value-added growth. Thus investment in human resources and ICT capital along with overall multifactor productivity were significant in improving productivity in the financial and business sectors. 1 http://www.iosco.org/ 2 http://www.iaisweb.org/ 3 van Ark, O'Mahony, Ypma, (2007) The EU KLEMS Productivity Report: An Overview of Results from the EU KLEMS Growth and Productivity Accounts for the European Union, EU Member States and Major Other Countries in the World 144 Table 14.7 Gross Value Added Growth and Contributions Gross Contribution Contributio Contributio Contributio Contributio Contributio Contributio value of labor input n of total n of labor n of capital n of ICT n of non- n of multi- added growth hours composition input capital ICT capital factor growth worked growth productivit y growth (1) = (2) (2) = (3) +(4) (3) (4) (5) = (6) (6) (7) (8) +(5) +(8) +(7) 1995-2004 Distribution 4.7 .5 .2 .3 1.4 1 .4 2.8 services Finance & 4.9 2 1.6 .4 2 1.2 .7 .9 business services Personal & 2.6 1.7 1.4 .2 1 .4 .6 .0 social services (annual average volume growth rates, in %) Source: van Ark, O'Mahony, Ypma, (2007) EU KLEMS Productivity Report In distribution services, multi-factor productivity played a particularly important role in growth from 1995 to 2004. Productivity growth in wholesale, retail, transportation, and warehousing services was largely due to expansion of multi-factor productivity, which contributed 2.8% of value-added growth. US service industries have been particularly adept at leveraging the traditional and "intangible" factors related to a knowledge-based economy. 1 While multifactor productivity captures the productivity of traditional inputs of labor, ICT capital, and non- ICT capital, it also absorbs, to some degree, "intangible" factors related to a knowledge- based economy. Table 14.8 identifies inputs to the knowledge economy and their subsidiary components, which are all important to service industries. Table 14.8 Capital Inputs to the Knowledge Economy ICT capital Human Knowledge Organizational Customer Social capital capital capital capital capital Hardware Formal Research & Engineering design Marketing Language education development & patents Telecommunications Company Licenses, brands, Organizational Relationships Ability to create infrastructure training and copyrights design new relationships Software Experience Other Structure in Product feedback Reputation technological database and its use & specialization innovation Remuneration of innovative ideas 1 van Ark, O'Mahony, Ypma, (2007) 145 Source: van Ark (2004)1 The Knowledge Economy The ability to create an innovative environment where elements of ICT, human, knowledge, organizational, customer, and social capital are effectively put to use depends on a wide variety of variables. To some degree these are captured in indexes of competitiveness. For example, in 2007, the World Economic Forum's Global Competitiveness Report rated the United States as the most competitive economy according to a number of measures. Although facing significant macroeconomic challenges, the US maintains its position due to "an excellent university system that works closely with business, a very flexible labor market, a unique ability to attract talent and a financial sector that supplies the needed capital for risky innovation ventures." 2 Service industries gain from the intangible aspects of the knowledge economy including those elements that facilitate exchange of ideas and innovation. Market information The United States puts a heavy emphasis on the quality and availability of market information to investors, citizens, and the government. For example, legislation requires that government rulemaking is undertaken in an environment of transparency, participation, and analysis. Information about the content and structure of rules is circulated through formal procedures for public notice, public comment, regulatory analysis and interagency coordination.3 Quality and availability of market information extends to disclosure requirements for corporate and public entities involved in market activities. US service firms trading internationally are also required to report on trading activities under the International Investment and Trade in Services Survey Act to facilitate the collection of trade in services data at the international, national, and state level.4 In the US, the media also plays an important role in providing commercial information to actors in the marketplace, policy makers, and the public at large. The media in many instances propels public policy discussions on the fine points of services industry policy including competition and investment policy as well as trade policy, for example. Reported corporate and product market information and regular data releases of economic conditions shape public discussion as well as regulatory oversight. For example, public information on costs of services products, quality of telecommunications, 1 van Ark, (2004) The Measurement of Productivity: What Do the Numbers Mean? in G. Gelauff, L. Klomp, S. Raes, T. Roelandt Fostering Productivity. Patterns, Determinants and Policy Implications, Contributions to Economic Analysis 2 Blanke, (November 6, 2007) The Factors That Put the US on Top of the World Letter to the Editor Financial Times . Page 10. 3 S.P. Wood, (June 2005) United States Government Rulemaking Transparency, Participation, Analysis, and Accountability at http://www.ustr.gov/assets/World_Regions/Europe_Middle_East/Europe/US_EU_Regulatory_Cooperation/ asset_upload_file76_7145.pdf 4 Bureau of Economic Analysis (2000) United States Statistics on Trade in Services 146 financial, and transport services drive investment and use as well as government oversight. Market information and comprehensive and quality economic data are valuable components of a knowledge economy. They are commercially meaningful for industries operating in the services sector and critical to responsive policy making. Export promotion The US employs an expansive export promotion program to support service industry exports. The US Commercial Service of the International Trade Administration is adept in its use of electronic government to assist service exporters. The Commercial Service has a wide variety of online means to help service exporters. These electronic offerings are supported by a network of commercial service officers at the state, federal and international level. Their ability to provide market analysis and specialized assistance helps service firms establish and operate in foreign markets. Table 14.9 highlights export support activities for service firms. Table 14.9 US Commercial Service Activities Advocacy US officials posted abroad can help firms navigate regulatory requirements Buyer, partner, agent, US officials can help identify joint venture distributor matching partners and distributors in foreign markets Corporate profiles US officials can help with credit checks and due diligence on foreign customers Counseling US officials can help develop effective export strategy and evaluate competitors Finance USG offers a variety of financial assistance through supporting agencies Market research Overviews of 120 markets and updates on new regulations Trade fairs & missions Assists firms with exhibitions abroad and orchestrates trade missions to meet qualified foreign firms Source: United States Commercial Service, International Trade Administration. http://www.ita.doc.gov. The US is also unique in the degree to which government agencies cooperate with each other, academia, and trade associations on international commercial policy issues. For example, agency consultation on trade obstacles in conjunction with trade advisory committees of service stakeholders improves the overseas investment environment for US service exporters. Such institutionalized services trade policy dialogue helps to effectively address issues in services markets at home and abroad as service industries evolve. Singapore Although Singapore is a small city state it offers important practical approaches to developing a world-class services economy. Singapore maintains a receptive FDI environment, highly efficient regulatory institutions, and a well organized trade promotion authority. Of particular interest to China are Singapore's pragmatic efforts to attract service industry professionals from around the world. Singapore has also worked 147 to develop a broad scope of services industries that go beyond a narrow focus on information technology and back-office services. Singapore has also recently made important changes to its policy environment including with regard to Government Linked Companies (GLCs). Creating service industry clusters In the face of increased competition in manufacturing, Singapore's Economic Review Committee (ERC) established initiatives to strengthen the services sector using investment in human resources, increased labor flexibility, competition policy, and R&D.1 Singapore endeavored to create an educational industry to attract the best and the brightest from abroad and serve its own citizens. At the same time, Singapore has allowed for increased labor flexibility, while sustaining the standard of living with public support of housing and education. 2 Singapore also introduced a competition law to effectively lower domestic input costs. The island nation promoted collaboration among research institutes, universities, and industry to foster service industry clusters. 3 Such clusters create a network effect and contribute to innovation through information sharing and a concentration of expertise as illustrated in Figure 14.3. Figure 14.3 Service Industry Clusters Biosciences Tourism Educational services Singapore service industries Financial Marine services engineering Attracting service industry professionals Singapore welcomes foreign professionals and emigrants and has intentionally created an environment that will attract service industry expertise. Dynamic cities such as Hong Kong, London, and Singapore compete to attract professionals. London, for example, attracts international talent due to the scope and reputation of the firms already 1 International Monetary Fund (2006) "Trends and Variation in Domestic Competition and Markup Costs" Singapore: Selected Issues 2 The Economist (25 October, 2007) "High-flyer" 3 Caroline Long (2006) "Singapore in Transition: from Technology to Culture Hub" Journal of Knowledge Management Vol. 10, Iss. 5; p.79 148 established, international accessibility, and regulatory environment. 1 Singapore has put in place those elements that attract knowledge workers. For example, the government "articulated the need for a culturally vibrant Singapore to attract global creative talents," funds were set aside to invest in the arts sector over the next five years.2. Singapore views this investment strategically as a means to attract talent and also as a way to stimulate growth in creative industries. Singapore established a constellation of magnets to attract knowledge workers from around the world as illustrated in Figure 14.4. Figure 14.4 Magnets to Attract Service Industry Talent Service industry firms R&D Quality facilities educational institutions Service industry experts Ease of doing Cultural and business artistic institutions Transport & ICT infrastructure Competition policy Singapore used competition policy to strengthen service industries. Singapore assessed its services markets and recognized that an absence of competition initially in telecommunications, media, and energy were holding back the economy. Consequently it instituted privatization, established sector specific regulators, with specific authority to address anti-competitive practices. Subsequently, at the urging of the Economic Review Committee, Singapore enacted the 2004 Competition Act. The Act supports previous sector specific provisions and addresses the dominant position of resource-rich Government-Linked Companies (GLCs) and their ability to impede the development and growth of small and medium-size enterprises. The Act prohibits "any conduct on the part of one or more undertakings which amount to the abuse of the dominant position in any market in Singapore."3 Singapore's relatively recent return to competition policy as a tool to strengthen the services economy demonstrates the importance of acting to prevent anti- competitive practices that inhibit service industry establishment and growth. Table 14.10 captures tools to improve the services economy and trade. 1 Bridget Rosewell, Consultant Chief Economist, GLA Economics (2007) "London As a World Services Center: Factors for Success" 2 Long (2006) 3 Burton Ong (2006) "The Origins, Objectives and Structure of Competition Law in Singapore" World Competition 29(2):p. 269-284 149 Table 14.10 Examples of Singapore Service Industry Policy Tools Singapore Domestic Competition Investment Service Trade Regulation capacity policy & IPR environmrnt sectors promotion Services Deregulatio Limiting Wave of Important Attraction of Increasing represent n& position of liberalization in supplier of Service industry public rising share liberalizatio GLCs 99' -- 02': in seaport, professionals consultation of n of utilities banking, airport, employme Introduction of insurance, trading Focus on value- nt at 75.6% overarching securities, and services added services in 03' competition telecom (entrepot) law 2004 Competition Increasing Act exports of business services 99' - 03' Source: WTO1 Japan As a long-standing developed economy in the region and East Asia's largest commercial services trader,2 Japan offers valuable insight into methods to boost productivity in the services sector. Japan evaluated its services economy and took steps to improve key aspects of service industry productivity including: "labor market flexibility, ICT use, competition, entrepreneurship, and the framework for innovation."3 Japan is enhancing its investment in human resources, applying manufacturing expertise to service industries, and increasing exchange of information among academia, industry, and the public sector. Japan also revisited fundamental aspects of its governance of foreign direct investment to increase competition and absorb innovative service industry practices. Services assessment Japan's Ministry of Economy, Trade and Industry (METI) recently assessed the productivity of Japan's services sector. METI found that Japanese services firms had lower labor productivity and lower investment in information technology software compared to the EU and the US. 4 The Ministry associated these factors with a comparatively lower propensity to expand abroad. The Ministry also found that the rate of establishment of new services firms in Japan was on average 50% lower than in the United States from 2001 to 2005. 5 METI attributed this difference to the scope of Japanese regulations required to establish a business in the services sector. Compared to the US and Europe, Japan also experienced a lower ratio of foreign direct investment in 1 World Trade Organization (2004) Trade Policy Review Singapore Report by the Secretariat 2 World Trade Organization (2007) World Trade Report 3 International Monetary Fund (2007) Japan: Selected Issues 4 Ministry of Economy, Trade and Industry (2007) White Paper on International Economy and Trade Japan's Trade Strategy on Improving Industrial Productivity and Accelerating Economic Growth. 5 Ministry of Economy, Trade and Industry (2007). 150 services to nominal GDP at 1.3%, compared to 8% in the US and 20.3% in the UK,1 which suggests a low level of competition from foreign service suppliers. In the light of these findings, Japan has leveraged a variety of policy tools to strengthen the productivity of service industries based on a model2 that illustrates intangible aspects of service industry productivity. Figure 14.5 Services Productivity and Enabling Environment Create environment of quality & trust facilitated by information flow Value added + New business Develop human resources Services productivity = Efficiency Apply scientific & engineering approaches to services Source: METI3 Development of human resources A primary government initiative to improve service industry productivity is to deepen human capital. The government is taking a pragmatic approach in conjunction with industry and academia to identify "needs of service industries for human resources, what kind of people are required (knowledge, skills, technologies, etc.) and career paths and companies,"4 and developing university curricula to address these needs. The government is also working to facilitate labor mobility. Through corporate hearings, the government found ongoing service industry employment trends in Japan's services economy, for example, employees experience a greater degree of turnover, firms increasingly use independent contractors, and firms more frequently engage part-time workers.5 To facilitate labor flexibility in the services economy, the government will increase "security and reemployment support"6 to workers who have lost their jobs. 1 Ministry of Economy, Trade and Industry (2007). 2 Ministry of Economy, Trade and Industry (2007) Towards Innovation and Productivity Improvement in Service Industries 3 Ministry of Economy, Trade and Industry (2007) Towards Innovation and Productivity Improvement in Service Industries 4 Ministry of Economy, Trade and Industry (2007) Towards Innovation and Productivity Improvement in Service Industries 5 Ministry of Economy, Trade and Industry (2002) Toward the Establishment of a Diversified, Creative Work System Conforming to the Trend Toward a Service Economy 6 Ministry of Economy, Trade and Industry (2002) 151 Application of manufacturing approaches to service industries Japan established the Service Industry Productivity Council to draw industry, academia, and government together to study and advance programs to improve the service sector. As a result, Japan has an initiative to apply its manufacturing expertise to service industries. For example, in the area of health services, a hospital applied Toyota's "just- in-time" production method to minimize wait times for patients. In the past, doctors would see patients with and without appointments. After the application of manufacturing processes to health services, wait times were reduced when certain doctors only saw patients with appointments and other doctors only saw patients without appointments.1 Japan's focus on improving the competence of domestic service firms will help prepare them to compete internationally. Creating a business environment of quality & trust Japan is working to improve the environment for intangible aspects of service industries. METI attributes the exchange of information between supplier and consumer as a driver of quality improvement. The Productivity Council will facilitate communication and information exchange in the market. The government has also taken positive steps to improve transparency in the marketplace which facilitates the flow of market information. For example, regulatory agencies now make available online inspection manuals, supervisory guidelines and interpretation of rules.2 Japan attracts investment interests due to "it's mature business climate and well- developed legal system.3 Japan improved "the climate for entrepreneurs and start ups, for example by offering more favorable tax treatment for venture capital investments, reducing the minimum capital requirement for new businessmen to yen 1, and making it easier for startups to issue share options to staff."4 Japan is also undertaking financial sector reform to improve the efficiency of the capital market and make financing more available to new service firms. The Ministry recognizes that creating a business atmosphere that fosters innovation will promote value-added services.5 1 Ministry of Economy, Trade and Industry (2007) Towards Innovation and Productivity Improvement in Service Industries 2 Andrew Morse, (10 December, 2007) Japan Moves to Improve Market Climate Wall Street Journal 3 Kelly Holman, (26 November, 2007) "Japan Holding Fast" Investment Dealers Digest: IDD New York 4 "Not Invented Here" (1 December, 2007) The Economist Vol. 385, Iss. 8557; p. 14 5 Ministry of Economy, Trade and Industry (2007) Towards Innovation and Productivity Improvement in Service Industries 152 Table 14.11 Policies to Address Service Industries Weaknesses Service Industry Policy Response Weakness low labor productivity investment in human capital improved academic programs increased unemployment and reemployment support Source: METI low level of new regulatory reform to streamline rules and increase business transparency financial sector reform to increase transparency and competition to facilitate a more efficient capital market Source: METI low foreign direct unilateral policy reform to facilitate trade in services investment in services for example: o allowing filings in English o mechanisms to handle regulatory queries o allowance for broader scope of services products positive engagement in negotiations on services Source: WTO Competition policy Japan is using competition policy to improve productivity in different service sectors. Japan is increasing competition to lower market entry barriers to domestic and international firms by strengthening investigatory and prosecutorial powers of the competition authority. For example, in the wholesale and retail sector, restrictions on market access inhibited competition indicated by comparatively high prices.1 In 2006 the Anti-Monopoly Act was amended to strengthen the powers of the Japan Fair Trade Commission (JFTC) enhancing its ability to investigate and strengthening prohibitions against collusion in government procurement. The JFTC is now actively monitoring telecommunications, operating software, railway, wholesale, and medical administrative services, for example.2 Table 14.12 Competition in Wholesale & Retail Sector Policy Weakness Indicators Wholesale & retail Minimal competitive pressures High prices high concentration ratios constancy of market share restrictive regulations low ICT capital accumulation 3 Source: IMF 1 International Monetary Fund (2007) Japan: Selected Issues 2 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Japan 3 International Monetary Fund (2007) 153 Identifying service industry expertise The government recognizes Japanese services firms that have successfully created unique service industry models they were able to replicate successfully in foreign markets. 1 Business case studies of domestic firms are useful in targeting those unique aspects of service industry operations that contribute to market success. As another example, Australia's Trade Commission "Austrade" facilitated case studies of successful service exporters concentrated in professional and business services. 2 The studies identified practices that contributed to profitable export ventures from Australia into Asia. Table 14.13 Primary Practices for Service Export Success Long term commitment Establishing a local office, providing training, upgrading service offerings, and consistent promotional activities contributed to success. Relationship & network Establishing relationships that facilitate distribution, help identify joint building venture partners, identify clients, and navigate local regulations ease trade. Local relationships should also help the firm understand how different bureaucracies function. Success at home Although the Internet and national diasporas allow service firms to more easily export, those in the study experienced success at home in advance of exporting. Patience Export success took as much as a few years. In some cases, success also followed initial failures. Entrepreneurship Export professionals in the firm were working to carve out a niche, moving into "new" markets, and searching for unique returns. Source: Center for Applied Marketing, University of New South Wales for the Australian Trade Commission Austrade, March 2002 Japan is implementing a number of government measures to improve services productivity. Japan is promoting regulatory reform in medical, education, construction, legal, financial, energy, and transport sectors and working to build service industry clusters in healthcare.3 In addition, Japan's Revised Offer on Services conveyed to WTO members in June of 2005 proposes to eliminate certain market access limitations on legal, courier, insurance, and maritime services4 this mature economy is refining its approach to foreign direct investment to boost productivity of service industries. Table 14.14 captures tools to improve the services economy and trade. 1 Ministry of Economy, Trade and Industry (2007) Towards Innovation and Productivity Improvement in Service Industries 2 Center for Applied Marketing, University of New South Wales for the Australian Trade Commission Austrade (2002)"Exporting Australian Services: Case Studies of 17 Service Exporters". 3 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Japan 4 World Trade Organization (2005) Japan Revised Offer 154 Table 14.14 Examples of Japan Service Industry Policy Tools Japan Domestic Competition policy Investment Service sectors Trade promotion Regulation Trade capacity & IPR environment arrangements Services Building human 2005 Amendment of Adjusting FDI Comparatively low Japan External Trade New 2006 Proposed new represent rising resource the Anti-Monopoly regime level of service Organization (JETRO) Program for bindings in services share of capacity with a Act industry Promoting under GATS employment at focus on Unilateral actions productivity vis-à- Special Zone for Structural Regulatory negotiations 69.8% in 03' academia New authority to to lower market vis EU & US Reform Act permits Reform Japan Fair Trade access barriers retirement of specific concentrating on Japan-ASEAN Privatizing Commission in created by Increasing regulations in geographic medical, Comprehensive Japan Post criminal administrative transparency in the areas education, Economic investigations rules and governance and construction, Partnership Accelerating regulations disclosure Example: extension of legal, financial, deregulation of Engagement requirements of temporary residency for energy, transport EPAs w/ Singapore, financial, internationally to financial services foreign service sectors Mexico, Malaysia energy, & legal strengthen and professionals cover investment & services harmonize IPR Established new services protections corporate code of conduct Source: WTO1 1 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Japan 155 China, Hong Kong Special Administrative Region China, Hong Kong SAR's success as a services economy and its relationship with China offers lessons in regulatory approaches that improve service industry performance. Hong Kong SAR is recognized for its formulation and implementation of government measures, regulations and administrative rules and their positive influence on industry, which is dominated by services at 90% of GDP. Hong Kong SAR's open investment environment, increasing attention to intellectual property protection, and its use of incentive programs demonstrate how a successful services economy works to maintain its position in the global economy. In addition, the establishment of the Closer Economic Partnership Arrangement (CEPA) confirms key tenets of services trade policy and the value of market access to service suppliers and service users. Governance Hong Kong SAR's has a reputation as an open and transparent economy, which is reflected in established competitiveness indexes 1 that measure the efficiency of public institutions, educational institutions, regulatory transparency, and ease of establishing a business. For example in 2007, Hong Kong SAR ranked at the highest level in regulatory quality under Governance Indicators of the World Bank as a result of surveys focused on regulations.2 Hong Kong SAR's highly rated regulatory approach includes, for example, a disclosure based regulatory regime that requires corporate entities to provide timely and accurate information including quantitative and qualitative data.3 FDI environment Hong Kong SAR has experienced comparatively strong productivity growth in trade and tourism, transport, and financial services, which is largely attributed to total factor productivity (TFP).4 TFP is a "measure of gains in the efficiency with which inputs are used, including technical progress." 5 Hong Kong SAR's service firms are effectively leveraging technology in this environment and creating innovative services across a swath of service industries. Hong Kong SAR's population of service industry professionals, open investment regime, and quality regulatory environment enables firms to access service industry expertise, venture-capital, as well as market information. Table 1 International Monetary Fund (2007) "Competitiveness: Trends and Prospects" People's Republic of China-Hong Kong Special Administrative Region: Selected Issues Synthesis of competitiveness indexes: Global Country Forecast by the Economic Intelligence Unit, Competitiveness Report by the World Economic Forum, Doing Business Survey by the World Bank 2 D. Kaufmann, A. Kraay, M. Mastruzzi, (2007) Governance Matters Romans VI: Governance Indicators for 1996-2006 The World Bank 3 Paul Chow (2004) Implementation and Enforcement in Corporate Governance the Case of Hong Kong OECD-6th Asian Roundtable on Corporate Governance http://www.oecd.org 4 International Monetary Fund (2007) HKSAR 5 Barry Bosworth, Susan M. Collins, (2007) Accounting for Growth: Comparing China and India National Bureau of Economic Research 156 14.15 shows growth as a percentage of GDP of individual service sectors from 2000 to 2004. Table 14.15 Hong Kong SAR Services % of GDP Share of service sectors in current GDP 2000 2001 2002 2003 2004 Services 86.6 87.5 88.4 89.3 90.0 Wholesale and retail trades 3.2 3.3 3.1 2.9 3.5 Import/export trade 18.5 19 19.6 20.6 21.3 Restaurants and hotels 2.9 2.7 2.4 2.1 2.6 Transport, storage, and communications 9.5 9.4 9.9 9.8 10.1 Transport and storage 7.4 7.2 7.6 7.6 8.3 Communications 2.1 2.2 2.3 2.2 1.8 Financing and insurance 11.9 11.3 11.5 12.3 12.2 Real estate 5.1 4.6 4.3 4.0 4.2 Business services 4.4 4.3 4.3 4.5 4.9 Community, social, and personal services 19.9 21.1 21.5 21.8 21.0 Ownership of premises 11.3 11.8 11.8 11.2 10.2 1 Source: WTO Intellectual property rights (IPR) protection Government measures can support industry innovation and knowledge development by protecting knowledge investments. In communications, financial, and technical business services, "innovators stressed the use of copyrights and trademark."2 Since 2000, Hong Kong SAR has strengthened its intellectual property rights regime extending protection and improving administration. For example, the Copyright Ordinance strengthens protection of copyright works and expands electronic administrative procedures for filings.3 The Trade Marks Ordinance strengthens prohibitions against misuse and also eases registration. Hong Kong SAR's expansion of IPR protection and improvement in the government's ability to manage the IPR regime can benefit service industry innovation. Recently Hong Kong SAR slipped in competition rankings due to perceptions about public institutions with regard to judicial independence, property rights, and government impartiality. Market concentration in domestic service industries as well as comparatively low enrollment in tertiary institutions also caused downgrades. 4 Sustaining institutional quality is a universal challenge, while addressing market concentration in the service sector requires pragmatic implementation of policies that prevent anti-competitive behavior and reduce market entry and market exit barriers. Hong Kong SAR's Competition Policy Review Committee has urged greater attention to anti-competitive conduct. With regard to education, Hong Kong SAR spends 4.2% of GDP on education but has a comparatively low combined gross enrollment ratio for 1 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 2 Guy Gellatly, Valery Peeters (1999) Understanding the Innovation Process: Innovation and Dynamic Service Industries Statistics Canada 3 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 4 International Monetary Fund (2007) Competitiveness: Trends and Prospects People's Republic of China-Hong Kong Special Administrative Region: Selected Issues. 157 primary, secondary, and tertiary education at 76.3%.1 Hong Kong SAR is more recently focusing on retraining and skills upgrading programs for workers. Air quality detriment to services industries Poor air quality is influencing the ability of services firms in Hong Kong SAR to attract service industry expertise. In 2006, one forth of companies in Hong Kong SAR reported challenges attracting staff. 2 Since 2002, Hong Kong SAR has strengthened environmental protection of air to reduce pollution. For example, Air Pollution Control Regulations governing fuel, vehicles, and admissions have been tightened. 3 Strengthening regulations can have a potential knock on effect of improving the environmental services industry as a whole. Environmental services industry growth is driven in part by government regulations and their consistent enforcement to protect air, water, and land. Environmental service industries face the same trade barriers as traditional service firms. Thus the removal of restrictions on environmental service providers can help improve the provision of environmental services. Table 14.16 identifies common barriers that inhibit environmental service firms from exporting. Table 14.16 Trade Barriers to Environmental Service Industries Restrictions on participating in government procurement processes Prescribed forms of commercial organization Ownership restrictions Joint venture requirements Foreign remittance constraints Prohibitions on service provision to the public sector Exceptions for provision to certain sectors Professional licensing quotas Ambiguous or unreasonable licensing requirements Nationality limitations on professional service providers Limitations on advertising, public relations, communications Incentive programs Hong Kong SAR actively supports the service sector with tax, financing, and R & D incentive programs. The Hong Kong Science and Technology Parks Corporation offers incentives for investors in a group of service industries including information technology, telecom, and biotechnology. 4 The "DesignsSmart" program fosters development of design incubation, design education, and design networking with a "one-stop shop". 5 Research and development support extends to technology for logistics, ICT, and 1 United Nations (2008) UN Human Development Report 2 International Monetary Fund (2007) HKSAR 3 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 4 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 5 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 158 nanotechnology. 1 The large majority of service firms in Hong Kong SAR have less than 50 employees, consequently, Hong Kong offers financing for SMEs to "enter new markets, upgrade human resources, and enhance competitiveness." 2 The SME Development Fund also supports trade organizations, professional groups, and think tanks to strengthen SMEs. 3 Closer Economic Partnership Arrangement (CEPA) The establishment of the CEPA confirms the parties` recognition of the key tenets of services trade policy and the value of market access to service suppliers and service users. The expressed purpose of the Arrangement between mainland China and the Hong Kong Special Administrative Region is to promote joint development and allow "first mover" advantage to Hong Kong service suppliers.4 For example, in legal services, residency requirements and quantitative restrictions have been waived for Hong Kong law firms. 5 The Agreement's provisions on trade in services are expansive and anticipate progressively deeper liberalization. The CEPA provides preferential access to Hong Kong SAR services suppliers to the Chinese economy earlier and wider than China's commitments. The CEPA deepens market access for 27 services sectors. Commitments are in the form of a positive list and are prescriptive. The CEPA also address the environment for service industries. Article 13 of the agreement commits the respective regulators to share information and deepen cooperation. Article 16 addresses transparency and Article 17 speaks specifically to "transparency in laws and regulations". 6 Article 15 commits professional organization to establish a means for mutual recognition of qualifications. Article 12 expands market access to services firms of WTO members established in Hong Kong SAR and providing services. The components of the Arrangement reaffirm the value of regulatory cooperation, transparency, mutual recognition as well as the trade creating benefits of MFN and national treatment. The implementation of the Arrangement will demonstrate how these measures enhance growth across the economy. Table 14.17 captures tools to improve the services economy and trade. 1 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 2 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 3 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 4 Mainland and Hong Kong Closer Economic Partnership Arrangement (2004) Frequently Asked Questions http://www.tid.gov.hk/english/cepa/ 5 Hong Kong Trade Development Council (2007) Legal Services http://professional.tdctrade.com 6 Mainland and Hong Kong Closer Economic Partnership Arrangement (2004) http://www.tid.gov.hk/english/cepa/ 159 Table 14.17 Examples of HKSAR Service Industry Policy Tools Hong Kong Domestic Competition Investment Trade in Trade promotion Regulation Trade capacity policy & IPR Environmrnt services arrangements Services Focus on Competition Preeminent in Dominated by Maintains commercial Exceptional Closer were 86% of education Policy Review openness & SMEs officers abroad regulatory Economic employment Committee ease quality Partnership in 05` Retraining & (CPRC) Prominent Special attention to SMEs Arrangement skills urges attention to Disclosure sectors: trade, that dominate the services (CEPA) upgrading anti-competitive based finance, sector conduct regulatory insurance, Provides Telecom regime in transport, Incentives: tax and greater market liberalization Legislative financial storage, financing R&D, design & access for 27 began in 95' amendments in services communications innovation technology service sectors fully IPR renewed & tourism upgrading HKSTPC liberalized by focus on Undertaking 03' protection and further Insurance support: Export enforcement liberalization Credit Insurance Liberalizing of specific Corporation utilities services sectors with Maintains specific policies unilateral in aircraft, freight actions in forwarding, hotel, banking, for construction, professional, example testing, travel to promote exports Source: WTO1 1 World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China 160 Conclusion Service industries have grown in economic importance in national economies and international trade. Governments can improve services productivity by facilitating trade and investment. They can ensure domestic institutions promote fair play in the marketplace and provide an environment of transparency. Governments can institute policies that support investment, competition, and innovation. They can facilitate a services policy dialogue to stay abreast of the ever evolving issues in the services market. China can use a variety of measures to strengthen service industries and facilitate trade in services. Each country reviewed offers useful lessons for China. The European Union's examination of service industry constraints among members drove the development of a Services Directive that takes a pragmatic approach to reducing process and regulatory barriers to services trade. The United States puts a heavy emphasis on the quality and availability of market information to investors, citizens, and the government to draw investment into service firms and inform policymaking. India's ability to free computer and information services from the historically burdensome Indian regulatory regime has made service exports an engine of growth and catalyst for reform in other service sectors. In the last few years, the Republic of Korea, Singapore, Japan, and Hong Kong SAR, revised government measures to strengthen key aspects of their respective service economies. Together they represent a clear trend in the structuring and implementation of competition policy and increased attention to intellectual property protection. Subduing anti-competitive practices in services markets became a renewed priority for these leaders in services trade due to comparatively high costs and inefficiencies in services as well as lethargic incumbents.1 Many also recently relaxed FDI measures on a variety of service sectors to build service sector productivity and renew growth across the economy. Each economy offers valuable insight into how governments strengthen services trade and the challenges inherent in building and maintaining a vibrant services economy. 1 Simon Evenett, (2005) Lessons from the Six Country Analysis Competition Policy and Development in Asia Asian Development Bank 161 References "Not Invented Here" (1 December, 2007) The Economist Vol. 385, Iss. 8557; p. 14 India Turns a Corner January (2007) Trade Finance Andrew Morse, (10 December, 2007) Japan Moves to Improve Market Climate Wall Street Journal Anna Fifield, (26 June, 2007) Seoul looks to echo London 'big bang' Financial Times London (UK): p. 10. Asia-Pacific Telecommunity Yearbook 2006 Barry Bosworth, Susan M. Collins, (2007) Accounting for Growth: Comparing China and India National Bureau of Economic Research Blanke, (November 6, 2007) The Factors That Put the US on Top of the World Letter to the Editor Financial Times p. 10. Bridget Rosewell, Consultant Chief Economist, GLA Economics (2007) "London As a World Services Center: Factors for Success" Bureau of Economic Analysis (2000) United States Statistics on Trade in Services Burton Ong (2006) "The Origins, Objectives and Structure of Competition Law in Singapore" World Competition Vol. 29(2), p. 269-284 Caroline Long (2006) "Singapore in Transition: from Technology to Culture Hub" Journal of Knowledge Management Vol. 10, Iss. 5; p.79 Center for Applied Marketing, University of New South Wales for the Australian Trade Commission Austrade (2002)"Exporting Australian Services: Case Studies of 17 Service Exporters". Commission of the European Communities (2007) Handbook on Implementation of the Services Directive D. Kaufmann, A. Kraay, M. Mastruzzi, (2007) Governance Matters Romans VI: Governance Indicators for 1996-2006 The World Bank European Commission (2005) Examples of Problems the Services Directive Would Help Solve. http://ec.europa.eu European Commission. (2005) Commission Non Paper for the FSC-Meeting http://ec.europa.eu/internal_market Geraldine Lamb, (January 1, 2008) Davos: Indian Capital Markets The Banker Gurcharan Das, July/August (2006) The India Model Foreign Affairs 162 Guy Gellatly, Valerie Peeters (1999) Understanding the Innovation Process: Innovation and Dynamic Service Industries Statistics Canada Hong Kong Trade Development Council (2007) Legal Services http://professional.tdctrade.com http://www.bis.org/ http://www.iaisweb.org/ http://www.iosco.org/ Indian Institutes of Technology Alumni ITT History http://www.iit.org International Competition Network (2003) Capacity Building and Technical Assistance: Building Credible Competition Authorities in Developing and Transition Economies International Monetary Fund (2006) "Trends and Variation in Domestic Competition and Markup Costs" Singapore: Selected Issues International Monetary Fund (2006) Korea's Transition to a Knowledge-Based Economy: Prospects and Challenges Ahead Republic of Korea: Selected Issues International Monetary Fund (2007) "Competitiveness: Trends and Prospects" People's Republic of China-Hong Kong Special Administrative Region: Selected Issues. 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Nadkarni, (June 2005) "The Knowledge Economy in India" Asian Business & Management Vol. 4, Iss. 2; p. 213 Simon Evenett, (2005) Lessons from the Six Country Analysis Competition Policy and Development in Asia Asian Development Bank Somini Sengupta, (17 January, 2008) Education Push Yields Little for India's Poor The New York Times Sundeep Tucker, (13 January, 2008) Reliance Can Do No Wrong in the Eyes of Indians Financial Times The Economist (25 October, 2007) "High-flyer" International Telecommunication Union Economies by Broadband Penetration (2006) 164 http://www.itu.int Transparency International (2007) Corruption Perceptions Index http://www.transparency.org United Nations (2008) UN Human Development Report 2007/2008 United Nations Conference on Trade and Development (2007) World Investment Report US Bureau of Economic Analysis (2006) US International Services Cross-Border Trade in 2005 and Sales through Affiliates in 2004 van Ark, (2004) The Measurement of Productivity: What Do the Numbers Mean? in G. Gelauff, L. Klomp, S. Raes, T. Roelandt Fostering Productivity. Patterns, Determinants and Policy Implications, Contributions to Economic Analysis van Ark, O'Mahony, Ypma, (2007) The EU KLEMS Productivity Report: An Overview of Results from the EU KLEMS Growth and Productivity Accounts for the European Union, EU Member States and Major Other Countries in the World World Trade Organization (2004) Trade Policy Review Singapore Report by the Secretariat World Trade Organization (2004) Trade Policy Review Republic of Korea Report by the Secretariat World Trade Organization (2005) A Handbook on the GATS Agreement World Trade Organization (2005) Japan Revised Offer World Trade Organization (2005) Republic of Korea Revised Offer on Services World Trade Organization (2007) International Trade Statistics World Trade Organization (2007) Trade Policy Review Report by the Secretariat India World Trade Organization (2007) Trade Policy Review Report by the Secretariat Japan World Trade Organization (2007) Trade Policy Review Report by the Secretariat Hong Kong, China World Trade Organization (2007) World Trade Report 165 15 Promoting Trade in Services: Case Studies Introduction This paper examines three global industries: information technology, transport, and animation services. For each sector, leading exporters are identified, industry trends are explored, and strategies China can use to improve market conditions are suggested. China has significant competitors operating globally in each industry. Chinese policymakers and industry leaders can improve prospects for Chinese firms with attention to particular factors influencing global competition in each sector. Information technology is a global industry with firms from around the world offering a broad scope of information services in an intensely competitive environment. Innovation, cost pressures, and more recently energy concerns are driving companies to create new products that offer choice in software applications, hosting, and delivery. Firms across industry sectors continue to offshore and outsource operations on a global basis. Emerging markets are important providers of information technology services due to market reforms and investment in communications and education. China can improve the domestic environment for Chinese firms by increasing the expertise of its labor force across many skill sets, improving access to venture capital, and strengthening the intellectual property protection regime. The transport industry ties sea freight, air freight, trucking, and rail together to facilitate the movement of goods from point of origin to final destination. Across the transport sector, firms are responding to important trends by lowering costs and enhancing efficiency to remain competitive. Transport firms are also encountering increasing congestion, heightened environmental requirements, and stringent security rules. Industry leaders are focusing on technology to improve efficiency, protect the environment, and meet security regulations. China can concentrate on technological innovation and improve the domestic and international regulatory environment to better position Chinese firms in the global transport market. Many countries have a vibrant animation sector creating original content and operating in a growing and intensely competitive market. Technology and labor costs influence the structure of the value chain of the animation industry. The emergence of a multitude of media platforms creates growing demand for animation. Chinese animation houses are globally competitive and can adopt strategies used by leaders in the industry to capture a greater share of the market. China can also adjust its domestic policy environment to improve the competitive position of Chinese animation houses. Although information technology, transport, and animation are very different industries they share common industry trends. Each industry is experiencing exceptional trade growth and emerging markets are significant providers in each sector. Deployment of technological innovation can be a competitive advantage for firms operating in each 166 industry. Management's ability to respond to competition, orchestrate strategic alliances, and anticipate challenges and opportunities on the horizon is also a determinant of export success. Information technology and animation firms are particularly reliant on a vibrant venture capital market and robust protection of intellectual property. Changing regulations in transport require astute engagement by Chinese policymakers and proactive leadership from industry captains. Firms from each sector also gain from accessing quality and skilled professionals from around the world. Information technology services Information technology is a global industry with firms from around the world offering a broad scope of information services in an intensely competitive environment. Innovation, cost pressures, and more recently energy concerns drive companies to create new products that offer choice in software applications, hosting, and delivery. Firms across industry sectors continue to offshore and outsource operations on a global basis. Emerging markets are important providers of information technology services due to market reforms and investment in communications and education. China can adjust the policy environment to capture a greater share of the global market estimated at $467 billion in 2006 with 6% growth prospects through 2011.1 Main services providers In 2005 after the EU, India was the largest exporter of computer and information services, followed by the US, Israel, Canada, China, and Japan as illustrated in the graph below. Many emerging markets experienced exceptional export growth in the last few years. Since 2003, the Russian Federation's information technology exports grew 60%, Malaysia's exports increased 50%, and China's exports rose 40% annually from 2003. 2 As emerging markets expand and deepen the expertise of their labor force they capture a growing share of this dynamic industry in developed and emerging economies. 1 Standard & Poor's (March 15, 2008) Stock Report Wipro Limited 2 World Trade Organization (2007) 167 Figure 15.1 Major Exporters & Importers of Cmp. & Inf. Services, 2005 (million dollars) 70000 60000 50000 40000 30000 Exports 20000 Imports 10000 0 Extra-EU Japan India a China Israel b Canada Union (25) United States European Norway b (25) exports Source: WTO (2007)1 Notes: "a" represents estimate by the WTO Secretariat, "b" represents computer services Remarkable export growth from emerging economies reflects market reforms and investment in communications infrastructure and education. The globalization of enterprise, outsourcing of key business operations, and offshoring of computer services boosted demand for information technology services from low-cost markets. India exemplifies an economy that graduated from low-cost provider to global leader in the provision of information technology services. China's investment in education and communications infrastructure as well as significant market reforms has enabled Chinese industry to compete in the global information technology market. Table 15.1 Sample Factors Influencing Export of Computer and Information Services Globalization growing cross-border flows of capital increased foreign direct investment expansion of trade in goods and services Market reforms regulatory reform lifting of FDI restrictions Investment ICT infrastructure technical, business, continuing education physical infrastructure Offshoring Firms are locating abroad through establishment, joint venture, or subcontract to perform: R&D IT services Outsourcing Manufacturing and service industries are subcontracting non-core operations: payroll finance data processing supply chain logistics, etc. 1 World Trade Organization (2007) 168 Industry trends Technological innovation shapes the information technology services market. Software firms consistently spend as much as "10% to 20% of revenues" on research and development (R&D).1 R & D focuses on applications as well as the means to deliver software products. The exceptional growth of the Internet, global communications systems, and broadband access promotes the evolution of different delivery mechanisms for different types of information technology services on-site, remotely, and from abroad. Software as a service, web-based software, and the commercialization of supercomputing are transforming the industry. Software as a service (SAAS). The introduction of software as a service reflects the growing ability to provide software remotely using a combination of infrastructure. As a service, vendors maintain greater interaction with their customers and consequently refine products in the near term through constant feedback. Remote provision has enabled firms to offer different sales models including: on-demand software subscription software leased software With SAAS firms can access state-of-the-art programs at lower cost. A firm can easily obtain access to programs that provide security and firewalls as well as remote monitoring. Firms can also migrate into additional business process outsourcing from remote providers. These models offer greater flexibility, graduated payment terms, and less risk associated with committing to one software product. Web-based software. Web-based software programs are emerging as alternatives to packaged products. Particularly in the consumer market, migration to web-based applications is growing. E-mail, database services, video services, finance offerings, payment services, and personalized portal offerings made available at no cost to the consumer attracts buyers away from traditional packaged applications. 2 The extraordinary growth of Google, which was publicly listed in 2004, attests to the favorable reception of web-based services. The business model for offering web-based software to consumers is distinct from traditional packaged products. Google has a unique program "AdWords" that creates targeted opportunities to advertise products to Web users. Rather than charging the consumer directly, Google relies on advertising for 99% of revenues. 3 The combination of advertising revenue and data collection create distinct value for the firm. 1 Zaineb Bokhari (October 11, 2007) Standard & Poor's Industry Surveys Computers: Software 2 Standard & Poor's (February 23, 2008) Stock Report Google Inc. 3 Standard & Poor's (February 23, 2008) 169 In response to competition, software innovators are lowering costs and improving value. Salesforce.com a "leading provider of on-demand customer relationship management software," 1 which offers 575 applications attributes the evolution of the sector to a progression from: mainframe to client/server systems rise of the PC creation of the Internet development of Web services & technologies migration to service oriented architecture software as a service2 Software as a service continues to evolve with access to supercomputing. Information technology firms are offering combinations of computer infrastructure based on a usage fee. Google, Microsoft, IBM, and Amazon are "networking large groups of servers"3 to provide supercomputing services to academia, researchers, and the commercial market. Industry clients continue to drive firms to deliver the best computing services at the lowest cost. Companies working to control energy, personnel, and hardware costs are moving to a fee-for-service model that enables them to access "a collection of resources - - applications, platforms, raw computing power and storage, and managed services,"4 for their IT needs. Intense competition across industry sectors that use IT services has also boosted use of open-source software. Open source software. Industry analysts expect open source software to maintain a distinct position in the market and put downward pressure on the price of packaged software. A number of programs eschew proprietary code and make their code freely available. Open source systems include: Linux Apache JBoss Online interactivity facilitates the dispersion and improvement of open source systems. Firms such as Novell and Red Hat provide open source training, monitoring, security, and updating support to open source users and have helped to bring the products into the mainstream. 5 Academia's use and exercise of open source software as a teaching 1 Standard & Poor's (March 15, 2008) Stock Report Salesforce.com Inc. 2 Salesforce.com (March, 2008) "How We Got Here" http://www.salesforce.com 3 BusinessWeek (November 16, 2007) "IBM, Yahoo!, and Google Are All Putting the Power of Cloud Computing to Work. Here Is a Short Primer on How the Technology Works." http//www.businessweek.com 4 Bill Snyder (March 13, 2008) InfoWorld "Cloud Computing Begins to Emerge from the Haze" http://www.infoworld.com 5 Jessica Twentyman (March 19, 2008) Financial Times "Linux Tries Not to Be a Victim of Its Own Success" p.3 170 instrument has also created a large pool of users who are comfortable with open source when they enter the business world. 1 As software users face increasing competition in their own industry, they seek to lower costs and adopt alternatives that do not require licensing agreements. Open source software that can operate on any system also provides "hardware independence" allowing additional cost savings. 2 Due to low cost, flexibility, and reliability, open source software will continue to attract buyers away from packaged providers. Offshoring. Firms continue to establish operations abroad to capture cost savings from lower-cost labor markets and reduced tax liabilities. The table below provides average IT salaries in specific countries for 2006. Rates are fluid and dependent on demand for IT professionals in the home and external markets. "Labor costs have been rising in India, as demand for workers increases, not only from domestic employers, such as Wipro, but also from multinational corporations, which have opened bases of operation to take advantage of the labor force."3 As more companies establish in low cost labor markets and as domestic demand for IT professionals grow in those markets, wages rise and compensation packages develop. Table 15.2 Average Annual IT Salary in Dollars for Selected Countries, 2006 Country Average IT Country Average IT salary salary Switzerland 79630 China 21060 United States 73220 Malaysia 18130 United Kingdom 64590 Russia 17720 Canada 59180 Thailand 15870 Ireland 51470 Vietnam 14820 Mexico 26210 India 13910 Czech Republic 21110 Philippines 12420 Source: Standard & Poor's (2007)4 In addition to cost, the quality and skill of the labor pool influence information technology productivity. Particular expertise enables professionals to contribute to the overall productivity of the company. Software engineering skills are a priority, however, soft skills that facilitate collaboration, problem solving, and innovation are also necessary for the firm to remain competitive in the global market.5 Emerging markets that produce a well educated, technically and professionally diverse workforce that can graduate from basic IT to advanced information technology services are best positioned to compete globally. 1 Jessica Twentyman (March 19, 2008) 2 Jessica Twentyman (March 19, 2008) 3 Standard & Poor's (March 15, 2008) Stock Report Wipro Limited 4 Dylan Cathars (November 1, 2007) Standard & Poor's Industry Surveys Computers: Commercial Services 5 Officer. Multinational Information Technology Services Firm. Interview. March 14, 2008 171 Table 15.3 Favorable Labor Pool Attributes for IT firms Quality of university graduates (In some countries new hires require 6-12 months of additional training.) Scope of labor pool (Corporate operations require qualified developers, programmers, middle managers, generalists, and support staff.) Exposure to leading-edge technologies Experience with global business practices Multilingual capability Interpersonal, collaboration, & problem solving skills Multicultural sensitivity Access to continuing education programs Source: Interview1 Services Demand. On a global basis, the outsourcing market is expected to continue to grow. Industries in developed and emerging markets are adopting outsourcing to reduce costs. Exceptional growth is expected in horizontal business outsourcing of non-core activities. Information services outsourcing will grow albeit to a lesser degree. Network and desktop outsourcing, hosting infrastructure services, application management, and hosted application management will grow at moderate rates. The line graph below highlights anticipated growth in distinct segments of the market. Figure 15.2 Worldwide Services Spending by Foundation Market (billion dollars) 300 Information services outsourcing 250 Network and desktop 200 outsourcing Application management 150 Hosted application 100 management Hosting infrastructure 50 services 0 Key horizontal business 2006 2007 2008 2009 2010 2011 outsourcing Source: IDC Research Inc. (April 2007)2 Spending on traditional IT services such as systems integration, network consulting and integration, IT consulting, business consulting, and custom application development is also expected to expand. The graph below illustrates the expectation that services spending on systems integration will continue to be a priority. 1 Officer. Multinational Information Technology Services Firm. Interview. March 14, 2008 2 IDC Research Inc. (April 2007) Worldwide Services 2007-2011 Forecast: a Market in Transition 172 Figure 15.3 Worldwide Services Spending by Foundation Market (billion dollars) 120 Business consulting 100 IT consulting 80 Systems integration 60 40 Network consulting and integration 20 Custom application development 0 2006 2007 2008 2009 2010 2011 Source: IDC Research Inc. (April 2007)1 Demand by Industry. Export trends also reflect the growth in demand for computer and information technology services by particular industries around the world. The industries with the greatest expenditure as well as the largest expected growth are led by discrete manufacturing, communications and media, banking, and process manufacturing. Expenditures by government, academia, and consumers are expected to grow at a compound annual growth rate of 6.1%, 3.9% and 4.3% respectively through 2011. 2 The graph below indicates the anticipated growth in spending by specific industries. Figure 15.4 Worldwide IT Spending by Vertical Market (million dollars) 60000 Banking 50000 Communications & 40000 media Discrete 30000 manufacturing Insurance 20000 Securities & 10000 investment services 0 Process manufacturing 2006 2007 2008 2009 2010 2011 Source: IDC Research Inc. (April 2007)3 -vis China vis-à India, Eastern Europe, Ireland, and the Philippines A snapshot of India, Eastern Europe, Ireland, and the Philippines identifies factors that contribute to each markets success as an information technology services exporter. 1 IDC Research Inc. (April 2007) 2 IDC Research Inc. (April 2007) 3 IDC Research Inc. (April 2007) 173 Countries compete on tax rate, communication costs, quality of physical infrastructure, labor costs, and most importantly the depth, scope, and quality of the work force. They also benefit from language affinity and geographic proximity to wealthy markets. Intense competition also rewards technological innovators. i. India. India is a mature provider of information technology and business process outsourcing that has successfully built intellectual capital across several IT skill categories.1 In 2005 exports generated approximately 80% of software revenue and Indian firms captured approximately "3% of the global IT market."2 Indian companies progressed from low- cost IT service providers to higher value added services providers with foreign establishment in North America, the Middle East, China and Eastern Europe and a track record of corporate acquisitions as well as ADR3 listings. Indian firms compete on cost, service, and innovation. Indian firm Wipro provides IT consulting, custom application design, development, reengineering and maintenance, systems integration, package implementation, technology infrastructure outsourcing, BPO services, and research and development services in the areas of hardware and software design. 4 The firm exemplifies leading Indian companies providing services at client facilities, from remote development centers, and from other operations around the world. Indian firms face intense global competition as well as the universal challenge of adequate labor supply in terms of cost, quality, and scope. In India firms are experiencing increasing wage rates, an appreciating currency, and competition in its domestic markets from other information technology firms.5 These developments have prompted the migration of Indian firms to China. -vis China has a clear advantage in labor costs vis-à India. China can invest in education and actively recruit from the global labor pool to match India's scope of IT and BPO expertise. To achieve a comparable global reach, China can expand language capabilities and promote innovation in non-voice BPO. According to industry analysts, China has a more favorable broadband subscriber base of 7.2 per 100 people to India's 1 per 100 people. In 2007, China's domestic market also spent 30% more than India's on information technology services. 6 China's diverse domestic market represents an 1 NeoIT (September 2005) Offshore Insights Market Report Series: "Research Summary: Mapping Offshore Markets Update 2005" Vol.3, Iss.8. 2 Economist Intelligence Unit Industry Wire Forecast (December 10, 2007) "India: Telecoms and Technology Forecast" 3 American depository receipt 4 Standard & Poor's (March 15, 2008) Stock Report Wipro Limited 5 Standard & Poor's (March 15, 2008) 6 Economist Intelligence Unit Industry Wire Forecast (January 29, 2008) "China: Telecoms and Technology Forecast" 174 important catalyst for Chinese information technology service firms to improve the scope and quality of their products. 1 ii. Ireland Ireland's emergence as a software provider originates from favorable investment incentives, recruitment of foreign information technology experts, and investment in infrastructure. Ireland attracted investment with exceptionally low corporate tax rates, which stood at 12.5% in 2007. 2 The Irish Software Association recognizes the contribution of foreign technology workers to Irish firms in the light of falling numbers of indigenous IT graduates.3 The "Celtic Tiger" was an early beneficiary of European Structural Funds that helped build out infrastructure for its "well educated, highly literate, English-speaking labor force." 4 A concerted effort by specific institutions helped to develop the software industry in Ireland including the: National Software Directorate Industrial Development Authority National Informatics Directorate Center for Software Engineering Software Program for Advanced Technology ICC Venture Capital Fund Ireland developed an educational focus on business, engineering and computer science to build its software industry. 5 Ireland is a mature provider of software services with favorable proximity to the EU and the United States. iii. Eastern Europe Many software service firms migrated to Eastern Europe to take advantage of low labor costs, multiple language capabilities, and excellent engineering skills. Firms have matched outsourcing opportunities from Western Europe with language capabilities in a variety of East European countries. "The region has an advantage over cheaper rivals such as India, Russia, and the Philippines because it is closer in time zone, distance and culture to customers in Western Europe."6 Engineers in the Czech Republic, Poland, and Hungary are well regarded as are the professionals who support IT firms.7 "Hungary has 1 Economist Intelligence Unit Industry Wire Forecast (January 29, 2008) 2 Industrial Development Authority (December 2007) Ireland Vital Statistics 3 Irish Software Association (2006) Annual Review 2005-2006 4 William Birdthistle (February 23, 2008) "Books: Burning Bright; How the Celtic Tiger Proved the Begrudgers Wrong" Wall Street Journal p. w. 8 5 Ciara Heavin, Brian Fitzgerald (2004) "Institutional Impact on the Development of an IT Industry: the Irish Experience" Journal of Global Information Technology Management Vol.7, Iss. 4 6 Robert Anderson (December 15, 2006) "Skilled Workers Fuel Investment" Financial Times http://www.ft.com 7 McKinsey Global Institute (June 2005) The Emerging Global Labor Market: Part II - The Supply of 175 the highest number of Field medal winners in mathematics, the equivalent of the Nobel Prize." 1 Universities are recognized for their strong mathematical and computer engineering programs. Eastern Europe's proximity to Western Europe and membership in the EU has made the region a magnet for IT firms. The European market poses challenges for China. To provide information technology services and business process outsourcing, Chinese firms must overcome language obstacles, cultural distance, and geographic proximity. To capture market share in Europe, Chinese firms can strategically recruit from the global pool of labor for technical and language skills. They can adopt a global perspective and recruit selectively from different countries for "onshore, nearshore, and offshore" operations. iv. The Philippines The Philippines has an expanding business process outsourcing industry with 90% foreign- ownership. 2 Inbound and outbound voice operations services, software development, and back office services are the leading revenue generators as indicated in the table below. "Low labor costs, high linguistic and cultural compatibility with the US, and the quality of telecommunication infrastructure are widely recognized factors at work in the Philippines' favor, especially for voice related operations."3 The Philippines also competes on location costs.4 In comparison to China, the Philippines has lower fixed telecom costs, lower office rent, and a lower corporate tax rate. 5 Table 15.4 The Philippines BPO Industry Overview 2005/2006 BPO service 06` Service 05` Revenue 05` Employment providers (million $) (thousand) Contact center 114 1792 112 Back office 62 180 22.5 Medical 64 70 5.5 transcription Legal 9 6 .45 transcription Other data -- 39 3 transcription Software 300 204 12 development Animation 42 40 4.5 Engineering 14 48 2.8 design Digital content 11 7 .5 Total 616 2386 163.25 Offshore Talent in Services 1 K. Yatish Rajawat (December 4, 2004) "High Tech Companies Plug into Eastern Europe" Knight Rider Tribune Business News 2 Asian Development Bank (March 2007) An Analysis of the Philippine Business Process Outsourcing Industry 3 International Monetary Fund (March 2007) "Can a Shift to Services Set the Philippines on a Stronger Growth Path?" IMF Country Report Philippines: Selected Issues 4 Asian Development Bank (March 2007) 5 Asian Development Bank (March 2007) 176 Source: Asian Development Bank (2007)1 India, Eastern Europe, Ireland, and the Philippines effectively compete in information technology and business process outsourcing. India relies on skilled professionals to help Indian firms capture IT and business process outsourcing. Ireland welcomes foreign workers and maintains a low corporate tax rate. Education in mathematics, engineering, and a broad scope of professional fields has enabled firms to excel not only in information technology services but also in business process outsourcing. Geographic proximity and language affinity with wealthy, mature, technology markets such as the European Union, the United States, and Japan benefit firms from Eastern Europe, the Philippines, India, and China. Eastern Europe and Ireland have the advantage of favorable market access in terms of movement of people and convenient contact with clients in Europe. As outsourcing of non-core business operations rise, opportunities in finance, law, and research, will expand for economies with exceptional professionals. Synthesis of China's industry in a global context & recommendations China has a burgeoning information technology and outsourcing industry. Wuxi, China is the selected site for a "cloud computing center" that will provide supercomputing to small and medium-size enterprises. 2 China has a presence in the business process outsourcing market serving clients primarily from Japan in traditional and "non-voice business process outsourcing." 3 China has well established companies such as Ufida, Neusoft, and Digital China serving the domestic and in some cases global clients and working closely with foreign direct investors. China's exceptional economic growth, low cost labor pool, and reliable infrastructure attracted investment from information technology leaders such as Microsoft, IBM, Hewlett-Packard, Tata Consultancy Services, Wipro, and Infosys. 4 Tata Consultancy Services expects the sizable Chinese workforce to enable the firm to expand operations on a large scale over the long term to provide outsourcing to global clients. 5 Firms established operations in China to serve outsource clients in neighboring markets, execute low cost R&D, and establish a foothold in the expanding Chinese market. Industry analysts suggest China needs to expand the scope and enhance the quality of information technology professionals. The rapid emergence of the commercial economy and exceptional demand for professionals has caused a skills shortage in China.6 Tata Consultancy Services also found higher operating costs, language a challenge, and significant "staff attrition." 7 China can also build expertise in soft skills such as 1 Asian Development Bank (March 2007) 2 J. Bonasia (February 29, 2008) "Cloud Computing Initiatives Being Floated" Investor's Business Daily 3 Talasila Rao (July 3, 2005) "Inside the Chinese IT Services Business" Business Today p. 66 4 CFO (October 2003) "The China Syndrome: US Companies Are Beginning to Outsource Technology R&D to India and China. Will a Meltdown in Tech Jobs Follow?" Vol. 19, Iss. 13; p. 74 5 Joel Leahy (April 17, 2007) TCS Pushes into China to Set up an Eastern Hub" Financial Times http://www.ft.com 6 McKinsey Global Institute (October 2005) Addressing China's Looming Talent Shortage 7 Joel Leahy (April 17, 2007) 177 communication, teamwork, and problem solving, which facilitate efficient and productive business operations.1 In China analysts suggest, "access to venture capital remains limited, intellectual property protection is poor and the link between academia and industry are still relatively weak."2 China is well positioned to compete in the global market due to low labor costs and its gradual progress into higher value added information technology services. Industry analysts suggest, however, that as much as 90% of high-technology exports from China can be attributed to foreign investors. 3 China can improve intellectual property protection to foster technological innovation at home. Chinese firms can expand the scope and quality of professional skills to improve their competitive position in information technology and business process outsourcing. The information technology industry requires a variety of professionals with technical and interpersonal skills that facilitate operations and contribute to effective service production and delivery. Industry surveys4 also anticipate a skills shortage and increased demand for the following technical categories: coders developers general networking operating systems programmers radio frequency mobile security wireless technology Language skills are invaluable in attracting clients for information technology and business process outsourcing from Asia, Europe, and North America. Although Chinese firms are well established in non-voice business process outsourcing, expanding language capability will enable Chinese firms to serve clients in a greater range of information technology and business process outsourcing segments and on a broader geographical scale. To meet demands in language, technical, and business management skills, academia can help provide in-house training and continuing education in technical and soft skill development. Adult education can help build expertise for new graduates and those already in the marketplace. Ministry officials, corporate leaders, and academia can consider how to most effectively improve educational attainment and expansion. 1 Officer. Multinational Information Technology Services Firm. Interview. March 14, 2008 2 Mure Dickie (October 9, 2007) "Innovation: Research and Development Is Slow to Grow" Financial Times http://www.ft.com 3 Economist Intelligence Unit IndustryWire Forecast (January 29, 2008) China: Telecoms and Technology Forecast 4 The Center for Strategy Research, Inc. (2007) Skills Gaps in the World's IT Workforce: A CompTIA International Research Study 178 Chinese firms can also strategically recruit from the global workforce to strengthen key positions within the enterprise. China can improve the financial environment for information technology and business process outsourcing enterprises. Rapid technological innovation is a consistent feature of industry trends in software delivery, product development, and infrastructure. Academia, corporate and public research and development facilities generate technological innovations. However, within the global industry, new businesses or "startups" play an important role creating and commercializing technological innovations. New technology businesses in China have comparatively less access to venture capital than "startups" from abroad. In China, according to industry analysts, "although the private sector contributes 52% of GDP...it accounts for only 27% of outstanding loans from the banking sector." 1 Chinese majority state-owned banks provide "the vast majority of funds to state owned enterprises."2 To compete on a global basis, Chinese "startups" require comparable access to venture capital and a more robust financial services industry. China can strengthen its intellectual property protection regime. High piracy rates depress software income. With an 82% piracy rate in China, owners of proprietary software forgo income. This represents an opportunity cost for firms that could otherwise invest such income in research and development, employee training, marketing, etc. Piracy can be deterred through public education, enforcement of copyright treaties, dedicated resources, and government practice. With the protection of intellectual property, software firms can invest income, otherwise lost to piracy, in technological innovation, new technical and language skills, and export strategy, for example, to improve their position in an intensely competitive global software market. Table 15.5 Percentage of Total Software Revenues Spent on Pirated Software, 2006 Country % Country % Switzerland 26% China 82% United States 21% Malaysia 60% United Kingdom 27% Russia 80% Ireland 36% India 71% Czech Republic 39% Philippines 71% Source: BSA and IDC (2006)3 Transport 1 Economist Intelligence Unit Industry Wire Forecast (January 29, 2008) "China: Financial Services Forecast" 2 Economist Intelligence Unit Industry Wire Forecast (January 29, 2008) 3 Business Software Alliance (2006) Fourth Annual BSA and IDC Global Software Piracy Study http://www.bsa.org/globalstudy 179 World exports of transport services grew on average 10% per year from 2000 to 2006.1 Demand for international sea freight, air freight, and auxiliary services reflects growth in global trade. Transport firms are encountering increasing congestion, heightened environmental requirements, and stringent security rules. Transport firms and governments are working to counter congestion with infrastructure investment, increased off-loading efficiency, improved rail and trucking services as well as route adjustments. They are focusing on technology to improve efficiency, protect the environment, and meet security regulations. The leading exporters and importers of transportation services in 2006 were the European Union (25), the United States, Japan, the Republic of Korea, Hong Kong China, and China according to the WTO. The EU's share of exports grew from 42.2% in 2000 to 44.4% in 2006, the US share decreased from 14.5% in 2000 to 11.1% in 2006, Japan's share also decreased from 7.3% in 2000 to 6% in 2006. 2 The Republic of Korea's share grew from 3.9% in 2000 to 4.1% in 2006. Hong Kong China's share decreased from 3.7% in 2000 to 3.5% in 2006. 3 China's share of the total value of transport grew from 1.1% in 2000 to 3.3% in 2006. Large trading economies receive a substantial proportion of transportation exports. Over 50% of EU exports went to other EU countries, 15% went to the United States, 3.4% to Switzerland, and 2.5% to Japan. 4 For the US, 32.3% of exports went to the EU, 12.8% to Japan, 9% to Canada, 4.8% to Mexico and 4% to Korea. 5 For Japan, 22.9% of exports went to the EU, 21.4% to the US, 7.9% to Hong Kong China, 7.7% to China, and 6.7% to Korea. 6 For Korea, 23.2% of exports went to the United States, 17.1% to China, 13.9% to the EU, and 10.2% to Japan. 7 Hong Kong's exports to the United States were also significant at 18.2%, 16% of exports went to China, and 15.4% went to the EU.8 The top two traders of transportation services have substantially different compositions of trade. Sea freight is almost 50% of transportation services exports from the EU. While air passengers represent the largest portion of the US transportation services exports. Exports by sector are detailed in the charts below for the EU (25) and the US. 1 World Trade Organization (2007) 2 World Trade Organization (2007) 3 World Trade Organization (2007) 4 World Trade Organization (2007) 5 World Trade Organization (2007) 6 World Trade Organization (2007) 7 World Trade Organization (2007) 8 World Trade Organization (2007) 180 Figure 15.5 Structure of Transportation Services Exports Extra-EU (25), 2005 10.8% 6.1% 5.5% Air freight 20.0% 1.0% Air passengers Other air transport Sea freight 8.6% Sea passengers Other sea transport 47.8% Other transport Source: WTO (2007) Figure 15.6 Structure of Transportation Services Exports United States, 2005 5.1% 14.4% Air freight 18.7% Air passengers Other air transport Sea freight 0.5% Sea passengers 8.0% 32.8% Other sea transport Other transport 20.5% Source: WTO (2007) In terms of trade in transport services with China, the EU was the largest exporter followed by the Republic of Korea, Hong Kong China, Japan, the United States, and Singapore. The leading importers from China were the EU, the US, Hong Kong China, Japan, the Republic of Korea, and Singapore. The value of trade is growing with each economy. Japan in particular is increasing its imports of transport services from China. The US is also increasing its imports however at a decreasing rate. The same dynamic is true for Singapore and the European Union (EU) and to a lesser degree the Republic of Korea. The chart below illustrates transport exports and imports from China in 2005. 181 Figure 15.7 Trade in Transportation Services with China in 2005 (million dollars) 5000 4500 4000 3500 3000 2500 Exports to China 2000 Imports from China 1500 1000 500 0 European Korea, Hong Japan United Singapore Union Republic Kong, States (25) of China Source: WTO (2007) Industry trends Growth in international sea freight, air freight, and auxiliary services mirrors trade expansion. International seaborne trade reached 7.4 billion tons in 2006 (see chart below). The growth trajectory according to UNCTAD is positively correlated with "world GDP and merchandise trade."1 In addition, "about 90% of world trade is seaborne, and both the EU and China are major participants in maritime affairs.2 At the same time, rates for seaborne services continue to decline in part due to rising capacity. 3 In October of 2007, many carriers found that they were facing significant cost pressures and that "current rate levels [were] unsustainable."4 Despite increasing demand and significant market entry barriers, competition is intensifying in seaborne trade. 1 For a thorough review of seaborne trade in crude oil and petroleum products see: United Nations Conference on Trade and Development (2007) Review of Maritime Transport 2 BBC Monitoring Asia Pacific (February 28, 2008) "China-EU Shipping Pact to Take Effect 1 March" p.1 3 Organization of Economic Cooperation and Development (August, 2001) Regulatory Issues in International Maritime Transport 4 Logistics Today (October 2007) "Transpacific Growth Sustainable, Rates Aren't." Vol. 48, Iss. 10. p.14 182 Figure 15.8 Development of Intl. Seaborne Trade, Selected Years (millions of tons) 8000 7000 6000 5000 tanker cargo dry cargo 4000 main bulks 3000 total (all cargo) 2000 1000 0 1970 1980 1990 2000 2006 Source: UNCTAD (2007) The air freight market is expected to expand at a rate of "6.1% per year"1 as a reflection of increased global trade. Generally air freight costs "7-10 times that of ocean transport." 2 This relatively "high-value" segment of the transportation market is dominated by firms such as Federal Express Corp., United Parcel Service Inc., and DHL Worldwide. "International shipments, particularly in Asia, have recently been climbing at annual rates near 20%. 3 Bilateral arrangements govern landing rights for the air freight industry; consequently, governments are engaging counterparts in fast-growing economies to secure market access. The trucking sector is also experiencing a boom. In the US "imports from Asia surged from 7.8 million TEUs to 13.6 million TEUs between 2000 and 2005, an average increase of 11.7%."4 Many governments are aggressively regulating "noxious emissions from the trucks that move containers between marine terminals and local distribution centers and railheads." 5 Increased demand for rail in Asia, Europe, and the US is prompting infrastructure investment. In the short term, networks are using "double tracking and increasing side length" to accommodate volume. 6 Over the long term, governments are using tax incentives, public private partnerships, and privatization to renew and build out rail infrastructure. Time-to-market. The transport industry ties sea freight, air freight, trucking, and rail together to facilitate the movement of goods from point of origin to final destination. Across the transport sector, firms are responding to important trends by lowering costs and enhancing efficiency to remain competitive. 1 Boeing (2007) Current Market Outlook http://www.boeing.com/ 2 Logistics Today (September 2006) "How Much Does Port Congestion Costs? Bottlenecks add Costs That Can Scuttle Any Companies Sourcing Strategy" Vol. 47, Iss. 9; p.10 3 Kevin Kirkeby (December 27, 2007) Standard & Poor's Industry Surveys Transportation: Commercial 4 Note the standard measure of container size is 20 foot equivalent units or TEUs John Gallagher (March 12, 2007) Leveraging China" Traffic World p.1 5 Peter Tirschwell (March 10, 2008) "Why Trucks May Sink Trade" Journal of Commerce p.1 6 Kevin Kirkeby (December 27, 2007) 183 Shippers are increasingly focused on time-to-market to ensure the profitability of new and unique retail products. Consequently, firms are developing express services to meet this demand. "JB Hunt Transport Services is teaming with Matson Navigation Company to launch an expedited freight service...[that will] guarantee transit times and deliveries of container shipments."1 Tight deadlines are forcing firms to move to a combination of sea and air freight particularly in the face of transport bottlenecks. "As much as half the air freight from China to the US could be upgraded ocean freight that's flying to ensure schedule integrity."2 Industrial manufacturers are contracting with one or two large firms rather than several to obtain "faster service". 3 The influence of time-to-market on profitability, particularly in the retail sector, will continue to motivate transport firms to improve the speed of transport services. Efficiency. Firms are squeezing efficiency out of every aspect of door-to-door transport to manage the costs of the total supply chain. They are combining less than container load into single containers and shooting for "fantastic` capacity utilization of 99%." 4 They are "targeting efficiency improvements where land and water meet."5 At the Port of Los Angeles, trucks use "barcoded routing passes and optical character recognition cameras" 6 to quickly transit the terminal. In rail, companies are adopting lean management techniques to improve efficiency. Companies are assessing total distribution costs and looking for cost savings in transport and inventory-related expenditures. To remain competitive in the industry, firms consistently focus on driving down costs. Information technology integration. IT firms and logistics firms are integrating to improve efficiency and security. Firms are using innovative technology to consolidate, synchronize, and disperse loads quickly and respond to security concerns. The development of bar coding, radio frequency, sensor technology, as well as real time tracking, exemplify innovations now viewed as necessities due to efficiency and security needs. 7 With the successful deployment of these technologies, regulatory entities are adopting technological innovations as requirements. For example, radio frequency identification (RFID) truck tags are now standard requirements in Los Angeles and Long Beach. 8 Security certifications are also helping to facilitate business. 9 Effective 1 John Gallagher (March 12, 2007) "Leveraging China" Traffic World p.1 2 Logistics Today (September 2006) "How Much Does Port Congestion Costs? Bottlenecks add Costs That Can Scuttle Any Companies Sourcing Strategy" Vol. 47 Iss. 9; p.10 3 Katherine Yung (August 21, 2005) Chinese Trade Strains Port System" Knight Rider Tribune Business News 4 Jillian Hunter (July 2007) "Going Green on Land and Sea: What Is the European Industry Doing to Cope with Rising Transport Energy Costs and Demands for Sustainability? Transport Vol. 49, Iss. 7; p. 34 5 Katherine Yung (August 21, 2005) 6 Katherine Yung (August 21, 2005) 7 Larry Greenemeier (September 20, 2005) "IBM Launches Wireless Shipping Security" InformationWeek http://www.informationweek.com 8 Logistics Today (October 2007) "Los Angeles/Long Beach Require Truck Tags" http://www.logisticstoday.com 9 Certifications under the US Customs-Trade Partnership Against Terrorism (C-TPAT) and the EU`s more recent Authorized Economic Operator (AEO) are necessities for easily conducting business. Bernie Hart (January 2008) "Opportunities or Adversity for Global Supply Chains in 2008?" Logistics Today 184 technology adopters stand to gain from successful implementation of efficiency and security innovations. Firms are using relationships with technology companies to develop and deploy innovative solutions to meet efficiency and security demands. Outsourcing. Surveys of shippers found that they are inclined to outsource more of their logistics business to reliable firms. 1 Manufacturers continue to expand their use of external transport companies to reduce costs and capture new technologies. Transport firms are therefore working to provide a portfolio of IT enhanced transport services that tackle administrative and security issues. Competition for the outsource market is intense and studies have shown that contracts for such services are growing in length of time.2 Furthermore, factors in addition to cost influence the outsourcing relationship. Companies consider the level of trust, confidence, reliability, and consistent quality of service, when engaging a partner. 3 Rising fuel costs . The principal determinants of cost in the transportation industry are fuel, weather, labor, and equipment. 4 To respond to rising fuel costs shippers are examining alternative modes of transport. For example in Europe, rail is sought as a substitute for trucking. "Rotterdam's newly opened Betuwelijn rail line...[will] eventually double the height of trains to...allow optimal fuel efficiency."5 In the trucking industry, firms are working to achieve driving techniques that slow fuel consumption. Firms are also experimenting with different fuel mixtures, synthetic diesel, and biofuels to reduce emissions. 6 With the expectation of higher environmental standards, "some shipping companies have already announced voluntary conversion to cleaner fuel." 7 To conserve fuel and reduce emissions, carriers are "plugging into shore side electrical power...rather than burning diesel fuel while at berth."8 Industry alliances. Within the industry there is an increasing number of alliances and cross modal deals. Firms in the transportation industry are entering into cooperative arrangements to offer efficient and fast service. Maersk will "enter a trans-Pacific vessel sharing agreement... to cut costs and maintain or expand service while still competing on price and service."9 Schneider Logistics (Tianjin) "purchased a port consolidator and an air freight forwarder," 10 to control efficiencies and ensure delivery times. Firms are integrating across modes to adapt to the changing composition of trade. China is http://www.logisticstoday.com 1 Bill Dibenedetto (October 29, 2007) "Gaining Ground" Journal of Commerce p. 1 2 Yuko Aoyama, Samuel J. Ratick (April 2007) "Trust, Transactions, and Information Technologies in the US Logistics Industry" Economic Geography Vol. 83, Iss. 2. 3 Yuko Aoyama, Samuel J. Ratick (April 2007) 4 Kevin Kirkeby (December 27, 2007) Standard & Poor's Industry Surveys Transportation: Commercial 5 Joanne Hunter (July 2007) "Going Green on Land and Sea: What Is the European Industry Doing to Cope with Rising Transport Energy Costs and Demands for Sustainability? Transport Vol. 49, Iss. 7; p. 32 6 Joanne Hunter (July 2007) 7 South Florida Sun Sentinel (February 15, 2008) "US Seeks to Cut Pollution from Foreign Ships" p. a. 9. 8 World Trade (March 2006) "What Business Leaders Need to Know about Pacific Maritime: As Trade Volumes Hit New Highs, West Coast Ports add Capacity and Pay More Attention to the Environment" Vol. 19, Iss. 3; p. 40 9 Joseph Bonniy (March 10, 2008) "Follow the Leader" Journal of Commerce 10 John Gallagher (March 12, 2007) "Leveraging China" Traffic World p.1 185 producing more industrial equipment such as car and machine parts, ocean carriers and trucking companies are coming together to offer services to these "longer industrial supply chains."1 Intermodal conveyance is helping to carry industrial goods in a more seamless manner from point-to-point. Rules & Regulations. A complex set of rules govern international shipping including "legal, technical and economic regulations."2 Multilateral institutions set standards and address rights and obligations as well as regulations. Governments are taking steps to open the market in shipping and tightening environmental and security requirements. Bilateral agreements on maritime are on the rise with the intent of easing trade via provisions on port access, establishment, and national treatment. The conference system is also experiencing a shift to discussion agreements. The regulatory environment for carriers is changing. The principle governing body in international shipping is the United Nations and its subsidiary entity the International Maritime Organization (IMO). The UN Convention on the Law of the Sea (UNCLOS) is the seminal legal instrument that sets out rights and obligations of member states with regard to their vessels. The United Nations also established conventions on: liner conferences, carriage of goods by sea, maritime liens and mortgages, multimodal transport of goods, and conditions for registration of ships, which have various contracting states.3 The IMO`s 158 members have agreed numerous conventions and are responding to environmental and security concerns. The conventions address: load lines, oil pollution, civil liability, prevention of collisions, container safety, safety of life at sea (SOLAS), professional standards, safety management (ISM Code), double hulls, removal of wrecks Security concerns prompted the IMO to adopt the International Ship and Port Security Code (ISPS), which took effect in 2004. The IMO's Maritime Safety Committee (MSC) circulates guidance to members on security developments. IMO members are considering a convention on ship recycling due to environmental concerns. 1 Paul Page (March 12, 2007) "Reliable Service" Traffic World p.1 2 Bill Dibenedetto (October 29, 2007) "Gaining Ground" Journal of Commerce p.1 3 The status of these conventions can be found at http://www.UN.org/law/ 186 The World Customs Organization (WCO) has 144 members and helps to facilitate trade. Due to security concerns, the WCO adopted the Framework of Standards to Secure and Facilitate Global Trade in 2005. The Framework emphasizes customs-to-customs and customs-to-business coordination.1 In 2006, the International Labor Organization (ILO) adopted the Maritime Labor Convention in 2006 encompassing "65 international labor standards related to seafarers" from the past eight decades. 2 International maritime laws and conventions are extensive and have been divided into two groups by the OECD. OECD Index of Regulations: Regulations related to the rights and obligations of states and to safety and the protection of the environment: the Law of the Sea - rights and obligations of flags states; international safety and environment regulations; national environmental and safety regulations; flag state and port state inspections; international labor regulations. Regulations related to commercial operations and practices: shipping specific economic policy regulations; ship registration conditions; cargo reservation/cargo sharing provisions; cabotage laws; cargo liability regimes; national security measures; competition legislation. 3 In terms of the impact on industry, it is important to examine those regulations that are in flux and have a direct impact on cost, technological investment, and market access. National regulations At the national level, a number of governments are revisiting competition policy and foreign direct investment with regard to shipping, port services, and logistics. In Korea, 1 United Nations Conference on Trade and Development (2007) Review of Maritime Transport 2 United Nations Conference on Trade and Development (2007) 3 The OECD's review of regulatory issues in international maritime transport provides a comprehensive and detailed review of individual rules and regulations. The report can be found on the SourceOECD database. Organization of Economic Cooperation and Development (August, 2001) Regulatory Issues in International Maritime Transport 187 the government has granted parity for international carriers to move commodities nationally. The government has eased the licensing requirements for foreign branch establishments and allows "foreign ownership of Korean vessels." 1 To lower transportation costs "foreign flagged vessels are allowed to use Korean ports subject to the same conditions as Korean flagged vessels." To expand port infrastructure, the Korean government is welcoming foreign investment and offering build-operate-transfer concessions. They are also allowing private investment to expand container terminals. Singapore maintains a relatively open market with minimal restrictions on "foreign participation in the shipping industry" 2 including for port services. In the air freight sector, Japan privatized its postal services creating four new entities including Japan Post Service company. The company has entered into a joint venture "to provide international logistics services, focusing on China and the rest of Asia."3 Japan is also using bilateral agreements to provide market access for air freight carriers.4 Establishment opportunities in Japan allow transport firms to fortify their operations and extend services into the entire region. The European Union established regulatory priorities for the maritime industry for environmental protection, security, and strategic industrial issues. The EU is in the early process of establishing rules for the "reduction of CO2 emissions and pollution by shipping"5 and reducing exhaust from ships at port with tax incentives for "shore-side electricity." 6 From a security standpoint, the EU intends to strengthen surveillance systems to ensure "the safety of navigation, marine pollution, law enforcement, and overall security." The European Commission amended the Community Customs Code in 2006 with measures to ensure security.7 The EU intends to strengthen international regulations governing air and ballast discharges and will seek stronger "enforcement of international maritime law." The EU will promote shipping as an alternative to trucking, which is less energy efficient. To facilitate shipping the EU will simplify the "administrative and customs formalities for intra-EU maritime services." 8 The EU intends to bring scientists, industry, decision- makers together to consider measures to attain "competitive, safe and secure shipping, ports and related sectors." As one of China's largest trading partners, these policy priorities will bear on the operation and pollution controls of Chinese carriers. 1 World Trade Organization (2004) Trade Policy Review Republic of Korea Report by the Secretariat 2 World Trade Organization (2004) Trade Policy Review Singapore Report by the Secretariat 3 Journal of Commerce (February 27, 2008) "Japan Post to Set up International Logistics Firm" p.1 4 Logistics Today (October 2007) "Air Freight: UPS and Polar Two Expands Japanese Air Operations" http://www.logisticstoday.com 5 Commission of the European Communities (October 10, 2007) Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions: an Integrated Maritime Policy for the European Union 6 Commission of the European Communities (October 10, 2007) 7 United Nations Conference on Trade and Development (2007) 8 Commission of the European Communities (October 10, 2007) 188 The United States has set priorities for stronger environmental and security policies. Congressional representatives are investigating the pollution created from ships at port in the United States. They are considering legislation in advance of the proposed agreement under consideration in the UN International Maritime Organization to reduce pollution from shipping.1 The US imposed security regulations that, for example, require advance submission of documentation 24 hours before cargo is laden on board a vessel in a foreign port bound for the US or before cargo is laden on a vessel in a US port."2 At the international level, the conference system for carriers is changing. There is a shift away from conferences to "consortia, strategic alliances, capacity accords and discussion agreements." 3 These cooperative mechanisms are designed to provide stability in the industry with agreements on freight rates, allocated sailings, and door-to-door services for example. The UN Convention on a Code of Conduct for Liner Conferences ("UN Liner Code") sets out standards and obligations. As restrictions on competition, such agreements are coming under increased scrutiny. A number of governments are considering the impact of national antitrust immunity exemptions on the larger economy. The European Commission, US Department of Justice, and South Korean competition authority are reevaluating liner arrangements. 4 Revisions to EU regulations, for example, are expected to allow for information sharing and prohibit price-fixing and collusion.5 The practical effect of such changes will be more intense competition in the industry and potentially lower profit margins. Cabotage: coastal shipping Cabotage restrictions remain firmly in place in many countries. A few countries have taken steps to ease restrictions. For example, New Zealand lifts cabotage requirements in instances where "specialist" ships are required. The European Commission's Regulation 3577/92 eased rules for intra-EU trade. The Jones Act remains securely intact in the United States. Such restrictions according to the OECD raise costs for domestic shippers. 6 Recommendations for China 1 South Florida Sun Sentinel (February 15, 2008) "US Seeks to Cut Pollution from Foreign Ships" p. a. 9 2 Purchasing (October 9, 2003) "Ocean Shipping Industry Weather Is a Sea Change" Vol. 132, Iss. 5; p. 49 3 The OECD's review of regulatory issues in international maritime transport provides a comprehensive and detailed review of individual rules and regulations. The report can be found on the SourceOECD database. Organization of Economic Cooperation and Development (August, 2001) Regulatory Issues in International Maritime Transport 4 Perry Trunick (May 2006) Maritime's Antitrust Immunity Is Coming to an End" Logistics Today Vol. 47, Iss. 5; p.1 5 Peter Leach, (September 10, 2007) "End of the Line" Journal of Commerce p. 1 6 The OECD's review of regulatory issues in international maritime transport provides a comprehensive and detailed review of individual rules and regulations. The report can be found on the SourceOECD database. Organization of Economic Cooperation and Development (August, 2001) Regulatory Issues in International Maritime Transport 189 Many trends in the transport industry originate from the emergence of China as a leading exporter and importer. Moving goods in and out of China has reshaped shipping routes and is gradually bringing the global industry into the mainland. "The Chinese logistics market generated revenue of $7.38 trillion in 2006" and is expected to grow to $28.78 trillion by 2013." 1 China can improve the domestic and international regulatory environment and firms can concentrate on technological innovation and strategic alliances to compete in the global transport market. A complex set of rules govern international shipping including "legal, technical and economic regulations." 2 Multilateral institutions set standards and address rights and obligations as well as regulations. Governments are taking steps to open the market in shipping and tightening environmental and security requirements. Bilateral agreements on maritime are on the rise with the intent of easing trade via provisions on port access, establishment, and national treatment. The conference system is also experiencing a shift to discussion agreements. Chinese engagement multilaterally and bilaterally can help reduce obstacles for Chinese firms. China can expand its significant engagement in the International Maritime Organization, World Customs Organization, and the International Labor Organization. From an industry standpoint, increasing international and national concerns about the environment and security will have an impact on how carriers operate at home and abroad. More stringent rules will influence industry investment decisions, routes, and day-to-day operations. As a prominent participant in the transport industry, China's experience grappling with pollution, safety, and life at sea is important in shaping the global regulatory environment for the transport industry. China can foster technological innovation in the transport industry. Technological innovation can help Chinese firms grapple with rising energy costs, infrastructure constraints, and environmentally damaging levels of pollution from air, ground, and sea transport. Firms that are able to reduce energy consumption, improve carrying capacity and inter-modal transfers, and reduce pollution will be better positioned to compete globally. China can focus on technological innovation to enable firms to effectively operate in a global regulatory environment that at the international and national level will implement more stringent environmental and security regulations on carriers. In China regional regulatory differences, infrastructure shortcomings, and bottlenecks contribute to comparatively high domestic logistics costs. 3 Different rules and regulations at the regional and local levels are a primary challenge. "Complex licensing processes...[and] unnecessary unloading and uploading cause delays and add to excessive costs"4 Underdeveloped financial services, particularly in the bonding market 1 Business Wire (December 6, 2007) "Increasing Government Support for Transportation Infrastructure Aid the Growth Of the Logistics Industry in China 2 Bill Dibenedetto (October 29, 2007) "Gaining Ground" Journal of Commerce p.1 3 Peter Tirschwell (June 11, 2007) "China's New Mantra: Rail Journal of Commerce p.1 4 Business Wire (December 6, 2007) 190 also constrain transport firms. These matters influence the overall cost of conducting international business, delivery times, and quality of service. To improve the position of Chinese firms in the global transport market, China can improve and harmonize transport rules and regulations and their administration at home at the provincial and city level. The Chinese government does intend to "streamline administration" in transport with consolidation of responsibilities in super ministries. 1 China can foster cooperation among city and provincial administrators with information sharing, exchange of technical experts, and electronic government. With mobile and broadband technology, transport officials at each level of government can gather virtually to share their regulatory experiences with the transport industry. They can cooperatively establish procedural transparency and make available online rules and regulations to facilitate industry`s understanding of administrative and licensing procedures and implementation. They can explain how they have worked to address environmental and security concerns. Regulatory officials can describe practical approaches that improve administrative efficiency in trucking, rail, and maritime trade. China can also promote this degree of cooperation at the multilateral level. In summary, policymakers can be attuned to and engage in multilateral and bilateral discussions on: changes in national competition policies and foreign direct investment in shipping, port services, and logistics increasing international and national environmental standards and security requirements for air, ground, and ocean carriers domestically, the government can foster regulatory cooperation across provinces with electronic government to ease costs for Chinese firms operating globally Firms can: anticipate more stringent rules on air, ground, and water pollution develop and deploy technology to lower emissions and improve energy efficiency of carriers in operation as a competitive strategy use relationships with technology companies to consolidate, synchronize, and disperse loads quickly to meet efficiency demands use industry alliances to build efficient and fast service across modes from point of origin to point of destination recognize that firms outsourcing transport and logistics services consider, in addition to cost, the level of trust, confidence, and consistent quality of service when engaging a partner 1 Financial Times (March 4, 2008) "China to Merge Ministries in Government Revamp" http://www.ft.com 191 Animation Animation is a global industry with participants around the world engaging in a variety of production components and market segments. Many countries have a vibrant animation sector creating original content and operating in a growing and intensely competitive market. The emergence of a multitude of media platforms creates growing demand for animation. Labor costs and technology also influence the structure and the development of the animation industry. Intellectual property protection is an important determinant of profitability for animation houses and venture capital influences their growth. Firms in the animation industry use a variety of methods to sustain profits and compete in a dynamic global market. Animation is an important part of the audiovisual, broadcasting, advertising, and multimedia sectors. In 2006, four of the top 10 grossing movies of the year worldwide were animated and special effects were used in all of the other six.1 In broadcasting, animators experience increasing demand from television, cable, and broadband channels dedicated to children and animation, for example, "Nickelodeon (1.33 million subscribers), Cartoon Network (5.2 million subscribers)," 2 as well as the website Aniboom. 3 Commercial advertisements, educational programs, and medical videos provide a steady stream of revenue and creative projects for many animators. Web content, the gaming industry, and mobile phones are also expanding markets for animators. In 2008, the size of the global animation market was estimated at $100 billion.4 Examining trade in audiovisual services provides insight into trade in animation related to motion pictures and television programs. In 2005, the United States was the number one exporter of audiovisual services at $10,379 million. The European Union (25) was second at $9,223 million, Canada exported $1,896 million, followed by Mexico, Hong Kong, Norway, Argentina, China, and the Republic of Korea. The principal importers were the European Union (25), followed by Canada, the US, Japan, Australia, the Russian Federation, Norway, Brazil, and Mexico. Over 60% of US exports go to the European Union (25), 9% to Japan, 7% to Canada, 3.8% to Australia, and 2.4% to Mexico followed by Brazil at 2.3%. Over 50% of EU exports go to other EU countries, 20% go to the United States, 6.7% to Switzerland, 6% to Japan, .9% to Brazil. 1 Tuna Amobi, William Donald (September 20, 2007) "Industry Surveys Movies & Home Entertainment" Standard & Poor's 2 Television Asia (December 2006) Anime Expands its Horizons Vol. 13, Iss. 10; p. 86 3 http://www.aniboom.com/ 4 Kathleen Kingsbury (February 11, 2008) "Fantasy League" Time Vol. 171, Iss. 6; p. 1. 192 Figure 15.9 Destination of 05` US Exports of Audiovisual & Related Services (million dollars) Others, 527 Brazil, 239 Mexico, 244 Australia, 397 Canada, 726 Japan, 938 European Union (25), 6630 Source: WTO (2007)1 Animation around the world Animation houses are well established in China. "Chinese animated films have been winning international awards since the 1950s." 2 According to Animation Magazine, China hosts 5,473 animation studios, produced 1,400 hours of animation, with industry revenues of $336 million, in 2006. 3 The 2005 release of "Thru The Mobius Strip" a three-dimensional (3-D) animated feature film produced at the Institute of Digital Media Technology in Shenzhen demonstrates the growing production and business acumen of Chinese animation houses. The film uses a storyline originating from France, was underwritten by Hong Kong investors, and was created for domestic and international distribution with merchandising and downloadable offerings.4 Animation houses thrive in: Japan, Korea, the Philippines, India, Thailand, Hong Kong SAR, Singapore, Malaysia, and Australia and New Zealand. These countries have successful animation houses and audiences with unique tastes. For example, Japanese animation offers a unique genre of "anime," originating from "manga" (comic books), which has grown in global popularity through "cartoon, film, TV, video, video games and digital formats." 5 In 2006, Japan hosted 630 animation houses and had a market size of $2 billion. The Japanese animation industry produces original content and consistently engages in co-production arrangements with other firms from the region and in the West. 1 World Trade Organization (2007) 2 Mary Farquhar (May 2002) "Animation in Asia and the Pacific" The Journal of Asian Studies Vol. 61, No. 2; p. 678 3 Claire Webb, (April 2007) "The Asian Connection: Facts & Figures" Animation Magazine Vol. 21, No. 4; p. 20 4 Bizchina China Daily (May 4, 2006) "HK Could Boost Mainland in the Nation Industry" see http://www.chinadaily.com.cn 5 Mary Farquhar (May 2002) 193 The Korean industry is also well developed. In 2006, Korea hosted 300 animation houses with exports of $76 million.1 Korea has a reputation for "meticulous cartoon-drawing skill based on storyboards provided by European and American studios," 2 Korean animation houses create proprietary content. For example, Korean firms Ocon and Iconix co-produced the cartoon series "Pororo the Little Penguin" for worldwide broadcast and online distribution. 3 The Japanese and Korean industries are noteworthy due to their ability to create original, commercially valuable animation productions. Firms in each country also use co-production arrangements to effectively produce, distribute, market, and merchandise their animation fare globally. Animation houses in India, the Philippines, and Thailand originated primarily as outsourcing bases and are now moving into the creation of original content to capture higher value-added returns. In 2006, revenues totaled $354 million for the Indian animation industry, 4 and entrepreneurs are rapidly creating original productions. The Philippines had over 20 animation studios in 2006,5 and was one of the original locations for cartoon outsourcing in the region. The Philippine government is investing in the animation industry and supporting technical schools as well as international animation festivals to recapture the market lost to lower-cost producers. Thailand's Monk Studio produced "Kankluai" a 3-D animated feature recognized at international film festivals in Toronto and Madrid. 6 In 2007, Thailand's animation industry was estimated at $380 million. European animation houses are well established and produce a significant share of animated films. In 2005, Europe produced 32 animated films, the US produced 34, and 18 were from other countries.7 From the perspective of the European DVD animation market, France is the leader with the greatest share at 19.4%, followed by Germany at 11.7%, Italy at 14%, Spain at 8.5%, and the UK at 6.9% in 2007. 8 Firms in these countries maintain an international perspective in investment and production. For example, the "Galician Audiovisual Consortium [based in Spain] is looking toward second-phase expansion: deepening international R&D, honing an exportable product, [and] diversification."9 Animation houses around the world are part of an increasingly integrated global market. 1 Sarah Gurman (April 2006) "By the Numbers" Animation Magazine Vol. 20, No. 4. http://www.animationmagazine.net 2 Yonhap (January 4, 2006) "South Korea to Inject Huge Funds into Animation Industry" http://www.yonhapnews.net/engservices 3 Hollywood Reporter (January 14, 2007) "Drawing Attention: Seven Companies Leading the Way in International Animation" Vol. 397, Iss. 43; p. 20 4 Ritesh Gupta (October 1, 2007) "India Rising" Asia Image http://www.onscreenasia.com/article-927- indiarising-onscreenasia.html 5 Claire Webb (April 2007) 6 Harry Maurer, Cristina Linblad (November 26, 2007) "Animation Nation" Business Week Iss. 4060; p. 10 7 Screen Digest (July 2006) "Banner Year for European Animation: a Huge Chunk Out Of the Hitherto Hollywood Dominated Market" Vol. 234 http://www.screendigest.com/ 8 Screen Digest (February 2007) "Animation Migrates from VHS to DVD: Slow Transition from Analog to Digital Holds Lessons for Hi-def." Vol. 39 http://www.screendigest.com/ 9 Variety (September 25, 2006) "Media Locals Think Global" Vol. 404, Iss. 6; p.23 194 Global industry The global industry is largely networked through commercial arrangements across the industry's value chain. A critical aspect of the industry is the life cycle of an animated production. The return on investment for the initial components of the lifecycle, for example, from planning to post-production to theater, generally amounts to a breakeven point.1 Profitability for animation productions is dependent on the latter stages of the life cycle involving, for example, DVD sales, licensing, and syndication returns. Therefore profitable animation houses effectively manage their intellectual property. Firms work together using a variety of commercial agreements to designate production and distribution responsibilities as well as ownership of intellectual property rights. Table 15.6 Sample Industry Value Chain Planning Pre- Production Post- Distribution Platforms production productio n Initiation of feature Artwork Clay modeling Color Film festivals (Market Broadban film, cartoon, correction for animation d commercial, special productions) effects production Financing: maybe Character Computer Generated Editing Franchising (cereal Broadcast sole or cooperative development Imagery (CGI): boxes, clothes, financing from a software includes coloring books, toys,, variety of sources maya, after effects, etc.) soft image, side effects, flash, lightwave, toonboom Partnerships: Color Drawing or cel Musical IPR intermediaries DVDs agreements across the selection animation score value chain Scripting Motion capture Sound Licensing (syndication Film technology design of broadcasts) Storyboardin Machinima Marketing (activities Gaming g (originating from the to create public devices gaming community) awareness of the forthcoming production) Voice Online animation tools Wireless recording (Aniboom) platforms Source: Interview2 The commercial leaders in the global industry are media conglomerates such as Disney Company, News Corp., Sony Corp, and Viacom. These conglomerates invest in a broad scope of industry segments, for example, animation software producers, independent proprietary production houses, animation outsource service providers, as well as ancillary media firms that provide distribution, marketing, merchandising, and licensing expertise. Conglomerates have also moved quickly into new media. The table below illustrates these investments. 1 Animator. Los Angeles-based production company. Interview. March 3, 2008 2 Animator. Los Angeles-based production company. Interview. March 3, 2008 195 Table 15.7 Sample Internet Interests of Conglomerates Disney News Corp. Sony Corp. Viacom ClubPenguin.com MySpace I Beam i Film Broadcasting Jetix.tv IGN.com Gametrailers.com Video.com Indya.com Nickelodeon online Source: Standard & Poor`s (2007)1 At the heart of industry are production houses, for example, Aardman Animation, DreamWorks Animation, Pixar, Lucasfilm, Sony Pictures Digital, and Wild Brain, which operate as independent firms or subsidiaries to media conglomerates. Production houses create feature films, cartoons, commercials, instructional videos, special effects, and downloadable content for diverse communication platforms. These production houses are noteworthy for their creative talent and proprietary software that generates unique productions. Animated feature films identified in the table below experienced commercial success globally. Table 15.8 Sample Animated Feature Filmsure Films Pixar Aardman Animation Sony Pictures Digital Cars Wallace and Gromit Stuart Little Finding Nemo Chicken Run Surf's Up Toy Story Creature Comforts The Water Horse Sources: http://www.pixar.com, http://www.aardman.com, http://www.sonypictures.com Industry trends The animation industry is increasingly competitive with more players in the market. Labor costs are decreasing, technological innovation continues to move forward at a rapid pace, and creativity remains a pivotal production factor for animation houses. Animation houses develop animation products with merchandising, franchising, and cross-platform distribution in mind. Firms are using a variety of strategies to compete, for example, targeting market segments, concentrating on quality and turnaround time, expanding into new distribution platforms, and seeking out new audiences abroad. Co- production agreements continue to be an important means of entering new markets and reaching new audiences. These strategies in conjunction with contemporary marketing methods remain viable in today's global market. Competition. Animation is an intensely competitive industry with low entry barriers due to a profusion of animation technologies including off-the-shelf software and programs hosted online. Low-cost labor supplies are expanding in emerging markets and reducing production costs as well as outsourcing margins. Government subsidies in Canada, Europe, the Philippines, the Republic of Korea, Malaysia, and Japan, increase the number of animation houses operating in the global market. The threat of substitute products is high, as an entertainment product, consumers can choose many other substitutes such as 1 Tuna Amobi, William Donald (September 20, 2007) Standard & Poor's Industry Surveys Movies & Home Entertainment 196 sports, the performing arts, or consumer created entertainment posted on "YouTube". New communication mediums are giving rise to new animation markets. Web-based industries and mobile mediums offer new revenue streams in addition to traditional motion picture, broadcast, and advertising purchasers. "The problem is the pie is getting bigger, but the slices are getting smaller."1 Intense competition motivates firms to master those aspects of the industry that influence success. Labor costs, technology, and creativity are some of the main drivers in terms of cost, structure, and profitability in the industry. Labor. Animation is traditionally labor intensive. This element of the art propelled many production companies to outsource labor intensive components of the production process to low-cost labor markets. "More than 90% of animation for American films and television shows is processed in Asia, mainly in Japan and South Korea."2 The firm IDT Entertainment, for example, undertakes scripting and storyboarding in Los Angeles and outsources "the laborious frame by frame execution of the animation itself."3 Another firm handles the early creative work such as character development and story line and uses animators in China, India, and South Korea to animate cartoons. Establishment abroad. Animation houses are opening offices abroad to take advantage of lower-cost production and flowering talent. For example, Lucasfilm established a production studio in Singapore.4 With the growth of the Internet and emerging pools of animation talent, firms are networking the production process with multiple houses in multiple countries. "There is a growing pool of high-quality animators around the world," 5 this combined with government incentives is reducing production costs and outsourcing margins. The digital nature of much of the art allows a fluid process of production that flows across many continents. Technological innovation. Production technology has a substantial influence on the industry in terms of cost, entertainment value, and visual acuity. A range of methods are used to create animation from traditional drawing and cel animation to computer- generated imagery (CGI) and motion capture technology. Off the shelf software packages lower costs and help to level the playing field by reducing initial capital investment. At the same time, successful animation houses do use laborious clay animation and stop motion puppetry with interesting storylines to great effect. There is a continuous drive for technological innovation in the industry to create new animation spectacles. For example, Pixar developed proprietary software evolving with each film in conjunction with an exceptional creative team to resounding success. 6 As another example, Digital Dream Studios has a "state-of-the-art pipeline for 3-D animation 1 Chris Grove (November 2005) "Bigger Pie, Smaller Slices" Animation Magazine Vol. 19, Iss. 11; p.34 2 Kathleen Kingsbury (February 11, 2008) "Fantasy League" Time Vol. 171, Iss. 6; p. 1. 3 Alan Deutschman, (December, 2005) "Attack of the Baby Pixar's" Fast Company No. 101 60-5 4 Kathleen Kingsbury (February 11, 2008) 5 Alan Deutschman (December 2005) 6 Standard & Poor's (February, 2008) Company Profile of The Walt Disney Company 197 production" using computer graphic imagery (CGI) and continuously develops proprietary animation software. 1 Animation houses use innovation in technology, combinations of animation methods, in conjunction with exceptional talent to attract audiences. Creativity. Creativity in character and content remains a central aspect of animated entertainment, "Strong stories and enduring characters are what make hits." 2 Sony Pictures ImageWorks identified "character animation as an essential component" of their business according to their spokesperson. 3 Originality in character, storyline, and animation techniques helps firms secure market share. Production studios are commissioning original music scores and mixing animation methods to create original productions that appeal to audiences.4 Animation houses that formerly relied on service work are changing their strategies and concentrating on developing proprietary characters, shows, and brands. Animation houses concentrate on creativity as a strategy to compete. Original content. Animation houses face the challenge of creating and maintaining value in an art that is becoming increasingly commoditized. Many emerging market firms are turning away from a narrow business model focused on outsourcing to a model that produces original content. With lower profit margins, animation houses work to maintain control of their intellectual property rather than sharing exploitation rights with broadcasters or investors. "You build the business by having rights, and not just for primary, but for secondary and tertiary exploitation - the selling cycle can go on for a long time." 5 Merchandising and licensing, for example, extends the profitability of the original content. Animation houses consider how proprietary products can be licensed for toys, games, clothes and additional entertainment vehicles, for example, live theater productions. Business value of intellectual property protection. Animation houses operating in markets with intellectual property protection are able to create and sustain value from their work. With intellectual property protection firms are able to secure long-term income from their original productions as well as derivative products. "Licensing does not simply generate income in a narrow sense in terms of royalties, but in most cases increases the value of the IPR," 6 and subsidiary products. In addition, animation production companies establishing abroad look for markets with an effective intellectual property regime. Lucasfilm Animation "chose to operate in Singapore because of the country's strict copyright laws and advanced legal system."7 IPR protection is important to initial and long-term profitability of animation houses. 1 Business Korea (February 2001) "Box Report" Vol. 18, No. 2; p. 42. 2 Animation Magazine (February 2008) "Trend Spotting with Toon Execs" Vol. 22, No 2; p. 37 3 Animation Magazine (January 2007) "Company Town" Vol. 21, No. 1; p. 62-72 4 Claire Webb (January 2007) "Ain't Nothing like a Hound Dog!" Animation Magazine Vol. 21, No. 1 ; p. 42 5 Mark Solomons (May 1, 2001) "British Animation" Financial Times p. 8 6 Managing Intellectual Property (December 2002) "Rich Licensor, Poor Licensor" S 83 7 Kathleen Kingsbury (February 11, 2008) 198 Evolving income streams. Animation houses are paying close attention to evolving revenue streams. For example, firms "license content to Internet sites [and] provide content on a pay for download basis" via handheld devices.1 This is a burgeoning market attracting a comprehensive distribution approach. "A key licensing trend...is that properties are increasingly developed with more than one media sector in mind (licensing, animation, online, mobile, etc.)" 2 Creating content across several disciplines such as feature films, TV animation, and video games is "the new world order in entertainment."3 Sample animation revenue streams: character licensing children's books DVD sales educational products live theater production medical illustrations merchandise licensing for games, toys, clothes, etc. mobile character downloads, wallpaper, clips, ring tones, interactive games print comics television cartoons Co-production agreements. Animation houses use co-production arrangements to reach export markets and expand into different market segments. For example, "Toei Animation, Japan's oldest and largest animation house...signed a co-production agreement with Walt Disney Television International" for an anime television series. 4 DreamWorks Animation Inc. a leader in computer-generated images (CGI) animation is collaborating with Activision a video games publisher. 5 The Philippine Animation Studio Inc. (Pasi) assigns co-production deals to the creative director who intentionally includes senior artists at the outset of discussions to strengthen in-house capabilities and absorb the most benefit from the international arrangement.6 Co-production agreements are an important vehicle for exposing animation firms to different aspects of the market. Attention to consumer segments. To remain competitive some animation houses focus on consumer segments. For example, the main character of the cartoon "Atomic Betty" appeals to girls 6-11 while keeping the attention of boys with two "strong boy sidekicks". The story line also balances themes interesting to girls with those interesting to boys.7 As another example, animators will appeal to a local taste for humor and story line "jokes 1 Tuna Amobi, William Donald (September 20, 2007) Standard & Poor's Industry Surveys Movies & Home Entertainment 2 Karen Raugust (April 2006) "Crossing Borders" Animation Magazine Vol. 20, No. 4; p. 40 3 Kathleen Kingsbury (February 11, 2008) 4 Television Asia (December 2006) "Anime Expands Its Horizons" Vol. 13, Iss. 10; p. 86 5 Standard & Poor's (February, 2008) Company Profile of DreamWorks Animation Inc. 6 Christopher Harz (April 2002) "Playing with Pasi: a Studio with Heart" Animation Magazine Vol. 16, No. 4; p. 34 7 Chris Grove (November 2005) 199 that are funny in Canada may be met by a bemused smile in Hydrabad." 1 Therefore deft knowledge of a local market's entertainment tastes and preferences can give a firm a competitive advantage. Firms also concentrate on quality and turnaround time particularly for those market segments, such as TV animation, which adhere to tight schedules.2 Animation houses may cater to animation buyers, for example, pharmaceutical manufacturers using animation to advertise their products. Animation houses offer content to education companies. Heewon Entertainment, a Korean firm, created "Element Hunter" the "show's characters are on a mission to find elements in the periodic table and put them together into compounds."3 Animators may concentrate on special effects for motion picture production or wallpaper and character downloads for mobile phones. Concentrating on a market niche is one way of staying ahead in a fiercely competitive market. Regional styles. To attract global audiences, animation houses are using successful animation approaches from different regions of the world. "DreamWorks Animation's 'Kung Fu Panda' embraces many Asian anime techniques, including held poses in action sequences - instead of moving slowly, characters seem to freeze when punching or kicking."4 "Kappa Mikey is the kind of show that supports our mandate to deliver our global audience the best compelling entertainment available."5 The Chairman of Foothill Entertainment asserts "we are finding good stories from a lot of different countries -- things have become very multicultural." 6 Animation houses working to appeal to a global audience incorporate popular styles from around the world. Lessons from successful animation exporters China has an emerging animation industry that is attentive to the primary aspects of the market. For example, Chinese animation houses serve as low-cost leaders in animation outsourcing. They compete with houses in the Philippines, India, and South Korea for the outsource market. To attain a competitive edge in this intensely competitive outsourcing market, Chinese animation houses can work to meet high standards of quality, execution and timely delivery. They can avoid inconsistency in product and missed deadlines. They can attain proficiency in a variety of animation techniques and adapt to new technologies. Chinese animation houses can build a reputation as adept, cost-efficient outsourcing houses. Chinese animation houses also engage extensively in international co-production arrangements "and are producing original programming for the international 1 Chris Grove (November 2005) 2 Kate Calder (January 2008) "Canadian Animation Studios Face Off Against Dollar Parity" KidScreen p. 8 3 Jocelyn Christie (October 2007) "KOCCA's 2007 Stars Shining Bright" KidScreen p. 48. 4 Jeremy Smith (May 29-June 4, 2006) "Anime Gives Kick in the Art" Variety Vol. 403, No. 2; p. A10 5 Ramin Zahed (April 2006) "A Sushi Out Of Water" Animation Magazine Vol. 20, No. 4; p. 37 6 Animation Magazine (February 2008) "Trend Spotting with Toon Execs" Vol. 22, No 2; p. 37 200 marketplace."1 The government allows private investment in the animation sector and established 3 cartoon channels and 30 kids channels. 2 Ensuring the benefits of an effective intellectual property regime for creative and knowledge industries remains the Achilles heel in the domestic market. Piracy rates in the DVD market are estimated at 95%.3 Such piracy rates in the domestic market inhibit the profitability of animation firms. Recognition of the value of IPR to the growth and development of creative and other knowledge-based industries in conjunction with public education may help lower piracy rates. The Japanese market offers Chinese firms an example of current labor issues in the animation industry. In Japan, the animation industry lost many animators to the gaming industry. Animators found more attractive salaries, rapid advancement, and better apprenticeship opportunities in the gaming industry. 4 As a result, Japanese animation houses are now paying greater attention to the professional development of their labor force. They are exposing staff to a variety of animation techniques, giving them experience in pre-production activities, and ensuring a quality apprenticeship where new skills are learned and mastered.5 Animation leaders offer Chinese firms examples of how to foster creativity. Firms promote creativity by allowing animators to work on a variety of projects. Aardman Animations based in the UK encourages animators to work on TV programming, commercial production, and web and mobile film, "commercials feed the fire of talent, and we encourage people to cross over between the divisions to keep things fresh" 6 The firm also encourages experimentation in all animation forms of "traditional clay, CGI, and 2-D and 3-D media." 7 "Good writers, directors, and producers need time and access to good projects to develop their skills," as well as opportunities to collaborate with a talented pool of animators.8 In some markets training programs in animation separate instruction in technical skills from instruction in creative skills resulting in competent rather than creative animators. Animators can develop creativity by exposure to different media and projects, collaborating with others skilled professionals, and unified education programs. The US market offers Chinese firms insight into management priorities. The commercial success of animation houses is in part attributable to the management of the enterprise. The leadership must in some instances secure financing, seek out partnership agreements, determine appropriate derivative products and develop revenue streams. From an 1 Harvey Deneroff (November 2000) "East Asian Service Studios Hard-Hit by Downturn in US Production Due to Anime" Animation Magazine Vol. 14, No. 10; p. 18 2 Television Asia (October 22, 2006) "Numbers Talk" Vol. 13, Iss. 8; p. 22 3 In-Store (April 12, 2007) "International News: Pirates Profit in China DVD Boom" Vol. 15 4 Japan Ministry of Economy, Trade and Industry (2005) "Japan Animation Industry Trends Japan Economic Monthly 5 Leo Lewis (March 1, 2007) "Companies International: Japanese Animation Produces Kamikaze Cartoonists" Financial Times 6 Emma Hall (August 27, 2007) "A British Empire of Animation" Advertising Age Vol. 78, Iss. 34; p. 9 7 Emma Hall (August 27, 2007) 8 Asia Image (November 22, 2004) "A Work in Progress" Vol. 9, Iss. 10; p. 22 201 aesthetic perspective, management must foster a creative environment. Management must also ensure continuing investment in technology, as proprietary software represents a pivotal factor in the success of animation productions. Closing the "management gap" with increased educational opportunities and internships with corporate partners is a high priority. Leaders of animation houses watch the industry's horizon. The leadership in the industry tenaciously pursues opportunities with new communication platforms. Management also attends to the scope of its audience. From a very early stage, animation houses in the US maintained a global perspective on animation audience with regard to content and distribution. Thirty-five of the top 50 movies in 2006 derived 50% or more of their worldwide grosses from overseas attendance." 1 Animation industry leaders also determine how to manage each aspect of the business, particularly marketing and intellectual property rights, which bear on the success of the animation production. The major media conglomerates offer Chinese firms examples of contemporary marketing methods. Disney is known for permeating retail and leisure outlets with animated character toys, clothes, and games just before the release of a major production. Entrepreneurial houses are using the Internet and specifically community groups to get the word out about their productions. Awards ceremonies also offer an opportunity to introduce audiences to exceptional productions. Animation houses in China can absorb marketing techniques through their commercial agreements with leaders in the marketing field. Global leaders in the industry offer Chinese firms strategies to compete globally. In the early phases of production, management contemplates financing vehicles, partnership arrangements, as well as marketing strategies. They do consider the variety of communication platforms and how to best leverage those for marketing, distribution, as well as licensing. From a creative standpoint, leaders in the industry foster creativity and technical skill by exposing animators to different technical tools and animation productions. They keep in mind a global audience and rising popularity of regional styles. They also consider the evolving preferences of distinct consumer markets for cartoons, commercials, special effects, and feature films for example. Global leaders have responded to competition with technological innovation and penetration into the new mediums. Firms have taken opportunities to lower their labor costs but at the same time recognized the need to properly reward and retain creative and skilled animators. Leaders in the market also aggressively protect their intellectual property and make use of merchandising and licensing to increase and extend IPR value. Leaders in the industry pay close attention to evolving revenue streams from new media. They exercise a number of strategies to collaborate with different players in the market across the production chain. 1 Tuna Amobi, William Donald (September 20, 2007) Standard & Poor's Industry Surveys Movies & Home Entertainment 202 The global animation industry is on the cusp of convergence of "content, technology and services." The premier firm in the industry Walt Disney Co. which owns Pixar has identified a corporate strategy to compete in the rapidly changing market. Walt Disney Co.'s "top strategic priorities include creativity and innovation, international expansion, and leveraging new technology applications...management [is] aggressively exploring new avenues to offer its branded contents, characters and entertainment franchises across emerging digital platforms such as a broadband and wireless, while making further investments in other areas such as video games." 1 Chinese firms can expand their position in the market with improved management practices, increased creativity, greater technological innovation, attention to professional development, and a strengthened intellectual property protection regime. 1 Standard & Poor's (February, 2008) Company Profile of The Walt Disney Co. 203 Refereces Alan Deutschman, (December, 2005) "Attack of the Baby Pixar's" Fast Company No. 101 60-5 Animation Magazine (February 2008) "Trend Spotting with Toon Execs" Vol. 22, No 2; p. 37 Animation Magazine (January 2007) "Company Town" Vol. 21, No. 1; p. 62-72 Animator. 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