EastandSouthAsiainglobaltrade:RegionalintegrationandgeopoliticsShiroArmstrongCrawfordSchoolofEconomicsandGovernmentAustralianNationalUniversity

‐‐‐PreliminaryDraft:pleasedonotcite‐‐‐AbstractThispapermeasurestheintegrationoftheEastAsianandSouthAsianeconomiesintheglobaleconomyandtheirpotentialforregionalandglobaleconomicintegrationthroughmerchandisetrade.EastAsianeconomiesareshowntobeachievingmuchmoreoftheirpotentialtradethanSouthAsianeconomies,bothintermsofintra‐regionaltradebutalsointradewiththerestoftheworld.SouthAsiarealisesmoreofitspotentialtradewithtradepartnersoutsidetheregionthanwithinitsownregion.EastAsianeconomiesingeneralachievemoreoftheirtradepotentialamongEastAsianpartnersthanglobally.IndiaisshowntobeachievingmoreofitstradepotentialwithEastAsia,mostprominentlywithChina,thanwithinitsownregion.TheSino‐Japan,India‐Pakistanandcross‐straitsTaiwan‐mainlandChinabilateralrelationshipsareexaminedtoexplainthatintegrationintotheglobaleconomy,startingwithdeepregionaleconomicintegration,hasallowedeconomicrelationstodominateandconstraindifficultpoliticalrelationsinEastAsiawhileinSouthAsia,adversepoliticalrelationshavehampereddevelopmentoftheeconomicrelationships.ThereisalsoevidenceoftradeinthelessintegratedSouthAsiabeingaffectedmorebytheupsanddownsofpoliticalrelationsthaninEastAsia.

ContentsBackground............................................................................................................................................1

Tradeperformance.............................................................................................................................3

Measuringtradeperformance..................................................................................................3

Results.................................................................................................................................................6

Tradeandpolitics............................................................................................................................10

Politicsinexplainingtradeperformance..........................................................................10

Sino‐Japanrelations...................................................................................................................13

Cross‐Straitsrelations...............................................................................................................14

India‐Pakistanrelations...........................................................................................................15

Conclusions.........................................................................................................................................18

References...........................................................................................................................................19

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BackgroundEconomicintegrationcanencompassmanydifferentdimensionsofopeningupandincreasingeconomicactivityandinterdependenceacrossborders.Itessentiallyinvolvestheremovalofbarriersatandbehindtheborderwiththeaimofincreasingwelfarefromincreasedtrade,investmentandeconomicactivitythatcomesfromtheabilitytospecialize,developtheeconomyandtakeadvantageofmutuallybeneficialexchangewithothercountries.Thispaperfocusesontrade,themostobviousmeasureandindicatorofeconomicintegration.IntegrationofEastAsianandSouthAsianeconomiesintotheglobaleconomyshowverystarkdifferencesinhowentireregionsapproachandachieveopenness.CountriesinEastAsia1havepursuedpolicystrategiesofopennesstotradeandinvestmentthathaveledtotheirhavinghightradeshareswithotherEastAsianeconomiesaswellasglobally.EastAsiaisoneofthemosteconomicallyintegratedregionsintheworldwithlowbarrierstotradeandinvestmentwithintheregionbutalsotowardstherestoftheworld(ArmstrongandDrysdale,2011).SouthAsia2,ontheotherhand,isoneoftheleasteconomicallyintegratedregionsintheworld(ADB,2008)and,ifmeasuredintermsofintraregionaltradeasashareoftotaltrade,istheregionwiththelowestintegrationglobally(Sally,2011).IntraregionaltradeinSouthAsianwas3.5percentoftotaltradein20093,upfromalowof2percentin1967butsignificantlylowerthanthe19percentin1948(KumarandSingh,2009).Highintraregionaltradeisnotanendgoalinitselfandtradingpartnershipsinopeneconomiesshouldbedeterminedbycomparativeadvantageandmarketforces,buttheadvantagesofproximityareimportant(Linnermann,1966;Frankel,SteinandWei,1997;DisdierandHead,2008).SouthAsianeconomieshadonaveragetradetoGDPratioof42.7percentin2008showingthattheyarestillrelativelylessopenthanEastAsiawhichhadanaveragetradetoGDPratioof63.2percentin20084.Includingservicestrade,theestimatesriseto51percentand67.3percentforSouthAsiaandEastAsia,respectively.SouthAsianeconomieshavelowtradebothwithintheregionandgloballydespitegrowthovertime.Therestofthepaperfocusesonmerchandisetradeandnotservices1EastAsiaisdefinedinthisstudyas‘integrating’EastAsiaastheADB(2008)studydefinedwhichismostoftheeconomiesencompassinggeographicEastAsiaexceptNorthKorea,Burma/MyanmarandthePacificIslandeconomies.2ForthepurposesofthisstudySouthAsiafollowstheWorldBank’sdefinitionandiscomprisedofSAARCmemberslessAfghanistan:Bangladesh,Bhutan,India,theMaldives,Nepal,PakistanandSriLanka.32009and2010dataarenotcompleteforSouthAsianintraregionalflowsintheUnitedNationsComtradedatabaseortheWorldBank'sWorldDevelopmentIndicators.4Source:WorldBank'sWorldDevelopmentIndicatorsonline.EastAsiais'EastAsiaandthePacific'asdefinedbytheWorldBank.

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tradedespiteitsimportanceinSouthAsiantradeduetodataavailability5.Aregionthathasloweconomicintegrationcanfaceproblemsbeyondlosingoutonbenefitstotradefromeconomicproximity.Politicalinteractionstendtooccuratamuchhigherfrequencybetweenneighboursandhighereconomicinterdependencecanameliorateanddampenadverseeffectsofpoliticaltensions(MansfieldandPollins,2003).Politicaltensionscanactasalargebarriertoeconomicintegrationandlackofeconomicintegrationandinterdependencecanactasaconstraintontheimprovementofpoliticalrelations.SuchanequilibriummightbethoughttocharacterizetheIndia‐Pakistanrelationship,forexample.TheEastAsiancaseisverydifferentwithbilateralrelationshipsthathaveunresolvedhistoricalissuesandpoliticalmistrustenjoyinghighlevelsoftradeandeconomicintegrationbetweenthem.Someoftheserelationships,suchasthatbetweenJapanandChinaandacrosstheTaiwanStraitsbetweenChinaandTaiwan,showtrendsofimprovingpoliticalrelationsovertimeaseconomicrelationsdeepen.ButjusthowintegratedareindividualeconomiesinSouthAsiaandEastAsia,withintheirregionandwiththeglobaleconomy,andhowmuchtradecanweexpectwithinandbeyondtheseregions?ArethelowintraregionaltradesharesinSouthAsiaexpectedgiventheeconomicstructuresofSouthAsiaeconomiesandtheotherdeterminantsofthesecountries'tradepatterns?ArethehighintraregionaltradesharesinEastAsiaduetohowfarEastAsiahasalreadyproceededwithintegrationintotheglobaleconomyorforotherreasons?Thispaperestimatespotentialtradebetweencountriesandanswersthosequestionsthroughanalysisoftheachievementofthatpotential.Itisnotclearfromtradeshareswhetherthesmallintraregionaltradeandtradebetweencertainpartners,suchasIndia‐Chinatrade,isaboveorbelowwhatmightbeexpectedgiventheunderlyingdeterminantsandcharacteristicsofthesecountries'trade.Withoutbenchmarkingtradeperformance,itisnotclearwhetherIndia'stradewithChinaandEastAsia,seeminglyattheexpenseofitstradewithSouthAsianpartners,isduetopolicystrategyorbecausetheEastAsianeconomiesarelargerandmoredynamic.Thepaperisorganizedasfollows.Thenextsectionintroducesthemodeltomeasuretradeperformance.ThentheresultsofachievementoftradepotentialforEastAsia,SouthAsiaandotherregions,aswellasbilateralrelationswithineachregion,arepresented.Politicaldistanceandothermeasuresarethenusedtoexplainsomeofthedifferencesintradeperformance.Thefollowingsectionlooksatthetradeandpoliticalrelationshipsofsomeofthekeybilateralrelationshipsinbothregionsbeforedrawingsomeconclusionsonthe5Servicestradewillhavetobeincludedintheanalysisinadifferentmannerasdifferentmodesofservicesareaffectedbydistancetovaryingdegrees.

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interactionbetweeneconomicandpoliticalrelations.

Tradeperformance

MeasuringtradeperformanceTradeperformanceisdefinedastheachievementofpotentialtradewithpotentialtradebeingestimatedasthemaximumamountoftradeachievablegiventhecharacteristicsofthetradingrelationshipwhicharebenchmarkedbythecharacteristicsofallothertraderelationships(Armstrong,2007).TradepotentialismeasuredusingstochasticfrontieranalysisappliedtoagravitymodeloftradeandwaspioneeredbyDrysdale,HuangandKalirajan(2000)6.Thefrontier,orpotentialtrade,isdefinedbythecharacteristicsofthemostliberaltradingrelationshipsglobally.Thetradefrontierisbasedonthedeterminantsoftradeandisdefinedbythebesttrade'technologies’worldwideThestandardgravitymodelestimatesthemeaneffectsofalldeterminantsoftradewithvariationsfromthatmeanallsummingtozero.Thestochasticfrontierapproachofthegravitymodelallowsacompositeresidualthatseparatesoutimpedimentstotrade(inefficienciesinthestochasticfrontieranalysisliteraturerelatedtoproduction)thatreducetradefromthefrontier,fromrandomshocksandmeasurementerror,andmostlyfromunobservablefactors.Theperformanceoftraderelationships,ortheirachievementofpotentialtrade,canalsobethoughtofasameasureofeconomicdistancewhere,sincegeographicdistanceisalreadycontrolledfor,highperformanceshowslowresistancetogoodsorcapitalflowsbetweencountries.ThemostliberalandfreeflowingtradeandinvestmentrelationshipsarecharacterisedbyloweconomicdistanceFigure1isastylizeddiagramofthedifferencebetweenagravitymodelwithandwithoutafrontier.Withagravitymodel,thecomparisonofwhereatradeflowperformsisrelativetothemean,orwhatthemodelwouldpredicttradeis,whereasitisanupperbound,orpotential,withthefrontierapproach.

6ForotherstudiesthatusethisapproachseeKalirajanandFindlay(2005),Kalirajan(2008),KangandFratianni(2006)andArmstrongandDrysdale(2011),

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Figure1Frontierandconventionalgravitymodelcomparison

Source: Kumbhakar and Lovell (2000). Theverticalaxisshowstheamountoftradeandthehorizontalaxisisavectorofthedeterminants.Therearemanyvariantsofthegravitymodelinusewiththechoiceofvariablesandspecificationsvaryingconsiderably.Notallareconsistentwithderivationsfrommicro‐foundationsandnotallhavetheoreticunderpinnings.ThispaperusesavariationofthereducedformversionoftheAndersonandvanWincoop(2003)modelthatiswidelyusedbutaddsacomplementarityvariabletoreflectendowmentstructuresbetweeneconomies.Themodeltobeestimatedis

ln xijt ln0 1 ln yit 2 ln yjt 3 ln Distij 4Borderij 5COMPijt ijt vijt uijt

where

xijtisthetradefromitojattimetandisfromtheIMF’sDirectionofTradeStatisticsandtheUnitedNations'Comtradedatabase(variousyears).Tradeflowsarecalculatedfromimportsinsteadofexportsforaccuracy7.

7Importershavelessincentivetounder‐reportandimportsareamoreaccuratereflectionoftradeflowvaluesthanreportedexports.TheexceptionisEuropeantradewherethereisataxincentivetounder‐reportimportsduetothevalueaddedtaxstructurebutimportflowswereusedforconsistency.Thisiscommonpractice.

X

Trade determinants

Y

potential

actual

Conventional Gravity

Frontier Gravity

X

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yitiscountryi’ssize(GDP)attimetisfromtheWorldDevelopmentIndicators(WDI)andatcurrentprices.

rDistijtherelativedistancefromitoj.The(greatcircle)distanceisbetweeencapitalcitiesandrelativetothesquarerootofthesumofalldistancesforiandjbetweentheirtradingpartners.ThedataarefromtheChemicalEcologyofInsectswebsite8andtheCEPIIgeodesicDistancesdatabase9.

Borderijisavariablethattakesonthevalueofoneifiandjshareacommonlandborder,zerootherwise.COMPijtisanindexofcomplementarityofi’stradewithjattimetandisfromDrysdale(1967)andDrysdaleandGarnaut(1982):

k j

kj

ki

kw

iw

i

ki

ij M

M

MM

MM

X

XC

whereXisexports,Misimports,subscriptsdenotecountry(i,jandworld)andsuperscriptkimpliescommodityk.TheindexiscalculatedatthethreedigitlevelfromtheAustralianNationalUniversity’sInternationalEconomicDatabank10forallcombinationsofcountriesandyears.Theindexcapturesthecomplementarityoftradestructuresbetweencountriesandthehighertheindexthehigherdegreeofcomplementarity.Multilateral(orthirdcountry)effectsarecontrolledforusingtime‐invariantcountrypairfixedeffects(µij)andtimevaryingcountrypairfixedeffects(µijt)asiscommonlydonetoavoidbiasthatAndersonandvanWincoop(2003)identify(seeBaldwinandTaglioni,2006).Thedisturbancetermvijtaccountsforrandomvariationintradesimilartothedisturbanceterminthestandardordinaryleastsquaresmodel.Thenon‐negative(orone‐sided)disturbanceterm,uijt,measuresthedifferencebetweenpotentialtradeandactualtrade.Moreprecisely,itistheamountoftradethatfallsshortofthefrontierfortradefromcountryitojattimet.Othervariablescommonlyincludedingravitymodels,suchastradebarriermeasures(tarifflevels),measuresofriskoreconomicfreedom,regionalgroupingsandlanguagesimilarity,arenotincludedherebutareinsteadincludedinexplainingthetradeperformanceinaseparatemodellaterinthepaper.ThecoredeterminantsasperAndersonandvanWincoop(2003)areusedtoestimatethepotentialandthenalltradeimpediments,policyvariablesandotherinstitutionalqualityindicatorsareusedfirsttoexplainthedistancefromthefrontier.

8http://www.chemical‐ecology.net/9http://www.cepii.fr/anglaisgraph/bdd/distances.htm10http://iedb.anu.edu.au/

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Themodelisestimatedforadatasetthatisarepresentativesampleofworldtradecomprisedofbilateralflowsbetweenthetop65tradingnationsfortheperiod1990to2006.ThisperiodisusedbecauseitincludestheIndianreformsoftheearly1990s,theperiodwhenChineseimportswerealmostcompletelybannedbyTaiwan,China'saccessiontotheWTOandothersignificanteventsisbeforetheglobalfinancialcrisis.Also,theavailabilityofthepoliticaldistancedata,discussedlater,islimitedtotheperiod1990‐2004.ThemodelcanbeestimatedusingthestatisticalprogramsGAUSS,STATA,LIMDEP,andFRONTIER4.1.TheresultsoftheestimationusingFRONTIER4.1areshowninTable1.

ResultsTable1Maximumlikelihoodestimationfrontiergravityestimationresults

(1) (2) (3)Dependentvariableln(tradeijt)

OLS Frontiercountrypair

Frontierw

countrypair&timedummies

Constant ‐24.28*** ‐20.52*** ‐21.05*** (0.1207) (0.1214) (0.127)

lnGDPit 0.85*** 0.77*** 0.78*** (0.0033) (0.0034) (0.0033)

lnGDPjt 0.79*** 0.76*** 0.76*** (0.0031) (0.0031) (0.0031)

rDistij ‐2.42*** ‐2.27*** ‐2.24*** (0.0243) (0.0237) (0.0229)

Compijt 1.11*** 1.33*** 1.089***

(0.0329) (0.0307) (0.0302)

Borderij 1.73*** 1.97*** 1.98*** (0.0137) (0.0155) (0.0145)

sigma‐squared 1.77 52.04*** 7.908*** (0.1529) (0.173)

Gamma 0.89*** 0.88***

Mu ‐5.37 ‐5.29

loglikelihoodfunction ‐103285 ‐101457 ‐101324Numberofobservations 60565 60565 60565

Note: Standard errors in parentheses. * p < 0.05, ** p < 0.01, *** p < 0.001. Coefficient estimates for time dummies are not included to save space.

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TheresultsareconsistentwiththefindingsofthevastliteratureongravitymodelsandshowtheexpectedsignandmagnitudeforthecoefficientestimatesofGDP,distanceandbordervariables.Ahigherdegreeofcomplementarityintradeexplainshighertrade.Loglikelihoodratiotestsdeterminethatthespecificationincolumn3ofcountrypairandtimedummyvariablesisthebestfitforthedata.Loglikelihoodratiotestsalsodeterminedthatatruncatednormaldistributionfortheone‐sidederrortermfitsthedatabetterthanahalfnormaldistribution.Tradeperformance,orrealisationofpotentialisgivenbyactualtradeasaratioofpotentialtrade.Table2showsthattheworldaveragetradeperformanceis50percentovertimeandisfairlysteady.AlthoughresultsforselectedyearsonlyareshowninTable2,theworldtradeperformanceiseither49percentor50percentineachyearforthewholeperiod.Table2Tradeperformanceresults,selectedregionsandyearsRegion 1990 1995 2000 2006 Average

Worldaverage 0.49 0.50 0.50 0.49 0.50

EastAsianExports 0.54 0.57 0.59 0.60 0.58

EastAsianImports 0.54 0.55 0.54 0.54 0.54

EastAsianIntraregional 0.63 0.64 0.66 0.67 0.65

SouthAsianExports 0.39 0.43 0.41 0.41 0.41

SouthAsianImports 0.45 0.45 0.41 0.44 0.43

SouthAsianIntraregional 0.31 0.35 0.24 0.25 0.27

Europeintraregional 0.53 0.54 0.57 0.54 0.54

NorthAmericaIntraregional 0.47 0.58 0.59 0.58 0.57

Source:Author'scalculationsNote:EuropeisEU‐15.

At60percentforexportsand54percentforimportsin2006,EastAsiantradeonaveragerealisesmoreofitstradepotentialthantheworldonaverage;EastAsiaaveragesclosetothosenumbersoverthewholesampleperiod.EastAsianintraregionaltradeisat67percentofpotentialin2006whichisthehighestintheworldwithNorthAmericaat58percentandEuropeat54percent.TherealisationofSouthAsianregionaltradepotentialisthelowestamongtheseregions,at25percentin2006.SouthAsiarealisesmoreofitspotentialtradewithtradepartnersoutsidetheregionthanwithinitsownregion.SouthAsiarealisesover40percentofbothexportandimportpotentialwithextra‐regionaltradingpartners,onaverage,comparedtoaround27percentofitsintraregional

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tradepotential.SouthAsia'sintraregionaltradeperformancehasalsobeenfallingovertime.TheresultsareconsistentwiththoseobtainedinArmstrong,DrysdaleandKalirajan(2008)whichalsousedastochasticfrontierappliedtoagravitymodelbutwithdifferentspecifications.InthatstudyASEANhadthehighestintraregionaltradeperformance,followedbyEastAsiamorebroadly,thenNorthAmerica,EuropeandwithSouthAsiathelowest.Table3showsselectedbilateralandcountryaverageresultsforthesameyearsasTable2.Theresultsareselectedandaveragedfromthe60,565bilateralresults(thesameasthenumberofobservationsinmodel—seeTable1).Pakistanitradeisclosertopotential,onaverage,thanPakistanitradewithIndia.Indiaisachievinghighertradepotential,onaverage,thaninthebilateralrelationshipwithPakistanaswell.Averageexporttradeperformanceisaround40percentofitspotentialovertimewithaverageimporttradeperformancefallingovertimefrom46percentto41percentofpotentialin2006.Bycomparison,Pakistan'stradewithIndiaislower,achievinganaverageof21percentoftradefromPakistantoIndiaovertheperiod1990‐2006and32percentofpotentialtradeintheotherdirectionoverthesameperiod(Table3).India'stradewithEastAsiaisclosertopotentialthanitstradewiththerestofSouthAsia.BothIndia'sexportsto,andimportsfrom,EastAsiaarerisingovertimewithexportsat53percentofpotentialandimportsat59percentofpotentialin2006,bothhigherthantheworldaverage.India'stradeisshowingbias,orstrongerperformance,intradewithEastAsiathanwithIndiantradeoverall,asuccessfulresultofglobalopennessaswell,perhaps,ofthelookEastpolicystrategy.SomebilateralrelationshipsinEastAsiaareworthspecialnote.TradebetweenJapanandChinarealisedmoreofitspotentialthanJapan'stradeonaverageandChina'simports,whileonparwithChina'saverageexportperformance.Atanaverageof59percentovertheentireperiodforChineseexportstoJapan,and57percentforimportsfromJapan,therelationshipisrealisingmoreofitspotentialthantheaverageofitsglobaltradingrelationships,at50percentofpotential.Whiletheglobalaverageissteadyovertime,theJapan‐Chinarelationshipregistersimprovementinrealisedpotentialovertheentireperiod.

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Table3Countryandbilateraltradeperformance,selectedyearsExporter Importer 1990 1995 2000 2006 Average

Worldaverage 0.49 0.50 0.50 0.49 0.50

EastAsiaChina World 0.50 0.54 0.58 0.65 0.57

World China 0.46 0.48 0.47 0.54 0.48

China EastAsia 0.58 0.62 0.64 0.68 0.63

EastAsia China 0.49 0.55 0.60 0.65 0.58

China Japan 0.55 0.57 0.60 0.64 0.59

Japan China 0.48 0.56 0.57 0.62 0.57

Japan World 0.53 0.50 0.52 0.54 0.52

World Japan 0.46 0.42 0.43 0.45 0.43

China Taiwan 0 0.18 0.45 0.67 0.36

Taiwan China 0.42 0.64 0.65 0.71 0.63

Taiwan EastAsia 0.68 0.63 0.64 0.67 0.64

EastAsia Taiwan 0.67 0.67 0.67 0.67 0.67

Taiwan World 0.61 0.60 0.61 0.62 0.60

World Taiwan 0.54 0.58 0.58 0.58 0.57

SouthAsiaIndia World 0.37 0.45 0.45 0.47 0.44

World India 0.39 0.38 0.41 0.50 0.42

India SouthAsia 0.31 0.23 0.18 0.29 0.26

SouthAsia India 0.26 0.37 0.38 0.42 0.35

India EastAsia 0.43 0.50 0.51 0.53 0.50

EastAsia India 0.44 0.47 0.50 0.59 0.50

India Pakistan 0.30 0.28 0.24 0.24 0.21

Pakistan India 0.32 0.27 0.27 0.30 0.32

Pakistan World 0.38 0.42 0.37 0.37 0.39

World Pakistan 0.46 0.46 0.36 0.41 0.41

SriLanka World 0.45 0.46 0.47 0.43 0.46

World SriLanka 0.53 0.53 0.47 0.45 0.50

Source:Author'scalculationsNotes:datafortheyear2000wasmissingforsomeintra‐SouthAsiantradesothedatadisplayedistheaverageofdatafrom1999and2001.Thedataarerelativelystableovertime.

Cross‐straitstradeperformancebetweenTaiwanandChinaisalsoveryhighin2006at71percentfromTaiwantoChinaand67percenttheotherway.Andthisachievementcanbemeasuredinthecontextoftheirhavingbeenvirtuallynodirecttradebetweenthetwoeconomiesintheearly1990swithTaiwanpursuingapolicyofunilateralbansonimportsfromChinathatwereonly

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graduallyliftedovertheperiodunderstudy.ActualtopotentialTaiwanesetradeinEastAsiawasveryhigh(ataround65percent)throughouttheentireperiodunderstudydespiteitsseverelylimitingimportsfromChina.Taiwan'stradeinEastAsiarealisedmuchmoreofitspotentialthanTaiwan'stradewiththerestoftheworld.Ireturntodiscussionofthisrelationshipbelow.

TradeandpoliticsWhataretheimplicationsofSouthAsiaonlyrealizing27percentofitspotentialintraregionaltradecomparedto65percentinEastAsia,54percentinEuropeand57percentinNorthAmerica?WhatisinhibitingIndiaandPakistanfromrealisingmoreoftheirtradepotentialandhavingtheirpotentialeconomicinterdependenceimprovetheirpoliticalrelationship?Therestofthispaperattemptstoaddressthesequestions.

PoliticsinexplainingtradeperformanceThetradeperformancecanbeexplainedbyvariablesthatreflecttradepolicy,domesticandpartnereconomicandpoliticalconditions,aswellasinstitutionalfactors.Thissectionindentifiesanumberofvariablesthatproxythesedeterminantsoftradeperformanceandallowameasureofwhethercertainvariablessuchaspoliticaldistancebetweencountriesaffectthetradeperformanceasmeasuredindetailabove.Thereisavastliteratureontheinteractionbetweentradeandinterstateconflict(orcooperation)thatrevealsacomplicatedrelationshipwithcausalitybetweentradeandpoliticsdependingonthecountries,thesymmetryintherelationship,thetypeofgoodstradedandthetimeperiod(ReuvenyandKang,1996;MansfieldandPollins,2003).EachbilateralrelationshipfacesdifferentcircumstancesatdifferentpointsintimeandafewofthekeyrelationshipsinEastAsiaandSouthAsiathathaveresultedindifferentoutcomesintheinteractionbetweenpoliticsandeconomics,areworthreviewing.Politicaldistancebetweencountriescausesuncertaintytoincreaseandactsasanimpedimenttotradeorinvestment.Significantandprolongedlowintensityconflicts,aswellaspositivepoliticaldevelopmentsfosteringcooperationintherelationship,canaffectatradeoreconomicrelationship(Armstrong,2009).Thepoliticaldistancevariableusedinthisstudyisameasureof‘sentiment’towardsanothercountry,separatedintobothpositiveandnegativeelements,basedoneventcodingfromnewspaperarticles.ThedataarefromKing(2003)andareupdatedto2004datainthenewIDEAdataset.Eventsoractions

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betweencountriesaregivenweightsonascaleofseveritythathas200categoriesand,toreducereportingbias,isallcodedfromReutersBusinessBriefs.Thereisanestablishedliteraturewhichemploys,testsanddevelopssucheventdata(MansfieldandPollins,2003).Thedataareeventsoractionsbetweencountriesandishighfrequency(monthly)whichareaggregatedtoanannualmeasureforthisstudyandthecooperationnetofconflictisusedhereasinArmstrong(2009)andArmstrongandDrysdale(2011).Inordertoestimatewhetherpoliticaldistancebetweencountrieshasaneffectontrade,orinthiscasewhetherithelpsexplaintherealisationorlackofrealisationoftradepotential,itisincludedasanexplanatoryvariablealongsideothervariableswiththeactualtopotentialtraderatioasthedependentvariable.Theothervariablesincludeindexesofeconomicfreedomforbothexporter(i)andimporter(j)whicharefromtheFraserInstitute(Gwartneyetal.,2008).Theaveragetariffrateforeachexporterandimporterisalsoextractedfromtheindexofeconomicfreedom.Thereisassumedtobeverylittlecorrelationbetweentheeconomicfreedomindexandthetariffrate,astheeconomicfreedomindexiscalculatedfrommanyvariablesofwhichthetariffrateisonlyone.AlanguageindexisalsoincludedanisbasedonBoissoandFerrantino(1997)whichisanindexthattakesavalueof0ifnoneofthepopulationofcountryispeaksthesamelanguageasincountryjandavalueof10,000ifallofthepopulationinbothcountriesspeakthesamelanguage.Duetothelackofdataavailability,thelanguagesimilarityindexdoesnotchangeoverthe27yearperiod.ItispreferabletootherlanguagesimilarityvariablessuchasintheCEPIIdatabasethatareoftenbinary,takingthevalueofoneiftwocountriessharethesamelanguageandzerootherwise.Finally,regionalgroupingvariablesareincludedtoseewhetherbeingamemberofaparticularregionalgroupinghelpsexplainsomeoftherealisationoftradepotential.TheresultsforthemodelarepresentedinTable4.

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Table4Explainingtradeperformance (1) (2) (3)

Freedom index Exporter 0.0248*** 0.0238*** 0.0196*** (0.0008) (0.00084) (0.000835)

Freedom index Importer 0.0247*** 0.0229*** 0.0207*** (0.000673) (0.000698) (0.000691)

Exporter tariff 0.000795** 0.000280 0.000300 (0.000292) (0.000302) (0.000297)

Importer tariff -0.00232*** -0.00274*** -0.00256*** (0.000296) (0.000307) (0.000301)

Language similarity 0.0000104*** 0.0000103*** 0.00000929*** (0.000000418) (0.000000411) (0.000000414)

Political distance -0.0000129 (0.0000221)

EA* Political dist 0.000394*** (0.0000959)

SA* Political dist -0.00423*** (0.000742)

Lagged political dist -0.0000131 -0.00000945 (0.0000217) (0.0000212)

EA* Lagged political dist 0.000377*** -0.0000132 (0.0000935) (0.0000920)

SA* Lagged political dist -0.00542*** -0.00240** (0.000821) (0.000850)

APEC 0.104*** (0.00328)

ASEAN 0.0919*** (0.00921)

NAFTA 0.00267 (0.0259)

EU 0.0491*** (0.00386)

SAARC -0.177*** (0.0168)

ANDEAN 0.0637*** (0.0123)

MERCOSUR 0.103*** (0.0116)

constant 0.179*** 0.204*** 0.238*** (0.00661) (0.00705) (0.00708) N 40181 38984 38984 Note:Standarderrorsinparentheses.*p<0.05,**p<0.01,***p<0.001.

Threedifferentmodelsareestimatedwithdifferentspecificationsforpoliticaldistanceandwiththelastmodel(incolumn3)includingavariableforregionalgroupings.Higherscoresofeconomicfreedomforboththeexporterandimporterareassociatedwithhigherrealisationoftradepotential.Highertariffsbytheexportingcountryreducesthedistancetothefrontierbuthighertariffsbytheimporterisassociatedwithlowerrealisationoftradeperformance,aswouldbe

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expected.Languagesimilarityisassociatedwithincreasedtradeperformance.BeingamemberofAPEC,ANDEAN,ASEAN,MERCOSERandtheEUareassociatedwithhigherrealisedtradepotentialwithinthatgroup.BeingamemberofSAARCisassociatedwithlowertradeperformanceamongSAARCmembers—aresultthatisthesameasthatdiscussedabove.TheresultssuggestNAFTAdoesnothaveastatisticallysignificanteffectontradeperformance.aresultwhichisunexpected.AllthreeNAFTAmembersarepartofAPECsotheNAFTAeffectmaybepickedupintheAPECvariable.Thepoliticaldistancevariablesthatareincludedareforthewholesample(Politicaldistance),aswellasthatvariableinteractedwithadummyvariableforEastAsiaandSouthAsia.Theyarealsoincludedwithaoneyearlagtoreflectthelaggedeffectwhichoftenvariesbutisgenerallyacceptedtoberoughlyoneyear.(ReuvenyandKang,1998).TheresultsshowthattradeperformanceinSouthAsiaismoreaffectedbypoliticaldistancethanitisinEastAsia.Thisisanimportantresult.ThereisnostrongevidencethatpoliticsaffectstradeperformanceatthegloballevelconsistentwiththeideathatmosttradeisconductedundertheWorldTradeOrganizationsystemandisarms‐lengthandsowouldnotbesosensitivetopolitics,unlikeinvestmentthatrequiresmorecommitmenttoeconomicengagementinanothercountry(ArmstrongandDrysdale,2011).Thelackofaglobalresultforpoliticsaffectingtradeisnotsurprisinggiventhatthedirectionofcausalitybetweenpoliticaldistanceandtradeisnotclear(Polachek,1980;ReuvenyandKang,1998;MansfieldandPollins,2003)andthatthedirectionofeffectisalsounclear.Whileimprovedpoliticalrelations(anarrowingofpoliticaldistance)isusuallyassociatedwithanincreaseintrade,tradehasbeenfoundtoincreaseaswellasdecreasepoliticalamityandenmitybetweencountries(BarbieriandSchneider,1999;MansfieldandPollins,2001).Giventhattheeffectofpoliticalrelationsontradedifferbycountrypairandovertime,thenextsectiontakesacloserlookatsomekeyrelationsinEastAsiaandSouthAsiathatcanfurthertheunderstandingofthefindingsthusfar.

Sino‐JapanrelationsTheeconomicrelationshipbetweenChinaandJapanisoneofthelargestintheworld.Intermsoftrade,itisbehindonlyChina‐USandUS‐Canadainaggregatesize.Giventhattheyarethesecondandthirdlargesteconomiesglobally,andtheyareincloseproximity,ahighleveloftradeisexpected.Buthightradesharesandeconomicinterdependencehaveoccurredwiththebackdropofunresolvedhistoricalissuesthatflareupfromtimetotimeandstrainthe

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politicalrelationship.Theperiodcoveredinthispaper,1990to2006,includestheperiod2001to2006wherepoliticaltensionsrosetoalevelwhereleadershipvisitsweresuspendedbetweenthetwocountriesandtherewerelargeprotestsinChinaagainstJapanandboycottsaimedatJapanesegoods.Yetthesepoliticaltensionsdidnotderailtheeconomicrelations.Thetradeperformanceresultsshowthatinfact62percentoftradefromJapantoChinaand64percentoftradefromChinatoJapanisrealised,significantlyhigherthantheglobalaverage,theaverageofJapan'sexports,theaverageofJapan'simports,theaverageofChina'simportsandonparwiththeaverageofChina'sexportsin2006(seeTable2).Thisperformanceagainstpotentialwasnotaffectedsignificantlyatallbydisturbanceinthepoliticalrelationshipbetweenthesetwopartners.SotheJapan‐Chinatraderelationshiprealisedmoreofitspotentialtradethanothertraderelationships,onaverage.Thathappeneddespitethepoliticaltensionsandconflictsthatrosefairlyhighfromtimetotime.Theperiodofheightenedpoliticaltension,representedbytherisingnegativeactionsoreventsstartingin2001,coincidewithaperiodofpositivegloballydirectedactionsoreventstodowithChina'saccessiontotheWorldTradeOrganization(WTO)inDecember2001.ItwasnotsimplythepositivenewsfromChinajoiningtheWTOthatoffsettheconflictandtension.LowintensityconflictexistedpriortoWTOaccessionandindeedthecontemporaryJapan‐Chinarelationshipsinceengagementin1978featuredperiodsofhighintensityconflict.ButChina'scommitmenttotheglobaltradingsystemsince1986withrapidtradeliberalisationandeconomicreformiswhatgaveJapanesefirmsconfidenceindealingwithChinesecounterparts(Armstrong,2009).Chinasteadilyandincreasinglyconstraineditselftoglobaltradingrulesandnormsthroughits15yearaccessionmarchtowardsmembershipoftheGATTandlatertheWTO.

Cross‐StraitsrelationsPoliticalrelationsbetweenTaiwanandChinaareevenmoredifficultandcomplicatedthantherelationsbetweenChinaandJapan.Inadditionto,andbecauseof,thepoliticaldifficulties,TaiwanhadearlierbannedimportsfromChina.Thesebanswereonlygraduallyliftedduringthe1990sandthenmorerapidlyafterbothChinaandTaiwan’saccessiontotheWTO(DrysdaleandXu,2004;Armstrong,2010).

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Asaresultofthegradualliftingofbans(aconsiderablenumberofwhichstillpersistin2011)realisationofpotentialtradefromChinatoTaiwanhasrisenrapidlyandin2006wasat67percent,significantlyhigherthantheworldaverageandTaiwan’saverageimportsglobally,andonparwithTaiwan’simportsfromotherEastAsiancountries.Politicalandeconomicrelationshaveimprovedfurthersince2006withasignificanteconomicframeworkagreementthataimstoreducethetradeandotherbarriersovertimesignedin2010.ThereareTaiwanesefirmsinChinathatwerenotabletoexportproductsbacktoTaiwanandmanystillcannoteasilyrepatriateprofits.MuchtradeandcapitalhadtopassthroughHongKongwhichwascostlygiventheextradistanceandtransactionscostsinahighlycompetitiveregionwithsmallprofitmarginsacrosstheproductionchain.TaiwanesetradewiththerestofEastAsiawasperformingatanaverageofcloseto60percentfor1990to2006.Taiwanwasdeeplyintegratedintotheregionaleconomyandpartofthecomplexproductionnetworksthatproducespartsandcomponentswheretheyarecheapesttoproduceandthentradedthemtobeassembled.GiventhatbothChinaandTaiwanaresointegratedintotheregionaleconomy,thelostpotentialintradewastoolargeandtheopportunitycostofTaiwan’sdiscriminatoryprotectionistpoliciesbecametooapparentandacute.ItwasthedeepintegrationintotheregionaleconomybybothChinaandTaiwanthathascarriedthebilateraleconomicrelationshipbeyondbeingsimplybilateralinitsnature.EconomicinterdependencebetweenChinaandTaiwangrewastheyincreasinglybecamemoreinterdependentonthesameregionaleconomy.

India‐PakistanrelationsWhiletherelationshipbetweenIndiaandPakistanisunique,andthepoliticaltensionsandhistoricalcircumstancesseriouslydifferfromtheJapan‐China,cross‐Straitsandotherrelationships,thereareusefulinferencesthatcanbedrawnfromthoserelationshipsthathighlightthereasonswhythenegativepoliticshashamperedthedevelopmentofanysignificanttradebetweenIndiaandPakistan.TradefromPakistantoIndiawasachieving30percentofpotentialin2006andtradefromIndiatoPakistanwasat24percentofpotential,significantlybelowaverageIndiantradeperformance,averagePakistantradeperformanceandtheglobalaverage.Thoseresultsareconsistentotherestimatesthatusedthegravitymodelwithoutafrontiersuggestingthatpotentialtradecouldbebetween5and

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10timeshigherthanactualtrade(Taneja,2006;Batra,2004;Kemal,Abbas,andQadir,2002;Khan,2009).Positivenewsandeventshaveincreasedineitherfrequencyorintensitysincethebeginningofthelastdecade(seeFigure2)buttheyhavebeencompletelyswampedbyveryhighintensitynegativeconflicts.Figures2and3showtheKing(2003)datausedaboveforIndiaandPakistan.Thevariablereportedasaction,eventornewsfromIndiatowardsPakistanishighlycorrelatedwiththereportingintheotherdirectionsoFigure3showsthenetofpositiveandnegative,whichiswhatwasusedintheanalysisabove11.Figure2PositiveandnegativenewsandeventsasreportedfromIndiatowardsPakistan

Source:datafromKing(2003)

11Thenegativeeventsaresubtractedfromthepositiveeventstoobtainameasureofnetpoliticalcloseness.Asinutilitytheory,theassumptionhereisthatpositiveeventscanceloutnegativeeventstoacertainextent.Therefore,apositivevalueforthepoliticalvariableindicatespoliticalclosenessandanegativevalueindicateswideningpoliticaldistance.Amovementinapositivedirectionimpliesanarrowingpoliticaldistance.

0

20

40

60

80

100

120

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Positive Negative

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Figure3NetcooperationasreportedfromPakistantowardsIndia

Source:datafromKing(2003).Netcooperationispositivenewsandeventslessnegativenewsandevents.

BothFigure2andFigure3showthatthenegativesoutweighthepositivesintheIndia‐Pakistanrelationship.Whilethatcouldbetheresultoftheweightingsystemappliedtotheeventsdata,thenetcooperationvariableforJapan‐ChinaandTaiwan‐Chinaisconsistentlypositive.Pakistanhasnotyetreciprocatedmostfavorednation(MFN)statusforIndiaandmaintainsafairlynarrowpositivelist(786items)ongoodsthatIndiamayexporttoPakistan(Khan,2009).Atthesametime,India’stariffratesremainhigh,especiallyforgoodsofparticularinteresttoPakistan,suchastextiles,leather,andonyx,andnontariffbarriersaresubstantial(Khan,2009).Unlikethecross‐Straitscasewhereimpedimentstotradewerereducedovertimeastheregionaleconomybecamemoreintegratedaroundthem,thelackofSouthAsianeconomicintegrationandinterdependencemeansthereismuchlessincentivetoreducebarrierstotradeorimprovethepoorinfrastructure,liftbansoninvestmentandeasepeoplemovementacrosstheborder.SinceSouthAsianeconomicintegrationislagging,dealingsbetweenIndiaandPakistanareprimarilybilateralanddonothavethepositivesumeconomicelementthatispresentinEastAsia.Thatinevitablyleadstothepolitical‐securityissuesdominatingbilateraldealings(andlackofpositiveeconomicnewsandeventsbetweenthetwoinFigures2and3).Politicaltensionshavedominatedtheeconomicrelationsandeconomicrelationshavenotbeenabletoimproveandhaveapositiveeffectonthepoliticalrelationship.

‐160

‐120

‐80

‐40

0

40

80

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

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ConclusionsTherearethreesetsofconclusionsthatmightbehighlightedfromthisdiscussion.First,EastAsiaismoreintegratedthanSouthAsia,bothintermsofintraregionaltradeandwiththeglobaleconomy.EastAsiaisalsorealisingmoreofitsintraregionaltradepotentialthanNorthAmericaandEurope.Infact,EastAsianeconomiesingeneralachievemoreoftheirtradepotentialamongEastAsianpartnerscomparedtotheirtradeglobally.SouthAsia,ontheotherhand,realisesmoreofitspotentialtradewithtradepartnersoutsidetheregionthanwithinitsownregion.Keybilateralandcountrytraderesultsaddtotheunderstandingofthoseregionalleveltradepatterns.IndiaisrealisingmoreofitstradepotentialwithEastAsiathanwithitsownregionandtherestoftheworld.PakistanitradewithIndiaisrealisingmuchlessofitspotentialthanPakistanitradeoverall.TradebetweenJapanandChinaovertheperiod1990‐2006andbetweenChinaandTaiwanlaterinthatperiod,areperformingclosertopotentialthantheiroveralltradeandmuchmorethantheglobalaverage.Second,theeffectontradeofpoliticaldistancebetweencountriesismorepronouncedforSouthAsiathanitisinEastAsia.ThisresultismostlikelyduetothefactthatEastAsiaismuchmoreeconomicallyintegratedthanSouthAsia.ThestoryinmostofEastAsiahasbeenthatofeconomicrelationsdominatingthepoliticalrelationsandthepositivesofincreasedeconomicinterdependencedampeningtheeffectsofthenegativeaspectsofpoliticalrelations.InSouthAsiatheupsanddownsofpoliticalrelationshavealargernegativeeffectontrade.Finally,theexperienceoftheJapan‐Chinarelationshipshowstheimportanceofcountriesintegratingintotheglobaleconomyandbeingpartoftheglobaltradingsystemforbilateralrelationshipstoprosper.Theexperienceofthecross‐Straitsrelationshiphighlightstheimportanceofintraregionaleconomicintegrationforimprovingbilateraleconomicrelations.IndiaandPakistanareneighboursinaregionthathasmuchlowerachievementofpotentialtradethantheglobalaverageandistheleasteconomicallyintegratedregionglobally.Allbilateraleconomicdealingsareswampedbybilateralpoliticaldealingswhicharedominatedbynegative‐sumorzero‐sumsecurityissues.TheexperienceofEastAsiawhichshowsthatbilateraleconomicrelationsnestedinahighlyintegratedregionthatisoutwardlookingandgloballyorientedcanhelptodampenandevenreversetheeffectsofpolitical

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conflictontrade.Thenon‐integratingEastAsianeconomiesofNorthKoreaandMyanmarareimportantexamplesofclosedeconomiesassociatedwithpoliticalconflict'sdominatingbilateralrelationswiththeirneighboursandbeyond.AstrategicinferencefromtheseconclusionsandtheargumenthereisthatpoliticalproblemsthatlimiteconomicintegrationinSouthAsiaarelikelytobecomemoretractableifthewholeregionistiedmorecloselyintopositivetradeandeconomicrelationstrans‐regionallyandgloballyandtofullobservanceoftheglobalrulesoftrade.

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