(Reprinted from HKCER Letters, Vol. 9, July 1991) 


Economic Integration in East Asia:
Doing What Comes Naturally

James Riedel


The Theory

The question I want to address is whether the growth in intra-Asian trade and investment is a natural outcome of market forces, or whether there is something more ominous behind it at all. As an academic economist, I naturally look first to theory and see what it has to say about inter-regional trade.

Essentially the theory says that where there are strong complementarities among economies, international trade will arise to exploit profit opportunities, provided that barriers are not in the way. By complementarity I mean the differences among countries in production capabilities or comparative advantage. So where there are strong comparative advantages among countries, one would expect a large potential gain from trade. This is true in general, and should also be true among the Asian economies. The same principle applies in the theory of international investment. Like international trade, direct investment is a market response to opportunities provided by differences among countries in production capabilities.

The question then is what is the nature of complementarities among Asian economies? This is an empirical question involving all kinds of unmeasurable variables. For our purpose, we might just take the most readily available indicator of relative resource endowment, and that is per capita income. Presumably the higher the per capita income, the greater the stock of physical capital, human capital, and natural resources that country has.

If we use per capita income as a measure of relative resource endowment, then in Asia we observe a great deal of complementarities among economies. We have all the way from Japan, which in 1988 had a per capita income of about US$24,000, to Bangladesh, which in the same year had a per capita income of about US$170. Those two incomes differ by over a hundred years of growth at an annual rate of 5 percent. In other words, if Bangladesh grows at 5 percent per annum constantly, it will take more than 100 years for it to catch up with Japan, even if the latter stands still. Between Japan and the next highest income countries, Hong Kong and Singapore, there is about a dozen years of growth at 5 percent per annum. At the same rate, there is another 10 or 12 years between Hong Kong and Taiwan, the same between Taiwan and Korea, between Korea and Malaysia, and between Malaysia and Thailand, and so on. So there are certainly very strong complementarities among the Asian economies.

It seems quite clear that these per capita income differences are due to differences in endowments of physical and human capital, rather than that of natural resources. The richest and the poorest countries in Asia share a very meager endowment of natural resources. The countries in the middle, the ASEAN countries, are the more notable net exporters of natural resources.

The Evidence

Thus there should be a lot of intra-Asian trade, given these rather large comparative advantages among the Asian economies, and indeed this is true. My statistics show that Asian countries export 38 percent to other Asian countries, although the Asian countries' share of world income or purchasing power is only about 25 percent. Only 30 percent of Asian exports go to North America, 18 percent to Europe, and 14 percent to the rest of the world. Asia is Asia's largest market for export. Furthermore, since 1986, the growth of exports of the Asian economies to other Asian countries has been the most rapid of all exports. In the period from 1980 to ?6, when the dollar was appreciating in real terms, the United States naturally was the fastest-growing market for Asian exports. But since 1986, with the realignment of exchange rates, Japan and other Asian economies have become more important markets. So intra-Asian trade is large, and it is growing more rapidly than trade with other countries.

In order to summarize things well, I use some country-grouping of the Asian economies: Japan, the NICs (the newly-industrialized economies or the so-called four dragons of Hong Kong, Singapore, Taiwan, and South Korea), the ASEAN four (excluding Singapore), South Asia (including India, Bangladesh, Pakistan, and Sri Lanka), and China. Among those groups, the one which relies most heavily on Asia as a market is China; 65 percent of its exports go to other Asian countries. There is some distortion here since most of these exports are to Hong Kong as entrepot trade and are destined for markets beyond Asia. The ASEAN countries are second, with 57 percent of their exports to other Asian countries. Again, this too is biased by the role of Singapore as the entrepot port for Malaysia and Indonesia. Then there are the NICs, about 32 percent, and Japan, with about 26 percent of its exports to Asia. Finally, there is South Asia, which, with all its barriers to trade, relies relatively little on Asian economies.

In manufactures, Japan and the NICs together account for 80 percent of Asian exports to Asia. In machinery, it is higher, at 90 percent. So intra-Asian trade is essentially trade between Japan and the NICs, and to a lesser extent, the ASEAN economies. Among these groups themselves, among the NICs, there is not much trade, except for the entrepot trade to Hong Kong. Taiwan and South Korea trade hardly at all with each other. The ASEAN economies trade very little with each other, and the same among the South Asian economies. This is perfectly natural since these economies are relatively similar. There is not much complementarity between, say, Taiwan and South Korea. They are more competitive than complementary. The same is basically true among the ASEAN economies, perhaps to a lesser extent.

A similar pattern is found with direct investment. Again, the largest investor in Asia is naturally Japan. This is the country in Asia with the greatest advantage in terms of accumulated capital, skill, and technology. Where does Japan invest? Naturally Japan invests in those economies which are growing and open -- the NICs, and more recently, the ASEAN economies. What is particularly interesting is the recent surge in direct investment from Taiwan and Hong Kong in Asia. It is interesting to see that these recipients of direct foreign investment in the 1960s and 1970s, now, as a consequence of their success, are investing in more labor-abundant and lower-wage economies in Asia. They have moved up the ladder of comparative advantage, devoting resources to more capital- and technology-intensive branches, and at the same time pulling the other countries up the ladder.

Policy Implication

This is sort of my view of what is happening. We see that the East Asian economies are indeed becoming more and more integrated through international trade and direct investment. I would expect that this will continue, so long as the Asian economies continue to move toward liberalization, and as long as they are able to maintain reasonably high rates of investment, as they have. The question now is whether there is a case for government intervention to promote intra-Asian trade and investment.

Perhaps the recent U.S.-Canada free trade agreement and the current discussion about a similar agreement between the U.S. and Mexico, possibly including Canada, together with the move in the European Community toward 1992 and all that, the idea of regional trade preferences may be appearing in Asia, if for no other reason than as a defensive strategy to what have been developing in North America and Europe. However, if we look at the past experience of developing countries with regional trade arrangements, it is not very encouraging. For the most part, regional trade arrangements, from past experience among developing countries, have only prolonged the inefficient import-substituting kind of industrialization. It seems to me, as long as external barriers are relatively high, and they are still among the ASEAN countries, there is a potential danger from trade preference schemes. However, if the Asian economies liberalize their trade policy in a non-discriminatory way, I would expect intra-Asian trade to expand, and it may expand disproportionately because the fundamentals are there, the complementarities are there.

If there is not a case for trade preference, what about government coordination of intra-Asian trade and investment? Some people believe this is already happening under the Ministry of International Trade and Investment of Japan. However, it is not only Japan which has accelerated its trade and investment in Asia. We also observed an acceleration of intra-Asian trade and investment just as dramatic in Hong Kong and Taiwan. It looks like East Asian integration is, as I put it in my subtitle, doing what comes naturally. It is a natural consequence of market force and of the liberalization that has occurred in China. If this is the correct view, that is, doing what comes naturally, then it seems that the obligation of government (and the Asian Development Bank) is to stay out of the way and let it happen.

Professor James Riedel is an economist at the Johns Hopkins University. He is on the Board of Academic Advisors of the Hong Kong Centre for Economic Research and also serves as consultant to the World Bank and the Asian Development Bank. His talk was delivered at a lunch seminar organized by the Centre.


| Index | Research Projects | HKCER Letters |
| Speaker Program / Conference | Index of Economic Freedom |
The Hong Kong Centre for Economic Research
School of Economics and Finance
The University of Hong Kong
Phone: (852) 2547-8313 Fax: (852) 2548-6319
email: hkcer@econ.hku.hk