The Australian APEC Study Centre

Achieving effective trade liberalisation in APEC:

The limitations of "Open Regionalism"

ALAN OXLEY,

CHAIRMAN OF THE AUSTRALIAN APEC STUDY CENTRE

November 1996

This paper is based on a presentation made to the APEC Study Centres Network Conference, Manila 1996

Executive Summary

At the Bogor Summit in 1994, the APEC Leaders committed to reduce all barriers to trade by 2010 for industrialised countries and 2020 for developing countries. As policy makers grapple with these programs, it is becoming increasingly clear that the liberalisation process has been rushed and that the proper groundwork is yet to be laid for an effective process of trade liberalisation.

Collective trade liberalisation is a very complex endeavour. No multilateral or plurilateral process has ever been achieved quickly. It was unrealistic of APEC Leaders to direct preparation of detailed plans for liberalisation in twelve months, as they did at Osaka.

There is a need to develop a broader consensus about the strategic purpose of trade liberalisation among APEC economies. There is also a need for substantial discussion and research about the modalities for successful liberalisation in APEC.

The concept of "Open Regionalism" has encouraged advocacy of collective unilateral liberalisation. This approach lacks the rigour and institutional strength which is needed for an effective process of liberalisation. Until there is a wider consensus over the strategic issues which liberalisation creates and more ground has been prepared on designing workable mechanisms to cut trade barriers, the results of liberalisation from APEC will be slight. More time is needed. It is available.

Introduction

At the Bogor Summit in 1994, the APEC Leaders committed to reduce all barriers to trade by 2010 for industrialised countries and 2020 for developing countries. A year later at Osaka, APEC Leaders decided that by the Subic Summit in November 1996, programs to achieve the Bogor targets would be completed. As policy makers grapple with these programs, it is becoming increasingly clear that the liberalisation process has been rushed and that the proper groundwork needs to be laid for an effective process of trade liberalisation.

For collective trade liberalisation to be successful, several, critical elements are necessary. First, there has to be a high level of political commitment to liberalise. Second, the strategic interests in economic integration of all participating economies have to be understood and provided for. Finally, a mechanism has to be established which ensures that the process is comprehensive and binding. All sectors of commerce must be included and all parties must be formally bound to the process. As well, the process must produce a net economic benefit for members of the group as well as their trading partners.

This third element is the hardest to create. Governments need help to cut trade barriers. The reason they chose to do it collectively is that the existence of an international mechanism and obligation assists them to overcome domestic resistance to change. It is common in all large processes of collective trade liberalisation to spend as much time settling the modalities as on the actual process of negotiating the reductions.

To date, only one of these elements has been created. The Bogor Declaration provided the high level political commitment. There has been little discussion of the strategic interests involved, but the issues are large. For example, what is needed to secure US commitment to such a process? How can China's half market economy be integrated with market economies? The debate does not have to be conducted publicly in APEC fora. But it needs to be the subject of constant review and discussion among opinion-makers, academics and policy makers.

Discussion of the modalities has only just begun. It is not possible for sixteen countries, including three of the world's biggest economies to settle the modalities for a process of liberalisation of the scale envisaged in the Bogor Declaration in just two years. It took nearly four years to settle the modalities of the Uruguay Round, and they already had basic rules for negotiating reductions in place. The political Leaders performed themselves and APEC a disservice by decreeing as they did at their Summits at Bogor and Osaka, that the modalities would be settled in two years.

The dominant concept for shaping the modalities to date is what has generally been termed "Open Regionalism". This concept is broad and attempts to articulate the desire of the APEC economies to pursue regional economic integration without creating a closed economic region. The concept was not rigorous, in keeping with the requirement in the early stages of APEC's development to focus on building consensus by emphasising what is common and disregarding what is not.

The Open Regionalism advocates promoted another consensus-friendly approach when it came to the question of how to cut trade barriers. This was the concept of cutting trade barriers by a collective process of unilateral reductions. This modality appealed to APEC official who had been directed by the Osaka Summit to come up with an agreed approach within twelve months. Its utility was that it was an approach with which all APEC governments could agree.

But therein lays its weakness. Issues over which there are fundamental differences remain unaddressed. Is agriculture in? Is investment in? Is there a common timetable for reductions? Who will be classified a developing economy in 2010?

There will be no substantial process of liberalisation until all the key elements which are the necessary pre-conditions of any process of collective trade liberalisation are in place. The negotiations in the Uruguay Round and other recent regional processes of liberalisation provide a wealth of experience from which to draw. Many lessons about how processes can assist governments to support and implement trade liberalisation are there to be drawn.

Government officials are well aware that these issues need to be addressed. They have been constrained to respond to the timetables imposed by Leaders. Deliberation takes time and they were not given it. Academics have not been so constrained, but discussion about how liberalisation should occur has nevertheless been limited. Apart from brief advocacy of the idea of a regional Free Trade Agreement by some academics in the US, the idea of "Open Regionalism" and the related concept of unilateral reductions virtually enjoys the status of an orthodoxy among academics in the region. Many significant issues have gone unaddressed.

The Strategic Issues

Trade liberalisation creates economic integration. Integrating one economy with another is a highly political act. Governments cannot do this unless they are satisfied that very basic strategic interests are being advanced or protected. APEC includes three of the largest economies in the world. It includes all of the fastest growing economies. Integrating the APEC economies entails integration of the economies of countries with highly disparate cultures. Previously, all regional processes of economic integration have involved economies that are contiguous or have a high level of political and economic homogeneity.

Achieving economic integration among the APEC economies is a major task. There are a number of major strategic issues that need to be tackled if significant liberalisation among APEC countries is to be realised. Some key issues are:

Will the US use APEC as an instrument for economic integration?

Is Japan prepared to open protected and heavily regulated sectors?

Can China resume market reform in a systematic way?

Are ASEAN economies prepared to open strategic national industries to competition?

Will Asian economies open services sectors to competition?

Will Asian economies remove barriers to investment?

Until governments accept that trade liberalisation will bite into some very sensitive and difficult issues, general commitments to liberalise remain in the realm of political rhetoric. Substantial public discussion of all these issues is a necessary precondition to realise the Bogor Declaration.

The Challenge of Liberalisation among APEC Economies

The need for further trade liberalisation among APEC economies is evident. Even after the Uruguay Round results are taken into account, average levels of protection remain higher among the developing economies of APEC than among OECD countries in general. Even then, the incidence of protection is still significant among industrialised economies in the region.

The recent analyses of trade barriers which PECC has produced for APEC provides a useful picture of what has been achieved and what needs to be done1. They also contain a cautionary message which academics and policy makers need to address. They show that not all economies in the Asian Pacific region have engaged in substantial unilateral liberalisation over the last decade. It would appear that trade barriers in Thailand have not fallen. It is also clear that there is distinct disinclination across the region not to open markets for services.

Rates of growth among the Asian economies of APEC have been higher than the global average for more than a decade. To maintain sustainable and stable growth, the governments of these economies will need to bind economic activity to laws and systems which steadily increase exposure to competitive forces. In most economies in the region, there are major impediments to fuller development of market economies.

Until the seventies, the strategic mission of trade liberalisation in the Post War period was to reduce tariffs and eliminate non-tariff barriers in industrial products. This program has generally been successful. Tariffs in industrialised countries have been reduced to a global average of around 5 percent. There is still some mopping up to do. Trade barriers, both tariffs and non-tariff barriers, are significant in particular sectors. But the overall aim has been achieved - greater economic growth by creation of international markets. The result has been greater integration of global economic activity.

The strategic mission of trade liberalisation today is removal of barriers to trade in services. In Europe, the most important achievements of the EC Single Market Program were to reduce barriers to services trade among European countries. NAFTA is most notable for its provisions on services and investment. The Closer Economic Relations Trade Agreement (ANZCERTA) between Australia and New Zealand also opened service markets. The global complement to these regional arrangements was the inclusion of services in the mandate of the Uruguay Round and the consequent negotiation of the General Agreement on Trade in Services (GATS).

While markets for services industries are being steadily opened in North America and Europe, there is resistance to similar liberalisation in Asia. Asian economies have been slow to accept the importance of the liberalisation of the services sectors. The ASEAN economies played an influential blocking game in the negotiation of commitments to liberalisation in the services negotiations in the Uruguay Round. Japan was also reluctant to open markets for financial services. Reportedly, ASEAN leaders have now accepted that ASEAN Free Trade Agreement (AFTA) should be extended to cover services. It is yet to be seen how this will translate into binding commitments.

The foregoing demonstrates the size and complexity of the task of meeting the Bogor targets of eliminating all barriers to trade and investment. Governments will need help to achieve it.

Mechanisms for Liberalisation

There are three traditional paths to liberalisation: multilateral liberalisation through the

processes of the GATT and WTO; unilateral liberalisation by individual countries; and regional liberalisation through free trade arrangements. Each contribute in varying degrees to the need of governments to manage the politics of trade liberalisation.

Multilateral Liberalization

Most liberal economists would accept that the most effective form of trade liberalisation is through the multilateral processes of the WTO. Each barrier reduced through the processes of the GATT opens the market to every other GATT Party. These reductions are non-discriminatory. The maximum benefit is extended to all countries which are party to the GATT. The WTO processes have been developed over the years. There are at their most sophisticated yet as a result of the Uruguay Round. They embrace a number of elements which assist governments to deal with the politics of opposition to liberalisation.

First, the multilateral negotiating process entails an international commitment which is binding. It justifies a review of domestic levels of protection, it mandates participation in an international process, and it creates an obligation to seek reductions. Governments can utilise these broad obligations to justify the need for cuts in domestic protection to constituents which are resisting change. The Governments of Japan and Korea did this to justify cuts in farm protection.

Second, it enables governments to demonstrate that the pain of cuts is spread. There is no doubt that, by pointing to the cuts that US farmers faced, the French Government was assisted in arguing the case for cuts in French farm budgets to its farmers.

Third, the multilateral process allows linkages to be established between programs of reductions in different sectors. This enables other interests to be enlisted to support liberalisation. The French Government enlisted the support of French companies who would benefit from cuts in manufacturing and services to counter the political weight of opposition from farmers. Representatives in the US Congress were able to make similar arguments to counter the influence of the US clothing and textile industry.

Finally, a comprehensive program of liberalisation which embraces a large number of countries and a wide range of products can create a liberalising dynamic among groups of countries. In the Uruguay Round, there was a broad deal between industrialised and developing countries that liberalisation on new issues of greater interest to industrialised countries, such as on services and intellectual property, would be accepted by developing countries provided there was liberalisation by industrialised countries in sectors of greater importance to developing countries, notably agriculture and textiles.

The plain lesson of the Uruguay Round is that notwithstanding the economic gains to be made in France, Germany, Switzerland, the US, Japan and Korea from cutting the level of support for domestic farmers, the mere assertion of that fact would never have been enough to enable governments in those countries to overcome domestic opposition to cuts. They could not have agreed to the even modest cuts that were ultimately made without its being buttressed by the obligation of participating in an international endeavour and the formal commitments which were created by the Uruguay Round.

It was always open to these governments to try to secure those benefits by liberalising unilaterally. This would have been far quicker than the inevitably prolonged process of multilateral negotiations. This did not occur because it was not a political option. The logic of the case of the economic benefit to be won by unilateral liberalisation was not powerful. The international mechanism of the WTO gives governments access to a wider range of influences and forces to support the political case for liberalisation than are available in a domestic political system.

Can we look to the WTO to advance liberalisation in the region? This would be an ideal vehicle. There will be a successor Round to the Uruguay Round, but when? According to the Bogor Declaration, all barriers in industrialised APEC economies are to be removed by 2010. However, we are not likely to see further cuts to barriers from global liberalisation from the WTO processes inside 12 years. No date has been set for the next WTO trade round. The dates set for the end of the reform period for agriculture and the end of the reform period in textiles agreement in the Uruguay Round - 2000 and 2004 respectively - create a time period during which the start of the next round of WTO negotiations is likely. And if the next round takes 7 years like the last one, we will not see the beginning of the next round of reductions in trade barriers before 2008 or 2011. If the periods for reducing barriers average 7 years, as they do in the Uruguay Round, the changes from the next round will not be fully implemented until between 2015 or 2018

It should be noted that it would not be realistic to expect all trade barriers to be removed as a result of the next round of WTO trade reductions, in particular because barriers in the sectors of agriculture, textiles and services are so high. Further reductions are likely, but elimination of all barriers is not. So the Bogor targets are very ambitious. If APEC Leaders wish to instigate a substantive process of liberalisation, something more than working through the WTO processes is required.

Unilateral Liberalisation

If early and comprehensive liberalisation cannot be secured through a WTO multilateral process, the next best means is for each country to reduce trade barriers unilaterally. Some neo-classical economists argue that under any circumstances, unilateral liberalisation is the preferred approach. It will generally create a greater gain in economic welfare. In most cases this will be so.

What are the prospects for unilateral liberalisation as a vehicle for achieving reductions of trade barriers across the board among APEC countries? The broad trend of the eighties of steady liberalisation of tariffs and non-tariff barriers is likely to continue among the emerging economies in the region. But there is evidence of reluctance to cut trade barriers comprehensively. It is increasingly common to leave certain sectors more highly protected. Usually this is justified to support development of a strategic industry. This has been the case among industrialised economies for several decades. The industrial sectors where trade barriers tend to remain high are agriculture, iron and steel, processed chemicals, automobiles and clothing and textiles.

It is one of the principle reasons the GATT system has been used for trade liberalisation. There is a presumption that all sectors of trade are covered.

There are plenty of indications of reluctance in Asia to liberalise across the board. The embrace of trade liberalisation by the ASEAN countries through AFTA has been hesitant. Its liberalising objectives are modest. The amount of trade which they affect is limited. The scope of the treaty has recently expanded, but the effect is uncertain. AFTA is likely to have a significant discriminatory effect on trade in a number of industrial products. There are also signs that the ASEAN countries may reinstitute a discriminatory investment regime. The AFTA process has been a slow one, notwithstanding the recent decision to speed up the timetable for implementation.

It should be expected then that the processes of unilateral liberalisation would only yield liberalisation in sectors where trade or domestic production capacity is not significant or where domestic industry is globally competitive. Areas where this is not the case would be set aside. As discussed later, the experience with efforts at unilateral liberalisation after the Osaka Summit tend to bear this out.

Regional Liberalisation

A third option is regional liberalisation. This is usually achieved through a bilateral or plurilateral treaty which sets out timetables for reduction and establishes formal legal commitments to secure that liberalisation. Until recently, there were not many examples of successful free trade agreements. ANZCERTA and EFTA were the most significant.

The trade agreement landscape has been radically altered during the eighties. First the Canada/US free trade agreement was negotiated and then extended to Mexico in NAFTA. The ASEAN Free Trade Agreement (AFTA) and the MERCORSUR agreement between Brazil, Argentina, Uruguay and Paraguay have been negotiated. Chile is to negotiate a free trade agreement with the US. Argentina is interested in an agreement with the US and New Zealand is exploring an agreement with Chile. These agreements are bound in rules and therefore can assist governments to manage the politics of trade liberalisation. The extent to which this applies depends on a variety of factors, in particular the comprehensiveness of the scope of the agreement and the number of participants. If there has been such a proliferation of free trade agreements, why is there such hostility to the idea when the issue of how to secure liberalisation in the Asian Pacific region is considered?

The conventional answer has been that free trade agreements are discriminatory. The general contention is that if all the APEC economies agreed to reduce trade barriers among themselves, this would distort the patterns of world trade and produce a less than optimum gain in net economic welfare for the countries concerned. While this contention is correct as a generality, its validity does depend on the circumstances.

The GATT decrees that a free trade area or a customs union can coexist with a multilateral trading system, provided that the net effect is that third parties do not find their overall trade diminished once the new arrangement comes into effect. When Spain and Portugal joined the EC, the US complained that barriers to US agricultural exports rose. The EC countered that US trade across the board would remain at the same level because barriers on other products would come down, compensating for the loss markets for agricultural products.

A set of trading arrangements which discriminate against trade with third parties compared to trade between members of the agreement does not cause a net loss of economic welfare if the members to the agreement also phase down trade barriers with the third parties. This was the case with Australia and New Zealand in ANZCERTA. If the AFTA countries reduce trade barriers with their non-AFTA trading partners at roughly the same rate as they cut trade barriers among themselves, there should be no net adverse effect on economic welfare.

This leads to a very fundamental point. The level of discrimination matters. A number of economists believe today that if the level of discrimination is small, the net effect on economic welfare will not be negative. So the range of questions which should be asked about discrimination should be broadened. The question should not only be "is it discriminatory?", it should also be "how discriminatory will it be?" and "what will be the net effect on economic welfare?".

Revisiting "Open Regionalism"

Concern to avoid the possibility of a discriminatory agreement appears to have been instrumental in development of the concept of "Open Regionalism". Advocacy of the concept has not been matched by practical consideration of how to make it work. Efforts to practically apply the concept usually reduce to a statement of the criteria which should be satisfied when liberalisation takes place, and invariably to only one criterion - liberalisation should be non-discriminatory. There are only two ways this can be achieved - by liberalising through the WTO, or by liberalising unilaterally.

Trade reductions negotiated through GATT processes apply to all trading partners, not just APEC countries. To realise the Bogor Declaration this way, might amount to a strategy whereby APEC countries would take a common approach into the next round of WTO trade negotiations and act as a caucus to push for it through that forum. As observed above, this would seem to lead to a more modest result than that implied in the vision and bold sentiments of the Bogor Declaration.

The other presumption of the "Open Regionalism" advocates is that governments would act in a unilateral and voluntary way to reduce barriers, but in concert. This is a process which we might conveniently style "concurrent unilateral voluntary trade liberalisation" (cuvtl).

The major shortcoming of this approach is that is does not help governments to manage the politics of trade liberalisation. If domestic constituents are aware that there is no formal obligation to liberalise, they will press governments to omit sensitive sectors, as Japanese farmers did before the Osaka Leaders meeting.

This phenomenon is already evident in the efforts of APEC Governments to take create unilateral programs to reduce trade barriers in the lead up to the Subic Leaders Summit. At the previous summit at Osaka, they committed to develop "Individual Action Plans" (IAPS) in which they would set out national programs of unilateral reductions to achieve the goals of the Bogor Declaration. The results were very modest. In almost all cases, commitments did not go beyond standing commitments, usually those made in the Uruguay Round, and most sensitive areas were avoided. This is no surprise. There are no cases where it can be demonstrated that a "cuvtl" process has been effective.

The history of trade liberalisation tells us that successful international efforts to reduce trade barriers involve international commitments which are legally binding, require trading partners to accept similar obligations and establish a formal obligation to be part of a broad international deal. These are also features of regional agreements, such as ANZCERTA, NAFTA and AFTA.

Can the concept of some form of regional agreement which involves more binding commitments be applied to processes of liberalisation among APEC economies? To date, the concept has been set aside because it has been regarded as failing the requirement to produce liberalisation which is non-discriminatory. The issue of discrimination should be looked at empirically. What sort of problem does it create?

In the traded goods sector, the major problem would be trade between the emerging economies of the region and Europe in industrial products. It is likely that a general reduction of tariffs on industrial goods in an APEC regional free trade agreement would result in discrimination against imports from Europe2. Trade barriers between Europe and the industrialised members of APEC are roughly the same. Internal APEC reductions would lower barriers in the emerging Asian economies to exports from the industrialised members of APEC, but not to exports from Europe.

How big a problem would this be? Until some analysis is done, it is impossible to say. If the margins were not great, there may not be a net negative impact on economic welfare. If the margins were significant, the negative effect may be significant and this is not a situation that anyone would want. The European Union would not be likely to tolerate it. Its markets for exports from Asia and its levels of investment outflow to Asia are sufficiently large that it could exert significant influence on the countries of the region to pay regard to its interests. The interest of economies in the APEC region in trade and investment with Europe are sufficiently great that they would not want to follow a course of action which jeopardised it.

Even such an outcome does not of itself warrant a judgement that some form of free trade arrangement could not work. There are mechanisms that can be adopted which would obviate the negative effects of discrimination against trading partners outside APEC. A regional agreement might specify that all trade reductions should be made MFN. Certain commitments might be made conditional on their adoption in a WTO multilateral trade negotiation. The point is that a regional agreement should not ipso facto be ruled out until empirical work is done to assess the impacts of various models of liberalisation.

The Special Problem of Services

The services sector creates a different set of problems which do not appear to have been systematically addressed. It is still unclear what sort of international system for liberalising trade in services will develop under GATS. Commitments to liberalise have been made in many areas, but in the critical sectors - financial services and telecommunications - the absence of commitment by both the US and the EU to the basic principles of MFN - is a serious weakness. The GATS cannot yet be said to be an instrument of the market, like the GATT. To date is more in the character of arrangement for scheduling individual commitments to access.

The ultimate direction of the GATS may not be settled until the next WTO round. It may end up little more than a register for bilateral agreements on reciprocal access if there is not universal and unqualified commitment by all parties to apply competitive principles to access to markets. In the interim, regional markets for services are developing in Europe and North America, fostered by regional agreements.

There are many options for APEC countries to consider to open services markets. A regional agreement could be vehicle to advance a level of market opening and commitment to market principles which has not yet been achievable under the GATS. Regional commitments under a regional agreement to create regional markets for services would have a positive impact. If there was agreement to apply the GATS fully to the financial services and basic telecommunications sectors, pan-regional agreements to liberalise would create an incentive to transfer commitments to build global markets into GATS.

A major issue here would arise with the EC. Under the Single Market program, the EC has already undertaken a form of discriminatory liberalisation in services. Single Market commitments apply only to members of the European Economic Area. They have guaranteed access to each other's markets. Third parties have access to those markets on a reciprocal basis. The EC will not deny access if it considers that its service providers receive national treatment in foreign markets. If Asian Pacific economies were to set up a regional framework for liberalisation which implied the same principles, it would create powerful incentives to trade rights of access across trade blocks to create multilateral markets.

One thing is clear. Given the lack of interest to date in liberalising services, there is no reason to assume that a "cuvtl" process would yield anything of benefit in services.

Developing an Effective Approach to Trade Liberalisation

Collective liberalisation of trade is a very complicated business. No multilateral or plurilateral program of trade liberalisation has ever been achieved quickly. Sometimes bilateral free trade agreements can be speedily negotiated. The larger the number of countries involved, the more complex is the process. A very long process of pre-negotiation is required to establish the terms of, targets for, and modalities of any process of negotiating reductions.

It was unrealistic of the APEC leaders to decide at the Osaka Summit that detailed plans for the achieving the reductions in trade barriers which were agreed the year before at Bogor could be developed within twelve months.

There is also a need to develop a general consensus about the strategic purpose of trade liberalisation in the APEC region. Most pre-existing cases of regional and bilateral liberalisation are undertaken to achieve more than just the economic benefits that collective action to reduce trade barriers can create. There is often a strategic or political benefit to be won from the economic integration that comes from the reduction of barriers to trade and investment.

The APEC countries appear to be agreed that there is strategic benefit in enhancing economic integration. But it is not clear that they yet have articulated this strategic interest sufficiently to move to take concrete action to start to reduce seriously trade barriers.

There is also a need for substantial discussion and research about the modalities of successful trade liberalisation among the academics, government policy makers and researchers in APEC economies. What would be the economic effects of various scenarios of liberalisation? How long will it before the next tranche of trade liberalisation can be realistically expected from the WTO processes? By what means can regional processes of liberalisation arm governments to contend with domestic opposition to liberalisation? Is a regional free trade agreement out of the question? What is the net economic effect of discriminatory agreements where the levels of discrimination are low? What devices might be used in a regional agreement to ensure that the optimal liberalising benefit is achieved from regional liberalisation?

The proponents of "Open Regionalism" have proffered one approach. It has encouraged advocacy and encouragement of collective unilateral liberalisation. However this approach does not provide the rigour or institutional strength which is needed for an effective process of plurilateral trade liberalisation.

Until there is a substantial degree of consensus over the strategic issues and greater body of work on the issues on how to liberalise, the trade liberalisation processes of APEC will yield slight results. This takes time. It is available.

Footnotes

1. PECC 1995, Singapore "Survey of Impediments to Trade and Investment in the APEC Region" and PECC, 1995, "Milestones in APEC liberalisation: a map of market opening measures by APEC economies"

2. It is assumed that the pattern of liberalisation would be similar in all other international and regional agreements, Namely that the pace of liberalisation in the more sensitive and more highly protected sectors such as agriculture, textiles, automobiles, plastics and chemicals would be slower and therefore not create special problems in trade with Europe.

Alan Oxley is Chairman of the Australian APEC Study Centre. He is a former Australian Ambassador to the GATT and a former Chairman of the GATT Contracting Parties. He has published "The Challenge of Free Trade",(St Martin's New York 1990) and "International Trade and Environment Agreements on CD-ROM" (Informit, Melbourne 1995).

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