TWN Info Service on Free Trade Agreements

24 January 2007


FTA Fever Hits Malaysia

Below is a series of articles on the Malaysia-US FTA talks published in the Edge weekly.

It gives an overview of the contentious issues that are currently on the table between the two countries. While it mentioned some of the areas that Malaysian companies and the public might benefit, it also highlights the pitfalls that Malaysia could encounter.

To find out who is likely to gain – and who will lose, we have attached below the main articles from the series.


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Item 1

Mad race for FTAs
Stories by Maryann Tan, The Edge, 15 January 2007

The numbers 338 and 339 have great significance to those in the garment business. They are the category numbers for cotton knit, round-neck and collared shirts, the most common products manufactured by Malaysian garment companies.

Categories 338 and 339 also make up part of the sensitive and highly protected categories in the US garment market. Even after the quotas were abolished with the expiry of the WTO Agreement on Textiles and Clothing in 2005, Malaysian manufacturers have found it difficult to exploit the US garment market.

"The numbers — 338 and 339 — are hot categories. We don't have to worry about quotas anymore but the import duties are still an irritant," grumbles Tan Ching Yong, senior vice-president of Axis Incorporation Bhd, a Johor-based contract manufacturer for brands like GAP, Puma and Macy.

Notoriously protective of its textiles and garments market, US import duties on Malaysian garments range from 12% to 20%. Even without quotas, US imports of apparel from Malaysia grew a mere 0.02% in 2005.

Like the rest of the industry, Tan has high hopes that made-in-Malaysia T-shirts will be able to enter the US market, free of duties, when Malaysia and the US conclude talks on a proposed free trade agreement (FTA).

"If there are no more duties, we will consider expanding our sample room facilities in Malaysia and we could bring high-value garment manufacturing back to Malaysia," he says.

Tan reckons he would need to hire between 500 and 1,000 workers if he does. Axis laid off 500 workers when it moved manufacturing facilities from Johor to Vietnam and Cambodia in 2004.

This opportunity for Axis to create jobs for Malaysians seems like excellent news to domestic policymakers, but it will only happen if those import duties are actually removed.

Realistically, can Malaysia wring out a concession from the Americans to eliminate import duties and subsidies of their sensitive sectors?

It seems unlikely when even other developed countries have failed to gain meaningful access to the US agricultural market through an FTA.

Australia, for instance, wanted higher quotas for its sugar exports to the US but it failed to win even a spoonful. Australia's increased beef quotas under the Australia-US FTA was confined to low-grade beef and spread over 18 years.

There's also the question of whether the US Trade Representative (USTR) can legally offer more to its prospective FTA partner.

By law, the USTR only has executive powers to offer a reduction in tariffs that exceed 5% by no more than half.

So, at best, categories 338 and 339, namely cotton knit, round-neck and collared shirts, can have their tariffs lowered to about 10%. That may be insufficient for Axis to consider moving back here. And that's not even considering the complicated rules of origin that come with agreements on textiles and garments.

US trade reports as of last November indicate that Malaysia is seeking early elimination of tariffs on textiles and garments, rubber and wood products, ceramics, electronics and agriculture. These categories of goods have tariffs of between 5% and 32%.

Broadly, both countries have also discussed phasing out tariffs on industrial and agricultural goods — some immediately and others over five, seven and 10 years. There is also a list of sensitive products that will carry an undefined phased-out time frame.

It is estimated that an agreement on market access for goods may cost Malaysia US$950 million (about RM3.4 billion) in tariffs over the period of the Ninth Malaysia Plan (9MP). Eliminating tariffs may benefit the US more since its tariffs are, on average, lower than Malaysia's.

The US is Malaysia's largest trading partner, with RM160.95 billion (US$44 billion) in two-way trade recorded in 2005. Malaysia is also netting a healthy and growing trade surplus with the US (2005: US$23.3 billion).

While manufacturers like Axis are still optimistic, those examples illustrate how tricky FTA negotiations can get. Developing countries especially, with their limited resources and data, are often at the losing end when dealing with their richer counterparts.

For an idea of how difficult the negotiating table looks, try this for size. Of the 23 issues or chapters that will be discussed in the US-Malaysia Free Trade Agreement (USMFTA) talks, Malaysia is represented by 11 ministries and departments. These ministries also consult with trade groups like the Federation of Malaysian Manufacturers and the Malaysian Textiles Manufacturers Association.

The USTR is advised by the Trade Policy Advisory Committee System established in 1974. This consists of 33 advisory committees with 1,000 advisers, representing the private sector. This committee system is made up of three tiers: the President's Advisory Committee for Trade Policy and Negotiations; six policy advisory committees and 26 technical sectoral and functional advisory committees.

In US-Malaysia talks, behind the face of the USTR are many more faces representing big American corporations. They band in the form of the US-Malaysia FTA Business Coalition, a club that includes names like American International Group, Cargill, Citigroup, Intel Corp, General Electric, Federal Express and ExxonMobil.

"As far as we know, on the US side they bring along experts and lawyers to negotiations but on the Malaysian side, they are mostly civil servants," says Lim Li Ching, a researcher with the Third World Network, the non-governmental organisation that is part of a coalition against the USMFTA.

The lack of disclosure from the Malaysian side is making certain segments of civil society nervous. Last week, rice farmers and environmental groups presented a memorandum to the Prime Minister, protesting the USMFTA talks and demanding greater transparency. Some 296,000 farmers rely on rice for a living.

"There needs to be a wider national discussion about all these issues because they are wide ranging. To be honest, when you ask Malaysians about the FTA, do they know anything about it?" Lim says, adding that the hushed talks with Japan caught many people by surprise last year.

Ironically, it is US web sources that provide information and updates on Malaysia's position after each negotiating round.

Why FTAs?

Certainly, the ideal of a bilateral FTA is realised when both parties agree to remove barriers to trade, allowing both to exploit their comparative advantage; mutually prospering as a result.

The FTA logic suggests that when markets liberalise, consumers are accorded greater choice and lower prices.

Inefficient industries or players are forced out of the market, leaving only the best to survive. The winners will ultimately outweigh the losers.

If only it were that simple.

It is true that trade liberalisation as a tool to enrich all was the guiding principle behind the formation of the World Trade Organisation (WTO). But in recent years, the WTO has acknowledged that different countries have different development requirements. It is patently unfair to pit a heavyweight against a featherweight. Thus was born the principle of special and differential treatment.

Unfortunately, where the multilateral system of the WTO succeeded in giving members equal treatment, it has failed to see a trade deal through, as with the latest suspended Doha Round.

With negotiations yet to be revived, faith in the multilateral system is vanishing. Are FTAs the answer for a country like Malaysia, then?

Trade sceptics would say no if it involves developed countries like the US. Agreements are not just confined to traditional issues of trade in goods and services, and non-tariff barriers. These days, they are wide ranging, and their repercussions are much more difficult to predict.

The problem in dealing with the US, though, is that Malaysia needs to be certain which sectors require protection. This is because USFTA talks take a "negative list" approach in discussing the services sectors.

This approach requires parties to the negotiations to list down all the sectors they wish to protect. Any sector not on the list, or new sectors that emerge in future, will automatically be opened to US competition regardless of its readiness.

Again, this is disadvantageous for developing countries with less market knowledge and resources.

Among the issues under discussion are the liberalisation of professional services, telecommunication sectors, media and broadcasting, express delivery services and a separate chapter for financial services.

The US wants full market access and national treatment for some of these sectors.
In financial services, the US is interested in gaining greater market access through bank branching and changes to the limits on foreign ownership of banks and insurance companies.

While Malaysia has unilaterally committed to liberalising the financial sector, a USMFTA will probably bind Malaysia to the timeline it has set under the Financial Sector Masterplan. This gives Malaysia less flexibility, if it wants to adjust the time line.

One of the things that Malaysia may have to compromise is its autonomy to set capital controls in a financial crisis —something that hits very close to home.

As recalled in The US-Singapore Free Trade Agreement: Highlights and Insights, whose editors include Tommy Koh, Singapore's Ambassador-At-Large and chief negotiator of the USSFTA, Singapore's leaders were ready to seal the deal with the US but the Americans wanted to include text that would prohibit Singapore from imposing capital controls in a period of financial crisis.

The Singaporeans left Washington with no deal when the Americans wouldn't back down. Only after another two months of talks did both parties agree to allow capital controls with some exceptions.

Trade researchers, however, are still unsure whether Singapore has fully preserved all the rights it needs, in the event.

FTAs as a means to control trade

In many ways, economists see FTAs as much less about enhancing trade than about controlling trade.

"As far as trade in goods is concerned, it's pretty much level already. That era is over," says Datuk Dr Sothi Rachagan, economist and vice-president of Nilai International College.

"The areas of focus now are the Singapore issues, and particularly intellectual property protection."

The "Singapore issues", as they are known, were first proposed at a 1996 WTO Ministerial Conference in Singapore. They encompassed issues relating to transparency in government procurement, competition policy, protection of investor rights, and trade facilitation.

Rich countries had pushed hard for these items to be included in WTO talks, but strong protests from poorer countries (including an adamant Malaysia) led to the WTO General Council to declare that only "trade facilitation" would be included in the current Doha Round of negotiations.

Not surprisingly, those issues that were once seen to have little regard for developing countries' needs, are coming back to haunt them through FTAs. Nations like Japan, the European Union and the US insist that the issues rejected at the WTO be an essential part of FTAs.

The economic counsellor of the US Embassy in Malaysia, Colin Helmer, readily admits this.

"If all this was like the WTO, then there'd be no point investing all this effort," he said when The Edge met with him in December. "It's pretty expensive to do these things — a lot of time, a lot of business-class air tickets. So, we wouldn't be bothered if it was just about doing a WTO."

For Malaysia's part, it has already crossed into new territory with the Japanese. Text in the Japan-Malaysia Economic Partnership Agreement (JMEPA), signed in December 2005 and implemented last June, includes provisions for investor-state dispute settlement and the principle of national treatment for investments.

This means Japanese investors in Malaysia must be given the same rights and privileges as Malaysian investors, unless otherwise stated. This article doesn't apply to portfolio investments, showing some flexibility to the agreement.

"To have given national treatment at all is already a big deal," says a trade lawyer, who doesn't think the Americans will grant much flexibility in the investment chapter of the USMFTA.

It is the track record of USFTAs that gives rise to this belief. The USTR uses a template when it negotiates FTAs, regardless of the development level of its partners. The contentious chapters on intellectual property rights, competition policy, investment and government procurement will likely be worded in similar language to USFTAs with Australia and Singapore.

This homogenisation of FTAs between US and Asean countries (the US has expressed its desire for FTAs with all Asean countries), has fuelled the idea that comprehensive FTAs preferred by developed countries are nothing more than an infrastructure for the control of trade.

Charles Santiago, an independent political economist and consultant on development issues who runs his own outfit, Monitoring Sustainability of Globalisation, thinks an FTA with the US will bring devastating effects to Malaysia.

This may not happen immediately, but eventually Asean countries, in their eagerness to court US investment through signing FTAs, are going to destroy each other in what he calls a "mad race that they can't win".

"What we are seeing through these series of FTAs is the convergence of domestic laws with that of the US and the Europeans," he tells The Edge. "American, Japanese and European MNCs want to consolidate their presence in Southeast Asia; what they are doing is asking for greater investor rights."

Legally binding FTAs, which determine the rules on investment and intellectual property (allowing companies to sue governments for expropriation), give MNCs a strong assurance that there will not be flip-flops in investing rules.

Santiago wonders how such deals actually enhance trade and lead to wealth creation when governments' policy spaces are severely compromised.

In his paper on the impact of USFTAs in the Asean region, Santiago notes that governments are competing intensely with each other for available FDI — most of which is today flowing to India and China.

This means they need to create a conducive business environment to attract FDI, and, therefore, have little choice but to respond to the dictates of the MNCs. International Trade and Industry Minister Datuk Seri Rafidah Aziz's comments on the USMFTA reflects this notion.

Last August, she was quoted as saying FTAs were negotiated with the interests of the business community in mind.

"We are talking about opening up the market for the industry, whether services or goods. Thus, we must remember because the industry is the one that tells us [government] what we need to do," Rafidah said, in a Bernama report.

Neither Rafidah nor Miti officials responded to requests for an interview by The Edge.

If declining FDI were one of the main drivers, an FTA could be a remedy. Four months into JMEPA, Japanese FDI to Malaysia jumped five times to 203 billion yen (July-October 2006).

"The increase may reflect Japanese businesses' confidence in the business environment in Malaysia, and JMEPA, which paved the way to assure Japanese investors would not be worse off, improved predictability in the business environment in Malaysia," says Kentaro Sakai, the financial/customs attache and first secretary of the Japanese Embassy.

Still, the World Bank notes that the economic benefits from granting stronger investor protection have yet to be demonstrated.

And to be really beneficial, countries ought to keep tabs on the FDI that flows in (see separate story on FDIs).

In all fairness, like JMEPA, the USMFTA will likely allow for safeguards and reservations for Malaysia to carry out its socio-economic policies. The obvious strategic interests can still be protected under an agreement.

Santiago is sceptical, though. He thinks it will be big businesses on both sides which will benefit the most from a treaty.

It is the small and medium-sized enterprises and individuals by the wayside that will be trampled on as they struggle to compete on developed country's terms.

For every garment maker hoping to sell more shirts to the US, there is an angry rice farmer fearing the loss of livelihood or a generic drug maker that may lose the equal opportunity to produce affordable medicines.

Alas, they have become merely necessary casualties of globalisation.

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Item 2

Contentious issues in US-Malaysia FTA talks

Government procurement
Malaysia's policies that give special rights to bumiputeras will inevitably be raised in the negotiations.

The US says it is sensitive to Malaysia's socio-economic development policies and will accommodate some of her needs. It does, however, want Malaysia to be more transparent in the decision-making process.

This may be a welcome development since many Malaysian companies have been grumbling that the government hasn't followed through with its promise to make open tenders the norm and to limit direct negotiations.

The American-Malaysian Chamber of Commerce, in its public submission for the USMFTA, requests that foreign companies which bid for government contracts should not be required to have 30% of their equity held by bumiputeras. It also wants to eliminate "middlemen" in the submission of tenders.

Trade experts advise caution, nonetheless. Transparency in GP at the WTO was seen as a way by developed countries to get their foot in the door before eventually gaining full market access and national treatment.

The other principle of GP is reciprocity. This means the US will make available its GP market in equal proportion that Malaysia is willing to.

So, the entire US$250 billion US GP market may not be opened to Malaysian companies.
"We talk about other ways of shaping the package… another way of looking at it is balanced access," says Colin Helmer, economic counsellor at the US Embassy. "It's not dollar for dollar, ringgit for ringgit... if you say to us we can open up 50%, then we'll try and say for package, it's roughly 50% on our side."

The Malaysian GP market in 2004 was estimated to be worth 20% of GDP or RM90 billion.

The US also notes that a GP will benefit US manufacturers in Malaysia like Dell who aren't able to sell its PCs to the US government because of an absence of a GP agreement. Helmer also cites rubber gloves makers as examples of companies which can take advantage of GP.

But whether Malaysian companies can, in reality, benefit is questionable. The US government's Federal Procurement Data System shows that for 2005, 94% of the initial contract value went to companies located in the US. The remaining 6% was divided up among companies located in 170 countries and territories. That speaks volumes of the competition in the US.

TRIPs and more?

Among Malaysian manufacturers which keenly support the USMFTA, there is a sole dissenting voice from the Malaysian Organisation of Pharmaceutical Industries (MOPI).
Of grave concern is the chapter on intellectual property which raises the standards of copyright laws, patent protection, and the extension of the list of things that can be patented to plants and animals.

Past USFTAs have been criticised for restraining countries with laws that were over and beyond what's deemed as sufficient under the WTO's agreement on Trade-Related aspects of Intellectual Property rights (TRIPs); in other words, they are TRIPs-plus agreements.

"It is absolutely TRIPs plus; it goes back to the idea that if all of this were TRIPs, then why are we wasting our time? It's got to be TRIPs plus," Helmer says.
Trade lawyers say TRIPs-plus provisions undermine a country's liberty to use what is known as "compulsory licensing" (CL).

If governments feel there is a need to prevent the spread of an epidemic and if its resources to do so are limited by the high cost of drugs that are still on patents, it can issue a CL to a private company or a government agency to exploit a patent without the patent holder's consent.

Among the typical reasons cited for granting a CL are the refusal of a patent holder to grant authorisation, national emergencies and extreme circumstances or to remedy anti-competitive practices. Legally, WTO members are free to determine further grounds for issuing CLs.

The Doha Declaration of the 2001 WTO Ministerial Conference reaffirms this right.
Malaysia has made use of the CL provision to authorise the private sector to produce low-cost anti-retroviral drugs for HIV sufferers. This has also benefited companies like Duopharma Biotech.

MOPI says that in 2005, generic medicines worth RM1.2 billion were manufactured.
USFTAs generally want to narrow the grounds for issuing CLs to three circumstances. Furthermore, the US also wants to include data exclusivity in the IP chapter.

This means generic producers won't be able to rely on clinical trials done by a drug's inventor when it wants to register its generic version with the Ministry of Health.
The availability of clinical trial data helps the public gain quicker access to cheaper medicines. Data exclusivity could render CLs useless.

Data exclusivity can help extend the monopoly of the inventor, effectively making medicines more expensive.

"We have to be really careful about this, especially medicines. Some countries have drawn a red line, saying they won't compromise on that," says Lim Li Ching, researcher at Third World Network.

"What are Malaysia's non-negotiables? We don't know. We think that medicines should be one of it. We shouldn't negotiate away our health."
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Item 3
The detrimental effects of unbridled FDI

If attracting foreign direct investment (FDI) were like a beauty pageant, then Malaysia's vital statistics show that her once solid figure is going a little pear-shaped.

According to United Nations Conference on Trade and Development (Unctad)'s World Investment Report 2006, Malaysia was ranked 62nd last year in receiving FDI, a far cry from fourth place in 1994 and fifth in 1995.

In dollar terms, Malaysia's receipts are correspondingly falling, too. Economists and politicians couldn't help but worry over Unctad's report which showed Indonesia overtaking Malaysia with US$5 billion (about RM18 billlion) in FDI in 2005 against the US$4 billion that flowed into Malaysia.

Malaysia was also nowhere to be seen on the top 25 list of preferred FDI locations, according to the 2005 AT Kearney Global FDI Confidence Index. This was a marked deterioration from 2004 when Malaysia rose from 23rd spot to 15th because of governance reforms.

For sure, the allure of China and India has made Southeast Asian economies a little uneasy.

It's no surprise then that richer Asean economies are polishing themselves up to keep multinational corporations (MNCs) within their shores or at least, keep them from uprooting to lower-cost bases.

The trouble is MNCs know this only too well. By design or not, Asean economies' craving for FDIs put the large corporations in much stronger bargaining positions.
Lump these MNCs together with trade negotiators of developed countries and you have a deadly combination, capable of squeezing out huge concessions and privileges from smaller economies.

At the World Trade Organisation (WTO) level, developed countries such as the US have tried hard to push through an agreement on investment, which would have compelled developing countries to loosen foreign investment regulations.

These could range from lifting ownership restrictions, prohibiting countries from applying performance indicators, and limiting technology transfer, local content and local labour requirements.

But the multilateral process proved difficult as developing countries, including Malaysia, banded together to push such demands which they saw as more "win-lose than win-win", on the back burner.

With the US pursuing bilateral agreements, these issues are coming back to nag developing countries.

Critics see the United States Free Trade Agreements (USFTAs) as a way for MNCs to advance their interests at the expense of the needs of developing countries.

Of profound concern is the expropriation provision and an investor-to-state dispute settlement process. The aim is to reduce the risk associated with investing in a foreign country.

This gives the investor the right to claim compensation, including interest, on losses that arise from direct or indirect expropriation.

The question now for Malaysia is: Is greater liberalisation worth the incremental FDI?
One economist has taken a critical look at FDI, studying its effects from a balance-of-payment standpoint.

In a 2003 study done for Third World Network titled Financial Effects of FDI in the Context of a Possible WTO Agreement on Investment, David Woodward warns of the dangers when such an agreement threatens to take away the policy space governments need for prudent management of FDI flows.

Woodward argues that the pile-up of FDI stock in developing countries in the 1980s and 1990s was responsible for the current account deficits that made them vulnerable to financial crises like the one that rocked Asia in 1997.

These unprecedented levels of FDIs, he says, are analogous to high foreign debt levels with interest payments that will have a strong impact on the countries' balance of payments in the long term.

The basis of Woodward's take on FDI is to look at FDI flows as if they were loans; the repatriation of capital to the home country by the investor, as repayments; and the profits on investment, like interest payments.

There is a balance of payment (the net of transactions between Malaysia and the rest of the world) effect when foreign enterprises spend on local inputs like paying wages, selling their products in the domestic market and exporting them to other markets.
In order for the FDI to have a net positive effect on the host country, the foreign enterprise's local spending less its local sales must be greater than its total profits from the venture. This is because the domestic and export sales are viewed as outflows when they accrue to the foreign firm.

Better still if the entire venture is purely an export one. That way, there won't be any leakages through domestic sales by the foreign firm, only investment in inputs which have a multiplier effect on the host economy.

From this analysis, a positive effect in the services sector is virtually impossible. This is especially so when investment in the services sector typically involves either an acquisition of an established firm in the host country or the local incorporation of a company by the foreign investor to provide services in the host country.

Woodward distinguishes the effects of FDIs that create new capacity, FDI in the services sector and FDIs that purchase existing productive capacity (without subsequent expansion); he notes that the latter two will have negative financial effects.
Taking Malaysia's historical data, Woodward notes that even its high export-oriented FDI in the 1990s contributed substantially to the current account deficit, thereby rendering it more vulnerable to the capital flight that followed.

Between 1994 and 1996, the FDI inflow (as reflected in the capital account), was inadequate to offset the FDI-related current account deficit.

Malaysia had exceptionally large stock of FDI in the 1990s — 48% of gross domestic product (GDP). By their export-oriented nature, the effect on the balance of payments should have been more favourable but this wasn't the case.

He thus warns that FDI inflows should not be allowed to spiral out of scale with economic growth.

"The prudent course is not to get onto this path in the first place, by being cautious in accepting inward FDI, and selective in what forms of FDI are accepted to ensure that the benefits outweigh the long-term costs," Woodward explained, when The Edge contacted him via email.

Yet, it is hard to imagine Asian economies limiting the extent of inward FDI when, at its best, FDI can bring huge indirect benefits.

Export sector jobs are believed to be better paying than domestic ones. It is also a quick way to develop local skills and knowledge.

A number of companies listed on Bursa Malaysia, for instance, were founded by people who had spent some years with US electronics giants like Intel and Hewlett-Packard.

By most measures, Telenor's investment in DiGi did shake up Malaysia's telecommunications industry for the better. Woodward himself acknowledges that telcos may be a possible exception to his general scepticism about FDI in the services sector, although he had in mind, poor countries suffering from severe limitations in telco infrastructure.

Furthermore, Woodward doesn't consider FDI in the services outsourcing sector, much of which is an export-oriented service employing locals.

Still, the study does remind countries of the need to maintain autonomy over investment policies.

It is unclear if Malaysia will accede to US demands when negotiating the investment chapter of the FTA. Its proponents note that countries that have signed FTAs with the US
typically experience a surge in FDI.

Even so, critics see it as a temporary measure that won't fix Malaysia's real shortcomings. It should instead focus on long-term structural changes involving human capital development.

Like any health-conscious beauty queen hopeful, Malaysia should know that crash dieting can be bad for her.