2005 Asia-Pacific Outlook

Date: 01-12-2005

This report includes the following pieces by East-West Center specialists:
1. Impact of Natural Disasters Takes Center Stage, by Allen Clark
2. Oil and Energy Outlook: Prices Have Entered New Plateau, by Kang Wu
3. China Outlook Remains Cloudy, by Chris McNally
4. Indonesia: Challenge and Opportunity, by Richard W. Baker
5. South Asia: Same Challenges, Growing Opportunities in Trade and Energy, by Arun Swamy
6. Economic Focus: U.S. Deficits, Japan Economy, Tsunami Recovery, Textiles,
by Sumner La Croix
7. Asia's New Role in Globalization of Innovation, by Dieter Ernst
8. Peaceful Resolution or Confrontation? Awaiting a Turning Point on North Korea,
by Choong Nam Kim
9. For World Climate Community, A Significant Year Ahead, by ZhongXiang Zhang

By Allen Clark, senior research fellow, executive director, Pacific Disaster Center on Maui, which is managed by the East-West Center, Honolulu (808) 944-7509 or Maui (808) 554-6184,
clarka@eastwestcenter.org .

The global community has been dealt a deadly body blow, generated by the Great Sumatra Earthquake and Tsunami. In 2001, the world's attention was dramatically refocused away from natural disasters to our war on terrorism. The pendulum has now swung back, necessarily refocusing the world's attention to the relentless and devastating impact of earthquakes, tsunamis, and other natural hazards on sustainable development in the Asia- Pacific region. The 2004 Atlantic hurricane season, spawning familiar names of Charlie, Frances, Ivan, Jeanne -- matched only by the counterpart Pacific Typhoon season in which Japan was battered by more than 10 typhoons -- was merely a harbinger for the humanitarian crisis in Southeast and South Asia we face today. These events necessitate that the focus of the global community will be on international cooperation and response; global disaster risk reduction; natural disaster early warning systems; and the creation of disaster-resistant communities.

International cooperation and response will be the No. 1 priority in 2005 as the billions of dollars of promised assistance are allocated and distributed to meet the needs of the Asia-Pacific region. This allocation process will first have to meet the immediate needs of the millions of displaced and homeless people for shelter, water and sanitation; second will be the need to ensure that the spread of disease that so often follows such disasters is controlled; and third, that essential services of communication, infrastructure and governance are provided for. Once these needs are met, the longer-term process of rebuilding can begin.

Global disaster risk reduction has taken center stage, following the horrific loss of life and property from the Sumatra earthquake and tsunami, and it is certain to be one of the most important major global issues for 2005. The issue will be foremost on the agenda of the 5,000 policymakers, planners, decision makers, and disaster management experts who will attend the Jan. 18-22 United Nations' 2nd World Conference on Disaster Reduction: A Safer World for All. It is widely anticipated that this conference will increase the international profile of disaster-risk reduction in terms of social, cultural, environmental and developmental costs; promote integration of disaster-risk reduction concepts into development planning and practice; and strengthen local and national capacities to address the causes and impacts of disasters that continue to devastate and impede the development of many countries.

Early warning systems, particularly for the Indian Ocean region, needed to ensure adequate preparedness and warning in case of natural disasters, will be a second focus of the international community. Such systems will need to be developed and integrated with existing capacities in order to develop a truly global early warning system. Although technologically feasible, such systems will need to focus on two associated issues:

-- The "Last Mile" -- developing the technology and implementing the systems that provide warning to those in remote/isolated areas.
-- Multi-hazard warning systems -- developing systems that warn of all types of natural hazards rather than the present system of individual hazard-warning systems.

Creation of disaster-resistant communities -- particularly with respect to areas and/or communities/cities bordering on the ocean -- will be a third focus. Central to achieving sustainable development in the face of continuing natural disasters is the development of disaster-resistant communities. This will be a major and continuing focus for 2005 and beyond for the East-West Center, Pacific Disaster Center, and the global community.

Four component parts of developing disaster-resistant communities will have to be addressed concurrently and over an extended period of time:
-- Global risk and vulnerability analyses to identify the communities at risk and put in place the appropriate preparedness and mitigation plans.
-- Rebuilding for sustainable development based on identifying the links between disaster-risk reduction and long-term development planning so that the errors of the past are not revisited.
-- Capacity-building at the local, national, and regional levels so that the tools and expertise are available to effectively anticipate, communicate and address the impacts of natural disasters.
-- Governance for effective risk management that draws upon the strengths and capabilities of all shareholders (government, civil society and local communities) for the development of accessible, effective and innovative disaster management for all communities.

By Kang Wu, East-West Center research fellow, oil and energy specialist, (808) 944-7521,
wuk@eastwestcenter.org .

Global Oil Market and Oil Prices:
World oil prices rose 22-35 percent in 2004, reaching the highest levels by the year-end since 1980. Although in real terms, oil prices today are still half of what we had in the early 1980s, there is no doubt that the prices have entered a new plateau of high levels as compared to a few years ago. For 2005, global oil supply is expected to be tight while oil demand will be growing continuously. The Asia-Pacific region as a whole is likely to account for over half of the incremental oil demand in 2005, though the demand growth in both Asia and the world is expected to be lower. Factors that will influence actual oil prices in 2005 include overall oil demand, the role of OPEC (Organization of Petroleum Exporting Countries), the supply of non-OPEC countries, oil inventory variations, levels of terrorist activities, frequency of energy-related accidents, and weather conditions. Given the fundamentally tight demand and supply of oil, volatilities of oil prices caused by short-term interruptions are inevitable for the year.

Asia's Rising Dependence on Middle East Oil:
In 2004, Asia's dependence on imported oil, particularly imports from the Middle East, rose to unprecedented levels. The dependence is expected to rise in 2005. The Strait of Malacca is now the world's busiest waterway for massive oil shipping, where over a half-billion metric tons of oil flowed in 2004, primarily from the Middle East to Asia. Fortunately, the tragic tsunami in the Indian Ocean caused by the earthquake off Sumatra has had little direct impact on the sea-lane transportation of oil and on the Strait of Malacca itself. However, the impact of potential interruptions of sea-lane oil transportation will certainly cause increased concern over energy security in many Asian countries. Although this means it is more important for Asian countries to have more and better-coordinated energy cooperation, the rising oil dependence on imported energy and potential danger of supply disruptions may also raise tensions in the region, where goals and needs of individual countries for energy security differ from each other.

China's Energy Demand:
In 2004, China had double-digit growth for demand of oil, gas, coal, power, and energy as a whole. Electric power shortages have occurred in over half of the provinces in the country. For oil, China's estimated demand growth in 2004 was 15 percent, accounting for about one-third of the global incremental oil demand. Although it is unfair to blame China entirely for the surge of world oil prices, the country does play a big role in sustaining these high prices. For 2005, the high energy demand growth in China seen in 2004 may not be sustainable but the growth will continue to be positive and strong. The issue of China's energy demand is thus worth being observed throughout 2005.

Energy Cooperation and Competition in Northeast Asia:
The rivalry between Japan and China over the routing of Russia's oil pipelines in Northeast Asia came to an end at the start of 2005 as Russia decided to build the pipeline to the Pacific Far East rather than to China. For 2005, the challenge for Russia is how to implement the multi-billion pipeline project, which is supported by Japan to the disappointment of China. How bilateral or trilateral relationships between Japan, China, and Russian will be affected is another issue to assess in 2005. In the meantime, ASEAN (Association of South East Asian Nations) Plus 3 (Japan, China, and Korea) is calling for more energy cooperation in Asia. It will be interesting to see how energy cooperation and competition unfold and affect each other in Northeast Asia and Asia at large.

By Chris McNally, research fellow and China specialist, (808) 944-7239,
mcnallyc@eastwestcenter.org .

The year 2004 was a good year for China in most respects. The economy boomed and is expected to have grown 9.2 percent. Foreign trade jumped 30 percent, making China the third largest trading power in the world. Most importantly, the government seems to have at least initially succeeded in reining in red-hot investment in property and large industrial plants, dissipating some of the dangers of a popping bubble.

On the political front, the Chinese Communist Party completed a smooth hand-over of power to the fourth generation, a rather exceptional feat for a still authoritarian regime. Yet, society seems to have become restless, with incidences of urban and rural unrest rising. Beijing has also continued to face challenges along China's outer rim. The Hong Kong government struggled with political demands and social activism, while in Taiwan, Chen Shui-bian won another term for president. Tensions across the Straits are thus set to continue.

The outlook for 2005 remains cloudy, mainly because China has become so much more integrated with the global economy. Any external shocks, such as a spike in oil prices or a rapid decline of the U.S. dollar, could ricochet and check China's economic boom. Without any of these unforeseeable events taking place, China's economy is likely to continue its rapid growth. Indeed, with low labor costs and the removal of textile quotas, China will continue its march toward becoming one of the most competitive economies in the world.

The year 2005 is likely to produce more challenges on the political front. One way or another, the Chinese government must get a better handle on corruption and the growing wealth gap. Further institutionalization of governance and better rule of law are in need of a major boost. Perhaps the darkest side in China's outlook concerns Taiwan. With Chen Shui-bian unlikely to shy away from his pro-independence agenda, and Beijing ratcheting up the ante with the proposed Secession Law, the Taiwan Strait will continue to be a dormant volcano.

By Richard W. Baker, special assistant to the president and Indonesia specialist, (808) 944-7371,
bakerr@eastwestcenter.org .

The year 2005 will be the determining year for the new Indonesian government under retired general Susilo Bambang Yudhoyono. The reformist ex-security coordinating minister came into office on a wave of popular sympathy and support following his break in early 2004 with former president Megawati, besting her by a landslide 60 percent to 40 percent in the presidential runoff election of Sept. 20. His cabinet appointments showed an ability to combine professional expertise with a broadening of his political coalition. In December he scored a major coup when his vice president, Jusuf Kalla, won the chairmanship of the Golkar party, which holds the largest voting bloc in the parliament and had previously been allied with Megawati's party in opposition to Yudhoyono. With the improved outlook for parliamentary support, Yudhoyono is now much better positioned to proceed with his program.

But the substantive challenges of institutional reform (including reducing endemic corruption), producing a responsible budget, and reducing budget-breaking but politically super-sensitive energy subsidies remain. To these has now been added the overwhelming task of responding to the Dec. 26 tsunami, which will require the virtual physical and human rebuilding of the rebellious province of Aceh. Yudhoyono's government has made an earnest though predictably uneven start in dealing with the disaster. Its popular standing will be significantly influenced by its ability to bring order and coordination to the multinational response and to meet the enormous long-term challenges of relief and reconstruction -- while also dealing with the longstanding secessionist sentiments in the province.

Indonesia's international standing will also be impacted by the new government's actions over the next few months, importantly though not exclusively its response to the tsunami. Among other things, there is an opportunity to repair Indonesia's military relations with the United States, hobbled due to human rights violations over the years by the Indonesian armed forces. The problem of international terrorism, including a series of terrorist attacks in Indonesia, has given new importance to U.S.-Indonesian security cooperation. Cooperation in the tsunami emergency -- including the presence of U.S. troops delivering relief on Indonesian soil -- provides an opening for a broader reconciliation, but this cannot be consummated (and the U.S. Congress will not approve resumed security assistance) without tangible steps toward reform of Indonesia's military institutions and culture.

Together these issues would be a very full plate for a well-established, experienced leadership team. They present even more formidable obstacles for Yudhoyono and his new government. But circumstances have dictated that they must be dealt with, quickly and effectively. Temporizing is not a viable political option.

By Arun Swamy, research fellow and South Asia specialist, (808) 944-7542,
swamya@eastwestcenter.org .

While the tsunami on Dec. 26 devastated many island and coastal communities in South Asia, a year from now only the two smallest countries, Sri Lanka and the Maldives, will likely still feel its effects. Pakistan and Nepal were untouched and Bangladesh barely
affected, while India is so large and has seen such an overwhelming response from the public that reconstruction is likely to be relatively swift and GDP growth is still projected to be around 7 percent.

In 2005 the major challenges in South Asia will be what they have been for years -- managing India's relations with its neighbors, especially the nuclear-armed rivalry with Pakistan; promoting economic growth in one of the world's poorest (but faster growing) regions; and containing domestic unrest. The three challenges are linked. Domestic unrest in each country
spills over to affect neighbors. Separatist conflicts in India and Sri Lanka, a Maoist insurgency in Nepal and Islamic militancy in Pakistan and Bangladesh have all caused tension between India, the only South Asian country to border any of the others, and its neighbors. However, trade and energy are increasingly a source of cooperation.

The prospects for negotiated settlements in any of these conflicts in 2005 are not good. The ongoing talks between India and Pakistan reveal once again the unbridgeable gap between the two positions on Kashmir. In Nepal, the Maoists are unlikely to be satisfied with less than the overthrow of the monarchy and the immediate future is likely to see an Indian effort to
assist in repressing the insurgency. In Sri Lanka, relief efforts following the tsunami might eventually result in a rapprochement but it has so far revealed the depth of distrust between the government and the separatist Tamil Tigers. Negotiations between India and its northeastern insurgencies
could lead to peace agreements but these have failed in this region in the past.

Economic cooperation in South Asia, though, is slowly improving. A new free-trade area, which Pakistan has not yet joined, is providing a modest fillip to regional trade, while cross-border trade between India and Pakistan is growing rapidly. India's energy needs are leading to some
creative cooperation, too. Bangladesh, which has large untapped reserves but resists selling gas to India, has been willing to let private Indian firms carry out operations. More dramatically, India and Pakistan have discussed proposals to pipe natural gas from Iran to India through Pakistan. This is unlikely to transpire in the short run but the willingness of both parties to discuss the idea without linking it to the resolution of the Kashmir dispute is remarkable.

Unlike Southeast Asia, the scope for U.S. influence in the region is limited. India, the regional giant, continues to distrust the United States and is especially concerned with U.S. proposals to sell arms to Pakistan. Late in 2004 India took steps to improve defense ties with both long-term ally Russia and long-term rival China. India's role following the 2004 tsunami underscores this point as Indian armed forces take part in relief operations in Sri Lanka, the Maldives and even Indonesia, in addition to
working in affected parts of India. President Bush's decision to include India in his four-country coalition to carry out relief efforts following the tsunami of 2004 -- along with U.S. treaty allies Japan and Australia -- reflects the reality of India's centrality to the region and the need to respond to Indian overtures to other powers, as much is it does the state
of U.S.-Indian relations.

By Sumner La Croix, senior research fellow, specialist on Asian economies, trade and WTO, (808) 944-7508,
lacroixs@eastwestcenter.org .

The large U.S. trade and budget deficits as well as low U.S. interest rates are factors that are raising concerns about the future course of the U.S. dollar. Countries that have persistent trade deficits greater than 4 percent of national income (GDP) typically experience a substantial depreciation of their currency, and the U.S. trade deficit is currently well above this threshold level. Governments and businesses in the Asia-Pacific region are
very concerned about the consequences of a dollar depreciation, as a dollar depreciation would likely result in reduced exports to the United States and more competition from U.S. businesses in home markets.

The course of Japan's economy will also be closely watched throughout the region. Japan's economy has registered relatively healthy growth rates for the last two years, but there are some recent signs that this recovery may be stalling. Since Japan is still a major destination for the exports of East and South Asian countries, slower Japanese growth would mean slower growth in other Asian countries. The critical question is whether the Koizumi government has the will and the means to continue to press its reform agenda as Prime Minister Koizumi's term heads into its final years.

Recovery from the December 2004 tsunami disaster will be prolonged because the tsunami hit the region with virtually no warning to residents and inflicted such tragic and enormous losses of life and property. The large number of deaths in Aceh, Sri Lanka, India, Thailand, and the Maldives will complicate rebuilding efforts, as the owners of damaged properties may no
longer be alive, individual records have surely been lost in the flooding, and some families may be preoccupied with personal tragedies rather than immediate rebuilding. Rebuilding along affected coastlines is, however, likely to proceed relatively quickly, as individuals and governments correctly conclude that such destructive tsunamis occur extremely infrequently and that countries in the region will act quickly to put a regional tsunami warning system in place. Most rebuilding will likely replicate what was previously in place: vacationers want hotels by the beach; stores locate near the beach to provide goods and services; roads go through these towns. In some areas, such as hilly stretches on the Sri Lankan coast, it would be quite expensive to relocate roads and railroads inland. On the other hand, it would certainly be worthwhile for national and local governments to consider whether vital public works, such as wells used for drinking water and power stations, could be relocated to less vulnerable locations.

By Dec. 31, 2004, all countries belonging to the WTO had agreed to end quotas on textile and clothing imports. The consequences for the Asia-Pacific region will be profound. Developed countries such as Japan, the United States, and Singapore, are likely to see a flood of clothing and textile imports, closures of domestic textile and clothing factories, and
lower prices on clothing and textiles. China and India have the lowest costs of producing clothing and textiles and are likely to see a big increase in employment and output in these industries. However, some developing countries in the region like Indonesia, Bangladesh, Cambodia, and Thailand, could experience a loss of employment and output in these industries as firms decide to move to China and India. There is a potential for disputes to arise over the shift of production within Asia
and the closure of textile and clothing factories in developed countries. Developing countries may also react to the end of quotas by devising new protectionist devices to stem the expected flood of imports. And in the background
are the negotiations to conclude a new WTO trade agreement.

By Dieter Ernst, senior fellow, specialist in impact of globalization and information technology on economic growth, (808) 944-7321,
ernstd@eastwestcenter.org .

During 2005, the Asia-Pacific region will have to cope with two transformations in the international economy that have not yet made it into the media headlines: fundamental changes in Asian regionalism and the region's new role in the globalization of innovation. Both transformations are likely to create new conflicts and rivalries, posing new challenges for policymakers and management. But they also provide precious opportunities to strengthen Asia-Pacific economic collaboration.

Fundamental changes in Asian regionalism have been gathering momentum since the turn of the century due to a combination of three developments: an accelerated integration into global production networks (GPNs) that is no longer restricted to manufacturing, but includes services as well as engineering, product development and research; transformations in the region's trade patterns, in both the destination of final products and in the origin of intermediates, and a much more fine-grained division of labor; and the rise of China as a global export production base, as a sophisticated growth market for commodities as well as high-tech products, and as a new source of R&D and innovation.

As a result of the above developments, the Asia-Pacific region will have to cope with a distinct "Asianization" of the region's trade, centered on Greater China, and a decline of the region's reliance on triangular trade centered on the United States and Japan. And while periodic hard or soft landings may slow down China's growth, it is unlikely to lose its role as an engine of regionalization. The region thus is likely to experience increasing disparities -- the spatial agglomeration of economic and innovative activities in a handful of leading clusters, concentrated on Greater China, Korea and Southeast Asia's Singapore-centered growth triangles.

A related transformation is the region's new role in the globalization of innovation. Since the late 1990s, global corporations have expanded their overseas investment in research and development into new locations in Asia (primarily in the above new high-tech clusters), while seeking to integrate their geographically dispersed innovation clusters into global networks of production, engineering, development and research. But leading Asian firms (from Korea, Greater China, India, Singapore and Malaysia) are playing an increasingly active role as sources of innovation and in shaping relevant standards.

As R&D and innovation are critical for economic growth, competitiveness and welfare, the internationalization of innovation creates new challenges and opportunities for a wide range of public policies in the Asia-Pacific region that affect FDI (foreign direct investment) and innovation. In the United States, there are concerns that this may extend the "hollowing-out" well beyond manufacturing to research and development, the most fundamental sources of its wealth. Asian economies, on the other hand, are all searching for strategies that would enable them to benefit from integration into global R&D and innovation networks. Unfortunately, there is still very little research on what precisely is driving the more recent extension of R&D and innovation into Asia. And even less do we know about possible impacts and what are effective policy responses.

By Choong Nam Kim, U.S.-Korea and North Korea specialist, (808) 944-7372,
kimcn@eastwestcenter.org .

The North Korean nuclear crisis continues to be one of the most serious issues in the Asia-Pacific region. The year 2005 will be a turning point in the crisis for a peaceful resolution or a confrontation. Which way it goes will have profound impact not only on the region but in the world. Therefore, the crisis requires much more attention and coordinated efforts.

Due to the U.S. presidential election, Pyongyang refused to attend the next round of Six Party Talks. With the official establishment of the second-term Bush administration, the multilateral negotiations will be resumed. However, the prospects of a peaceful resolution of the issue seem to be not so bright. Since Washington is preoccupied with the turbulent Iraq situation, it will be difficult to confront North Korea. The conciliatory attitudes of China and South Korea toward North Korea also may help maintain Pyongyang's uncompromising stance in the talks. Pyongyang may be determined to remain a nuclear state. Without strong determination and commitment in Washington, Pyongyang would like to adopt continual delaying tactics and to develop more nuclear weapons or fissile materials. Time is on Pyongyang's side: the longer the negotiations stall, the stronger North Korea's position.

The world, especially the United States, cannot wait forever; one way or the other, the crisis needs to be resolved as soon as possible. But the problem is that there is no good alternative. Without the consent of South Korea and considerable stabilization of Iraq, pre-emption is less feasible for Washington. The level of effectiveness of economic sanctions against North Korea is also low. The North Korean economy is isolated; it is minimally dependent on foreign trade. Without full support from China and South Korea, an economic embargo will be of limited effect. Washington's shift to a harder-line policy will also likely stir anti-American sentiments in South Korea, further straining the U.S.-South Korean alliance.

As President Bush said, five nations in the Six Party Talks need one voice. Therefore, Washington needs to make intense efforts to arrive at a consensual stance among the United States, Japan, China and Russia before it goes to the negotiating table with North Koreans. The United States has poured hundreds of billion dollars into the Iraq crisis but still is far from achieving its goal. To prevent a possibly devastating conflict in Asia, diplomacy is much cheaper.

9. FOR WORLD CLIMATE COMMUNITY, A SIGNIFICANT YEAR AHEAD: By ZhongXiang Zhang, research fellow, energy and environmental economist, (808) 944-7265, zhangz@eastwestcenter.org .

The year 2005 will be a significant one for the world climate community at least on two grounds. First, the European Union just launched emissions trading scheme (ETS). This scheme will be the first transnational CO2 emissions trading scheme in the world. By setting uniform, mandatory excess emissions penalties well above the prevailing price of allowances, and imposing mandatory emissions monitoring requirements, this scheme clearly builds on many of the lessons learned from earlier experience with emissions trading programs. It covers more industrial sectors and has more regulated sources than the existing U.S. SO2 (sulfur dioxide) trading program. Its structure is also more decentralized than that of the U.S. SO2 trading program. Moreover, the scheme incorporates a variety of new features to further lower the overall compliance costs, such as allowing clean development mechanism credits to be converted into EU allowances and providing the possibility for member states to undertake a modest experiment with auctions. On balance, the EU ETS is well designed with respect to efficiency. That said, the biggest concern is about implementation. On allocations and enforcement, the two crucial elements for the overall scheme, the Emissions Trading Directive gives considerable flexibility to member states to develop specific allocation and monitoring procedures. The Directive also delegates emissions verification to the member states but without imposing uniform, mandatory standards. All this decentralized design could lead to an inconsistent and uneven approach to allocating allowances and enforcing compliance among member states, thus creating damaging competitiveness distortions in the EU internal market.

Implementing any new, major initiatives is not an easy matter. There is no exception for the EU ETS. It is expected that there will be significant leaning-by-doing in the initial years of implementing the scheme. Further fine-tuning of certain elements in the scheme is thus expected to enhance its effectiveness. Whatever happens, the stakes are certainly high for the EU, because it will carry out the world's unprecedented grand policy experiment aimed to find ways to substantially reduce greenhouse gas emissions at the lowest cost. But the stakes are high for the rest of the world as well, because the outcomes of this experiment might affect its decision on whether to follow suit to set up similar programs.

Another significant event is that the Kyoto Protocol will enter into force on Feb. 16, 2005. This means that 30 industrialized countries (excluding Australia and the United States) will be legally bound to meet quantitative targets for reducing or limiting their greenhouse gas emissions. Kyoto's entry into force also sets the stage for a new round of negotiations that are due to start in 2005 as mandated under the Protocol. This opens a window of opportunities to engage the United States and major developing countries like China and India in the international climate effort. However, what became crystal clear at the recently completed United Nations climate conference in Buenos Aires is that some countries are not ready to embark on negotiations on post-2012 commitments. Therefore, it is expected that there are great challenges ahead regarding how to get non-Kyoto parties like the United States engaged in this negotiation process and how to ease developing countries' concerns about the imposition of new commitments.

This is an East-West Wire, copyright East-West Center