Introduction

It is often said that if a hundred economists were placed in a room and were asked to state
their opinion on an economic matter, the room would come up with a hundred different
answers. Yet, it has been generally accepted by economists that free trade is the best trade
policy when it comes to benefiting the world as a whole. It is true that free trade results in
gains for some and losses for others. However, it is understood that society as a whole will
benefit enough through trade to offset the losses incurred by individuals. Not only that, but
trade, when free from distortions, works based on supply and demand thus optimizing
resource allocation (Wong, et al., 2004)

This paper will attempt to explain to what level of [economic] integration is possible in the
Northeast Asian Region (henceforth the NAR), or China, Japan, and Korea. The levels of
economic integration are as follows (Kim, 2009):
1) The free trade area, where internal tariffs are banished yet each member country
maintains separate trade policies towards non-member countries.
2) The customs union, which is like the free trade area but trade policies towards
non-member countries are harmonized so a common external tariff is set.
3) The common market, which is like the customs union but mobile factors of
production (labor and capital) are free to move around amongst member
countries, and migration is no longer restricted among citizens.
4) The economic union, which is like the common market but a common currency is
established as well as common tax rates, and common monetary and fiscal

policies are established.

5) The final, the political union, is the economic union plus additional factors, such
as a common administrative branch, a common legislature, a common judiciary
system, etc.
It will first analyze the current status and trend of trade and other economic activities between
the three countries, then state the situations that exist in the NAR that may hinder economic
cooperation, such as conflicts of identity or competition of economic activities between
countries. Finally, it will suggest the appropriate level of economic integration based on
current trends and limitations and some guidelines on approaching this goal. Based on the
trend of the increasing amount of trade within this region as well as the limitations, the
hypothesis of this paper remains that the procurement of a free trade agreement is fully
possible, but a full economic union seems unlikely in the near future. The goal should remain,
though, for higher levels of integration to eventually promote further benefits in the NAR,
such as security or cultural spread.

Before continuing, there needs to be an argument for the necessity of a regional economic
entity in the NAR. The benefits of Regional Trade Agreements are numerous, especially
when compared to multilateral attempts made by the WTO. The WTO, established on January
1, 1995, has been a major organization in the world to promote free trade across the world.
However, despite its strength in the sheer size of the organization, there are many limitations
that arise from this vast size as well. For example, it is very difficult, at times, for 153
countries to come to a unanimous decision about trade policies, which makes the decisionmaking process long and drawn out should any number of member countries disagree in the

agreement-making process. So, because the goal of the WTO is to promote free trade
amongst countries, RTAs were legalized (WTO Facts and Figures) (under GATT Article 24
and the enabling clause) since they increased trade amongst the member countries and the
decision-making processes were much shorter due to the smaller number of decision-making
countries. Not only that, but especially in the NAR, there exist many cultural commonalities
and shared understandings of each other because of its millennia of shared history and culture.
Should the three countries come together to cooperate, they will share together a market size
of over 1.53 billion people, accounting for 22.7% of the world population, as well as a shared
nominal GDP of over 10.8 trillion (USD, 2009, World Bank) which accounts for over 12.8%
of the world GDP, as well as some of the most advanced technology (Japan) and cheapest
labor (China) in the world. That is to say, if the three countries could come together despite
their conflicts and cooperate, they would become a powerful regional economic entity in this
world.

However, when it comes to trade, there are many impediments such as tariffs and other nontariff barriers like import quotas, customs requirements, etc. and these result in decreased
efficiency in trade. Based on what we have learned in class, through the elimination of tariffs
and other such trade barriers, there is more overall consumption by consumers through
lowered prices of products.

Before Trade

After Trade

Change

Consumer Surplus

A+B+C+D+E+F

A+B

-(C+D+E+F)

Producer Surplus

C+G

+C

Govt Surplus

None

+E

Total Surplus

A+B+C+D+E+F+G

A+B+C+E+G

-(D+F)

The area D+F shows the fall in total surplus and represents the deadweight loss of the tariff
(Mankiw, ).
This establishes that through at least a trilateral free trade agreement, the first level of
economic integration, should be agreed on to further economic and welfare gains through
trade amongst the three.

The Status Quo

Currently, there is a lot of intra-regional economic activity going on in the NAR and the trend
seems to be heading for more interdependence. For example, in 1991, the share of intra-

regional trade in Northeast Asia was 13.9% but increased to 22.2% in 2007, which is similar
to the situation in early European integration around 1950. Intra-regional Foreign Direct
Investment (FDI) also increased, from 2.7% in 1991 to 13% in 2007, after experiencing a dip
to below 10% during the Asian Financial Crisis and reaching a peak of 26.7% in 2004. While
the numbers are much lower compared to the EUs intra-regional activities, they are
comparable to the intra-regional trade and FDI in ASEAN and are much larger than that of
MERCOSUR, an established economic union in South America (Kim et al., 2009). However,
in the past five years, the ratio of intra-regional trade has been decreasing. For example,
Koreas total import in 2005 was US$261.26B, and US$435.28B in 2008, increasing by
66.61%, but the total amount of import from China and Japan only grew from US$87.05B to
US$137.89B between 2005 and 2008, resulting in only a 58.4% increase. To sum up, the ratio
of total Korean import to imports from China and Japan decreased from 33.32% to 31.68%.
The trends were similar with China and Japan imports (China, 26.86% down to 23.2%
between 2005 and 2008, and Japan, 5.03% down to 4.07% during the same period) (UN
Commodity Trade Statistics Database). Despite the recent trend, overall absolute amounts of
intra-regional trade have been increasing by as much as 63.74% (between China and Korea
between 2005 and 2008) and it is a well-known fact that China has surpassed the US as
Koreas largest trade partner. All in all, the overall trend of the past two decades point to
increasing intra-regional economic activity. Based on such trends, it seems natural that the
region may seek to increase gains from trade through cooperation.

Limitations of the Region

Despite the positive implications of a potential Northeast Asian economic entity, there exist
limitations in the region that will prove to be obstacles for the establishment of such an entity.

One obstacle is that there is a conflict of identities. According to Kim and Schmitter (2005),
the EU came together and created a common interest (not identity) as a base for integration.
However, though the three countries in the NAR may be able to agree on common goals to
pursue, there exists an underlying conflict regarding the interpretation of history, especially
around the early to mid-20th century. For example, both China and Korea were victims to
Japanese power during the World War II era. Another conflict that constantly rises whenever
non-related economic or military issues arise amongst the countries is that of territorial
disputes. Such fundamental conflicts of history and territory, which construct national
identities that may be negative towards one another, may hinder further any economic
cooperation beyond that of the FTA because these sentiments arise from citizens whenever
any conflict in another area arises.

Another possible obstacle may be that there is increased competition amongst the three
countries in product export. Because of Japans advanced technology advancements, there
has been a wild-geese flying effect(Wong et al., 2004) on Korea in terms of making it
somewhat easier for Korea to catch up with Japan. A similar effect showed for Korea, making
it easier for China to catch up with it in terms of development. This can be seen in the table
below, taken from Kim and Lees paper (2003):

PP

RB1

RB2

LT1

LT2

MT1

MT2

MT3

HT1

HT2

1986

3.28

0.72

0.84

3.04

0.51

0.04

0.59

0.10

0.04

0.46

1991

1.28

0.57

0.73

4.21

1.27

0.77

0.67

0.62

0.36

0.28

1996

0.77

0.67

0.75

4.13

1.75

0.11

0.77

0.72

0.85

0.50

China

2001

0.57

0.59

0.68

3.81

1.75

0.17

0.72

0.86

1.28

0.34

1986

0.07

0.27

0.30

0.28

1.08

2.70

0.82

1.63

2.11

0.57

1991

0.07

0.29

0.44

0.21

0.84

2.56

0.83

1.60

2.12

0.57

1996

0.09

0.28

0.56

0.17

0.76

2.08

0.91

1.69

1.78

0.88

2001

0.12

0.32

0.58

0.19

0.69

2.23

1.02

1.61

1.39

0.79

1986

0.28

0.49

0.40

4.13

1.73

0.47

1.11

0.92

1.48

0.31

1991

0.23

0.41

0.54

3.06

1.29

0.42

1.62

1.03

1.77

0.22

1996

0.18

0.44

0.72

1.47

0.93

1.05

1.64

1.03

1.80

0.22

2001

0.19

0.49

1.10

1.42

0.87

1.13

1.40

1.15

1.77

0.16

Japan

Korea

PP Primary Products / RB1 resource-based products (agriculture-based) / RB2 resource-based product

(other) / LT1 Low-technology products (textile/fashion) / LT2 other low-technology products / MT1
Medium-technology products (automotive) / MT2 medium technology products (process industries) / MT3
Medium-technology products (engineering) / HT1 high-technology products (electronics and electrical
products / HT2 other high-technology products

As can be seen from this table, China has lost its comparative advantage in primary products,
but maintained its comparative advantage in textiles, comparative advantage in laborintensive products. Comparing medium- and high-technology products in China and Korea, it
seems to show that Korea is more advanced in technology in producing such products. And
China seems to be following Koreas patterns of development, because while LT1 and LT2
RCA decreased in Korea between 1986 and 2001, Chinas has increased. Meanwhile, Japan
seems to remain relatively stable in most sectors, but is rapidly losing its comparative
advantage in HT1 products (electronics, etc) while China and Korea are rapidly gaining.
Because their industry structures became similar, competition between the three in exporting

to other countries has increased greatly. This may prove to be a hindering factor in creating a
regional economic institution because they will all be trying to produce and export similar
products should they try to make the regional so integrated and common that they are all
competing against one another. However, based on the standard trade model that we have
learned in class, we know that it is beneficial for overall consumer welfare for countries to
produce and trade the same products in the same industry, so a regional FTA should not prove
to be too difficult thanks to the benefits of intra-regional trade.

Guidelines and Conclusion

Based on the research so far, it seems that some sort of economic integration would be
beneficial for all countries involved, since the trend seems to be increasing trade amongst the
NAR countries. The elimination of tariffs would benefit the economies through elimination of
deadweight losses. And despite the increasing similarities in production industries, there still
remain significant enough differences in comparative advantage that should the three
countries cooperate and pursue division of labor based on their respective comparative
advantages, each would be able to use its comparative advantage in furthering the
development and productivity of that industry. For example, China would use its plentiful
labor market to make labor-intensive products, and Korea, with its comparative advantage in
electronics higher than even Japan as of 2001, may use that to produce relatively cheaper,
good-quality high-technology products. Also, Even though the countries may be increasingly
competing against one another in high-technology products due to the geese flying effect,
trade amongst the three will result in increased consumer welfare and economies of scale
advantages.

However, due to the fundamental conflicts that bar the region from full cooperation, such as
conflicts over history and territory, it seems unlikely that integration beyond an RTA is
feasible. To create even a customs union, the second level of integration, countries need to
form a common interest with which they can create common customs and policies with. But
since it seems unlikely that the three may resolve these decades-old identity conflicts anytime
soon in order to create a regional economic entity and pursue their own interests, a customs
union may be out of reach in the NAR in the near future.

The goal, however, still remains a level of integration beyond a simple trade agreement in the
NAR. Some guidelines for the post-RTA period may be found in Kim and Schmitters paper
(2005). First, we need to keep in mind that the EU started small, with a cooperational focus
on coal and steel before evolving into trade liberalization, agricultural cooperation and
liberalization, and eventual monetary integration. The NAR could also focus on a small
sector that is not too sensitive, though coal and steel seem unlikely in this time and age, and
cooperate jointly for more efficient production. Some suggestions might be that of increased
technological cooperation in electronics; to use Japans and Koreas engineering and Chinas
cheap labor to create a product would have enormous impact on the world market. Or,
cooperation in energy and transportation would also create many positive spillover effects
and contribute to deeper integration. Second, we need to realize that economic integration
does not mean that the area will be free from conflict; in fact, they still continue even in the
EU despite the fact that theyve reached the fourth level of economic integration and have
political union-like factors as well. Finally, and in this papers view, most importantly, it is
vital that we know integration is a process, not a goal, and that no one knows exactly what

this will lead to. However, it needs to be peaceful and voluntary. This process will change the
nations perceptions of each other, motives, and stimulate interest associations across all
levels as more cooperation leads to positive results.

References
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Kim, S. & Schmitter, P. C. (2005). The Experience of European Integration and Potential for
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Kim, Nam-kook. (2009). Globalization and Regional Integration in Europe and Asia. Surrey, England:
Ashgate Publishing, Ltd.
Kim, Y. and Lee, C. H. (2003). Intraregional Trade in Northeast Asia: Trends and Characteristics. In
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