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USJI Voice Vol.12

International production/distribution networks and mega FTAs

2016.03.23
Dr. Mitsuyo Ando
Keio University

The international division of labor has changed dramatically over the last few decades. In general, international production/distribution networks are formed within a region since various factors must be considered, particularly for trade in parts and components (P&Cs), such as the timing of procurement, coordination of production processes, lowering of service-link (SL) costs to connect remote production blocks (PBs), and connectivity of ICT and logistics. SL costs include transport costs, telecommunication costs, and coordination costs arising from the geographical separation of production processes, while tariffs and non-tariff measures (NTMs), for instance, are added when PBs are located in different countries. Moreover, when production networks are extended beyond the region, not only physical costs but also time costs and difficulties in coordinating PBs and procuring P&Cs at the necessary timing rise, making high-quality logistics links indispensable.

Recently, however, active trade in P&Cs is occurring even beyond the region. In particular, the supply of P&Cs from East Asia has played an important role for production in North America and Europe. Both regions are still important as consumers for production networks in East Asia, but are also stepping up production links with East Asia.

One of the major players in production networks in East Asia is the machinery sector. In recent years, there has been a pattern of restructuring or change in the extent and depth of production networks within the region. The intra-regional share of machinery P&Cs trade remains around 60 percent, while intra-regional trade is expanding. However, an examination of intra-regional trade in terms of extensive margins (the number of exported/imported product–country pairs by destination/origin at the HS 6 digit level) reveals a change in the composition of trading pairs within the region or a reshuffling of regional production networking in East Asia. More specifically, regional production networking is being reorganized within countries that have already joined the networks. At the same time, the East Asian emerging economies or CLMV (Cambodia, Laos, Myanmar, and Vietnam), and particularly Vietnam, are rapidly becoming involved through newly formed trade relationships with other East Asian countries.

The trade relationship between the U.S. and East Asia has long been strong; for instance, East Asia already accounted for about half of U.S. machinery imports (around 60 percent for electric machinery goods and 70 percent for electric machinery final products only) in the early 1990s. Interestingly, while keeping this direct connection, the U.S. is starting to strengthen production links with East Asia through Mexico as a bridge.

Production sharing in the U.S.-Mexico nexus has developed mainly through intra-firm transactions between parent firms in the U.S. and their affiliates in Mexico. The major destination of Mexico’s machinery exports continues to be the U.S.: among Mexico’s machinery exports to the world, the U.S. accounts for almost 90 percent for machinery P&Cs and around 80 percent for machinery final products. On the other hand, the value of Mexico’s machinery imports from East Asia increased 56 times during the 20 years from 1991 on a nominal base, with East Asia’s share rising from 10 percent in 1991 to over 40 percent in 2011 (Table 1). In particular, corresponding figures for the value and share for electric machinery P&Cs are as large as 180 times (130 times for all machinery P&Cs) and close to 60 percent (43 percent), respectively. Moreover, the rapid increase in the number of imported product–country pairs for Mexico’s imports from East Asia, especially after the enactment of the North American Free Trade Agreement (NAFTA), indicates that the rapid increase in Mexico’s machinery P&Cs imports from East Asia has been through not only existing trade relationships but also newly created trade relationships (Figure 1). These facts suggest the rapid and dramatic increase in the importance of East Asia as a source of P&Cs for the emerging production sharing in the U.S.–Mexico nexus. *1

Such a change in the organization of production beyond the region, i.e., the expanding importance of East Asia as a source of P&Cs and the stronger links of production networks between both regions with Mexico serving as a bridge, appears to reflect factors such as the reduction in SL costs, changes in trade and investment-related policies to promote the activities of MNEs in Mexico, including NAFTA, the Maquiladora, and The Program of Sectoral Promotion (PROSEC), growing activities of multinational enterprises (MNEs) in both directions, and the strengthening competitiveness of East Asia as a production site.

As the discussion above shows, bilateral free trade agreements (FTAs) and mega FTAs may influence the patterns of the international division of labor. Their contents are tending to switch from simple tariff reduction to deeper liberalization and facilitation not only of trade in goods but also investment and trade in services as well as the establishment of (common) international rules. A typical example is the Trans-Pacific Partnership (TPP). The text of the TPP consists of the preamble and 30 chapters, which cover various aspects that may help stimulate production networks, beyond simple tariff reduction. In the following, we discuss the expectations for FTAs from the perspective of promoting production networking, taking the TPP as an example.

Regarding trade in goods, high-quality liberalization is of course important, but the economic benefits of tariff reduction under FTAs (and resulting reductions in SL costs) can be attained only when preferential tariffs that are (usually) lower than most-favored nations (MFN) tariffs are actually used. The key is to set up user-friendly rules of origin and ensure easier implementation. In the case of the TPP, the common rules of origin are applied to 12 member economies, which take the form of full cumulation, with a self-certification system. These rules can help reduce the physical, time, and administrative costs of obtaining the certificate of origin to utilize preferential tariffs, and may also raise the possibility of applying preferential tariffs, particularly when production networks are extended to many more economies. Moreover, from the perspective of Japan, they may allow PBs for producing high value-added products to be located in Japan, while still utilizing preferential tariffs.

Trade facilitation also helps to reduce SL costs and boost activity in supply chains. Transparent administrative customs procedures and smooth and speedy customs clearance are also important. In the TPP, advance notice of an administrative change and/or modification of a law or regulation regarding customs procedures is obligatory; a time limit to release shipments at customs clearance is specified (for instance, express shipments are supposed to be released within six hours after submission of the necessary customs documents); and advance rulings are requisite in no case later than 150 days after a request, provided that the requester has submitted all the information. These arrangements are expected to lead to more transparent, smoother and faster custom clearance.

The liberalization of trade in services is likely to be valuable not only for the services sector but also for the
manufacturing sector. The share of the service sector, mainly the distribution and logistics sectors, in the value-added of manufacturing exports is growing, indicating that the service sector provides important inputs for manufacturing exports. In addition, some studies have shown that liberalization of the service sector boosts productivity in the manufacturing sector. If high-quality services become available through liberalization of trade in services, productivity growth of manufacturing firms as well as expansion of trade in services can be expected. The TPP adopts the negative list approach, and thus it is easier to grasp the degree of liberalization compared with the positive list approach taken in the General Agreement on Trade in Services (GATS) and many Japanese FTAs. Moreover, some contents, including the prohibition of the requirement for local presence, are beyond the arrangements in GATS.

Technical Barriers to Trade (TBT) can be NTMs and influence trade patterns. In the TPP, trade facilitation is expected to be improved by eliminating unnecessary TBT, enhancing transparency, and promoting greater regulatory cooperation and good regulatory practice at all stages of the preparation, adoption and application of all technical regulations, standards and conformity assessment procedures (resulting in reduced burden of adjusting to new regulations and lowering costs of conformity assessment), while the arrangements under the World Trade Organization (WTO) agreement on TBT are kept. This is particularly beneficial to establish proper procedures, especially in developing countries.

The agreements on investment, intellectual property rights, and government procurement are also covered in the WTO agreement as the Agreement on Trade-Related Investment Measures (TRIMs), the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs), and the Agreement on Government Procurement (GPA), respectively. The agreements on these areas in the TPP, however, include cases with a broader range of application or the first international commitments. For instance, access to the market of government procurement is expected to improve because this is the first international commitment for Malaysia, Vietnam, and Brunei (they have not committed under the WTO) and also because some countries such as the U.S., Canada, and Singapore commit to the range of application beyond the WTO and/or existing FTAs.

Facilitating the temporary entry of businesspersons who are engaged in the trading of goods, supply of services or investment activities is also important to promote smooth activities in the wide-ranging international division of labor. In the TPP, a committee on temporary entry for businesspersons is supposed to be established to review implementation and discussion, and application procedures for immigration formalities including visas are expected to be prompt with reasonable application fees so that they do not unduly impair or delay trade in goods or services or the conduct of investment activities.

Small and medium-sized enterprises (SMEs) have played an important role in forming production networks and industrial clustering in East Asia, but they tend to make much less use of FTAs than large firms. In the chapter on SMEs in the TPP, a committee on SMEs is supposed to be established to assist SMEs to take advantage of the commercial opportunities and also to provide them with information.

The contents of other chapters such as electronic commerce, competition policy, transparency and anti-corruption, and state-owned enterprises (with larger shares in the economic activities of developing countries) can also influence regional supply chains both directly and indirectly, and thus improving these areas should help to create a better business environment.

As mentioned above, even among areas covered by the WTO and/or existing FTAs, the TPP agreement includes cases where the range of application is wider and/or that are the first international commitments for some countries. Although some arrangements refer only to the direction of obligation of efforts without a guarantee of actual implementation, the TPP agreement is indeed meaningful in the sense that it provides extensive and comprehensive rules to promote global supply chains.

Since supply chains now extend to many countries including developing countries, particularly emerging economies such as Vietnam, and have developed beyond the region through stronger production links between North America and East Asia, FTAs, particularly mega FTAs can help promote production networks when they provide common international rules that cover a larger number of countries as well as various measures to improve the business environment, particularly in developing countries, in addition to the high level
of trade liberalization.

Furthermore, regarding production networks in East Asia, major players of the networks such as China and Thailand are not members of the TPP. It may be difficult to achieve the same (or higher) level of deep liberalization and to provide a wider range of contents to establish international rules, but the existence of the TPP and its contents are expected to stimulate negotiations of Regional Comprehensive Economic Partnership (RCEP) with higher-quality consequences. Accelerated and deepening economic integration through competition among mega FTAs should be used to establish the new international economic order.

Reference
Ando, Mitsuyo and Fukunari, Kimura (2014) “Evolution of Machinery Production Networks: Linkage of North America with East Asia” Asian Economic Papers, Vol. 13, No. 3. pp. 121–160.

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*1 Note that patterns of international division of labor vary among the machinery sectors, depending on their nature. In the electric machinery sector which often uses standardized P&Cs or small and light ones, transactions over long distances are relatively easy. On the other hand, in the transport equipment sector which basically uses heavy P&Cs requiring high transport costs and prefers to form industrial clusters, transactions tend to be conducted over closer distances. Even in this sector, however, Mexico’s imports of P&Cs from East Asia are tending to increase, though not as extensively as in the electric machinery sector.

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