Asean Economic Integration: Trade, Foreign Direct Investment, And Finance : Trade, Foreign Direct Investment, and Finance 9789814289184, 9789812569103

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Advanced Research in Asian Economic Studies – Vol. 6

ASEAN Economic Integration

Trade, Foreign Direct Investment, and Finance

Advanced Research in Asian Economic Studies

(ISSN: 1793-0944)

Series Editor: Manoranjan DUTTA (Rutgers, The State University of New Jersey, USA)

Published Vol. 1

Asian Economic Cooperation in the New Millennium: China’s Economic Presence Edited by Calla Wiemer (East Asian Institute, National University of Singapore) & Heping Cao (Peking University, China)

Vol. 2

China’s Industrial Revolution and Economic Presence by Manoranjan Dutta (Rutgers, The State University of New Jersey, USA)

Vol. 3

International Economic Integration and Asia Edited by Michael G Plummer & Erik Jones (Johns Hopkins University SAIS-Bologna, Italy)

Vol. 4

Economic Dynamism of Asia in the New Millenium: From the Asian Crisis to a New Stage of Growth Edited by Yoshinori Shimizu (Hitotsubashi University, Japan)

Vol. 5

Future Perspectives on the Economic Development of Asia by John Malcolm Dowling (Singapore Management University, Singapore)

Vol. 6

Asean Economic Integration: Trade, Foreign Direct Investment, and Finance by Michael G Plummer (Johns Hopkins University, SAIS-Bologna, and East-West Center, Italy)

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Advanced Research in Asian Economic Studies – Vol. 6

ASEAN Economic Integration Trade, Foreign Direct Investment, and Finance

Michael G Plummer The John Hopkins University, SAIS-Bologna, and East-West Center

World Scientific NEW JERSEY

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LONDON

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SINGAPORE

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BEIJING

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SHANGHAI

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HONG KONG

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TA I P E I

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CHENNAI

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British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

Advanced Research in Asian Economic Studies — Vol. 6 ASEAN ECONOMIC INTEGRATION Trade, Foreign Direct Investment, and Finance Copyright © 2009 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the Publisher.

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ISBN-13 978-981-256-910-3 ISBN-10 981-256-910-3

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Dedication To Seiji F. Naya who taught me so much about ASEAN, and to my father, Louis R. Plummer, who taught me so much about life.

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Foreword Globalization has been growing at an exponential rate in all areas of economics. The current global financial crisis, which arguably began (or at least the dams broke) in September 2008, will no doubt provoke a steep global economic contraction in the near future, and, with, it the pace of globalization will slow . . . momentarily. But the globalization trend will continue. Developing countries have become not only an important part of the globalization process but, perhaps, its main protagonist. As suggested by Jagdish Bhagwati in his important work, In Defense of Globalization, in the 1950s and 1960s the developed world embraced globalization while the developing world resisted; in the 2000s, the roles have changed: the developing world is forcing the issues of trade liberalization (especially in agriculture and labor-intensive manufacturing, which tend to be the most protected), labor migration, and the like, while the developed countries are resisting. Regional integration across developing countries has also been rising. Regional economic cooperation accords between developing countries have been around for a long time in various forms, but they have especially proliferated over the past five years. By far the most successful, and in many ways the most ambitious, is the Association of Southeast Asian Nations (ASEAN), a group that has been around since 1967 and started to become very serious about regional economic integration in the early 1990s. I have been privileged to witness this evolution of ASEAN integration since I started working on the subject with Seiji Naya, Director of Research and my former boss at the East-West Center; Nargonchai Akrasanee, former Minister of Commerce of Thailand and currently Executive Chairman of the Export-Import Bank of Thailand; the late Kernial Sandhu, founding Director of the Institute of Southeast Asian Studies; and Cesar Virata, former Prime Minister of the Philippines. They have been excellent teachers over the years and even better friends and colleagues. vii

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This volume represents new work on ASEAN integration with revisions of selected older studies, some of which were co-authored with associates inside and outside ASEAN. They include Reid Click of George Washington University (Chapters 5 and 6), Ganeshan Wignaraja of the Asian Development Bank (Chapter 7), and, of course Seiji Naya of the East-West Center and the University of Hawaii (Chapter 9). My work on ASEAN and economic integration more generally have been influenced and improved greatly by an army of colleagues who have always been generous with their time and ideas. To name a few: Max Kreinin, Charles Morrison, Chung Lee, Ted James, Nancy Lewis, Chia Siow Yue, Peter Petri, Shigeyuki Abe, Masahiro Kawai, Richard Pomfret, Wisarn Pupphavesa, Mohammed Ariff, Hadi Soesastro, Hal Hill, James Wallar, David Martin, Des Grimble, Tim Buehrer, Pearl Imada-Iboshi, Giovanni Capannelli and Robert McCleery. They have all contributed in one way or another to this work (without assigning culpability!). Alexandra Jarotschkin assisted me in finalizing the manuscript. Finally, I would like to thank the staff of the East-West Center, including Ralph Carvalho, Kim Fujiuchi, and Laura Moriyama, and Barbara Wiza of the Bologna Center, for all of their help and support over the years. Michael G. Plummer November 28, 2008 Bologna, Italy

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Contents Dedication

v

Foreword

vii

1. Introduction and Overview

1

Part I: Trends in ASEAN Economic Cooperation

17

2. ASEAN Economic Integration in a Global Context: Trade, Investment, and Policy Issues

19

3. Aligning ASEAN Commercial Policies in the AEC

78

4. ASEAN Investment Cooperation

130

5. Bond Market Development and Integration in ASEAN

189

6. ASEAN Stock Markets: Trends in Convergence

224

Part II: Relations with Dialogue Partners

251

7. Integration Strategies for ASEAN: Alone, Together, or Together with Neighbors?

253

8. The ASEAN Economic Community and the European Experience

276

9. ASEAN and the United States: The Economics of the Enterprise for ASEAN Initiative

306

Index

339

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Chapter 1

Introduction and Overview 1. Introduction The decision to create an ASEAN Economic Community (AEC) by 2015 constitutes a milestone in the evolution of ASEAN economic integration. ASEAN was formed in 1967 with the Bangkok Declaration but significant steps toward deepening cooperation through a policy-led process only began to emerge with the ASEAN Free-trade Area (AFTA) in 1992. Since then, regional cooperation has been moving forward on many fronts, e.g., trade in services, trade facilitation, investment cooperation, intellectual property rights (IPRs), and even approaches to closing the “development gap” through the Integration for ASEAN Initiative. But it was the AEC, adopted at the 12th ASEAN Summit in Cebu in January 2007, that brought it all together by committing the region to a “single market and production base”, a “highly-competitive economic region fully integrated in the global economy”, as well as a “more equitable economic region”. The scope of the AEC is articulated in the AEC Blueprint, published in November 2007. ASEAN economic cooperation in the 2000s is taking place at the same time that the region is becoming more integrated with its Asian neighbors and the world as a whole. It is dedicated to “open regionalism”, that is, regional integration as a means of becoming more globally competitive. More than any other economic block, ASEAN integration initiatives emphasize their outward-oriented nature and intentions. The overriding goal of the AEC is not the boosting of trade and investment shares per se but rather a reduction in the costs of doing business in the region, diffusion of best practices, and more extensive integration with global production chains, rather than merely Southeast Asian ones. As expressed in the AEC Blueprint: The AEC is the realisation of the end goal of economic integration as espoused in the Vision 2020, which is based on 1

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a convergence of interests of ASEAN Member Countries to deepen and broaden economic integration through existing and new initiatives with clear timelines. In establishing the AEC, ASEAN shall act in accordance to the principles of an open, outward-looking, inclusive, and market-driven economy consistent with multilateral rules as well as adherence to rulesbased systems for effective compliance and implementation of economic commitments.

This study attempts to analyze ASEAN economic integration from a variety of perspectives: trade, development, investment, and finance, as well as its relationship with Dialogue Partners, e.g., in Asia, the EU, and the United States. The bulk of this book deals with issues of economic integration. In this introductory chapter, we attempt to give some background information on the macroeconomic and microeconomic environment that characterizes the ASEAN Member Countries at present (Section 2), and we give a brief synopsis of the volume’s chapters in Section 3.

2. A Survey of the Business Environment in ASEAN While ASEAN Member Countries are diverse in terms of investment and other measures affecting the private sector, all countries appear to be interested in liberalizing their respective policy structures in order to create a more business-friendly environment. Deeper economic cooperation and integration in ASEAN also constitute a general priority to lure Foreign Direct Investment (FDI); ASEAN’s diversity in this sense is a strength rather than a weakness, as it would allow ASEAN- and non-ASEAN-based multinational corporations to take advantage of a vertical division of labor. As an introduction to trends in the region facing the ASEAN private sector, we consider below the existing macroeconomic and microeconomic environments in ASEAN. This, hopefully, will help set the stage for the analysis of regional economic integration in subsequent chapters. 2.1. Macroeconomic Environment While diversity in macroeconomic performance varies across ASEAN countries, in general the region has performed well relative to other developing regions. One aggregate indicator of robustness — and the most oft-cited — would be GDP growth performance which gives an aggregate impression of

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Source: IMF, World Economic Outlook Database. Fig. 1.1.

GDP Growth (%) of ASEAN + 3 (1980 to 2005).

the business environment of a country. Obviously the business investment will depend on income growth (just as income growth will depend on business investment). As can be seen from Figure 1.1, economic growth in the ASEAN Member Countries has rebounded since the Asian Crisis to a pace that may be lower than the region’s pre-Crisis trajectory but is enviable when compared to other regions. ASEAN average economic growth over the past decade has been lower than that of China, which is a key reason why China has been so successful in luring FDI flows. Interestingly, as noted in Chapter 7, growth rates of the ASEAN Member Countries have become increasingly correlated with each other and the ASEAN + 3 (ASEAN, China, South Korea and Japan). This is a manifestation of closer economic integration and interaction at a variety of levels, and in particular the rise in intra-industry trade.1 In turn this intra-industry trade is a result of multinational activities in ASEAN, i.e., the “production fragmentation” process, discussed at length in Chapter 2. In addition to a robust market, the private sector requires macroeconomic stability. After all, Latin America experienced very high growth rates in the 1960s and some of the 1970s, but irrational macroeconomic policies that led to high inflation, exchange rate instability, and burgeoning government debt ultimately condemned the region to economic crisis and stagnation in the 1980s. Moreover, economic growth does not necessarily mean development; economic growth in Botswana has been the highest in the world over the past three decades, but its growth has been based 1 Rana

(2006).

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4

on diamond production. Venezuela, Russia, and many of the Gulf States have been growing rapidly over the past few years, but this is a reflection of commodity prices, rather than a healthy across-the-board private-sector expansion. One of the primary drivers of the “Asian economic miracle” has been the region’s conservative monetary and fiscal policies which have led to low rates of inflation and relative stability of other macroeconomic variables (World Bank 1993). Tables 1.1–1.3 give indicators of macro stability in the ASEAN countries in terms of inflation rates, interest rates, and fiscal balances, respectively, over time and compared to other major Asian economies. Inflation rates tend to be low by developing country standards for most ASEAN countries in recent years, with the exception of the Asian Crisis and other periods of economic turbulence. Since the Crisis, inflation and exchange rate volatility have been generally quite low. In addition, as in the case of GDP growth, these macroeconomic indicators appear to be increasingly correlated across ASEAN countries. Regarding fiscal policy, ASEAN countries fare reasonably well. While problematic fiscal deficits tend to precede economic crises in Latin America, ASEAN Member Countries affected by the Crisis actually had budget surpluses. With the Crisis, these surpluses naturally turned into deficits, but fiscal balances have rebounded since, with all budgets improving over the last few years (and all deficits are less than five percent of GDP). In sum, the macroeconomic environment in most ASEAN Member Countries, while not perfect, has generally been amenable to private sector Table 1.1. Average Inflation Rates for the 1990s and for 2000–07. (Average Inflation). Country Thailand Singapore Philippines Malaysia Indonesia Cambodia Vietnam Myanmar Korea China India

1990–99 (%) 4.3 1.5 9.5 3.7 15.6

Double digit 6.7 7.8 8.9

2000–06 (%) 2.6 0.6 5.4 3.4 11.8 2.4 5.7 Double digit 2 3.1 4

2007 Inflation (%) 2.3 2.1 2.8 2.0 6.4 5.9 8.3 36.9 2.5 4.8 4.4

Source: IMF, International Financial Statistics; ADB, ADO 2008.

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Introduction and Overview

Table 1.2.

5

Interest Rates. (Average Money Market Rate).

Country

2000–06 (%)

Thailand Singapore Philippines Malaysia Indonesia Vietnam, Cambodia, and Myanmar Korea China India (for comparison)

2006 (%)

2.2 1.9 8.1 2.8 9.7 N/A

4.6 3.5 7.8 3.4 9.1 N/A

4.2 N/A N/A

4.2 N/A N/A

Sources: IMF, International Financial Statistics; ADB Key Indicators and OECD Statistics Database; Data refer to the general government sector, which is a consolidation of accounts for the central, state and local governments plus social security. Table 1.3. Average Fiscal Balance/GDP Ratio for Asian Countries (%). Country Thailand Singapore Philippines Malaysia Indonesia Cambodia Vietnam Myanmar Korea China India

1990–99

2000–06

2007

1.26 11.01 −1.20 −0.42 −0.27 −3.98 −2.22 −1.75 −0.90 −2.59 −5.91

−0.72 5.69 −3.67 −4.80 −1.45 −2.39 −2.81 0.71 1.21 −2.15 −5.06

−1.7 12.2 −0.2 −2.8 −1.2 −3.2 −4.9 n/a −2.3 0.7 −5.5

Sources: 1988–2005: http://www.adb.org/Documents/Books/Key Indicators/2006/default.asp, with country data in each Excel file. 2006: http://www.adb.org/Documents/Books/Key Indicators/2007/default. asp, with country data in each Excel file; Pre-1988 data has only government finance data instead of government finance ratio of GDP so pre- and post-data will not be consistent; IMF, International Financial Statistics Database, and CEIC Database.

growth and development and, given strong growth and responsible macroeconomic policies, attractive to multinational corporations. Moreover, the correlation of these variables across ASEAN countries has been rising over time; this would suggest that what happens in one country will affect other

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countries (that is, there is a clear “policy externality”), which increases the case for closer economic cooperation. 2.2. Internalizing Policy Externalities: Learning from the Asian Crisis This last point deserves elaboration. The Asian Financial Crisis that began in July 1997 sent shockwaves through policy circles of affected East Asian economies. There was a clear “contagion” effect of this Crisis, in which the financial crisis in Thailand spread quickly to its ASEAN neighbors (and subsequently Hong Kong and South Korea). The transmission mechanisms through which contagion spreads are many, including: (1) “real contagion”, in which investors believe that the shock to one country will affect other countries that are major trading partners and/or compete with it in third markets; (2) “financial contagion”, in which multinational banks when exposed to increased risk in one market are forced to reduce exposure in other regional economies; and (3) “herd behavior” of banks, in which a crisis in one market leads to panic among financial institutions, who follow each other out of the market. In general, all three types of contagion existed during the Asian Crisis. As ASEAN becomes more integrated, it will likely be the case that investors will increasingly perceive the region as being interdependent and, as such, the potential for contagion will rise. Hence, as economic (real, financial, policy) integration proceeds apace, what happens in one ASEAN country will affect other Member Countries as well. This is what is meant by “policy externality”: macroeconomic policy in one ASEAN Member Country will increasingly have a bearing on macroeconomics in others. As is the case with all externalities, the market will fail to be efficient unless this policy externality is “internalized”, which in this sense relates to macroeconomic monitoring and “peer pressure” with respect to pursuing prudent macroeconomic policies. After the Asian Crisis, together with the Asian Development Bank-ASEAN Member Countries established a monitoring system that has worked well to date. This sort of approach will be increasingly important as intra-regional trade and investment rise over time, and the AEC is put into place. The EU, for example, saw that it had to formalize such policies at higher levels of integration which have come to be enshrined in the “Maastricht Criteria” and the “Stability and Growth Pact”. From Tables 1.1–1.3, we see that the ASEAN countries are relatively close to meeting the Maastricht Criteria, were it applied in the context of

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ASEAN integration. It is yet to be seen if this will keep up throughout the on-going global economic crisis. 2.3. Microeconomic Environment As noted above, it is often difficult to compare investment-related measures and policies across countries. In ASEAN, each country has a unique history of microeconomic policy formation and hence, even policies that appear to be the same may well be different in practice. Moreover, capturing empirically the effects that various policies have had on the private sector is complicated, especially since so many factors influence domestic investment and FDI. For example, in the early 1980s, reforms in Sri Lanka made it one of the most liberal countries in the developing world. However, the civil war that began at that time nullified the expected private-sector response to these initiatives. One way to get around the problems associated with such estimates of the real implications of various investment measures and policies would be merely to focus on the results of these policies. If a country seems to have fairly liberal investment measures in most areas but de facto the private sector struggles, a problem obviously exists. We would then be able to focus on where the shortcomings exist and chart out means to rectify them. Annually the World Bank attempts to do just this. In its Doing Business database, it seeks to gauge as objectively as possible business regulations and their enforcement in practice. Included in its survey are 175 different countries, including all ASEAN Member Countries save Brunei Darussalam and Myanmar. Such a survey suits our purposes well, as it provides: (1) a general idea of how liberal and open the region’s economies are in various crucial areas of business regulations and enforcement; (2) a global comparison of the policy environment existing in the ASEAN Member Countries, suggesting which countries come closest to global “best practices”; and (3) a good indication of how diverse ASEAN is at the microeconomic policy level. In Table 1.4, we summarize the results of Doing Business 2007 for ASEAN Member Countries. Global rankings of each are given in relation to an overall indicator of “ease of doing business” and 10 additional areas: (1) starting a business; (2) protecting investors; (3) dealing with licenses; (4) paying taxes; (5) employing workers; (6) trading across borders; (7) registering property; (8) enforcing contracts; (9) getting credit; and (10) closing a business. Under each of these general areas, there are

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Table 1.4. Policy Diversity Towards Business in ASEAN: Global Rankings of Private-Sector Efficiency. Country Measure Ease of doing business (overall rank) Starting a business Protecting investors Dealing with licenses Paying taxes Employing workers Trading across borders Registering property Enforcing contracts Getting credit Closing a business

Camb Indo Laos Malaysia Phil Sing Thai Vietnam 143

135

159

25

126

1

18

104

159 60 159 16 124 114 100 118 174 151

161 60 131 133 140 60 120 145 83 136

73 170 130 36 71 161 148 146 173 151

71 4 137 49 38 46 66 81 3 51

108 151 113 106 118 63 98 59 101 147

11 2 8 8 3 4 12 23 7 2

28 33 3 57 46 103 18 44 33 38

97 170 25 120 104 75 34 94 83 116

Note: No data available for Myanmar and Brunei Darussalam. Source: World Bank, Doing Business 2007. (www.worldbank.org)

subcategories with separate rankings for additional questions. For example, under “starting a business”, the survey includes rankings for “procedures” (number), “time” (days), “cost” (as a percentage of per capita income), and “minimum capital requirements” (as a percentage of per capita income). While interesting, we mainly limit ourselves to the general areas in Table 1.4; the interested reader can get additional information from www.worldbank.org. Beginning with “ease of doing business”, it is clear that ASEAN Member Countries run the entire spectrum of liberal and restrictive policies. For example, Singapore ranks number 1 globally, whereas the transitional ASEAN economies, the Philippines, and Indonesia all rank above 100. Thailand and Malaysia each have a favorable environment, ranking 18 and 25 respectively, better than a number of OECD countries. This diversity across ASEAN Member Countries obviously reflects great differences in investment measures and the regulatory environment that exists in the region. Reducing disparities has been an important goal of ASEAN investment cooperation (see Chapter 4); creating a more integrated and harmonious region characterized by minimal transaction costs associated with production chains would be attractive to multinational corporations. Hence, harmonization of relevant measures and policies necessary for regional integration, as in the case of the EU, could result in not only

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a significant increase in FDI flows to the region but, more importantly, a more attractive business environment for domestic investment. In this sense, the fact that ASEAN has among its Member Countries highly-competitive regimes could serve as examples for other countries to follow. In particular, some of the original ASEAN economies have a great deal of experience that they can share with the transitional economies, something that is encouraged (even mandated) by the Initiative for ASEAN Integration (IAI). In its Doing Business 2005 survey, the World Bank showed a clear positive correlation between ease of doing business and the UNDP human development index. The EU experience testifies as to how an established, liberal framework can be “exported” to other countries within an integrating region. The enlargement of the EU to include 10 Central and Eastern European countries in 2004, and two more (Bulgaria and Romania) in 2007, involved significant technical and financial assistance to the transitional economies joining the EU in order to upgrade business practices to be compatible with the EU. This process on the whole has been successful in areas relevant to regional economic interchange. With respect to ranking for other questions, the transitional ASEAN economies continue to perform relatively poorly, with the exception of Vietnam, which scores well in “dealing with licenses” and “registering property”. Moreover, the Philippines and Indonesia receive lower rankings than Vietnam in most areas. Thailand and Malaysia are generally quite competitive, with a few exceptions (in particular, “trading across borders” for the former and “dealing with licenses” and “enforcing contracts” for the latter). Singapore does well in essentially all categories. It is also interesting to compare ASEAN to various competing economies in East and South Asia, which are given in Tables 1.5 and 1.6. Interestingly, we see that ASEAN’s two main developing-country competitors, China and India, do far worse than some of the ASEAN countries in most categories. Their respective rank in terms of ease of doing business, for example, are 93 and 134, i.e., not particularly competitive. China, therefore, is probably a great competitor because of its size, wealth, and dynamism, rather than some highly supportive policy framework. ASEAN should be able to exploit this advantage on international markets, and closer economic cooperation and integration will allow it to compete more effectively in terms of size. In short, there exists a great deal of diversity in the region with respect to the policy framework affecting the private sector in ASEAN Member

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Table 1.5. Policy Diversity Towards Business in Japan, China and Asian NIEs: Global Rankings of Private-Sector Efficiency. Country Measure

China

Hong Kong

Japan

S Korea

Singapore

Taipei, CH

Ease of doing business (overall rank) Starting a business Protecting investors Dealing with licenses Paying taxes Employing workers Trading across borders Registering property Enforcing contracts Getting credit Closing a business

93

5

11

23

1

47

128 83 153 168 78 38 21 63 101 75

5 3 64 5 16 1 60 10 2 14

18 12 2 98 36 19 39 5 13 1

116 60 28 48 110 28 67 17 21 11

11 2 8 8 3 4 12 23 7 2

94 60 148 78 154 42 24 62 48 4

Source: World Bank, Doing Business 2007. (www.worldbank.org) Table 1.6. Policy Diversity Towards Business in South Asia: Global Rankings of Private-Sector Efficiency. Country Measure Ease of doing business (overall rank) Starting a business Protecting investors Dealing with licenses Paying taxes Employing workers Trading across borders Registering property Enforcing contracts Getting credit Closing a business

Bangla Bhutan India Nepal Pakistan Sri Lanka 88

138

134

100

74

89

68 15 67 72 75 134 167 174 48 93

79 118 145 68 116 150 41 56 159 151

88 33 155 158 112 139 110 173 65 133

49 60 127 88 150 136 25 105 101 95

54 19 89 140 126 98 68 163 65 46

44 60 71 157 98 99 125 90 101 59

Source: World Bank, Doing Business 2007. (www.worldbank.org)

Countries. The region performs relatively well overall, but there certainly is room for improvement particularly in several Member Countries. While many of these policies tend to be more relevant to national jurisdiction and will not require harmonization in the AIA or the AEC, the potential

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11

for improving the regional environment through concerted action is considerable. Case Study: Focus on Microeconomic Policy Change in Cambodia, Lao PDR, and Vietnam (CLV) The above analysis would suggest that the ASEAN countries on the whole provide a positive macroeconomic environment for business but that the microeconomic environment is somewhat mixed across countries and within countries. But how has this environment changed over time? Are the ASEAN countries becoming more or less investor-friendly? All ASEAN Member Countries have stressed that they would like to improve the business environment, and initiatives at the ASEAN level are one way of accomplishing this. But, in practice, is this happening? This question is especially compelling the context of the CLV countries (as Myanmar is not included in the Doing Business rankings, we are unable to include it here). These transitional economies have had to reform their economic systems extensively, and it is interesting to see how they have fared. Given the base that they started from, it is to be expected that they would rank relatively low. But as most countries have been embracing comprehensive reform, we would also expect that they should be rising in the rankings. Table 1.7 summarizes the changes in various categories in ASEAN countries over the past two years. We are limited to the 2005–2006 period because, while there has been an annual survey for each of the past five years, in the 2005 survey the World Bank changed significantly the format of analysis, such that only a few questions overlap with the earlier surveys. Hence, we only have two data points (2005 and 2006, which emerge from Doing Business 2006 and 2007, respectively). In the analysis below, we focus on the transitional ASEAN countries, but interesting results emerge for the original ASEAN countries as well. One important caveat before beginning: rankings reveal relative changes. Hence, a country may indeed be enacting effective reforms but may not improve much (or even fall) in the rankings if the rest of the world is doing more. We would suggest that this is still appropriate; a competitive environment particularly for FDI must be evaluated in a comparative context. Globalization does not give good marks to a country for its reform program unless it is outperforming its competitors. However, in the analysis of the Cambodia, Laos, Malaysia, Vietnam (CLMV) countries, we look beyond

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Table 1.7. Diversity in Business-Related Reform in ASEAN: Changes in Global Rankings of Private-Sector Efficiency. Country Measure Ease of doing business (overall rank) Starting a business Protecting investors Dealing with licenses Paying taxes Employing workers Trading across borders Registering property Enforcing contracts Getting credit Closing a business

Camb Indo Laos Malaysia Philip Sing Thai Vietnam −1

−4

5

0

−5

1

1

−6

−4 −2 4 −1 0 0 −6 −3 0 0

0 −2 −2 −4 1 −5 −2 −1 −7 −10

38 0 3 0 1 2 0 −1 0 0

−5 −1 −3 0 −1 −5 2 −3 0 −4

−9 0 −1 −10 0 −2 −7 −9 −5 −4

0 0 2 0 1 −2 0 0 0 0

−5 0 3 −3 0 −6 −2 −1 8 −2

−8 0 3 −4 33 −7 −4 −4 −7 −11

Note: Bold/italicized numbers indicate large changes in rankings (rise or fall of six or more places). Positive numbers indicate a rise (improvement) in the rankings; negative indicates a fall. Source: World Bank, Doing Business 2006–2007 ). (www.worldbank.org)

the simple rankings to try to capture whether or not reform is taking place at the micro-level in various countries by including additional information in the dataset. 1. Cambodia. In overall ease of doing business, Cambodia dropped one place in the ranking, attributable to a fall of six in the “registering property” category ranking. Of the elements that make up this index, the only change was a very small (two per cent on a base of 4.7) drop in the “registering property cost” as a percentage of property value, which actually is a slight improvement. This leads to the conclusion that other countries made reforms that improved their spots in the rankings, rather than steps backward on the part of Cambodia. 2. Lao PDR. Laos rose five spots in the overall rankings, attributable to a 38 spot improvement in the “starting a business” category. Laos saw little change in the other categories. This 38 spot jump can be traced to changes in three different components: (1) an 18 percent reduction in the number of days to start a business (better); (2) a 15 percent increase in business start-up costs as a percentage of per capita income (worse); and

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(3) a 100 per cent reduction (from 23.4 to zero) of minimum capital required to start a business as a percent of per capita income. 3. Vietnam. This dynamic transitional economy paradoxically fell six spots in the overall rankings. There was one major improvement, that is, a rise of 33 spots in “employing workers”, offset by large steps backward in five other categories. The big jump in “employing workers” was due to very large improvements in both the Difficulty of Hiring Index (from 33 to 0) and Rigidity of Employment Index (48 to 37). On the other hand, as with Cambodia, the categories in which Vietnam fell in the rankings are, on the whole, attributable not to steps backward on the part of Vietnam, but improvements in other countries. For example, Vietnam fell eight spots in the ‘Starting a Business’ ranking, despite a 12 per cent reduction in Starting a Business Cost as percentage of per capita income (50.6 to 44.5). Likewise, a fall of seven spots in ‘Trading Across Borders’ (68 to 75) was accompanied by an eight percent reduction in the number of days required for export (38 to 35). In short, the CLV countries are making progress in a number of areas, but they still have a long way to go in terms of improving the microeconomic environment in which their respective private sectors and foreign multinationals can flourish. 3. Summary of Chapters The topic of ASEAN economic integration is, indeed, a vast one. Gone are the times when we could merely focus on (often half-hearted) ASEAN initiatives in trade and investment and feel confident that we had captured most of the issues. Today, ASEAN cooperation extends to almost all areas of economics as well as many social, cultural and security areas. Indeed, the AEC is but one pillar of the “ASEAN Community”, the others being the ASEAN Security Community and the ASEAN Socio-Cultural Community. Still, given the enormous scope of the task, this book endeavors to concentrate as much as possible on the policy dimensions of trade, investment, finance, and development in the region. Part I focuses on issues of ASEAN economic development and integration. Chapter 2 gives a broad overview of ASEAN economic integration in the Asian context. It tries to answer the following questions: What is shaping structural change in the region in the 2000s? Which are the most important variables determining competitiveness and productivity? How

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has policy change been reshaping Asia in an era of increasing globalization? How can regional integration be bolstered through formal and informal channels? It argues that structural change in Asia has been impressive over the past few decades, and much of this change can be attributed to economic liberalization. It underscores the importance of production value chains and fragmented trade in the globalization process in Asia generally and in ASEAN in particular, and argues that deeper economic cooperation, if it is outward-oriented and based on the principle of best practices rather then mere national treatment, will be an effective tool in bolstering regional competitiveness. This is rightly the most important economic priority of the AEC. Next, Chapter 3 considers the question of how ASEAN countries should align their commercial policies as they create the AEC. It is a complicated question: to create a “single market and production base”, one arguably needs a customs union, as was the case in the EU experience. But the diversity of the tariff structures in the ASEAN countries makes this a challenging process. The chapter explores how this might be done from a variety of perspectives, including the possibility of an extremely liberal Common External Tariff, which it argues would allow the region to be inclusive of all Member Countries (rather than having to resort to the “10-X” formula) and could generate maximum economic gains. Chapter 4 considers ASEAN investment cooperation. While FDI in ASEAN has been relatively strong over the past few years, it has generally been disappointing in most countries since the Crisis, and its share of global FDI as present is only about half of what it was in the mid-1990s. As FDI is an important priority in the ASEAN region, it is important to assess how effective investment cooperation has been in the region thus far, and what can be done in the future to improve its attractiveness. We find that ASEAN has made a good deal of progress in this regard, but that much more can be done in order to exploit the potential of the region. We suggest that the ASEAN Comprehensive Investment Area (ACIA), which will be the instrument through which the common investment area envisioned in the AEC will be realized, has considerable potential to create a unified market, with likely very high returns. Financial issues are covered in Chapters 5 and 6,2 which focus on fixed-income and stock markets, respectively. Financial market development 2 These

chapters were adopted from work done with Reid Click of the George Washington University.

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revealed itself to be the Achille’s heel of ASEAN development when the Asian Crisis hit; improving these markets continues to be a high priority in the region. In Chapter 5, we consider the development of bond markets and compare the inter-relationship between the bond markets of the ASEAN Member Countries, with a view to underscoring key areas that need to be addressed. We also consider the potential for the creation of an ASEAN bond market. Chapter 6 has a more specific purpose: It tests the degree to which ASEAN stock markets are integrated. Our hypothesis is that ASEAN stock markets are co-integrated and, hence, integration of these markets can be done without losing any diversification advantages. Thus, by increasing potential scope and liquidity, closer integration of these markets would make the region more attractive for portfolio investment flows. Part II focuses on ASEAN’s economic relationships with its most important economic (and strategic) partners. Chapter 73 looks at ASEAN regional economic integration in the broad context of Asian integration. Given the rising importance of Asia in the global economy and in ASEAN’s trade and investment, it is only natural that ASEAN considers how it might “nest” its approaches to economic integration with the Asian region in its entirely. It considers related questions in terms of real and financial cooperation. Using a CGE model to simulate various scenarios of potential trade agreements, it concludes that an ASEAN + 3 agreement would generate most of the benefits that one would expect from any configuration of regional agreements. Moreover, it shows that ASEAN countries are becoming more integrated in terms of macroeconomic variables and demonstrates that while ASEAN/Asia may not be an Optimal Currency Area, in terms of economics, it performs pretty much as well as the EU. The problem relates to the political will to embrace closer forms of monetary union. The chapter argues that the free-trade areas being negotiated in Asia will likely increase the probability of deeper monetary integration in the medium-long run. Chapters 8 and 94 explore ASEAN’s relationship with the EU and the United States, respectively. These markets are traditionally very important for ASEAN trade and investment; the EU is the most important source of FDI and the United States has traditionally been the most important market for ASEAN’s exports of manufactures. In both chapters, we argue 3 This chapter was adapted from work undertaken with Ganeshan Wignaraja of the Asian Development Bank. 4 Chapter 9 represents an updated version of Naya and Plummer (2005).

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that closer economic cooperation between ASEAN and these key dialogue partners make a good deal of economic sense, as well as having important political benefits. References Naya, S.F. and Plummer, M.G. (2005). The Economics of the Enterprise for ASEAN Initiative. Singapore: ISEAS. Rana, P.B. (2006). Economic Integration in East Asia: Trends, Prospects, and a Possible Roadmap. ADB Working Paper Series on Regional Economic Integration, No. 2. World Bank (1993). East Asian Miracle: Economic Growth and Public Policy. Oxford: Oxford University Press.

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Trends in ASEAN Economic Cooperation

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ASEAN Economic Integration in a Global Context: Trade, Investment, and Policy Issues

1. Introduction The Asian region has recovered nicely from the Asian Crisis. While governments have a general tendency to eschew economic reform in times of economic downturn and uncertainty, Asian countries emerged from the crisis ostensibly more determined to embrace liberalization than ever before. Still, much remains to be done in terms of promoting competitiveness and formulating effective economic reform policies at the national and regional levels. Asia’s growth trajectory seems to have slightly decreased; growth performance indicators are strong overall but there exists considerable variance across economies. The region’s economies have been successful in maintaining macroeconomic stability but much remains to be done in terms of microeconomic domestic policy reform. Asia’s outward-oriented approach to economic development has clearly survived its most important test 10 years ago, but continued economic success will not permit complacency. What is shaping structural change in the region in the 2000s? Which are the most important variables determining competitiveness and productivity? How has policy change been reshaping Asia in an era of increasing globalization? How can regional integration be bolstered through formal and informal channels? How can Asia confront emerging challenges, be they environmental- and energy-related constraints or technological challenges? These are all core questions that relate to the multifaceted determinants of real-sector growth and development in the region. In this chapter, we address these and associated questions with the objective of ascertaining how Asia in general and ASEAN in particular can increase productivity and competitiveness through regional integration. We stress that Asia’s real 19

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sector has been transformed by the emergence of economic giants, China and the more recent rise of India, and the economics of “fragmented trade”, that is, the development of production networks that enable economies to specialize in various links of the production process. Although the region’s exports are still substantially driven by extra-regional final demand, fragmented trade has intensified interdependence. Real sector economic integration has been supported by trade and investment regimes that remained open despite the challenges of the Crisis. While the origins of the Asian development model have been hotly debated in the literature — e.g., which are truly common features of the Asian “success story” and, in particular, the role of the state in successfully guiding development — there is consensus that international trade has been a key protagonist at all stages of development. Import-substitution was embraced by most economies early on in the development process, but the transition to export orientation was generally promulgated when the limits of the domestic market became apparent. Far from constituting a group of countries that would be locked into the “periphery” and doomed to producing natural-resource and agricultural-based products by a “core” of industrial countries with overriding technological superiority, many Asian developing countries, even some of the most resource-rich, were able to diversify production effectively and move up the value-added chain through economic reform. Today, over 90 percent of East Asian exports are manufactures and increasingly sophisticated, with electronics being by far the most important sector. Moreover, Asian economies, particularly India, have been successful in developing new services such as “outsourcing”. Asian developing economies have relied upon outward-orientation for technology transfer and productivity growth. Often, this was attracted through the promotion of foreign direct investment (FDI); unlike other developing regions, ASEAN, Hong Kong, China and Taipei, China distinguished themselves in generally having a pro-FDI approach to development which brought in new technologies, capital, foreign exchange, and readymade access to external markets. It also plugged them into fragmentedtrade networks. Other countries, such as South Korea and Japan, promoted technology transfer through international trade (e.g., advanced capital-good imports), licensing, or other approaches to purchasing new technologies. At later stages of development, even these two countries actively began to seek FDI. As their economies matured, they also counted on outward FDI in order to facilitate structural change and enhance competitiveness, allowing

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them to focus on niche markets in high-tech electronics and automobiles. Since its 1991 financial crisis, India has also begun to open up its economy to FDI and, while the stock of FDI remains low, the growth rates of inward and outward FDI have been relatively robust. This embrace of the global marketplace through policy reform is arguably the most important reason why Asia has excelled relative to its peers in terms of rising economic indicators, from plummeting poverty rates to burgeoning middle classes. In contrast to many OECD economies and a number of countries in Africa and Latin American, Asia has accepted globalization as an opportunity to be seized rather than a threat to mitigate or avoid altogether. Economic openness has resulted in the global marketplace — rather than government directive or conservative reflexes to maintain the status quo — driving rapid structural change in the region; economic reform has facilitated the flow of factors of production across sectors in such a way as to reduce the costs of economic transition and permit an efficient reallocation of resources. Such flexibility has kept the region limber and responsive to global market impulses. Due to structural and often political resistance to global market forces, other (developed and developing) countries have fared less well. The diversity of economic characteristics and stages of development in Asia has rendered it a natural area in which vertical integration of production and fragmented trade could take place. This “stitching” of economies together through production networks has increased regional trade and investment, bolstered growth, and facilitated technology transfer. China has been at the center of this process for the past decade. As noted by the Asian Development Bank (ADB) (2007), “The PRC’s [People’s Republic of China] successful participation in international production networks (or global value added-chains) during the last decade has been instrumental in the country’s recent technological upgrading” (p. 279). This vertical integration of production is complex, but, in general, has taken the form of multinational corporations (MNCs) using the region as a production base, allowing them to formulate production decisions according to the comparative and competitive advantages of the region’s composite economies. Lower barriers to trade and investment through liberalization and facilitation policies have improved prospects for production-network building and fragmented trade, a process that improves efficiency and best exploits opportunities offered by the region’s diversity. The natural result of this process is raising intra-regional trade, intra-industry trade, and intraregional FDI.

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Note, however, that unlike the experience of most regions (e.g., Europe, North America, Latin America, even Africa), Asian integration has been characterized by regional integration and driven by the market, rather than through formal preferential and non-preferential trading agreements, that is, regionalism, which is quite new to Asia. In fact, prior to 2000, there was no major free trade agreement (FTA) in Asia proper outside of ASEAN, and the ASEAN Free Trade Area (AFTA) was only then being implemented (See Box 2.1). Today, there is a plethora of bilateral and multilateral Box 2.1. ASEAN Economic Integration: Building a Core of Regional Cooperation in the Heart of Asia. The ASEAN economic integration experience in many ways reflects the movement from regional integration to regionalism in Asia. While economic “deepening” has been gradual, its pace has quickened and has been focused on the need to use regionalism as a means of supporting market-led integration. Founded in 1967 with the Bangkok Declaration, ASEAN is the most advanced institution of regional cooperation in Asia and one of its oldest. At first, its goals were mainly political in nature. In particular, it sought to promote peace in what was at that time a volatile region. While these diplomatic initiatives did not promote economic integration directly, the peace and security that followed paved the way for economic growth and development throughout Southeast Asia. It also allowed for a stable environment in which to promote economic reform. ASEAN did not attempt any significant economic cooperation initiatives until the new international political environment emerged at the end of the 1980s. Its first major initiative was AFTA, which was established in 1992 and originally only covered trade in manufactured goods over a 15-year period. But ASEAN subsequently broadened the scope and shortened the implementation period of AFTA so that it was technically in full effect at the beginning of 2004 for the original ASEAN countries and Brunei Darussalam (“ASEAN-6”), although there are transitional periods for products on the temporary exclusion lists. Recently, ASEAN decided to speed up the process such that AFTA will be fully completed in 2007, with some derogation for CLMV countries. ASEAN has also made important strides in the area of investment cooperation, e.g., in the form of ASEAN “one-stop investment centers” and the ASEAN Investment Area (AIA), and trade facilitation (e.g., customs cooperation). These efforts at industrial cooperation have been designed with essentially the same goal in mind as AFTA: reduce transactions costs associated with intra-regional economic interaction. The AIA, for example, seeks to ensure national treatment for ASEAN investors by 2010 and for all investors by 2020 (see Chapter 4). As most MNCs in ASEAN are from non-member countries and ASEAN countries are actively courting FDI, legislation is emerging or is in place in a number of member countries (Continued)

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Box 2.1. (Continued ) that would accord national treatment for all investors together. Singapore, for example, does not discriminate between ASEAN and non-ASEAN investors. In November 2002, the ASEAN Heads of Government meeting in Phnom Penh proposed that the region should consider the possibility of creating an “ASEAN Economic Community” (AEC) by 2020. The ASEAN leaders actually agreed, at the Bali ASEAN Summit in October 2003, to create a region in which goods, services, capital and skilled labor would flow freely, though the details remain to be worked out (the blueprint to achieving this is to be approved at the ASEAN Summit in Singapore in November 2007). In the 2007 “Cebu Declaration” the ASEAN leaders pushed up the deadline to 2015. As part of the AEC process, ASEAN is developing an ASEAN Charter, which will significantly enhance the formal nature of ASEAN integration by making it an international legal entity. The Charter is arguably a necessary step in order to deepen integration as substantially as the AEC requires. ASEAN celebrated its 40th birthday in 2007. It continues to defy its critics and impress its observers. Many pundits have argued that ASEAN economic integration has merely been a “fig leaf” for its political and diplomatic agenda. They point to the lacklustre performance in implementing “deep” economic integration initiatives as a case in point. Some economists have argued that ASEAN makes no sense as a regional institution itself, as its diversity and small levels of intra-regional trade and FDI suggest it is not a “natural” economic bloc. But ASEAN has shown that its political goals are not only consistent with deepening economic initiatives but actually re-inforce them. Moreover, to say that ASEAN is not a “natural” economic bloc is to miss the point: such a criticism would only be valid if it were inward-looking; rather, an outward-oriented approach to integration is its explicit goal. Indeed, the myriad official ASEAN communiqu´es, agreements, and other initiatives often stress the need to remain outward-oriented and market-friendly. The primary goal of economic integration in ASEAN, as articulated by its leaders, is to reduce transactions costs associated with economic interchange and to make the region more attractive to MNCs wishing to take advantage of its diversity and openness in rationalizing production networks. In this sense, it is both determining and determined by the new wave of outward-oriented regionalism in Asia. In short, regionalism in ASEAN is supporting regional integration, rather than vice versa (e.g., in the EU case). ASEAN continues to face many challenges, but its initiatives clearly demonstrate a desire to use trade and investment liberalization through the AEC as a means to promote competitiveness and integration with the global economy and Asia.

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accords in place and many more in the works. While there are many motivations driving the FTA movement in Asia, certainly a salient goal is to further this process of creating an integrated region in which local, regional, and global MNCs can operate more easily and connections among markets can be strengthened. These FTAs could be one means by which partnercountries could reduce barriers to economic interaction and, as such, profit from greater efficiency. China has in many ways been leading this process. In addition to being a center of the fragmented-trade chain, it has been a key protagonist of closer regional integration. It has in place an FTA with ASEAN and has been an active participant in “ASEAN +3” (ASEAN, China, South Korea, and Japan) activities and the East Asian Summit. Moreover, competition from China has created a greater incentive for deeper regional integration elsewhere in Asia. For example, just as deeper integration in the EU was driven by a need in Europe to compete with the United States in terms of economies of scale and associated economic synergies, ASEAN integration is motivated in part by a perceived need to reduce transaction costs to crossborder production in order to compete with China (and India). Competition is breeding competition. Modern economics would teach us that this is what drives the wealth of nations. Of course, these FTAs have positive and negative sides to them, so it is incumbent upon Asian policy makers to maximize the former effects while minimizing the latter through comprehensive strategies in terms of FTA planning, and the adoption of “best practices” in terms of their execution. The region’s long-term development should target the vision of free trade throughout Asia — that is, fully integrated regional markets seamlessly connected to the global economy. The goal of this chapter is to give a general overview of the characteristics of the ASEAN economies and policy challenges facing ASEAN in the context of the Asian region. It is organized into four additional sections. Section 2 gives a general overview of rising interdependence in the region, structural change, and the important driving forces behind them, in particular the emerging regional division of labor and fragmented trade. Section 3 focuses on policy analysis: first, it gives an in-depth policy analysis of the domestic microeconomic environment in Asian developing countries, followed by a review of the status quo commercial policy environment. This sets the stage for an evaluation of regional economic cooperation in Asia in Section 4. Finally, Section 5 considers emerging challenges to medium- to

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long-term growth in the region and hypothesizes as to what will be required to create an outward-looking, competitive real sector in Asia in the context of a rapidly-changing global environment. 2. Structural Change, Microeconomic Policy, and Rising Interdependence This section considers the complicated nature of structural change in Asia in an increasingly globalized economy. After a review of relevant stylised facts, it focuses on the characteristics of structural change in Asia with a focus on trade and investment. It shows how fragmented trade has become a key protagonist in regional integration and underscores the critical role that China is playing in this process. 2.1. Liberalization, Growth and the Forces Behind Regional Integration By any measure, Asian economic growth and development over the past two decades has been remarkable, particularly in East Asia. We noted above that it is easy to trace this remarkable performance to the region’s rising outward-orientation, technological upgrading, and new mechanisms of production fragmentation. Some salient stylised facts (Table 2.1) of the past two decades include: (1) The internationalization of Asian economies has been extremely impressive and, in some cases, phenomenal. The ASEAN transitional economies have essentially been transformed from autarchic to considerably open economies over these two decades. Vietnam, for example, saw its share of exports (imports) as a percentage of GDP rise from seven percent (17 percent) to 66 percent (74 percent) over the 1985 to 2004 period (that is, even before it joined the WTO in 2005). Historically few large economies have experienced such a rapid internationalisation over such a brief time span. Other countries also registered impressive changes, with the two Asian Giants of India and China both significantly expanding their shares of exports and imports in GDP, as well as their global presence. (2) Economic liberalization, particularly of commercial policies, has been behind this internationalization of developing Asian economies, and there has generally been a strong correlation between measures of interaction

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with the global economy (e.g., through rising shares of trade) and economic prosperity. Opening up of the most closed economies (i.e., the transitional ASEAN economies, China, and India) paid the greatest dividends. While per capita income in Asia continues to be lowest in the transitional ASEAN Table 2.1.

Basic Economic Indicators of Asian Economies. GDP Per Capita, PPP (Current International $)

Brunei Cambodia Hong Kong, China India Indonesia Japan Korea, Rep. Lao PDR Malaysia Myanmar Philippines PRC Singapore Taipei, China Thailand Vietnam

1985

2004

1985

n.a. 1.144,3 10.319,7 965,0 1.232,4 13.331,0 4.631,7 673,0 3.246,6 n.a. 2.489,0 822,7 7.690,9 6.194,8 2.105,1 861,9

n.a. 2.422,9 31.165,1 3.163,2 3.601,2 29.251,4 20.471,2 1.962,5 10.276,1 n.a. 4.664,2 5.895,8 28.859,8 26.240,6 8.090,0 2.774,4

223,0 8.100,6 5.456,2 765.147,0 163.036,0 120.754,0 40.806,0 3.621,4 15.667,2 37.237,2 54.265,8 1.051.040,0 2.736,0 19.258,1 50.611,6 58.868,0

Gross Capital Formation (% of GDP)

Cambodia Hong Kong, China India Indonesia Japan Korea, Rep. Lao PDR Malaysia Myanmar Philippines PRC Singapore Taipei, China Thailand Vietnam

Population, Total (‘000) 2004 365,7 13.798,1 6.882,6 1.079.721,0 217.587,5 127.764,4 48.082,2 5.791,7 24.894,5 50.004,0 81.617,0 1.296.157,0 4.240,3 22.615,3 63.693,7 82.162,1

Gross Domestic Savings (% of GDP)

1985

2004

1985

2004

9.4 21.5 23.7 28.0 28.5 30.0 7.0 24.8 15.5 14.3 37.8 42.5 18.9 28.2 14.4

25.8 21.8 30.1 23.1 23.9 30.2 17.4 22.6 15.0 17.1 38.7 19.4 21.5 27.1 35.6

1.9 31.7 21.2 29.7 31.9 30.6 1.3 29.9 11.5 16.5 33.6 40.5 n.a. 25.5 4.5

14.7 30.7 28.1 25.8 25.5 34.6 n.a. 43.9 12.4 17.7 41.2 47.0 n.a. 31.8 28.3

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Table 2.1.

(Continued )

Exports of Goods and Services (% of GDP)

Cambodia Hong Kong, China India Indonesia Japan Korea, Rep. Lao PDR Malaysia Myanmar Pakistan Philippines PRC Singapore Taipei, China Thailand Vietnam

27

Imports of Goods and Services (% of GDP)

1985

2004

1985

2004

2.6 107.5 5.4 22.2 14.3 32.0 2.4 54.1 4.6 10.4 24.0 10.0 157.2 53.3 23.2 6.6

64.7 190.2 19.0 31.3 11.8 44.1 24.8 121.2 n.a. 16.0 50.6 34.0 243.0 64.8 70.5 66.4

10.1 97.4 7.8 20.4 10.9 31.4 5.8 49.1 8.6 22.8 21.9 14.1 159.1 39.8 25.9 16.6

75.8 181.3 21.0 27.3 10.2 39.7 32.6 99.9 n.a. 14.9 50.0 31.4 213.1 61.3 65.8 73.6

Sources: World Bank, World Development Indicators Database; IMF; World Economics Outlook Database; CEIC Database.

countries, in each of these economies it has better than doubled since 1985.1 Vietnam, which launched its economic reform program (doi moi) in 1986 and has promulgated increasingly comprehensive liberalization policies, performed the best of these countries, more than tripling its per capita income over this period. The process of joining the WTO — of which the decision to negotiate a Bilateral Trading Agreement with the United States in 2001 was a major step — has been an important protagonist in this reform program, as it has been for China. India is another relatively poor, reformist economy that has been able to better than triple its average income over the past two decades, though its reform push began later (i.e., after its 1991 economic crisis). (3) The overall change in sectoral shares of output in these economies has shown a classic “Kuznets” development trend, with agriculture falling over time in all economies (save Myanmar), and manufacturing rising or reaching a plateau in all developing Asian economies (save Myanmar 1 The

exception may be Myanmar, for which we do not have a complete data set covering this time period.

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and the Philippines, where the manufacturing share fell).2 This structural change is consistent with the dynamic comparative advantage of regional economies. As noted above, the Asian embrace of globalization implies that the international marketplace has been dictating structural change. And the relative flexibility of the economic systems in Asia has enabled it to respond quickly, adjusting to the constantly changing price signals generated by the global economy. (4) With respect to productivity, a number of Asian countries have been closing the gap with the technology-frontier countries. As noted by ADB (2007), some of the Newly Industrial Economies (NIEs) have already essentially caught up with OECD productivity levels, and China, India, and the ASEAN countries — especially Malaysia and Thailand — have generally made progress in closing the productivity gap with the OECD, although gaps have been widening in Indonesia and the Philippines.3 (5) There is strong empirical support for the rise of an “Asian economy” based on MNC network building, using the diversity of the region to create a vertical division of labor that reaps greater efficiencies through fragmented trade. For example, Rana (2006) uses a gravity model to show that there has been a rise in economy symmetry that derives from an increase in intra-regional trade, which in turn is being led by rising intraindustry trade. In other words, the post-Crisis Asian economy is being more closely knit through a process of vertically-integrated production networks and fragmented trade. This approach makes sense as a development strategy, especially for the less developed Asian economies: fragmented trade allows specialization in niches and, therefore, reduces the number of skills that must be mastered before entering international production chains. Moreover, it would appear that the Asia-Pacific region offers up a “special” model of MNC network activity. This is the conclusion of Dee 2 ADB (2007). This study of structural change in Asia in a global context notes that, at higher level of per capita incomes, agriculture actually tapers out more quickly in Asia than the global average. It confirms the general Kuznet process of structural change, although there is no evidence that industry expands ahead of services (p. 272). 3 ADO (2007), p. 272. The ADO makes the distinction between relative and level measures of productivity. The Malaysian case is an interesting example. Between 1980–1985 and 200–2004, relative productivity improved from 16 percent to 21 percent of the OECD average. Thus, we would say that it is converging. However, the gap in the level of productivity actually rose. The ADO notes that once Malaysia reaches one-third of OECD productivity, its levels should begin to converge.

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(2006), who stresses that this uniqueness is a result of the forces of economic geography. She finds that comparative advantage is an important driving force but that it is mitigated by economies of scale and transport costs. The literature would also suggest that the stress on outward-oriented FDI is also a salient feature of this “special” model.4 (6) There are many real-world examples of the production fragmentation process and the building of networks in Asia. One recent example of this sort of regional complementarity would be the decision of Intel, an American MNC, to open up a $40 million design and development center in Malaysia following a $200 million semiconductor chip facility in Chengdu, People’s Republic of China.5 For ASEAN, which is explicitly using regional integration to attract MNCs, there are also myriad examples of this type of regional production chain formation (Table 2.2). Production networks have Table 2.2. Selected Multinational Corporations Involved with Regional Production Networks in ASEAN. Company

Product/Industry

Countries Involved

Universal Integrated Corporation Consumer Products PT Indo Sukses Makmur Sanden Denso

Detergent

Indonesia, Singapore

Detergent Automotive Automotive

Toyota

Automotive

Honda

Automotive

Volvo Ford Sony Matsushita

Automotive Automotive Electronics Electronics

Nestle/Goya

Food processing Electronics Electrical Agriculture machinery

Indonesia, Singapore Singapore, Thailand Indonesia, Malaysia, Philippines, Thailand Indonesia, Malaysia, Philippines, Thailand Indonesia, Malaysia, Philippines, Thailand Malaysia, Thailand Philippines, Thailand Singapore, Thailand, Vietnam Indonesia, Malaysia, Philippines, Thailand Indonesia, Malaysia, Philippines, Thailand Malaysia, Vietnam Indonesia, Malaysia Indonesia, Thailand

Samsung Clipsal/Bowden Yanmar

Source: ASEAN Secretariat. 4 This

literature is vast, but one particularly influential work is Dobson and Chia (1997). author is grateful to Jay Menon of the ADB Institute for drawing his attention to this example. 5 The

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been more extensively developed by Japanese MNCs than American or European ones in the region. Will this new division of labor in Asia lead to greater complementarity in economic structure? This is a theme that has been treated extensively in the European economic integration literature, particularly with respect to monetary union. A truly integrated regional market would free up MNCs to produce whatever they would like in different markets, profiting from the inherent comparative advantages in the regional economies and exploiting economies of scale inherent in production fragmentation. Hence, in the context of Asia, one would predict that complementarities will persist due to the wide-ranging factor endowments in the region. But, as Bela Balassa remarked, comparative advantage is man-made. As countries build up their physical and human-capital base, their comparative advantage changes. For example, in the 1950s, Japan was one of the most labor-abundant countries in the world and it specialized in the export of labor-intensive goods. Today, it is the most capital-abundant country in the world and its comparative advantage has changed commensurately. Thus, one would expect that, for the least developed countries in Asia, there will continue to be complementarities in the short-run. However, middle-income and upper middle-income developing countries in the region are already rising up the development ladder and are producing increasingly sophisticated products, though the progress has varied considerably across the region (ADB 2007). One concrete example of this would be the fact that the most important export of most ASEAN6 countries is electronics, and electronics trade in the region plays an important role in the rising degree of intra-industry trade (discussed below). Another would be the type of production niches being developed in the region, spanning sectors ranging from sophisticated manufactures to services, including “business process outsourcing” (see Box 2.2). Further evidence is found in a comprehensive study by the ADB (ADB 2007), which compares baskets of exports of developing Asian countries according to how similar they are to rich countries. They confirm a general “flying geese” picture, in which the NIEs are followed by the resource-rich ASEAN countries, China, and India. In addition, there is a clear increase in the level of complexity and sophistication of these export baskets over time. The growth in intra-regional trade is developed more thoroughly in other chapters, especially Chapter 3. Suffice it to note here that Rana (2007) demonstrates that a process of integration, convergence and industrial upgrading is transpiring across the board in Asia. He calculates the

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Box 2.2. Upscale Services: The Indian Outsourcing Sector. The growth in the export of “outsourcing” services from India is an excellent example of how globalization is creating myriad new opportunities in terms of production niches. The term “outsourcing” became an important business concept in the 1980s but it only became significant in the public realm in the 2000s. It evokes considerable emotion among both “pro” and “con” camps in developed countries: the former includes a growing number of firms that see it as an efficient way to reduce costs and increase access to capabilities, while the latter considers it a futuristic vehicle for exporting “jobs”. Wikipedia defines outsourcing as “utilizing experts from outside the entity to perform specific tasks that the entity once performed itself”. Hence, it is clear why the antioutsourcing camp sees it as a threat to existing jobs in a given country. On the other hand, advocates suggest that, by making firms more cost-effective and competitive, it can actually lead to the creation of new jobs, as well as ensuring greater job stability through cost competitiveness. In many ways, the economic benefits of outsourcing are no different from that of other internationally traded goods and services; the McKinsey Global Institute, for example, estimates that for every dollar the United States sends abroad in outsourcing, it gets back $1.12.6 Whatever the analytics of outsourcing in developed countries, it has become an important source of services exports in certain developing economies. India has emerged as a global leader in the provision of outsourcing services. Its key comparative advantage relates to its endowment of skilled yet inexpensive labor and strong English language skills. The boom in outsourcing services has been guided by rising local giants in the field, such as Infosys, Tata Consultancy Services, and Wipro.7 Key clients of these companies include Bank of America, Microsoft, and Ericsson. The sophistication of these services varies greatly from medium-skill call centers to design of next-generation cockpits for Boeing and Airbus and financial analysts for Wall Street firms.8 The market has been growing annually by approximately 25 percent and is estimated to rise in value to $60 billion in 2010 from $17 billion in 2005.9 By these estimates, it could employ directly 2.3 million people and indirectly 6.5 million in India. Thus, outsourcing is a key “niche” services export of India and could be increasingly important in years to come. Moreover, opportunities are being created in a wide variety of sectors. Other countries have been impressed by the Indian success story in this area and are actively trying to develop their own outsourcing sectors. China has (Continued) 6 http://economistsview.typepad.com/economistsview/2006/05/mankiw outsourc.html, as cited by Gregory Mankiw. 7 Sabrina Siddiqui, http://www.businessweek.com/debateroom/archives/2007/10/ indian outsourc.html. 8 http://www.iht.com/articles/2007/04/03/business/rupee.php. 9 http://www.infoworld.com/article/05/12/12/HNindiaoutsourcingvalued 1.html.

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Box 2.2. (Continued ) already emerged as an important competitor to India. Local Indian firms are even establishing their own global back offices. For example, Infosys has back offices in Mexico, China, and Thailand, whereas Tata already employs 5,000 workers in Brazil, Chile and Uruguay.10 All indications are that outsourcing is becoming a global industry in which borders matter less and less. Globalization will continue to generate important new opportunities in this and related areas.

Table 2.3. Intra-Industry Trade, Correlation of Industrial Production, and Trade Intensity in Selected East Asia Economies (Relative to Group, 1993 and 2004). East Asia Economies

PRC Indonesia Japan South Korea Malaysia Philippines Singapore Thailand

Intra-Industry Trade

Correlation of Ind. Production

Trade Intensity

1993

2004

1993

2004

1993

2004

0.31 0.20 0.28 0.31 0.35 0.33 0.47 0.33

0.47 0.36 0.44 0.52 0.50 0.42 0.56 0.55

0.16 (0.06) 0.23 0.22 0.09 0.06 0.30 (0.11)

0.28 0.26 0.43 0.40 0.39 0.44 0.47 0.53

1.02 2.19 2.57 1.85 2.93 1.59 3.61 2.09

1.59 3.14 2.72 1.94 3.62 2.85 3.93 3.04

Source: Adopted from Rana (2007).

degree of intra-industry trade, the correlation of industrial production structures, and the trade-intensity (though a double-density approach) for the ASEAN +3 group (relative to each other) for the 1993–2004 period and finds that in all cases these measures have risen in all countries (Table 2.3).11 Intra-industry trade now accounts for between 36 percent and 56 percent of intra-regional trade, up from 20 percent to 47 percent in 1993, an indication of rising production fragmentation through a vertical division of labor and greater sophistication of trade. Trade intensity, which gives an idea of the importance of intra-regional trade for the size of the economies in question, suggests that the region trades with itself from 60 percent to almost 400 more than what would be the case if these were randomly-distributed 10

http://www.nytimes.com/2007/09/25/business/worldbusiness/25outsource.html?8br= &pagewanted=all. 11 Due to data restrictions, he excludes the ASEAN transitional economies, Taipei, China, and Hong Kong.

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economies. With the exceptions of China and South Korea (both dependent on the US market), this trade intensity is far higher than the corresponding average for the EU, which has had a customs union in place for a half century and has increasingly deepened its integration agenda. As a final point in this regard, we have stressed the vertical nature of FDI and trade in Asia. This is not to say that horizontal trade and investment are becoming less relevant; rather, certain aspects of horizontal trade and investment will continue to be extremely important in driving the globalization of Asian economies. It is difficult to sort through the data and determine the exact magnitudes of horizontal versus vertical FDI. However, changes in sectoral FDI might give us some indication. We noted above that FDI in electronics has been rising in the region and constitutes an important part of the fragmented trade process. But it is also the case that FDI inflows to developing Asian countries have been increasingly in the services sector, particularly financial services. About 50 percent of total FDI inflows to ASEAN went into services in 2006, with financial services and wholesale trade being the largest categories. Given the rise in importance of services in the developing process, we would expect that this type of horizontal FDI will rise in importance over time. The services sector is also becoming an increasing component of total trade in Asia, coming to approximately one-third of total trade in the original ASEAN countries, for example. The importance of services is underscored below in the context of structural change. In short, rapid economic growth in Asia has taken place pari passu with increased regional integration resulting in a large degree from a rising vertically-integrated regional production chain. Moreover, growth and integration are being fuelled by greater economic openness. Next, we consider how this process has affected the economic structure of the Asian economies themselves. 2.2. Structural Change Though often used interchangeably, growth and development are related but fundamentally different concepts. For example, over the past three decades the fastest growing economy in the world has been Botswana. However, this growth has been based on diamond production rather than some process of structural change leading to development. The same is true in recent years of oil-producing countries that have benefited from high oil prices. While it is difficult to conceive of development without growth,

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there are examples of poor regions making strong progress in terms of social indicators without much growth in per capita income, as in the case of the Indian region of Kerala (Sen, 2001). But, in general, structural change of industrial production and trade will give us important insight into whether or not growth is leading to development. Clearly, economic growth and development are dynamic, non-linear processes. Ex-ante models of economic development have a difficult time capturing these processes, both due to complications associated with the non-linearities that determine medium- and long-term growth and the fact that the myriad interactions of internal and external factors affecting growth are exceedingly difficult to model. Ex-post, however, we are able to gauge the degree to which development transpires by focusing on various types of structural change. In this section, we focus mainly on the manifestation of this structural change in the trade sector, but do include some analysis of investment (in the ASEAN context). The literature is replete with studies of overall structural change in Asia. The most recent, comprehensive study of these changes is ADB (2007). It tells a story that is consistent with the fragmented-trade story told in the previous section. That is, there is strong evidence that developing Asia has succeeded in moving up the value-chain of production. Manufacturing in the Dynamic Asian Economies (DAEs) (especially South Korea, Malaysia, Singapore, Taipei, China and Thailand) have transformed their productive structures such that more technology- and economies-of-scaleintensive sectors are becoming much more important, if not dominant, in their economies. In China and India, the structural change has been taking place less rapidly but technological- and scale-upgrading is taking place in these giant economies as well. International trade is a key protagonist in this restructuring process. In order to capture structural transformation via trade, we consider first to what degree the exports of Asian economies to major markets have been changing over time. One way to try to gauge this is by estimating the extent to which the export mix of Asian exports to major markets has been changing. In that this export mix changes significantly, we would infer that a country has been experiencing dynamic structural change. Hence, we correlated the exports of Asian economies to the region’s largest export markets, i.e., the OECD aggregate, the EU and the United States, over the past 10 years, separating them into three subperiods: 1996–2000, 2000–2005, and 1996–2005 (full sample). Moreover, we do this using a disaggregated export database (5-digit SITC, yielding up to around 3000 observations per series) in order to best capture structural changes in export structure.

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Degree of Structural Change

0.70 0.60 0.50 0.40 0.30 0.20 0.10

Br un e C i* am b* * C hi n H K, a C H N In di a In do Ja pa n Ko re a M al ay Ph il Si n Ta g i,C H N Th ai Vi et ** *

0.00

Countries Notes: Correlation includes only commodities with value ≥$250,000. ∗ Brunei values are from 1994 to 2003 due to missing data in 2005. ∗∗ Cambodia values are from 2000–2005 due to missing data. Correlations are performed with 2004 instead of 2005 data. ∗∗∗ Vietnam values are from 2000–2005 due to missing data. Correlations are performed with 2004 instead of 2005 data. Source: UN COMTRADE (5-digit SITC). Fig. 2.1.

Structural Change in Asia, 1996–2005.

The methodology we use here — as well as elsewhere in this chapter — is a correlation technique known as Spearman Rank Correlation Coefficient (SRCC). The SRCC is a non-parametric statistic that correlates two series. It varies from +1 (perfect correlation) to −1 (perfect negative correlation), with 0 suggesting no correlation at all. Hence, a country whose exports to the OECD are highly correlated would be consistent with a stable export structure, whereas lower correlations denote greater structural change. Thus, to simplify the interpretation of the degree of structural change in exports, we calculate (1-SRCC)12 in Figure 2.1: the higher this value, the greater the degree of structural change. Moreover, we focus on all exports to the OECD market for the 1996–2005 period in Figure 2.1 (Appendix Table 2.1 provides all results, including the three periods and three markets noted above, as well as breaking down the commodity classifications into “manufactures” and “all commodities”13 ). 12 We do this for simplicity of interpretation rather than for any other motivation. The fact that none of the estimated coefficients was negative permitted this. 13 The “manufacturing” and “all” classifications make little difference, as the overwhelming share of exports in Asia is comprised of manufactures. The breakdown into three separate export destinations does not make a big difference, though it is clear that,

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Japan’s export structure since 1996 has essentially stayed the same, with an estimated correlation coefficient of 0.13. This is not surprising given that Japan is an advanced, industrial economy with a strong, stable comparative advantage in electronics and automobiles. Taipei, China and Hong Kong also have relatively low degrees of structural change (0.29 and 0.24, respectively), whereas estimates for Singapore and South Korea lie above the 0.40 range, along with Malaysia, the Philippines, and Thailand. Note that these latter economies (along with Taipei, China) are the same ones receiving high marks for technological upgrading in ADB (2007). Over the entire sample, changes in export structure are the most evident in the case of Indonesia (0.41), Vietnam (0.41), and India (0.43), but Cambodia’s export structure over the 2000–05 period changed more than any other economy save Brunei.14 As we will see in the next section, it is no coincidence that these countries have been among the most significant reformers. The results for China are interesting. Over the 1996–2005 period, China emerged as an export powerhouse that has intimidated small and large countries alike. It has also embraced significant reform of its trade policy; it joined the WTO in December 2001, for example. However, according to our estimates, the structure of China’s exports has remained relatively stable. This might be explained by the fact that it continues to have a strong comparative advantage in labor-intensive products, and this has not changed greatly over this period, though obviously it has been able to diversify to some degree (its degree of structural change coefficient comes to 0.28). Moreover, as can be seen from Appendix Table 1, structural change in its exports to the US market has been more rapid than for the OECD as a whole. In any event, this result of slow structural adjustment in exports is also generally consistent with the ADB (2007) conclusions as well as Athukorala (2007). Of course, there is no “magic SRCC value” that would tell us what would constitute a dynamic export process. Nor have we been able to correlate changing export structures with economic reform affecting trade performance directly. However, we are able to substantiate that there has in most cases, Asian exports to the US market have been more dynamic than those going to the OECD in general and the EU in particular. All estimates are statistically significant at the 99 percent level of confidence. 14 Of course, Brunei’s SRCC coefficient at 0.67 is actually the lowest. However, Brunei is somewhat of an exception in this analysis because 90 percent of its exports are petroleumrelated. But these exports only occupy a relatively few commodities in the 5-digit SITC line-up, and since the SRCC is non-parametric in nature, this leads to a clear bias.

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been substantial change in the export structure of all Asian developing economies, with some showing particularly impressive change over a very short time period. There is some indication that the same process is at work in terms of FDI. The lack of detailed FDI data makes it difficult to run SRCCs due to the aggregation bias associated with such a technique. However, Plummer and Cheong (2007) do correlate FDI inflows into the ASEAN countries for the pre-Crisis (1993–1997) and post-Crisis (1998–2005) periods using the most detailed database (UNCTAD) available, including up to 26 individual industries. While this is an extremely small sample relative to our export data (i.e., up to 3000 commodities), the results do show relatively high degrees of structural transformation in the ASEAN countries for which data were available. Applying the same (1-SRCC) technique to gauge the degree of structural change, we calculate their estimated coefficients to be as follows: Indonesia, 0.31; Malaysia, 0.79; the Philippines, 0.34; Singapore, 0.53; Thailand, 0.51; and Vietnam, 0.30.15 These are impressive, especially given the aggregation bias mentioned earlier. Along with other empirical techniques, they conclude that FDI in the ASEAN region has been quite dynamic, particularly since the Asian Crisis. 2.3. Fragmentation, the Search for New Production Niches, and the Significance of China We noted above that the literature suggests that production networks and clusters in Asia result in greater efficiencies and productive upgrading. This process is behind the rise in intra-regional trade and investment discussed earlier and manifests itself in the trade-FDI link, which has been growing in importance over time.16 While the production fragmentation process is sometimes difficult to disentangle empirically, studies have generally found that MNCs are increasingly using the region as a verticallyintegrated production base. This expansion and deepening of regional production networks have been encouraged by a number of factors, including the changing corporate production strategies adopted due to the potential benefits offered by a wider integration process. This regional integration, both through informal and formal channels, allows an MNC to optimize benefits associated with a regional division of labor. For example, in the 15 All values are statistically significant at the 95 percent level except in the case of Malaysia. 16 See, for example, Lee and Roland-Holst (1999).

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ASEAN context, the ASEAN Industrial Cooperation Scheme (AICO) was created in 1996 to supercede earlier cooperative arrangements and serve as a transition program as AFTA was implemented. It reduced preferential tariff rates to between zero and five percent and included other advantages, such as a guaranteed rapid turnaround on applications, references to dispute settlement, and more liberal equity restrictions for foreign investors. It has encouraged automobile and electronics manufacturers to adopt efficient production networks based throughout the region. As of February 2007, 140 projects had been issued AICO certificates for joint-production activities involving two or more ASEAN Member Countries.17 Most of these regional production networks were associated with automotive knock-down packs, automotive components, electronics, and food processing. Regional production networks are carried out by many multinational corporations, examples of which were listed in Table 2.2. China has become a major destination of global FDI (Table 2.4); some of the production from these investments is destined for the domestic market, but most use China as a production base for re-exports. It is estimated, for example, that the lion’s share of Chinese exports are undertaken by affiliates of foreign MNCs and domestic value-added is relatively low.18 ASEAN countries, as well as other developing and even developed countries, have sometimes blamed their sometimes disappointing FDI performance on the “Chinese Threat”. In fact, while FDI flows to ASEAN have been rising significantly of late in nominal terms, Table 2.4 reveals that the sub-region’s share of global FDI flows in 2005 was only half that of its pre-Crisis share. As China has become a major player in the regional and global economies, it has become an economic competitor as well as a partner to developed and developing economies, including ASEAN. Its rise on the global stage is due to a number of factors, including its sheer size, pace of economic reform (including joining the WTO), break-neck economic growth, and its strategic position in the most dynamic region in the world. Nevertheless, the fragmented-trade trend also could have a positive side to it for ASEAN; in other words, being a neighbor to China creates opportunities in addition to competition. This has shown up empirically; when controlling 17 ASEAN

Secretariat. example, using input-output tables, Chen (2007) finds that while overall trade would suggest that Chinese exports to the United States were four times that of US exports to China, in terms of domestic value-added, they were less than two times that of US exports to China. Athukorala (2007) decomposes China’s trade and finds that, although the growth rate of high-tech exports from China has been impressive, the actual value added in terms of high-tech activities embedded in these exports is low. 18 For

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Share of World FDI Inflows, 1995–2005. (Selected Countries and Regions, % Share.)

Host

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

17.30 37.90 0.01 11.00 0.37 21.70 8.27

21.50 31.80 0.06 10.60 0.51 21.90 7.77

21.10 29.2 0.66 9.24 0.54 19.40 7.01

24.50 39.80 0.45 6.38 0.71 12.20 3.13

25.80 45.70 1.16 3.67 0.88 9.58 2.62

22.30 49.40 0.59 2.89 0.61 9.87 1.67

19.20 45.90 0.75 5.63 0.46 11.70 2.34

12.10 49.70 1.50 8.54 0.49 13.20 2.55

9.53 45.50 1.13 9.59 0.70 15.80 3.57

17.2 30.10 1.10 8.53 1.09 18.30 3.61

10.90 46.00 0.30 7.90 0.79 16.80 4.05

0.34

0.39

0.49

0.71

1.10

1.41

0.83

0.62

0.56

0.71

0.92

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a. The figures for PRC do not include inflows to Hong Kong, China and Macao. b. East Asia includes PRC, Hong Kong, China; Taipei, China; South Korea, Cambodia, Indonesia, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam. c. ASEAN includes Brunei, Cambodia, Indonesia, Lao People’s Democratic Republic, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam. Source: UNCTAD FDI Statistics Online.

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United States European Union 25 Japan PRCa South Korea East Asiab ASEANc World FDI Inflow (US$ billions)

1995

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Table 2.4.

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for other factors, Busakorn et al. (2004) find that FDI flows to China are positively related with FDI to other Asian countries, and that a 10 percent increase in the former will lead to a 2–3 percent increase in the latter. Athukorala (2007) notes that: “China’s rapid integration into cross-border production networks of vertically integrated global industries as a major assembly center has created new opportunities for the other East Asian countries to specialise in parts and components production and assembly. This development is an important counterpoint to the popular belief that China’s global integration would crowd out other countries’ opportunities for international specialization” (p. 20). Plummer and Cheong (2007) use a knowledge-capital model to estimate determinants of FDI in ASEAN and also find a positive People’s Republic of China effect, ceteris paribus. Chinese competition is forcing ASEAN countries to become bolder in terms of national economic reform programs and regional initiatives, which we discuss below. It has also led the region to pursue close links with China in order to exploit potential complementarities in the production fragmentation chain, e.g., through the ASEAN-China Free Trade Area and subsequent initiatives. In other words, developing Asian countries, though nervous about the rise of China, are responding to its presence by embracing economic reform at the national level and adopting policies to take advantage of it at the regional level. From an economic perspective, then, the “Chinese Threat” has, in fact, been an important catalyst of market-oriented reforms and deeper economic integration in the region. This is the correct policy response. It is interesting to note that other economies, including OECD countries, have addressed the rise of China in exactly the opposite way, i.e., greater protectionism and threats of protectionism. From an economic perspective, this is the wrong response. Despite the rapid integration of Asian productive systems, OECD markets remain important for final goods produced in Asia. In trying to capture this effect, several scholars have focused on electronics and transport equipment (SITC 7), which, as we noted above, has become the most important export sector in most Asian economies. For example, Tamamura (2002) uses input-output analysis to capture the FDI-export link in East Asia, as well as decompose the effect of external demand (by country) on production, using electric/electronics as a case study.19 He finds that, for 1995 (his latest year), in every country, external demand induced 19 He also includes transport equipment as a case study, but as this category takes up a much smaller share of SITC exports of East Asia, we focus here on the results he obtained in the electronics sector.

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more production than domestic demand except in China and (marginally) Indonesia, where, however, domestic demand fell in 1985 from 94 percent of total production to 66 percent in the case of the former and from 87 percent to 52 percent in the case of the latter. Most countries followed a similar pattern of internationalization of electronics production. The most extreme cases were Malaysia and Taipei, China, where domestic demand induced only 6 percent and 10 percent of production, respectively. The United States was the most important external source of induced demand in electronics in 1995 (often by a considerable margin), with a simple average share of approximately 25 percent for the sample. In the key cases of Malaysia, the Philippines, and Taipei, China, US demand was even more important than domestic demand, and in the case of Thailand, they are about the same. In sum, this section underscores the great dynamism of the Asian economies in terms of their aggregate success, structural change, and trade and investment performance. We also emphasized the “Asian-ness” of this process; the complementarity of the Asian economies and their respective dynamic comparative advantages have created an excellent environment in which to create a vertically-integrated production network and exploit efficiencies associated with production fragmentation. But we only hinted at the policy origins of these changes. The rest of the chapter focuses on domestic and international commercial policy reform, with a stress on emerging regional economic cooperation. 3. Policy Analysis of Post-Crisis Developments in the Real Sector In this section, we first consider policy-oriented variables that have been driving real-sector growth in the region. We begin by taking stock of the microeconomic policies embraced by Asian economies vis a vis the private sector in order to get an idea of economic reform at the national level. Next we consider reform of international commercial policies in individual Asian economies, focusing on declining barriers to trade and investment. In the next section, we analyze regional trends in economic cooperation with a focus on the economics of the rising number of bilateral and regional FTAs in Asia and other initiatives. 3.1. Microeconomic Policy Indicators In Asia, each country has a unique history of microeconomic policy formation and so even policies that appear to be the same may be different in

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practice. Moreover, capturing empirically the effects that various policies have had on the private sector is complicated, especially because so many factors influence domestic investment and FDI. For example, in the early 1980s, reforms in Sri Lanka made it one of the most liberal countries in the developing world but the civil war then nullified the expected private sector response to these initiatives (and impeding the government’s investment in necessary infrastructure). One way to avoid misestimating the real implications of various investment measures and policies is to focus on the results of these policies. If a country seems to have liberal investment measures in most areas but the private sector struggles, a problem obviously exists. The World Bank, in compiling its Doing Business Database, attempts to do just this, by gauging business regulations and their enforcement objectively. Included in its annual survey are 175 countries, encompassing all ASEAN countries (except Brunei and Myanmar) and most other major Asian economies. This survey suits our purposes well, because it provides a general idea of how liberal and open the region’s economies are in various areas of business regulation and enforcement. We split our sample into two developing regions: ASEAN (Table 2.5a) and non-ASEAN (Table 2.5b). The results flow from the most recent Doing Business Survey (World Bank 2007). Global rankings of each country are given in relation to an overall indicator of “ease of doing business” as well as 10 additional areas: (1) starting a business; (2) protecting investors; (3) dealing with licenses; (4) paying taxes; (5) employing workers; (6) trading across borders; (7) registering property; (8) enforcing contracts; (9) getting credit; and (10) closing a business. Under each of these general areas are sub-categories. For example, under “starting a business”, the survey includes rankings for the number of procedures required to start a business, the number of days it takes to complete these procedures, the cost as a percentage of per capita income, and minimum capital requirements as a percentage of per capita income. These sub-categories are interesting, but we focus on the general categories in our presentation.20 ASEAN Member Countries run the entire policy spectrum between liberal and restrictive. For example, Singapore is No.1 in ease of doing business, whereas the transitional ASEAN economies, the Philippines, and Indonesia rank in the 100s. Thailand and Malaysia have good rankings — 18 and 25, respectively — better than some OECD countries. 20 For

greater details regarding these subcategories, see http://www.doingbusiness.org/.

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Measure

Indonesia

Lao PDR

Malaysia

Philippines

Singapore

Thailand

Vietnam

143 159 60 159 16 124 114 100 118 174 151

135 161 60 131 133 140 60 120 145 83 136

159 73 170 130 36 71 161 148 146 173 151

25 71 4 137 49 38 46 66 81 3 51

126 108 151 113 106 118 63 98 59 101 147

1 11 2 8 8 3 4 12 23 7 2

18 28 33 3 57 46 103 18 44 33 38

104 97 170 25 120 104 75 34 94 83 116

Note: No data available for Myanmar or Brunei Darussalam. Source: World Bank, Doing Business 2007.

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Cambodia

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Ease of doing business (overall) Starting a business Protecting investors Dealing with licenses Paying taxes Employing workers Trading across borders Registering property Enforcing contracts Getting credit Closing a business

Diversity of Business Policy in ASEAN: Global Rankings.

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Table 2.5(a).

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Table 2.5(b). Diversity in Business Policies in Japan, PRC, India and Newly Industrialized Asian Economies: Global Rankings of Private Sector Efficiency.

Measure Ease of doing business (overall) Starting a business Protecting investors Dealing with licenses Paying taxes Employing workers Trading across borders Registering property Enforcing contracts Getting credit Closing a business

PRC

Hong Kong

India

South Korea

Singapore

Tai, CHN

93 128 83 153 168 78 38 21 63 101 75

5 5 3 64 5 16 1 60 10 2 14

134 88 33 155 158 112 139 110 173 65 133

23 116 60 28 48 110 28 67 17 21 11

1 11 2 8 8 3 4 12 23 7 2

47 94 60 148 78 154 42 24 62 48 4

Note: No data available for Myanmar or Brunei Darussalam. Source: World Bank, Doing Business 2007.

This diversity in rankings reflects great differences in investment measures and regulatory environments in ASEAN countries, as well as the effectiveness of the implementation of these measures. Hence, although progress has been made in terms of investment cooperation at the ASEAN level (from the one-stop business centers to the AIA), ASEAN remains a region of highly diverse countries, suggesting that completing the AEC will be no mean feat. Of course, the Doing Business 2007 Survey shows considerable diversity in the EU as well, which has had a common market for more than a decade.21 Still, it will be necessary to reduce the disparities if the private sector is to view the region as relatively integrated and harmonious and, therefore, an advantageous platform on which to engage in a vertical division of production. Section 5 discusses means to achieving this through such means as regional cooperation, concerted policy reform, “aid for trade”, and other forms of technical assistance. With respect to the non-ASEAN countries, we see less diversity across the NIEs, though Hong Kong (and, of course, Singapore) perform, by far, the best. South Korea generally offers a more attractive microeconomic environment than Taipei, China; both perform generally well in all individual categories with the exceptions of costs of starting a business and 21 For

example, in ease of doing business, Finland, Germany, and Greece rank 14, 21, and 109, respectively.

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employing workers. Moreover, Taipei, China has some of the highest cost licensing in the world (rank of 148). China and India continue to have relatively unfavourable microeconomic environments, with rankings of 93 and 134, respectively, in the global sample. In general they do much worse than the ASEAN countries in most categories, with the exception of some of the transitional economies. It would appear, then, that the Two Giants are great competitors because of their size, wealth, and dynamism, not because of any supportive policy framework — or at least not yet. Thus, while there has been a great deal of progress in terms of policy reforms in developing Asia, the degree of liberalization varies considerably across countries. In most cases, significant improvements are necessary in order to reap greater efficiencies at the domestic level and facilitate productive investment. Results from Dee (2007) strongly support the view that domestic regulatory reform should be the most important priority for most developing Asian economies. 3.2. Commercial Policy Reform As was noted at length above and in myriad economic studies on Asian growth and development, the modern Asian success story is based in large part on an outward orientation. Taking advantage of international markets requires that many variables be in place, including macroeconomic stability, correct microeconomic signals, necessary infrastructure, forward-looking government policy (e.g., in terms of developing human capital, capacity building, information dissemination regarding international markets, and overcoming market failures), and a well-prepared private sector. These conditions cannot be created overnight; they often take a great deal of time, trial and error, and patience before outward orientation can bear fruit. These types of reforms have been embraced by successful Asian developing countries over the past several decades: first the NIEs, then the original ASEAN economies, followed by China, and next the transitional ASEAN economies and India. Liberalization actually paid relatively quick dividends in most cases. No doubt there was a “demonstration effect” at work in the Asian neighborhood; in addition to “role models” and lessons that policy technicians could glean from the development experience of economies nearby, the lucrative dividends reaped by these countries provided a positive reference for policymakers that had to pay significant political costs in order to execute an ambitious reform agenda. Extensive economic policy change creates losers as well winners, and the former will

May 28, 2009 14:24

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put up resistance to change. It is, therefore, critical to show that economic welfare will rise with reform; this can be done with numbers, but success stories help. Continuing to take advantage of the international marketplace requires vigilance and vision; economic reform is, after all, a process. Asian countries have become famous for their forward-looking and competitive reform programs in the real sector, though obviously the region traditionally conjures up less envy with respect to financial sector development. How does one proxy economic reform? This is no mean feat, as many macroeconomic and microeconomic measures and policies have critical bearings on trade and investment performance. And it is difficult to get good, comparative data on these variables. One way to capture the reform process would be to focus on trade liberalization, for which data are fairly good (at least with respect to tariffand tariff-equivalent barriers to trade). We do this in Table 2.6, which presents calculations of average applied tariffs for three different periods: early 1990s, early 2000s, and the most recent year. Given that we are more interested in changes in sectoral production rather than overall average production, we present data for 10 product categories (based on one-digit HS classification, aggregating from five-digit HS). Several observations are worth noting. First, Hong Kong and Singapore are essentially free trade economies and have been so for some time; they have overcome their small size constraint through entrepot trade and relying on the global market. Brunei has cut tariffs to essentially zero for most sectors except machinery and transport equipment and miscellaneous manufactures. Along with Cambodia and the Laos, it hopes to be able to overcome size limitations through the AEC. Second, China has made major changes in its tariff structure essentially across the board, from globally high levels in 1992 to relatively low levels in 2005, comparing favorably even to most ASEAN countries. Third, India’s liberalization has been less dramatic but still significant, particularly in response to the 1991 Crisis. Average tariffs in all manufactured sectors have decreased by at least 50 percent, and sometimes by much more, since 1990, even if tariff “spikes” in sensitive sectors continue to exist. Fourth, in the ASEAN-4 countries, tariffs on manufactures have generally come down and sometimes significantly, with average tariffs being less than 10 percent in all sectors except a small increase in some manufactures in Malaysia and in miscellaneous manufactures in Thailand. Fifth, Vietnam’s tariffs have been generally stable since 1994. However, this could be misleading in that Vietnam reformed

Trade Policy Change in Asian Economies. (Ad Valorem∗ Applied Tariffs, Selected Years.) Brunei

Product

’92

’01

0.0 0.1 24.2 168.6 3.8 0.5 0.0 0.0

’01

0.1 9.7 0.0 9.8 0.6 7.9 0.0 22.4

0.0

0.0

’03

PRC ’92

’00

’88

’98

12.2 13.8 18.0 30.9 12.5 9.0 105.5 75.2 49.7 12.2 7.6 13.7 11.3 21.7 3.5 21.6 8.2 8.2 8.1 1.6

0.0 0.0 0.0 0.0

27.2 18.5 39.7 13.2

’05

India ’90

’92

’01

Indonesia ’05

’90

’95

’00

’05

0.0 0.0 0.0 0.0

0.0 40.7 22.3 39.6 46.0 9.3 5.9 0.0 284.3 298.9 121.3 83.7 18.5 14.1 0.0 66.5 20.4 16.8 12.4 4.3 4.7 0.0 4.0 0.6 17.6 11.0 3.6 3.6

2.4 8.0 2.1 3.0

5.8 31.5 1.8 3.8

0.0

0.0

0.0 116.8 56.8 74.9 82.3 18.6

8.4

5.8

3.8

7.0

7.0

2.3 1.1 1.1 6.8 1.6 0.4 1.6 16.9 6.2 19.0 11.4 18.9

5.9 16.8 18.8

22.2 21.5 13.0 41.8 33.1 14.5 34.0 29.8 12.8

7.3 6.4 4.0

0.0 0.0 0.0

0.0 0.0 0.0

0.0 93.5 60.0 30.3 14.7 7.1 6.7 0.0 71.7 26.0 33.3 16.1 13.3 11.1 0.0 74.0 51.6 22.8 9.8 19.5 15.8

5.5 8.3 6.1

5.7 8.6 5.6

4.3

2.1

3.7 20.8

21.0

50.2 39.9 16.1

7.6

0.0

0.0

0.0 66.5 53.2 28.3 11.3 16.0 14.4

9.5

9.3

0.0

0.0

0.0

36.5 25.5

5.6

0.0

0.0

0.0 93.7 65.0 35.0 15.0 18.8

3.1

0.5

0.3

0.4

6.6

South Korea

Malaysia

Philippines

6.0

Singapore

’95

’00

’05

’90

’95

’99

’04

’91

’01

’05

’90

’95

’00

’05

’89

’95

’01

’05

12.6 13.9 1.0 1.6

22.5 3.3 0.8 0.7

18.8 6.2 0.9 1.1

16.9 3.9 0.6 0.6

11.9 37.9 3.6 5.5

13.4 33.9 2.8 4.7

12.5 26.1 2.6 4.8

93.3 21.9 23.4 4.0

4.4 44.1 3.0 3.6

2.3 22.6 1.3 2.4

3.0 19.8 1.1 1.2

19.5 27.1 11.8 10.3

25.7 47.9 9.6 10.2

12.4 10.3 3.8 3.1

7.7 9.6 3.2 4.8

0.1 0.0 0.0 4.3

0.0 0.0 0.0 0.0

0.0 2.9 0.0 0.0

0.0 4.0 0.0 0.0

8.0

7.1

2.9

3.4

8.9

6.2

6.6

7.2

1.9

2.8

2.1

24.6

30.9

9.4

10.5

0.0

0.0

0.0

0.0

(Continued) 47

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Food/animal Beverage & tobacco Crude material Mineral fuel, lubricant etc. Animal & vegetable oil

Hong Kong ’05

Japan Product

’94

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0.0

Cambodia ’05

ASEAN Economic Integration in a Global Context

Food/animal Beverage & tobacco Crude material Mineral fuel, lubricant etc. Animal & vegetable oil Chemical products Manufactured goods Machinery & transportational equipment Miscellaneous manufacturing Commalities Not Elsewhere Specified (CNES)

May 28, 2009 14:24

Table 2.6.

South Korea

’95

’00

4.3 3.0 0.1

3.3 3.1 0.0

6.2 0.3

’05

’90

’95

’99

2.2 2.1 0.1

1.9 11.4 1.8 10.7 0.1 11.5

7.5 6.9 7.4

7.3

5.9

4.8 12.8

0.8

1.3

1.0

3.4

Malaysia ’04

’91

Product

’90

Singapore

’00

’05

’89

’95

’01

7.1 6.5 5.5

7.4 9.9 4.4 4.9 12.7 12.1 4.0 13.4 11.0 15.5 19.8 20.2 3.5 10.3 4.3 2.8 13.4 12.4

5.1 7.6 2.1

5.0 6.0 1.8

0.0 0.0 0.9

0.0 0.0 0.0

0.0 0.0 0.0

0.0 0.0 0.0

7.8

7.9

6.3 12.4

5.9

4.8 21.2 20.5

6.7

5.7

0.8

0.0

0.0

0.0

3.0

2.9

2.8

0.0

0.1 28.7 28.7

3.7

3.8

0.0

0.0

0.0

0.0

2.5

’05

Thailand

’05

Vietnam

’92

’00

’05

’91

’95

’00

’05

’94

’01

’05

16.7 42.5 1.7 10.6

16.7 42.0 0.9 5.7

16.5 24.6 0.7 6.2

10.6 16.7 0.4 1.1

47.4 19.0 14.5 24.9

33.1 55.2 6.1 3.0

30.6 52.1 7.0 0.4

10.0 59.3 4.4 0.4

17.5 119.8 0.6 36.6

19.0 85.8 1.6 12.3

17.7 77.0 1.8 14.8

11.2 6.5 9.1 12.8

4.5 25.4 6.0 7.8

5.3 3.3 4.1 2.5

1.7 1.9 1.9 2.7

20.0 31.3 18.3 37.4

22.7 15.2 13.4 15.6

22.1 10.5 12.4 8.8

15.7 6.8 5.5 6.1

15.4 2.5 18.6 12.0

21.7 3.9 17.7 19.9

33.9 3.9 18.0 13.2

9.1

5.3

3.4

2.2

42.8

18.0

11.9

11.2

20.3

19.1

21.7

0.9

0.0

0.0

0.0

35.1

3.0

0.3

0.2

0.6

2.0

6.6

∗ Note: Ad-Valorem Equivalents Calculated Using UNCTAD Method 1. Source: UNCTAD TRAINS. through World BankWITS database.

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Philippines ’95

Taipei, China

’01

9in x 6in

’90

ASEAN Economic Integration

Chemical products Manufactured goods Machinery & transportational equipment Miscellaneous manufacturing CNES

(Continued )

May 28, 2009 14:24

Japan Product

48

Table 2.6.

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extensively its non-tariff barriers during this period and has become a much more open market. Finally, Japan, South Korea, and Taipei, China are quite open except in the area of agriculture, where Japan and South Korea have high barriers to trade. Data on non-tariff barriers are notoriously difficult to obtain. They are also difficult to evaluate, since they vary greatly in terms of substance. We may know exactly what the (static) economic effects of an import quota would be, for example, by calculating a tariff equivalent. But what about a required licensing arrangement? The effects of the latter would certainly be more restrictive than a more or less automatic licensing arrangement. Moreover, should anti-dumping duties be included in the list of non-tariff barriers? Most economists (including this one) would agree that antidumping duties tend to be protectionist in nature rather than compensating for some nefarious pricing strategy of foreign firms. In fact, it has become the new “protectionist tool of choice” for developed countries and some developing countries (India, for example, has recently become one of the most aggressive users of anti-dumping duties). But one cannot deny that dumping sometimes occurs, and anti-dumping duties are permitted by the WTO (under certain general guidelines, of course). In any event, classifying anti-dumping in some aggregate measure of non-tariff barriers might be theoretically correct but extremely complicated. The Uruguay Round made substantial progress in addressing non-tariff barriers, particularly in the area of “tarifficating” existing quotas in many sensitive agricultural products and doing away with (what was euphemistically called) “orderly-marketing arrangements” such as the Multi-fibre arrangement, which was phased out under the Uruguay Round Agreement on Textiles and Clothing. In fact, some of the changes in tariffs in Table 2.6 — particularly in agriculture — were less impressive or even rose due to this process of transforming non-tariff barriers into more transparent and less problematic tariffs, which are now being normalized and are certainly easier to liberalize. There are still complicated arrangements in agriculture but things have been greatly improved with the Uruguay Round. And quotas are supposed to be a thing of the past; existing import quotas placed on Chinese textile and clothing exports to the EU and the United States, for example, were permitted only as part of China’s accession agreement and will have to be phased out in 2008. Nevertheless, Feridhanusetyawan (2005) generates trade restrictiveness indices for Asia, including Non-Tariff Barriers (NTBs). This will give us a general indication of the degree of importance of NTBs in the region’s

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economies. The restrictiveness of NTBs is categorized into three groups: restrictive, intermediate, and open. The only economies receiving a clean bill of health for NTBs are Singapore, Hong Kong, China, and Taipei, China. Most others fall in the intermediate range, including India, People’s Republic of China, the ASEAN-5, and Cambodia. Only three countries fall in the restrictive range: Vietnam, who joined the WTO after these rankings were compiled, Myanmar, and Laos, who has yet to join the WTO (but is an observer). As a benchmark, the global score on NTBs is placed in the intermediate range. In short, NTBs notwithstanding, there has been extensive reform of commercial policies in the Asian region almost without exception. Rather than retrenching and increasing tariffs in the wake of the Asian Crisis as a defensive technique, the Crisis-affected economies essentially took the exact opposite path. Moreover, this reform goes even further than what the tariff indicators would suggest, particularly for transitional economies that have had to put in completely new commercial policy regimes as part of the process. Nevertheless, there continue to be high tariffs in certain sectors, and even within sectors with seemingly low averages, tariff spikes exist. NTBs continue to be a problem in many countries, though there is evidence of considerable improvement. In other words, commercial policy liberalization in developing Asia has been impressive and in some ways spectacular, but much more needs to be done. We came to the same conclusion above with respect to private sector-related domestic policies. Obviously, trade reform will have an important effect on trade performance, combined with changes in other national policies and global developments. It would be useful to check how these reforms ultimately manifested themselves in export and import dynamism at a disaggregated level, and how similar this real response has been across the region. Hence, using the Spearman Rank Correlation technique described above, we correlate export and import growth at the 5-digit SITC level over the 1996–2005 period to gauge the degree to which trade dynamism in Asia has been similar. We calculate the growth rates in exports (imports) at the product level in each Asian economy and correlate them with that of its regional partners to capture the degree to which this growth dynamism has been correlated over time. In addition, we correlate this export (import) growth with global trends as a benchmark. We present the results in Table 2.7. With respect to export dynamism, China’s and Singapore’s performances have been the closest to that of global trade. India and Brunei have the most asymmetric growth trends. India’s export dynamism is far more

World

Comparative Structural Trade Dynamism in Asia. (1996–2005, SRCC). India

Jpn

Korea

Malay

Phil

Sing

Thai

a. Export Dynamism World 1.00 −0.05 Brun∗ PRC 0.58 HK, CHN 0.39 Indo 0.49 India 0.31 Jpn 0.42 Korea 0.46 Malay 0.49 Phil 0.38 Sing 0.52 Thai 0.39 TaiCHN 0.44

1.00 0.26 0.21 0.12 −0.05 −0.07 −0.10 −0.16 0.06 0.03 0.07 0.11

1.00 0.53 0.38 0.38 0.07 0.22 0.43 0.24 0.37 0.36 0.25

1.00 0.38 0.42 0.06 0.23 0.39 0.50 0.50 0.25 0.36

1.00 0.18 0.23 0.54 0.45 0.48 0.38 0.37 0.31

1.00 0.25 0.38 0.13 0.21 0.07 0.47 0.37

1.00 0.57 0.34 0.29 0.39 0.37 0.39

1.00 0.43 0.44 0.40 0.62 0.58

1.00 0.45 0.47 0.36 0.53

1.00 0.43 0.38 0.24

1.00 0.34 0.37

1.00 0.56

b. Import Dynamism World 1.00 −0.02 Brun∗ PRC 0.32 HK, CHN 0.57 Indo 0.10 India 0.37 Jpn 0.67 Korea 0.56 Malay 0.45 Phil 0.44 Sing 0.47 Thai 0.57 TaiCHN 0.62

1.00 −0.21 −0.15 0.03 −0.04 0.22 0.17 −0.05 0.06 −0.03 0.14 −0.07

1.00 0.45 −0.04 0.08 0.14 0.25 0.35 0.10 0.27 0.31 0.32

1.00 −0.08 0.06 0.36 0.25 0.38 0.13 0.53 0.20 0.40

1.00 0.26 0.06 0.35 0.22 0.28 −0.04 0.28 0.05

1.00 0.22 0.20 0.22 0.57 0.11 0.46 0.24

1.00 0.46 0.32 0.44 0.20 0.45 0.57

1.00 0.14 0.38 0.36 0.43 0.61

1.00 0.32 0.11 0.26 0.15

1.00 0.15 0.64 0.47

1.00 0.09 0.31

1.00 0.44 51

Brunei values are from 1994 and 2003 due to missing data in 1996 and respectively. and Vietnam data unavailable. + Correlation includes only commodities with value ≥ $250,000. Source: UN COMTRADE.

∗∗ Cambodia

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Brun

∗ Notes:

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Table 2.7.

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correlated with the NIEs and certain ASEAN countries. This would suggest that, while the actual (static) structure of India’s exports remained quite diverse from East Asian economies,22 the growth trend is such that it is becoming more like them. Should this trend continue, we would expect that India’s structure will increasingly resemble that of developing East Asia. With respect to import dynamism, China’s growth pattern is actually quite different from global trends, unlike the case of its exports, with only Brunei and Indonesia having lower estimated correlation coefficients. Taipei, China had the highest import-growth correlation, whereas in the case of exports it was essentially in the middle of the pack. China’s import growth pattern is also lower than its export performance relative to all original ASEAN countries, in some cases significantly so. Indian import growth tends to be more consistent with the original ASEAN countries and South Korea than is the Chinese case, though its growth pattern relative to the other NIEs is quite diverse. To summarize this section, we note that while the domestic policy environment varies widely across the region, there has been considerable — and, sometimes, remarkable — liberalization of the commercial policies of the developing Asian economies. This liberalization has taken place partly in the context of the WTO but mostly in line with an outward-oriented development strategy embraced by the region’s economies. The result has been dynamic trade performance and an increasingly interdependent region. In the next section, we consider regional cooperation policies that may (and may not) be used to further this process.

4. Regional Economic Cooperation in Asia: Making Regionalism Support Regional Integration As mentioned earlier, FTAs have become the policy instrument of choice in fostering economic integration in Asia. The dramatic rise in the number of Asian FTAs beginning in 2000 and continually picking up speed, is being driven to a large degree by MNCs operating in the region rather explicit policy initiatives (such as FTAs) designed specifically to increase intraregional trade and investment (ADB 2008). In fact, top-down approaches 22 We

correlated the structure of exports across Asian economies to get an idea of export competitiveness in OECD markets. The results are presented in Appendix Table 2. In 2005 India’s exports were only substantially correlated with People’s Republic of China (and Cambodia).

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to regional economic integration frequently lead to problematic outcomes. There are many examples of proposed FTAs and even common markets in the developing world that have been unsuccessful mainly because they derived from political decisions that were inconsistent with market realities. Thus, regional economic integration via formal arrangements in Asia differs from arrangements in other parts of the world in at least two critical ways: First, it has not been led by a top-down approach to integration; rather, Asian economies began to embrace deeper government-led integration only when market realities appeared favorable. Second, FTAs that have been created have tended to be outward-oriented, or at least this is the intention. But the road to hell is paved with good intentions, and the need to ensure that formal integration in Asia follows the market is essential. In this section, we consider the economics of, and various policy-related factors associated with the regionalism movement in Asia. We begin with a discussion of the origins of this movement, followed by an overview of the FTA movement itself. Next, we analyze the economics of preferential trading agreements, not only in terms of traditional (static) analysis but also the dynamic effects of FTAs. The final subsection discusses general strategies to regionalism in Asia. We argue that the overriding priority in the advancement of regionalism is that, in constructing FTAs, Asia needs to keep its “eye on the prize”: an open global and regional marketplace in which Asian economies can thrive. This means bringing down transactions costs to economic exchange at the micro level in order to facilitate the creation of vertically-integrated production chains, and at the macro level, reducing protective barriers to final goods and services and creating a level playing field for all economic actors. This is the overriding goal of the WTO; hence, the WTO as the pre-eminent institution of multilateral trade must continue to receive top priority in formulating economic cooperation initiatives. We suggest, however, that there is much more that Asia can do in terms of cooperation than what can be expected of the 151-member WTO, whose member states do not yet all share the common outward-oriented development strategy that East Asian economies do. But in deepening integration beyond what the WTO is able to do, Asian nations should ensure that FTAs provoke the least discrimination possible, that they include policies that are consistent with global best practices (including “WTO-plus” arrangements), and that they continue to be open. Indeed, outward-oriented regionalism in Asia would optimally be a model for other developing regions and a force leading to greater policy momentum for liberalization at the multilateral level.

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4.1. Factors Influencing the Regionalism Movement in Asia There are a number of factors behind the regionalism trend in Asia. Following Menon (2007), though using somewhat different classifications, we might classify these into “general” and “specific” factors. For our purposes we define general factors as being applicable to the FTA movement as a whole, whereas the specific factors apply mainly to Asia.

General Factors 1. Regionalism in Developed Countries:“Market Restoring” and “Sector Expanding” Motivations. At the turn of this century, essentially all developed countries were embracing discriminatory trading arrangement with potential trade- and investment-diverting implications for Asia. Europe had been implementing deeper regional initiative between its member-states and former colonies for about a half century; however, the “deepening” of integration had increased substantially in the 1990s (from the single market to monetary union between 12 of its members, with Slovenia’s adoption of the euro in January 1, 2007 bringing the count to 13) and its membership had expanded to include transitional economies that could potentially compete with Asia in terms of trade and investment. The United States had few preferential trading arrangements before 2000 but then bilateral FTAs became an important part of its commercial policy in subsequent years and continues to be a major force today. Menon (2007) suggests that this motivation is “market restoring”. This consideration becomes more important as globalization continues apace. As argued above, final goods demand in developed countries is leading much of the fragmented trade taking place in Asia. If the United States and the EU create FTAs from which Asian economies are excluded, rules of origin exigencies in these accords (discussed below) could have an important bearing on MNC intermediate-input sourcing strategies. Particularly with a WTO that has not yet been able to reach a multilateral agreement in the Doha Development Agenda negotiations (at the time of this writing, i.e., Fall 2008), discriminatory trading arrangements giving preferential treatment to Asia’s competitors increases the incentive for the latter to use regional integration to preserve their status in the production chain and restore market access.

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Another effect of this trend regards the perceived success of deeper integration, particularly “behind the border” liberalization and facilitation that can improve competitiveness and reduce transaction costs associated with production fragmentation. This was especially evident in the case of the EU single market but also in the case of NAFTA, which was only an FTA but had extensive “new age” aspects, including national treatment for investment. Menon (2007) refers to this as “sector expanding”. 2. Doha once again. An incentive for FTAs in Asia is the need for the type of “deep integration” that the WTO has yet to be able to deliver (and probably won’t be able to do so in the short-medium term). In order to facilitate the construction of production networks and profit from the process of fragmented trade, it is critical to remove as many obstacles to trade and investment as possible, and FTAs between two (or a small group) of likeminded countries is easier to achieve than in the context of the WTO. While a successful Doha would reduce the potential negative effects of regionalism (at the margin), generate important welfare benefits,23 and would help to knit the global economy together, it would not stem the growth in the FTA movement, especially in Asia. As noted earlier, East Asian countries have a “deeper” integration agenda than could ever be expected to emerge out of the WTO in the medium- (or even long-) term. The economic development strategy of Asia is predicated on outward-orientation, and the deep integration measures associated with FTAs appear to be a more effective means of advancing globalization at present. China enters the debate once again in the context of Doha. China’s joining the WTO in December 2001 was a major event for that country and for the global trading system as a whole. China has become one of the most important trading countries in the world and has emerged in a relatively short period of time. That, coupled with the sheer size and potential of the country, has created considerable nervousness in developed and developing countries alike. This has important implications for the WTO as well. Although as a WTO member, China has had to enact many rules-based policies to open up its market and create more opportunities for FDI and trade (and, as noted in Table 2.6, has reduced its trade barriers significantly), it would appear that its membership has caused some members to be cautious about offering up “too much” in terms of trade liberalization at the WTO out of fear of increasing Chinese competition in domestic markets. 23 ADO

(2006), Part I, put potential global gains of a “deep” Doha scenario at $155 billion (2001 prices).

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For example, this was explicitly noted as a motivation for Brazil’s initiation of FTA negotiations with the EU.24 Alas, this could be one reason why there is less effort being devoted to ensuring a successful Doha outcome. And if significant, it would also be detrimental to future WTO prospects. It would certainly be supremely ironic if, once China was brought into the WTO fold, the WTO would be brought to a halt in order to isolate China! Specific Factors 3. For ASEAN, Bilateral FTAs by ASEAN member countries. As ASEAN itself is only an FTA at present, individual members have the right to pursue their own FTAs with non-ASEAN partners. This poses a perceived threat to ASEAN “solidarity” and even integration, since some of these FTAs are even deeper than existing accords that exist in the ASEAN framework. Moreover, through deeper integration it can ensure the integrity of ASEAN even in the face of deeper integration at the regional level. In addition, the political economy of FTAs is such that ASEAN will create better outcomes in negotiations as a group rather than individually. But to negotiate as a group, deep integration is necessary. This theme is taken up in Chapter 3. 4. China. As was noted above, concerns associated with the emergence of China (and India) have become increasingly acute since the Asian Crisis. In fact, a key motivation for creating an ASEAN Economic Community (AEC) by 2015 is to compete with China and India: by creating one market it will be less at a disadvantage in terms of size, allowing it to enjoy economies of scale in production fragmentation, a more efficient regional division of labor, and other “dynamic” features of integration that will enhance the attractiveness of ASEAN to foreign investors and its competitiveness in local and third markets. 4.2. Brief Review of Regionalism in East Asia An in-depth review of the many FTAs in Asia would be beyond the scope of this chapter as well as being somewhat redundant, given that many excellent surveys already exist25 and the ADB ARIC website26 gives realtime updates of the bilateral and regional FTA agreements and news. 24 Wall 25 For

Street Journal On-Line, July 5, 2007. example, ADB 2006, Feridhanusatyawan 2005, and Kawai 2005, but there are

many. 26 ADB Asian Regional Integration Center, www.adb.aric.org.

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But note that the pace of Asian integration has quickened considerably over the past decade. ASEAN integration, for example, took off with the ASEAN Free Trade Area (AFTA) and is being implemented at the same time that its member-countries are establishing FTAs with non-partners. ASEAN itself has negotiated an FTA with China and is currently in talks with other countries and groupings, including Japan, Australia/New Zealand, South Korea, and India. However, the deepest accords have been bilateral FTAs with developed countries, in particular the United States and Japan. The US-Singapore FTA, for example, is being used as a model for other FTAs with ASEAN Member Countries under the “Enterprise for ASEAN Initiative”. It has the usual characteristics of a “new age” FTA, including chapters stipulating WTO-plus features in IPR and FDI; government procurement; e-commerce; technical barriers to trade; environment and labor; and financial services, telecommunications, and cross-border services.27 Moreover, given that bilateral and regional FTAs in Asia are outwardoriented in nature, it is only natural that attempts to integrate these accords at the regional level would emerge. We see this happening in the fledgling ASEAN +3 meetings and the East Asian Summits. While little concrete progress has been made, the fact that these forums are being established is significant. Such initiatives may even extend outside of Asia to include the Asia-Pacific as a whole, either under the rubric of the Asia-Pacific Economic Cooperation (APEC) or independently. Indeed, there have been recent proposals to establish a “Free Trade Area of the Asia-Pacific” (FTAAP), a concept that is being advocated by the APEC Business Advisory Council (ABAC), the voice of the private sector in APEC. In 2007 the EU became active in setting the stage to launch FTA negotiations with ASEAN and other regional economies. Table 2.8 enumerates the FTAs that ASEAN and ASEAN membercountries have concluded, are negotiating, or have been proposed as of mid-2007. These agreements are separated into intra-regional (within the Asia-Pacific) and cross-regional categories. Moreover, it considers the same units of analysis for ASEAN as a regional organization, i.e., “ASEAN+1” initiatives. Clearly, by every reasonable measure ASEAN member-countries have been active in the regionalism movement; almost none of these agreements were in existence prior to 2000. Singapore has been the most active, with 27 For

details, see Naya and Plummer (2005), Chapter 4.

Total

Inside IA

Outside IA

2 3 1 7

4 0 0 6

0 4 2 9

6 7 3 22

4 3 2 8

2 4 1 14

1 8 3 8 6 3 4 1 2 11 4 6 1

1 10 1 7 5 0 5 1 0 10 2 6 1

0 12 6 4 11 2 4 2 4 5 1 6 2

2 30 10 19 22 5 13 4 6 26 7 18 4

1 8 4 12 9 3 5 2 3 6 0 7 3

1 22 6 7 13 2 8 2 3 20 7 11 1

44

49

41

134

30 14 8 8

104 30 41 33

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Under Negotiation

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Status as of December 2007 ASEAN Brunei Darussalam Cambodia China, People’s Republic of Hong Kong, China India Indonesia Japan Korea, Republic of Lao PDR Malaysia Myanmar Philippines Singapore Taipei, China Thailand Vietnam

Concluded

58

Negotiating Body

Integrating Asia’s Free Trade Agreements.

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13 agreements at various phases of implementation, followed by Thailand with eight. In addition, Singapore has by far the most FTAs with extraregional countries (five), whereas Brunei, Indonesia and Malaysia each have one and the others do not have any. ASEAN itself has three accords in place (all within the Asia-Pacific) and four are under negotiation. One reason why the more developed ASEAN members, such as Singapore and Thailand, are more active in negotiating these FTAs no doubt is linked to their superior trade negotiation capacity and pressures from their outward oriented private sectors. Less developed ASEAN members, especially the transitional members (Cambodia, Laos, Myanmar, and Vietnam, or CLMV) tend to rely on AFTA and ASEAN-negotiated FTAs (e.g., the ASEAN-China or ASEAN-Korea FTAs). In sum, Table 2.8 shows us that: (1) bilateral FTAs have become increasingly popular in the region and ASEAN itself has started to become active, with more accords under negotiation than it has finished; and (2) there is an obvious “revealed preference” for Asia-Pacific-centered FTAs. In the next subsection, we consider the economics of these accords. 4.3. The Economics of Regionalism in Asia Given the increase in intra-industry trade, the process of fragmented trade, and the fact that export markets are still driven by final goods demand in OECD markets (especially the United States), anything but outwardoriented FTAs could be detrimental to the development strategies being pursued by the region’s economies. There is a rancorous debate in economics over whether bilateral and regional FTAs in the global economy constitute a threat or an opportunity to the multilateral trading system and the cause of open international markets. In practice the response to this question is a function of the type of accord that is being developed. Discrimination inherent in these agreements has the potential to create inefficiencies and distort international markets; the trick is to minimize these negative effects (e.g., traditional trade and investment diversion, higher transactions costs through rules-of-origin-induced “spaghetti bowl” effects, and the like). Still, if these accords are outward-oriented and embrace best practices, the probability that the FTA movement will be salutary to the international trading system improves greatly. In this subsection, we give a brief overview of some of the major issues associated with the FTA debate. We conclude that FTAs potentially have strong advantages but that they also have negative aspects to them that

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need to be eschewed. Moreover, we stress that, as Asia is interested in deepening integration through FTAs in order to augment international competitiveness, FTAs need to be open and only undertaken in the context of a strong WTO. Any discussion of the economics of FTAs must begin with the classic assessment of their price — or “static” — effects. These generally refer to the effect on production of price changes induced by preferential tariff (and non-tariff) liberalization. Free trade areas remove discrimination between partner countries and domestic firms (“trade creation”), but introduce a distortion between partner and non-partner countries, discriminating in favor of the former and to the detriment of the latter. Ultimately, trade diversion results in negative terms of trade effect in that it implies a country will be purchasing imports from a higher-cost source. Moreover, the greater the degree of discrimination inherent in an FTA, the greater the potential for “investment diversion” in which FDI flows to a country merely to take advantage of protected regional access. This is why FTAs are referred to as “second best”, as opposed to “first best” multilateral liberalization, which does not introduce any country discrimination. On the other hand, FTAs tend to be more comprehensive in terms of the coverage of goods (and services) and depth of liberalization28 than has been the case of multilateral liberalization. Hence, FTAs discriminate across countries but less across products, implying less potential negative effects in terms of effective rate of protection distortions. Free trade areas can also deliver liberalization of a wider range of areas in a shorter period of time. More importantly, however, the argument in favor of FTAs relates to their dynamic — rather than static — effects. And these tend to be more relevant to the Asian goals in FTAs: price changes induce one-time allocative-efficiency effects, whereas “dynamic effects” refer to medium- and long-term implications of regional integration and, as such, tend to be more significant. Dynamic effects are also more pervasive, affecting almost all areas that relate to an economy’s competitiveness. These would include: economies of scale, technology transfer and FDI, trade facilitation measures, harmonization of product standards and professional qualifications, and structural policy change and reform.29 28 For

example, Article XXIV states that FTAs should generally reduce tariffs to zero. detailed review of these dynamic effects would be beyond the scope of this text. For a more detailed review, see Plummer (2006). 29 A

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We argued above that the demand for FTAs on the part of Asian economies relates to the need to reduce transactions costs associated with the creation of a regional productive base, which would have the effect of furthering regional integration and improving competitiveness. Fragmented trade relies on this type of facilitation; it can gain from economies of scale due to a larger, freer market. With greater FDI inflows, the potential for technology transfer improves. Moreover, FTAs tend to require harmonization of various microeconomic policies and present a strong case for adoption of “best practices” in terms of accounting standards, management techniques, harmonization of customs classification and procedures and other trade and investment facilitation measures, adoption of common product standards, and so on. These types of “deep integration” policies are exactly the type of measures that MNCs seek; by reducing transactions costs and forming a more cohesive environment in which to exploit a vertical division of labor, FTAs can create a common marketplace that transcends national borders. However, for the same reason deep integration is politically controversial because it involves “behind the border” measures that are open to political criticisms regarding “national sovereignty”. This is why diversity of attitudes toward globalization can impede progress in global forums such as the WTO; in Asia, outward orientation guides economic policy and application of best practices becomes easier,30 whereas certain countries in Latin America, Africa, and even the OECD are more resistant to globalization and skeptical of deeper integration. Further, as is the case with trade liberalization generally, greater exposure to international competition has positive effects on a partner country in an FTA through greater competition. Increased exposure to competition from partner-country producers not only leads to trade creation (and, therefore, greater structural efficiency) but also increases the potential profits for competitive (or potentially competitive) firms. This produces an important incentive to invest in more efficient productive processes and technology. In other words, an FTA leads to the adaptation of new technologies from abroad by increasing the potential for success in using those technologies to crack open partner-country markets. As a final point, FTAs can potentially help global liberalization by weeding out the most resistant forces to global liberalization. Trade creation in an FTA affects the least-competitive firms, who have the strongest 30 We

say easier here, rather than easy — such liberalization always takes a good deal of political will.

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incentive to oppose any type of trade liberalization. For example, US textile manufactures have always been among the greatest opponents to the GATT/WTO. If, for example, North American Free Trade Agreement (NAFTA) were to force structural adjustment in the US textile sector such that its labor-intensive operations either move to Mexico or go out of business, this “weeding out” of textile will reduce at the margin domestic resistance to liberalization in the WTO context. Nevertheless, FTAs can have problems that go well beyond trade diversion issues. In particular, in order to avoid trade deflection, FTAs require “rules of origin” (ROO) that ensure that a certain percentage of value-added or a substantial transformation of the product takes place within the partner-countries’ borders. As these ROOs are product specific, they can be costly in terms of their bureaucratic requirements and, in fact, can be used as a hidden form of protectionism. For example, the ROOs in NAFTA require 62.5 percent value-added in North America, and textiles essentially require 100 percent (through the “yarn forward” rule). A country that has many FTAs could end up having different ROOs for trade in a certain product for each FTA, potentially creating confusion but also influencing the input-sourcing decisions of a representative firm in a way that could be detrimental to efficiency. Kawai and Wignaraja (2007) use the example of ROOs across Asian FTAs to compare similarities and differences for major four-digit HS codes in autos and auto parts, i.e., 87.01, 87.03, 87.04, 87.08, 87.11, 87.14.31 Substantial differences exist. For instance, if we compare the Japan-Thailand, Japan-Singapore, and Japan-Malaysia FTAs, we find that ROOs are not consistent across FTAs in any product line, and are only generally the same in 87.01 and 87.14 for the Japan-Thailand and Japan-Malaysia agreements. James (2006) also examines ROOs in preferential trading agreements covering at least one Asian economy and finds a general lack of internal consistency. None of these latter studies, however, quantify the associated costs of ROO. Estevadeordal and Suominen (2003) estimate that compliance costs between 3–5 percent of the value of exports, but this paper is an exception to the rule: there are few studies that explicitly estimate the cost of ROO compliance in Asian FTAs. Indeed, it is strange that an area that has become so controversial has not led to a much greater interest in the empirical literature. But whatever the true cost of compliance, a strong advantage of the WTO framework is that it generally (but not totally) avoids this problem. 31 Table

10 in their paper.

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Another consideration relates to the point made by Dee (2007), who suggests that the benefits of the “behind the border” liberalization within an FTA might be limited. This is because countries forming an FTA will deal only with non-border issues that affect them. She argues that these types of issues are relatively limited compared to the most important “behind the border” measures affecting a country’s domestic policy environment. The fact, for example, that the policy environment at the national level in EU countries are so diverse would suggest that regional integration can only go so far.32 In sum, FTAs have both positive and negative aspects to them. What has been the net effect of the current wave of bilateral and regional agreements in Asia? It is too early to tell; the regionalism movement is just too new to Asia: even the most advanced accords offer a very small time horizon within which to try to capture the effects ex-post. Ex-ante models (e.g., ADB 2006, Kawai and Wignaraja 2007) tend to show positive effects of bilateral FTAs, but these bilaterals tend to generate far smaller effects than region-wide accords, such as in the ASEAN +3 and APEC-wide contexts. It should be noted that these models tend to have a downward bias in estimating the effects of FTAs, as they generally leave out the important dynamic effects mentioned above. Moreover, since these models often rely on tariff liberalization and tariffs have come down significantly over the past two decades (Table 2.6), one would not expect a very large effect on output. This would also explain the (reportedly) low utilization rates of preferences granted by Asian FTAs. For example, Baldwin (2007) suggests that “almost no one uses AFTA preferences” and that the AFTA utilization rate is less than 3 percent.33 Plummer (2006) attempts to assess bilateral and subregional accords in Asia based on a series of “best practice” indicators. He finds that these 32 For example, Greece and Finland are both EU members and are part of the euro-zone. However, in terms of “ease of doing business”, the World Bank ranks Greece at 104 in the world, whereas Finland ranks at 14. 33 We would note that there may be many reasons for this, not the least of which being the fact that intra-ASEAN trade constitutes about one-fourth of the region’s total trade, and much of this is either in petroleum — in which there are not only low or zero tariffs but also much double-counting — and intra-industry electronics trade, where tariffs are affected by the WTO Information Technology Agreement (ITA) and export-processing zone duty waivers and drawbacks. Hence, this much-quoted low utilization rate may give a downward bias as to how effective AFTA has been. Moreover, Singapore accounts for the largest share of intra-ASEAN trade, a large percentage of which is entrepot and not eligible for trade preferences.

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accords generally are quite open and deserve high marks in most categories, with the exception of Roos (in bilateral agreements with OECD countries) and product and service coverage (in the case of developing economy accords). We come back to the issue of “best practices” in the next section. 4.4. Regional Strategies: WTO, Regional, Subregional, Bilateral As we emphasized throughout this chapter, Asian growth and development is increasingly determined by the global economy. True, Asia is an increasingly important part of that global economy, and the Asian regional interdependence that is proceeding in tandem with globalization implies a rising role for the region itself in shaping the future of Asia’s composite economies. Yet, non-Asian countries continue to be extremely important in the determination of many economic indicators of global interaction. The US and EU markets, for example, are the largest markets for the manufactured exports of many Asian economies, and final demand in these markets, we have argued, is leading the process of fragmented trade. US and EU multinationals are among the greatest protagonists of integration in the region through their vertically-integrated production chains. The US dollar is the dominant currency used in the region for a variety of transactions; it may be losing this overwhelming position but mainly in favor of a rising euro. In part, the rising convergence of Asian business cycles is a by-product of their increased correlation with the G3 business cycles. The same can be said of asset markets. Adding political economy and political factors, we can easily come to the conclusion that the rest of the world continues to matter a great deal to the region. Analogies can also be drawn with the regionalism trend in Asia. It is new, it is interesting, it is impressive, it is exciting. And we would argue that it could be very productive if undertaken in the context of an outwardoriented commercial policy. However, these initiatives in no way should substitute for the WTO, which continues to be the trade governance institution par excellence for the region. Regionalism must be complementary; it will only be effective if it is correctly nested in the multilateral framework. There can be no substitute for a vibrant international trading system. It certainly is not in the interest of Asia to create “blocs” that would isolate the region from the rest of the world. Moreover, it is not in Asia’s interest to alienate its European and North American partners, who are hubs of

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their own FTAs and various preferential configurations. Only a strong multilateral system will prevent the “gravitational pulls” unleashed by the new wave of regionalism from harming the global trading system. Hence, Asia and its regional partners need to always recognize the primacy of the WTO in maintaining an open international trading system and act to promote its goals. This means ensuring that regionalism is consistent with not only the letter but also the spirit of the WTO, and supporting the WTO itself. The 2007 APEC Summit stressed the importance of overcoming the current impasse at Doha. That said, regionalism is here to stay. Even a successful conclusion to Doha will not turn back the clock. We have argued that a main reason for this regards the need for regionalism to support regional interdependence, which in turn requires the type of deep integration policies that are far easier to adopt in the context of bilateral and regional agreements. Dee (2007) notes this importance but warns against believing that these types of “deep integration” policies will suffice. Negotiations in bilateral and regional arrangements will limit themselves to issues that we might refer to as “national treatment”, i.e., affecting preferential treatment in favor of local producers over foreign producers. This approach potentially has two problems: it could lead to advantages accorded to partner countries over non-partners (the corollary to Viner’s “trade diversion”) and it means that some of the most important “behind the border” measures will be left out of the liberalization package. Having stressed this crucial role of the WTO and the potential limits to the aspirations of regionalism in supporting regional integration, we note that outward-oriented bilateral and regional trading arrangements can potentially lead to improvements over the status quo. The WTO is key but it, too, is limited in what it can achieve. Moreover, a “Doha-Lite” agreement that avoided sensitive issues and led to marginal liberalization could be worse than no agreement at all.34 If FTAs can expand product coverage to highly sensitive areas such as textiles and financial services, deepen cuts in tariffs to essentially zero, abolish non-tariff barriers, produce trade and investment facilitation measures, include deep integration areas such as those included in the “Singapore Issues” (e.g., investment protection, competition policy, transparency, and government procurement),35 and the 34 ADO

(2006) discusses the issues and comparative gains associated with various Doha scenarios. 35 The Singapore Issues are named as such because, at the WTO Ministerial in 1996, four working groups pertaining to these issues were set up. They were taken off the agenda

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like, then they can help achieve the goal of creating an efficient regional productive base. True, the gains will not be comprehensive and will not substitute for domestic economic reform. But they could be a step in the right direction. Which would be the best configuration of FTAs in the region? Currently, there is a strong revealed preference for bilateral FTAs for a variety of reasons, not the least of which would be the difficulty of negotiating multilateral FTAs. However, while a system of bilateral FTAs might lead to positive welfare gains, economic studies have shown that wider arrangements, e.g., in the form of an ASEAN +3, ASEAN +6, or APEC-wide arrangement, would tend to have far greater effects, as well as circumvent or mitigate problems associated with the “Asian noodle bowl”. In fact, the ADO (2006) uses the GEMAT CGE model to show that an Asia-wide FTA (including Japan) would increase developing Asia’s income by 1.1 percent, whereas a global free trade deal would only increase it marginally higher (1.3 percent). Using the same GEMAT model, Plummer and Wignaraja (2006) show that the current “fragmented scenario” of the existing series of FTAs would yield relatively small gains in economic efficiency and welfare, whereas wider arrangements would have much larger effects. The summary results of this study are presented in Figure 2.2. As Harrigan et al. (forthcoming 2008)

180 160 140 120

Asia World

100 80 60 40 20 0 Fragmented ASEAN+3 Scenario FTA

ASEAN+6 FTA

Asia-wide FTA

APEC FTA Global Free Trade

Source: Plummer and Wignaraja (2006). Fig. 2.2.

Effects of Six FTA Scenarios Real Income (EV), US$billions.

at the Cancun Ministerial Meeting in 2003 after protests from developing countries, that is, the issues were thought to be too sensitive by some of the key developing membercountries. Some progress, however, has been made on trade faciliation.

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conclude from their simulations of various FTA configurations, “Regionalism — or the creation of a wider, single FTA within Asia — is likely to generate greater benefits for developing Asian economies than bilateralism or the creation of hub-and-spoke systems that ‘fail to connect the spokes’”. Kawai and Wiganaraja (2007) also focus on the issue of which configuration would be best for Asia. They stress the potential costs of the existing bilateral FTA approach and make a strong case for a single East Asian FTA that would reduce potential costs associated with overlapping Roos and other inefficiencies. They conclude that a ASEAN+6 arrangement would generate the largest gains, while costs to non-members in terms of trade diversion would be small. Nevertheless, they stress the point that we made at the beginning of this subsection: regionalism in Asia needs to take into account the region’s relationship with major trade, investment, and diplomatic allies such as the United States and the EU. They support the formation of either an East Asia-North America FTA or an APEC FTA.

5. Looking to the Future Asian economies have prospered significantly since they’ve been implementing their respective outward-oriented reform programs. Even with the dramatic shock of the Asian Crisis, these economies persevered in their reform of the real sector. Moreover, they have reacted to the rise of the People’s Republic of China and India in the globalization process by expediting reforms and embracing FTAs to open international markets even further, rather than retreating behind protectionist barriers. We have argued that regionalism in Asia needs to aim at improving regional competitiveness by reducing intra-regional transactions costs and supporting the market-led regional integration process in Asia. This is an explicit objective of AFTA and the AEC, for example. In order to be effective, it must be outward-oriented and complementary to the WTO. But while the prognosis for Asian economic development and integration in the future is positive, the region will continue to face many challenges. This will require the adoption of a vector of outward-oriented, efficiencyfocused policies both at the national and regional levels that will be necessary for Asia’s continued success. We argue that bilateral and regional FTAs can help in this process if the region adopts best practices in constructing these agreements.

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The goal of this final section is to devise a series of policy recommendations that will enhance productivity and competitiveness, improve the allocation of resources, and facilitate economic transition to modern, knowledge-based economies. We hypothesize that regional cooperation can help Asia achieve many of these goals, but only in tandem with policy change at the national level. This section adopts a medium and long-term time horizon and, as such, includes recommendations for policy change in non-traditional areas, such as energy and the environment that will ultimately have important bearings on long-term competitiveness. We consider nine principal areas that should be considered by Asian policymakers in striving to perpetuate rising competitiveness of the region’s economies: 1. Enhance Labor and Capital Mobility. Given its politically-sensitive nature, intra-regional labor flows are low across most countries in Asia.36 The economic case for greater liberalization of unskilled labor mobility in the region is strong, particularly given demographic trends: some Asian economies (e.g., Northeast Asia) are already coming up against labor shortages and rising dependency ratios, whereas population growth in certain other countries has led to excess supply. Nevertheless, the diversity of size, wealth, and various social-cultural factors in the region complicate significantly reforms in this area. Greater liberalization of unskilled labor flows will become increasingly attractive in terms of economics, but in terms of socio-political aspects will continue to be problematic in the shortmedium run. This topic is taken up in detail in other chapters of this volume. On the other hand, there is also a strong case to be made for greater liberalization of skilled labor flows, and these are far less politically controversial. Facilitation of skilled labor flows is often necessary in order to augment FDI inflows, create a more attractive business environment, and complement existing endowments of skilled labor. Liberalization in this area is already becoming a priority in many countries and certain steps have been taken to loosen up associated restrictions (e.g., facilitating visa permits or waiving them altogether for business people). The AEC actually has as a goal the freeing up of skilled labor flows by 2015, and shortterm visa advantages for ASEAN nationals are already in place in many 36 At least in terms of official flows. There is strong evidence that unofficial flows of unskilled labor have been important for some countries (and often the source of bilateral disputes).

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countries. However, any analysis of the economics of skilled labor flows would have to consider the potentially negative consequences of “brain drain”. It will also be important to free up capital flows. Liberalization of long-term capital flows, such as FDI, is a top priority in just about all Asian economies. This will essentially require movements toward national treatment of FDI, but national treatment should not be the only goal for relevant sectors. From an economic perspective, providing a level playing field is a laudable objective but making sure that the field is in good shape to play on is even more important. Advocating best practices in business policies needs to be a priority in Asia, especially given the diversity in which the private sector is treated throughout the region. As noted by Dee (2007), domestic regulatory reform is extremely important. With respect to short-term capital flows, as was noted in earlier chapters, liberalization in this area is politically and economically controversial (see, for example, Kose, et al., 2006). Still, as financial institutions are built up in the region, liberalization of even short-term capital flows could have significant positive effects on growth and development. As much of the financial intermediation of Asian economies takes place largely outside of the region, there is a clear incentive to free up capital controls and deepen equity and fixed-income markets in order to enhance the financial role of Asian capital markets. 2. Develop the Knowledge Economy. The international marketplace is being increasingly driven by knowledge-based developments. At early stages of economic development, successful economies have based their technological strategies on learning and imitating; however, technological upgrading requires investment in resources that build up indigenous technological capacities. While the success in building the knowledge economy varies considerably across the region, every economy needs to facilitate the adoption of appropriate technologies and prepare for technological upgrading. Otherwise, productivity and competitiveness will suffer. Doing so requires forward-looking government policy in terms of human-capital development, infrastructural investments, and ensuring that the right market signals flow to the private sector (e.g., in terms of incentives for investment in research and development). Moreover, given that some of the most successful knowledge-based economies are found in the Asian region, there is a good deal of potential for technical assistance to countries that have less developed knowledge-based economies.

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3. Work to Ensure a Successful Conclusion to the Doha Development Agenda. At the time of this writing (Fall 2008), the Doha Development Agenda appears to be at an impasse, although progress was made in July 2008. It would appear that member states are coming close to a deal, but the political cycle in some countries, including the US Presidential Election, has put things on hold. While key member countries — including members of APEC — have all stated their desire to bring the negotiations to a successful conclusion, not enough has been offered to cement a deal. As we argued at length in the last section, Doha is more important today than it has ever been. We have focused on the need for the regionalism movement to be successfully nested in the WTO as a reason for this. But it is also the case that multilateral liberalization needs to keep pace with the growth in globalization, and this has not happened (one reason why regionalism has become so popular). Hence, we would argue that what is needed is not only a Doha deal but a good deal, that is, “Doha-deep” rather than “DohaLite”. “Doha-Lite” would be, for example, a “flexible” package under nonagricultural market access (NAMA) in which many sensitive products are excluded, minimal “value added” in terms of progress in agriculture, and mere rhetoric in services and “rules”, with some compensation under “aid for trade”. Such a package would be problematic for a number of reasons, including the fact that non-uniform tariff cuts could lead to distortions in the value-added chain that could potentially negate any gains from liberalization. Mere patch-work in agriculture would repeat the mistakes of previous GATT/WTO rounds; it would thwart necessary structural reform in developed and developing countries, and would leave much for future rounds. Rather, Asian economies should work in favor of a “Doha-deep”, that is: a balanced approach to both NAMA and agriculture with as few excluded sectors as possible and aggressive cuts; significant phase-out of export subsidies in agriculture; some progress in services, particularly where they affect FDI and immigration; fairer and more transparent rules on contingent protection; better definitions and rules on transparency in FTAs, including a commitment to keep them consistent with multilateralism; and generous offers in terms of “aid for trade” and “trade facilitation plus”.37 After a multilateral agreement is made, it generally takes a decade to implement it and a good deal of time to get the next Round off the ground. For instance, the Uruguay Round was launched in 1986, began 37 See,

for example, ADB (2006) for a complete discussion of these issues.

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implementation in 1994, and was pretty much in place by 2005 (e.g., in January 2005 the Agreement on Textiles and Clothing expired). That’s almost 20 years. What happens at Doha will be instrumental in shaping the short- and long-term global policy environment facing Asia. Hence, the region needs to do what it can to finalize an effective agreement. 4. Reform Services Sectors. There is a clear need to reform certain services sectors that have hitherto been mostly untouched by the liberalization process in some countries. In particular, financial services and telecommunications services have been neglected in the economic reform process. These sectors are extremely important in the development of modern economies, as they serve as important inputs to other sectors in the economy. Various empirical models effects that include services tend to generate far greater results from regional integration than models focusing on goods alone. 5. Improve Competition Policy. Many countries in Asia do not have comprehensive competition policies or laws in place. This can lead to increasing problems as the economy integrates with the rest of the world, particularly with respect to such areas as utilities, telecommunications, and postal services where there tends to be (direct or indirect) government involvement. In the medium- and long-term, an effective competition policy framework will need to be put in place. 6. Adopt More Efficient and Forward-looking Environmental and Energy Policies. As Asia continues to develop, it will face increasingly important environmental and energy-related constraints. For example, coal dominance in the energy mix in developing Asia is giving rise to serious environmental pollution, health risks, and escalating greenhouse gas emissions. The poor tend to be the most exposed to this environmental degradation. Environmental quality in Asia is also becoming increasingly affected by pollution from neighbors, e.g., trans-boundary pollution takes the form of atmospheric brown cloud, acidification, and dust and sandstorms, suggesting the need for regional as well as local approaches. Moreover, certain Asian countries are notorious for the high energy intensity of production, which has both a serious effect on the environment as well as rendering countries more vulnerable to adverse energy shocks. Advocating “green policies”, beginning with greater energy efficiency, makes sense for the future growth prospects of the region’s economies. It also would ensure that the region will be a “good environmental global citizen”.

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7. Support “building blocs” and avoiding stumbling blocs: best practices. An obvious question that emerges from the discussion of Section 4 is how regional agreements themselves can work in favor of global free trade. While there has been an exhaustive debate as to whether or not FTAs in general constitute “building blocs” or “stumbling blocs” in the movement towards freer international markets, in practice, the inclination of the regional accord tends to be extremely important. Clearly, if the group is being formed as a means of enhancing inward-looking development strategies or as a way of isolating the region from global competition, this initial policy thrust would set in motion many of the problems articulated by the antiregionalism camp. However, we would argue that this will not be the case in Asia, as: (1) it is unlikely that an Asian country wishing to promote outward-looking policies, including extensive unilateral liberalization and active participation at the WTO, would contradict this stance in favor of a regionally-closed system; (2) reductions in trade barriers within a preferential trading arrangement make it more attractive for a country to reduce external barriers, in effect multilateralizing regional concessions,38 because a main cost of an FTA is trade diversion and lower external barriers will reduce associated costs; (3) the “weeding out” of least competitive industries discussed above, and making the political economy of trade liberalization more favorable over time seems to have been important empirically39 and (4) the membership of preferential trading arrangements tends to expand and to become more diverse over time, thereby reducing regional sources of support for protectionism in a particular country and industry, as well as reducing the overall potential for trade diversion. In short, while the risk of regionalism is real and, as with any realworld second-best policies, costs exist, it would appear that what is driving the regionalism movement in the 2000s is based on an outward-looking approach to integration. AFTA and other expressions of ASEAN integration are exemplary of this. Still, minimizing costs is of the essence. This brings us to the discussion of “best practices” in regional trading agreements. Plummer (2007) develops a blueprint for best practices in FTAs, delineating a series of 10 rules that, if followed, would minimize the negative effects of regional trading agreements and maximize the potential

38 For

example, as AFTA began implementation, there was a proposal offered by the Philippines with a good deal of support that would have multilateralized AFTA cuts. 39 Perhaps it would be more accurate to say “anecdotally”, as the empirical literature on this subject is not well developed.

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welfare-enhancing aspects. Briefly, these are: (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

comprehensive coverage of goods; comprehensive coverage of services; low and symmetrical rules of origin; globally-accepted best practices in customs procedures and related measures; TRIPs Plus; national treatment and comprehensive treatment of FDI; anti-dumping procedures and dispute resolution need to be transparent and fair; open and non-discriminatory government procurement policies; competition policies should create a level playing field; and technical barriers to trade need to be kept to a minimum and should be non-discriminatory and transparent.

Plummer (2007) also evaluates existing Asian-related FTAs in these various areas and gives them a score along a spectrum of “A” (generally conforms to best practices) to “C” (does not conform and could be inwardlooking).40 These are replicated in Table 2.9. His main conclusions are that while Asian FTAs are generally outward-oriented and conform better to best-practice rules than do most FTAs in other regions, there are still some shortcomings, particularly in the area of ROO (for accords in which at least one developed country is a signatory) and comprehensiveness (for developing country accords). In addition, APEC and the Pacific Economic Cooperation Council (PECC) have taken up the issue, setting up a series of general principles and guidelines.41 They stress that FTAs should embrace non-discrimination (presumably where possible, as FTAs by their very nature are discriminatory), comprehensiveness, flexibility, WTO-consistency, transparency, and cooperation. These all would be consistent with the best-practice rules discussed above. However, as noted by Scollay (2004), the language of related statements do not go far beyond that of the relevant clauses in the 1994 WTO Understanding on Interpretation of GATT Article XXIV. Harrigan, et al. (forthcoming 2008) try to measure the impact of “good practice agreements”. They compare good-practice FTAs to shallow agreements along three dimensions: the costs and restrictiveness of the 40 If

information was incomplete, the grade assigned is “I”. for example, PECC Trade Policy Forum 2004 and summaries in Scollay 2004.

41 See,

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Table 2.9. Accord AFTA SGP-NZ EFTA-SGP JPN-SGP US-SGP AUS-SGP KOR-CHILE JPN-MEX THAI-AUS INDIA-SGP KOR-SGP

Grading existing FTAs in Asia.

Goods Serv. ROO GovPro Comp A A C A A A B A A B B

C B A A A A B B B B B+

A− A− C C C C C C C C C

I B+ B+ A A A A A B− C A

I A B B A A A A A C A

Inv. A− A A A A A A A A B+ A

IPR Mon TBT I A A A A A A A A C A

C A A A A A A A A A A

I A B B A A A A A A A

Notes: 1. Goods = Trade in Goods; Serv = Trade in Services; ROO = Rules of Origin; GovPro = Government Procurement (chapter/ clauses); Comp = Competition (chapter/clauses); Inv. = FDI provisions; IPR = Intellectual Property Protection (WTO TRIPs plus related conventions); Mon = Monitoring and dispute settlement provisions; TBT = Technical Barriers to trade. 2. Grading is based on: consistency with WTO and outward-orientation; best-practices; scope. Source: Plummer, M.G. (2007). Best Practices in Regional Trading Arrangements: An Application to Asia. The World Economy, doi: 10.1111/j-1467.9701.2007.01061.x, Table 1.

agreement; the degree to which “spokes” of an FTA hub are lined up; and the diversity of the members involved. They characterize these differences using two parameters: (1) a utilization rate (high for good-practice FTAs; low for others) and (2) compliance-costs of satisfying rules of origin and other requirements. Using the GEMAT model, they run simulations for a number of potential configurations. For example, ASEAN +3 and ASEAN +6 regional FTAs are compared to an “ASEAN hub” approach, in which ASEAN has FTAs with each of the “three” or the “six”. Two main results would be that: (1) shallow FTAs yield small gains compared to the good-practice arrangements; and (2) region-wide FTAs tend to generate far greater gains than the bilateral and subregional arrangements. For example, an ASEAN FTA only leads to an increase of 0.57 percent above baseline GDP; adding People’s Republic of China in an ASEAN +1 arrangement almost triple the gains to 1.56 percent, and an ASEAN +6 agreement adds another 50 percent to 2.45 percent. We would argue that it will be difficult, if not impossible, to impose any set of best practices on Asian economies or the member states of the WTO in general. However, Asian economies are now pursuing FTAs to open up new markets and embrace globalization. An effective, even non-binding, set

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of rules would have a good chance of being successful in many accords, or at least creating a benchmark against which negotiations can be pursued. It would behove us to work to ensure that regionalism be consistent with the WTO, rather than to reject regionalism outright as being incompatible with multilateralism. The latter approach may make for consistent theory but bad economic policy. As a final point in this regard, it is worth stressing that the process of structural change, even if it is efficiency-enhancing, creates not only winners but also losers. It is important that “safety nets” be set up to help distribute the costs of structural change and resources be made available to industries that are “weeded” out in order to facilitate adjustment. 8. Development of Economic Integration Infrastructure. In order to enhance regional economic integration, infrastructure is necessary. “Infrastructure” is a seemingly catch-all word, but in this context we mean that economies need to have: 1. efficient physical infrastructure to take advantage of regional and multilateral initiatives; 2. sufficient human-capacity to deal with the exigencies of modern international trade and investment; and 3. effective interconnectivity in terms of internet-related resources and communications. One reason why African countries, for example, have been unable to reap the advantages of globalization relates to insufficient (or non-existing) investments in these areas. No doubt, for each there is a strong argument for forward-looking government policy; without it, the fruits of globalization may well be unobtainable particularly for the less developed Asian economies. We would argue that investments in these areas need to be a high priority of national governments, international and regional financial institutions, aid organizations, and concerned NGOs.

References Ahmed, S. and Loungani, P.N. (1998). Business Cycles in Asia. Mimeograph. Athukorala, P. (2007). The Rise of China and East Asian Export Performance: Is the Crowding-out Fear Warranted? Working Papers in Trade and Development, 2007/10, September. Australian National University. Asian Development Bank (2008). Emerging Asian Regionalism. Manila: ADB. Asian Development Bank (2007). Asian Development Outlook 2007. Manila: ADB. Asian Development Bank (2006). Asian Development Outlook 2006. Manila: ADB.

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Baldwin, R.E. (2007). Managing the Noodle Bowl: The Fragility of East Asian Regionalism. ADB Working Paper Series on Regional Economic Integration, No. 7, February. Barro, R.J. and Sala-I-Martin, X. (2004). Economic Growth. Cambridge: MIT Press. Busakorn, C., Fung, K.C., Iizaka, H. and Siu, A. (2004). The Giant Sucking Sound: Is China Diverting Foreign Direct Investment from Other Asian Countries? Asian Economic Papers, 3(3), Fall 2005, pp. 122–140. Chen, X. (2007). Total Domestic Value Added and Total Imports Induced by China’s Exports. Paper presented at the 16th International Input-output Conference, 2–10 July, Istanbul, Turkey. Das, D.K. (2000). Asian Exports: The Present Predicament. In Asian Exports, Dilip, D. (ed.). Oxford: Asian Development Bank/Oxford University Press. Dee, P. (2007). Asian Integration and Alternative Strategies to Integration. Mimeograph, June. Dee, P. (2006). Multinational Corporations and Pacific Regionalism. Pacific Economic Papers, No. 358, Australian National University. Dobson, W. and Chia, S.Y. (1997). Multinationals and East Asian Integration. Ottawa: International Development Research Center. Eichengreen, B. and Rose, A. (1998). Contagious Currency Crisis: Channels of Conveyance. In Changes in Exchange Rates in Rapidly Developing Countries, Ito, T. and Krueger, A. (eds), pp. 29–56. Eichengreen, B., Rose, A. and Wyplosz, C. (1996). Contagious Currency Crisis. Scandinavian Economic Review, 98(4), pp. 463–484. Estevadeordal, A. and Suominen, K. (2003). Rules of Origin: A World Map. Paper presented at PECC/LAEBA symposium on Regional Trading Agreements in Comparative Perspective: Latin America and the Caribbean and the AsiaPacific, 23 April, Washington, DC: Inter-American Development Bank. Fernald, J., Edison, H. and Loungani, P. (1998). Was China the First Domino? Assessing Links between China and the Rest of Emerging Asia. FRB International Finance Discussion Paper, No. 604. Grilli, E. (2002). The Asian Crisis: Trade Causes and Consequences. World Economy, 25(2), February 2002, pp. 177–207. Harrigan, F., James, W., Plummer, M. and Zhai, F. (forthcoming 2008). Regionalizing Bilateral FTAs in Asia. In From Growth to Convergence: Asia’s Next Two Decades, Zhai, F. (ed.). Palgrave: MacMillan. Feridhanusatyawan, T. (2005). Preferential Trading Agreements in the AsiaPacific Region. IMF Working Paper Series, WP/05/149, July. Glick, R. and Rose, A.K. (1998). Contagion and Trade: Why are Currency Crises Regional? Journal of International Money and Finance, 18, pp. 603–617. James, W.E. (2006). Rules of Origin in Emerging Asia-Pacific Preferential Trade Agreements: Will PTAs Promote Trade and Development? ARTNet (AsiaPacific Research and Training Network on Trade) Working Paper Series, No. 19, August. Kawai, M. (2005). East Asian Economic Regionalism: Progress and Challenges. Journal of Asian Economics, 16(1), Spring.

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Kawai, M. and Wignaraja, G. (2007). ASEAN +3 or ASEAN +6: Which Way Forward?, ADBI Discussion Paper 77. Tokyo: Asian Development Bank Institute. http://www.adbi.org/catalog. Kim, S., Kose, A. and Plummer, M. (2001). Understanding the Asian Contagion. Asian Economic Journal, 15(2), August, pp. 111–138. Kochhar, K., Loungani, P. and Stone, M. (1998). The East Asian Crisis: Macroeconomic Developments and Policy Lessons. IMF Working Paper, 98/128. Kose, A., Prasad, E., Rogoff, K. and Wei, S. (2006). Financial Globalization: A Reappraisal, Mimeograph. www.imf.org. Lee, H. and Roland-Holst, D. (eds.) (1999). Economic Development and Cooperation in the Pacific Basin: Trade, Investment, and Environmental Issues. Cambridge: Cambridge University Press. Menon, J. (2007). Bilateral Trade Agreements and the World Trade System. Asia Pacific Economic Literature. Plummer, M.G. (2007). Best Practices in Regional Trading Arrangements: An Application to Asia. The World Economy, doi: 10.1111/j.1467.9701. 2007.01061.x Plummer, M.G. (2003). Structural Change in a Globalized Asia: Macro Trends and U.S. Policy Challenges. Journal of Asian Economics, 14(2), April 2003, pp. 243–281. Plummer, M.G. and Cheong, D. (2007). FDI Effects of ASEAN Integration. Paper presented at Is Free Trade Optimal in the 21st Century? 15 June 2007, Brandeis University. Plummer, M.G. and Wignaraja, G. (2006). The Post Crisis Sequencing of Economic Integration in Asia: Trade as a Complement to a Monetary Future. Economie Int´ernationale, 107, pp. 59–85. Rana, P.B. (2006). Economic Integration in East Asia: Trends, Prospects, and a Possible Roadmap. ADB Working Paper Series on Regional Economic Integration, No. 2. Scollay, R. (2004). PTAs in the Asia-Pacific Region: An Overview. PECC, pp. 79–104. www.pecc.org. Sen, A. (2001). Development as Freedom. Oxford: Oxford University Press. Stiglitz, J. (2002). Globalization and Its Discontents. New York: Norton. Tamamura, C. (2002). Structural Changes in International Industrial Linkages and Export Competitiveness in the Asia-Pacific Region. ASEAN Economic Bulletin, 19(1), April, pp. 52–82. World Bank (1993). East Asian Miracle: Economic Growth and Public Policy. Oxford: Oxford University Press.

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Chapter 3

Aligning ASEAN Commercial Policy in the AEC

1. Introduction By any measure, ASEAN economic cooperation has come a long way. ASEAN adopted relatively superficial measures to reduce intra-regional barriers in the 1970s and 1980s, with little effect on trade and investment flows. As noted in Chapter 2, while most ASEAN countries experienced a boom in international economic interaction and export-oriented growth in the 1980s, this was due to unilateral, country-based liberalization programs rather than any regionally-driven process. In fact, after the stabilization of Southeast Asian geopolitics in the late 1980s, some predicted the demise of ASEAN as a cohesive group. The argument was that, since the diplomatic, political glue that held ASEAN together had dissipated, ASEAN leaders would soon abandon even the elementary economic integration policies that were in place. How wrong they were. Beginning with the decision to create an ASEAN Free Trade Area (AFTA, 1992), a process that will be completed shortly, ASEAN leaders have progressively launched various initiatives to deepen regional economic integration. The process has been unique in that it has been geared at not merely fostering intra-regional trade but also reducing transactions costs in the region to become more globally competitive. In this sense, ASEAN economic integration has always been outward-looking with a policy of “open regionalism” at its heart. Post-AFTA Economic “deepening” in ASEAN has been taking place on many fronts, for example, in the areas of investment (ASEAN Investment Area, AIA), services (ASEAN Framework Agreement on Services, or AFAS), trade facilitation, and intellectual property protection. The Hanoi Plan of Action (1998) outlined a series of first steps along the way to fulfil

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the goal of the ASEAN Vision 2020 (December 1997), elaborated on by the ASEAN Concord II (October 2003), to create an Economic Community (AEC) by the year 2020 (moved up to 2015 at the Cebu ASEAN Summit in January 2007). As noted in the ASEAN Concord II: The ASEAN Economic Community is the realisation of the endgoal of economic integration as outlined in the ASEAN Vision 2020, to create a stable, prosperous and highly competitive ASEAN economic region in which there is a free flow of goods, services, investment and a freer flow of capital, equitable economic development and reduced poverty and socio-economic disparities in year 2020. The ASEAN Economic Community is based on a convergence of interests among ASEAN members to deepen and broaden economic integration efforts through existing and new initiatives with clear timelines. The ASEAN Economic Community shall establish ASEAN as a single market and production base, turning the diversity that characterises the region into opportunities for business complementation making the ASEAN a more dynamic and stronger segment of the global supply chain.

The mandate of the Hanoi Plan of Action expired in 2004 and has been superseded by the Vientiane Action Plan (November 2004), or VAP, which outlined specific goals and strategies intended to create the AEC.1 The term ASEAN Economic Community evokes the European experience of integration, with its common market. As such, a critical aspect of the AEC will likely have to be the creation of an ASEAN Customs Union (ACU). The process of establishing a customs union among such a diverse group of countries will no doubt be fraught with difficulties. The commercial policies of ASEAN Member Countries (AMCs) range from an essentially free-trade zone (Singapore) to some relatively protected economies. Moreover, the level of development of the AMCs, which influences the speed at which liberalization can take place, varies widely; ASEAN includes high income, middle income, and least developed economies.2 1 In fact, the AEC is only one of three pillars in the development of an “ASEAN Community”, together with an ASEAN Security Community and an ASEAN Socio-Cultural Community. However, the VAP focuses on the AEC. 2 The coefficient of variation (standard deviation divided by the mean) of per capita income across AMCs in 2004 came to 1.62. This would put it among the most diverse regional organizations in the world.

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While the aim of AFTA has been to reduce progressively tariffs on internal trade to zero through the Common Effective Preferential Tariff (CEPT) approach, Member Countries continue to maintain their individual tariffs and administrative measures to trade with third countries (see Chapter 2, Table 2.6). Essentially, a customs union would introduce a Common External Tariff (CET) on third country trade for all Member Countries; harmonise related laws, regulations, practices and control mechanisms; and eliminate internal borders so that, to all intents and purposes, ultimately Member Countries operate as a single entity. In addition to the economic implications in terms of the management of trade, also of special concern is the plethora of third party free trade agreements (FTAs) now being entered into by both ASEAN and individual member countries. The introduction of a customs union (CU) will have a serious impact on the customs administrations of Member Countries that perform the day-to-day controls on imports and exports where the effects on the cost of trade, if not properly managed, can vary considerably. Under Article XXIV of the GATT/WTO, FTAs and CUs are each recognised as means of expanding world trade through closer integration between the economies of the contracting parties. Whether or not such bilateral and regional trading agreements are healthy for the international trading system is a hotly-debated topic in the economics profession. Nevertheless, the boom in international trade and investment in recent years has coincided with the vast increase in the number of global bilateral and regional trading agreements, which have more than doubled over the last 10 years. This offers prima facie evidence that regionalism is at least compatible with globalisation. On completion of an FTA like AFTA, a next logical step in the agenda of regional integration is usually the formation of a Customs Union (CU) or a similar trade arrangement. On a number of occasions since the 1980s ASEAN has considered the idea of forming a regional CU. However, without strong political commitment and/or the prior development of some tools or “building blocks” required to establish a CU, there was little likelihood of this happening. In fact, the vast majority of regional trading agreements throughout the world remain FTAs and do not proceed to the level of a CU. Still, recent developments show there may be room for this situation to change.3 3 The

formation of a CU implies a higher level of synchronisation and harmonisation of policy measures to promote the free flow of goods and commodities as mandated by

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First, fresh impetus was provided by the ASEAN Concord II, and the ASEAN Leaders’ decision to create the AEC will arguably require a CU (discussed below). Second, it is generally recognised that AFTA will be insufficient to bring about the targeted market integration (and greater intra-regional goods flows) due to high transaction and compliance costs. Of particular concern are the issues of origin determination under AFTA, and erosion of CEPT marginal preferences in the context of declining most favored nation (MFN) rates globally. Third, rules of origin are increasingly complicated by the web of third-party FTAs being completed both by ASEAN and Member Countries in the region (the “spaghetti bowl” problem). Fourth, ASEAN customs co-operation has been intensifying in recent years. The integration of customs systems within the region is a key element in the ASEAN Customs Vision 2020. The 2005 ASEAN Strategic Plan of Customs Development (SPCD) puts this into concrete action. Effective realisation of the ASEAN Cargo Clearance Model and ASEAN Customs Declaration Document in 2006 can equally be seen as turning points in regional customs integration. Moves are also underway to create an ASEAN Single Window and Client Service Charter for customs. It is recognised that irrespective of how extensive or deep AFTA would eventually be, ASEAN would remain a constellation of 10 separate economies. This would add to the cost of doing business in ASEAN. At the Fourteenth Meeting of ASEAN Directors General of Customs, held in Cebu in November 2005, some informal discussion took place on the idea of reexamining an ACU (or similar arrangement) from a technical perspective, with a view to realising a more integrated customs environment as the practical manifestation of the SPCD. At the same time, additional study is required on the VAP commitment to ‘increase co-ordination of extraASEAN economic agreements and the closer alignment of MFN tariffs’. Considerable progress has already been made to date with respect to nuts-and-bolts measures that will ultimately be necessary in erecting the ACU. With respect to customs harmonization, the Hanoi Plan of Action specifies4 that ASEAN should: a. Enhance trade facilitation in customs by simplifying customs procedures, expanding the Green Lane to cover all ASEAN products and the Vientiane Action Programme. Its prime objective is to help optimise the economic efficiency of international trade transactions, including those among the members of the regional grouping. 4 Hanoi Plan of Action (2005), paragraph 2.1.2, “Customs Harmonisation”.

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b.

c.

d.

e. f.

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implementing an ASEAN Harmonised Tariff Nomenclature by the year 2000; Promote transparency, consistency and uniformity in the classification of goods traded within ASEAN and enhance trade facilitation through the provision of facilities for obtaining pre-entry classification rulings/decisions at national and regional levels by the year 2003; Promote the use of transparent, consistent and uniform valuation methods and rulings through the implementation of the WTO Valuation Agreement by the year 2000; Operationalise and strengthen regional guidelines on mutual assistance by the year 2003 to ensure the proper application of customs laws, within the competence of the customs administrations and subject to their national laws; Fully operationalise the ASEAN Customs Training Network by the year 2000; and Undertake customs reform and modernisation, in particular to implement risk management and post-importation audit by the year 2003.

While ASEAN has made a great deal of progress in achieving these objectives, including the successful creation of the ASEAN Single Window approach, more planning and strategies need to be adopted in order to create the ACU consistent with the goals of the AEC. The overarching goal of this chapter is to consider the feasibility of an AEC, develop a possible roadmap for how it might be completed with an emphasis on the creation of an ACU, and assess the economics associated with the AEC in general. Inter alia, we will: a. Analyze the commercial policy regimes of the AMCs and suggest means to harmonize them in the ACU. b. Evaluate the costs and benefits of the AEC from both quantitative and qualitative (policy) perspectives given the emerging changes in the global economic environment. c. Consider the AEC in the context of the myriad FTAs that ASEAN Member Countries have negotiated or are negotiating with non-regional partners. This study is organized as follows. Section 2 considers ASEAN commercial policy in a global context, followed in Section 3 by an in-depth review of ASEAN economic integration. Section 4 evaluates the economics of the

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system of FTAs that ASEAN countries are currently negotiating. Section 5 addresses issues related to the need to align commercial policies and the process of creating a customs union. Finally, Section 6 gives some brief concluding remarks. A final point before beginning. This chapter (like others in this volume) is dedicated to economic analysis. However, as we note throughout, political and political-economy issues will have a great bearing on the future direction of the AEC and its ultimate success. Many have doubted the political courage to push through various aspects of the AEC, especially the “single market and production base” component. While it is true that politically-difficult measures will have to be tackled, there is cause for optimism. ASEAN has surprised in the past: the creation of AFTA itself was doubted by many, and just about every ASEAN economic initiative has had its share of doomsayers. Many pundits doubted that the ASEAN Charter — a key document in the implementation of the AEC, as well as the other “pillars” of the ASEAN Community — would ever be ratified, and yet all Member Countries have done so (October 2008). The political will to create an AEC clearly exists at the highest levels; how well the AEC fares will be a function of how effective policymakers prove to be at the “working level”. 2. ASEAN Commercial Policy in a Global Context Unlike the EU or NAFTA, the main trading partners of the ASEAN Member Countries tend to lie outside the region. As of 2006, intra-regional trade in ASEAN came to about 26 percent of total trade (Figure 3.1). At the individual country level, intra-regional trade as a percentage of total 100

Brunei Darussalam

80

Cambodia

60

Indonesia Lao PDR

40

Malaysia 20

Myanmar Philippines

0 1980

1982

Fig. 3.1. 2006).

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Singapore

Intra-ASEAN Trade Share of Member Countries. (% of total trade, 1980 to

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trade was highest for the transitional economies of Laos and Myanmar. In terms of the value of intra-regional trade, Singapore is number one (followed by Malaysia), though it should be noted that Singapore’s share is particularly high due to the fact that it engages considerably in intraregional entrepot trade. Outside of the region (Table 3.1), approximately 14 percent of ASEAN exports were destined for the EU market, less than the 16 percent accounted for by the United States but greater than the 12 percent going to Japan. The EU is the most important single market for four ASEAN countries (Singapore, Laos, Myanmar, and Vietnam); and the United States and Japan are the largest market for three countries each, i.e., Malaysia, Thailand, and Cambodia; and Indonesia, the Philippines, and Brunei, respectively. The “Triad” (the United States, Japan, and the EU) also dominate FDI flows to the region. Hence, regional economic integration in ASEAN has to be appreciated in the context of a regional organization that is largely plugged into the global economy. As will be discussed below, this important fact has been a key reason why ASEAN economic integration has been mainly geared toward “open regionalism”; the cost of an inward-looking approach to regionalism, or “Fortress ASEAN”, would be far too high. Regionalism in developing countries that have focused on creating fortresses have generally failed (e.g., the Latin American Free Trade Area). It would be a disaster in ASEAN’s case. With respect to commercial policy at the national level, there is considerable volatility in the structure of tariffs across the ASEAN Member Countries and, in fact, across commodities within countries. Table 2.6 in the last chapter offers comparative tariff data for the ASEAN countries in a comparative, disaggregated context. With the exception of certain tariffs on beverages and certain food items, Singapore is a free-trade economy. The tariff structures of the other countries vary considerably by sector. Tariffs tend to be low on electronics and general machinery; no doubt, this relates to the fact that ASEAN Member Countries have “revealed” that electronics especially is a sector in which they have comparative advantage. It is also a result of the WTO agreement in information technology products. Now, these relatively aggregate tariff data hide an even greater diversity at the product level, where tariff peaks in ASEAN are common, particularly for certain manufactured items such as transport vehicles and related items. Two important implications emerge from this reality. First, the diversity makes it difficult to harmonize all tariffs into one Common External Tariff (CET), which will be required in creating an ACU. Second,

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ASEAN-6

ASEAN-10

CH

JA

APT

DA

CER

US

NAFTA

EU-15

71.550 126.510 39.680 179.674 96.245 4.511 518.170 2.589 540 3.161 25.850 550.310

17.14 24.00 15.48 21.95 18.08 17.22 20.53 3.05 19.43 44.62 11.35 20.15

18.17 25.09 17.23 24.30 22.01 17.25 22.62 7.47 32.85 45.32 13.04 22.24

6.44 6.69 6.69 8.57 7.38 4.50 7.41 1.05 2.10 5.94 8.98 7.44

22.31 10.10 20.12 6.44 13.98 38.13 12.25 3.49 1.35 5.17 13.57 12.22

55.60 51.34 54.77 53.24 50.41 73.91 52.87 12.55 36.55 58.45 39.53 52.07

37.82 44.83 35.00 50.68 38.55 35.80 43.89 9.10 35.27 66.24 26.39 43.03

2.90 3.63 1.31 4.21 2.90 14.14 3.51 0.13 0.10 0.40 7.21 3.64

12.28 18.77 18.17 12.96 16.10 8.64 15.23 55.88 0.62 0.00 20.14 15.55

13.28 19.92 19.21 13.74 17.68 8.70 16.29 60.04 1.85 0.60 21.48 16.64

12.20 11.80 16.43 13.72 14.31 2.60 13.26 25.46 26.96 15.55 22.52 13.78

1/ASEAN-10 plus PRC, Korea, Japan and Hong Kong, China. 2/Developing Asia refers to all Asia except for Japan. Source: IMF, Direction of Trade Statistics, CD-Rom, April 2006.

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ASEAN Exports to Selected Partners: 2004. (% and US$ millions).

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such heterogeneity in tariff structure at the national level can actually lead to considerable economic distortions, because of its effect on sectoral protection, which economists call the “Effective Rate of Protection”. An example will illustrate the point. Suppose that Malaysia produces automobiles, and to do so, production requires imported inputs (to simplify, let’s say steel) accounting for 50 percent of the final price, i.e., value-added in automobile manufacturing in Malaysia is 50 percent. Suppose that automobiles receive a 50 percent tariff against imported automobiles and steel also faces a 50 percent tariff. This would suggest that value-added in autos in Malaysia receives a 50 percent effective protection, because the final product is protected exactly as much as the inputs. However, suppose that Malaysia were to abolish tariffs on automobiles as part of a liberalization program, whereas steel was not liberalized because it was a “sensitive” product. This would imply a negative effective rate of protection: the tariff regime of Malaysia doesn’t protect automobiles at all, but the auto industry still has to pay tariffs on its steel inputs. Hence, the effective rate of protection tells us exactly to what degree the commercial policy regime protects value-added in an industry. Table 3.2 calculates effective rates of protection for the original ASEAN countries and Vietnam (the corresponding nominal tariff rates are included for comparison). While there is little difference between nominal and effective rates of protection in the case of Singapore, certain sectors in other countries experience considerable changes in protection when we focus on value-added: some sectors even experience negative effective rates, despite having positive nominal rates of protection. It is likely that the effective rates of protection in the CLMV countries exhibit even greater volatility in effective rates. Thus, merely looking at the nominal rates of protection will not give us a complete story regarding the actual efficiency effect of the various AMC policy regimes. It strongly suggests that, as the ACU is being created, it will be important not only to harmonize tariffs across countries into one CET, but also to harmonize tariffs across sectors so as to avoid exacerbating productive distortions. We give recommendations as to how ASEAN might do this later in the study. 2.1. ASEAN and the Doha Development Agenda The Doha Development Agenda is the ninth “round” of multilateral trade talks and the first after the creation of the WTO. It is the most

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Table 3.2. Nominal and Effective Rates of Protection in ASEAN: Selected Countries. (Percentages, 1997). A. Nominal Rate of Protection

Sing

Indo

Malay

Phil

Thai

VN

Agriculture Forestry Fishing Mining Food Pdts and Bev Textiles Pulp and Paper Chemicals Iron, Steel and Metal Pdts Transport Machinery Electronic Equipment General Machinery Other Manufacturing

4 0 0 0 5 0 0 0 0 0 0 0 0

5 1 8 3 15 16 6 7 8 25 8 4 10

31 0 1 1 15 16 9 9 6 20 1 5 8

15 1 7 1 19 14 11 6 8 10 3 6 12

20 2 45 0 37 27 13 15 12 32 9 10 13

14 3 9 3 37 34 19 16 8 37 10 7 17

B. Effective Rate of Protection Agriculture Forestry Fishing Mining Food Pdts and Bev Textiles Pulp and Paper Chemicals Iron, Steel and Metal Pdts Transport Machinery Electronic Equipment General Machinery Other Manufacturing

4 0 0 8 0 0 0 0 0 0 0 0 0

5 1 8 3 30 23 12 12 12 36 9 2 11

37 0 1 1 −15 27 20 0 10 28 −2 7 12

16 0 7 0 29 19 24 5 17 19 1 6 19

21 1 54 0 71 37 15 18 14 38 9 11 15

15 3 10 4 134 84 61 58 15 157 20 20 34

Source: Urata, S. and Kiyota, K. (2005). The Impacts of an East Asian Free Agreement on Foreign Trade in East Asia. In International Trade in East Asia. Table 7.4, p. 228. Ito T. and Rose A. K. (eds.), Chicago: Univ. of Chicago Press.

comprehensive round of trade talks to date, dealing with tariff peaks in manufacturing, elimination of agricultural export subsidies and other tradedistorting measures in the farm sector, services, “contingent protection” (such as anti-dumping and countervailing duties), and how to deal with the global trend towards bilateral and regional trading agreements. Moreover, this is the first round explicitly devoted to developing-country interests. There could be a great deal at stake for ASEAN at Doha. First, given the outward-oriented policy strategy that essentially all ASEAN countries now embrace, the region relies increasingly on a vibrant, open international

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marketplace. All sectors currently being negotiated are relevant to the economic prosperity of the region. Second, in addition to opening up foreign markets, concerted, multilateral liberalization facilitates domestic policy reform and efficient structural adjustment. Economic estimates of the effects of multilateral liberalization consistently show that the countries with the highest levels of protection tend to be the ones who gain most. Third, the rise in the number of bilateral and regional trading agreements that exclude AMCs could harm the region due to trade and investment diversion (discussed below). While it is unlikely that even a highly successful conclusion to the Doha Development Agenda would stop the regionalism movement, it would have the effect of reducing the potential discriminatory impact of any given FTA/CU against ASEAN (since it would lower barriers to trade generally) and would increase the credibility of the multilateral system, to which most ASEAN Member Countries are wedded (and others are at various phases of courting). The December 2005 Hong Kong Ministerial Meeting adopted a framework for liberalization that offered considerable potential for ASEAN. The acceptance of the “Swiss Formula”, a technique which offers a transparent, effective way to harmonize and reduce tariffs across countries and sectors, for trade in manufactures is particularly interesting, provided that it allows only a very small percentage of trade to be excluded from the cuts. Extending such an approach to agriculture would be especially fruitful, for it would permit trade in manufactures and agriculture to be tackled in the same way, making linkage easy. Since developed countries have insisted on liberalization in manufactures while developing countries, including AMCs, have been adamant about agricultural liberalization, such a balanced approach would allow for effective compromise (and the Hong Kong Ministerial Meeting insisted that agricultural liberalization should be just as ambitious as liberalization of manufactures). However, at present the negotiators are following a complicated “tiered” approach. Agriculture remains probably the most controversial area in the Doha talks. Trade in services, which has become increasingly important to all ASEAN countries, has not made much progress in the negotiations and it is unlikely that much will happen in this sector. The same is true for negotiations covering rules applied to contingent protection and regional and FTAs/CUs. However, this being the Doha Development Round, greater emphasis is being placed on means to facilitate the participation of developing countries in the global trading system (“aid for trade” and “trade facilitation”).

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Simulations of the potential economic effects of Doha are very much governed by the relevant underlying assumption of the model and what the outcome of Doha will be. However, an ambitious package coming out of Doha would have a fairly significant effect on global income and a disproportionately large impact on Asia. For example, in the Asian Development Outlook 2006,5 the Asian Development Bank, using its new General Equilibrium Model of Asian Trade (GEMAT) model, suggests that 70 percent of the rise in global income due to an ambitious Doha scheme would accrue to Asia overall, with Developing Member States being the biggest winners. As expected, the most protected economies tend to gain the most. A less ambitious package would cut the global gains by almost half, with Asia losing out relatively more than the rest of the world. The idea of “special and differential treatment” (SDT) has been frequently cited during the Doha Development Agenda. Progress in trade facilitation and other aspects of “aid for trade” will no doubt be extremely important particularly for the Least Developed Countries (LDCs) of the region, as they are in most need of improvement in the soft and hard infrastructure necessary to take advantage of international markets.6 Regardless of the great importance of the Doha Development Agenda to ASEAN and the multilateral trading system overall, as of the time of this writing (October 2008) prospects for a successful conclusion look quite bleak in the short run. The deadline stipulated at the Hong Kong Ministerial Meeting of April 2006 for a negotiated package came and went without any real progress. Negotiations broke down in early July 2006 and again in July 2008. On a positive note, the positions of developed and developing countries at the July 2008 negotiations converged considerably. The differences that prevented an agreement seemed small, leading the Executive Director of the WTO, Pascal Lamy, to be optimistic. However, the outbreak of the global financial crisis in September 2008, coupled with electoral seasons in the United States and the EU, make a near-term agreement unlikely — at least a ratification. Still, if the financial crisis convinces the world that it needs to take an opposite approach than during the Great Depression, it may actually serve as a protagonist for a Doha breakthrough. The G-20 Heads of State Meeting in November 15, 2008, for example, offered a strong 5 A soft version of this publication can be downloaded from the Asian Development Bank’s homepage, www.adb.org. 6 At present, only Cambodia would benefit, given the relatively high incomes of the other AMCs that are WTO members. However, as Vietnam will likely join this year, it, too, could profit from associated initiatives.

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commitment to complete Doha. Still, no one is holding his or her breath that this will be the case in the short run. While Doha is important to ASEAN and ASEAN Member Countries that are members of the WTO should work hard to ensure a successful conclusion, it is important not to exaggerate what will happen if no accord is reached. Despite some concerns that there will be a disintegration of the international marketplace or that the world economy would break up into competing “blocks”, the success to date of the GATT/WTO in reducing international barriers to trade, the exigencies of globalisation, and the economic incentives to preserve the system will mitigate against any such threat. A failure at Doha will not destroy the WTO. Moreover, it is highly likely that the discussions will be delayed, rather than scrapped. After all, the Uruguay Round “died” twice (December 1990 and December 1992) before an accord was reached. Nevertheless, it is highly probable that a (temporary) failure at Doha will fuel an increase in the number and depths of FTAs and CUs. Hence, ASEAN Member Countries will continue to feel pressure to negotiate FTAs with non-ASEAN countries as a “defensive” strategy, i.e., to not lose a competitive footing in key non-partner markets. As is discussed later, this is an important incentive to unifying commercial policy under the ACU; otherwise, there could continue to be a tendency toward the dilution of intra-regional ASEAN integration accords. Moreover, as has been clearly demonstrated by the European experience, ASEAN Member Countries will be able to negotiate FTAs (as well as in international forums, such as the WTO) on better terms as a group, rather than as individual countries.

3. ASEAN Economic Integration In this section, we review the experience of ASEAN economic integration over the past four decades and discuss the case for economic “deepening” in the region.

3.1. The General Case for Regionalism Regionalism, especially the creation of FTAs and CUs, has become the most important trend in international commercial policy. At the end of 2005, there existed approximately 300 regional trading agreements of various degrees of “depth”, more than twice the number of 10 years ago. Asia has

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been a latecomer to this trend; at the turn of the century, only AFTA existed as a formal FTA, and even it was far from being complete. Since 2000, Asia has seen an explosion of FTA negotiations, with about two dozen actually in place. In addition to economic co-operation accords under ASEAN itself, AMCs have been active participants in this process. Disillusionment with progress at Doha may be one reason for the proliferation of regional agreements in Asia and the rest of the world, particularly accords between developed and developing countries. The ambitious agenda of Doha, from both developed- and developing-country viewpoints, could be more easily managed bilaterally or between a small group of countries than in an organization of 149 highly divergent economies. Hence, it is no mystery as to why many of the new FTAs are between developed and developing countries: what is needed to integrate global markets further, from non-tariff barriers to non-border issues, may be too much to handle at the WTO. The regionalism trend is highly controversial among economists. This is basically because FTAs and CUs give preferential treatment to partner countries at the expense of non-partners. Therefore, in certain commodities in which a partner country may have higher costs than in a non-partner country, the fact that the former does not face any tariff may be enough for it to out-compete the latter in local markets. This is known as “trade diversion” and is both detrimental to non-partner countries, whose exporters are disadvantaged, but also to the home (importing) country, who now has to pay more for imports (i.e., there is a deterioration in the terms of trade). An example may illustrate the point. Suppose that Malaysia imports trucks from Japan before AFTA. This would suggest that Japan is the most competitive country and, thus, its relatively cheap exports benefit Malaysian consumers. But if Malaysia enters into AFTA in which preferential treatment advantages ASEAN Member Countries, it may just be that the margin of preference granted to, say, Thai exporters of trucks will allow it to out-compete Japan in the Malaysian market. Malaysia will then buy its trucks from a higher-cost source (Thailand), which will hurt its terms of trade (which shows up, for example, in the fact that it will now get zero government revenue from truck imports). However, it is also true that an FTA will create a more efficient regional division of labor within a given region. AFTA, for example, will allow for free competition across ASEAN, thereby allowing countries to specialize in the goods in which they have regional comparative advantage. This will cause a contraction of less efficient firms in favor of more efficient sectors.

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This effect is known as “trade creation”: zero tariffs across the region allow for specialization and therefore more trade. There is also an FDI-related counterpart to trade creation and trade diversion. An FTA could lead to the anticipation of a more dynamic region and therefore attract more FDI. Lower costs to doing business in the region, thereby allowing multinationals to take advantage of a regional division of labor, will also attract welfare-inducing FDI. These two effects are known as “investment creation”. On the other hand, it may be that an FTA will attract FDI in order to “jump” tariffs. For example, Japanese FDI went into Mexico after NAFTA because of the tariff-free access that Mexico would have in the US market due to NAFTA, rather than due to the fact that Mexico would be the most efficient place to produce. In fact, perhaps the Philippines would have been a better location; however, NAFTA would give the incentive to invest in Mexico at the Philippines’ expense. Mexico might be happy about this, but certainly the Philippines would not be, and global efficiency would fall. This is known as “investment diversion”. Now, non-discriminatory tariff liberalization under the WTO avoids any trade and investment diversion, as it is non-preferential, while allowing for gains in terms of trade and investment creation. This is the main reason why many economists fear the regionalism trend; they would much prefer multilateral accords. Still, the usefulness of regional agreements — and certainly one reason for their popularity lies in their ability to drive integration and cooperation in areas that have hitherto been neglected by the WTO, e.g., sensitive sectors like agriculture, various non-tariff and non-border measures, and much deeper tariff cuts in traditional sectors. Thus, while it is true that a multilateral approach would dominate a bilateral/regional strategy if all the same measures are included and harmonized/liberalized to the same extent, it is not a dominant strategy once we relax this (unrealistic) assumption of symmetry in liberalization. The policy effects of FTAs are also extremely important. For example, many American economists supported NAFTA not for love of regionalism or their belief that it would have great effects on efficiency in North America through the liberalization of tariff and non-tariff barriers, which were, after all, low in the aggregate. Effects on the United States and, especially, Canada, were estimated to be small. Rather, it was supported in the main because it would lock in the Mexican economic reforms leading up to NAFTA and would set the stage for further liberalization. In 2005, the US government gave a high priority to an FTA with Central America

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(“CAFTA”) in hopes that it would have the same stabilizing effect. And while the percentage of total Mexican trade has risen to somewhat over three-fourths (from two-thirds) in the wake of NAFTA, a result of both trade creation and diversion, one cannot say that Mexico has been “captive” in NAFTA. In fact, Mexico now has negotiated some 39 FTAs. Moreover, openness of the Mexican economy has allowed non-partner countries to benefit; the financial sector in Mexico, for example, is characterised by a considerable European presence. Moreover, time and depth matter. Many protagonists of a purely multilateral approach to economic cooperation tend to present arguments without a well-defined time horizon. A heuristic example may help underscore this point. Suppose, say, Indonesia, has an option to create an FTA with Japan, but its leaders know that this will have some costs in terms of trade diversion. The “first-best” (global free trade) policy, its leaders might reckon, would ultimately be the best deal for Indonesia, as nondiscriminatory free trade would have no trade diversion and could maximize trade creation. But timing would be crucial as to whether or not Indonesia should agree to the accord from an economic perspective. Suppose that global free trade were an option immediately. Ceteris paribus, free trade would be better than the deal with Japan. But what if the FTA with Japan were possible today, and yet global free trade would take five more years? Which would be better? It would depend on what the Indonesia-Japan deal would look like (relative to the global deal); nevertheless, it could be that free trade would still be worth the wait. But what if free trade were to take more like 20, 30, or 40 years? After all, the GATT/WTO has existed for almost a half-century, and global free trade is nowhere in sight. This is not to argue that ASEAN has a strong incentive to move forward without regard for the GATT/WTO. Quite the contrary; the WTO is extremely important to all ASEAN Member Countries and a successful Doha Development Agenda should be a high priority. However, economic deepening could have many positive effects on the region, provided that it continues to be open. And there is ever more reason to believe that it will be; the ASEAN leaders have always placed a strong priority on keeping regionalism “open”, with a pervasive commitment to outward-oriented policies. ASEAN Leaders have consistently placed a priority on reducing transactions costs as a way of attracting FDI inflows, which are becoming increasingly hard to attract a competitive, globalised economy with formidable competitors such as India and China. AFTA and associated trade-facilitation arrangements can be important instruments for attracting

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FDI, as is the ASEAN Investment Area (AIA). Indeed, AFTA has often been called more of an investment agreement than a trade agreement. As noted by the Asian Development Bank Institute in its Executive Summary Series No. S58/52 (Asian Development Bank Institute 2002: p. 1), FDI is a prominent motivation for FTAs: In the implementation of regional integration agreements, large locational advantages and environmental change could result in substantial impacts on the regional distribution of FDIs. In particular, technological change and other efficiencies should strengthen the positive linkages between regional agreements and intra-regional FDI flows.

The AEC will go much further by essentially creating a common market, in which multilaterals will be able to plan production in ASEAN as if it were a single economic space. Is it possible that economic integration programs could actually in practice be detrimental to the outward-oriented reform processes of the American Member Countries? Anything is possible. The debate surveyed in Chapter 2 confirmed that several outcomes are possible. However, in practice it is highly improbable, for: (1) it is unlikely that ASEAN Member Countries, who are engaging in major liberalization programs to various degrees and are active protagonists at the APEC and WTO levels, would for some reason contradict this outward-oriented approach in favour of a regionally-closed system, particularly since just about all official integration documents favour openness; (2) reductions in trade barriers within AFTA make it more attractive for a country to reduce external barriers, in effect “MFN-ising” regional concessions, because the most important cost of regionalism is trade diversion and lower external barriers will reduce associated costs (no doubt this was one reason for the Philippine proposal to multilateralise AFTA cuts discussed in the next section); and (3) the “weeding out” of least competitive industries in an FTA make the political economy of trade liberalization more favourable over time, an effect that has been borne out empirically.7 One might add to this the list of nontraditional benefits for especially the CLMV countries that would accrue due to necessary reforms to meet ASEAN-related (official and unofficial) policy requirements in AFTA and other accords, for example, macroeconomic stability, easier technology transfer, improved protection of intellectual property (which should help attract FDI), capacity building that 7 Perhaps

it would be more accurate to say “anecdotally”, as the empirical literature on this subject is not well developed.

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would have to go along with deeper integration and harmonisation within ASEAN (i.e., implementation of “best practices”), efficient structural policy change and reform, and various positive political and political-economy aspects of formal integration. 3.2. Brief Review of ASEAN Economic Integration Initiatives While the Bangkok Declaration was signed in 1967, initial preferential trade and investment programs did not really start until the first two ASEAN Summits in 1976 (“ASEAN Concord”) and 1977. Even in the 1976/77 programs, the margins of preference on trade concessions were kept low and the lists of goods offered for liberalization included many products which these countries do not import (snow plows is one infamous example). This is a typical problem in a “positive list” approach to economic integration, in which only goods explicitly specified are included in negotiations (as opposed to a “negative list” approach, in which only excluded items are listed). Industrial programs,8 which had the goal of exploiting regional market opportunities and “pooling resources”, were also weak and generally ineffective in spurring intra-regional economic interaction. Although substantial improvements in trade and investment programs were made at the Third Summit in December 1987, the increase in intra-regional trade and investment was minimal. Recognizing the need to enhance economic integration, the ASEAN leaders began in December 1990 to discuss “bold and innovative” approaches to intra-regional economic cooperation. While at the diplomatic level ASEAN cooperation had been successful in bringing regional peace to its member-states and in fostering peace in Indochina in the late 1980s, the political imperatives could no longer be the over-riding driving force that could hold ASEAN together. Deeper economic integration was clearly necessary for the organization to perpetuate its relevance in a rapidly-changing 8 ASEAN industrial programs included: (a) ASEAN Industrial Projects (AIP), which was a government-to-government scheme where industrial projects were allocated to each country; (b) ASEAN Industrial Complementation, which was intended to integrate vertically the production of one product within ASEAN (subsequently expanded to include “brand-to-brand” complementation, or “BBC”, to date only used in automobile production); and (c) ASEAN Industrial Joint Ventures (AIJV), which was a private-sector-based, flexible initiative for smaller joint ventures between ASEAN and non-ASEAN-based firms. The programs have essentially been superseded by the ASEAN Investment Area (AIA) approach.

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global economy. And moving forward on the economic front became possible for the first time because all ASEAN countries were undertaking the same, outward-oriented development strategies, making the resistance to liberalization less of an impediment to integration. Moreover, developments at international and regional levels suggested that ASEAN was at a watershed. The result was a decision at the Fourth Summit in January 1992 to create an ASEAN free-trade area in 15 manufactured products. The liberalization formula agreed upon (an Indonesian proposal known as the “Common Effective Preferential Tariff”) would harmonize internal tariff rates to 20 percent or less in eight years, and to five percent or less within 15 years. Subsequently, the AFTA process was expedited and deepened to include all goods with a shortened phasing-in period, so that AFTA should be fully implemented in 2003, with the exception of items on the temporary exclusion lists and the CMLV countries, who were granted more time. According to the ASEAN Secretariat (ASEAN Secretariat 2006, Chapter 2), 99 percent of the products in the CEPT Inclusion List of the ASEAN-6 have been brought down to the 0–5 percent range, with an ultimate goal of zero tariffs. The average tariff rate for ASEAN countries under CEPT has come down to 1.51 percent, down from 12.76 percent in 1993 (when the process began). Products that remain outside of the CEPT scheme at present include the High Sensitive List (i.e., rice) and the General Exclusion List. With respect to the CMLV countries, considerable progress has been made; Vietnam has until 2006 to bring down the tariffs on products on the CEPT Inclusion list to five percent or less, and Laos, Myanmar and Cambodia have until 2008, 2008, and 2010, respectively, to complete the transition. ASEAN has been working on including the products under the General Exclusion List under the CEPT Scheme, with the Coordinating Committee on the Implementation of the CEPT Scheme of AFTA (CCCA) taking the lead. The region is also working on eliminating non-tariff barriers, as well as adopting policies to render AFTA more effective, such as through improving rules of origin and trade facilitation measures in such areas as customs. Interestingly, consistent with the idea of “open regionalism”, shortly after AFTA was created the Philippines tabled a proposal, backed by Singapore and Indonesia, that would allow any regional liberalization to be extended to outsiders, thereby “multilateralizing” cuts within AFTA (this concept will be developed further when we discuss options for the ASEAN Customs Union). Such a non-discriminatory approach would minimize (or abolish) trade diversion, whose costs fall primarily on the host market.

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Further, since 1995 ASEAN has been aggressive in trying to incorporate “non-traditional” areas of economic integration. These include common investment policies; agreements on intellectual property rights, standards, and customs; cooperation in services; other trade liberalization and facilitation measures; and a fledgling dispute settlement mechanism. A few words on cooperation in the area of financial matters are warranted, even in a study on the “real” sector such as this one. As was painfully apparent in the experiences of the EU (e.g., the European Monetary System Crisis of 1992) and Mexico (i.e., the Mexican Peso Crisis, which exploded the year that NAFTA was implemented), there is a need to stress the role of stable financial and macro policies along with the real sector, as well as to include provisions to address possible exchange-rate shocks. ASEAN countries have been slowly embarking on means to strengthen regional cooperation by bringing in the financial sector. The Ministerial Understanding on ASEAN Cooperation in Finance (March 1997) sets out the broad goals of cooperation in diverse areas of finance and macroeconomics, including banking, capital markets, insurance matters, taxation and public finance, as well as in exchanging information on developments affecting ASEAN countries in various multilateral and regional organizations. Recently, the most visible ASEAN endeavours in the area of finance in ASEAN relate to the Chiang Mai Initiative (CMI). Together with China, Japan, and South Korea, the “ASEAN+3” group has developed an embryonic swap arrangement (coming to approximately $70 billion at present) and other means to provide liquidity should another crisis occur.9 In addition, the new ASEAN Swap Arrangement (which actually dates back to 1977) specifically allows for the eventual accession of the CMLV countries. Realizing the importance of developing capital markets in the region, the ASEAN Finance Ministers endorsed a Finance Work Programme designed to deepen capital markets in the region. In the Joint Ministerial Statement of the Fourth ASEAN Finance Ministers Meeting (25–26 March 2000), the ministers agreed that ASEAN should “. . . further strengthen corporate governance practices, including transparency and disclosure, and establish a regional framework for the development of the ASEAN bond market. Our 9 The currencies available under the swap arrangement are those of the Triad, i.e., the US dollar, yen, and euro. The CMI is generally complementary to IMF financial resources and, in fact, countries drawing on the facility must accept IMF conditionality, though the swap arrangement allows for 10 percent to be accessed automatically, i.e., free of IMF conditionality.

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aim is to develop and deepen ASEAN’s capital markets, particularly bond markets”. In December 1999, the ASEAN heads-of-government focused on the need to move towards greater regional cohesion and economic integration, as expressed in the ASEAN Vision 2020 statement. In this document, they pledge, among other things, to maintain regional macroeconomic and financial stability through closer cooperation in terms of monetary and financial policies. Moreover, the next year in Vietnam they agreed to the Hanoi Plan of Action, discussed above, which calls for: (1) maintenance of financial and macroeconomic stability; (2) strengthening of the financial systems; (3) liberalization of financial services; (4) intensification of cooperative efforts in monetary, tax, and insurance matters; and (5) developing ASEAN capital markets. As a final point in this review, it behooves us to mention that several ASEAN countries have united under subregional cooperative accords, such as “growth triangles”. These are cross-border regional arrangements to promote trade and investment by the private sector, where the governments involved serve as catalysts and facilitators. The most advanced is composed of the southern Malaysian region of Johore, Singapore, and Indonesia’s Riau islands. This accord promotes trade and investment by exploiting economic complementarities between Singapore and the two adjacent provinces, through trade benefits, infrastructural development (such as industrial parks), and other means. This type of arrangement has been lauded as a private-sector-based form of economic cooperation that works from the “bottom up”. It was endorsed by the Fourth ASEAN Summit. Other subregional arrangements include: (1) Brunei, Indonesia, Malaysia, PhilippinesEast ASEAN Growth Area (BIMP-EAGA); (2) ASEAN Mekong Basin Development Cooperation (AMBDC); (3) the Greater Mekong Subregion (GMS); and (4) the Ayeyawady-Chao Phrava-Mekong Economic Cooperation Strategy (ACMECS), all of which were recognized and applauded in the VAP as useful, complementary, “prosper-thy-neighbor” arrangements targeted to help improve the economic development gap in ASEAN. In sum, while ASEAN economic integration has a long way to go before realizing the AEC, it has come a long way over the past four decades, and the pace of economic integration is accelerating both in terms of marketdriven regionalization and formal economic “deepening”. Table 3.3 gives a short chronology of the latter up to 2004, when the AEC began to hold prominence in ASEAN economic deepening. The AEC will be implemented through the AEC Blueprint which was published in November 2007.

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99

Chronology of ASEAN Integration.

Main Points: ASEAN ASEAN Concord 1. Established ASEAN Secretariat. 2. Treaty of Amity: Mutual Respect for independence, sovereignty, equality, territorial integrity and identity of nations, i.e., non inference. 3. Establishment of Zone of Peace, freedom, and neutrality.

ASEAN Summit

Year

1st — Bali

1976

1. ASEAN Industrial Project agreed upon. 2. Preferential Trading Agreement (PTA).

2nd — Kuala Lumpur

1977

1. Accelerate PTA. 2. Accelerate and make more flexible ASEAN Industrial Joint Venture (AIJV).

3rd — Manila

1987

1. ASEAN Free Trade Area (AFTA). 2. Common Effective Preferential Tariff (CEPT).

4th — Singapore

1992

5th — Bangkok

1995

1st informal — Jakarta 2nd informal — Kuala Lumpur

1996 1997

6th — Hanoi

1998

3rd informal — Manila

1999

1. Proposal for ASEAN Vision 2020 2. ASEAN 2020 presents a broad, long-term vision for ASEAN in 2020 (with ASEAN Economic Community in mind). Hanoi Plan of Action adopted to move towards Vision 2020: 1. Advance AFTA to 2002, 90% intra-trade subject to 0–5% tariff. 2. ASEAN Investment Area (AIA)-goal investment liberalization within ASEAN by 2010, outside ASEAN by 2020. 3. ASEAN Surveillance. 4. Eminent Persons Group (EPG) proposed to come up with plan for ASEAN Vision 2020. EPG develops plan for Vision 2020: 1. Concern that ASEAN not effective in responding to Asian Crisis, so proposed financial cooperation. 2. Speed up AFTA. 3. Accelerate AIA. 4. To respond to surge of China, need to become more competitive, attract investment, faster integration, and promote IT.

(Continued)

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Table 3.3.

(Continued )

Main Points: ASEAN Adopted Initiative for ASEAN Integration (IAI): 1. Framework for more developed ASEAN members to assist those less developed members in need. 2. Focus on factors to enhance competitiveness for new economy: education, skills development, and work training. — Challenges facing ASEAN: Declining FDI, erosion of competitiveness. — Road map for Integration for ASEAN to achieve by 2020. — Go beyond AFTA and AIA by deepening market liberalization for both trade and investment. — AEC end goal of Vision 2020. — Vientiane Action Plan. — Australia attends for 1st time

ASEAN Summit

Year

4th informal — Singapore

2000

7th — Brunei

2001

8th — Phnom Penh 9th — Bali 10th — Vietianne

2002 2003 2004

Source: Adopted from Naya and Plummer (2005).

Real-time data on ASEAN agreements can be found at the websites of the Asian Development Bank’s Office of Regional Economic Integration (www.aric.adb.org) and the ASEAN Secretariat (www.aseansec.org).

4. ASEAN FTAs with Third Countries As noted in Section 2, ASEAN Member Countries depend more on economic integration with non-partner countries than they do with partner countries. This is natural, given the relative size of the ASEAN economies and their respective levels of economic development. Hence, regional economic integration programs within ASEAN cannot be developed in a vacuum; what happens in the rest of the world has enormous implications for the ASEAN countries and the formation of the AEC. In this section, we review some of the economics of the flurry of FTAs outside the ASEAN context but have important relevance for economic deepening in the region. The review is not exhaustive; these accords have been increasing in number at such a rapid pace that it is difficult to keep up with them.

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4.1. Review of Existing Accords In this subsection, we give a brief review of the various FTAs and related framework agreements that have been established in Asia with an ASEAN partner (major developments in ASEAN major markets will be discussed subsequently). The flurry of negotiations makes it quite difficult to keep up with proposed FTAs, which tend to start off with a bilateral trade agreement and/or a formal framework agreement. Thus, we confine ourselves to established agreements for which there is transparent information. For a July 2005 survey of various accords in the Asia-Pacific region, see Feridhanusetyawan 2005.10 For a list of actual and emerging agreements, the Office of Regional Economic Integration at the Asian Development Bank and the UN Economic and Social Commission for Asia and the Pacific (ESCAP) keep tabs on their respective homepages. The texts of modern Asian FTAs are complicated and can be quite diverse, though there tends to be considerable overlap in terms of topics addressed. In order to simplify the task of reviewing these accords, we group them into three different types. i.e., Full FTAs, Limited FTAs, and Framework Agreements, and summarize their salient components in Table 3.4. Full FTAs tend to be highly comprehensive, covering both goods and services and usually investment. A good benchmark for Full FTAs are Singapore’s bilateral agreements with developed countries, which are all advanced, as is clear from Table 3.4. Limited FTAs usually contain a positive list of goods and/or services that are accorded tariff preferences, to be expanded gradually. They tend to be a first step towards stronger integration. As far as Framework Agreements are concerned, those that involve ASEAN stipulate objectives to strengthen and enhance cooperation on economic, trade, and investment matters, to liberalize progressively and promote trade and to facilitate the more effective integration of newer ASEAN members. In general, they lay the foundation for negotiations in future FTAs. There appears to be general conformity on issues undertaken in negotiations under Full FTAs. Hence, in Table 3.4 we do not detail all possible features of these agreements (in order to save space). Other components that emerge in these agreements include: (1) abolition of tariffs and non-tariff barriers on included projects; (2) anti-dumping provisions; 10 Note

that even this study is dated.

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102 Table 3.4. Countries. Year

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Type

2000

ANZSCEP (SGP/NZ)

Full FTA

2000

EFTA-SGP

Full FTA

2002

JSEPA (J/SGP)

Full FTA

2003

USSFTA (US/SGP)

Full FTA

2003

SAFTA (SGP/Australia)

Full FTA

Main Features Comprehensive; ROO: general VA rule (40%); “negative list” in services; FDI essentially fully covered; IPR included: TRIPS; general commitments on competition; only APEC non-binding rules on government procurement. Comprehensive; complicated productspecific ROO; FDI essentially fully covered; IPP included: TRIPS; refers to WTO Government Procurement Agreement. Comprehensive; complicated, product-specific ROO; “negative list” in services; separate financial services and capital market development measures; FDI essentially fully covered; IPR included, doesn’t refer to TRIPS; builds on WTO Government Procurement. Highly Comprehensive; 10-year implementation; restrictive mainly in textiles and apparel; complicated, product-specific rules of origin (ROO), including “Integrated Sourcing Initiative”; generous “negative list” in services; capital controls only as safeguard; FDI essentially fully covered; extends WTO TRIPS; limits on SOE competition; builds on WTO Government Procurement. Comprehensive; simple general ROO: 30% or 50% local value content; “negative list” in services, no safeguard measures except for BoP purposes; FDI covered; separate, additional commitments for financial services to ensure transparent market access; measures on movement of persons included; builds on TRIPS; Australia not signatory to WTO GPA, but government procurement covered. (Continued)

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Table 3.4. Year

Partners

Type

2004

SJFTA (Jordan/SGP)

Full FTA

2005

Thailand/ Australia

Full FTA

2005

CECA (India/SGP)

Full FTA

2005

KSFTA (Korea/SGP)

Full FTA

2005

Trans-Pacific SEP (Brunei/Chile/ NZ/SGP)

Full FTA

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(Continued ) Main Features Comprehensive; complicated product-specific ROO, separate provisions for textiles and apparel; investment governed by separate bilateral treaty (2004); IPR refers to WTO commitments. Comprehensive; complicated productspecific ROO; special safeguard measures for sensitive agricultural goods; services broadly included and full coverage of FDI; builds on TRIPS; government procurement not covered, but commitment to add as soon as possible. Comprehensive; ROO: generally 40%, but includes product-specific rules as well; services and FDI broadly covered; “negative list” in services; measures on movement of persons included; commitment to develop IPR co-operation, no mention of TRIPS; does not cover Government Procurement, India not signatory to WTO GPA. Comprehensive; 10-year implementation; complicated ROO, product-specific rules that apply only to non-originating materials; “negative list” in services; FDI and financial services broadly included, some sector specific commitments for financial services; provisions on movement of persons; builds on TRIPS; parties signatories to WTO GPA. Not fully comprehensive; complicated and product-specific ROO; “negative list” in services that excludes financial services, but parties commit to commence negotiations on financial services chapter in 2 years; FDI not covered; builds on TRIPS; parties not signatories to WTO GPA but government procurement extensively covered. (Continued)

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Table 3.4.

(Continued )

Year

Partners

Type

2001

ASEAN-CER (ASEAN/Aus/ NZ)

Framework Agreement for CEP

2003

ASEAN/Japan

Framework Agreement for CEP

2004

ASEAN/India

Framework Agreement for RTIA

2002

ASEAN/China

Framework Agreement for FTA

Main Features Goal is to double trade and investment between the regions by 2010; negotiations for FTA started in 2005. Parties agree to negotiate in order to progressively liberalise trade in goods and services and create a liberal and transparent investment regime. The implementation of measures leading to the CEP, including elements of a possible FTA, should be completed by 2012. Parties agree to negotiate in order to establish a RTIA (Regional Trade and Investment Area) which includes a FTA in goods, services and investment. Negotiations are to be finalized by 2005 (FTA and ROO) and 2007 (trade in service and investment). Parties agree to negotiate in order to establish a full FTA by 2012. Newer ASEAN members are allowed a longer timeframe (2015).

Source: Adopted from Plummer (2006).

(3) customs procedures, essentially modelled on “best practices”; (4) professional services (either with details included specifically in the agreements or as a framework for future negotiation); (5) dispute-settlement mechanism (of various degrees of detail); and (6) balance of payments safeguards, generally referring to the IMF protocols and the GATT 1994 “Understanding on Balance of Payments Provisions”. Here are a few salient observations regarding these agreements: 1. With respect to multilateral accords, that is, between a region and a country or another region, no Full or Limited FTA currently exists, though ASEAN has Framework Agreements towards this end with Australia and New Zealand, Japan, India, and China. No doubt this reflects the difficult nature of negotiating a bilateral accord in the context of an FTA, rather than a CU. Indeed, the EU, which from its beginning

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as the EEC, has been able to negotiate myriad agreements with countries and even regions with relative ease due to the fact that it has a united commercial policy. No such united policy exists in the context of an FTA, and ASEAN commercial policies, though relatively liberal compared to other developing countries, tend to be highly diverse, as noted above. Still, ASEAN has always had a preference to negotiate with partners as a group, in part out of fear that separate trade deals could hurt the process of economic integration within ASEAN itself. At first ASEAN was even against any deepening of integration within the context of Asia Pacific Economic Cooperation (APEC) beyond mere consultation (the “Kuching Consensus”). ASEAN has now accepted the reality of the bilateral FTAs that its members are now negotiating, choosing to avoid any diminishing of the ASEAN integration process by pushing forward under the AEC and in other cooperative areas. Nevertheless, ASEAN does appreciate the potential benefits of developing multilateral accords wherever possible, commensurately with bilateral accords. For example, soon after the ASEAN-China Framework agreement in December 2001, Japan decided to begin its own negotiation process with ASEAN, culminating in the 2003 Framework Agreement. It is doing this while at the same time negotiating FTAs and bilateral trade agreements with individual ASEAN countries. On the other hand, through its “Enterprise for ASEAN Initiative”, the United States has implicitly demonstrated that it is not interested in an agreement with ASEAN but rather with its component members.11 2. With respect to the Framework Agreements themselves, ASEAN and Australia and New Zealand (through their “Closer Economic Partnership” (CEP) which is an advanced FTA) finally followed up on its Framework Agreement intentions in March 2005 with negotiations toward the creation of an FTA. ASEAN and CEP ministers recently finished their 10th consultations (29 September 2005). China has moved much more quickly; after its “early harvest” program with ASEAN in January 2004, it finalized a deal on trade in goods and a blueprint for FTA negotiations by the end of that year. The agreement on trade in goods began implementation in July 2005 and China and ASEAN are currently working on services and investment; the fourth consultation between Chinese and ASEAN senior officials began on September 26, 11 There

are a number of reasons for this, including the diversity of ASEAN. Moreover, Laos is still not a member of the WTO.

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2005. Still, it is important not to exaggerate how much the trade and goods agreement itself covers; to date, tariff lines enjoying zero tariffs only constitute 4.8 percent of the total.12 The services agreement is expected to be signed at the 11th ASEAN Summit in Malaysia in December.13 The ASEAN-India Framework Agreement stipulates that the first phase of negotiations on an FTA (and the rules of origin) should be complete by the end of 2005, leaving the agreement on services and investment for 2007. A (relatively-soft) FTA was signed between ASEAN and India in August 2008. 3. Bilateral accords with key non-regional OECD members, in particular the United States, the EU, Japan, and Australia, are in many ways quite similar. These tend to be “Full FTAs” with extensive product coverage for goods and services, especially for the agreements involving Singapore (Singapore has FTAs with Japan, the United States, Australia, and New Zealand14 ), and include the many areas cited above under Full FTAs. In fact, the United States has said explicitly that it would like the USSingapore FTA to be a “model” for bilateral FTAs with all qualifying ASEAN countries,15 and at the time of this writing it had recently finished its fifth round of bilateral negotiations with Thailand. The United States and Japan are both signatories to the WTO Government Procurement Protocol, and their bilateral FTAs tend to build on these, even with partners that are not signatories. Australia is not a signatory to the WTO Government Procurement protocol but it does tend to include government procurement in its arrangements. New Zealand explicitly includes the APEC Non-binding Principles on Government Procurement in its FTA with Singapore (ANZSCEP). All OECD partners include chapters dealing with intellectual property protection (IPR) that extend and/or reinforce WTO TRIPs, and 12 http://english.people.com.cn/200509/29/eng20050929

211656.html. 211656.html. 14 EFTA also has an FTA with Singapore, but the EU does not. However, the EU did launch the Trans-regional EU-ASEAN Trade Initiative (TREATI) talks in April 2003 to improve economic relations between the EU and ASEAN regions. Its practical emphasis was on health and hygiene standards and the protection of intellectual property rights, with trade barriers and other issues left to be handled at the Doha Development Agenda talks. 15 There are two conditions: (1) the ASEAN member state must be a member of the WTO; and (2) it must have a Trade and Investment Facilitation and Liberalization (TIFL) accord in place, meaning it must have normal trade relations with the United States. 13 http://english.people.com.cn/200509/29/eng20050929

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investment provisions tend to be fully covered. Indeed, in these agreements the WTO “Singapore Issues”, which it was said “doomed” the WTO Cancun Ministerial Meeting, are addressed essentially in full. The agreements with the United States tend to be the deepest and include such sensitive sectors as financial services, capital controls, and competition policy, including competition by state-owned enterprises. 4. Japan’s first FTA was its agreement with Singapore in 2002. The agreement is comprehensive, but somewhat less so than the USSingapore agreement. Since then, it has reached FTA accords with several ASEAN countries, most recently (August 2005) with Thailand. But this FTA has been put on hold for the moment due to political transition in Thailand. 5. The EU has not yet negotiated an FTA with any Asian country. It may appear odd that this economic grouping, which more than any other has led the regionalism movement and has often served as a model for ASEAN and others, has not joined other OECD countries in forming FTAs in the region. As Asia is the most dynamic region in the world, such neglect obviously comes with considerable risk. In part, this neglect is due to the fact that the EU’s attention has been focused elsewhere: in 2004, it enlarged to include 10 additional Central and Eastern European members and in 2008 added two more (Bulgaria and Romania); it has been focusing on internal growth problems and debates surrounding its commitment to become the most competitive knowledge-based economy in the world by 2010 (the “Lisbon Agenda”); and its primary trade initiatives in Asia have focused on dealing with China in the wake of the expiry of the Agreement on Textiles and Apparel in January 2005. However, the EU has always kept a close watch on these trends in Asia. Its response to APEC was to create ASEM, but it has done little with Asia Europe Meeting (ASEM) — as APEC itself has done little in terms of deeds — outside of basic consultations and studies as to how to improve bilateral relations. Moreover, the EU is now rising to the challenge: In April 2005, the EU and ASEAN trade ministers agreed to set up a “Vision Group” to consider such new cooperative initiatives, including a possible EUASEAN Free Trade Area. There have been a number of negotiations regarding a possible ASEAN-EU FTA but nothing concrete has yet been achieved. In sum, ASEAN has been successful in negotiating a number of bilateral and regional FTAs with non-ASEAN partners, and the region has plans

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for several plurilateral agreements. This process is very recent; outside of AFTA (1992), the first bilateral FTA in the region, between Singapore and New Zealand, was signed only in 2000. If one includes all of the proposed agreements at various levels of discussion and negotiation, as well as the others that will emerge in response to these, it is easy to forecast a complicated web of formal relationships, of various degrees of depth, binding the region together. It is not difficult to understand and appreciate the anti-regionalism camp’s concern that such a “spaghetti bowl” of regional accords could be potentially damaging to the global trading system. The EU has had to live with such a system for decades, and it has created considerable complications in certain areas (Messerlin, 2001). 4.2. Economic Effects of Third-Country FTAs on ASEAN: A Brief Survey In this section, we consider the economic effects of regional trading agreements on ASEAN and its constituent member states. Our focus is on Japan, the United States and the EU, but we also include other key agreements in the brief survey. Studies of the potential effects of these third-country accords on ASEAN are relatively few. One such study, Scollay and Gilbert (May 2001), offers a typical model that is especially useful in the context of analyzing the trade diverting effects of various FTAs on AMCs. They use an economy-wide “Computational General Equilibrium” (CGE) model, which has become a standard approach to estimating the effects of regional trading arrangements, to assess these effects. The results for the following potential FTAs are summarized in Table 3.5: Japan-Mexico; South Korea-Mexico; Singapore-United States; a group of open Asia-Pacific economies, the “Pacific 5” (Australia, New Zealand, Chile, Singapore, and the United States); Japan-Singapore; Japan-South Korea; and a Northeast Asian FTA (Japan-South Korea-China). Several observations are worth noting. First, for the Singapore-US agreement, net trade diversion for other ASEAN Member Countries does show up in all cases. But the aggregate effect on the economy is always small (ranging from −0.01 percent of GDP in the case of Thailand to −0.05 percent in the case of the Philippines). In relative terms, the negative effect on the ASEAN economies is in every case greater in the case of USSingapore than Japan-Mexico, for example.

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Table 3.5. Effects of Various FTAs on EAI Countries. (Equivalent Variation Basis; Percent of GDP). FTAs Japan-Mexico South Korea-Mexico Singapore-United States Pacific 51 Japan-Singapore Japan-South Korea Japan-SK-China Global Free Trade

Indonesia

Malaysia

Philippines

Thailand

0.00 0.00 −0.02 −0.02 −0.02 −0.01 0.15 1.31

−0.03 −0.02 −0.04 −0.13 −0.35 −0.07 −0.70 6.05

0.01 −0.01 −0.05 −0.06 −0.08 −0.05 −0.35 3.42

0.00 0.00 −0.01 −0.02 −0.09 −0.03 −0.21 2.57

Note: 1. Pacific 5=FTA between Australia, Chile, New Zealand, Singapore, and the United States. Source: Scollay, R. and Gilbert, J.P. (2001). New Regional Trading Arrangements in the Asia-Pacific? Washington, DC: IIE.

Second, with respect to arrangements involving Japan, the JapanSingapore FTA is even more significant and negative for the other ASEAN countries than is the case of Singapore-US, ranging from −0.02 (Indonesia) to −0.35 (Malaysia) of GDP. The greatest blow in relative terms comes from the Northeast Asian FTA, with negative effects ranging from −0.15 (Indonesia) to −0.70 (Malaysia) of GDP. In fact, Malaysia seems to be the most vulnerable among the ASEAN countries to Japanese FTAs, as it always receives the largest negative effects. Third, with respect to the overall effects of global free trade on the included ASEAN economies undertaken by Scollay and Gilbert, Malaysia gains considerably (at least in relative terms) from global free trade, with a positive effect equivalent to over six percent of GDP; the Philippines comes in at a distant second (3.42 percent) followed by Thailand (2.57 percent) and Indonesia (1.31 percent). Thus, global liberalization yields relatively large economic gains. Two key points emerge from the above analysis for our purposes: first, bilateral FTAs between an individual ASEAN Member Country and an extra-regional partner(s) will affect negatively other ASEAN Member Countries, everything else held constant. This result underscores the importance of a joint approach to external relations with extra-regional partners: when ASEAN Member Countries negotiate their own bilateral FTAs, the potential for trade and investment diversion is real. An ACU would preclude any such problems. Second, given the reliance of the ASEAN Member Countries on trade and investment with extra-regional partners, there is

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no substitute for multilateral liberalization. ASEAN needs to continue to be outward-looking and dedicated to the multilateral liberalization process being spearheaded by the WTO. With respect to ASEAN’s relationship with the EU, ASEAN countries have always benefited from the EC’s Generalized System of Preferences (GSP) scheme, which allows for the duty-free entry (up to a certain point) of ASEAN manufactured exports and processed agricultural products, with a number of exceptions. Like in the case of other GSP programs, areas in which the resource-rich ASEAN countries have had comparative advantage (e.g., textiles and clothing, agricultural products) have been generally excluded from the EU GSP. According to Messerlin (2001), who surveys the EU’s GSP scheme, the limited preferential margin implied small gains to developing countries. Moreover, ASEAN countries have had to deal with the EU’s “pyramid of preferences” in exporting to the EU market, that is, with the ACP countries for agriculture and labour-intensive items, and with the CU or FTAs in the case of (intra- and extra-EU) European countries. Moreover, the EU has used fairly extensively non-tariff barriers as a means of protecting its market. The Common Agricultural Policy (CAP) is, perhaps, the most notorious example. Over the past 10 years, there have been essentially three major changes in Europe regarding intra-regional economic integration of relevance to the ASEAN Member Countries: (1) the Single Market Program (EC-1992) — creating a European common market in which goods, services, capital and labour flows — was essentially completed in 1994, though there continue to be certain areas that have not been completely freed (e.g., financial services and the energy market); (2) the introduction of the euro on January 1, 1999 (with the “hard euro” being introduced January 1, 2002); and (3) the membership expansion of the EU to include 10 new Central and Eastern European countries on May 1, 2004 (the Fifth Enlargement) followed in 2007 by a Sixth Enlargement with the accessions of Bulgaria and Romania (in December 2004, the EU also agreed to formally begin accession negotiations with Turkey in October 2005, but these talks are currently proceeding very slowly). The Fifth and Sixth Enlargements to include Central and Eastern European countries should not have a large impact on ASEAN but that the effect will be negative: Lee and van der Mensbrugghe (2004) estimate that the Fifth Enlargement will cost ASEAN countries in the range of $810 million to $1.05 billion. Moreover, the introduction of the euro had no direct effect on Asia and, in fact, the indirect effects will likely be positive, as the US dollar now has greater competition in international markets.

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With respect to the United States, relative to its predecessors, the Bush Administration has been aggressive in developing regional agreements in all parts of the world. In fact, prior to the US-Israel Free Trade Agreement (in manufactures) signed in 1985, US trade policy was strictly multilateral under the auspices of the GATT. Shortly after that, the United States negotiated a number of FTAs and special trading agreements, most notably with Canada (1989) and Mexico (NAFTA, 1994) but also with other groups. The Bush Administration has made it very clear that it intends to pursue the regionalism route as a key economic and diplomatic policy. Even as far back as his presidential campaign, President Bush was a strong protagonist of the Free Trade Area of the Americas (FTAA), to include the entire Western Hemisphere (save Cuba). True to his word, he has actively pursued agreements in Latin America (e.g., an FTA with Chile and FTAA negotiations) but has also been aggressive in other regions. In the AsiaPacific, these have been in the form of “normal” FTAs (e.g., the USSFTA in 2003 and the US-Australia in 2004) and special trading agreements (e.g., US-Vietnam, US-Laos Bilateral Trade Agreements); in Africa, the Bush Administration has added to the Clinton-era “African Growth and Opportunities Act” well-publicized proposals for US-African FTAs; and in the Middle East, it has offered up the possibility of FTAs with Middle Eastern countries, building on the US-Jordan free trade area (2000) and the USIsrael agreement. It has signed agreements with Colombia and South Korea, but thus far the accords have not been ratified by Congress (and won’t be considered until the next Administration). The effect of NAFTA on the ASEAN economies is still not clear. Few studies have analyzed ex post the effects of NAFTA on the ASEAN countries in particular. An exception is Kreinin and Plummer (2002), which, unlike its estimates for the Single Market Program, actually calculates a positive effect on ASEAN to the tune of $13 billion in 1996, or four percent of total ASEAN exports to North America. Over a third of this net external trade creation is accounted for by Malaysia, and in all countries the greatest effect occurs in SITC 75 and SITC 77, which would be expected given the orientation of Malaysian exports. However, it should be stressed that these are tentative results, as the data only reflected a few years of NAFTA. Still, as a basically outward-oriented agreement, one would expect that external countries could ultimately benefit in terms of trade, particularly given the positive policy reform that Mexico has had to embrace in order to take part in NAFTA.

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The Free Trade Area of the Americas (FTAA), however, could potentially be more harmful to ASEAN, given its size and the fact that it would include countries with highly diverse factor endowments, overlapping with ASEAN member-states (from the poorest to the richest). There is also the fear that the FTAA would be a policy diversion (away from Asia) for the United States, though this fear does not seem to have been realized. Perhaps fortunately for ASEAN, the FTAA is currently at an impasse. What happens to the US advances in the area of regionalism will depend on the US elections in November 2008. The candidate for the Republican Party, John McCain is an advocate of such trade agreements (and free trade in general) but the Democratic candidate (and favorite) Barak Obama seems less supportive, even having suggested the possible renegotiation of NAFTA. Still, Congress makes trade policy in the United States, and the Democrats are heavily favored to win back a majority in the House and Senate. Hence, even if John McCain wins, it is unclear if the United States will be continuing the wave of agreements that the Bush Administration has espoused. This could be good or bad for ASEAN. Good, in the sense that it suggests that there will be less potential for trade and investment diversion with regard to accords with third parties. Bad, in the sense that it would mean that the Enterprise for ASEAN Initiative will be put on hold. It also suggests that US leadership at the WTO might be weakened. 4.3. The China Question The increasing presence of China in the international marketplace is evident and very much on the minds of ASEAN policymakers. And well it should be: studies have shown (e.g., Naya and Plummer, 2005) that ASEAN countries are facing increased export competition in OECD markets from China. In fact, at even a very disaggregated (5-digit SITC) level, correlations between Chinese exports and those of the ASEAN Member Countries in OECD markets is higher than ASEAN Member Country competition with each other (with the exception of Singapore). It is clear that the Chinese economic boom poses an important challenge to ASEAN; export growth was a central factor in the economic success of many ASEAN countries, and as China begins to move up the development ladder, it will continue to compete in areas in which ASEAN countries have comparative advantage. This competition will create risks as well as opportunity. Perhaps even more important than competition in the area of trade, the huge increase in FDI flows to China is feared to be more problematic

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for ASEAN. In addition to bringing in new non-debt-creating capital and foreign exchange, FDI has been actively courted as a means of stimulating technology transfer, increasing efficiency in the economy, and providing ready-made markets for a country’s exports. Indeed, mounting empirical evidence suggests that trade and investment are intricately linked, with larger FDI flows being associated with robust exports. Moreover, the Asian Crisis was a result in part of a maturity mismatch in which the ratio of footloose capital flows to long-term flows (i.e., FDI) rose prior to the Crisis, thereby leaving the country open to capital flight. Hence, attracting greater FDI inflows became a more pressing priority after the Asian Crisis, as evidenced by the creation of the AIA and other ambitious “deepening” programs. The perceived Chinese threat has no doubt been a main protagonist in the process. The Chinese economy has “internationalized” rapidly over the past decade, with exports growing at a far more rapid clip than imports until very recently. Moreover, the structure of trade is changing such that China appears to be competing increasingly in higher-end markets, especially in the electric machinery and transport category. This is why there is such a high correlation between Chinese and the exports of some ASEAN countries to third markets. In sum, three important conclusions emerge from research regarding China and its competition with ASEAN: (1) China has become a major competitor on international markets and to ASEAN in particular both in terms of trade and FDI inflows; (2) the structure of Chinese trade has been changing rapidly in the direction of more sophisticated exports, thereby increasingly competing with ASEAN countries; and (3) the literature would suggest that there is a clear trade-investment link in the process of Chinese internationalization. Several mitigating issues, however, that emerge from the literature on the topic are important to keep in mind: 1. FDI diversion toward China. While it may very well be true that FDI is being “diverted” to China away from ASEAN, this may reflect deficiencies in local market rather than Chinese competition per se. Ultimately, multinationals will invest where they believe they will make money; if China promises very high returns and ASEAN merely high returns, a rational multinational — at least one that is not financially constrained, and at least as a group they are not — will invest in both

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markets. Even before China’s huge increase in FDI inflows, ASEAN countries were facing bottlenecks in the attraction of FDI. Moreover, the Chinese emergence as a major player in a way has shifted at the margin the regional focus of multinationals, which could also have positive spillover effects for other Asian countries. Indeed, much of the successful attraction of FDI to ASEAN in the real sector since 2005 is attributed to the production networks in which China is an important player (ADB, 2008). 2. China as an import market. China does have a large trade surplus, and its massive accumulation of foreign exchange reserves reveals that China has been keeping its exchange rate at an artificially low level in past years. These reserves increased from about $600 billion five years ago to $1.5 trillion today. However, most Asian developing countries also have a trade surplus. Moreover, as noted above, the Chinese economy appears to be overheating, suggesting that its real exchange rate will appreciate even if it does not revalue. And in fact the RMB has been revaluing: since the Chinese government began to allow the currency to fluctuate in value less than five years ago, the RMB has risen from RMB8.2 per dollar to RMB6.84 today, an appreciation of 17 percent. This appreciation is considerably more than that of most ASEAN currencies. The focus on China in the media has been on its role as a competitor; however, the Chinese market is huge and presents many opportunities for developing Asian exports, especially since China is now a member of the WTO. Clearly, Chinese competition will speed-up structural adjustment in ASEAN but this is not necessarily a bad thing, as the country will offer tremendous opportunities as an export market. 3. China as a partner. There is no doubt that Chinese economic growth has increased the profile of China at the economic-diplomacy level in various regional and international forums. But most Asian countries feel that its role has been generally constructive. For example, during the Asian Crisis, it was feared that China would devalue its currency in order to maintain competitiveness in light of the tremendous depreciations of Crisis-affected currencies. It did not. During the current 2008 financial crisis, China’s role has been applauded, even by the Sino-skeptic US government. China has also been pro-active in APEC. Moreover, it has been entering into regional agreements with ASEAN, e.g., the ASEANChina FTA, agreement on services, and negotiations on investment are indicative of this process.

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Welfare

Effects

of

Various

Chinese

115

Commercial

Policy

China ASEAN- ASEAN- ASEAN ASEANChinaUnilat China Japan +3 China-EU Japan-US GTLa

(A) Absolute deviations ($1997 billions) 5.4 ASEANb United States 13.8 World 142.4

26.0 0.8 61.8

28.4 −1.4 37.7

41.8 −0.9 231.1

43.0 −2.9 223.4

−16.5 60.6 198.1

38.1 70.9 732.2

2.5 0.0 0.2

2.7 0.0 0.1

4.0 0.0 0.7

4.2 0.0 0.6

−1.6 0.6 0.6

3.7 0.7 2.1

(B) Percent deviations ASEAN United States World

0.5 0.1 0.4

Notes: a GTL denotes “global trade liberalization” (free trade). b Only Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam are included in ASEAN. In the GTAP database, Brunei, Cambodia, Laos, and Myanmar are aggregated into the rest of the world. Source: Lee, H., Roland-Holst, D. and van der Mensbrugghe, D. (2004). China’s Emergence and East Asian Trade under Alternative Trading Arrangements. Journal of Asian Economics, 15, 4, pp. 697–712, August, Table 1.

As noted earlier, China has been active in developing FTAs with various countries and regions (including ASEAN). Lee et al. (2004) calculate what the effects of various Chinese commercial policy initiatives would be on a number of countries and country groupings, including ASEAN. The results are summarized in Table 3.6. The effects of an ASEAN-China FTA are actually quite high (an increase of 2.5 percent of GDP, or $26 billion), only slightly less than an ASEAN-Japan FTA. However, a China-Japan-US agreement would have a significant negative effect on ASEAN (to the tune of $16.5 billion, or 1.6 percent of GDP). But certainly such an agreement is unlikely in the near term (far less likely, for example, than a US-ASEAN accord).

4.4. On the “Spaghetti Bowl” Effect and Best Practices The “spaghetti bowl” effect refers to the Italian pasta dish famous for being highly intertwined. The term is used generally in a derogatory manner by critics of regionalism to underscore problems in terms of coverage diversity, overlap, and “contradictions” associated with a country’s having many different preferential trading agreements. As was noted above, this is potentially a real problem in the global marketplace. A strong advantage of MFN

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in the WTO framework is that it generally (but not totally) avoids this problem. We discussed in Chapter 2 what the effects of the “spaghetti bowl” might entail. In this subsection, we consider it a bit more in-depth. Even though a great deal has been written on issues related to the “spaghetti bowl” effect, little has been done to focus on specific components of regional trade groupings themselves and how they influence the debate. True, there are many anecdotes, with rules of origin being a favourite example as to how FTAs embody a good deal of hidden protectionism. However, focusing on such anecdotes may not be productive; what matters is the entire picture and how it compares to the status quo. APEC and the Pacific Economic Cooperation Council (PECC) have taken up the issue of best practices in FTAs, and they have articulated key general principles and guidelines that the Asia-Pacific region needs to embrace in order to reduce business-related transaction costs.16 They stress that FTAs should embrace non-discrimination (presumably where possible, as FTAs by their very nature are discriminatory), comprehensiveness, flexibility, WTO-consistency, transparency, and cooperation. However, as noted by Scollay (2004), the language of related statements does not go far beyond that of the relevant clauses in the 1994 WTO Understanding on Interpretation of GATT Article XXIV. I have also taken up the issue in a recent publication in The World Economy (Plummer, 2008), in which I delineate the “10 commandments” of best practices in FTAs. These are: 1. Product Coverage: Goods. Comprehensive coverage is best, to be included within a reasonable period of time (defined as 10 years by the GATT/WTO). 2. Product Coverage: Services. Again, comprehensive coverage and a reasonable time period for implementation are best from an economic perspective, and transparency is important in some areas. 3. Rules of Origin. Rules of origin should be as low as possible as well as symmetrical.17 16 See,

for example, PECC Trade Policy Forum 2004 and summaries in Scollay 2004. of rules of origin in FTAs is the most common criticism of regional agreements by economists. In our discussion of existing FTAs in Asia above, we noted that developed country agreements tend to be more comprehensive and “deeper”. They also have their dark sides, and the darkest of these sides is arguably the rules of origin provisions. Research as to how much compliance with rules of origin taxes efficiency is difficult to find. One estimate (Estevadeordal and Suominen, 2003) calculates the cost to be in the range of three–five percent of the f.o.b. value of the exported goods. 17 “Abuses”

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4. Customs Procedures. To the greatest extent possible, customs procedures should follow global best practices and GATT/WTO-consistent protocols. 5. Intellectual Property Protection: IPR guidelines should be nondiscriminatory and consistent with TRIPS, TRIPS Plus, and related international conventions. 6. Foreign Direct Investment. Investment-related provisions should embrace national treatment, non-discrimination, shun performance requirements, and have a highly-inclusive negative list, as well as provide the usual protection necessary for foreign investors. 7. Anti-dumping. Anti-dumping procedures and dispute resolution need to be transparent and fair, and the process needs to be well specified and effective. 8. Government Procurement. Government procurement should be open and as non-discriminatory as possible, and procedures should be clear and as open as possible. 9. Competition. Policies related to competition should create a “level playing field” for both locals and partners, and they should not put nonpartner competition at a disadvantage. 10. Technical Barriers to Trade. These should be kept to a minimum, with clear and transparent mechanisms for determination of standards.18

By adopting best-practices, FTAs can generate significant gains in terms of economic efficiency, well beyond the effects of traditional FTAs (which can potentially be welfare-inhibiting) and, arguably, beyond what any realistic multilateral approach could possibly hope to generate. How much is “significant”? This would be difficult, indeed, to model. However, the EC’s Single Market Programme, which did not focus entirely on best practices but is largely devoted to improving efficiency through the harmonization of the types of policies included in this section, was estimated (Cecchini, 1988) to increase EC GDP by up to 6.5 percent. 18 The

WTO Agreement on Technical Barriers to Trade (TBT) attempts to “ensure that technical negotiations and standards, as well as testing and certification procedures, do not create unnecessary obstacles to trade”. What would be critical for efficiency and outward-orientation would be that any TBT clauses in FTAs should be based on international standards, have high levels of transparency, embrace best practices, and eschew discrimination against outsiders as much as possible.

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APEC and PECC have also been active in trying to estimate the potential benefits that might accrue from trade facilitation measures. For example, in the APEC Economic Committee’s Report, “2004: Trade Facilitation and Trade Liberalization: From Shanghai to Bogor” (APEC, 2004), a methodology developing proxies for the measurement of various trade facilitation policies is offered, followed by some empirical estimation comparing trade facilitation improvements to reductions in tariffs. The Report finds that the trade creation effect of tariff liberalization is greater than that of trade facilitation: when APEC economies liberalize tariffs by 10 percent, intra-regional imports rise by about two percent, whereas they only rise by about one percent in the case of trade facilitation. However, it also suggests that trade facilitation can be an excellent complement to tariff reduction. 5. Aligning ASEAN External Tariffs The practical issue as to how one might create the ACU is relatively complicated, and the experience of the EU, which is the most successful customs union in the world, holds some important lessons. In this section, we focus on the economic motivation for creating an AEC — which, as we argued earlier, requires the formation of a CU — and what ASEAN’s options might be in creating an ACU. 5.1. Why an AEC? The reasons behind the decision to create the AEC are many, including: (1) desire to create a post-AFTA agenda that would be comprehensive; (2) perceived need to deepen economic integration in ASEAN in light of the new international commercial environment, especially the dominance of FTAs; (3) given (2), the possibility that bilateral FTAs could actually jeopardize ASEAN integration since all member states were free to pursue their own commercial policy agenda; and (4) the recognition since the Asian Crisis that cooperation in the real and financial sectors must be extended concomitantly, and that free flows of skilled labor will be a necessary complement to freer flows of goods, services and capital. Outside of strong political incentives, some salient economic motivations for creating the AEC would include: 1. Potential benefits of creating a Single Market. These will be many; indeed, as noted earlier, the EU estimated that the creation of a Single

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Market in Europe would yield large benefits, perhaps as high as over six percent of the EU economy at the time. Given the state of economic development of the ASEAN countries, we would suggest that the gains of harmonizing rules, regulations and policies under the AEC, combined with the traditional economic effects of a CU, would likely be far larger. In addition to giving clarity as to what the associated magnitudes of the economic effects would be, using these figures would constitute an excellent vehicle to publicize the potential benefits of the ACU. The Cecchini Report was a useful tool for the EU in this regard; it allowed the European Commission to push through politically difficult reforms in favour of these extensive economic benefits and the “European Good”. ASEAN could hope to do the same. 2. Locking-in Best Practices in ASEAN Member Countries, particularly the CLMV. As is explicit and implicit in the VAP, the process of creating the AEC will require the harmonization of many areas of microeconomic policies. Most likely, the AEC will require some sort of “subsidiarity” approach to harmonization issues, as is the case in the EU. “Subsidiarity” refers to an approach to harmonization in which policies should be adopted at the lowest but most efficient level of aggregation. Under such an approach, there will, of course, continue to be national rules and regulations in place; however, where policies affect economic interaction with other regional partners or could be potentially detrimental to regional goals, region-wide rules and regulations would dominate. In principle, this approach is implicit in ASEAN even today; ASEAN decisions, where they contradict with national policies, are supposed to govern. In practice, this is not necessarily the case to date. With the AEC, there will be no choice but to do so, and application of subsidiarity will allow for ASEAN to develop the most efficient practices in various areas of microeconomic policy, with the potential for large gains in terms of economic policy reform, particularly with respect to the CLMV countries, who tend to have a somewhat less developed microeconomic framework. 3. The AEC will allow for a truly integrated market in ASEAN, allowing for greater gains from trade and more FDI than one could expect from AFTA. While AFTA is estimated to have an important economic effect in certain sectors (see above), an FTA does not guarantee a truly integrated market. This is because divergent commercial policies allow for divergent prices across the board. This has the additional affect of making the region less attractive to multinational corporations, who

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face more transaction costs to doing business in an economically segmented market than they would in the case of a Single Market. In fact, there is a strong theoretical argument (e.g., Dunning and Robson, 1987) that would suggest that a Single Market would have a far greater effect on luring FDI from outside the region than would be the case in an FTA. 4. Need for Macroeconomic Harmonization in a Single Market would reduce potential negative “policy externalities” and, hence, reduce the chances of a future financial crisis in ASEAN. The Asian Crisis underscored that what happens in one ASEAN country will affect the others. And what happens in the financial sector will quickly affect the real sector (something that is also a sad reality in the current financial crisis). This interdependence suggests an important “policy externality” exists and its importance will rise with the single market. Hence, there will likely be a strong incentive to cooperate in terms of both macroand microeconomic policies, with a tendency toward best practices.

5.2. An ASEAN Customs Union? 5.2.1. FTAs and CUs Compared: Economic and Non-Economic Issues As noted above, the creation of a CU requires a strong political commitment and much compromise in creating the CET, no mean feat particularly in divergent developing countries. Even the United States and Canada, two countries will relatively similar tariff structures, trade regulations, political and legal structures, as well as per capita incomes, chose to create an FTA rather than a CU in 1989. Still, once the political resolve exists, as appears to be the case in ASEAN, there could be far-reaching economic benefits well beyond what could be achieved from an FTA, under certain conditions. These benefits would include: (a) Like an FTA, CUs have the same trade creation and diversion effects associated with the liberalization of internal trade. However, as the CET is created, there are additional effects that derive from the adoption of a single vector of tariffs (and non-tariff barriers) in the context of a CU. Let us use the case of Common Market of the South (MERCOSUR) as an example. When MERCOSUR created its CU in 1991 (with, unfortunately, important exceptions, especially in motor vehicles, which proved to be highly problematic), it came up with basically a joint set of tariffs under its CET.

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This meant that in, say, Argentina, some external tariffs had to be lowered (that is, in sectors where the CET was less than the Argentine tariff) and raised in others (where the CET is greater than what was the case prior to MERCOSUR). In the former case, trade is expanded in Argentina vis-` a-vis third countries: hence, the EU, which is not a member of MERCOSUR, saw a reduction in the tariffs its exports faced in Argentina. This has a positive effect, related in many ways to unilateral liberalization, and is called “external trade creation”. On the other hand, in the case where tariffs are raised in Argentina, the opposite occurs: the Argentine market closes to third countries, with an associated “trade erosion” effect. Therefore, from a static welfare point of view, the CU could either improve upon a FTA or not, depending on what happens with the CET. However, Article XXIV of the WTO requires that on average the CET should not be higher than what was the case prior to the agreement.19 Indeed, when Spain adopted the EU’s CET in 1986, the United States sued (and won) for compensation for higher tariffs on feed-grains in the Spanish market. Nevertheless, we argue below that the CET of an ACU would be far more liberal than the average tariffs across the ASEAN countries. There are strong reasons for this, including: (a) ASEAN has explicitly committed itself to outward-oriented, “open” regionalism; (b) given the essentially free trade economies of Singapore and Brunei, a more liberal CET would allow ASEAN’s commercial policies to be more consistent with economies outside of the CET; and (c) ASEAN has already contemplated the idea of multilateralising AFTA cuts (discussed above), which would essentially have the effect of harmonizing tariffs at very low levels. No doubt, ASEAN will likely discover that, without an extremely liberal CET, it will have to consider a “10-X” strategy, where X are the member countries excluded, to the considerable detriment of the creation of the AEC, and will have to accept a ceiling on what can be achieved in the AEC. This is already recognized, one feels, by the Directors-General of Customs in accepting the need for “special access” for Singapore. What about a zero-tariff CET? Such an equilibrium is the only one that would allow for an all-inclusive CET. Administratively it would be the easiest to set up; it would merely have to harmonize technical aspects of 19 Of

course, since ASEAN countries benefit from the “Enabling Clause” in the WTO, it presumably would not be bound by this. However, it could potentially face retaliation. We won’t elaborate on this point as it is highly unlikely that the CET would be more protectionist. We argue that just the opposite will happen.

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the CU, such as customs practices, data, and the like. It would allow for the greatest welfare benefits in terms of market expansion, competition, and economies of scale. And it would allow ASEAN to “sell itself” internationally as a truly integrated, global market. Nevertheless, there will certainly be political obstacles to overcome before such a scenario would be possible. (b) From an economic perspective an all-inclusive, highly-liberal CET that would not only allow for maximum gains in a common market but also would expedite the economic reform programs in the individual ASEAN countries would be the ideal solution. Average tariffs in the ASEAN countries are already low by developing-country standards and not so different from the developed-country average. And 10–15 years (with more time for the CLMV countries) should be plenty to allow any infant industries to grow up. Further, as the EU experience demonstrates, it will continue to be possible to have a targeted industrial policy even with free trade: it just won’t be possible to do so with commercial policies. Economists are almost in complete agreement that such policies are clumsy and often counterproductive anyway. (c) An ACU will ultimately be necessary to the creation of the AEC. With divergent commercial policies in ASEAN, there will always be considerable market segmentation. Multinationals will not be able to use the region as a truly integrated marketplace. As the attraction of FDI from outside the region and greater intra-regional FDI flows are high priorities for the ASEAN leaders, this is an important consideration. Barriers to market integration will reduce the potential for competition across markets and, therefore, will lower the potential efficiency effects of the AEC. The EU experience is again instructive in this regard. Prior to the Single Market Programme launched in 1986, the EU had a CET but did not have common commercial policy, as non-tariff barriers to trade were still implemented at the national level. As non-tariff barriers to trade were rising in the 1980s, this became increasingly problematic: market segmentation was getting worse. Realising that the continuation of such a trend could severely damage economic integration in Europe, the EU leaders passed the Single European Act, with the goal of creating a common market with common commercial policies. This required an extensive overhaul of the way things were done in the EU, including the implementation of 284 major Directives. While politically difficult, the process eventually allowed for even the abolition of border controls. The potential gains were estimated to be on the order of six percent of GDP.

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Compared to the mid-1980s in Europe, the non-tariff barrier problem is, perhaps, less significant an issue than it is today in ASEAN, where the abolition of non-tariff barriers is an explicit goal, and various successes at the Uruguay Round of the WTO in abolishing non-tariff barriers in manufactures have reduced their importance. Nevertheless, the inherent benefits of market integration through a CET are comparable. (d) Within the context of an ACU, ASEAN Member Countries will not have to worry about rules of origin and related “spaghetti bowl” problems. The figure included in the preceding section provides a compelling picture of the complexities associated with accommodating the increasingly diverse sets of overlapping rules of origin. The attendant costs of this are difficult to quantify, but at least one study places20 it at up to five percent of the value of exports, no small figure, particularly since as a negative rent it is essentially pure waste. A CET within the context of an ACU would preclude any need for rules of origin, as tariffs would have been harmonized (and “trade deflection”, in which exporters take advantage of a lower-tariff country in an FTA in order to lower their trade-tax bill, would be impossible). (e) Importantly in today’s environment, an ACU will require the integration of accords that the ASEAN Member Countries have with nonpartner countries. As noted above, it has always been a fear on the part of ASEAN leaders that bilateral FTAs between ASEAN countries and third parties could lead to a dilution of ASEAN economic integration, thereby threatening the region’s solidarity. Moreover, given the considerable overlap between the exports of most AMC countries, an FTA between one ASEAN country and a third party could force other member states also to adopt FTAs with that party, so as to not lose competitiveness. For example, the United States formed an FTA with Singapore in 2002. Subsequently, the United States entered into negotiations with Thailand to form an FTA. However, those talks for various reasons (related to reservations on the Thai side) have been put on hold. In the meantime, the United States is also holding talks with Malaysia about an FTA. As these negotiations appear to be going rather smoothly, it may be that Thailand will have no choice but to finalize its talks with the United States, even though it is not certain

20 Research as to how much compliance with rules of origin taxes efficiency is difficult to find. The estimate cited above refers to Estevadeordal and Suominen (2003), who calculate the cost to be in the range of 3–5 percent of the f.o.b. value of the exported goods. This study is available on the PECC website, http://www.pecc.net/trade washington.htm.

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that it is ready for such a deal, so as not to compete at a disadvantage in its most important market with Malaysia. Moreover, an additional preoccupation is that these third-party agreements will even be deeper than the accords that hold ASEAN together: it is already the case that certain agreements between individual ASEAN countries and third parties are “deeper” than, say, AFTA. It is, of course, possible to require certain exigencies on members when they enter into such agreements, e.g., clauses that state that no ASEAN Member Country will give greater access to its market to a third party than it does to other ASEAN countries. While feasible, such clauses have been hitherto absent from ASEAN accords with third countries. Creating an ACU will allow ASEAN to avoid these problems. It would be impossible to create an ACU without forcing an integration of bilateral agreements into one common ASEAN policy vis-`a-vis outsiders. This would protect and, indeed, strengthen ASEAN solidarity while at the same time removing distortions. (f) Related to this last point is the fact that an ACU would finally allow ASEAN to benefit from a joint negotiating position in various international forums. As a CET aligns commercial policies and leads to a regional division of labour, ASEAN will be able to launch a common position at the WTO, APEC, ASEM, etc. Thus far in its existence, ASEAN has not been able to take advantage of a joint position in international forums, something that has served the EU, for example, very well. Even in the current Doha Development Agenda impasse, which has important implications for ASEAN, this region of 500 million people has had little, if any, effect on the negotiations. An essential reason why ASEAN has not been able to cooperate more effectively relates to the diversity in its commercial policy regimes. With a CET, the ASEAN countries would, therefore, be more effective. In addition, an ACU would advance the clout of the region in negotiating FTAs with non-partners. ADB (2006), for example, estimates that a “hub and spoke” East Asian bilateral FTA network that used China as a hub would generate about $15 billion in improved welfare for the individual ASEAN countries, whereas an “ASEAN hub” would increase that figure by more than four-fold to $67 billion (Table 3.7, p. 288). Obviously, there are gains through the promotion of ASEAN centrality. (g) It is important to note that the economic clout that would pertain to a joint ASEAN commercial policy could also manifest itself in non-economic realms. For instance, the more that the EU was able to integrate its markets,

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the greater was its negotiating position not only in economic forums but also on the international stage, e.g., with respect to foreign affairs, security, and other aspects of diplomacy. In fact, the EU really has only had one truly integration policy, its commercial policy, which it has used explicitly and implicitly to achieve non-economic objectives. It has also used institutional mechanisms to consolidate various positions on the international scene, though this has not always been successful. Moreover, two EU countries are already members of the UN Security Council; however, there exists a strong movement at the UN to give a seat to the EU as well. A greater role for ASEAN, with its half-billion people in a strategically vital region, would be facilitated considerably by the ACU and the AEC more generally. (h) Finally, in terms of socio-cultural areas, a single market would allow for a greater integration of the tremendous cultural wealth that ASEAN enjoys. Again, the EU was able to make far more progress in this area once it created its Single Market, and has been able to go even further with monetary union. In short, there are many reasons to believe that the ACU will be an important step forward in cementing a single market in ASEAN and in achieving the goals stipulated by the ASEAN Founding Fathers to pool resources and markets. It also constitutes a critical building-bloc of the AEC. It is a logical next step in a post-AFTA strategic plan and, provided that the ACU is outward-looking, should help guide commercial policy reform in Southeast Asia and generate myriad additional economic, as well as non-economic, benefits to the region as a whole.

5.2.2. Design of an ASEAN Customs Union The effective design and implementation of the AEC pose major challenges to ASEAN. While the European experience would suggest that considerable gains can be made from the creation of a single market, as noted above, the diversity and level of economic development of the ASEAN Member States render even the creation of a CU, an essential feature of any single market, extremely complex, at least in terms of political economy-related issues. There are at least two key issues in this regard. First, as noted above, the diversity of commercial policies that currently exist in ASEAN make it difficult to unify tariffs. This was a much more manageable problem in the context of the EEC or even MERCOSUR. In particular, the zero tariffs in the Singapore commercial policy structures result from the fact that Singapore has based its development on complete openness and it would

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never consider raising its tariffs, arguable even if ASEAN unity relied on it. It is just too open to global trade, investment, and associated value chains. A “10-X” ACU, allowing Singapore (and Brunei) to be excluded, would render the creation of a CET easier, but it would make little sense in terms of economics: Singapore is the life-blood of intra-ASEAN trade and FDI, accounting for more than 50 percent of the total. Alternatively, the ASEAN CET of zero, with perhaps a few exclusions for highly sensitive products, would be another ASEAN. It would also be applauded by economists and, in fact, such an approach would not be foreign to ASEAN thinking on issues related to economic integration (e.g., the Philippines proposal to MFNise AFTA cuts discussed above). Moreover, the transition period is, in effect, relatively long: nine years (at a minimum, assuming the 2015 date for the completion of the AEC is accepted) for the more developed ASEAN countries should be a sufficient amount of time to allow for the necessary structural adjustment and the adulthood of any “infant industries”, assuming they exist.21 However, embracing pure “open regionalism” and a tariff-free zone will be a politically difficult, albeit noble, fight. In any event, the ASEAN leaders are serious about creating the AEC and, in fact, are currently studying options as to how a customs union in ASEAN might best be formed. Of course, the transitional economies pose unique problems here. Cambodia, for example, received until only recently about 70 percent of its government income from import-related taxes. However, it is reducing reliance on international trade-based taxes as part of its membership in the WTO22 with technical assistance from developed countries. Vietnam has made tremendous progress in its transition program and is essentially on-line with AFTA already. Allowing the logical progression of this reform program to continue to 2020 will not be easy but would be quite desirable from an economic development perspective. Again, 2020 is a long way off and much can happen. But Vietnam has reinvented itself

21 From a practical point of view, it should be noted that a deadline of 2015 (or 2020, for that matter) will not be etched in stone: no doubt flexibility in the more delicate sectors will be permitted. The European Single Market Program had 1992 as a deadline (hence the sobriquet, “EC 1992”); however, it was not until 1994 that the lion’s share of the relevant directives had been implemented in the EU Member States. Further, some of the sectors continue to defy integration, especially in finance and energy. 22 The WTO accepted Cambodia’s application to join in 2003, though its formal accession, which followed after approval by the Cambodian parliament, came in September 2004.

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from a non-market, closed, and state-directed economy into an increasingly outward-looking, market-oriented economy in less time than it will have for the AEC. Laos recently followed in the footsteps of Vietnam by signing a bilateral trade agreement with the United States, similar to the US-Vietnam BTA, in September 2003, which went into effect with the US Congress’ granting normal trade relations. It is currently in negotiations to join the WTO, which would be an important milestone for ASEAN since it is the last ASEAN Member Country to not be a member. The second problem regards national sovereignty issues. Europe has distinguished itself in its ability to “pool sovereignty”. ASEAN’s ability to do this is far more limited. Moreover, even the EU has been thwarted at various stages, e.g., the first rejection of the Maastricht Treaty in 1991, the shunning of accession by key developed European countries (Norway and Switzerland), opt-outs for monetary union, the failure to ratify a European Constitution, and the recent rejection of the Lisbon Treaty, which was designed to replace the European Constitution, by Ireland. While the ACU may make economic sense, it will require considerable political will to make it a reality. 5.3. Institutional Considerations Developing appropriate institutions under which the AEC can evolve will be necessary. The ASEAN Secretariat has been significantly strengthened but is still extremely small compared to the tasks that will be required by the AEC. Perhaps this is not such a bad thing: the European bureaucracy is widely criticized as being far too large, non-transparent and expensive. The drain on human capital in a large bureaucracy would be something that ASEAN could ill afford. However, many of the directorates of the EU could be emulated in the ASEAN context. The executive component of ASEAN integration will have to be enhanced considerably, but this could arguably be done by adapting and expanding current institutions. This approach has been essential in the EU context. On the other hand, the creation of some sort of judicial authority to “enforce” (hitherto a bad word in ASEAN) AEC rules will be necessary. No doubt this will be difficult, as it is in the EU. But even if the AEC does face challenges along the way, the process of integration will likely be salutary for domestic economic reform, for many of the reasons noted above. Moreover, as economic deepening proceeds in ASEAN, it will become easier to negotiate positions at various regional

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forums as a group, thereby augmenting significantly its clout (as the Europeans have been able to do). The ratification of the ASEAN Charter in October 2008 by all ASEAN Member Countries should render institutional development easier. It makes ASEAN an international legal body and, hence, will facilitate administrative affairs considerably. However, financing the expansion of the ASEAN Secretariat and institutions necessary to the smooth functioning of an AEC will require far more resources from the member states than is currently in evidence, that is, a lump-sum contribution of less than $1 million from each Member Country.

References Asian Development Bank (2008). Emerging Asian Regionalism. Manila: ADB. Asian Development Bank (2006). Part III, Routes to Asia’s Trade, Asian Development Outlook 2006. Manila: Asian Development Bank. Asian Development Bank Institute (2002). Executive Summary Series, No. S58/02. Trade Policy Series: 25 February–March 2 Singapore Executive Summary of Proceedings. Tokyo: ADBI. Brooks, D.H., Roland-Holst, D. and Zhai, F. (2005). Asia’s Long-Term Growth and Integration: Reaching Beyond Trade Policy Barriers. ADB ERD Policy Brief No. 38. Cecchini, P. (1988). The Costs of Non-Europe. Brussels: EC Commission. Frankel, J.A. (1997). Regional Trading Blocs in the World Trading System. Washington, DC: Institute for International Economics. Feridhanusatyawan, T. (2005). Preferential Trading Agreements in the AsiaPacific Region. IMF Working Paper Series WP/05/149. Gilbert, J.P. (2003). CGE Simulation of US Bilateral Free Trade Agreements. Background paper prepared for the conference on Free Trade Agreements and US Trade Policy, May 7–8, Washington: Institute for International Economics. Hertel, T.W., Walmsley, T. and Itakura, K. (2008). Dynamic Effects of the “New Age” Free Trade Agreement between Japan and Singapore. Mimeograph. Purdue University: Center for Global Trade Analysis (GTAP). Herzstein, R.E. and Whitlock, J.P. (2005). Regulating Regional Trade Agreements: A Legal Analysis. In The World Trade Organization: Legal, Economic and Political Analysis, Macrory, P.J., Appleton, A.E. and Plummer M.G. (eds.), pp. 203–247. New York: Springer. Kawai, M. (2005). East Asian Economic Regionalism: Progress and Challenges. Journal of Asian Economics, 16(1). Kreinin, M.E. and Plummer, M.G. (2002). Economic Integration and Development: Has Regionalism Delivered for Developing Countries? London: Edward Elgar.

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Lewis, J., Robinson, D.S. and Wang, Z. (1995). Beyond the Uruguay Round: The Implications of an Asian Free-Trade Area, Mimeograph. Menon, J. (2005). Can Subregionalism or Regionalism Aid Multilateralism?: The Case of the Greater Mekong Subregion and the Association of Southeast Asian Nations Free Trade Area. Mimeograph. Messerlin, P. (2001). Measuring the Costs of Protection in Europe. Washington, DC: Institute for International Economics. Naya, S.F. and Plummer, M.G. (2005). The Economics of the Enterprise for ASEAN Initiative. Singapore: Institute of Southeast Asian Studies. Panagariya, A. (1998). Should East Asia Go Regional? In Economic Development and Cooperation in the Pacific Basin, Lee, H. and Roland-Holst, D.W. (eds.), pp. 119–159, Cambridge: Cambridge University Press. Plummer, M.G. (2007). Best Practices in Regional Trading Arrangements: An Application to Asia. The World Economy, doi: 10.1111/j.1467.9701.2007. 01061.x. PECC Trade Policy Forum (2004). Asia-Pacific RTAs as Avenues for Achieving APEC’s Bogor Goals. Mimeograph. Scollay, R. (2004). PTAs in the Asia-Pacific Region: An Overview. In PECC, www.pecc.org, pp. 79–104. Scollay, R. and Gilbert, J.P. (2002). New Regional Trading Arrangements in the Asia Pacific? Washington, D.C.: Institute for International Economics. World Bank (2005). Global Economic Prospects: Trade, Regionalism, and Development 2005. Washington, DC: The World Bank.

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Chapter 4

ASEAN Investment Cooperation

1. Introduction The attraction of FDI inflows is an important goal of the AEC; it will also in large part determine the success of ASEAN’s integration efforts. In fact, stimulating FDI inflows by reducing business costs associated with multinational activity in the region has always been a primary objective of ASEAN economic cooperation; FDI inflows have become paramount to an outward-looking development strategy in the contemporary global economy. They bring in new (risk-sharing, non-debt-creating) capital flows, foreign exchange, easy access to foreign markets, and technology transfer. They also have a tendency to strengthen institutions within developing countries, including in the financial sector (see, for example, Prasad, Kose, Rogoff, and Wei, 2006), and create a more stable environment and internal “policy competition”.1 In doing so, they establish an attractive business environment within which multinationals can easily profit from a vertical division of labor and production and facilitate the emergence of multinationals within the developing region itself. These are all explicit goals of ASEAN economic cooperation. The diversity of economic structure in the ASEAN region makes it a particularly strong candidate for investment cooperation. In addition to reducing transaction costs through trade liberalization and facilitation, in the past ASEAN has tried to enhance the attractiveness of the region through industrial cooperation, with somewhat disappointing results. The ASEAN Industrial Projects (AIP) and ASEAN Industrial Complementary (AIC) programs were early attempts at doing this, 1 By

“policy competition”, here we imply that countries within a free trade area will have an incentive to adopt best-practices, promote a low-cost business environment, and embrace greater transparency if they are to compete effectively for FDI flows within a given trade area. 130

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though their top-down approach proved to be unappealing to the private sector. The ASEAN Industrial Joint Ventures (AIJV) approach, which at the Third ASEAN Summit in 1987 was reinforced to allow for deeper margins of preference and more attractive equity schemes, also produced relatively disappointing results, due to a variety of inhibiting factors, including bureaucratic costs, some confusion in terms of regional and national legal applications and jurisdictions, and lack of active promotion.2 With the advent of AFTA, the margin of preferences in the AIJV scheme became redundant. Hence, a transitional program that could serve as a base from which to build future cooperation was established in the ASEAN Industrial Cooperation Scheme (AICO) in 1996, which officially superseded the Basic Agreement on AIJVs (15 December 1987) and the Memorandum of Understanding on the Brand-to-Brand Complementation (BBC) Scheme dated 18 October 1988.3 The AICO would reduce preferential tariff rates to between zero and five percent and would have other advantages over other programs, such as a guaranteed rapid turnaround on applications, references to dispute settlement, and benefits in terms of more liberal equity restrictions for foreign investors. It has been especially popular in the area of vertical integration of auto parts production and electronics. The most significant attempt at economic cooperation in the area of FDI is the ASEAN Investment Area (AIA), created in October 1998. Rather than merely expanding existing programs in the new context of AFTA like the AICO, the AIA was designed to enhance a process of FDI policy liberalization, promotion, and, to some extent, harmonization across ASEAN Member Countries, as well as having certain investment facilitation features. It covers five sectors: manufacturing, agriculture, fishery, mining, and quarrying, as well as services incidental to the five sectors (“Services Incidental”). Thus, its scope is far larger than any other program; moreover, it will likely be an essential pillar in the building of the AEC. Given the high stakes being placed on the AIA, tracking its progress is of the essence. After eight years, has there been any discernable effect on FDI inflows to ASEAN? The purpose of this chapter is to address this question from a variety of perspectives, both quantitative and qualitative (i.e., in terms of policy analysis). In Section 2, we survey and analyze basic trends in FDI inflows to the ASEAN Member Countries in a comparative 2 Naya

and Plummer (1989). Brand-to-Brand Complementation Scheme was an augmented version of the original AIC program discussed above. It was intended to enhance vertical FDI across ASEAN Member Countries. 3 The

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perspective. From this analysis, we are able to glean some salient conclusions with respect to overall ASEAN FDI performance, as well as its structural change over time at the country level. Section 3 takes an applied statistical approach to identifying the major determinants of FDI in the ASEAN countries. After a brief theoretical review of what the FDI literature would suggest should be the key factors, we use several techniques to gauge whether or not ASEAN economic integration has made a difference in FDI inflows. Descriptive analytics reveal that, while the Asian Crisis was highly detrimental to FDI inflows, the region as a whole has recovered strongly, particularly over the 2005–06 period. The econometric analysis does not find a statistically significant ASEAN effect, but this result needs to be qualified by a number of problems with the modeling in terms of data, model specification, and time-horizon. Nevertheless, the results do suggest that “deep” integration programs in other regional groupings (e.g., the EU) do have an important effect. Hence, a salient lesson from this analysis is that while ASEAN has not yet had a discernable effect on FDI inflows (for reasons explained later), more comprehensive investment liberalization and facilitation could be highly productive, suggesting excellent prospects for the AIA and the AEC. Moreover, the econometric results underscore the critical link between trade and FDI, supporting the view that effective regional economic integration needs to be focused on both the real sector and FDI liberalization and facilitation. Section 4 evaluates the competitiveness/complementarity of FDI inflows into the individual ASEAN Member Countries over time. Given the clear trade investment links established in Section 3 from both theoretical and empirical perspectives, we also include a statistical analysis of changes in trade patterns over time, that is, the structure of ASEAN Member Country exports to the OECD. The purpose of this approach is to discern the degree to which exports to key foreign markets and FDI inflows to the ASEAN countries are in the same industries, as well as identifying any significant changes over time. Using disaggregated data, we find that the competitiveness in trade is not particularly high for most country pairs but is rising, while the FDI results would suggest a very high similarity in structure for a number of country pairs (mainly the original ASEAN countries and Vietnam), a trend which seems to be increasing over time. These results suggest that while great diversity in terms of socio-economic and institutional structures across ASEAN renders economic cooperation more difficult in many areas, a consistent approach to trade policy — i.e., a general desire to embrace lower barriers to trade and reduce bureaucratic

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costs — may well facilitate cooperation and joint efforts to harmonize trade policy in the future, even if there does continue to exist significant diversity in the structure of trade policy across Member Countries. The same is true of policies facing FDI; while there is no common investment regime in the region and significant divergencies exist, the policy direction is ostensibly the same, that is, toward greater investment liberalization and facilitation. Moreover, symmetry in the structure of FDI inflows should buttress the economic case for policy harmonization, though perceived competition for FDI could complicate policy cooperation. Some examples from the EU experience are used to illustrate these points. We also consider in this section (as well as in Chapter 3) the myth or reality of the “Chinese Competitive Threat”; we note that China has become a major host of global FDI inflows — in some years, the most important FDI recipient in the world — and has become a formidable competitor in terms of trade. This has been particularly in evidence since the Asian Crisis; FDI inflows into China have grown by leaps and bounds since the Crisis while inflows to ASEAN have been far less impressive earlier in the 2000s. China’s success has been the result of its (gradual) policy reforms that unleashed the potential of a large, expanding, and increasingly rich market. No doubt some of the FDI bound for China has come at ASEAN’s expense; there are frequent reports of ASEAN investors themselves picking up and moving to China in order to take advantage of inexpensive, relatively-educated labor, as well as its new prominent location in the regional production chain. We offer some actual case examples of firm relocation in this regard. Still, we argue that, while globalization — of which China has become an important protagonist — has increased competition for FDI flows, it has also created numerous advantages. The “problem” is not particular to China; it is globalization, and what will be necessary for ASEAN countries to thrive in an increasingly integrated world involves more competitive economic policies at the national level, as well as concerted cooperation and integration at the ASEAN level. The AEC in general and the AIA, therefore, have a bright future in this regard. Besides, while China’s joining the WTO increased its attractiveness by forcing policy reform in a number of areas, most ASEAN countries continue to have a superior policy environment facing FDI, according to World Bank estimates. The problem is one of a small, relatively segmented market, and regional economic cooperation and integration can help in this regard. Hence, we conclude that: (1) ASEAN Member Countries need to continue liberalization and facilitation of FDI at

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the national level in order to compete effectively; and (2) the AIA and the AEC can help create a large regional market of a half-billion people that will be better prepared to compete with such giants as China and India. After all, resource pooling and market expansion were explicit goals articulated by the ASEAN Founding Fathers. Next, Section 5 gives a brief introduction and overview of the AIA itself in the context of the evolution of ASEAN investment cooperation, followed by ASEAN investment agreements outside the AIA framework in Section 6, that is, the phenomenon of bilateral investment treaties (BITs) that individual ASEAN Member Countries have signed with regional and non-regional partners. We endeavor to categorize these BITs according to an existing framework, which had been previously used to evaluate European BITs. It turns out, however, that the BITs between ASEAN partners are somewhat difficult to place in this framework. Moreover, we note that the mere existence of these BITs between pairs of ASEAN Member Countries supports the view that a more expanded AIA agreement would be advisable. Lastly, Section 7 summarizes the conclusions of the above sections and tries to answer the question of whether or not the AIA has met its goals, as outlined in the original AIA agreement. Our response is a qualified “yes”; however, it still needs time, and the question really needs to be addressed in the overall context of ASEAN cooperation in general and the process of creating the AEC. As a final note to the beginning, in August 2008 ASEAN finalized the “ASEAN Comprehensive Agreement on Investment”(ACIA), which was dedicated in the AEC Blueprint to taking over the various agreements that currently exist in ASEAN dealing with FDI and rendering ASEAN a region where FDI would flow as freely as possible. Obviously the newness of this accord prevents any serious analysis in this chapter. However, we do note that the new provisions do improve upon many of the problems associated with the AIA and related agreements. Importantly, by superceding the many other agreements dealing with investment cooperation in ASEAN and placing them all under one document, the ACIA consolidation improves transparency and access. Moreover, it: (1) offers benefits to ASEAN and ASEAN-based MNCs along the same timeline (rather than giving an advantage to ASEAN investors), underscoring the “open regionalism” substance of the accord; (2) reduces costs associated with trans-border FDI in ASEAN; (3) solicits more input from the private sector and on a regular basis; and (4) provides for a dispute settlement process, “Investor-toState Dispute Settlement” (ISDS). These are important improvements over

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existing agreements and should complement well the other aspects of the AEC Blueprint.

2. Trends in Foreign Direct Investment in ASEAN To set the stage for detailed analysis of FDI in ASEAN in light of the AIA, we begin with a review of recent trends.4 There exist a plethora of potential approaches to evaluating FDI data; in this chapter, we employ several of them in order to attempt to gauge FDI performance from diverse perspectives. In general, FDI to ASEAN has been strong over the past few years in terms of flows and rate of growth after a period of slow growth associated with the 1997–98 Asian Crisis. Notwithstanding this favorable trend, there exists considerable potential for investment cooperation in order to strengthen the region’s competitiveness. A prime motivation for the AEC has been to enhance intra-regional and extra-regional FDI inflows, suggesting that certainly the ASEAN leaders believe that much more can be achieved, particularly in light of the phenomenal increases in FDI into China over the past decade. Below we provide descriptive background data with accompanying analysis, including the sources of FDI to ASEAN from around the globe, its distribution by sector and changes over time. 2.1. FDI Inflows in ASEAN Member Countries Table 4.1 puts FDI inflows to ASEAN in a global context over the 1995–2005 period. From this table we see that world FDI inflows have more almost tripled since 1995 to $916 billion in 2005, though this is less than the heyday of the 1998–2000 period, when FDI flows peaked at $1.4 trillion in 2000. These flows have been concentrated in the developed countries; the United States and the EU member states alone have consistently accounted for more than half of global FDI, with the exception of 2004 when their share was 47 percent. Over the entire period their combined share came to almost two-thirds of the total. 4 The available information on how FDI is defined by ASEAN countries and their major investment partners (i.e., the EU, Japan, and the US) generally indicates that these countries officially define FDI flows in conformance with IMF and OECD standards. According to the IMF and the OECD, FDI refers to an investment that gives an effective voice in the management of an enterprise operating outside of the economy of the investor. The IMF and OECD both suggest that a threshold of 10 percent of equity ownership qualifies an investor as a foreign direct investor.

Year Host

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

18.9 42.8 0.74 6.65 0.68 14.1 3.53 8,078,868

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Sources: UNCTAD FDI Statistics Online.

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1) The EU 25 include Austria, Belgium, Luxembourg, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, and the UK. 2) The figures for China do not include inflows to Hong Kong and Macao. 3) East Asia includes China, Hong Kong, Taiwan, South Korea, Cambodia, Indonesia, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam. 4) ASEAN includes Brunei, Cambodia, Indonesia, Lao People’s Dem. Rep., Malaysia, Myanmar, Philippines, Thailand, Vietnam and Singapore.

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17.3 21.5 21.1 24.5 25.8 22.3 19.2 12.1 9.53 17.2 10.9 37.9 31.8 29.2 39.8 45.7 49.4 45.9 49.7 45.5 30.1 46.0 0.01 0.06 0.66 0.45 1.16 0.59 0.75 1.50 1.13 1.10 0.30 11.0 10.6 9.24 6.38 3.67 2.89 5.63 8.54 9.59 8.53 7.90 0.37 0.51 0.54 0.71 0.88 0.61 0.46 0.49 0.70 1.09 0.79 21.7 21.9 19.4 12.2 9.58 9.87 11.7 13.2 15.8 18.3 16.8 8.27 7.77 7.01 3.13 2.62 1.67 2.34 2.55 3.57 3.61 4.05 340,336 392,424 489,709 712,032 1,099,919 1,409,568 832,248 617,732 557,869 710,755 916,277

% of Cumul. Total (1995–2005)

ASEAN Economic Integration

United States EU 25 Japan China South Korea East Asia ASEAN World (US$million)

1995

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136 Table 4.1. World Shares of FDI Inflows to ASEAN and Selected Other Countries and Regions. (Percentage of Total World FDI Inflows).

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Inflows into Japan and South Korea have actually been insignificant; together, inflows to these two large, OECD countries constituted less than two percent of global flows (only a fraction of flows going to ASEAN and China). FDI inflows into ASEAN as a percentage of total world inflows have dropped from their highs of the mid-1990s when ASEAN countries accounted for about eight percent of world inflows to the current percentage of only about four percent. Clearly, the cause for this downward trend was related to the Asian Crisis, which not only affected ASEAN countries but also other East Asian countries like China, though the Chinese share picked up relatively rapidly after the Crisis. Inward FDI into China has been on the rise in absolute and percentage terms. The rise in China begs the question as to why its share has been generally rising when ASEAN’s has been falling in terms of flows, even years after the Asian Crisis. Is this due to ASEAN policies, Chinese policies, or something else? We address these issues later. Regarding FDI to individual ASEAN Member Countries, Table 4.2 shows total inflows of FDI by destination in ASEAN over 1995–2005, using the ASEAN Secretariat database (as opposed to the UNCTAD database used in Table 4.1). Again, the difference between China and ASEAN (as well as other developing regions) over the entire period is stark; however, as we discuss below, it is important to note that compared to, say, Latin America and Africa, ASEAN has done well. Moreover, 2005 was a strong year for ASEAN and 2006 is estimated to have been even better; indeed, with inflows of $38 billion in 2005 and estimated flows in the range of $50–$60 billion, it has had some of its best years ever. Still, half of total inward FDI to ASEAN over the 1995–2005 period went to one country (Singapore). Thailand and Malaysia, whose growth during the “miracle” years was fuelled in part by robust FDI inflows, saw a significant slowdown in inflows coming into the 2000s, and Indonesia’s FDI inflows have usually been negative (sometimes significantly so) since the onset of the Asian Crisis until 2004 due, for example, to huge repayments of intra-company loans by foreign affiliates.5 All three, however, picked up in 2005, with Indonesia having a particularly strong year ($6.1 billion). Flows to the Philippines also relented significantly in the early 2000s but rebounded somewhat in 5 It

should be noted, however, that accounting for FDI inflows in Indonesia is tricky, especially with respect to the petroleum sector, where there is a large foreign presence but the inflows are generally not counted as FDI (but rather part of “product sharing” agreements). Moreover, as there was a large depreciation of the ruppiah during this period, end-year valuations of the change in FDI stocks would generally have a strong negative effect on the numbers.

Cumulative Total:95–05

1997

1998

1999

2000

2001

2002

2003

2004

2005

Brunei Camb Indo Laos Malay Myan Phil Sing Thai VN

583 151 4,346 88 5,815 318 1,577 11,503 2,070 1,780

654 294 6,194 128 7,297 581 1,618 9,303 2,338 1,803

702 168 4,678 86 6,323 879 1,261 13,533 3,882 2,587

573 243 −356 45 2,714 683 1,718 7,594 7,491 1,700

748 232 −2,745 52 3,895 304 1,247 16,067 6,091 1,484

549 149 −4,550 34 3,788 208 2,240 16,485 3,350 1,289

526 149 −3,279 24 554 192 195 15,649 3,886 1,300

1,035 145 145 25 3,203 191 1,542 7,338 947 1,200

3,123 84 −596 20 2,473 291 491 10,376 1,952 1,450

212 131 1,895 17 4,624 251 688 14,819 1,414 1,610

289 381 6,107 28 3,965 72 1,132 20,081 4,008 2,021

8,993 2,127 11,839 547 44,651 3,970 13,709 142,748 37,428 18,225

Total

28,231

30,209

34,099

22,406

27,375

23,541

19,197

15,773

19,664

25,661

38,083

284,238

Notes:

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Source: Statistics of Foreign Direct Investment in ASEAN, Eighth Edition, 2006.

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1) Data compiled from the respective ASEAN Central Banks and Central Statistical Offices. Unless otherwise indicated, the figures include equity and inter-company loans. 2) Figures for Brunei Darussalam, Cambodia and Malaysia include reinvested earnings for the whole data series. 3) Figures for the Philippines include reinvested earnings for the period of 1999–2002. 4) Figures for Singapore include reinvested earnings for the whole data series, but exclude inter-company loans for 1995–1996. 5) Figures for Vietnam include reinvested earnings for 2003. 6) Cambodia’s figures are estimated aggregate figures. 7) Indonesia’s figures for 2002 and 2003 include privatisation and asset sales under Indonesian Bank Restructuring Agency (IBRA) program. Figures for 2003 and 1st quarter 2004 are preliminary. 8) Myanmar’s figures are in fiscal year which ends in March of the following calendar year. 9) Philippines’ figures for 2003 and 1st quarter 2004 are preliminary. 10) Singapore’s figures for 2003 and 1st quarter 2004 are preliminary. 11) Thailand’s figures for 2003 and 1st quarter 2004 are preliminary. Figures include capital fund of banking sector.

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1996

ASEAN Economic Integration

1995

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FDI Flows to ASEAN 1995–2005. (USD $ Million).

138

Table 4.2.

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139

2005. Inflows into Vietnam have been relatively stable, generally falling in the range of $1.2 billion–$2.6 billion without any obvious trend. FDI inflows into the other transitional economies have been low and somewhat volatile. With respect to the sources of inward FDI flows over the same period, Table 4.3 aggregates cumulative FDI flows from ASEAN and major nonASEAN sources. The EU is by far the largest supplier of FDI to the region ($79 billion), which is 60 percent more than the value of US FDI in ASEAN ($49 billion) and more than twice that of Japan ($34 billion). In fact, the UK alone invested slightly more than Japan. China has been only a marginal source of FDI to the region ($1.8 billion) but the Asian NIEs (excluding Singapore) provided a total of $19 billion. While it has been declining since the Asian Crisis, intra-ASEAN FDI remains an important source of investment. It is a well-cited figure that intra-regional trade between ASEAN countries is approximately 25 percent of the region’s total trade with the world. This has led some to claims that ASEAN is not a “natural” economic bloc. Such analysis has two critical problems: first, it ignores the fact that ASEAN itself is quite small in terms of market size and, since size matters, one would not expect intra-regional trade shares to be high (indeed, controlling for size, ASEAN trades 4–5 times more with itself than one would predict if Member Countries were randomly distributed6 ). Second, since ASEAN accounts for the lion’s share of its trade with the outside world, this figure only accentuates the need for ASEAN economic integration to focus on enhancing global competitiveness. The goal of an effective FTA should not be to raise intra-regional trade shares but to stimulate global trade, enhance productivity, and ensure a more efficient division of labor. This argument is even more relevant to FDI inflows. As Table 4.3 shows, intra-regional FDI as a share of the total is far smaller than even in the case of trade; at $28 billion, it only amounts to 14 percent of the total, and is slightly less than the outflows of Japan alone. Moreover, Singapore dominates as a source of intra-regional FDI, constituting about two-thirds of the total, which is greater than its dominance of FDI inflows. Further, Singaporean outward FDI itself is concentrated in two countries, Malaysia and Thailand. About one-third of all intra-ASEAN FDI is accounted for by Singaporean investment in these two countries. From an economic perspective, the direction of FDI flows is far less relevant than the quantity and quality of the flows. This point deserves 6 Naya

and Plummer (2005).

FDI Flows to ASEAN Countries by Source (Cumulative 1995–2005, US$ Millions).

Total Cumulative Brunei Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam 1995–2005* Host

Source

119.42 467.93 406.17 61.76 1,854.59

3,163.75 3,207.82 3,203.50 4.32 1,491.30

12,201.8 28,385.0 27,559.0 825.99 57,173.5

9,403.70 4,024.51 3,937.23 87.28 4,677.92

2,619.48 921.23 872.78 48.45 4,297.74

34,378.79 50,417.83 48,945.66 1,472.14 94,815.85

6,029.31

32.04

10,426.8

1,852.62

1,410.59

45,201.3

3,925.8

3,475.26

79,041.43

588.96 494.90 3,616.36 1,423.21

12.38 0.50 0.06 7.98

293.68 3,909.32 1,303.29 3,597.05

697.71 8.70 8.10 1,133.22

268.04 −295.04 411.22 701.43

3,018.24 14.06 16,274.7 21,204.9

557.45 1,102.49 −204.99 1,662.69

1,008.90 58.50 1,441.94 799.24

6,500.25 5,313.64 21,870.86 34,488.39

545.59 556.64 817.28 836.23 18.01 −36.96 2,060.83 −26.84

37.98 37.15 120.90 110.10 1.87 8.23 275.23 0.00

288.37 120.59 2,204.05 125.23 1,443.91 634.91 8,562.10 298.51

159.73 156.26 301.46 55.79 245.67 − 1,045.74 —

311.91 303.72 1,151.43 242.29 702.77 206.36 1,316.70 0.29

1,495.12 360.30 5,777.80 655.16 1,090.79 4,031.85 8,230.81 194.89

151.23 57.13 4,324.24 305.93 2,736.76 1,281.55 6,517.32 4.12

242.96 236.86 5,237.26 1,686.58 1,418.33 2,132.35 3,103.41 2.00

3,251.23 1,832.09 18,859.80 4,056.53 7,690.39 8,263.60 32,531.27 472.97

0.04 —

2.64 293.31 0.16

— 38.82 —

— 38.56 0.01

5.71 3,388.06 0.93

13.43 44.30 −0.64

0.60 60.65 11.62

22.42 3,920.60 12.08

— —

(Continued)

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6,086.53 12,595.0 12,228.5 366.48 11,839.8

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19.42 7.84 4.66 3.18 33.80

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385.81 750.08 675.72 74.36 6,758.36

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Japan 378.88 North America 58.42 USA 58.10 Canada 0.32 Europe of 6,688.84 which: European 6,687.71 Union France 54.89 Germany 20.21 Netherlands 2,636.54 United 3,958.67 Kingdom ASIA of which: 18.34 China 3.44 ANIEs 76.81 Korea 39.22 Hong Kong 32.28 Taiwan (ROC) 5.31 ASEAN 1,419.13 Brunei Darussalam Cambodia — Indonesia 56.90 Lao PDR —

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Table 4.3.

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Table 4.3.

(Continued )

Total Cumulative Brunei Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam 1995–2005* Host

Source

97.18 0.05 — 10.62 160.86 6.48

57.28 0.48 96.82 7,622.90 209.13 38.16

3.80 750.20 195.64 —

87.72 — 1,167.21 22.61 0.03

4,045.94 59.80 105.47 406.26 23.76

226.72 1.71 222.95 5,998.91 5.82

578.12 — 48.81 1,909.66 491.95

6,301.41 62.04 496.09 19,530.84 1,638.11 74.42

Notes:

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1) Data compiled from the respective ASEAN Central Banks and Central Statistical Offices. Unless otherwise indicated, the figures include equity and inter-company loans. Figures for Brunei, Cambodia and Malaysia include reinvested earnings for the whole data series. 2) Figures for the Philippines include reinvested earnings for the period of 1999–2002. data on reinvested earnings by source countries are not available.

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976.21 — 13.28 954.08 144.06 —

ASEAN Investment Cooperation

Malaysia 232.24 Myanmar — Philippines 4.96 Singapore 1,117.26 Thailand 7.60 Vietnam 0.17

Figures for Singapore include reinvested earnings for the whole data series, but exclude inter-company loans for 1995–1996. 3) Figures for Vietnam include reinvested earnings for 2003. 4) “ ∗ ” Total cumulative figures for 1995–2005 (by source countries) exclude data on FDI flows to Cambodia. Source: Statistics of Foreign Direct Investment in ASEAN, Eighth Edition, 2006.

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to be stressed, as often the goal of trade and investment cooperation between developing countries is to increase intra-regional shares. But the basic advantage of FDI in terms of technology transfer, non-debt-creating capital flows, enhanced export competitiveness, and the like, has no real predetermined “nationality requirement”. Moreover, to the extent that the FDI is involved in the “fragmented production chain” across countries in the region, one would even expect that a successful policy of increasing FDI inflows could even lead to a decrease in intra-regional trade shares, if ASEAN valued-added in the production chain is low. But this is irrelevant if efficiency and welfare increase. Further, it is important, perhaps, to stress the role of Singapore in the process of integration. It serves as both an entrepot center for intra-ASEAN trade and a hub for FDI. Without Singapore, intra-regional trade and investment would be much diminished. Hence, while Singapore apparently does extremely well by almost any measure in attracting FDI, its destiny in many ways is linked to economic performance of the region. Enhancing the competitiveness of the ASEAN Member Countries, therefore, should be a key concern for Singapore. This would suggest that it is in Singapore’s interest to play an active role in promoting the AIA and the AEC more generally. In short, the quantity of FDI flowing into the ASEAN countries has been generally low in early post-Crisis years, at least relative to pre-Crisis levels and the performance of key competitors, but has been picking up significantly lately, with 2005/2006 being among the best years that ASEAN has seen. 2.2. Sectoral Distribution of FDI Next, we consider the sectoral structure of FDI in the ASEAN countries and how it has changed over time. In doing so, we hope not only to add another dimension to our descriptive analysis of FDI in ASEAN but also to capture its “dynamic” nature. If the ASEAN development is, indeed, proceeding at a rapid pace, we would expect to see significant changes in the structure of FDI in the Member Countries. Table 4.4 calculates the distribution of FDI in ASEAN by sector and source country over the 1999–2003 period.7 As expected, the sector with the largest share of FDI is manufactures, followed by financial services and 7 We consider the average over the entire period because of the volatile nature of annual FDI data.

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Table 4.4.

Cumulative FDI Flows to ASEAN, 1999–2003, by Economic Sector and Country. (Percentage of the total).

13.87 28.52 26.28 3.14 25.12 21.15 18.49 6.12 1.62 11.81 33.16 30.60 0.81 30.15 11.11 39.29 2.16

2.11 2.10 3.14 0.63 0.89 2.92 31.19 5.69 0.00 71.02 0.84 41.14 51.43 21.72 0.03 1.31 26.76

2.92 4.70 0.63 10.14 5.94 9.31 5.58 4.46 0.41 1.63 1.35 3.18 3.66 4.73 10.70 6.45 2.11

10.36 23.93 10.14 16.00 36.53 10.72 3.09 9.33 42.39 6.19 10.94 7.57 3.00 23.10 3.45 12.38 14.00

Total FDI flows 1992–2003 (US$ Millions) 9579.11 19315.23 35536.54 1463.82 3403.58 2164.19 446.4 64.73 9.86 1639.63 11.88 2635.11 33.31 158.4 9536.36 528.77 20.85

143

Note: The percentages are over the source country’s cumulative FDI flows from 1999–2003 to ASEAN. Source: Statistics of Foreign Direct Investment in ASEAN, Seventh Edition, 2005, Authors’ Calculations.

Others (Not elsewhere Classified)

Services

18.20 10.24 6.63 26.28 17.55 9.03 4.73 71.99 53.85 5.85 5.56 0.00 32.27 2.39 16.78 7.38 25.37

Real Estate

Trade/ Commerce

1.08 0.66 0.91 2.68 0.00 2.56 4.89 0.56 0.00 0.22 0.00 3.21 0.78 0.31 1.12 1.00 0.00

Financial Intermediation and Services

Construction

Mining and Quarrying

Manufacturing 48.61 23.11 33.13 23.86 12.81 40.69 27.50 1.85 1.72 2.64 48.15 2.61 7.87 3.86 52.97 19.30 28.78

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2.84 5.74 13.01 3.50 0.22 0.00 1.41 0.00 0.00 0.59 0.00 6.66 0.00 0.01 2.65 0.99 0.00

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0.00 0.99 0.53 13.78 0.94 3.63 3.12 0.00 0.00 0.06 0.00 5.04 0.18 13.72 1.19 11.90 0.82

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Japan USA EU R of Korea Hong Kong Taiwan China Brunei Cambodia Indonesia Lao Malaysia Myanmar Philippines Singapore Thailand Vietnam

ASEAN Investment Cooperation

Country

Agriculture, Fishery and Forestry

Economic Sectors

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trade/commerce. Manufactures is the single most important sector for all major sources of FDI with the exception of US FDI, whose investments in financial services and “other sectors” are greater than in manufactures. The EU also has large investments in financial services. Approximately half of Japanese and Singapore FDI went into manufactures. Trade/commerce is an important target area, with more than 10 percent of total FDI outflows, for all major source countries save the EU. South Korea, the Philippines and Thailand also have significant shares of investments in agriculture, fishery and forestry. Finally, we try to capture the “dynamism” associated with structure change in ASEAN FDI inflows. In other words, we ask the question: how much has the structure of FDI changed in individual ASEAN countries over the past 10 years? Conceptually, this is a straightforward technique: we merely rank sectors by importance (in terms of the value of FDI inflows) in two periods and calculate how well the two series are correlated. A high correlation would suggest little change, while a low correlation would imply just the opposite. Our expectation would be that a highly developed country would see little change in its structure, since the country would already be specialized in capital- and knowledge-intensive production. The same would be true of a country that engages mostly in agricultural production and the same unskilled labor-intensive goods. However, countries with rapid change in the sectoral distribution of FDI should have lower coefficients. The correlation technique we use is called the Spearman Rank Correlation Coefficient (SRCC). The SRCC is a non-parametric statistic that correlates two series in the way described above. As noted in Chapter 2, it varies from +1 (perfect correlation) to −1 (perfect negative correlation), with 0 suggesting no correlation at all. Given the volatility of annual FDI data, we choose two periods in which annual FDI flows are averaged: PreCrisis (1993–1997) and Post-Crisis (1998–2005). We also apply this technique for individual years in the appendix. The data we use for this exercise mainly come from the UNCTAD FDI database. Table 4.5 summarizes our results for these two periods. Data for Brunei, Cambodia, and Myanmar were insufficient in terms of the sectoral breakdown of FDI. Most estimates are statistically significant from zero, with the (surprising) exception of Malaysia. In addition to being the country with the lowest estimated coefficient, the fact that the SRCC is not significant from zero would imply that FDI into Malaysia has been the most dynamic over these periods. Singapore’s SRCC would be next at 0.47,

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Table 4.5. Structural Change of Inward FDI in ASEAN. (Spearman Rank Correlation Coefficient; Pre-1998 and Post-1998). SRCC Brunei Cambodia Indonesia Malaysia Myanmar Philippines Singapore Thailand Vietnam

NA NA 0.69∗ 0.21 NA 0.66∗ 0.47∗ 0.49∗ 0.70∗

Notes: 1) Average annual FDI flows were calculated by: (a) summing inflows from Denmark, Finland, Japan, the UK and the US to each ASEAN country’s industry for each year; and (b) taking the average for the periods (1993–1997) and (1998–2005). We then correlated the series using the SRCC approach. 2) The industries, across which the correlations were calculated, varied by country. The list of industries by ASEAN country is given in the appendix. 3) The data is for FDI flows classified by the ISIC Rev 3.1 System. 4) “ ∗ ” statistically significant at the 95% level or greater. Source: UNCTAD FDI Statistics Database and Japanese FDI Statistics from the Ministry of Finance (viewed October/November 2006).

whereas Vietnam (SRCC = 0.70) and Indonesia (SRCC = 0.69) have seen the least amount of change in the structure of their FDI. There is no “magic value” that would be consistent with a robust transformation in FDI structure. Moreover, as FDI data are notoriously problematic, we should not attach too much importance to comparative changes. This exercise suggests that the structure of FDI in ASEAN has generally been changing significantly in countries like Malaysia, Singapore, and Thailand. Regardless of what caused these structural changes in FDI (e.g., market forces, institutional changes, explicit measures applied to FDI, or shocks like the Asian Crisis), we take structural change as a positive indication of economic dynamism. The result probably reflects at least in part successful FDI liberalization and facilitation policies adopted by the ASEAN Member Countries.8 Regional approaches to investment liberalization and facilitation, therefore, should help reinforce this process as well 8 These

policies are analysed in depth in Sections 9 and 10.

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as augment the quantity of inflows. As is discussed below, the AIA could very well be an excellent instrument to do this. 2.3. Trends in the CLMV The five more developed ASEAN countries (Indonesia, Malaysia, Singapore, Thailand, Philippines) account for a sizable share of the total FDI flows into ASEAN. Over the 10-year period from 1995–2005, about 91 percent of total FDI flows went to these countries, with about half going to Singapore alone. As a group, Cambodia, Lao PDR, Myanmar and Vietnam accounted for just about 8.7 percent of total FDI flows into ASEAN. Just as Singapore attracted the largest amount and share of FDI, Vietnam over the 1995–2005 period dominated FDI flows into the CLMV group: Vietnam accounted for 73.2 percent ($18.2 billion) of the total FDI flows to this group. The FDI investment disparity within the CLMV is very sizable. Vietnam, with the highest share in cumulative terms, has 33 times more FDI flows than Lao PDR, which has the lowest share. The investment disparity between the highest and lowest recipient appears to be widening: in 1995 Vietnam received about 20 times more investment than Laos and by 1995 this had increased to about 72 times. The size of the FDI flows gap between Cambodia and Myanmar is less substantial than when FDI flows to these countries are compared with Lao PDR. Comparing pre- and post-Crisis period (1995–1997 and 1998–2005 respectively), we note that the impact of the financial crisis was not very severe; cumulatively over the 1995–1997 period FDI flows amounted to $8.9 billion and $16 billion for 1998–2005, giving an annual average FDI flow of $2.9 billion for 1995–1997 and $2 billion for 1998–2005. Laos PDR and Myanmar performed less well during the downturn phase in FDI inflows into the CLMV group. The significant decline in ASEAN-sourced investment to these countries was the main contributing factor. However, Vietnam almost doubled its FDI flows, weathering surprisingly well the difficult post-1998 period much better than the other countries in the group. In assessing the sources of FDI inflows into the CLMV group, a few points should be highlighted. Over the 1995–2005 period, cumulative FDI to ASEAN reached $284.2 billion and intra-ASEAN investment was $32.7 billion. For the CLMV group, cumulative intra-ASEAN investment amounted to $40 billion for 1995–2005 or about 14 percent of the region’s total cumulative FDI. The CLMV group’s average share of intra-ASEAN FDI was higher than the average for the whole of ASEAN, which suggests

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that intra-ASEAN FDI was a stronger force of integration for the CLMV group of countries. Overall, for the period 1999–2005 — that is, during the AIA phase — FDI flows into manufacturing accounted for the largest share (30 percent) of total FDI flows ($169.3 billion). As a group, manufacturing accounted for about 39 percent of total FDI flows, a higher share than the average for ASEAN. The sectoral FDI flows, however, into the CLMV showed some diversity. The bulk of the FDI inflows were to Vietnam and Myanmar, which accounted for $11.8 billion or 92 percent of total FDI flows over the AIA phase i.e., 1999–2005. For Myanmar, mining and quarrying attracted more than three-quarters of total FDI flows.

3. Determinants of FDI in ASEAN Which variables have been the most significant in determining ASEAN FDI over time? Has ASEAN FDI been driven by its own economic fundamentals, or has it been due to outside factors, such as FDI growth globally over this period or the emergence of China as a major recipient of FDI (at ASEAN’s expense)? In this section we try to determine whether or not ASEAN as a regional organization has made a difference for the attraction of FDI inflows using a variety of techniques, including descriptive analytics and an econometric “gravity” model, which has become a common tool in the literature to do this. We begin this section with a review of the theory of the determinants of FDI and trade-investment links, which have been extremely important in driving ASEAN competitiveness.

3.1. Brief Review of Variables Affecting Inward FDI A key point of departure in the theory of foreign investment is the distinction between portfolio investment and FDI. The former includes private and public transactions in securities (e.g., stocks and bonds, sovereign debt, concessionary loans from foreign donors). Portfolio flows can play a constructive role in economic development by providing investible funds and foreign exchange. In contrast, FDI involves a substantial degree of ownership control. Since FDI is associated with organizational and managerial participation by the investor, it typically produces a more complex matrix of economic interactions between the source and host countries. The minimum stock ownership used to define “control” may vary from country to country,

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but most countries adhere to the OECD definition of at least 10 percent of firm ownership. Before looking closely at the actual determinants of FDI in the ASEAN countries in recent years, we review briefly the motivations for FDI globally. This will give us a better idea of which policies will likely be the most important in affecting FDI inflows. The economic literature on foreign investment is extensive. However, unlike, say, trade theory, the complicated nature of FDI and the many reasons why firms engage in it make it difficult to envision any theory that is both comprehensive and testable (that is, easily verifiable through applied statistical analysis). Economic studies end up having to focus on one and sacrificing the other. Lizondo (1991) distinguishes between models that assume perfect markets for capital flows and those that depend on incomplete or imperfect markets. He identifies three approaches based on the assumption of perfect markets: (1) Differential rates of return; (2) Portfolio diversification; and (3) Output and market size. In the first, foreign capital flows from regions with lower rates of return to those with higher rates of return. In the second, foreign capital flows are induced by opportunities to reduce the risk. In the third, foreign investment simply varies proportionally with activity, and hence with output and market size. Clearly, of these three, ASEAN economic cooperation would be targeted at influencing especially the third channel, i.e., an increase in market size. But the problem with these approaches is that they fail to provide a special reason for FDI in contrast to portfolio investment. Moreover, they are not always consistent with reality. For example, (1) above would suggest that flows should be unidirectional (i.e., flowing out of countries with rates of return that are falling into countries where it is rising) but, in fact, we see flows going both ways. For example, the United States in recent years has been a large importer and exporter of capital, something that would be impossible to explain using this theory. In any event, if the control of foreign activities involves some cost, then the above objectives will be satisfied via arm’s length portfolio transactions rather than FDI. Firm-specific advantages (FSAs), for example in technology and manufacturing know-how, can sometimes be exploited through licensing rather than FDI. A theory of FDI, therefore, needs to be based on FSAs that are not easily commercialized through markets — such as knowledge of the final markets for the manufactured goods. For the advanced, large-scale multinationals, Buckley and Casson (1976) argued that such firms rely on FSAs

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extensively by producing complex products requiring coordination of labor procurement and training, marketing, research and development, and so on. Hence, certain manufacturing sectors would be more prone to FDI than others; electronics, for example, would be a prime candidate. This is a key sector in which ASEAN Member Countries have attracted FDI. While we have already discussed in the last section the distribution of FDI in ASEAN and will also do so later on in the study, suffice it to note here that the exports of a number of ASEAN countries are dominated by electronics, as part of the “production fragmentation” process. Hence, trade is intricately linked to FDI flows. In addition to FSAs, the theory of FDI requires a reason for producing abroad rather than exporting from home. Several theories focus on the factor endowment characteristics of the host country, for example, cheap labor or plentiful resources of a particular type, or perhaps the structure of markets. In markets characterized by economies of scale, differentiated products and transport barriers, firms will sometimes establish subsidiaries near markets or specialized suppliers even if that means operating on a reduced scale (for example, Brainard, 1992; Horstman and Markusan, 1992). These various theories of FDI are all encompassed in Dunning’s “eclectic approach”. Dunning highlights three key requirements for direct investment: (1) the firm must possess “ownership advantages” over other firms (FSAs); (2) the firm must find it beneficial to utilize these advantages directly instead of selling or leasing them (“internalization” advantages); and (3) the firm must find it profitable to combine these advantages with at least one factor input abroad so that local production dominates exporting (“locational” advantages). Locational advantages include proximity to markets, specialized suppliers, evasion of protective barriers, and factor endowment advantages. The eclectic approach is probably the most cited model used to explain the determinants of FDI flows. The bottom line for the ASEAN countries in this model would be simple: in order to lure FDI flows, it is necessary to affect the “locational” advantages of the region. This can be done through a variety of techniques, from adopting best practices vis-avis FDI inflows, providing a stable macroeconomic regime, establishing a secure environment in which FDI can thrive, reducing bureaucratic costs faced by foreign investors and the like.9 At the regional level, in addition 9 One

might be tempted to add two other policies that have been used to enhance locational advantages, that is, (1) increasing tariff barriers in order to force FDI to

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to providing peer support for efficient, sensible macroeconomic and FDI policies in the Member Countries, ASEAN as a regional organization can reinforce its attractiveness to MNCs by harmonizing FDI policies, creating a “one-stop investment center”, and reducing any transactions costs that would be associated with MNC activity that exploits the advantages that ASEAN has in terms of allowing for a vertical integration of production, larger markets for the sales of intermediate and final goods, and creating a major presence on international markets. As a final point, it is worth mentioning that intellectual property protection may also be important in ensuring the inflows of the “right kinds” of FDI. A new theoretical literature is emerging in which it becomes clear that MNCs consider the protection of intellectual property rights (IPRs) to be essential for certain types of FDI projects. These tend to be those in which the potential for technology transfer is highest. The argument is intuitive: a firm will protect its firm-specific assets especially in countries that do not have serious IPR laws (and enforcement) in place. While they still may invest in such countries, they will not innovate there; instead, they will focus on advantages flowing from factor endowments (e.g., cheap, unskilled labor). As technology transfer has been a high priority for the ASEAN countries, and is one of the main reasons why they are courting FDI, this argument would suggest that IPR protection should be a relevant area when revising and augmenting policies relevant to ASEAN industrial cooperation.

3.2. Trade and Investment Links As any foreign businessman working in ASEAN knows, FDI is closely associated with trade flows. It may be that trade precedes FDI ventures (e.g., in order to test the waters in the country or to establish brand name) or FDI may precede trade (e.g., an FDI project increasing sourcing from its home “tariff jump” if the firm wants to sell domestically, and (2) fiscal schemes such as tax holidays. However, attracting FDI through tariffs has revealed itself to be highly inefficient, as it is only useful for domestic sales of final goods (not a very relevant motivation in contemporary Southeast Asia in most industries) and it tends to lure FDI into sectors in which the country is not efficient (otherwise, it would not need tariff barriers), thereby reducing the efficiency of production in the country. Second, fiscal schemes such as tax holidays, which still exist in some countries (even in Myanmar) may succeed in bringing in FDI in the short run, but it tends to be quite costly. Moreover, it can lead to intraregional competition through tax regimes that is to the detriment of regional efficiency as well as regional solidarity.

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base, and final products may, in fact, be exported back home), but empirically the two are definitely causally-linked. Hence, while trade analysis is trade analysis and FDI analysis is FDI analysis and rarely do the twains meet, we miss a great deal of the dynamics of globalization if we do not accept that the two are intricately-linked. The theoretical FDI literature which gives a large role to trade is not large. In fact, the most important contributions came out of the 1960s and 1970s. Kojima (1973) distinguished between “trade-oriented” and “antitrade oriented” FDI. Trade-oriented investment occurs when the source country has a comparative disadvantage in the industry of the investment, and so capital flows toward countries with a comparative advantage in the activity. This kind of investment leads to greater trade and greater world-wide efficiency. Anti-trade-oriented investment occurs in industries in which the source country has a comparative advantage, but investment nevertheless occurs, perhaps because of protection or oligopolistic competition. In other words, a US multinational company might invest in a (capital-intensive) pharmaceutical factory in Thailand in order to “tariff hop” and sell directly to the domestic market. Such an investment might make sense from the profit-maximization strategy of the firm (it can avoid paying trade taxes) but would lead to investment in a sector in which the host country would have comparative disadvantage. This kind of investment leads to diminished trade, market segmentation, and possibly reduced global welfare. Vernon’s “product life-cycle” hypothesis (Vernon, 1966, and subsequent work) argues that FDI takes place as the production process of a new product in the innovating country (the United States) becomes standardized, making it more profitable to move production offshore, first to other developed countries and eventually to developing countries. In this model, the investment flow initially tends to diminish trade by replacing exports, but as the industry shifts entirely abroad, it tends to increase trade again. By the 1970s, the accumulated investment experience of US MNCs abroad had considerably foreshortened the linear progression suggested by the product-life cycle hypothesis. It was found that experience gained in the investment process reduced the costs of producing abroad so much that even relatively new products could now be located in the country with the optimal factor endowments. In this context, provided that location makes a difference, foreign investment is likely to lead to the concentration of production and to increased international trade.

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This also calls attention to the powerful role of international experience in the investment process. The relatively limited role of FDI in most national economies suggests that foreign investment is costly, presumably because of the investing firm’s inadequate knowledge of and experience in the foreign business environment. A history of successful investment and/or close contacts through trade and other economic linkages can substantially reduce this cost. With respect to FDI and the theory of regional economic integration, the literature is fairly sparse. At least two effects can be discerned conceptually: investment creation and diversion. If markets perceive that a regional trade grouping will lead to more dynamic growth, integration will attract greater inflows of FDI than would have otherwise been the case. This effect is consistent with economic efficiency and, hence, it is called investment creation. On the other hand, the discrimination inherent in a discriminatory trade grouping creates an incentive to invest in order to take advantage of free access to markets internal to the bloc. Such an effect leads to a less efficient allocation of global resources and inhibits efficiency; hence, it is known as investment diversion. As investment is likely to be diverted only in the case of high trade barriers in partner countries, investment diversion would occur in industries exhibiting trade diversion. For example, Dunning and Robson (1987) analyze how the EC’s Single Market Program (“EC 1992”), which was intended to create a common market in Europe, would affect intra-EU FDI flows and those from nonpartner countries to the EU (see Box 4.1 for a summary of the evolution of integration in the EU, including cooperation in investment). They reach the (perhaps counterintuitive) conclusion that the effect on intra-EU FDI flows is ambiguous, while that of non-partner countries will likely be positive. This is because reductions in transactions costs within Europe may lead to an investment creation effect, but it also could reduce intra-EU flows if previously-existing FDI in the EU member states existed because of pre“EC 1992” barriers to trade. On the other hand, the latter effect is irrelevant to non-partner countries, because barriers to trade with the EU do not change. However, there is still the potential for an investment-creation effect and, therefore, inflows from non-partner countries should unambiguously increase. Dunning and Robson conclude that, in effect, the United States and Japan will likely gain more from EC-92 than European firms, as the former countries tended to be more “European” in their corporate activities, whereas European firms continued to be saddled with a national corporate culture.

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Box 4.1. The Economic Integration of Europe: An Overview. Arguably, there were three primary motivations for economic integration in Europe in the aftermath of World War II: (i) to avoid wars of such magnitude, destruction, and loss of life; (ii) to draw markets and resources together for economic (and social) reconstruction; and (iii) to build a strong, integrated region as a bulwark against the Soviet Union (the reason why European integration was strongly supported by the US in its early years). Below, we give a brief review of its evolution: Economic Deepening Western Europe started to move toward economic integration in the early 1950s at a sector level with the European Coal and Steel Community (ECSC), created under the Treaty of Paris (1951). The group included Belgium, France, Luxembourg, Italy, Netherlands, and West Germany. The European Payments Union was created to ration then scarce US dollars. Then in 1957, the European Economic Community (EEC) and the European Atomic Energy Community (Euratom) were established by the same six nations under the two so-called “Treaties of Rome”. The EEC Treaty of Rome created what was essentially a customs union “plus” (with part of the “plus” the eventual incorporation of the Common Agricultural Policy). Sector schemes — the ECSC and Euratom — were integrated with the EEC and called the “European Communities” (EC) in 1967, after the European customs union was implemented. The Single European Act (1986) modified the EEC Treaty of Rome and sought to create a truly integrated common market in Western Europe — where goods, services, capital, and labor could flow freely. This was done via 284 sweeping directives. While the goal to complete the Single Market was stipulated to be the end of 1992 — hence the sobriquet “EC-1992” — the directives were only essentially in place in 1994. There still are areas to be liberalized in certain European Member Countries. While the Single Market Program progressed, EC leaders turned their efforts toward monetary integration, culminating in the Maastricht Treaty (1991), which eventually established the European Union (EU) and created the conditions for eventual monetary union. In 1999, 12 of the 15 EU members (Denmark, Sweden, and the United Kingdom opted out) adopted the “euro” as a unified currency, permanently fixing individual monetary units at a predetermined rate to the euro. This was prior to adopting the “hard euro” in 2002, when currencies were completely replaced. Economic Widening In early 1960, the United Kingdom (UK) expressed an interest in joining the EEC, but its application was rejected (vetoed by then French President Charles de Gaulle). However, the UK — along with Ireland and Denmark — joined during the 1973 First Enlargement of the EC. Greece joined in 1981 with the second and third bringing in Spain and Portugal in 1985. The main purpose of this recruitment was political: all were emerging from authoritarian regimes (Continued)

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Box 4.1. (Continued ) and the EC wanted to foster democracy by successfully integrating them into European institutions. The Fourth Enlargement brought in Austria, Finland, and Sweden in 1994 (Norway and Switzerland also had accession agreements with the EC, but these were rejected during national referendums). Thus, by the mid-1990s the EU-15 covered almost all countries in Western Europe. Central and Eastern European countries, however, remained outside the EU framework. Still, the EC placed high priority on drawing in Central and Eastern European countries, especially given the delicate state of their fledging democratic institutions after the 1989–1991 revolutions. Most recently, the May 2004 Fifth Enlargement accepted 10 Central and Eastern European countries — Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovenia, Slovakia, along with the small Mediterranean states of Malta and Greek-Cyprus. Bulgaria and Romania joined on January 1, 2007. Turkey is currently negotiating accession terms (albeit Turkey’s membership remains highly controversial within the EU). The European Experience in Investment Cooperation It is difficult to compare EU and ASEAN economic integration programs. The two regions are extremely different; the EU launched its investment policy at a time when all Member Countries were developed countries, whereas ASEAN of the 2000s includes developed, developing and least developed countries. Culturally, historically, socially, and politically the EU is homogeneous whereas it would be difficult for ASEAN to be less diverse. The international environment in the late 1950s and 1960s, when the EU was implementing its first economic initiatives, was different than it is today, too. Thus, any comparisons between the EU and ASEAN have to be taken with a grain of salt. However, the EU can serve as an example of how investment policy might be developed within the framework of a regional organization. Since 1958 (with the implementation of the Treaty of Rome), EU members have had to accord national treatment to FDI from partner countries. This suggests the need to treat EU foreign investors in the same way that local firms are treated, in terms of investment incentives, scope of action, residency, land ownership, and the like. It was obvious to European policy markers that, in order to exploit the benefits of trade integration, one would need the free flow of FDI. Coupled with the customs union created by the Treaty of Rome, this was an important component of creating an integrated European market. Homogeneity helped this process. In theory, there was not supposed to be any barriers to intra-regional investment (or, of course, trade). However, the complicated nature of FDI allowed member countries to discriminate in favor of their local firms. For example, even four decades later (and after the implementation of the EC ’92 program), the “Primarolo List”, published in 1997, revealed 100 practices in the EU that were discriminatory. Reducing this list has proven to be difficult due to politically-sensitive sectors; technically all discrimination has been removed but there still are complaints, (Continued)

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Box 4.1. (Continued ) from taxation questions to subsidies and, of course, the potential problem of “social dumping”. Also, some sectors continue to be problematic even in 2006, e.g., the financial and energy sectors. If this was the case in a homogenous region like the EU, it will obviously be even more difficult in a region like ASEAN. However, the EU experience shows that, by limiting exceptions and trying to establish the maximum level playing field that politics will conceivably allow, the economic gains can be substantial.

Nevertheless, it is not the case that recipient countries should be indifferent to whether or not inflows stemming from a regional agreement are due to investment creation or diversion. While both would lead to an increase in inflows of FDI, the latter effect would eventually have important efficiency costs that could, in the medium-long run, inhibit growth and development. Investment creation, however, will have the opposite effect, i.e., it will be salutary. Hence, regional trading arrangements that embrace an outwardorientation would have the added advantage of helping to ensure that the “best kind” of FDI will flow into the country. 3.3. Trade and FDI: Shifts from Horizontal to Vertical Operations due to AFTA There is an on-going effort by foreign investors to consolidate their production activities in ASEAN brought about by AFTA. If an industry faces FDI restrictions, it can still be serviced through the trade route under AFTA, which has reduced tariffs to 0–5 percent in the original ASEAN countries, and Vietnam with the other transitional economies to follow soon. Hence, from an industrial policy point of view there is little advantage to be gained through the exclusion of an industry from FDI liberalization while the same industry can be serviced through exports within the region. With open trade and investment reforms envisioned in AFTA and the AIA, horizontal FDI can be expected to fall while vertical FDI will increase as firms see the benefits associated with vertically integrated, specialized plants across a region as diverse as ASEAN. In a number of ways, FDI in ASEAN has become more regionally oriented, both for market-seeking and efficiency-seeking FDI. Arguably there will be less rather than more FDI as horizontal production activities are being consolidated. The increase in regional production networks has been encouraged by a number of factors. One key factor relates to the changing corporate

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production strategies adopted due to potential benefits of a wider integration process, allowing an MNC to optimise benefits associated with a regional division of labor. The ASEAN Industrial Cooperation (AICO) scheme is an excellent example of a successful ASEAN initiative in this light: it has encouraged automobile and electronics manufacturers to adopt efficient production networks spread through the region. The AICO scheme encourages production partnerships involving two or more countries in the region. This type of FDI helps strengthen regional integration as well as FDI targeting in areas in which ASEAN has a dynamic comparative advantage. As of February 2007, there were 140 AICO projects issued with AICO certificates for joint production activities involving two or more ASEAN countries. Most of these regional production networks were associated with automotive completely-knocked-down packs, production of automotive components, electronic products and food processing operations. Aside from AICO scheme, foreign companies are also using regional network productions to increase their production efficiency, minimize costs and ensure better control of “value chains”. Regional production networks could involve different aspect of production processes taking place in different locations or between production and services functions, all of which could be linked up in a productive chain within a regional context. 3.4. A Gravity Model Approach to the Determinants of FDI Outflows The theoretical and micro-review outlined above would suggest that there are many variables that could have a bearing on FDI inflows. In particular, locational variables would be the most important in this regard, as firmspecific advantages and internalization questions are firm-specific. In this section, we use an applied econometric technique, known as a “gravity model” to gauge which variables are the most important locational variables. While gravity models have become quite familiar in the trade literature (see, for example, Frankel, 1997 and Rose, 2004), they have been used less frequently in the FDI literature. This econometric procedure turns out to be useful to us here in that it will allow us to identify which factors have been the most important in driving outward FDI from source countries, and will permit us to pin down whether ASEAN cooperation to date has had an impact on these flows. We use a gravity specification of FDI to gauge whether or not the ASEAN Investment Area (AIA) has had any discernable effect on FDI inflows in ASEAN. As the model itself is actually

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quite technical, we place the details in Appendix 4.1. In this subsection, we outline the basic features of the model and merely summarize the results. Statistics and any quantitative technique that measure relationship, including the gravity model used here, suffer from a number of shortcomings. Econometric findings are reported on the basis of whether the results are statistically significant (or not) according to the levels of confidence, that is, the range within which one can place confidence in the results. This method is governed by a strict interpretation of the results on the basis of statistical theory. A finding that a relationship between variables is statistically insignificant does not necessarily mean that it is of some importance on some other non-statistical grounds. Econometric problems, such as multicollinearity, and heteroskedasticity and simultaneity must also be taken into account in interpreting the results. Econometric results that show relationships between variables indicate that there is an association between the selected variables. However, association is not the same as causation; that is, when variables are associated it does not mean that, for example, the movement of one variable is caused by another variable. Hence, in interpreting the results of the gravity model summarized in Appendix 4.1, one should keep in mind these shortcomings; the model suffers from the same problems associated with other gravity models. In fact, given the fact that theory would suggest a far more complicated vector of explanatory variables in the case of FDI relative to the (comparatively uncomplicated) determination of trade flows, one should not place definitive confidence in the results obtained. Rather, the goal of this exercise is merely to use an economy-wide model to seek out the determinants of FDI flows and, controlling for pertinent variables, try to see if we can discern any special effect associated with ASEAN integration. We posit FDI to be a function of traditional gravity-based variables, i.e., the size of the host and source countries, their relative wealth,10 and the distance between them, with distance being both a proxy for transportation and other “costs”.11 Moreover, given the strong theoretical arguments 10 Modern international trade theory suggests that per capita income between countries is correlated positively with trade. 11 These costs can either work in favor of FDI or against it (and, therefore, we are not able to say a priori whether or not this should be positive or negative). This expectation is less clear in the case of FDI than, say, for trade, as it may be that in the context of high transportation costs that a firm will choose to locate abroad in order to reduce them. However, to the extent that greater distance will most likely be correlated with higher information costs associated with learning about the country (countries that are further away are more “foreign”), the coefficient could be negative.

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supporting the trade-investment link, we also include bilateral trade as an explanatory variable. Finally, in order to test the hypothesis that the region really makes a difference, we add a regional dummy variable for relevant regional groupings, including ASEAN. If ASEAN has been an important positive attraction for, say, US firms above and beyond what wealth, distance, size and bilateral trade would suggest, the result will be a positive (and statistically significant) coefficient on the ASEAN binary variable. Such an approach allows us to separate economic characteristics from an ASEAN regional effect. As can be seen in Appendix 4.1, we endeavor to capture the determinants of FDI using the United States, selected key European countries (namely, the United Kingdom, France, and Germany), and Japan as the source countries. Table 4.3 identified the United States as the single most important source of FDI to ASEAN countries and, hence, it is a logical candidate. The EU as a region is an even larger investor than is the United States, but while using aggregate EU numbers would be possible, we opted to separate out main FDI source countries, as many EU Member Countries do not invest much in ASEAN.12 Finally, we also include Japan, which is the third largest investor in ASEAN behind the United States and the UK. We use outward FDI data flows to 125 host countries (depending on data availability), including the original ASEAN countries, generally over a 13-year period, i.e., 1991 to 2004. This period essentially covers the seven years preceding the signing of the AIA in 1998 and the first six years of its implementation. While the AIA still has a long way to go before it is implemented in a comprehensive manner, we would assume that some effect would be in evidence if the AIA was making an important difference. The statistical “fit” of the regression is consistent with other models of this sort. The most important determinant of FDI in this model turns out to be the bilateral trade variable; the trade variable is positive and important in all regressions, particularly for FDI outflows from the United States, UK, France, and Japan. With respect to the various regional (binary or “dummy”) variables, North American integration appears to have contributed positively to FDI outflows from all five source countries, although these positive estimates are significant for only Germany and France. The binary variable of the EU, which over the period of the regression deepened integration significantly by putting in place a common market that included 12 Moreover,

imposing the restriction that FDI from all EU countries are affected in the same way is probably unwise, given the differing FDI traditions, economic and political relationships, fiscal regimes, etc., that continue to exist in the EU.

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free capital flows along with national treatment of FDI in almost all sectors, is statistically significant and positive for the United States and Germany but is actually negative (UK) or insignificant for the other countries. Still, this is not surprising, given the potential “Dunning-Robson” effect discussed above. That is, given the process of creating a border-free environment in the EU, it may be that EU member states may or may not increase FDI outflows to partner countries. Non-partners, however, would unambiguously increase outflows to the region, which is what we see in the case of the United States.13 However, the ASEAN variable is insignificant in just about all cases, with the exception of Japan. This would suggest that, through 2004, ASEAN economic cooperation, be it through trade or investment, has essentially had little or no aggregate effect on FDI outflows, even though the region’s strong trade performance has been an important determinant of FDI inflows (and FDI has also increased trade). Nevertheless, this does not suggest that there do not exist certain success stories at the industry level. Moreover, given the fact that the application of the AIA has not yet been comprehensive and the time period has been relatively short, perhaps data over the next few years will generate a more impressive effect on the aggregate data. Since this gravity approach allows us to separate economic characteristics from country or regional effects, as a final exercise, we might consider the “Chinese Competitive Threat” hypothesis. In this scenario, the problem does not lie with AFTA or the AIA or anything particularly related to ASEAN itself but rather is exogenous, that is, the emergence of China as a major competitor for FDI (and in third markets for trade) is driving the results. This hypothesis is frequently articulated in Southeast Asian business and policy-marking circles. 3.5. The “China Threat” Hypothesis China has clearly been an important recipient of FDI inflows in sectors in which ASEAN is competitive. The Chinese success is the result of many factors, including its size, relatively low-cost and well-educated workforce, increasing wealth, location, and an outward-looking policy stance that has put in place incentives to draw in FDI. China has now emerged as a major regional power and increasingly competes with ASEAN in local and third markets, which in turn no doubt has a bearing on FDI inflows (as discussed 13 The EU binary variable for Japan’s regression is more difficult to explain, except that the EU is far less important to Japanese FDI outflows than its investments in the United States and other Asian countries.

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above). However, controlling for all of these things, the data do not support that China itself has become a special “threat” above and beyond what one expect from its economic characteristics; rather, globalization has led to an increasingly competitive international economy in which competition for markets and FDI have risen. For example, Lee and Plummer (2004) use a gravity model similar to the one above but with a more restricted database (and different years). They are able to reject the hypothesis that China has had any statistically significant bearing on outward investment from these OECD countries outside of the usual channels (i.e., those stipulated in the traditional gravity models, such as size, wealth, distance, and trade). In fact, Busakorn et al. (2004) even find that FDI flows to China are actually positively related to FDI in other Asian countries; they find that a 10 percent increase in the former will lead to a two–three percent increase in flows to the latter.14 In theory, this would be because the emergence of China as a major player has put the region “on the map” and multinationals have been using ASEAN to complement its investments in China. This result would go beyond merely dispelling the “China Threat” presumption and would actually suggest that China’s success in attracting FDI has actually helped ASEAN (and other Asian) countries by attracting complementary FDI, which is no doubt part of a production fragmentation chain that would involve China and its neighbors. As such interaction is facilitated by reducing trade barriers between China and ASEAN, the ASEAN-China FTA and negotiations for its expansion (and to include FDI in the process) would make a good deal of sense. Moreover, it would give ASEAN a competitive edge over other Asian countries. Nevertheless, the standard argument that China’s size makes it a particularly attractive location for FDI, an incentive that would clearly flow from Dunning’s Eclectic Theory, is strongly supported by this econometric model. In this, there is an encouraging lesson supporting the AIA: effective integration in which the region, which leads MNCs to consider ASEAN as an integrated network in which transactions costs are low and with potential for an efficient regional division of labor, could render ASEAN far more attractive to foreign investors than would otherwise be the case.15 The whole is greater than the sum of the parts. 14 As

cited in Cassidy (2005). critique of this would be that obviously ASEAN does not have plans for economic union, and, hence, it would be inexact to suggest that the AIA/AEC could create out of ASEAN what China has (on a somewhat smaller scale). While this is true, it is also a fact that China itself has significant bottlenecks across the country at the provincial level. Although it has political union, economic union has a long way to go. 15 One

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With or without “China” the globalization of markets is increasing global competition in terms of trade and FDI. If a Cuban boxer is bigger, stronger, faster, and more motivated than the competition, he will win because of these latter attributes and it is in these areas where the competition needs to focus . . . the Cuban nationality is largely irrelevant, unless there is something special about Cuban culture and policy toward boxing. Likewise, ASEAN needs to meet global competition through outwardoriented, efficient policy change and regional cooperation . . . it does not need to worry about a “Chinese Threat” per se, particularly since, unlike our hypothetical Cuban boxer, China has its own problems.16 In fact, as will be seen in Part 3, many ASEAN countries actually have a more businessfriendly environment than China (or India).

4. Issues of Competitiveness and Complementarity European economic integration, which is by almost any measure the most successful post-war regional grouping in existence, was made easier because of the fact that, at early stages, it was quite homogeneous. The original six countries of the EEC were all relatively rich, developed countries with a shared historical, cultural, and (basic) institutional setup. As Europe became more diverse, complications began to set in. The accession of Turkey to the EU, for example, has been problematic, even though the EEC Association Agreements with Greece (who joined the EC in 1981) and Turkey each took place in the early 1960s. And while accession talks with Turkey were officially opened in October 2005, its candidacy appears to have reached an impasse. The main reason for this is Turkey’s “diversity” in terms of per capita income, cultural, political institutions, and the like. Many attribute the rejection of the EU Constitution to opposition to Turkish admission. Hence, diversity matters. It poses a particular problem to ASEAN, which is one of the most diverse regional groupings in the world. It includes rich; high income; middle income; and least developed economies; the coefficient of variation17 of per capita income in ASEAN in 2004 came to 16 For example, in the financial sector, protecting intellectual property rights, property rights themselves, reforming its State-Owned Enterprises, and other issues involved in reforming a socialist market economy. 17 The coefficient of variation is merely the mean (in our case, mean per capita income in ASEAN) divided by the standard deviation across countries. Hence, it is a measure of diversity; the larger the coefficient of variation, the greater the differences in per capita income across countries.

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1.62, more than twice as high as that of the EU. Political institutions and historical experiences do not find many common traditions across the region; ASEAN Member Countries have Muslim, Buddhist and Christian majorities; and so on. Thus, it is often difficult to compare the EU experience to that of ASEAN. The challenge of diversity is much greater. There are many reasons why diversity would prove to be a challenge to regional integration, including different sectoral priorities, different institutional constraints, different fiscal resources to cope with structural change, different legal institutions influencing policy formation, etc. In fact, according to the World Bank’s “Doing Business” database which ranks countries across the world in terms of various competitiveness-related issues, the differences existing in ASEAN could hardly be greater. As is noted in Part 3, in terms of “ease of doing business” in 2007 globally, Singapore is ranked number 1; Thailand and Malaysia, numbers 18 and 25, respectively; Vietnam, the Philippines and Indonesia, numbers 104, 126 and 135; and Cambodia is number 143 (World Bank, Doing Business in 2007 ). We discuss this type of diversity more at length later on. However, ASEAN does have one thing in common that arguably the EU did not have in its early years: generally a common approach to international commercial policy. In particular, ASEAN countries are committed to macroeconomic stability and an outward-oriented approach to trade and investment relations. This bodes well for the AEC; indeed, without this joint commitment to open commercial policies, the launching of the AEC would never have been possible. Still, diversity in the region will continue to lead to problems in terms of the comprehensiveness of liberalization. This difficulty was borne out in the creation of AFTA and in subsequent disputes regarding exclusion lists, which are no doubt responsible in part for a less than stellar performance of AFTA to date (as indicated by a low level of utilization rates). Diversity could also be problematic in terms of the AIA, especially with respect to inclusion lists and the degree of liberalization. As is discussed more at length in the next Part, the AIA does provide for a “negative list” approach to FDI and there is a common “General Exclusion List”. However, to some degree the “temporary exclusion lists” and to a greater extent the “sensitive lists” vary across countries.18 Moreover, the trade-investment link 18 For

example, with respect to sensitive lists in manufactures, some ASEAN countries keep some industries closed but others do not. There is more consistency in the nonmanufactures sector but there is still considerable diversity (data provided by the ASEAN Secretariat, ASEAN Investment Area Publication Series 1 and 2).

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would suggest that diversity in trade patterns as well as diversity in FDI structure could be pertinent in advancing ASEAN investment and industrial cooperation. In this section, we attempt to measure diversity by using the same technique Spearman Rank Correlation Coefficient (SRCC) developed in Section 2. However, rather than looking at changes in the structure of FDI in the various ASEAN Member Countries over time (as an indicator of dynamism), in this section we focus on the degree of competitiveness (or similarity of structure) in terms of trade19 and then investment. 4.1. Competitiveness in Terms of Trade In this section we estimate the degree to which the original ASEAN countries compete with each other in OECD markets. As noted above, we again use the SRCC approach. However, in this case, we are comparing the structure of exports of ASEAN Member Countries to OECD markets, which are by far the most important to ASEAN exporters. In this exercise, we rank the structure of exports to these markets and calculate the SRCC. We choose two years to do this: 1995 and 1999, which gives some idea of changes over time. Finally, we also include Chinese exports to capture whether or not the Chinese Competitive Threat actually is in evidence with respect to trade (we found this not to be the case with above respect to FDI). If there is little export overlap, then it may well be that the Chinese Threat is exaggerated. To begin, we rank exports at the 5-digit SITC level (2881 commodities) for Indonesia, Malaysia, the Philippines, Singapore, and Thailand and China to the OECD and US markets for these two years. The results are presented in Table 4.6. Singapore has by the far the lowest SRCCs, indicating that its export structure does not compete much with other ASEAN countries in the US and OECD markets. With respect to the other ASEAN countries, the SRCCs fall in the 0.17 (Malaysia-Philippines, 1995) to 0.277 (IndonesiaThailand, 1999) range. While we have no yardstick by which to deem what constitutes a “high” SRCC and a “low” SRCC, these values suggest that there is not a great deal of overlap across countries. However, it is noteworthy that competition between Malaysia and the Philippines in the US market has been rising over time, while there has been less overlap between the Philippines and Indonesia. Competition between Thailand and the 19 These

estimates in terms of trade are taken from Naya and Plummer (2005). FDI SRCCs are original to this study.

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Table 4.6. Correlation of ASEAN-5 Exports to US and OECD Markets. (Spearman Rank Correlation Coefficients, 5-Digit SITC, 1995 and 1999). Indonesia

Malaysia

Philippines

Thailand

Singapore

— —

0.2460 0.2128

0.201 0.268

0.21 0.277

−0.112 −0.15

0.2460 0.2128

— —

0.191 0.174

0.187 0.199

0.174 0.203

0.201 0.268

0.191 0.174

— —

0.263 0.231

−0.105 −0.081

0.21 0.277

0.187 0.199

0.263 0.231

— —

−0.024 −0.006

−0.112 −0.15

0.174 0.203

−0.105 −0.081

— —

0.151 0.100

0.128 0.091

0.2206 0.2093

0.151 0.100

— —

0.13 0.092

0.247 0.229

0.114 0.162

0.128 0.091

0.13 0.092

— —

0.25 0.277

−0.123 −0.094

0.2206 0.2093

0.247 0.229

0.25 0.277

— —

−0.041 −0.229

a. US Market Indonesia 1999 1995 Malaysia 1999 1995 Philippines 1999 1995 Thailand 1999 1995 Singapore 1999 1995 b. OECD Market Indonesia 1999 1995 Malaysia 1999 1995 Philippines 1999 1995 Thailand 1999 1995

−0.024 −0.006

— —

−0.172 −0.177

Notes: 1. All SRCC estimates are statistically significant at the 99% level. 2. Additional OECD Markets are available from the authors upon request. Source: OECD, International Trade Statistics, 2003; Naya and Plummer (2005).

Philippines has risen and is relatively high, but it has fallen with respect to Malaysia and Indonesia. Regarding ASEAN exports to the OECD as a whole, the same general picture emerges, with a few exceptions. First, Singapore continues to have the lowest SRCCs in ASEAN. Moreover, even for the other pairs of countries, the SRCCs tend to be even somewhat lower than in the US case, with a range of 0.09 (Malaysia-Philippines, 1995) and 0.277 (Philippines-Thailand, 1995). Second, an upward trend in competition is more in evidence in the

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OECD market; with the exception of competition with Singapore and all its partners and between the Philippines and Thailand, all SRCCs actually rose over this time period for the ASEAN countries. Thus, while ASEAN export overlap in the US and OECD markets depends on the pairs of countries being considered, in general it is not exceptionally high. However, exports structures are becoming more similar over time. As the lion’s share of exports in the case of Singapore, Thailand, Malaysia and the Philippines is in the general area of electronics, it is likely that this similarity will continue to rise (i.e., diversity will fall). What about the Chinese Competitive Threat? As a last exercise, we consider the correlation of our selected (original) ASEAN Member Country exports and those of China. In addition to the overall OECD market and the United States, we also include the EU, Japan and Korea. The results are presented in Table 4.7. Table 4.7. Correlation of Chinese and Selected East Asian Exports to OECD Markets. (Spearman Rank Correlation Coefficients, 5-Digit SITC, Selected Years). Thai

Singapore

Philippines

Malaysia

Indonesia

Korea

Taiwan

OECD 1999 1997 1995

0.446 0.421 0.379

0.254 0.212 0.189

0.443 0.403 0.369

0.355 0.312 0.276

0.363 0.35 0.337

0.349 0.322 0.318

0.473 0.428 0.408

US 1999 1997 1995

0.400 0.419 0.401

0.107 0.105 0.101

0.362 0.406 0.369

0.279 0.312 0.317

0.3 0.324 0.404

0.227 0.215 0.268

0.438 0.435 0.427

EU 1999 1997 1995

0.307 0.305 0.294

0.118 0.077 0.047

0.352 0.318 0.327

0.214 0.198 0.200

0.241 0.236 0.224

0.148 0.131 0.135

0.336 0.296 0.289

Japan 1999 1997 1995

0.305 0.300 0.269

0.039 0.065 0.010

0.262 0.308 0.332

0.135 0.187 0.094

0.258 0.312 0.32

0.247 0.235 0.225

0.21 0.214 0.183

Korea 1999 1997 1995

0.131 0.111 Insign

0.396 −0.079 −0.224

0.127 0.181 0.123

0.041 0.02 −0.159

Insign 0.144 Insign

NA NA NA

Insign Insign −0.138

Note: All coefficients are statistically significant at the 99% level unless specified as insignificant (Insign). Source: OECD, International Trade Statistics, 2003; Lee and Plummer (2004).

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Unlike the case of FDI, in many ways the results are surprising and do not assuage the ASEAN fears of the Chinese Threat. Relative to intraASEAN competition in OECD markets (Table 4.6), the SRCC values are high and tend to be growing over time in most markets. In fact, for the OECD as a whole, Chinese export overlap is rising for every country, while in the case of exports to the United States and other main OECD markets, the picture is mixed. The only exception to this result is the case of Singapore, which has very low overlap with Chinese exports in the OECD markets. 4.2. Competitiveness in Terms of Foreign Direct Investment Inflows As is well documented in the literature, MNCs can often account for a majority of a country’s exports in an outward-oriented economy. It is estimated that fully two-thirds of China’s exports, for example, are undertaken by MNCs. This explains why rapid growth in exports has been accompanied by rapid growth in imports as well. China is now Japan’s largest market, having surpassed the United States. Much of this trade is intra-firm MNC trade. The same is true in ASEAN, particularly in the electronics sector. Therefore, we would expect that the similarity in the structure of trade across the ASEAN countries should also be reflected in the distribution of FDI. Of course, it is easier to estimate trade correlations, with details on almost 3,000 commodities used in the previous section (and even more would be possible, theoretically). But FDI information is far less available to the public (as well as to governments). Somewhat disaggregated data are available (e.g., 25 sectors, if one is lucky) but these data tend to be spotty and can frequently be censored by the public authorities due to privacy issues. For example, the OECD publishes a rich dataset of the FDI inflows and outflows of OECD countries by direction (i.e., source country in the case of inflows and recipient country in the case of outflows) and a fair number of sectors (up to 25 in most cases), but it does not have information on both. That is, we know how much the United States invested in Indonesia in 2003, and we know how much of US FDI overall outflows were in electronics, but we do not know how much the United States invests in the Indonesian electronics sector through that publication. We can receive more information on that from US sources (the Bureau of Economic Analysis) but the data are far more aggregated (and often are unavailable due to “disclosure” concerns). Moreover, referring to individual country sources runs

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into the problem of the compatibility of the data and the fact that even many developed countries do not offer much in terms of FDI data.20 Thus, while we expect that FDI structural changes and competition across ASEAN countries would commensurately follow trade changes, we cannot exactly replicate the process in the same way that we did for trade. However, UNCTAD does publish relatively detailed (actual) FDI data by year and country. Using these data, we were able to perform the same structural correlation tests using the SRCC as we did in the case of trade. The number of industries are far less than in the case of trade (usually around 24 sectors per year) but we were able to obtain a smooth time series for most ASEAN countries from 1993–2005. As noted above, yearly FDI data can be unpredictable; hence, rather than highlighting changes by year, we take averages over two periods: preAsian Crisis (i.e., 1993–1997) and post-Crisis (1998–2005). The SRCCs are presented in Table 4.8 for (A) pre-1998, and (B) post-1998. The results are illuminating. Among the original members of ASEAN, Singapore’s structure of FDI was remarkably similar to that of Thailand and Malaysia for both periods. The Singapore-Malaysia SRCC remained high in the two periods, and although the Singapore-Thailand SRCC dropped to 0.62 in the post-Crisis it was still relatively high. A correlation of 0.82 (pre-Asian Crisis) and 0.80 (post-Asian Crisis) in the case of Singapore with Malaysia suggests an almost identical structure, an interesting result if one recalls that Singapore is a city state and Malaysia is a resource-rich country. The same is also true to a lesser degree for the correlations of Thailand and the Philippines with Singapore before and after the Crisis. These results reflect the importance of electronics and other manufactures in the exports of these countries. In the case of Indonesia, FDI structure was positively correlated with that in Malaysia and the Philippines before 1998, but failed to be significant with any other country after 1998. In the case of newer ASEAN members, Myanmar and Vietnam did not have FDI structures similar to that of Singapore before the Crisis. In our results, Myanmar did not have a statistically significantly positive correlation with any other ASEAN country in either period. Apart from a surprisingly significant and positive post-1998 correlation with the Philippines, Vietnam did not have a similar FDI structure with any other ASEAN country in either period. 20 It

is easier to find data on FDI “approvals” rather than actual data, but such an approach is highly problematic: approval data are not good indicators of future FDI, though they may give some indication of the magnitude of sectoral interests with respect to FDI on the part of MNCs.

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Table 4.8. Correlation of the Structure of FDI in ASEAN Countries. (Spearman Rank Correlation Coefficients, Pre-1998 and Post-1998). Indon

Malay

A. Pre-1998 Country Pair Correlation Indonesia Correlation 0.55∗ Observation 17 Malaysia Correlation Observation Myanmar Correlation Observation Philippines Correlation Observation Singapore Correlation Observation Thailand Correlation Observation Vietnam Correlation Observation B. Post-1998 Country Pair Correlation Indonesia Correlation −0.04 Observation 21 Malaysia Correlation Observation Myanmar Correlation Observation Philippines Correlation Observation Singapore Correlation Observation Thailand Correlation Observation Vietnam Correlation Observation

Myan

0.37 6 0.43 6

−0.75 6 −0.06 6

Phil

Sing

Thai

VN

0.53∗ 0.26 0.45 17 16 17 0.53∗ 0.82∗ 0.66∗ 17 18 18 0.20 0.66 0.31 6 6 6 0.58∗ 0.79∗ 16 17 0.84 20

0.48 15 0.33 15 0.26 6 0.48 15 0.29 14 0.47 15

−0.26 −0.17 21 21 0.73∗ 0.80∗ 20 20 −0.03 −0.23 6 6 0.72∗ 20

0.02 −0.05 22 18 0.62∗ 0.29 21 18 −0.29 0.46 6 6 0.74∗ 0.80∗ 21 17 0.62∗ 0.25 21 17 0.37 18

Notes: (1) Cambodia is not present due to lack of data. (2) “ ∗ ” statistically significant at the 95% level or greater. (3) Authors’ calculations. Source: UNCTAD FDI Statistics Database and Japanese FDI Statistics from the Ministry of Finance (viewed October/November 2006).

There were insufficient data for Brunei, Laos, and Cambodia to compute the relevant SRCCs. A repeated theme that emerges from international economic data and studies focusing on international economic integration in Asia in general and ASEAN in particular relates to the electronics sector. The above review demonstrates this; FDI in electronics has become a key area in most ASEAN

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countries, and electronics exports constitute the most important sector in just about all original ASEAN countries and, increasingly, Vietnam. The ASEAN countries have been so focused on developing this sector that, perhaps, it has backfired; the overriding importance of electronics in the exports of the ASEAN countries rendered them vulnerable to changes in the global market in electronics, and the collapse in electronics prices, especially DRAMs, in the mid-1990s was no doubt an important impetus to the Asian Crisis (Grilli, 2002). Clearly there is an important link between trade and FDI in electronics, as well as growth and development in the region. And in this sense it is important to underscore the key role of foreign investors in the process. For example, Tamamura (2002) employs an input-output model to capture the FDI-export link in East Asia and decompose the effect of external demand (by country) on production, using electronics as a case study. He finds that, for 1995 (his latest year), in every country external demand induced more production than domestic demand except in China and (marginally) Indonesia. Most countries followed a similar pattern of internationalization of electronics production. The United States was the most important external source of induced demand in electronics. In fact, in the key cases of Malaysia, the Philippines, and Taiwan, US demand alone was even more important than domestic demand, and in the case of Thailand, they were about the same. In sum, while data restrictions limit the number of sectors we can include in our analysis, what emerges from this exercise is that all the original ASEAN countries received FDI inflows in essentially the same sectors. We noted in Section 2 that this would be mainly manufacturing and financial services; however, within manufacturing itself, there is still considerable overlap. In fact, some of the ASEAN Member Countries even had a higher degree of structural correlation of FDI with each other than they did for their own structure of FDI over time. 4.3. Concluding Remarks While the ASEAN Member countries continue to be diverse in terms of many socio-economic indicators, in terms of trade and especially FDI, there tends to be quite a bit of symmetry, at least for the original ASEAN countries. And this symmetry has been growing over time. These results dovetail with the literature on the symmetry of business cycles, which tends to show that the economic cycles of the ASEAN

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Member Countries are becoming increasingly symmetric. In other words, they are converging. For example, Kim et al. (2003), Bayoumi and Eichengreen (1999) and Bayoumi, Eichengreen and Mauro (1999) use a variety of indicators to gauge the symmetry of business cycles across ASEAN from analysis of intra-regional trade to correlations of aggregate supply shocks. They generally conclude that ASEAN has become increasingly symmetric (they exclude, however, the CLMV countries), even on par with the EU. In the same way that diversity posed certain problems, this economic symmetry bodes well for cooperation. We discuss more of this subsequently in our policy analysis.

5. Review of the AIA The above analysis mainly focused on data analysis. It gave an ex-post assessment of the performance of ASEAN Member Countries in a comparative context from a variety of empirical angles. The results suggest that most ASEAN Member Countries have experienced an impressive recovery in FDI inflows since the Asian Crisis. Moreover, we suggest that regional cooperation can enhance competitiveness for the future. Below, we try to explore why this might be the case by focusing on the review and analysis of region-wide agreements aimed at attracting FDI, in particular the AIA. Before plunging into the qualitative analysis of the AIA, it would behoove us to emphasize a point already made above in terms of the critical importance of national policies affecting FDI. A stable macroeconomic and political environment, market-friendly microeconomic policies in general, trade openness, and liberal FDI-related policies serve as quid pro quo for any effective initiatives at the regional level. They are also essential to the attraction of “high-quality” FDI. As stressed in the introduction to a major empirical study on the economic effects of FDI on development (April 2005): A systematic assessment of previous research suggests that the key [to attracting efficiency-enhancing FDI] lies in how competitive the conditions are into which FDI is introduced — in particular, the extent of openness to trade and investment. The degree of competition in the host economy determines the ability of foreign investors to enhance productivity, introduce new production possibilities, and generate positive spillovers that benefit host economies. (Moran et al. (2005) Does Foreign Direct Investment Promote Development? Institute for International Economics/Center for Global Development, April, p. xi, italics added).

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We argue in this study that ASEAN as a regional organization can do much to support this process of improving productivity and competitiveness. The AFTA, AIA, and the AEC will be instrumental in this regard. However, there is no substitute for economic reform at the national level. As noted above, the AIA was signed on 7 October 1998. The AICO was essentially an interim program in light of changing preferences associated with AFTA and the planned redundancy of the AIJV accord; it continues to play an important role in some sectors — especially auto parts — and likely will continue to do so until AFTA is fully implemented. The AIA was intended to set the stage for a new era in ASEAN investment cooperation, to be implemented in parallel with — and complementary to — AFTA. It took on a special significance when the goal of creating an AEC by 2020, set out in the original ASEAN Vision 2020, was supported by the ASEAN leaders. Not only that, they have decided to speed up the AEC to 2015 in view of what would appear to be pressing factors, including the trend toward bilateral FTAs between ASEAN Member Countries and nonmembers. Some of these FTAs are even “deeper” than AFTA itself. While many FTAs include investment aspects, AFTA does not. Of course, the same is true of other areas as well, such as services and intellectual property protection. Progress made in terms of ASEAN economic integration has not been achieved through a “single undertaking” but rather through progressive separate accords (which is one reason why many of them remain underdeveloped). The AIA is intended to cover the investment side, presumably until a more comprehensive approach can be taken under the rubric of the AEC. In the AIA, ASEAN leaders explicitly set the objective of the AIA to “make ASEAN a competitive, conducive and liberal investment area” through the following measures (in what follows, we paraphrase aspects of the agreement for simplicity): (a) implementing coordinated ASEAN investment cooperation and facilitation programs; (b) implementing a coordinated promotion program and investment awareness activities; (c) “immediate opening up of all industries for investment”, with a negative list composed of a Temporary Exclusion List (TEL) and a Sensitive List (SL) (this vocabulary is familiar from the evolution of AFTA) to ASEAN investors by 2010 and to all investors by 2020 (note: this reflects the “open regionalism”, or non-discriminatory aspect of the accord); (d) granting immediate national treatment, subject to the same TELs and SLs, over the same time period; (e) actively involving the private sector in the AIA development process; (f) promoting freer flows of capital, skilled labor,

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professional expertise and technology among the member countries (note: this is essentially the same wording found in the AEC); (g) providing transparency in investment policies, rules, procedures and administrative processes; (h) providing a more streamlined and simplified investment process (note: (g) and (h) are consistent with “best practices” in investment policy); and (i) eliminating investment barriers and liberalizing investment rules and policies in the sectors covered by the AIA. The AIA agreement covers five sectors (manufacturing, agriculture, fishery, mining, quarrying)21 and services incidental to these sectors (hereafter, “Services Incidental”). The original TEL in manufactures was slated to be phased out by January 2003 for the original ASEAN countries and Brunei, whereas the CLMV countries would have until January 2010. The SL would not be phased out but would be reviewed periodically (first review by the AIA Council in 2003); the “General Exclusion List”, or GEL, would be subject neither to removal nor review (the GEL includes sectors having to do with national security, public morals, public health or environmental protection). A ministerial-level ASEAN Investment Area Council was created to oversee the implementation of the Framework Agreement, assisted by the ASEAN Coordinating Committee on Investment (ACCI). The Council has met nine times since the AIA was launched; the most recent meeting took place in Kuala Lumpur, 21 August 2006. The Council statements generally take the form of reviewing FDI performance over the past year, highlighting any special developments, and approving/updating TEL and SLs. It also focuses on how ASEAN might better promote the region as a destination for FDI. Services Incidental are technically included in the AIA, but other services are not. The 2001 Protocol stipulates that Member Countries may include other services if they so agree, but it is not clear that anything has been forthcoming in this area, even if the AIA Council has recognized the importance of services in ASEAN economic cooperation and regional competitiveness. For example, in the “Joint Press Statement of the Sixth ASEAN Investment Area (AIA) Ministerial Council Meeting, Phnom Penh, 1 September 2003”, the Ministers underscore the fact that about 50 percent of inward FDI to the region over the previous two years was in services 21 Obviously, manufacturing will be more sensitive to these factors than natural resourceintensive sectors, for manufacturing investment is relatively footloose but natural resources can be country-specific.

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and they emphasize the need to include such areas as education services, health care, telecommunication, tourism, banking and finance, insurance, trading, e-commerce, distribution and logistics, transportation and warehousing, professional service such as accounting, engineering and advertising. The 2006 AIA Council meeting endorsed the TEL and SL “. . . for the Services Incidental to the Manufacturing, Agriculture, Fishery, Forestry and Mining & Quarrying sectors. These, along with the updated TEL and SL for the Manufacturing, Agriculture, Fishery, Forestry and Mining & Quarrying sectors, shall become an integral part of the AIA Agreement”. A decision was made to include Services Incidental in the AIA process, which takes a negative-list approach, and to tackle other services in the context of the ASEAN Framework Agreement on Services (AFAS), which, like the GATS, takes a positive-list approach. Hence, while Services Incidental currently falls under the purview of the ASEAN Chamber of Commerce and Industry (ACCI), other services are being handled by the ASEAN Coordinating Committee on Services (ACCS). Since it is by its very nature more inclusive, a negative-list approach generally tends to be a more effective way of opening up markets and is favored by economists. A positive-list can be cumbersome and may be less inclined to liberalize key sectors. ASEAN’s experience with positive lists in the area of trade, e.g., the original version of the Preferential Trade Agreement (PTA), led to little or no liberalization of intra-regional trade. The three programs described above are contained in Schedules I, II and III of the AIA Agreement. Member Countries submit their action plans taking into account “Individual Initiative” and “Collective Initiative”; these are expected to contribute to achieving the objectives of the AIA. Industries are to be opened up for national treatment and MFN treatment subject to certain conditions and implementation periods. As noted above, each Member is to submit a TEL22 and an SL for industries where it is unable to open up or accord national treatment to ASEAN investors. The TEL is to be phased out by 2010. Vietnam will phase out the List by 2013 and Lao PDR and Myanmar by 2015. As a final point, it is common in other investment agreements that issues related to the protection of FDI, e.g., against expropriation and certain guarantees of fair treatment, are covered. In ASEAN, this has not been the case. Rather, these types of issues are found in the Agreement for 22 The

countries that do not have TEL are: Cambodia, Malaysia, the Philippines and Singapore.

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the Promotion and Protections of Investments (1987), which was amended (slightly) in 1996 with the Protocol to Amend the Agreement for the Promotion and Protections of Investment. The ACIA will integrate these agreements under one accord. However, there continue to exist many Bilateral Investment Treaties (BITs), to which we now turn. 6. Agreements Outside ASEAN Framework: Bilateral Investment Treaties While certainly nothing compared to the FTA zeitgeist in trade policy, the negotiation of BITs has been popular among ASEAN Member Countries, as in much of the rest of the world. There is really no standard BIT framework; the many existing accords vary considerably. The literature distinguishes five main models with regards to FDI (we rank with ascending degree of sophistication)23 : 1. Investment control approach model. This model gives no automatic right of admission or establishment to foreign investors. Governments have a wide range of discretion both in the pre-establishment and post-establishment phase. 2. Elective liberalization model (or otherwise known as the “positive list” or “bottom-up” approach). The host country offers limited rights of establishment to foreign investors in industries or sectors included in a positive list (UNCTAD 2004a, pp. 143–144). As noted above, this type of model is also used by the General Agreement on Trade and Services (GATS) (WTO, 2002b, p. 1, paragraph no. 3). 3. Regional Industrialization Program model. In this model, full rights of entry and establishment are offered based on national treatment for investors from member countries of a regional economic integration organization. 4. Mutual National Treatment Model. All natural and legal persons from member countries of a regional economic integration organization actively engaged in cross-boarder business have full rights of entry and establishment. The main aim is to establish a common regime for entry and admission for investors from member states. The most significant example can be found in The Treaty Establishing the European Community (EC). 23 This

classification is taken from Gugler and Tomsik (2006).

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Articles 52–66 of the EC Treaty ensure that restrictions on the freedom of establishment, or the freedom to supply services, are removed for natural and legal persons possessing EC Member States nationality (Working Paper No 2006/04, page 15). The main distinction between this model and the “Regional Industrialization Program Model” above is that a right of establishment is generally available and is not dependant on the adoption, on behalf of the investors, of a particular form of industrial program or joint enterprise. 5. Combined National Treatment/Most Favoured Nation treatment model (NT/MFN). The NT/MFN approach can be considered the most liberal of all models. Parties must be able to stipulate specific exceptions to the agreement at the moment the treaty enters into force or only a short time after. The National Treatment section of this model prevents the host country from discriminating between foreign and domestic investors (but it does not prevent the host country from prohibiting private investment in certain sectors altogether). The Most Favored Nation section, on the other hand, establishes that foreign investors from one country cannot be more favored than investors from another country. No distinctions in the NT/MFN model are made between the pre-establishment and postestablishment. For example, the general template for US BITs are of this type, even if exceptions can exist. Table 4.9 summarizes the BITs that the ASEAN Member Countries have negotiated. In addition to listing the countries involved in each agreement, the table provides the year the agreement was negotiated as well as when it was implemented. A number of observations are worth noting: First, each ASEAN Member Country has negotiated at least several BITs; all have agreements with both ASEAN and non-ASEAN countries, with the exception of Myanmar, which only has agreements with several ASEAN Member Countries. All the original ASEAN countries have been active in cementing agreements with ASEAN and non-ASEAN countries, though Singapore does not have a BIT with three out of the four other original ASEAN Member Countries. Vietnam has clearly been the most active among the CLMV countries; indeed, it has been more active in this regard than some of the original ASEAN countries. Second, with respect to the substance of the ASEAN BITs, the general template of agreements between ASEAN agreements is virtually the same,

ASEAN Bilateral Investment Treaties.

Thailand Indonesia Malaysia Philippines Singapore

Vietnam Lao PDR Myan Cambodia

2005/. . .

—

2003/03 —

—

2000/01 2003/04

—

—

1995/97 —

2002/04 — 1978/79 — — — 2002/04 2003/04 2000/. . . 1994/95

2003/. . . 1973/75 1976/77 1991/95 1995/97 — 1970/72 2003/. . . 2002/. . . 1998/. . .

1960/63 1975/76 1981/88 1988/90 1995/96 — 1979/82 — 1994/96 1996/1998

1997/2000 1994/96 1980/81 1988/93 1993/94 2002/. . . 1998/. . . — — 1995/96

1973/75 1975/76 1975/75 — — — 1978/80 — — 1995/95

1998/2004 — — — — — — — — —

1993/98 1992/94 2002/. . . 1990/94 — — 1991/99 1996/98 — 1997/98

1996/99 1989/91 1995/95 — — — — — — —

— — — — — — — — — —

1999/00 2000/01 — — — — — — 2001/02 —

1994/96 1991/91 1972/73 1992/93 1993/94 2000/00 2000/02

1996/97 1992/96 1994/95 1992/93 1997/99 — 1992/93

1985/88 1993/95 1971/72 1993/94 — — 1979/79

1998/99 — 1985/87 — — — 1999/. . .

— 1997/99 1972/73 1993/93 — — —

— — — — — — —

1993/96 1994/95 1994/95 1994/94 — — 1993/94

— — 2003/. . . — — — 1996/97

— — — — — — —

— — 2003/. . . — — — —

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OECD US Japan Europe Germany France UK Italy Spain Portugal Belgium/Lux Bulgaria Croatia Czech Republic Finland Hungary Netherlands Poland Romania Slovenia Sweden

Brunei

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Table 4.9.

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Table 4.9.

(Continued )

Thailand Indonesia Malaysia Philippines Singapore Brunei Vietnam Lao PDR

Myan

Cambodia

1997/98 —

— —

— —

1993/94 —

1998/99 —

— —

— —

ASEAN Thailand Indonesia Malaysia Philippines Singapore Brunei Vietnam Lao PDR Myanmar Cambodia

NA 1998/98 — 1995/96 — — 1991/92 1990/90 — 1995/97

1998/98 NA 1994/94 2001/. . . 1990/90 — 1991/94 1994/95 — 1999/. . .

— 1994/94 NA — — — 1992/92 1992/. . . — 1994/. . .

1995/96 2001/. . . — NA — — 1992/93 — 1998/98 2000/. . .

— 1990/90 — — NA — 1992/92 1997/98 — 1996/. . .

— — — — — NA — — — —

1991/92 1991/94 1992/92 1992/93 1992/92 — NA 1996/96 2000/. . . 2001/. . .

1990/90 1994/95 — — 1997/98 — 1996/96 NA 2003/. . . —

— — — 1998/98 — — 2000/. . . 2003/. . . NA —

1995/96 1999/00 1994/96 2000/01 1996/99 — 2001/. . . — — NA

OTHER ASIA China Korea Taiwan

1985/85 — 1996/96

1994/95 2006/06 —

1988/90 2006/06 1993/93

1992/95 2006/06 1992/92

1985/86 2006/06 1990/90

2000/. . . 2006/06 —

1992/93 2006/06 1993/93

1993/93 2006/06 —

2001/02 2006/06 —

1996/99 1997/99 —

OTHER Argentina South Africa India Canada Egypt

2000/02 — 2000/01 1997/98 2000/02

1995/2001 — 1999/2004 — 1994/94

1994/96 — 1995/97 — 1997/. . .

1999/2002 — 2000/01 — —

— — — — 1997/98

— 2000/. . . — — —

1996/97 — 1997/99 — 1997/. . .

— — 2000/03 — —

— — — — —

— — — — — (Continued) 177

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1968/68 1991/94

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— —

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Denmark Norway

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Table 4.9.

(Continued )

Thailand Indonesia Malaysia Philippines Singapore Brunei Vietnam Lao PDR Myan Cambodia — — 2001/. . . 2000/. . . 1992/93

— — 1978/78 — —

— 1997/. . . 1997/99 — —

— — 1978/78 — —

— — — — —

— 1994/96 1992/92 — 1991/91

— 1996/. . . 1996/96 — 1994/95

— — — — —

— — 1996/99 — 2004/. . .

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Notes: 1. The United States of America signed on 25th August 2006 a Trade and Investment framework agreement with all ASEAN countries. The implementation of the agreement was upon signature. 2. “. . .” means that the BIT has not yet entered into force. 3. “— “ no BIT is in place. 4. “NA” = not applicable. 5. The Government of South Korea signed in May 2006 an agreement (FTA) with all ASEAN countries (with the exception of Thailand due to concerns about agriculture). The agreement took effect in July 2006. Source: UNCTAD database 2005, viewed October 2006. http://www.unctadxi.org/templates/DocSearch 779.aspx

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Israel Russia Switzerland Algeria Australia

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even if some emphasize certain areas and principles more than others. Indeed, it would be difficult to place these agreements in the context of the models specified above, as they sometimes have features of two or more categories. Regarding their setup, a section on “the promotion and protection of investment” is present in all agreements, as are sections related to the “Compensation for damages and losses”, “Expropriation”, “Subrogation”, and “Settlement of dispute between investors and the contracting Parties”. In short, many of the issues that are found in the 1987 Agreement for the Promotion and Protections of Investment. Third, it is interesting to note that the “Most favored nation provisions” is only present in some of the BITs (e.g., Indonesia-Cambodia, PhilippinesCambodia, and Indonesia-Vietnam). Inter alia, this Article stipulates that no Contracting Party shall provide better treatment to a non-contracting (third) party than it does to the other Contracting Party in the agreement. This type of approach has been pondered in ASEAN regarding trade agreements. That is, with the rapidly increasing number of FTAs that ASEAN Member Countries are negotiating with non-members, there is the fear that ASEAN economic integration will be diluted. However, this type of agreement between ASEAN countries would ensure that Member Countries would never have deeper relations with non-members. Currently, this certainly is not the case; many of Singapore’s FTAs are “deeper” with non-partner countries than they are with partner countries. Of course, a BIT of this type with a non-partner country would guarantee that the latter would receive MFN as well, thereby profiting from any deeper agreements between ASEAN Member Countries. But frankly this is not a problem for ASEAN investment cooperation; as noted above, the AIA, for example, intends to be non-discriminatory vis-a-vis non-members, even though the timelines for liberalization are sometimes faster for Member Countries. In sum, while there is some variance with respect to the exact details of the BITs that the ASEAN Member Countries have negotiated, and it is, perhaps, a bit difficult to sort them according to a standard classification system, the BITs have revealed themselves to play a role in increasing the protection of FDI in the region. In other words, if the existing accords were thought to be sufficient, there would be no need for bilateral BITs between ASEAN Member Countries. Ideally, the ACIA will render these accords (at least the bilateral ones) superfluous.

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7. Has the AIA Met its Goals? In the above analysis, we were able to show that with respect to FDI, as in the case of trade, ASEAN is a dynamic region, constantly reinventing itself. The structure of FDI flowing into the ASEAN Member Countries has changed considerably for most countries over the past decade. Moreover, the structures appear to be converging, that is, FDI these days tends to flow into the same sectors throughout the region. The same is essentially true (but to a lesser extent) with respect to trade flows. Hence, trade and FDI are becoming more symmetric over time (and the literature has shown that this is also true with respect to macroeconomic variables; the business cycles in the original ASEAN countries are becoming increasingly correlated). Our analysis would suggest that this is encouraging for the future of economic cooperation: while ASEAN is one of the most diverse regions in the world, at least with respect to international economic integration, key variables are lining up. This bodes well for the alignment of both trade and investment policies, which will be necessary if the goals of the AEC are to be reached in 10 to 15 years’ time. The ACIA is designed to abet this process. This is the good news. The bad news is that greater symmetry in trade and FDI structure will no doubt lead to greater competitiveness in terms of policy initiatives, and in the political realm makes investment cooperation all the more difficult. This problem has manifested itself frequently, from negotiations with the Dialogue Partners to positions at the WTO: ASEAN needs to be more cohesive. For example, ASEAN organized in 2000 the “ASEAN Road Show”, which involved inter alia key ASEAN government officials going to major global cities to promote investment in ASEAN countries. This appeared to be a great success in increasing interest in the region. However, there were problems in that: (1) the representation of ASEAN Member Countries varied greatly; (2) participants promoted their own countries, rather than ASEAN as a region; and (3) though a success, the ASEAN Road Show has never been repeated. This sort of enterprise is exactly the type of activity that could make a big difference in promoting FDI in ASEAN, if done correctly. Our qualitative analysis above revealed that the AIA is an open, liberal framework agreement and is a promising document upon which to build the investment-related pillar of the AEC. Moreover, it is a relatively new agreement that now appears to be picking up steam, with momentum provided by the AEC. Certain aspects of investment cooperation obviously need to be tightened up — as suggested by the numerous BITs that have

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been negotiated between ASEAN Member Countries — but on the whole the agreement presents an excellent example of an investment accord based on the principles of open regionalism. The trick will be to make sure that the negative lists remain short and that the national treatment commitment in the AIA be respected in practice. Hopefully, once the details of the ACIA are revealed, this will be the case. Of course, constructing an open regional investment regime based on national treatment and efficiency is much easier to do on paper than it is to implement in practice, particularly given the nature of institutional diversity across the ASEAN Member Countries. The AIA was signed only eight years ago; it took the EU over four decades to remove (just about) all bottlenecks to intra-regional FDI. Hopefully, this will not be the case in ASEAN, particularly since all Member Countries would generally like to move in the same direction. Nevertheless, more should be expected after almost eight years; the EEC essentially had a common FDI Framework including national treatment as soon as it was launched in 1958. True, the EEC was a “customs union plus” while AFTA and the AIA have not reached that level of integration yet. But ASEAN will have to approach that degree of integration — perhaps even having “deeper” provisions in certain areas — if the AEC is attain its goals. And the AEC process itself is imposing an expedited timeline. After all, 2015 is only seven years away. Our empirical work and most of our policy analysis would suggest that ASEAN still has a long road to travel before the AEC can become a reality. But timing will matter. Rome was not built in a day; regional economic integration takes time to affect the private sector. For example, the EU Single Market Program that began in 1986, known as “EC-92” because it was supposed to be completed by the end of 1992,24 also took time to have a significant effect on business. The European Commission estimates that since 1992, the common market launched by EC-92 has created 2.75 million additional jobs and has increased regional output by 2.2 percent.25 This is a significant effect that was well worth the investment, but note that this boost to the economy took place after the Single Market was in place. Politically, the Single Market continues to be highly popular in Europe (though this is not the case for the monetary union, i.e., the euro). In sum, the AIA has, indeed, likely been an important instrument contributing to ASEAN’s FDI performance. However, the AIA is a necessary 24 In effect, the vast majority of the directives were only in effect in all EU Member Countries in 1994, and some areas continue to be problematic. 25 The Economist, (24 February 2007). “Charlemagne: Singling out the Market”, p. 34.

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but not a sufficient condition to create an attractive region for multinational corporations to take advantage of an efficient “production fragmentation” process and a vertical division of labor: it will also be necessary to improve and, where appropriate, align domestic (microeconomic) policies and measures applied to FDI. We noted that the investment-related policy environment in the ASEAN continues to be highly asymmetric. While it would be unreasonable to expect that any harmonization through ASEAN cooperation could lead to a completely symmetric regime (after all, the framework affecting FDI at the national level even in the EU continues to reflect considerable diversity), there is ample room for harmonization. Given that ASEAN includes among its members some of the most liberal and successful investment regimes in the world, aligning investment policies according to best practices should be easier. Harmonization of national policies and more comprehensive measures at the regional level will no doubt facilitate the attainment of the ACIA/AEC objectives.

Appendix A Gravity Model of FDI: Has the AIA had a Significant Effect? As noted in the text, in this gravity model we posit FDI to be a function of: (1) the product of GDP of the source and partner country, which we call size ; we expect size to be positively correlated with FDI, due to economies of scale and market size, (2) the product of per capita income of the source and partner country, which we call wealth, we expect wealth to also be positively correlated with FDI,26 (3) the distance between the two countries, which is both a proxy for transportation and other “costs”; these costs can either work in favor of FDI or against it (and, therefore, we are not able to say a priori whether or not this should be positive or negative),27 (4) given the strong theoretical arguments supporting the trade-investment link, we also include bilateral trade as an explanatory variable, and, (5) in order 26 Modern international trade theory suggests that per capita income between countries is correlated positively with trade. 27 This expectation is less clear in the case of FDI than, say, for trade, as it may be that in the context of high transportation costs that a firm will choose to locate abroad in order to reduce them. However, to the extent that greater distance will most likely be correlated with higher information costs associated with learning about the country (countries that are further away are more “foreign”), the coefficient could be negative.

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to test the hypothesis that the region really makes a difference, we add a regional dummy variable for relevant regional groupings, including ASEAN. If ASEAN has been an important positive attraction for, say, US firms above and beyond what wealth, distance and size would suggest, the result will be a positive (and statistically significant) coefficient on the ASEAN binary variable. As a first attempt, we endeavor to capture the key variables using the United States, selected key European countries (namely, the United Kingdom, France, and Germany), and Japan as the source countries. As is clear from Table 4.3, the United States is the single most important source of FDI to ASEAN countries and, hence, it is a logical candidate. The EU as a region is an even larger investor than is the United States, but while using aggregate EU numbers would be possible, we opted to separate out main FDI source countries, as many EU Member Countries do not invest much in ASEAN.28 Finally, we also include Japan, which is the third largest investor in ASEAN behind the United States and the UK (Table 4.3). We use outward FDI data flows to 125 host countries (depending on data availability), including the original ASEAN countries, generally over a 13-year period, i.e., 1991 to 2004. This period essentially covers the seven years preceding the signing of the AIA in 1998 and the first six years of its implementation. Regressions are run on host country-annual combinations yielding 659 observations for the United States; 695 for the UK; 1568 for Germany; 1244 for France; and 493 for Japan.29 Annual dollar outflows of FDI is the dependent variable, while the independent variables (aside from a constant) are the ones described above. We have added the following binary variables to represent four regional groupings as follows: North American Integration: 1991: zero for all host countries. 1992: one for Canada and the USA; zero otherwise. 1993–2004: one for Canada, the USA, and Mexico30 ; zero otherwise.

28 Moreover, imposing the restriction that FDI from all EU countries are affected in the same way is probably unwise, given the differing FDI traditions, economic and political relationships, fiscal regimes, etc., that continue to exist in the EU. 29 Natural numbers were used. We experimented with logarithmic transformation, but did not obtain satisfactory estimates. 30 NAFTA did not come into effect until 1994. However, we try to capture an anticipatory effect here, as suggested by Freund and McLaren (1999).

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EU Integration: 1991: zero for all host countries. 1992–1994: one for the EC-12; zero otherwise. 1995–2004: one for the EU-15; zero otherwise. ASEAN (5 countries): 1991: zero for all host countries. 1992–2004: one for the ASEAN-5 members; zero otherwise. These dates are chosen according to various phases of formal regional cooperation. This means that for the case of ASEAN, our breakpoint is the year when AFTA was signed. Appendix Table presents the results. The R2 of the regressions, i.e., the percentage of the variance in the dependent variable explained by the independent variables, ranges between 18 and 31 percent (on par with other Appendix Table Determinants of Outward FDI from Major OECD Economies: United States, United Kingdom, Germany, France, and Japan.

Size Wealth Distance Trade EU NAFTA ASEAN Constant Observations R-squared

US

UK

Germany

France

Japan

−0.016 (0.038) 2.399∗∗ (0.510) −0.072 (0.057) 0.044∗∗ (0.009) 2,000∗∗ (392) 1,422 (1,415) 629 (659) 253 (501)

0.478+ (0.279) −1.399 (1.565) −0.016 (0.097) 0.344∗∗ (0.059) −1,174 (1,054) 2,553 (1,590) −30 (1,176) −217 (756)

0.888∗∗ (0.072) −1.299∗ (0.519) −0.059∗ (0.027) 0.014 (0.015) 1,056∗∗ (362) 1,416∗ (613) 306 (409) 404∗ (200)

0.448∗∗ (0.075) 0.366 (0.412) −0.026 (0.022) 0.107∗∗ (0.013) 254 (283) 1,286∗∗ (455) 124 (314) 43 (162)

0.207∗∗ (0.025) 0.388 (0.267) 0.045 (0.030) 0.066∗∗ (0.012) 348 (225) 451 (396) 631∗ (296) −827∗ (357)

659 0.31

695 0.18

1568 0.23

1244 0.28

493 0.61

Note: Standard errors in parentheses. ∗∗ = statistically significant at the 99% level and above. ∗ = statistically significant at the 95% level and above. + = statistically significant at the 90% level.

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models of this sort) for all source countries except Japan, whose R2 is an exceptionally high 63 percent.31 The size variable yields positive estimates as expected for the UK, Germany, France, and Japan. For the US, size has a negative estimate, but it is not statistically significant. The estimates on wealth are mixed in terms of the signs, although theory predicts that these would be positive. The estimates on distance, except for Japan, are negative, which is consistent with the idea that more “foreign” countries are less likely to receive FDI because of information costs. This result suggests that transport costs or other trade costs, as captured by the distance variable, may have little influence on FDI outflows, particularly relocation activity. The trade variable is positively estimated in all regressions, and it is highly significant for the US, UK, France, and Japan. It should be noted, however, that this type of regression does have what econometricians would call “multicollinearity” problems; in this case, the wealth and size variables are known to be important determinants of trade as well. Hence, trade may be picking up the effects of size and wealth. It is also the case that we have a “simultaneity” problem; as discussed above, trade might cause FDI but it may also be that FDI causes trade.32 Still, for our purposes, the important point is that trade is definitely an important factor in the determinant of FDI outflows. With respect to the regional binary variables, North American integration appears to have contributed positively to FDI outflows from all five source countries, although these positive estimates are significant for only Germany and France. The binary variable of the EU, which over the period of the regression deepened integration significantly by putting in place a common market that included free capital flows along with national treatment of FDI in almost all sectors, is statistically significant and positive for the United States and Germany but is actually negative (UK) or insignificant for the other countries. Still, this is not surprising, given the potential “Dunning-Robson” effect discussed above. That is, given the process of creating a border-free environment in the EU, it may be that EU member states may or may not increase FDI outflows to partner countries. Non-partners, however, would unambiguously increase outflows to the region, which is what we see in the case of the United States.33 The ASEAN 31 See,

for example, Lee and Roland-Holst (1999). confirm this by estimating Granger causality tests (not shown). 33 The EU binary variable for Japan’s regression is more difficult to explain, except that the EU is far less important to Japanese FDI outflows than its investments in the United States and other Asian countries. 32 We

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binary variable shows a positive and statistically significant estimate (at the 5 percent level) for Japanese FDI outflows. However, the ASEAN variable is statistically insignificant from zero at any reasonable level of confidence (and negative) for the other source countries, which individually and together represent larger sources of FDI for ASEAN. This would suggest that ASEAN has essentially had no effect on FDI outflows from the US, UK, Germany, and France despite AFTA and existing industrialcooperation programs. To summarize, this gravity exercise would suggest that: (1) trade matters; and (2) regional cooperative programs in ASEAN have had an effect on the attraction of Japanese FDI but no effect on most OECD FDI flows into the region. To answer the question of whether the AIA has had an impact on FDI flows to the ASEAN region, we conduct Chow tests on the gravity model for each of the five source countries. The Chow tests are essentially a means to see if there have been significant changes in the gravity model’s parameters after 1998, which is the year the AIA was signed. The results for the Chow tests reject the hypothesis that 1998 was the year of a structural break, implying that the AIA did not play a significant role in explaining post-1998 FDI flows to ASEAN countries. Instead of assuming that the structural break took place in 1998, we use the Chow tests to find a candidate year that was pivotal in changing FDI flows to ASEAN within our sample period (1991–2004). The test results reveal that there were no structural breaks in any particular year during our sample period. We therefore infer that, after accounting for the other determinants in the gravity model, FDI flows to ASEAN were not influenced by any ASEAN institutional development from 1991 to 2004. This is not to say that the AIA is ineffective, but only that its effects are still to be observed.

References Bayoumi, T. and Eichengreen, B. (1999). Is Asia an Optimal Currency Area? Can It Become One? Regional, Global, and Historical Perspectives on Monetary Relations. In Exchange Rate Policies in Emerging Asian Countries, Collignon, S., Pisani-Ferry, J. and Park, Y.C. (eds.), pp. 347–367. London: Routledge. Bayoumi, T., Eichengreen, B. and Mauro, P. (1999). On Regional Monetary Arrangements for ASEAN. Prepared for the ADB/CEPII/KIEP Conference on Exchange Rate Regimes in Emerging Economies, Tokyo.

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Brainard, S.L. (1992). A Simple Theory of Multinational Corporations and Trade with a Trade-off between Proximity and Concentration. MIT Sloan School Working Paper No. 3624–93-EFA. Buckley, P.J. and Casson, M. (1976). The Future of Multinational Enterprise. London: Macmillan. Busakorn, C., Fung, K.C., Iizaka, H. and Siu, A. (2005). The Giant Sucking Sound: Is China Diverting Foreign Direct Investment from Other Asian Countries? Asian Economic Papers, 3(3), pp. 122–140. Stanford University: Stanford Center for International Development. Cassidy (2005). Foreign Direct Investment Determinants and Policy Options for ASEAN Countries. Paper prepared for the State Department/USAID Technical Assistance and Training Facility at the ASEAN Secretariat. Dunning, J. and Robson, P. (eds.) (1988). Multinationals and the European Community. Oxford: Blackwell. Frankel, J. (1997). Regional Trading Agreements in the World Economic System. Washington, DC: Institute for International Economics. Freund, C.L. and McLaren, J. (1999). On the Dynamics of Trade Diversion: Evidence from Four Trade Blocs. International Finance Discussion Papers. No. 637. Grilli, E. (2002). The Asian Crisis: Trade Causes and Consequences. World Economy, 25(2), pp. 177–207. Gugler, P. and Tomsik, V. (2006). The North American and European Approaches in the International Investment Agreements. NCCR Trade Regulations, Working Paper No. 2006/04. Horstmann, I. and Markusen, J. (1992). Endogenous Market Structure in International Trade. Journal of International Economics, 32, pp. 109–129. Kim, S.H., Kose, M.A. and Plummer, M.G. (2003). Dynamics of Business Cycles in Asia: Differences and Similarities. Review of Development Economics, 7(3). Kojima, K. (1974). A Macroeconomic Approach to Foreign Direct Investment. Hitotsubashi Journal of Economics. Kreinin, M.E. and Plummer, M.G. (2003). Effects of Regional Integration on DFI: An Empirical Approach. Paper presented at the American Economic Association meetings, Washington, DC. Lee, H. and Roland-Holst, D. (eds.) (1999). Economic Development and Cooperation in the Pacific Basin: Trade, Investment, and Environmental Issues. Cambridge: Cambridge University Press. Lee, C. and Plummer, M.G. (2004). Economic Development in China and Its Implications for East Asia. Working paper, Manoa: University of Hawaii. Lizondo, S.J. (1991). Foreign Direct Investment. In Determinants and Systemic Consequences of International Capital Flows. International Monetary Fund (ed.), pp. 68–82, Washington, DC: IMF. Moran, T.H., Graham, E.M. and Blomstrom, M. (2005). Does Foreign Direct Investment Promote Development? Washington, DC: Institute for International Economics and the Center for Global Development. Naya, S.F. and Plummer, M.G. (2005). The Economics of the Enterprise for ASEAN Initiative. Singapore: Institute of Southeast Asian Studies.

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Naya, S.F. and Plummer, M.G. (1989). UNDP-ASEAN Private Sector Seminar: Enhancing the Role of the Private Sector in ASEAN Economic Cooperation. New York: United Nations, November. Petri, P.A. and Plummer, M.G. (1999). The Determinants of U.S. Investment Abroad: Evidence of Trade-Investment Linkages. In Economic Development and Cooperation in the Pacific Basin: Trade, Investment, and Environmental Issues, Lee, H. and Roland-Holst, D. (eds.), pp. 233–250, Cambridge: Cambridge University Press. Plummer, M.G. (2006). The ASEAN-EU Economic Relationship: Integration and Lessons for the ASEAN Economic Community. Journal of Asian Economics, 17(3), pp. 427–447. Rose, A.K. (2004). Do We Really Know that the WTO Increases Trade? American Economic Review, 94, pp. 98–114. Tamamura, C. (2002). Structural Changes in International Industrial Linkages and Export Competitiveness in the Asia-Pacific Region. ASEAN Economic Bulletin, 19(1), pp. 52–82. UNCTAD (2004). International Investment Agreements: Key Issues, I. New York and Geneva: United Nations. Vernon, R. (1966). International Investment and International Trade in the Product Cycle. Quarterly Journal of Economics, 80. World Bank (2007). Doing Business 2007. World Bank, IFC: Oxford University Press. http://www.worldbank.org. World Bank (2006). Doing Business 2006. World Bank, IFC: Oxford University Press. http://www.worldbank.org. World Bank (2005). Doing Business 2005. World Bank, IFC: Oxford University Press. http://www.worldbank.org. WTO (2002). WT/WGTI/W121: Concept Paper on Modalities of Preestablishment Communication from the European Community and its Members. Geneva: World Trade Organization.

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Chapter 5

Bond Market Development and Integration in ASEAN

1. Introduction All countries of ASEAN, from the most to the least developed, have been working diligently to enhance the strength, efficiency, and depth of their financial systems. Development of the financial sector has been a salient policy goal of most member states at least since the mid-1980s, but the urgency and determination with which ASEAN governments have focused on capital-market reform has increased dramatically with the advent of the Asian Crisis in July 1997. ASEAN leaders now place financial reform among their most important and pressing economic policy goals. The current 2008 global financial crisis enhances the urgency to improve financial structures and markets. Since the financial systems of all ASEAN countries are mainly based on banking, reform in this area has been the most crucial, especially because it was the banking sector that bore the brunt of the financial crisis. Over the past few years, Crisis-affected ASEAN countries have been struggling with the challenges of debt resolution in general — especially with respect to non-performing loans (NPLs) — recapitalization of banks, financial reforms to improve efficiency and reduce systemic risk, and the implementation of more effective monitoring and surveillance systems. ASEAN countries have chosen different ways to deal with the overhang of problems from the Crisis, but all have endeavored to tackle shortcomings as directly as possible and with the view of achieving long-run, sustained and sustainable economic development. As part of the financial reform program, ASEAN countries have been trying to diversify their heavy reliance on the banking sector in favor of other financial intermediation vehicles, including equity and fixed-income markets. It is only natural for banks to play an even more central role 189

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in developing countries than they do in developed countries. The information asymmetry that exists between borrowers and lenders, with borrowers having much more information than lenders, is more pronounced in the case of developing countries, and this constitutes one reason why banks need to play a prominent role especially at the early stages of development.1 Moreover, given the economies of scale related to fixed income and equity markets and complications related to enabling financial infrastructure,2 diversification of capital markets can be difficult. However, a one-pillar, bank-dominated financial system holds many risks, including possible efficiency losses and increased systemic risk. Importantly, it limits the way in which a financial system can price risk efficiently, and reduces the options open to investors and borrowers. Hence, while one would always expect the banking sector to assume a key financial intermediary role in the ASEAN countries, and fostering its health should be a perpetual priority, the development of alternative markets could be extremely important for the long-run growth and development of the financial sector, as well as the entire economy. Therefore, ASEAN’s greater emphasis on the development of equity and bond markets is not only appropriate but essential. This study focuses on developing the ASEAN Bond Market, for both sovereign/quasi-sovereign debt and corporate debt. It is the fixed-income counterpart to Chapter 6, which focuses on equity markets. We define “regional” bond markets to include development of the individual markets as well as a regional market through which cross-border issuances could be feasible. Arguably, a study on an ASEAN regional market could not be done any other way. Many individual bond markets in the region continue to be in a state of infancy or adolescence; only Singapore is classified by the experts as having a world-class bond market in which investment banks, multinational corporations, and regional development banks consistently raise capital in local currency. And even in the case of Singapore, some restrictions persist and initiatives are underway to improve liquidity in the secondary market. Before a vibrant regional market can be developed, 1 As markets develop, information becomes more open and standardized, and financial systems become more transparent, this asymmetry becomes less important and development of other forms of finance, more appropriate. 2 For an example of such constraints in the context of the Philippines bond market, whose Securities and Exchange Commission is the second oldest in the world — established in 1936, only two years after the US Securities and Exchange Commission — see Syquia, J. T. (undated). Trends and Developments in Enforcement in Emerging Equities Markets. Mimeograph. Manila: Asian Development Bank.

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a good deal of deepening in individual markets, as well as harmonization, must be pursued. The remainder of the paper is organized as follows. Section 2 considers bond-market potential in the ASEAN countries, followed in Section 3 by an analysis of bond-market cooperation in ASEAN to date. We give a brief survey of characteristics of the member state bond markets in Section 4 and analyze potential benefits through interest-rate convergence (Section 5) and development of most efficient bond markets based on best practices (Section 6). Section 7 focuses on a salient problem in developing national and a regional bond market: liquidity. Finally, Section 8 summarizes the case for regional and local bond-market development.

2. Bond-Market Potential in ASEAN: Supply, Demand and Institutional Considerations Bond markets globally have been growing at an impressive rate. According to Merrill Lynch, the size of the world bond market at the turn of the century was US$31 trillion, about 98 percent of global GDP, up from 60 percent in 1990.3 Much of this increase is due to robust growth in the corporate bond market, especially since the United States turned its large deficit in the 1980s and early 1990s into a large surplus in the late 1990s and 2000, and Europe has been fiscally conservative (in the main led by Maastricht Treaty-related exigencies). Of course, in the 2000s, the trend changed: since 2002, the United States has accumulated budget deficits of about $2 trillion. The Economic Report of the President 2008 estimates that this accumulated deficit will rise to about $2.5 trillion by the end of the 2009 fiscal year. Since this report was published in early 2008 (that is, before the 2008 financial crisis broke out in September and consequent estimates of a global slowdown and massive US fiscal spending to bolster markets) it is a strong understatement: most likely the accumulated deficits of the last two Administrations will come to at least $3 trillion, better than doubling the value of US government debt held by the public. Overall, at the end of the 20th Century, the aggregate size of developing Asian bond market came to US$722 billion, a large figure but quite small compared to the global market (about two percent). In ASEAN over the period 1990–1999, the share of corporate bonds in local markets rose from 3 Merrill

Lynch (2000). Size and Structure of the World Bond Market 2000.

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38 percent to 61 percent in the Philippines, 17 percent to 44 percent in Malaysia, 10 percent to 27 percent in Thailand, 0.4 percent to six percent in Indonesia, and one percent to 26 percent in Singapore. However, large and rising budget deficits since the Asian Financial Crisis, plans for infrastructural investment, and difficulties in stimulating corporate interest in bond issuances will likely allow sovereigns to hold their share of national fixed-income markets in the short- and medium-term. The position of the bond market relative to bank assets and stock market capitalization prior to the Asian Crisis was quite limited. As a percentage of GDP, bank assets, stock-market capitalization, and the bond market constituted, respectively 57 percent, 30 percent, and seven percent in Indonesia; 100 percent, 283 percent, and 56 percent in Malaysia; 54 percent, 87 percent, and 39 percent in the Philippines; 186 percent, 217 percent, and 72 percent in Singapore; and 110 percent, 94 percent, and 10 percent in Thailand.4 Since the Crisis, with the collapse of stock markets and the banking crisis, the bond market has, in relative terms, taken on a much more important role. And especially over the past two years, national monetary and financial authorities, ASEAN Finance Ministers, and APEC Finance Ministers have all underscored the important potential for bond-market development in the region. It may be useful to consider market growth from three perspectives: the supply, demand, and institutional aspects of financial markets. First, ASEAN countries have generally had high savings rates, at least compared to other developing countries. Before the Asian Crisis, with the exception of the Philippines, the savings rates of the ASEAN-5 were all higher than 30 percent of GDP. Even the transitional economies have high savings rates if adjusted for their low-level of per capita income; savings as a percentage of GDP in Myanmar and Vietnam in 1997 were 14.6 percent and 17 percent respectively. These relatively high savings rates apply not only to household but also government savings. Prior to the Asian Crisis, ASEAN governments had overall reduced public dis-savings considerably, to the point that many of the Crisis-affected countries actually had surpluses prior to July 1997. Given the region’s growth prospects, demographics, institutional characteristics, and savings behavior, it is likely that this supply of savings will continue to be huge over the long term. 4 Dall,

I. and Khatkhate, D. (1996). The Emerging East Asian Bond Market, Finance and Development, pp. 11–13.

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So where have these savings been going? Before the Crisis, a large share was invested in speculative markets such as real-estate ventures. A considerable amount also went overseas, especially to the United States but also to Europe, and only to come back to Asia in the form of short-term bank lending. The lack of financial instruments and capital-market information reduced the options offered to savers in Asia, be they households or institutions such as pension funds. The highly developed financial markets outside the region made it all too easy to avoid the hard choices and institutional reform needed to rectify this. This created an exposure of another kind: the capital-market implosion in the United States and EU (not to mention the crisis in Japan) in 2000 hurt significantly the financial wealth of ASEAN investors. Indeed, while economic growth in ASEAN in 2002 was higher than most economists had predicted, this was due more to the marginal increase in intra-Asian trade than greater diversification in financial investments. Intra-regional financial flows tend to be extremely small.5 Second, over the past few decades ASEAN has been one of the fastest growing regions in the world with a very strong demand for credit. Private investment rates in many ASEAN countries prior to the Asian Crisis fell in the range of 30–40 percent, and infrastructural investment has soared. The current account deficit came to five–eight percent in the Crisis-affected countries in the early-to-mid 1990s, with the corresponding inflows of foreign savings used to finance an excess of private investment demand. While the Crisis has led to a major decrease in capital inflows and forced current account surpluses, investment demand is still higher than in other developing regions, even though investment spending as a percentage of GDP has fallen in most ASEAN member states. Moreover, as ASEAN countries are now in deficit, they are being forced to find cheap and innovative ways of raising funds, or at least there is a much higher incentive to do so. In short, this strong demand for investible funds will no doubt persist over the long term. Further, from a political point of view, many ASEAN countries — as well as others in Asia — are a bit nervous about such a high reliance on intermediation outside the region. The recent turmoil in global financial markets, sparked by the sub-prime crisis in the United States, suggests that they were right to be nervous. But how has ASEAN been able to finance their investments? As was noted above, to date it has mostly been through bank lending. Equity 5 See,

for example, Plummer, M.G. (2002). Financial Cooperation Needed. Far Eastern Economic Review.

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markets tend to be thin, highly volatile, and illiquid; fixed-income markets are even less developed. While a strong reliance on bank lending is not necessarily an impediment to longer-term economic development (for example, Germany tends to rely on bank lending), it limits the options available to firms and places a greater strain on the banking system, as well as creating disproportionate reliance on the banking system for the health of the economy (which can, inter alia, cause moral hazard problems in itself). This lack of diversity in investment vehicles in ASEAN has been burdensome for the larger companies and public-sector equities facing highly limited sources of funds at home; either they work through the local banking system or they try to tap international markets, listing directly or via the bond markets. Once again, this strengthens the debt and liquidity of developed country markets but to the disadvantage of local development. Moreover, small companies, and especially start-up companies (so important in the ICT age) can be left out of the system completely, as banks have a natural tendency to rely on larger, more established clients and venture-capital markets are generally absent. The lack of a reliable yield curve has been a perennial problem for corporate issues. Thus, the huge supply of savings and strong investment demand in Asia was (and is) directly or indirectly intermediated outside the region, or if it took place inside the region, it was done mostly through the local banking system. The shortcomings of such a situation are obvious; most importantly, it makes the system entirely dependent on the banking system and creates high exposure to the actions of market participants of, and the economic performance in countries outside of the region. It also develops a tendency toward maturity mismatches. The Asian financial crisis underscored many of these weaknesses. Once the processes for addressing immediate problems stemming from the Crisis were set in motion (such as dealing with the NPL problem, recapitalizing the banking system, and improving banking laws, practices and monitoring/surveillance mechanisms), policymakers in the region began to turn their attention to market diversification and deepening issues. For example, most countries have enacted or have plans for reforms designed to deepen equity markets, and to create deeper and more liquid bond markets. In this sense, the Asian Crisis, though extremely costly in terms of social and economic costs, has had a positive side in that it is forcing governments to expand capital markets and strengthen financial systems, thereby increasing the potential of future sustained growth and, hopefully,

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mitigating the effects of any future crisis. As Robert J. Shiller notes in Irrational Exhuberance (2000): Given that speculative bubbles tend to occur, their eventual bursting may indeed be on balance a good thing. The Asian financial crisis of 1997–98, sparked by the withdrawal of world investors from Asian markets, may be viewed not as a crisis in the long-term sense but as a sanity check that prevented what might have turned out to be a more disastrous speculative bubble from ever developing.6

So as not to miss the forest for the trees, it is important to point out that Asian financial markets are still suffering from problems related to the Asian Financial Crisis. These need to be rectified, especially the issue of NPLs or, more generally, NPAs (Non-Performing Assets). The economic recovery of 1999–2000 allowed Asian governments more breathing room to enact reforms, but much remains to be done. In the current financial chaos, such reforms will obviously be put on hold. Fortunately, the region appears to be in good shape to weather this Crisis, given the large accumulation of reserves it has picked up over the past five years, better financial surveillance, and stronger balance sheets. Still, once the real sector is hit by the global liquidity squeeze, the region will be in for a rough ride. Hence, it is not surprising that the ASEAN+3 leaders, meeting on the sidelines of the Asia-Europe meeting at end-October 2008, have expressed their intention to set up a $80 billion facility to help liquidity-constrained countries. While the extent to which Asian countries are able effectively to create deeper financial markets in Asia will be a function of progress in dealing with these issues, there is no reason why countries should not begin to develop the necessary policies to bring about medium- and longterm financial deepening now. As is underscored by the conclusions of an important March 2001 publication by the ADB Institute: . . . Asian countries should place high priority on strengthening the banking system, but at the same time emphasize the importance of initiating to develop domestic corporate bond markets by eliminating all possible impediments since it takes time to establish sound corporate bond markets . . . the banking system and the corporate bond market should be complementary to each other in Asian developing countries (p. 4).7 6 Shiller, R.J. (2000). Irrational Exuberance, pp. 228–229. Princeton: Princeton University Press. 7 Yoshitomi, M. and Shirai, S. (2001). Designing a Financial Market Structure in PostCrisis Asia: How to Develop Corporate Bond Markets. ADB Institute Working Paper Series No. 15.

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A greater focus is being placed on the bond market in ASEAN, which has hitherto been quite neglected, at least in countries heavily affected by the Crisis. Fixed-income instruments can be important in complementing equity markets. Firms may wish to raise medium- and long-term financial capital without relinquishing more control of the firm, or possibly as a complement to equity issuances (or vice versa; major corporate bond issues are often accompanied by warrants). Moreover, as will be noted later, ASEAN governments have recognized that a stronger and more extensive local bond market can be strong protection against maturity and currency mismatches.8 But, in many ways, it is difficult to refer to national bond “markets” in ASEAN, as much of the activity tends to be in the form of buy-and-hold strategies of institutional investors. With little trading activity, markets tend to be shallow and illiquid. While some East Asian countries have been able to create a yield curve that can be used to benchmark future bond issues, most yields continue to be under 10 years. Moreover, even where in some ASEAN countries a yield curve technically exists, the market does not deem it to be reliable because secondary trading is so thin. Secondary markets, where they exist, are underdeveloped in all ASEAN countries, with the possible exception of Singapore. Moreover, most emerging-economy governments issue bonds, but in many of these countries, no real market exists. This is changing. Singapore, for example, has been highly active in trying to develop its bond market and further strengthen the country’s place in the international financial community. Singapore now allows foreign entities to issue bonds in Singapore dollars locally, with few restrictions (although until recently, the Singapore dollars were required to be swapped immediately into foreign currency). Beginning in 1998, the Singapore market has drawn considerable foreign participation in such issues, with just about all the major investment banks now having tapped the market. Deepening of the bond market in Singapore has also led to a greater role for the Singapore dollar in the international arena, though the government has been cautious and continues to be careful to not let the currency become too internationalized. 8 A “maturity mismatch” exists when a bank’s assets are long-term and its liabilities are short-term in nature, and a currency mismatch refers to assets being denominated in local currency whereas obligations are denominated in foreign currency. The currency and maturity mismatches are referred to as “original sin” by Eichengreen and Hausman (1999).

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The need to finance emerging government deficits in the region, robust demand for infrastructural projects, and ambitious business plans of many private-sector companies make the development of the bond markets a natural priority, though a major challenge. According to recent studies, including those conducted by the ADB Institute, the ADB, and APEC, much remains to be done in strengthening the local markets. To summarize briefly some of the findings from these reports, market impediments include: lack of reliable yield curves and liquidity in the markets; lack of local institutional investors that are active in the market; underdeveloped clearing and settlement systems; weak protection of intellectual property; and insufficient protection and fiduciary responsibilities.

3. ASEAN Financial Cooperation and the Bond Market It is difficult to understand the importance of an ASEAN Bond Market without appreciation for ASEAN itself, just as it would be difficult to understand the true goals of European economic cooperation without recognizing its unique context. While intra-regional trade and investment as a percentage of total economic activity is not high in ASEAN (e.g., as noted in earlier chapters, intra-regional trade as a percentage of total trade is only slightly over one-fourth, and less than that in terms of intraASEAN FDI), regional cooperation in the areas of trade and investment have initiated the process of developing a regional identity, with foreign investors, for example, increasingly evaluating the region as a fairly integrated whole. This became evident during the Asian Crisis; although “real” links between the ASEAN economies are not extensive, “contagion” of the Asian Crisis spread to the member states fairly quickly. The contagion issue is a complicated one, but the fact that international investors attach a certain intra-regional relationship and identity to ASEAN member states certainly played a role. “Policy externalities” are strong in ASEAN, that is, the macroeconomic and financial situation in one country will affect that prevailing in the others. Bolstering financial systems in individual member states will have important positive effects on the region as a whole. The existence of policy externalities, therefore, constitutes an important incentive to taking a regional approach to bond-market development. Moreover, cross-issuance of ASEAN bonds, albeit having important potential, will never attain the size of the individual markets as a whole. In sum, ASEAN is not the EU; however, regional cooperation has

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been important to ASEAN for a long time, and will be increasingly so in the future. Until the 1990s, scholars implicitly assumed that “real” economic integration through free trade areas like AFTA could be separated from “financial” economic integration. This is not the case in the contemporary economic system. The EU discovered that creating a truly integrated market required closer cooperation in the area of finance and macroeconomics, especially exchange rates. The Mexican Peso Crisis, which exploded the year that NAFTA was implemented, was a reminder of the need to stress the role of stable financial and macro policies along with the real sector, as well as to include provisions to address possible exchange-rate shocks. ASEAN countries have been slowly embarking on means to strengthen regional cooperation by bringing in the financial sector. The Ministerial Understanding on ASEAN Cooperation in Finance (March 1997) sets out the broad goals of cooperation in diverse areas of finance and macroeconomics, including banking, capital markets, insurance matters, taxation and public finance, as well as in exchanging information on developments affecting ASEAN countries in various multilateral and regional organizations. These topics were taken up in the finance-related chapters of the AEC Blueprint, published in late 2007. The most visible ASEAN endeavors in the area of finance in ASEAN relate to the Chiang Mai Initiative (CMI). Together with China, Japan, and South Korea, the ASEAN+3 group has developed an embryonic swap arrangement (coming to approximately $85 billion as of mid-2008) and other means to provide liquidity, should another crisis occur. The currencies available under the swap arrangement are those of the Triad, i.e., the US dollar, yen, and euro. The CMI is generally complementary to IMF financial resources and, in fact, countries drawing on the facility must accept IMF conditionality, though the swap arrangement allows for 10 percent to be accessed automatically, i.e., free of IMF conditionality. The additional resources promised at the October 2008 meeting of ASEAN+3 leaders could conceivably significantly increase the resources already available. Some nations have suggested that a surveillance mechanism is necessary if the CMI approach is to blossom; in fact, the ADB has already been active in supporting surveillance, from the creation of the ASEAN Surveillance Unit in the ASEAN Secretariat to direct support in ADB member-state finance ministries. Monitoring and surveillance will no doubt be a difficult sell in many Asian countries if the goal is a Maastricht-type approach

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to regional cooperation. However, to the extent that activities are mainly devoted to uniform data gathering and presentation and the compilation and dissemination of other information necessary for dialogue on macroeconomic and financial affairs, they could play a useful role in promoting transparency. In any event, the CMI, along with discussions to create a possible Asian Monetary Fund, constitutes an important step in what will likely be a long process of closer monetary and financial cooperation. Realizing the importance of developing capital markets in the region, the ASEAN Finance Ministers endorsed a Finance Work Programme designed to deepen capital markets in the region. In the Joint Ministerial Statement of the Fourth ASEAN Finance Ministers Meeting (25–26 March 2000), the ministers agreed that ASEAN should “. . . further strengthen corporate governance practices, including transparency and disclosure, and establish a regional framework for the development of the ASEAN Bond Market. Our aim is to develop and deepen ASEAN’s capital markets, particularly bond markets” (emphasis added). In December 1999, the ASEAN heads of government focused on the need to move towards greater regional cohesion and economic integration, as expressed in the ASEAN Vision 2020 statement. In this document, they pledge, among other things, to maintain regional macroeconomic and financial stability through closer cooperation in terms of monetary and financial policies. Moreover, the next year in Vietnam they agreed to the “Hanoi Plan of Action”, which calls for: (1) maintenance of financial and macroeconomic stability; (2) strengthening of the financial systems; (3) liberalization of financial services; (4) intensification of cooperative efforts in monetary, tax, and insurance matters; and (5) developing ASEAN capital markets. In the AEC Blueprint, ASEAN leaders stay away from a commitment to a free flow of capital to complement the free flow of goods, services, skilled labor and FDI. However, it does support the need for bolstering ASEAN-based capital markets, improving capital-market integration, harmonizing standards on debt securities, and facilitating crossissuance of securities.

4. The ASEAN Bond Markets: A Brief Overview As will be seen in the analysis below, many of the ASEAN countries have common characteristics, though the region is sufficiently diverse as to require a considerable amount of harmonization before an ASEAN Bond

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Market can be developed. Suffice it to note here that one critical common element in the original ASEAN countries is the clearing and settlements system. Each of these countries either has in place the Real Time Gross Settlements System (RTGS), or has plans for its implementation. This system has been designed as a means of handling large fund transfers, and has been adopted by a number of countries, including the G-10, EU, Japan, Hong Kong, South Korea, and China. It is a settlement system in which fund transfers (processing and final settlement) take place continuously. To the extent that fund availability permits, RTGS can essentially reduce the settlement lags to zero, and primary risk can be eliminated. It does not necessarily net out debit and credits but can do so (“netting” is an additional approach that is becoming more popular in countries like the United States). It reduces considerably the duration of liquidity and credit exposures, and is accepted internationally as a vehicle of sound market infrastructure for risk management. While they differ considerably in terms of culture, history, and socio-political institutions, the economies of the ASEAN-4 (Indonesia, the Philippines, Malaysia and Thailand) are similar in a number of ways. In particular, they are all resource-rich economies that have adopted economic liberalization policies indicative of an outward-oriented development stance, especially since the mid-1980s. They are all original members of ASEAN and AFTA, APEC, and are active participants in the WTO. Importantly, they are affected by the same types of external shocks in the global economy. They are also increasingly sensitive to macroeconomic policies adopted by each other. This became readily apparent during the Asian Financial Crisis, in which the ASEAN-4 represented Ground Zero. The ASEAN-4 countries have been focusing their efforts on the resolution of the crises in their respective banking systems. This process has been extremely costly and difficult, and while much has been accomplished, much remains to be done. The Asian Development Bank9 notes that, as of year-end 1998 (i.e., before the end of the Crisis), the estimated cost of bank restructuring in the ASEAN-4 came to: US$43 billion in Thailand (32 percent of GDP), US$70 billion in Indonesia (29 percent of GDP), US$13 billion in Malaysia (18 percent of GDP), and US$3 billion in the Philippines (4 percent of GDP). The annual interest costs on governmentbond issues to pay for bank restructuring as a percentage of GDP came 9 Asian

Development Bank (1999). Rising to the Challenge in Asia: A Study of Financial Markets, 2, Special Issues, p. 6.

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to three percent, 3.5 percent, 1.3 percent, and 0.5 percent in Thailand, Indonesia, Malaysia, and the Philippines, respectively. In short, it is obvious that the Asian Crisis has been extremely costly to the financial systems of the ASEAN-4 countries. An important reason why the ASEAN-4 countries have been in favor of taking a regional approach to capital-market development is the recognition that (1) as was noted above, it is important to reduce reliance on banking in their financial systems and avoid the currency and maturity mismatches of the past; bond-market development is one way to do this; and (2) since they are all in the same situation, a regional approach to these matters, where appropriate, should be explored. With respect to the ASEAN-4 bond markets, the IMF’s International Finance Corporation (IFC) maintains a complete database of government and corporate issues in Indonesia, Malaysia, Philippines, and Thailand. Aside from the Thai government bond index and the Malaysian corporate bond index, however, data are too limited to construct additional indexes. Domestic bond markets of the other ASEAN-4 countries have been developing rapidly, albeit at different speeds and from different initial conditions. The IFC offers a Bond Database as part of its Emerging Markets Information Center. In general, government bonds constitute the largest part of the market, but corporate bonds are important as well. Compared to Singapore and the ASEAN-4, domestic bond markets are considerably less developed in Laos, Myanmar, Cambodia, and Vietnam. With the possible exception of Vietnam, it is difficult to imagine active participation of these countries in regional bond-market initiatives except in the long run. This is true for several reasons. First, at this point in the economic development of these countries, development of a strong banking system is of the essence and should be of the most immediate priority in the CMLV countries. Vietnam’s banking system is fairly well-established, but the government has felt compelled to institute a series of banking reforms, especially since it has fairly significant NPL problems in some areas. The fragile state of Vietnamese finance as it began 2008 underscored many of the inherent problems in the country that persist. Second, the creation of an ASEAN Bond Market will require some legal and regulatory harmonization and sufficient market infrastructure to accommodate cross-border issuance and trading, such as linked clearing and settlement systems. The CMLV countries have a long way to go before these requirements are in place for their national bond markets, let alone a regional market.

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As the CMLV countries begin to develop more fully their national bond markets, their membership in ASEAN can be useful in helping them design best-practice techniques. ASEAN is dedicated to ensuring that the CMLV countries take part actively in regional initiatives to the extent that their governments would like. For example, the new ASEAN Swap Arrangement negotiated as part of the Chiang Mai Initiative allows for the eventual accession of the CMLV countries.10 Fourth, in creating a regional bond market, or even in drawing the interest of international investors, it is important for countries to have transparent financial regimes and liberal policies with respect to foreign exchange and capital controls. All of the CMLV countries have foreign-exchange and capital controls to varying degrees. Such controls became more common in some of the other ASEAN countries with the Asian Crisis, but to a much smaller degree than the CMLV countries (and probably only on a temporary basis). Fifth, and perhaps most importantly, in order to develop the national bond markets, as well as to participate in a regional market, all countries should have a clear vision as to where they would like to go with capital market development and deepening. This requires support from the highest levels of government, and this does not appear to be present in all countries.

5. Interest-Rate Analysis and Comparison: Some Evidence in Favor of an ASEAN Bond Market Interest rates across ASEAN countries might be studied in a comparative context, both with respect to individual member states and in comparison to the United States, Japan, and Germany, in order to judge the potential gains for further development of the ASEAN Bond Market. Table 5.1 presents summary statistics based on the interest rate data provided by the IMF through 2000. The table presents averages of nominal interest rates in three categories (government bonds, treasury bills, and money markets) and inflation rates, and calculates the ex post real interest rate. Let us begin with the example of Thailand, whose government bond market is fairly well-developed. For the period 1980–2000, real interest rates in Thailand seem to be higher than real interest rates in the United States, 10 UNCTAD

Nations.

(2001). Trade and Development Report, 2001, p. 125. Geneva: United

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Table 5.1. Average Nominal Interest Rates, Inflation Rates and Ex Post Real Interest Rates 1980–2000. 1980–2000 Inflation Rate

Real Rate

Interest Rate

Inflation Rate

Real Rate

Panel A: Government Bond Rates Thailand 9.82 4.70 Myanmar — — US 8.14 3.90 Japan 4.73 1.60 Germany 6.66 2.47

5.12 — 4.24 3.13 4.18

9.05 11.08 6.01 2.09 5.25

4.28 18.53 2.53 0.28 1.60

4.77 −7.45 3.48 1.80 3.66

Panel B: Treasury Bill Interest Rates Malaysia 4.95 3.46 Philippines 14.38 10.31 Singapore — — US 6.56 3.90 Germany 5.43 2.47

1.50 4.07 — 2.66 2.95

4.90 11.40 1.20 4.90 3.74

3.35 7.16 1.28 2.53 1.60

1.55 4.24 −0.08 2.38 2.14

Panel C: Money Market Interest Rates Indonesia 15.39 10.55 4.84 Malaysia 5.73 3.46 2.27 Singapore 4.99 2.11 2.88 Thailand 9.70 4.70 5.00 US 7.18 3.90 3.28 Japan 4.08 1.60 2.48 Germany 5.72 2.47 3.25

19.92 5.47 3.24 7.97 5.20 0.70 3.72

14.36 3.35 1.28 4.28 2.53 0.28 1.60

5.56 2.12 1.97 3.69 2.67 0.41 2.12

Country

Interest Rate

1994–2000

Source: IMF, International Financial Statistics, compiled by the International Monetary Fund.11

Japan, and Germany. This suggests, ceteris paribus, that there would be gains from a further development of an ASEAN Bond Market by integrating the market with bond markets in the major financial centers of the world. Such integration would lead to additional capital inflows to Thailand as investors seek the higher return on Thai bonds, and hence convergence of interest rates. In equilibrium, Thailand would have more capital and lower interest payments. The IMF reports treasury bill interest rates for Malaysia and the Philippines (and, for a more limited period, Singapore). Although these are 11 The

interest rate is the annual average, and inflation is the percentage change in the consumer price index from December to December. Both variables are in natural logarithmic terms, and the ex-post real interest rate is the nominal interest rate minus the inflation rate.

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short-term instruments, some additional observations regarding interestrate conditions can be made. Interest rates have been relatively high in the Philippines and relatively low in Malaysia, in both nominal and real terms. No doubt, this is due to higher risk in the Philippines market as well as capital controls during this period in Malaysia. In theory, ASEAN capital market integration would allow more capital to move from the lowinterest-rate country of Malaysia (where the cost of capital is thus lower) into the high-interest-rate country of the Philippines (where the rate of return on capital is higher). Such intra-regional flows would benefit capital owners in Malaysia, who would receive higher yields on their capital, and would benefit borrowers in Philippines by lowering their cost of borrowing to finance investment. In fact, interest rates in the Philippines have been higher than those in the United States and Germany, and interest rates in Malaysia have generally been even lower than those in the United States and Germany. Integration of the ASEAN capital markets with the capital markets in other global financial centers would enhance these benefits. The short history of treasury bills in Singapore suggests that nominal interest rates have been quite low, and slightly lower than actual inflation, so that the ex post real interest rate has been negative. Data on money market interest rates reinforce some of the previous conclusions and provide some additional comparisons. Interest rates have been relatively high in Thailand, in both nominal and real terms, suggesting again that benefits of further capital market development and integration could draw capital into the country. In addition, nominal and real interest rates have been high in Indonesia, suggesting that — like Thailand — further capital market development and integration could draw capital into the country. Of course, this analysis, consistent with the IMF approach, assumes, inter alia, constant risk across countries. While ASEAN-4 member state sovereign bonds no doubt have a smaller degree of risk dispersion than, say, the ASEAN-6 and certainly the ASEAN-10, risk differentials are still important. S&P and Moody’s rankings as of 2001 show that at least Indonesian debt is considerably below the average (CCC+); Thailand, Malaysia, and the Philippines approximately in the same range (around the BBB’s); and Singapore ranks among the second-tier best of the developed countries. Indeed, money market interest rates in Malaysia and Singapore have been roughly similar to those in US, Japan, and Germany. The money markets in Malaysia and Singapore are fairly well developed, suggesting that longer-term bond markets can now be developed on this foundation.

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Hence, interest-rate differentials to some degree are indicative of capitalmarket imperfections, either through exchange controls, capital controls, or information asymmetries, all of which could be improved through the process of bond-market development and the creation of an ASEAN Bond Market. For example, one requirement of developing an ASEAN Bond Market and integrating it with global financial centers is that barriers to crossborder bond transactions need to be minimal. The table below (Table 5.2) lists the restrictions on international capital flows and cross-border bond transactions as reported to the International Monetary Fund for its Annual Report on Exchange Arrangements and Exchange Restrictions as of end-2000. These are official restrictions, and they cannot be “weighted” in terms of importance. Moreover, it is always difficult to assess in a practical manner the severity of these restrictions. For example, even from this table, we cannot gauge the degree of difficulty in attaining authorizations, approvals, and registrations. If the restrictions are not too burdensome, the member states are in a very good position to develop capital markets both within the region and to integrate them with global financial centers. Of course, it is important to recall that, in contrast to global financial centers such as the United States, Japan, and Germany — all of which do not have reported restrictions on bond transactions — the presence of restrictions in ASEAN countries may be burdensome and hinder development of the bond markets. Such barriers will likely require elimination in order to facilitate the development of an efficient regional bond market.

6. Lessons from the Developed Markets: Key Components of Bond Market Development An excellent summary of the necessary characteristics of effective bond market development has been compiled in the Compendium of Sound Practices: Guidelines to Facilitate the Development of Domestic Bond Markets in APEC Member Countries (APEC Collaborative Initiative on Development of Domestic Bond Markets, September 1999). These guidelines were essentially developed from best practices in developed countries. Below, we review a number of the issues addressed, and apply them to what would be required of a regional bond market.

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Table 5.2. Restrictions on International Capital Flows and Cross-Border Bond Transactions. Country Brunei Darussalam Indonesia Laos Malaysia

Myanmar Philippines

Singapore

Restrictions Applicable to Cross-Border Bond Transactions None. Not regulated. All capital transactions require Bank of Laos (central bank) authorization. Sale or issue locally by non-residents requires approval. Purchase abroad by residents does not face controls for transactions valued at less than RM 10,000; but for those amounting to RM 10,000 or more, prior approval is required. Sale or issue abroad by residents requires approval. Not available. Purchase locally by non-residents: Registration with the Bangko Sentral ng Pilipinas is necessary only if the foreign exchange needed for capital repatriation and remittance of dividends, profits, and earnings that accrue thereon is purchased from the banking system. Sale or issue locally by non-residents: These transactions are allowed only after the proper license to do business in the country is secured from the appropriate government agency. Purchase abroad by residents: For amounts above $6 million, for which the source is the banking system, prior approval and registration by the Bangko Sentral ng Pilipinas is required. Sale or issue abroad by residents: These transactions are subject to prior approval by the Bangko Sentral ng Pilipinas if principal and interest amortization are to be serviced using foreign exchange purchased from the banking system or guaranteed by public sector entities or local banks. Sale or issue locally by non-residents: Financial institutions may, without prior consultation with the Monetary Authority of Singapore, arrange Singapore dollar bond issues for non-residents if the Singapore dollar proceeds from the issuance are used for pre-approved economic purposes in Singapore. Financial institutions must consult the Monetary Authority of Singapore when the proceeds are to be used outside Singapore or for purposes not explicitly allowed. The proceeds from all such bond issues must be converted or swapped into foreign currency for their use outside Singapore. Effective November 26, 1999, all rated and non-rated sovereigns and foreign corporations are allowed to issue Singapore dollar bonds. (Previously, only foreign entities of good standing were allowed to issue these bonds.) In the case of unrated corporations, the investor base is restricted to sophisticated investors. (Continued)

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Table 5.2.

Country Thailand

Vietnam US Japan Germany

207

(Continued)

Restrictions Applicable to Cross-Border Bond Transactions The sale or issue of securities is under the jurisdiction of the Securities Exchange Commission (SEC). Under the securities law, different rules and regulations apply to capital market securities (those with maturity of more than one year) and short-term money market securities (those debt securities with a maturity of not more than one year). The regulations imposed on capital market securities are generally stricter than those imposed on short-term money market securities. Companies wishing to issue securities to the public need approval from the Bank of Thailand and the SEC. Sale or issue locally by non-residents: These transactions require approval of the Ministry of Finance, the Bank of Thailand, and the SEC. Purchase abroad by residents: Purchases require approval of the Bank of Thailand. Sale or issue abroad by residents: The potential issuer must submit an application for approval to the SEC, and permission will be granted if the issuer can prove that the security will be pooled exclusively on primary or secondary markets abroad. There are controls on all transactions in capital and money market instruments and in collective investment securities. None reported. None. None reported.

Source: International Monetary Fund, Annual Report on Exchange Arrangements and Exchange Restrictions, 2000.

6.1. Sequencing Efficient bond markets cannot be developed in a vacuum; they must be created as part of a coherent plan for capital market development. As was mentioned before, banks should continue to play a central role in the ASEAN countries. But there is no reason why other markets should be neglected. In fact, bond-market development can improve bank performance by providing better investment vehicles and a healthier financial sector. Moreover, in developing the bond market, the government should first focus on creating an efficient primary market for government securities. This is important in creating a yield curve that can benchmark other issues. Next, a strong and active secondary market for government securities should be established. Without such trading, the yield curve is much less reliable as a risk-pricing vehicle. Once this is accomplished, the government should work

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on developing the primary and, eventually, the secondary corporate-bond market.

6.2. Supervision and Regulation In order to create a strong and active bond market, protection of investor interests is of the essence. There are three major risks associated with bond investments: credit risk, market risk, and liquidity risk. An investor naturally deals with market risk and some types of credit risk (e.g., sovereign risk) through appropriate asset-management techniques, and principal risk can be reduced effectively to zero through an efficient clearing and settlements system, as discussed below. However, liquidity risk and some types of credit risk can only be minimized through an effective supervisory and regulatory system. This involves the development of appropriate laws and rules governing fixed-income transactions, effective monitoring and auditing systems, transparent accounting practices (e.g., full, timely and accurate disclosure, internationally accepted standards), and strong communications channels. Governments, however, should be careful not to create an overly burdensome regime for the private sector. For example, rules and procedures should be predictable, enforceable, and effective. To adapt a famous maxim of Albert Einstein, a regulatory and supervisory regime should be as simple as possible, but no simpler than that. An efficient supervisory and regulatory framework also requires the advocacy of strong business practices, internal and external checks, and a clear division of labor and objectives of regulatory authorities. The system should also allow for open and transparent rule-making and involve close dialogue with the private sector. While every country is different and, hence, will always require laws and regulations that are sui generis, there exist many common denominators in efficient regulatory and supervisory systems. This is where the development in the EU of the concept of “subsidiarity” is useful; laws and regulations that are necessary for the smooth functioning of cross-border issuances of securities should be adapted at the regional level. However, regional policies should be adopted only where necessary. With respect to supervision, each country should be independent but must agree to common standards and rules of conduct. For example, in the EU, the European System of Central Banks is centralized with the main monetary policy decision-making authority located in Frankfurt, but supervision

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and regulation of the banking system is still left to the national central banks. 6.3. Market Infrastructure In creating efficient market infrastructure, governments first need to work closely with the private sector in developing procedures that address the three categories of risk cited above (i.e., credit, market, and liquidity). Investors need to be able to monitor, measure, and control these risks in developing their market portfolios. This can only be accomplished in an environment of sound risk practices, transparency, and accountability. Moreover, from a corporate-finance perspective, issuers also need to have easy, reliable access regarding rules, regulations, issuing procedures, and the modus operandi of the local securities market. Next, eliminating principal risk and creating an efficient bond market requires an effective clearing and settlements system. Developing such a system is a high priority in all ASEAN countries with a bond market. As was noted above, a delivery-versus-payment system, such as Real Time Gross Settlement (RTGS), essentially reduces principal risk to zero, expedites trading, and, if the system has a “critical mass” of transactions, reduces transactions costs. The RTGS establishes transfer instructions for the exchange of securities and payments on a trade-by-trade (gross) basis with final transfer between buyer and seller occurring at the same time (“real time”). In this process, all securities settlements are final. Moreover, the delivery-versus-payments approach should provide protection against liquidity risk, i.e., the possibility that one party will not be able to settle the transaction within the agreed time frame. All developed-country markets have in place a delivery-versus-payments system, working at various levels of sophistication. An additional advantage of a common RTGS system is that it will make linking such systems to each other in an ASEAN Bond Market that much easier. Many of the world’s most active clearing and settlement networks are linked directly. For example, Hong Kong has established the Central Moneymarkets Unit (CMU), which is a centralized electronic depository for debt instruments. The CMU is actually linked to the Euroclear and Clearstream systems, as well as to others in the region (e.g., in Australia and New Zealand). While liquidity in this system appears to be somewhat of a problem, the CMU has been praised as a potentially important model for linking of systems in a regional bond market.

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An oft-neglected aspect of market infrastructure regards human capital development. Maximizing risk-adjusted returns in investment portfolios, developing active long-term investment strategies, working with clients, and the like requires a well-trained managerial and financial workforce. In addition, from the government side, regulatory and supervisory authorities need to be well-prepared in order to ensure a smooth functioning of the system. All this requires significant training and investment in human capital. 6.4. Market Deepening Bond-market deepening is also a pervasive goal in ASEAN. In fact, the most basic objectives behind the creation of a regional bond market relate to the goal of deepening and expanding bond markets. This involves making the region more attractive for local, regional, and international investors. Hence, any initiatives taken to strengthen local bond markets and create a regional market need to bear this in mind. A key priority is liquidity. Active trading is necessary in order to construct a reliable yield curve, promote the corporate and secondary markets, and reduce transactions costs in the clearing and settlements system. International investors are reluctant to enter markets that are not liquid. Even the Japanese market, which is huge, has relatively low international “action” because the market is deemed to be fairly illiquid. Second, market deepening requires a competitive trading structure, a standardized settlement process, and many market participants. The latter is especially important in the ASEAN context, as most markets are dominated by only a few players. A competitive dealer structure needs to be maintained, and market-makers should be encouraged. Third, there needs to be regular, competitive bond auctions that are well-publicized. Fourth, taxation of bond transactions needs to be minimized. Moreover, the tax structure should not create a bias against the bond market. Fifth, it is probably not a good idea to have minimum credit rates for bond issuers. We will discuss credit-rating agencies at length below. However, the problem with minimum ratings is that experience has shown a tendency for such ratings to divert issuance into unregulated channels, and this could hurt a country’s risk profile. Finally, many experts have underscored the need to create active derivatives markets in order to support bond-market development. This is necessary at higher stages of development. For example, this is a priority in the case of Singapore.

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7. Promoting Liquidity in a Regional Market: Credit-Rating Agencies and the Currency Question As was noted above, most ASEAN countries suffer from liquidity problems in primary and secondary bond markets, albeit to different degrees. The reasons are many, varying from the typical buy-and-hold strategies of the institutional investors who dominate the market to regulations and taxation that inhibit trading. But without sufficient liquidity in bond trading, it is difficult for bond markets to serve their most important purposes. First, insufficient liquidity in the market renders the yield curve less reliable as a means of pricing risk in the economy. Second, market infrastructure sometimes requires a “critical mass” of trading before it becomes efficient. Third, an important goal of a regional bond market is the attraction of international investors, and lack of liquidity is a strong disincentive for foreigners to become active in the market. Below we look at two areas that will be important in the advocacy of liquidity in a regional bond market: credit-rating agencies, which are essential especially in the development of a liquid secondary market for corporate bonds, and the currency question, focusing on the possibility of an ASEAN basket of currencies.

7.1. Credit-Rating Agencies Credit-rating agencies can be essential in the creation of a vibrant corporate bond market. As they are often used as a regulatory tool for supervisory bodies, regulators need to have sufficient criteria in order to rate creditrating agencies. The Basle Committee on Banking Supervision suggests the following criteria: objectivity, transparency, credibility, international access, adequacy of resources, and recognition by a national regulatory supervisory authority. In order to deepen bond-market development in the ASEAN countries and to create a vibrant ASEAN Bond Market, it is essential that steps be taken to promote corporate-bond issues. Creating a deep and liquid corporate-bond market with a strong legal and regulatory infrastructure is a long-term objective of most ASEAN countries. However, with few exceptions, the corporate-bond market in ASEAN is either extremely small or only includes the very best and largest companies. Reliable credit-rating agencies will become increasingly important as the corporate side of the market develops. After all, the corporate bond

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markets in the ASEAN countries, to the extent that they exist, are dominated by only a few firms and, before this situation can change, a great deal needs to be accomplished, e.g., better benchmarks, liquid secondary markets, established market-makers, and, to some degree, a changed mentality with respect to finance on the part of the ASEAN corporate sector. Accomplishing this will take a good deal of time; the credit-rating-agency issue, though important, does not appear to be the most important, at least in the short run. Depending on the type, credit-rating agencies do play an important role not only in addressing the traditional information-asymmetries problem that exists in corporate-bond-market development, but also in promoting transparency in the system and, if successful, bringing in a wide variety of firms to the bond market. Reputable credit-rating agencies can also help in luring foreign-investor participation to the market. This last point is particularly important in the building of a regional bond market. In order to promote cross-border issuances of corporate debt, there are many information-related bottlenecks that need to be addressed, and a credible system of credit agencies, or even the emerging of ASEAN-wide credit agencies, could be important. Perhaps mutual recognition of credit agencies in ASEAN would not be necessary in an ASEAN Bond Market. Adopting the Singapore route, i.e., ultimately relying on international credit-rating agencies, is one option (however, rankings by these institutions are quite expensive). Moreover, the market would ultimately be able to decide credibility of the credit-rating agencies. If the agency in one country proves itself to be unreliable, the market will punish it. Hence, market discipline could decide; no cooperation or specific efforts on the part of the ASEAN governments to promote these agencies would be required or even desirable. Still, it will take a long time for the market to establish reputations. In the meantime, some mutual-recognition approaches to resident credit agencies could be useful. The EU, for example, in its drive for mutual recognition under the Single Market Program quickly found out that it is impossible to do this credibly if certain minimum standards are not met. Otherwise, there would be a race to the bottom: professional certification, product testing, etc., would have an incentive to work out of the same, least-cost country. In creating regionally acceptable credit-rating agencies, say, from which corporations would have to obtain a minimum rating from one to two agencies before a bond offering, ASEAN countries would have to work toward some minimum standards in terms of

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approach and methodology. In order to ensure that these agencies comply, an ASEAN-wide board would have to be established in order to keep track of the accredited agencies. Once the acceptable standards and methodology are established, mutual recognition would make a great deal more sense. Moreover, a board responsible for keeping tabs on accredited agencies could play an important role in stemming any corruption in a manner that would be far quicker than the market itself. It is important to note at this point, however, that establishing mutual recognition itself will be no mean feat. There currently does exist an ASEAN Forum for Credit Rating Agencies (AFCRA). It holds annual meetings and is completely open to new members from any rating agency in the region. In addition to the annual meeting, AFCRA also holds seminars, undertakes training programs, and exchanges information on ratings-related questions. However, not much has been accomplished in adopting common standards and methodologies in the region thus far. The reasons are no doubt many, but an important one stems from the fact that agencies are reluctant to reveal their methodologies, which could, after all, be their most important “firm-specific asset”. Nevertheless, a system could be established through which minimum standards would be expected of any individual agency, with the board monitoring the group. AFCRA members could be actively involved in establishing the minimum standards methodology, etc., as well as in drawing up the blueprint for the ASEAN agency board. Such a system would allow the agencies to retain their own approach, which obviously would be rated by the market itself, while at the same time creating safeguards and transparency. In sum, credit-rating agencies will play a critical role in the future development of the national and regional bond market. As Tony Latter, Deputy Chief Executive of the Hong Kong Monetary Authority, remarks in his speech, “Bond Markets: Where Are We Heading”? to Conrad International (12 July 2000): Plainly, it is essential that the investor community has confidence in the expertise and integrity of the rating agencies. A more local focus by established agencies, perhaps operating via joint ventures, might ensure confidence. If that is achieved, then the broader application of ratings may help expand the investor base, notably to embrace those institutional or individual investors who cannot themselves afford to make credit assessments of every issue but who are favourably disposed toward bond investment in principle. (p. 3).

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7.2. ASEAN Bond Market and the Currency Question ASEAN countries have exactly 10 different currencies. One might be tempted to reduce the number to an effective nine, as Brunei Darussalam maintains a perfect peg to the Singapore dollar, based on a currency board. This diversity in the number of currencies presents several salient problems in the creation of an ASEAN Bond Market. The currency issue is one of the most critical — if not the most critical — in the creation of a regional bond market, as well as being one of the most difficult to approach. It will be no doubt one of the biggest obstacles in developing active cross-issuance in the ASEAN Bond Market. In what currency should cross-issuances of bonds in ASEAN be denominated? Monetary union, it was noted above, would best address this issue, as it has in Europe. However, by the reckoning of most, if not all, experts in the area, monetary union in ASEAN or Asia is a long-term proposition at best. Hence, there are at least three other possibilities: issuances in any/all ASEAN currencies; denominate bonds in a key international currency (such as the US dollar or the euro or the yen); or denomination of cross-issuances in terms of a weighted basket of ASEAN currencies (which, of course, would have underlying correlations with the dollar, yen, and euro to the extent that the ASEAN currencies are linked). Experts have suggested that the first option would have at least one important drawback: lack of liquidity. While it may be true that the creation of an ASEAN Bond Market would facilitate, say, the issuance of a ruppiah-denominated bond by a Thai company wishing to set up a factory in Indonesia, it is likely that demand for this sort of transaction would be limited. Moreover, lack of liquidity implies high transactions costs in the clearing and settlement systems at national and linked-regional levels. Hence, although national-currency denomination should always be an option for cross-issuances, it would be useful to have other options available. Denominations in Triad currencies (US dollar, Japanese yen, euro) would have the important advantage of drawing attention among international investors. In fact, several ASEAN countries have successfully issued foreign-currency-denominated bonds, especially in US dollars. However, this practice has become less common since the Asian Crisis; issuances of bonds in terms of foreign currency tend to increase the foreign exposure of the financial system. And since an important reason why ASEAN countries would like to strengthen national markets and develop a regional

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market is to avoid the “currency mismatch”, promotion of a key-currency denomination could be self-defeating. Besides, it is not clear why in this case an ASEAN Bond Market would promote regional cross-issuances; such bonds could be issued in the deep and liquid developed markets. An option that would be much more feasible in the medium- or even the short-term would be to create a currency basket consisting of the ASEAN currencies. For example, an ASEAN currency basket might aggregate the currencies in proportions according to country GDP. The advantage of using a currency basket is that the bond becomes an obvious vehicle for holding a portfolio of ASEAN currencies, and is typically viewed as a safe alternative to holding just one currency because diversification reduces the exchange risk. Hence, it is able to address directly the currency mismatch and indirectly the maturity mismatch problems discussed earlier. Moreover, it would allow for greater liquidity in the regional market, which would also be important to obtain, inter alia, critical mass for the clearing and settlement system. Let’s consider this option from the viewpoint of an international investor, the type of participant that the ASEAN Bond Market would like to attract. Table 5.3 compares the risk of ASEAN currencies to a GDP-weighted currency basket using historical data from 1990–2000 as an example. The currency basket serves to diversify the risk of holding ASEAN currencies to some degree, but there are several individual currencies with lower risk than the basket. This analysis is based on historical data, though, and expectations of the future could be different. In general, investors will prefer the currency basket if they view its riskiness as low or moderate compared to the risk of the underlying currencies. The ASEAN currency basket would work something like the European Currency Unit (ECU) did during the 1980s and 1990s. The ECU was a basket of the currencies of the member countries of the European Community, weighted in line with each country’s gross domestic product and foreign trade (and therefore subject to change periodically). It was introduced in 1979 as part of the European Monetary System (EMS), to be used as the benchmark for determining the overvaluation/undervaluation of individual currencies and to serve as a unit of account among the central banks participating in the EMS. No physical ECU notes or coins ever circulated, so the ECU was strictly an artificial denomination. However, certain European banks established a banking product so that lenders and borrowers could carry out transactions in ECU. At first, an ECU transaction was just a portfolio of transactions in the separate underlying currencies; a deposit or

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Table 5.3. Standard Deviations of Currencies and a GDPWeighted Currency Basket. (Monthly Percentage Changes in Exchange Rates, 1990–2000).

Country

With Respect to US$

With Respect to DM

With Respect to YEN

Cambodia Indonesia Laos Malaysia Myanmar Philippines Singapore-Brunei Thailand Basket*

9.10 10.11 7.34 3.30 1.55 3.27 1.72 4.10 4.06

9.55 10.37 7.72 4.18 2.00 4.43 2.81 4.60 4.64

9.75 10.25 7.99 4.45 2.67 4.64 3.04 4.89 4.76

∗ Note:

The weights of the currencies in the basket are based on 1996 GDP: Cambodia, 0.4%; Indonesia, 27.2%; Laos, 0.3%; Malaysia, 12.1%; Myanmar, 14.8%; Philippines, 10.2%; Singapore-Brunei, 12.2%; Thailand, 22.8%. Vietnam is not included due to lack of data on exchange rates. The Brunei dollar is pegged to the Singapore dollar at par and are therefore taken together. Source: Plummer and Click (2005).

loan in ECU typically was recorded as separate deposits or loans in the individual currencies. However, banks soon established a clearing mechanism for the ECU, thus enabling the transfer of ECU without necessarily having to make separate transactions in each of the component currencies. This facilitated growth of the ECU for private commercial transactions; residents could use the ECU as a unit of account for bank deposits and companies could use it for invoicing sales or maintaining their accounting records. The first ECU-denominated bond was issued in 1981, just two years after the introduction of the currency basket. The ECU subsequently became a significant “currency” denomination in the Eurobond markets, outranked only by the US dollar and the German mark. A substantial amount of ECUdenominated bonds were placed privately as well. The use of the ECU in private transactions developed rapidly because the ECU exchange rate tended to be more stable than those of its component currencies. For European investors and borrowers, a depreciation of an individual home currency against other European currencies is offset by an increase in the home-currency value of the ECU, so there is an incentive to hold ECUs to diversify a portfolio. Similarly, non-European investors and borrowers were drawn to the ECU because it was less risky than

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the underlying individual currencies. In short, the ECU was an attractive alternative to single foreign currencies because it was less sensitive to the volatility of a single currency. On January 1, 1999, the euro replaced the ECU on a one-for-one basis as part of the first stage of European Monetary Unification. The fact that the ECU existed for 20 years prior to European Monetary Unification suggests that the simple introduction of a currency basket serves as a useful precursor to closer monetary cooperation. The success of the ECU was partially because of its official status within the European Monetary System binding the central banks of the participating countries together. Its success was also partially because the private sector found a pan-European currency denomination quite useful, and because the banking system was able to accommodate the demand. On January 1, 1999, under the aegis of the European Central Bank, the separate RTGS systems of all European countries were drawn together into the TARGET system. The instant success of TARGET suggests that linkages of RTGS systems are feasible and useful.

8. Concluding Remarks From the above analysis, it is clear that bond-market development is a priority in all ASEAN countries as part of their respective financial deepening programs. ASEAN countries are counting on bond markets to avoid/mitigate many of the problems that were evident during the Asian Crisis, as well as to prepare their financial systems for potential future shocks, such as the one the world began to experience toward the end of 2008. This includes rectifying currency and maturity mismatches; providing better vehicles to price risk; opening up alternative sources of longer-term capital flows; fostering more efficient asset management; and establishing a greater presence on international capital markets. While the bond market is certainly not the only capital market that needs to be deepened in ASEAN — in fact, in the short-run, taking care of the banking sector is more urgent in most ASEAN countries — it merits a high ranking among the policy exigencies of the ASEAN countries. Many challenges face the ASEAN countries in achieving this goal. It is unrealistic to believe that vibrant bond markets can be achieved by government initiative, irrespective of a country’s level of economic development, vibrancy of its private sector, and historical experience

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with capital markets. Moreover, although there are many common legal, regulatory, and market-infrastructure-related measures that should be adopted in creating liquid and efficient bond markets, each country will have its own special characteristics. There exists a three-tier structure in the nature of ASEAN financial development, an important consideration in the creation of a regional bond market. But this should not be surprising. The U.S., European, and Japanese markets, for example, are sophisticated and well-developed; yet, they vary in terms of their market structures. As ASEAN countries develop their bond markets together, they can learn a great deal from each other. But one must bear in mind that the ASEAN countries are diverse in terms of their economic structure, historical circumstance, and socio-political systems. ASEAN includes a country that is a global financial center boasting a per capita income even higher than the OECD median (Singapore); a small, rich country that has yet to create a bond market (Brunei Darussalam); several middle-income countries that have been listed among the “dynamic Asian economies” at one time or another and have at least primary bond markets at various degrees of sophistication (Thailand, Malaysia, the Philippines, and Indonesia); and four transitional economies counted among the least developed countries with an embryonic bond market (Vietnam) and either negligible or inexistent ones (Cambodia, Laos, Myanmar). Creating a regional bond market out of such a diverse group of countries constitutes a major — though worth-while — endeavor. It would certainly be consistent with the goals of the AEC. In general, capital markets in ASEAN are fairly segmented, even though attempts to integrate ASEAN capital markets are not new. For example, in 1978, the Federation of ASEAN Stock Exchanges was formed (including Indonesia, Malaysia, the Philippines, and Thailand as member states). Moreover, the Fourth Summit’s Singapore Declaration of 1992 placed capital-market development as a higher priority in regional cooperation. But it was not until the Asian Crisis and its aftermath that ASEAN began serious initiatives to integrate capital markets. Data on non-resident purchases of bonds in the ASEAN countries are difficult to obtain, and where they exist, they are not always reliable. However, studies show in general that: (1) in ASEAN, bond purchases represent as small percentage of total private capital inflows; and (2) there is very little evidence of much intra-ASEAN issuances of bonds. In fact, capital outflows from the ASEAN countries are overwhelmingly destined to the developed-country markets in general and the United States in particular.

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This is because the United States has offered a booming market (until 2001, the U.S. economy had only two years of recession over the past 18 years); diverse, liquid, stable and secure capital markets; and the U.S. dollar constitutes the core international currency. Moreover, investors in the ASEAN countries are more familiar with the developed-country markets than their own, an “information gap” that needs to be bridged. Below, we summarize some of the advantages of moving in the direction of a regional bond market. We restrict ourselves to 10 major points. In sum, creation of the ASEAN Bond Market, with its salutary effects on local markets, will strengthen ASEAN financial development in general by reducing the need for extra-regional intermediation; increasing the participation in the ASEAN Bond Market on both the demand and supply sides of the market, including higher participation on the part of international participants; creating greater diversity in the financial system; reducing to a minimum the currency and maturity mismatches that in part created the ASEAN Crisis; and developing a far more efficient capitalmarket environment in ASEAN, which will allow ASEAN not only to increase regional financial intermediation but also to boost its attractiveness internationally. 1. Bond markets have been growing rapidly globally, especially on the corporate side. It is part of a global financial restructuring that is useful to both developed and developing countries. However, ASEAN countries have been generally left behind in this process (with the exception of Singapore). Growth in demand for bonds internationally offers myriad opportunities for the ASEAN countries in attracting the attention of international institutional investors, investment banks, multinational lending institutions, and the like. Deeper domestic bond markets and the creation of the ASEAN Bond Market would increase investors’ interest in the region; harmonization and liberalization that would be necessary in building the ASEAN Bond Market would also render the local markets more attractive, hopefully building the necessary critical mass to put the ASEAN markets on the international radar screen. 2. As part of the financial reform program, ASEAN countries have been trying to diversify their heavy reliance on the banking sector in favor of other financial intermediation vehicles, including equity and fixedincome markets. Over-reliance on the banking system in ASEAN countries has created many risks that could otherwise be avoided. In particular, it limits the way in which a financial system can price risk

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efficiently, and reduces the options open to investors and borrowers. The ASEAN Bond Market and deepening of local markets could therefore strengthen the financial integrity of the ASEAN countries, thereby mitigating or avoiding financial crises in the future. 3. Demand for bonds in the region has been growing significantly, but resident ASEAN investors tend to purchase bonds from outside the region when seeking portfolio diversification and high yields. Indicators point to a strong increase in this demand in at least the medium and certainly the long term, due to high savings rates, medium-term growth prospects, demographic change, and financial development in the ASEAN countries. Facilitating cross-border purchases of ASEAN member-state bonds would allow greater regional intermediation of this projected boom in investible funds, and would serve to increase the attractiveness of local markets. Both would serve to reduce any currency mismatches. It will also allow for additional investor portfolio diversification options. Moreover, higher levels of cross-border debt issuance and trading activity would enhance liquidity in the local market, which in turn would increase their attractiveness. 4. Growth in the supply of bonds in ASEAN over the past two decades has been impressive, but the medium/long term potential for ASEAN bond debt issuances is even greater. ASEAN will likely continue to be one of the fastest growing regions of the world, with a strong demand for credit for (physical and human-capital) infrastructure and investments by the private sector as the economy modernizes and grows. ASEAN countries have also seen a big increase in fiscal deficits, a phenomenon that will likely continue into the medium run. Tapping ASEAN-related and national funds through improved regional and local markets for these investments, rather than merely relying on international capital flows, will permit the region to avoid the currency and maturity mismatches that created and fed the ASEAN financial crisis. Moreover, by increasing liquidity and diversity of bonds in the market, this process will lead to more reliable and longer yield curves, which would allow for better pricing of risk in the market and improve debt-management options in both the private and public sectors. 5. A key problem in fostering financial development in the region has been lack of transparency in national systems. This has been cited as an additional source of the ASEAN financial crisis. Moreover, the diversity of the region in terms of treatment of fixed-income-securities taxation, restrictions on foreign participation in bond markets, and

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various idiosyncratic investment laws in the ASEAN countries has made cross-border investment difficult. ASEAN investors find that markets outside the region are much easier to navigate, have far lower transactions costs, higher liquidity, and lower principle and credit risks. The ASEAN Bond Market will create a far more attractive environment by increasing transparency and efficiency; reducing transactions costs by lowering taxes and making the tax structures within (i.e., between the bond and other capital markets) and between markets more equitable and understandable; and harmonizing policies making cross-issuances and purchases of bonds much easier. 6. In ASEAN, corporate bond markets tend to be small, and where they are fairly large, they tend to be dominated by a few large, wellestablished countries and often lack dynamism. Much needs to be done to broaden and deepen participation in the ASEAN corporate markets. There are at least four specific advantages to improving the corporate bond market; First, it can help to avoid the “double mismatches”; second, a vibrant corporate bond market lowers the cost of borrowing by providing an alternative (competitive) vehicle in the financial markets (and, for well-established firms, interest rates on corporate bonds tend to be lower than interest rates applied in the banking sector); third, if the secondary market is well developed, corporate bond market development improves the efficiency of the financial sector by establishing accurate price signals in the market; and fourth, in times of a crisis and its aftermath, less of a reliance on the banking system allows firms to continue to borrow funds from the market when the banking sector is facing its financial restructuring difficulties. Moreover, once the corporate bond market reaches a threshold of sufficient liquidity, economies of scale will reduce transactions costs and lead to a “virtuous cycle”. Policies that need to be adopted in order to develop the ASEAN Bond Market will not only facilitate cross-issuances of corporate bonds, but will also help increase participation and liquidity in the local bond markets. 7. Liquidity in the local bond markets has been an important problem in essentially all ASEAN countries. In creating the ASEAN Bond Market, this will continue to be an important consideration, especially since certain market-infrastructure-related elements of the ASEAN Bond Market, such as the clearing and settlements system, will require a “critical mass” in order to be efficient. As the option of denominating bonds in a single ASEAN currency within the ASEAN Bond Market

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would help address this problem from both the issuers’ and investors’ perspectives, the creation of a basket of ASEAN currencies, which might be called the “ASEAN Currency Unit”, could be practical, as was the case in Europe (the ECU). Moreover, the ACU will have important indirect effects that, in turn, could strengthen national and the regional markets, for example, in fostering greater macroeconomic cooperation and appropriate regional policies, as well as dovetailing with the Chaing Mai Intiative process and discussion of monetary integration. This process of financial integration would serve to integrate ASEAN capital markets more fully, bring down the cost of capital while at the same time allowing for greater portfolio diversification, and lead to convergence of regional interest rates. In fact, the considerable interest-rate differentials that exist between the original ASEAN countries to some degree are indicative of capital-market imperfections, either through exchange controls, capital controls, or information asymmetries, all of which could be improved through the process of bond-market development and the creation of an ASEAN Bond Market. 8. Increasing FDI inflows in ASEAN has always been a salient policy goal of ASEAN leaders, in particular as a rationale for closer regional economic integration. The ASEAN Bond Market would help stimulate DFI flows by making it easier for multinational companies wishing to set up or expand their affiliates in ASEAN to raise funds locally, which is often a quid pro quo for DFI (especially for medium-sized firms). 9. ASEAN has a long tradition in regional economic cooperation, but its most significant successes have been in the area of trade, e.g., the ASEAN Free Trade Area. Yet, substantial potential exists for greater cooperation in the area of finance, especially in light of the financial crisis. An ASEAN Bond Market would be an important step in this direction. 10. While the degree of financial sophistication within the CMLV countries differs greatly, all have considerably less sophisticated markets than the original ASEAN countries. Nevertheless, each has plans to improve their respective financial systems, including creating or expanding local bond markets. The ASEAN Bond Market would prove a useful “blueprint” for best practices in developing bond markets in the CMLV countries, and would serve as an important incentive to foster development of the local market as a means to exploit the potential advantages of greater regional capital flows and FDI, as well as the domestic market.

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References Adams, C. (2002). Challenges and Opportunities for Developing Asian Bond Markets. Paper prepared for seminar on Development of Capital Markets, Kuala Lumpur. APEC (1999). Collaborative Initiative on Development of Domestic Bond Markets, Compendium of Sound Practices: Guidelines to Facilitate the Development of Domestic Bond Markets in APEC Member Countries. Asian Development Bank (1999). Rising to the Challenge in Asia: A Study of Financial Markets, 2, Special Issues, p. 6. Dall, I. and Khatkhate, D. (1996). The Emerging East Asian Bond Market. Finance and Development. March, 33(1), pp. 11–13. Eichengreen, B. and Hausman, R. (1999). Exchange Rates and Financial Fragility. In New Challenges for Monetary Policy: A Symposium, Kansas City: Federal Reserve Bank. Latter, T. (2000). Bond Markets: Where Are We Heading? Speech at Conrad International. Merrill Lynch (2000). Size and Structure of the World Bond Market 2000. Plummer, M.G. (2002). Financial Cooperation Needed. Far Eastern Economic Review, 5th Column. Plummer, M.G. and Click, R. (2005). Bond Market Development and Integration in ASEAN. International Journal of Finance and Economics, 10, pp. 133–142. Shiller, R.J. (2000). Irrational Exuberance, pp. 228–229, Princeton: Princeton University Press. Syquia, J. Tomas (undated). Trends and Developments in Enforcement in Emerging Equities Markets. Mimeograph. Manila: Asian Development Bank. UNCTAD (2001). Trade and Development Report, 2001, p. 125, Geneva: United Nations. Yoshitomi, M. and Shirai, S. (2001). Designing a Financial Market Structure in Post-Crisis Asia: How to Develop Corporate Bond Markets. ADB Institute Working Paper Series No. 15, Tokyo: ADBI.

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ASEAN Stock Markets: Trends in Convergence

1. Introduction This chapter examines stock market integration in Indonesia, Malaysia, the Philippines, Singapore, and Thailand (ASEAN-5) in the aftermath of the Asian Financial Crisis. These countries were the most affected by the Asian Financial Crisis and constitute the core of ASEAN outside of the CLMV countries, which are transitional economies endowed with far less developed stock markets (and the markets that do exist in these countries were only recently established). As the AEC Blueprint calls for greater capital-market development in the region, as well as freer flows of capital, a close examination of the process of asset-market integration could give us interesting insight into the current status quo and what will need to be done in order to deepen capital markets. Moreover, as will be discussed later in this volume, ASEAN Member Countries are beginning to discuss the feasibility of a currency union as well (either across ASEAN or in the context of the ASEAN + 3), which suggests that the countries are interested in multilateral approaches to many regional economic and financial issues. Integration in the ASEAN capital markets may include initiatives to coordinate the five national capital markets that already exit, or at an extreme, may involve the creation of supranational regional bond and stock exchanges. Hence, it is worthy of investigation. Rather than providing general analysis and a market-related overview as in the case of bond markets (Chapter 5), this chapter is a technical chapter that will focus on stock markets alone. In particular, it explores the degree of integration of the ASEAN-5 stock markets and endeavors to draw conclusions from the econometric results.

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Interest in stock market integration arises because an integrated regional stock market is more efficient than segmented national capital markets. Capital market efficiency in Southeast Asia has become even more important after the Asian financial crisis of 1997–1998, as countries seek to reduce the traditional dependence of firms on bank loans rather than bond and stock issuances, at the same time that they seek new capital from outside the region. With an integrated regional stock market, investors from all member countries will be able to allocate capital to the locations in the region where it is the most productive. With more cross-border flows of funds, additional trading in individual securities will improve the liquidity of the stock markets, which will in turn lower the cost of capital for firms seeking capital and lower the transaction costs investors incur. These suggest a more efficient allocation of capital within the region. An integrated regional stock exchange will also be more appealing to investors from outside the region, who would find investment in the region easier or more justifiable. As shares become more liquid and transaction costs fall, fund managers become increasingly willing to take positions in the stocks. In addition, outside investors may take notice of the regional stock exchange instead of dismissing a collection of small national exchanges: the whole (one regional stock exchange) might be greater than the sum of the parts (individual country exchanges). For example, Freeman (2000) makes the argument that total equity market capitalization is important to investment managers outside the region: “Institutional investors with global portfolios may simply dispense altogether with equity markets that have low asset allocation recommendations, as resources — such as research — are limited (p. 2)”. He suggests that, except for Malaysia and Singapore, equity markets in Southeast Asia may be edging toward irrelevance, and that one way to overcome the problem is to band together. Thus, an integrated stock market within the ASEAN-5 will help link the region with the world stock markets and bring more capital into the countries from abroad. This will allow ASEAN companies to expand their shareholder base and lower their cost of capital even further. In addition to interest from policy makers and investment practitioners, stock market integration also carries interest from an academic perspective. Recent advances in time series analysis allow investigation of a “long run” equilibrium among stock markets using the methods of co-integration. As Kasa (1992) points out, stock markets that are co-integrated have a longrun relationship, so long-run correlations of returns are higher than shortrun correlations typically examined. If n variables have p co-integrating

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relationships, they have n!p common trends. When n!p = 1, as in the case of the five developed-country stock indices investigated in Kasa (1992), correlations of returns converge to unity and there is no diversification potential in the long run. In this situation, the individual stock markets are completely and perfectly integrated. However, Richards (1995) points out that a major reason for the findings in Kasa (1992) is an inappropriately long lag length used in the estimation process. With shorter lags, Richards (1995) finds that the five developed-country stock indices are not co-integrated. In this situation, the individual stock markets are completely segmented. This chapter specifically considers whether the stock markets of Indonesia, Malaysia, the Philippines, Singapore, and Thailand are currently co-integrated. We examine the period after the Asian financial crisis, specifically July 1, 1998 through December 31, 2002, in order to consider the recent experiences of the ASEAN-5 markets rather than a long history.1 The database thus suffers from being a short four-and-a-half year span of time from which to extract a long-run relationship, but also has the advantage of being a well-defined period during which we can reasonably say that there have been few structural breaks or shifts in the data. There are three key features in our modeling strategy. One is that we consider both daily data and weekly (Friday or end-of-week) data over this period in order to examine what happens as analysts move from higher-frequency to lower-frequency data. In particular, the lowerfrequency data may contain less noise and relatively more information to estimate a long-run relationship. A second feature is that we consider data denominated in local currencies, in US dollars, and in Japanese yen. Analysis is often done in local currencies, but investors outside the ASEAN countries have to convert local currency returns into their home currencies, of which the dollar and the yen are the most widely used. In the period before the Asian financial crisis, the ASEAN countries were typically pegging their exchange rates to the dollar (and after the Crisis, most did so de facto as well). This meant that the choice of local currency versus the dollar did not matter much, but the stock market values denominated in yen were of course sensitive to fluctuations in the yen/dollar exchange rate. Currency issues have become more important in the aftermath of the Asian financial crisis, as countries have allowed their currencies to float against the dollar. A third feature is 1 For

a thorough analysis of the pre-crisis period 1986–1996, see Sharma and Wongbangpo (2002).

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that we carefully examine the lag structures of the models, and estimate co-integrating relationships in models with differing lag lengths. This allows us to determine whether our results are sensitive to the number of lags chosen. With five stock market variables, the number of common trends (n!p) can range from one to five, and this range forms something of a continuum from perfect integration to complete segmentation. If the stock markets are not co-integrated, resulting in five common trends, we infer that they are nationally segmented in the economic sense, and are not yet suitable for a supranational regional stock market. However, if these stock markets are co-integrated in the econometric sense, we infer that they are integrated in the economic sense. If the number of common trends is more than one, we conclude that there is a degree of interdependence somewhat short of complete convergence, so policy initiatives to further integrate the stock markets are appropriate. If the number of common trends is exactly one, we conclude that the stock markets are completely, perfectly integrated and are ready for the establishment of a supranational regional stock market. The empirical results in this paper demonstrate that the ASEAN-5 stock markets in the period after the Asian financial crisis are co-integrated, whether analyzed using daily data or weekly data, and whether analyzed in local currencies, the US dollar, or the Japanese yen. In addition, the finding does not depend on the number of lags used in estimation once a relevant range of lags is determined. The stock markets are thus not completely segmented by national borders. However, there is only one co-integrating vector among the five stock markets, leaving four common trends among the five variables. Once again, this finding is robust to the frequency of the data, the currency denomination considered, and the lag lengths chosen. Perhaps surprisingly, the coefficients in the co-integrating vectors are remarkably similar across all forms of the model, suggesting that data frequency, currency denomination, and lag length have relatively little impact on the long-run equilibrium estimated. We therefore conclude that ASEAN-5 stock markets are integrated in the economic sense, but that integration is not complete. On a policy level, initiatives to further integrate the stock markets are feasible, and in fact desirable. From the perspective of the international portfolio investor, benefits of international portfolio diversification across the five markets are reduced but not eliminated. This chapter is organized into four sections. After this introduction, Section 2 provides background on stock markets and integration in ASEAN. The first subsection considers public policies pertaining to ASEAN stock

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markets, with an emphasis on integrative efforts, and the second subsection surveys the academic literature on Southeast Asian stock market integration. Section 3 then considers the empirical analysis of stock market integration in ASEAN after the Asian financial crisis. The subsections consider data sources, short-run correlations of returns, unit root tests, lag length tests, and, most importantly, co-integration results. The final section is the conclusion.

2. Background The stock markets of the ASEAN-5 countries generally have market capitalizations in line with the sizes of their economies. Using 2000 data,2 Singapore and Malaysia have market capitalizations as a percent of gross domestic product quite similar to the United States; 165.7% and 130.4%, respectively, versus 153.5% for the US. The Philippines, where stock market capitalization is 69.9% of GDP, is quite similar to the level of Japan, at 65.2%. Thailand and Indonesia are the smallest markets, at 24.1% and 17.5% respectively, but not out of line with emerging markets around the world. These figures suggest that there is a general level of equity market development that may be conducive to integration. In contrast, the stock markets of Brunei, Cambodia, Laos, Myanmar, and Vietnam are either under-developed or non-existent. 2.1. Public Policies on ASEAN Stock Markets Attempts to coordinate ASEAN stock markets are not new. Wellons (1997, p. 28) points out that the ASEAN-5 countries agreed to form the Federation of ASEAN Stock Exchanges in 1978, but never followed through. The Singapore and Malaysian stock markets were fairly well-linked at this time, as many Malaysian registered companies traded on the Stock Exchange of Singapore (SES). However, financial crises in Singapore during 1985–1986 spilled over into Malaysia, and actually caused disintegration of the stock markets. 2 Data

on stock market capitalization come from the Standard & Poor’s Emerging Stock Markets Factbook 2001. The market capitalizations of the markets are as follows: Singapore, $152 billion; Malaysia, $117 billion; the Philippines, $52 billion; Thailand, $29 billion; and Indonesia, $27 billion. For comparison, the market capitalizations of the US and Japan are $15,104 billion and $3157 billion, respectively. Data on GDP come from the World Development Indicators of the World Bank.

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In 1989 the government of Malaysia de-listed Malaysian companies from the SES. The decision to de-list first appeared in the budget speech of the Finance minister on October 27, 1989. Sun, Tang, and Tong (2002) report that: He cited the need for the KLSE [Kuala Lumpur Stock Exchange] to develop its own identity and to become a leading regional finance center. To achieve that, a total separation from the SES could not be avoided. The second reason, as cited by the Minister, was to minimize the high correlation between the two markets. The Malaysian government has long been wary of developments in Singapore affecting the KLSE.

Similarly, according to Bank Negara Malaysia (1999), the “move represented the Government’s effort to develop the domestic capital market by establishing KLSE as an independent exchange, to confine dealings in Malaysian counters to the local exchange, to attract international investors as well as to reduce the market’s vulnerability to unfavorable developments on the SES (p. 316)”. In response to the Malaysian government’s action, the SES almost immediately announced a similar de-listing of Singaporean companies from the Malaysian Stock Exchange and a plan to develop an overthe-counter market to trade Malaysian stocks. The over-the-counter market, known as CLOB International, actually functioned up until September 1998, when the government of Malaysia announced that all dealings in shares listed on the exchange must be done through the Kuala Lumpur Stock Exchange or one recognized by KLSE.3 Wellons (1997) also points out that the Singapore Declaration of 1992 “raised the prospect of stronger capital market cooperation as part of an effort to direct ASEAN economic cooperation (p. 28)”. More generally, presidents of stock exchanges in the region call for cooperation from time to time to facilitate cross-border trading. “In 1993, for example, the SES president said that the time had come to promote intra-ASEAN markets. He saw the opportunity to cross-list and trade a handful of larger stocks on markets throughout ASEAN” (p. 28). In 1995, “the president of the Thai exchange urged closer cooperation among exchanges in the region (p. 28)” to boost poor trading volumes. According to Freeman (2000), the governor of the Bank of Thailand “proposed a joint venture between the Bangkok, Kuala Lumpur and Singapore equity markets in 2000 (p. 9)”. The dream of a regional stock market in ASEAN has not come to fruition, even though the AEC seeks to remove obstacles to cross-border 3 For

more on 1989 de-listings and the history of CLOB, see Sun, Tang, and Tong (2002).

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listings and other forms of integration. In particular, Malaysia’s imposition of selective currency and capital controls in dealing with Asian financial crisis (which went into effect on September 1, 1998) suggested that the stock market in Malaysia, which had been well-integrated with Singapore, would be separated from both world and regional stock markets.4 The exchange controls eliminated access to the ringgit by non-residents from sources in Malaysia and abroad, effectively closing down the offshore ringgit market.5 The ringgit was also pegged to the US dollar at the same time, and the peg has been successfully maintained since then. Some capital controls have been relaxed, suggesting that the Malaysian stock market is not completely segmented from world and regional stock markets. Initially, capital controls required foreigners to hold stocks for at least 12 months, but this was replaced with a 10% repatriation levy in February 1999. The KLSE was dropped from the Morgan Stanley Capital International index in late 1998, but was re-added at the end of May 2000.

2.2. Academic Literature The issue of stock market integration in Southeast Asia has also been studied in the academic empirical finance literature, particularly using the techniques of co-integration. The main issue being addressed is whether individual stock markets are highly (positively) correlated, although more recently the issue has been recast to address “contagion” across markets. There are several other aspects being examined as part of this general issue. One considers what the appropriate econometric technique for examining the correlations should be. A second addresses the time period to examine, and whether there have been changes over time such as convergence of markets or structural breaks or shifts in relationships (such as those related to liberalization of equity markets or to financial crises). A third is whether the empirical analysis should be conducted in the local currencies, US dollars, Japanese yen, or some other unit. A fourth is whether the local markets are influenced by the US market, or the Japanese market, or both. Taken together, the conclusions in the literature regarding the integration of Southeast Asian stock markets are contradictory. This might 4 See Johnson and Mitton (2003) for discussion of the Malaysian capital controls, particularly with respect to the thesis that the capital controls provided a screen behind which favored firms could be supported. 5 For more on this, see Bank Negara Malaysia (1999).

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be partially attributable to different methodologies, even when using cointegration techniques. Since several studies have examined Asian stock markets in the light provided by Kasa (1992), we restrict our focus to these. Conflicting and inconclusive results are still apparent, due in part to the wide range of sample periods and sampling frequencies considered; the selection of countries considered; and the exact modeling strategy being implemented. DeFusco, Geppert, and Tsetsekos (1996) examine weekly data for January 1989–May 1995 denominated in US dollars. They conclude that there is no co-integration in a block of Asia-Pacific countries consisting of US, Korea, Philippines, Taiwan, Malaysia, and Thailand. They also conclude that there is no co-integration in the other two other regions they examine, thus capital markets are segmented. Masih and Masih (1999) use daily data over 2/14/92–6/19/97 denominated in real US dollars. They find co-integration in a block of OECD and Asian countries including US, Japan, U.K., Germany, Singapore, Malaysia, Hong Kong, and Thailand, but conclude that there is at most one cointegrating vector, leaving seven independent common stochastic trends. Manning (2002) examines both weekly and quarterly data over January 1988–February 1999, denominated in both local currency and in US dollars. The system includes Hong Kong, Indonesia, Japan, South Korea, Malaysia, Philippines, Singapore, and Thailand, and alternately includes/excludes the United States. The general conclusion is that there are two common trends, indicating “partial convergence” of the indices. Phylaktis and Ravazzolo (undated) examine monthly data for January 1980–December 1998 (split into two periods: 1980–1989 and 1990–1998) denominated in local currency, US dollars, and real US dollars. The sample consists of the US, Japan, Hong Kong, South Korea, Malaysia, Singapore, Taiwan, and Thailand, and co-integration is found for both subperiods in all units of measurement. However, relatively few countries participate in the co-integrating vectors. This leads Phylaktis and Ravazzolo to conclude that the stock markets under investigation are not linked. A subsystem consisting of Taiwan, Thailand, Japan, and the US seems to reveal the strongest financial integration. In this subsystem, the estimated common trends suggest that the US has influence in the Pacific Rim, but that Japan plays a more significant role and is equally important as Thailand. Sharma and Wongbangpo (2002) examine monthly data from January 1986 through December 1996 for the ASEAN-5 markets denominated in

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local currencies. They find a long-run co-integrating relationship among the stock markets of Indonesia, Malaysia, Singapore, and Thailand, but conclude that the Philippine market does not share the relationship. Furthermore, there is only one co-integrating vector among the four markets, leaving three common trends. One particularly interesting finding is that Malaysia and Singapore move together one-for-one in the co-integrating vector, ostensibly because of the distribution of inward foreign direct investment flow, the strength of trade between the two economies, the geographical proximity, and cultural factors (p. 307). Taking these five studies together, it is certainly not clear what to expect for stock market integration in ASEAN in the aftermath of the Asian Crisis. A few additional studies use co-integration techniques to determine whether the local markets are influenced by the US market, or the Japanese market, or both, and generally add to the confusion; see Fernandez-Serrano and Sosvilla-Rivero (2001), Jang and Sul (2002),6 and Darrat and Zhong (2002). In addition, VAR approaches using differenced data without a cointegrating constraint offer even more positions. Two such studies are worth mentioning. Dekker, Sen, and Young (2001) use daily data in local currencies and dollars over the period 1987–1998 in 10-variable VARs to examine linkages among US, Japan, and eight other countries’ stock markets including Malaysia, Philippines, Singapore, and Thailand. The results indicate that the four ASEAN markets are linked to the US market, which exerts a great deal of influence, but that the Japanese market is segmented. Furthermore, the Malaysian, Singapore, and Hong Kong markets are closely linked, but the Philippine and Thai markets are segmented. Tan and Tse (2002) use daily data in local currencies over 1988–2000 in a nine-variable VAR to examine the linkages among US, Japan, and seven Asian stock markets including Malaysia, Philippines, Singapore, and Thailand. By truncating the data at the end of 1996 and restarting the data in mid-1998 to create a pre-crisis and post-crisis comparison, they find that markets appear to be more integrated after the crisis than before, and that Asian markets are most heavily influenced by the US but that the influence of Japan is increasing. The most noteworthy effect among the ASEAN-5 6 Jang and Sul (2002) also offer bivariate co-integration tests among the three ASEAN-5 markets studied. Thailand and Indonesia are co-integrated during the crisis and well after the crisis; Thailand and Singapore are co-integrated immediately after the crisis and maybe well after the crisis; Indonesia and Singapore may be co-integrated before the crisis but not during or afterwards.

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is that Malaysia is apparently an outlier; Malaysia is less affected by the US and Japan after the crisis, which can be attributed to the success of its capital and currency controls, but Singapore and Malaysia still affect each other strongly, which can be attributed to geographic proximity, economic linkages, and structural symmetry.

3. Empirical Examination This section considers the empirical characteristics of the ASEAN-5 stock indices. The indices themselves, denominated in local currencies, are considered foremost. However, the indices converted into US dollars and into Japanese yen are also considered in order to have the indices in common currency units. These series implicitly represent the sum of the returns on two assets, the stock index and the currency. The indices in local currencies, although representing a mix of currency units, are obtainable when the currency risk is perfectly hedged.7

3.1. Data The data consist of daily stock index quotes in local currencies over the four-and-a-half-year period from July 1, 1998 through December 31, 2002, for a total of 1175 observations. From this, we also consider weekly stock index data by taking the Friday (or other end-of-week) observations over the same period, for a total of 235 observations. We begin with mid-1998 because the bulk of the Asian Crisis had ended by then.8 The data are from Datastream, and represent composite stock price indices in Indonesia, Malaysia, Philippines, Singapore, and Thailand. We convert the local currency index into US dollars [Japanese yen] by multiplying the local currency index level by the dollars-per-foreign-currency [yen-per-foreign-currency] exchange rate, also obtained from Datastream. 7 We cannot convert from nominal currency units to real currency units because price level data do not exist at daily or weekly frequency. However, the stock market and exchange rate data are not materially influenced by inflation during the short time period under consideration, so such an adjustment would not need to be done anyway. 8 Tan and Tse (2002) use mid-1998 as the beginning of the post-crisis period. The crisis may or may not have been “over” at that date, however. Jang and Sul (2002) begin the post-crisis period earlier, on February 1, 1998, because the Thai, Indonesian, and Korean currencies reached record lows in January. Additional adjustments were yet to come, such as Malaysian currency and capital controls introduced September 1, 1998.

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Table 6.1. Short-run Correlations of Stock Index Returns. (July 1, 1998 through December 31, 2002). Indonesia

Malaysia

Philippines

Singapore

Panel A: Daily Data Local Currency Malaysia Philippines Singapore Thailand

0.17 0.25 0.27 0.28

0.14 0.29 0.28

0.28 0.28

0.43

US Dollars Malaysia Philippines Singapore Thailand

0.19 0.27 0.26 0.30

0.14 0.25 0.26

0.28 0.32

0.44

Japanese Yen Malaysia Philippines Singapore Thailand

0.26 0.32 0.31 0.33

0.27 0.37 0.34

0.38 0.38

0.48

Panel B: Weekly Data Local Currency Malaysia Philippines Singapore Thailand

0.22 0.36 0.30 0.44

0.26 0.27 0.28

0.37 0.50

0.56

US Dollars Malaysia Philippines Singapore Thailand

0.20 0.42 0.36 0.46

0.25 0.25 0.27

0.40 0.54

0.59

Japanese Yen Malaysia Philippines Singapore Thailand

0.21 0.41 0.35 0.45

0.34 0.36 0.32

0.47 0.55

0.60

3.2. Short-run Correlations Table 6.1 presents the simple correlation coefficients among the five stock markets. Panel A utilizes the daily data and Panel B utilizes the weekly data, and within each panel is a matrix for correlations of data denominated in local currency units, US dollars, and Japanese yen. Overall, the correlations are not very high — averaging just 0.336. Comparing the daily correlations to the weekly correlations suggests that correlations may be

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higher for the weekly data; the average correlation for the daily data is 0.294 and the average for the weekly data is 0.379. Among the 30 correlations, only four are lower in the weekly data than in the daily data. Although we don’t know whether this difference is statistically significant, it seems plausible that correlations among the five stock markets rise when moving from higher-frequency to lower-frequency data. The concern that correlations will converge to unity in the long run is precisely the motivation for using co-integration analysis to examine the long-run relationship. 3.3. Unit Root Tests In preparation for co-integration analysis, the univariate properties of the stock index data need to be examined to verify that the data series are nonstationary, or contain a unit root. Table 6.2 presents Augmented DickeyFuller (ADF) and Phillips-Perron tests allowing for a constant in the regression but no time trend. Once again, Panel A utilizes daily data and Panel B utilizes weekly data. The tests suggest that all of the series contain unit roots; the hypothesis of a unit root cannot be rejected at the five percent level for any of the 60 tests (and cannot be rejected at the 10 percent level for 58 of the tests). The number of lags utilized in the reported ADF tests is chosen using the Akaike Information Criterion, but the unit root finding is really invariant to the number of lags chosen. The number of lags in the reported Phillips-Perron tests is set to four, but again the results are invariant to the number of lags chosen. Since all series are non-stationary, co-integration analysis is appropriate. 3.4. Lag Length Tests The number of lags in the vector autoregression (VAR) used to estimate the co-integrating relationship is an important issue because the number of lags has been shown to affect the number of co-integrating vectors detected (e.g., Richards, 1995). Table 6.3 thus presents lag length tests from VARs of different orders. It considers the Akaike Information Criterion (AIC), the Schwartz Bayesian Criterion (SBC), and Likelihood Ratio Tests of exclusion restrictions on incremental lags that are distributed Π2 with 25 degrees of freedom. With daily data (analyzed in Panel A), most statistics suggest that only one lag is appropriate in the VAR. The AIC indicates that some additional

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Table 6.2.

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Unit Root Tests. (July 1, 1998 through December 31, 2002). ADF Test

Phillips-Perron Test

Lags

ϑµ

∆

Panel A: Daily Data Local Currencies Indonesia Malaysia Philippines Singapore Thailand

1 15 10 1 19

−1.19 −2.10 −1.24 −1.56 −2.46

0.998 0.995 0.998 0.997 0.992

−1.19 −1.92 −0.70 −1.57 −2.23

0.998 0.995 0.999 0.997 0.994

US dollars Indonesia Malaysia Philippines Singapore Thailand

1 5 11 1 2

−1.25 −2.12 −0.92 −1.43 −1.96

0.998 0.995 0.999 0.997 0.995

−1.23 −2.08 −0.39 −1.44 −1.87

0.998 0.995 0.997 0.997 0.996

Japanese yen Indonesia Malaysia Philippines Singapore Thailand

23 5 11 1 12

−1.81 −2.21 −1.12 −1.50 −2.27

0.996 0.993 0.998 0.996 0.993

−1.27 −2.15 −0.68 −1.54 −1.90

0.998 0.993 0.999 0.996 0.995

Panel B: Weekly Data Local Currencies Indonesia Malaysia Philippines Singapore Thailand

7 2 2 1 4

−1.57 −2.18 −1.35 −1.60 −2.35

0.983 0.976 0.986 0.984 0.960

−1.32 −2.03 −1.13 −1.63 −2.40

0.988 0.979 0.993 0.984 0.964

US dollars Indonesia Malaysia Philippines Singapore Thailand

2 7 2 1 4

−1.48 −2.83∗ −0.92 −1.52 −2.09

0.984 0.968 0.993 0.985 0.970

−1.43 −2.14 −0.75 −1.55 −2.05

0.987 0.977 0.997 0.986 0.974

Japanese yen Indonesia Malaysia Philippines Singapore Thailand

3 7 2 1 4

−1.71 −2.79∗ −1.14 −1.68 −1.99

0.981 0.957 0.990 0.976 0.968

−1.50 −2.17 −1.04 −1.61 −2.05

0.986 0.970 0.994 0.978 0.971

∗ Significant

at the 10% level. at the 5% level. ∗∗∗ Significant at the 1% level. ∗∗ Significant

ϑµ

∆

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Table 6.3.

237

Lag Length Tests. (July 1, 1998 through December 31, 2002). Information Criteria Lags

Panel A: Daily Data Local Currency 10 9 8 7 6 5 4 3 2 1

Likelihood Ratio Tests

AIC

SBC

Comparison

Π2 (25)

−48292 −48313 −48299 −48314 −48336# −48328 −48317 −48332 −48324 −48262

−46990 −47146 −47261 −47406 −47551 −47669 −47784 −47927 −48044 −48110#

11 vs. 10 lags 10 vs. 9 lags 9 vs. 8 lags 8 vs. 7 lags 7 vs. 6 lags 6 vs. 5 lags 5 vs. 4 lags 4 vs. 3 lags 3 vs. 2 lags 2 vs. 1 lag

1.91 4.05 1.89 9.12 8.12 17.32 10.24 8.16 7.94 20.95

US Dollar

10 9 8 7 6 5 4 3 2 1

−47043 −47046 −47032 −47063 −47080 −47082# −47065 −47080 −47074 −46992

−45751 −45880 −45993 −46150 −46295 −46423 −46534 −46675 −46795 −46840#

11 vs. 10 lags 10 vs. 9 lags 9 vs. 8 lags 8 vs. 7 lags 7 vs. 6 lags 6 vs. 5 lags 5 vs. 4 lags 4 vs. 3 lags 3 vs. 2 lags 2 vs. 1 lag

2.51 7.96 5.63 2.13 3.52 4.74 9.05 3.16 2.25 29.95

Japanese Yen

10 9 8 7 6 5 4 3 2 1

−46641 −46651 −46643 −46670 −46679 −46682# −46659 −46670 −46663 −46631

−45348 −45485 −45604 −45757 −45893 −46023 −46127 −46265 −46385 −46479#

11 vs. 10 lags 10 vs. 9 lags 9 vs. 8 lags 8 vs. 7 lags 7 vs. 6 lags 6 vs. 5 lags 5 vs. 4 lags 4 vs. 3 lags 3 vs. 2 lags 2 vs. 1 lag

4.55 5.97 7.14 3.80 8.06 5.09 9.08 4.71 2.18 23.07

−7779 −7797 −7808 −7817#

−7415 −7521 −7618 −7714#

5 vs. 4 lags 4 vs. 3 lags 3 vs. 2 lags 2 vs.1 lag

23.11 28.46 36.61∗ 38.48∗∗

−7495 −7516 −7521 −7538#

−7132 −7239 −7331 −7434#

5 vs. 4 lags 4 vs. 3 lags 3 vs. 2 lags 2 vs.1 lag

25.82 26.67 41.31∗∗ 31.92

Panel B: Weekly Data Local Currency 4 3 2 1 US Dollar

4 3 2 1

(Continued)

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Table 6.3.

(Continued )

Information Criteria

Japanese Yen

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Lags

AIC

SBC

4 3 2 1

−7424 −7450 −7455 −7465#

−7061 −7173 −7265 −7362#

Likelihood Ratio Tests Comparison 5 vs. 4 4 vs. 3 3 vs. 2 2 vs.1

lags lags lags lag

Π2 (25) 21.26 22.53 41.82∗∗ 37.72∗

#Denotes minimum value. ∗ Significant at the 10% level. ∗∗ Significant at the 5% level. ∗∗∗ Significant at the 1% level.

information may be captured around the one week lag: the minimum AIC occurs at six days of lags for the estimation in local currency and five days of lags for estimation in US dollars and Japanese yen. However, the SBC achieves minimal at one lag in all three daily models, and the likelihood ratio tests indicate that no additional lags beyond the first are statistically significant. In addition to the likelihood ratio tests reported in Table 6.2, we also calculated likelihood ratio tests of five lags versus one lag and six lags versus one lag, yet still cannot reject the null hypothesis that coefficients on the blocks of additional lags are jointly zero.9 We therefore estimate the co-integrating vector in two different VARs — one with one lag and another with five lags — in order to see what effect the number of lags might have on the co-integration analysis. We examine weekly data because we are interested in the effects of moving from higher-frequency to lower-frequency data. However, it is also somewhat more appropriate given that daily data may reveal some information at the one week lag but not before then. Utilizing weekly data may therefore be a more parsimonious way to estimate a VAR and cointegrating relationships. The lag length tests of weekly data reported in Panel B of Table 6.3 are broadly consistent with the daily data, but with some reversals of particular tests. With the weekly data, both the AIC and the SBC indicate that only one lag is appropriate. However, the likelihood ratio tests suggest that two lags may be appropriate for the local currency 9 The

likelihood ratio test of five lags versus one lag is distributed Π2 (100) and the likelihood ratio test of six lags versus one lag is distributed Π2 (125). The critical values for the 90 percent confidence level are 118 and 140, respectively. For local currency, Π2 (100) = 46.90 and Π2 (125) = 64.02. For US dollars, Π2 (100) = 44.00 and Π2 (125) = 48.55. For Japanese yen, Π2 (100) = 38.71 and Π2 (125) = 43.63.

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model and three lags might be appropriate for the dollar and yen models. In fact, likelihood tests of three lags versus one lag reject the hypothesis that coefficients on the blocks of additional lags are jointly zero for all three models. In local currency Π2 (50) = 74.23, which is significant at the five percent level. In US dollars, Π2 (50) = 72.52, which is significant at the five percent level. And in Japanese yen, Π2 (50) = 78.69, which is significant at the one percent level. As a result, we estimate the co-integrating vector using the weekly data in three different VARs — one lag, two lags, and three lags — to see once again what effect the number of lags might have on the co-integration analysis. 3.5. Co-integration Results Having established the unit root characteristics of the data and identified relevant ranges for lag length, we are ready to proceed with the examination of co-integration. In this section, we consider three interrelated questions. First, are the ASEAN-5 stock markets co-integrated? If so, how many cointegrating relationships are there? To answer these questions, we rely on the 8max and 8trace statistics. The 8max statistic tests the null hypothesis that the number of co-integrating vectors is r (ranging from zero to four) against the alternative of r + 1 co-integrating vectors. The 8trace statistic tests the null hypothesis that the number of distinct co-integrating vectors is less than or equal to r against a general alternative. Second, which countries participate in the co-integrating relationships? To answer this, we conduct individual exclusion tests of the null hypothesis that the coefficient on a variable in the co-integrating vector is zero. These tests are distributed Π2 with one degree of freedom. Third, what are the coefficients in the cointegrating vectors, and do they have reasonable magnitudes for interpretation? To answer this, we report the co-integrating vector and qualitatively discuss the coefficients. Table 6.4 reports the results of the co-integration analysis. Panel A again considers daily data, and reports the results for VARs with one lag and with five lags. Panel B again considers weekly data, and reports the results for VARs with one, two, and three lags. Within each panel and lag length, models are estimated using the three currency denominations: local currencies, the dollar, and the yen. There are thus 15 VARs estimated, and the results are astonishingly consistent across all versions. Tests for co-integration utilize both the 8max and 8trace statistics, reported on the left of the various tables. Models denominated in local

Analysis of Co-integration. (July 1, 1998 through December 31, 2002).

Model

H0

Panel A: Daily Data VAR with 1 Lag (1 day) Local Currency r = 0

8trace

r#1 r#2 r#3 r#4

r=0

74.82∗∗∗

r = 0 107.68∗∗∗

r r r r

12.76 9.97 8.05 2.07

r#1 r#2 r#3 r#4

32.86 20.09 10.12 2.07

r=0

62.50∗∗∗

r=0

91.97∗∗∗

r r r r

13.08 8.61 5.12 2.67

r#1 r#2 r#3 r#4

29.48 16.40 7.79 2.67

= = = =

= = = =

1 2 3 4

1 2 3 4

1 2 3 4

VAR with 5 Lags (5 days) Local Currency r = 0 66.62∗∗∗ = = = =

1 2 3 4

17.80 9.09 8.01 0.78

3.792 (35.16∗∗∗ )

2.012 (9.42∗∗∗ )

−3.452 (25.00∗∗∗ )

−3.768 (52.36∗∗∗ )

1.000 (12.37∗∗∗ )

3.199 (41.92∗∗∗ )

1.727 (20.93∗∗∗ )

−3.230 (33.49∗∗∗ )

−3.344 (54.53∗∗∗ )

7.937 (7.94∗∗∗ )

1.000 (15.17∗∗∗ )

2.715 (31.78∗∗∗ )

1.421 (14.59∗∗∗ )

−3.086 (29.74∗∗∗ )

−2.827 (46.31∗∗∗ )

12.965 (10.07∗∗∗ )

1.000 (8.89∗∗∗ )

3.581 (29.57∗∗∗ )

1.994 (9.42∗∗∗ )

−3.431 (23.95∗∗∗ )

−3.752 (48.20∗∗∗ )

37.84 19.46 9.43 1.13

r = 0 102.30∗∗∗ r#1 r#2 r#3 r#4

1.000 (8.60∗∗∗ )

b753-ch06

r r r r

Malaysia Philippines Singapore Thailand Constant

B-753

18.38 10.03 8.30 1.13

= = = =

Indonesia

9in x 6in

r = 0 113.03∗∗∗

Co-integrating Vectors (Exclusion Tests)

ASEAN Economic Integration

Japanese Yen

H0

75.19∗∗∗

r r r r US Dollar

8max

240

Co-integration Tests

May 28, 2009 14:24

Table 6.4.

35.68 17.88 8.79 0.78 (Continued)

(Continued )

Co-integration Tests Model US Dollar

8max

Indonesia Malaysia Philippines Singapore Thailand Constant

r = 0 59.90∗∗∗

r=0

94.13∗∗∗

1.000 (13.03∗∗∗ )

2.671 (28.35∗∗∗ )

1.500 (16.00∗∗∗ )

−2.903 (27.59∗∗∗ )

−3.116 8.941 (44.75∗∗∗ ) (10.67∗∗∗ )

r r r r

r#1 r#2 r#3 r#4

34.23 20.28 10.36 2.39

r = 0 53.17∗∗∗

r=0

83.28∗∗∗

1.000 (13.75∗∗∗ )

2.548 (24.37∗∗∗ )

1.429 (13.18∗∗∗ )

−3.141 (27.48∗∗∗ )

−2.851 15.189 (39.56∗∗∗ ) (12.57∗∗∗ )

r r r r

r#1 r#2 r#3 r#4

30.11 16.72 8.91 2.81

1.000 (8.45∗∗∗ )

3.995 (36.81∗∗∗ )

2.337 (12.15∗∗∗ )

−3.769 (28.57∗∗∗ )

−4.161 (56.98∗∗∗ )

1.000 (13.36∗∗∗ )

3.015 (38.88∗∗∗ )

1.753 (22.63∗∗∗ )

−3.192 (35.16∗∗∗ )

−3.396 8.684 (55.43∗∗∗ ) (10.28∗∗∗ )

= 1 13.95 = 2 9.92 = 3 7.97 = 4 2.39

= 1 13.39 = 2 7.81 = 3 6.10 = 4 2.81

r r r r

= 1 21.20 = 2 10.10 = 3 8.18 = 4 0.70

r = 0 118.75∗∗∗ r#1 r#2 r#3 r# 4

40.17 18.97 8.87 0.70

r r r r

r#1 r#2 r#3 r#4

= 1 15.13 = 2 9.98 = 3 8.78 = 4 2.11

36.00 20.87 10.89 2.11 (Continued)

b753-ch06

r = 0 110.09∗∗∗

241

r = 0 74.08∗∗∗

B-753

8trace

9in x 6in

H0

Panel B: Weekly Data VAR with 1 Lag (1 week) Local Currency r = 0 78.57∗∗∗

US Dollar

Co-integrating Vectors (Exclusion Tests)

ASEAN Stock Markets

Japanese Yen

H0

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Table 6.4.

Co-integration Tests Model Japanese Yen

H0

8max

r=0

63.80∗∗∗

1.000 (14.10∗∗∗ )

2.905 (32.96∗∗∗ )

1.698 (18.87∗∗∗ )

−3.434 (33.82∗∗∗ )

−3.132 14.607 (48.22∗∗∗ ) (11.78∗∗∗ )

r#1 r#2 r#3 r#4

31.23 17.15 9.22 2.78

r=0

87.15∗∗∗

1.000 (8.70∗∗∗ )

3.150 (20.31∗∗∗ )

1.762 (7.13∗∗∗ )

−3.103 (18.56∗∗∗ )

−3.310 (31.91∗∗∗ )

r#1 r#2 r#3 r#4

36.29 17.56 7.41 0.32

r = 0 52.79∗∗∗

r=0

89.71∗∗∗

1.000 (14.72∗∗∗ )

2.428 (24.25∗∗∗ )

1.315 (13.44∗∗∗ )

−2.671 (25.71∗∗∗ )

−2.839 8.848 (36.24∗∗∗ ) (11.67∗∗∗ )

r r r r

r#1 r#2 r#3 r#4

36.92 21.08 9.57 2.05

r = 0 47.77∗∗∗

r=0

79.77∗∗

1.000 (15.58∗∗∗ )

2.289 (20.85∗∗∗ )

1.218 (10.21∗∗∗ )

−2.836 (24.24∗∗∗ )

−2.603 14.548 (33.03∗∗∗ ) (12.73∗∗∗ )

r r r r

r#1 r#2 r#3 r#4

32.00 17.27 8.55 2.30

= 1 14.08 = 2 7.93 = 3 6.44 = 4 2.78

VAR with 2 Lags (2 weeks) Local Currency r = 0 50.86∗∗∗ r r r r

Japanese Yen

= 1 18.73 = 2 10.14 = 3 7.10 = 4 0.32

= 1 15.84 = 2 11.52 = 3 7.52 = 4 2.05

= 1 14.73 = 2 8.72 = 3 6.24 = 4 2.30

(Continued)

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r=0

B-753

Indonesia Malaysia Philippines Singapore Thailand Constant

95.03∗∗∗

9in x 6in

8trace

ASEAN Economic Integration

H0

r r r r

US Dollar

Co-integrating Vectors (Exclusion Tests)

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(Continued )

242

Table 6.4.

(Continued )

Co-integration Tests Model

H0

8max

r#1 r#2 r#3 r#4

43.08 19.65 7.48 0.20

r = 0 44.94∗∗∗

r=0

82.62∗∗

r r r r

r#1 r#2 r#3 r#4

37.68 18.96 8.46 1.81

r = 0 42.22∗∗∗

r=0

76.04∗∗

r r r r

r#1 r#2 r#3 r#4

33.82 16.81 8.51 1.78

r r r r US Dollar

Japanese Yen

= 1 23.43 = 2 12.17 = 3 7.28 = 4 0.20

= 1 18.72 = 2 10.50 = 3 6.64 = 4 1.81

= 1 17.01 = 2 8.30 = 3 6.73 = 4 1.78

1.000 (5.70∗∗ )

4.010 (19.50∗∗∗ )

2.436 (8.96∗∗∗ )

−3.945 (18.52∗∗∗ )

−3.945 (25.51∗∗∗ )

1.000 (8.83∗∗∗ )

3.041 (21.14∗∗∗ )

1.769 (14.37∗∗∗ )

−3.332 (22.80∗∗∗ )

−3.229 (24.57∗∗∗ )

8.856 (7.18∗∗∗ )

1.000 (6.72∗∗∗ )

3.774 (22.46∗∗∗ )

2.310 (15.85∗∗∗ )

−4.339 (24.63∗∗∗ )

−3.604 (22.92∗∗∗ )

13.863 (4.82∗∗ )

243

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92.17∗∗∗

B-753

r=0

VAR with 3 Lags (3 weeks) Local Currency r = 0 49.09∗∗∗

Indonesia Malaysia Philippines Singapore Thailand Constant

9in x 6in

8trace

Co-integrating Vectors (Exclusion Tests)

ASEAN Stock Markets

H0

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Table 6.4.

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currencies are estimated without a constant in the co-integrating vector because an exclusion test of the hypothesis that the constant is zero could not reject the null for any of the specifications. Models denominated in dollars and yen are estimated with a constant in the co-integrating vector because exclusion tests of the hypothesis that the constant is zero reject the null for all of the specifications. The inclusion of a constant in the co-integrating vector alters the critical values of the 8max and 8trace statistics; we use Table B of Enders (1995, p. 420) for both sets of critical values. Taken together, the 8max and 8trace statistics consistently (somewhat overwhelmingly) indicate that there is only one cointegrating vector regardless of currency denomination, lag length, or data frequency. Since co-integration determines whether the different stock markets have a long-run relationship, coefficients in the co-integrating vector can tell us how the stock markets are related in the long run. To the right of the 8max and 8trace statistics, the co-integrating vectors are reported along with exclusion tests of each variable. The reported co-integrating vectors (only one for each model) are normalized around Indonesia; in addition to being the first country alphabetically, it is also the smallest stock market and co-integrating vectors might be usefully interpreted in that context. Taken together, the coefficients appear remarkably similar across all versions of the model. As mentioned above, one difference among the models is that the local currency versions exclude a constant from the co-integrating vector while the dollar and yen versions include a constant.10 Another difference between the local currency models and the dollar and yen models is that the coefficients in the former are generally a bit larger in absolute value than the coefficients in the latter. Since we cannot say whether these differences are statistically significant, we consider the qualitative implications of all models taken together. The exclusion tests of the variables suggest that each variable indeed participates in the long-run co-integrating vector; no country’s stock market index should be removed from the analysis. Since the co-integrating vectors are all normalized around Indonesia, we can easily rewrite the co-integrating vector as if the Indonesian stock index was the dependent variable and all other variables were independent variables. Since the coefficients are similar across all models, we consider a 10 The

table reveals that the constant in the dollar models is between 7.9 and 8.9, averaging 8.7. The yen models have a constant ranging from 13.0 to 15.2, averaging 14.2. Not much importance can be attributed to these, as they are simply constants in the levels of the stock market indices, so we do not consider them further.

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representative co-integrating vector: INDON = −3.1 MALAY − 1.8 PHILI + 3.3 SINGA + 3.3 THAIL which is, in fact, simply a collection of the average coefficients across the 15 models. The long-run relationship suggests that a one percent increase in the Malaysian stock index lowers the Indonesian index by 3.1%, and a one percent increase in the Philippine stock index lowers the Indonesian index by 1.8 percent. Similarly, a one percent increase in the Singapore or Thai stock index increases the Indonesian index by 3.3%. Since Indonesia is the smallest market, the coefficients appear reasonable because they suggest that Indonesia is heavily influenced by the two largest markets (Malaysia and Singapore) and somewhat less influenced by the smaller Philippine market. Admittedly, the high magnitude of the coefficient on Thailand is somewhat puzzling, but is consistent with results in Phylaktis and Ravazzolo (undated) concerning the influence of Thailand. It is particularly interesting that Indonesia is inversely related to Malaysia and the Philippines, as economic integration usually implies that markets move together with a positive correlation coefficient. However, there are some circumstances in which markets will be systematically inversely related; any macroeconomic shock (e.g., an oil shock) which is favorable for Malaysia and the Philippines but unfavorable for Indonesia (and vice versa) will produce such a result. To convey the sense of proportions, as well as consider another perspective, we can re-normalize the co-integrating vectors around a different country. We briefly consider normalization around Singapore, the largest market. The representative co-integrating vector can be rewritten: SINGA = 0.3 INDON + 0.9 MALAY + 0.5 PHILI − 1.0 THAIL and reinterpreted. The Singapore stock index is positively affected by the Indonesian, Malaysian, and Philippine indexes with fairly reasonable magnitudes. For example, a one percent increase in the Malaysian market is associated with 0.9% increase in the Singapore market. The Singapore market is less affected by changes in the Philippine and Indonesian markets. Finally, a one percent increase in the Thai stock market is associated with a one percent decrease in the Singapore stock market, which again seems puzzling but might reflect shocks which are favorable for Thailand and unfavorable for Singapore (and vice versa).

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Taken together, the results of co-integration analysis convincingly reveal that the ASEAN-5 stock markets are co-integrated, and have only one cointegrating relationship. In addition, all five countries participate in the co-integrating relationship. Finally, the coefficients in the co-integrating vector are all reasonable, although some puzzles remain with regard to the magnitude associated with Thailand and inverse relationships among some market pairs. It is worth pointing out once again that these results are completely robust to the frequency of the data (daily versus weekly), the currency denomination examined (local currencies, dollars, or yen), and the number of lags chosen for the VAR (within an appropriate range indicated pre-testing). Such consistent results are rare in time series studies of this type, but may not be too surprising in this particular case. Cointegration is able to pick out a long-run relationship equally well from daily and weekly data. The fact that currency denomination does not matter most likely reflects a strong relationship in the underlying stock markets which is not substantially altered when the effects of exchange rates are added in. Finally, the co-integrating relationship is, not surprisingly, reasonably invariant to small changes in the number of lags utilized in the VAR.

4. Conclusion The empirical results in this chapter demonstrate that the stock markets of Indonesia, Malaysia, Philippines, Singapore, and Thailand in the period after the Asian financial crisis (July 1, 1998 through December 31, 2002) are co-integrated, whether analyzed using daily data or weekly data, and whether analyzed in local currencies, the US dollar, or the Japanese yen. In addition, the finding does not depend on the number of lags used in estimation over a reasonable range. The stock markets are thus not completely segmented by national borders. However, there is only one co-integrating vector among the five stock markets, leaving four common trends among the five variables. We therefore conclude that ASEAN-5 stock markets are integrated in the economic sense, but that integration is not complete. Exclusion tests of the variables suggest that each country index participates in the long-run co-integrating vector, so no market should be removed from the analysis. In addition, the coefficients in the co-integrating vector are remarkably similar across all versions of the models, and are reasonable in magnitude and interpretation.

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One implication of co-integration is that there is less long-run diversification benefit from investing in all five countries than the short-run correlation coefficients indicate. On a policy level, co-integration suggests that initiatives to further integrate the stock markets are quite feasible, and in fact desirable from the standpoint of efficiency. In particular, since there is less long-run diversification benefit from investing across all five countries, a regional stock exchange will nudge investors to spread their money into smaller markets where they otherwise may not. In fact, investors from outside the region may value the benefits of a regional stock exchange (such as higher liquidity and lower transaction costs) and allocate more capital to the region than they otherwise would. This will allow ASEAN companies to expand their shareholder base and lower their cost of capital. From the stock market perspective, regional integration suggests that even currency unification would be feasible. Although this issue needs to consider other financial and macroeconomic issues as well,11 the point here is that efficient flows of capital across borders within the region have the capacity to mitigate the effects of any asymmetric macroeconomic shocks. The inverse relationships in co-integrating vectors among some stock market pairs suggest that such cross-border flows are already occurring. Stock market integration is thus an important component of overall economic integration and might be a useful pre-condition for monetary unification.

References Bank Negara Malaysia (1999). The Central Bank and the Financial System in Malaysia. Kuala Lumpur: Bank Negara Malaysia. Bayoumi, T., Eichengreen, B. and Mauro, P. (2000). On Regional Monetary Arrangements for ASEAN. Journal of the Japanese and International Economies, 14, pp. 121–148. Bayoumi, T. and Mauro, P. (2001). The Suitability of ASEAN for a Regional Currency Arrangement. The World Economy, 24, pp. 933–954. Darrat, A.F. and Zhong, M. (2002). Permanent and Transitory Driving Forces in the Asian-Pacific Stock Markets. The Financial Review, 37, pp. 35–52. 11 For

more on the issue of ASEAN currency unification, see Eichengreen and Bayoumi (1999), Bayoumi, Eichengreen, and Mauro (2000), Bayoumi and Mauro (2001), Ling (2001), Zhang, Sato, and McAleer (2001), and Madhur (2002). These studies typically examine the nature of national aggregate supply shocks to determine whether they are positively correlated across countries (and thus more characteristic of an optimal currency area).

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DeFusco, R.A., Geppert, J.M. and Tsetsekos, G.P. (1996). Long-Run Diversification Potential in Emerging Stock Markets. The Financial Review, 31, pp. 343–363. Dekker, A., Sen, K. and Young, M. (2001). Equity Market Linkages in the Asia Pacific Region: A Comparison of the Orthogonalized and Generalised VAR Approaches. Global Finance Journal, 12, pp. 1–33. Eichengreen, B. and Bayoumi, T. (1999). Is Asia an Optimum Currency Area? Can It Become One? Regional, Global and Historical Perspectives on Asian Monetary Relations. In Exchange Rate Policies in Emerging Asian Countries, Collignon, S., Pisani-Ferry, J. and Park, Y.C. (eds.), pp. 347–366. London and New York: Routledge. Enders, W. (1995). Applied Econometric Time Series. J. Wiley & Sons. Fern´ andez-Serrano, J.L. and Sosvilla-Rivero, S. (2001). Modelling Evolving LongRun Relationships: The Linkages Between Stock Markets in Asia. Japan and the World Economy, 13, pp. 145–160. Freeman, N.J. (2000). A Regional Platform for Trading Southeast Asian Equities: Viable Option or Lofty “Red Herring”? Institute of Southeast Asian Studies Working Paper No. 4. http://www.iseas.edu.sg/rpapers.html. Jang, H. and Sul, W. (2002). The Asian Financial Crisis and the Co-Movement of Asian Stock Markets. Journal of Asian Economics, 13, pp. 94–104. Johnson, S. and Mitton, T. (2003). Cronyism and Capital Controls: Evidence from Malaysia. Journal of Financial Economics, 67, pp. 351–382. Kasa, K. (1992). Common Stochastic Trends in International Stock Markets. Journal of Monetary Economics, 29, pp. 95–124. Ling, H.P.Y. (2001). Optimum Currency Areas in East Asia. ASEAN Economic Bulletin, 18, pp. 206–217. Madhur, S. (2002). Costs and Benefits of a Common Currency for ASEAN. Working Paper. Asian Development Bank. http://www.adb.org/Documents/ ERD/Working Papers/wp012.pdf. Manning, N. (2002). Common Trends and Convergence? South East Asian Equity Markets, 1988–1999. Journal of International Money and Finance, 21, pp. 183–202. Masih, A.M.M. and Masih, R. (1999). Are Asian Stock Market Fluctuations Due Mainly to Intra-regional Contagion Effects? Evidence Based on Asian Emerging Stock Markets. Pacific-Basin Finance Journal, 7, pp. 251–282. Phylaktis, K. and Ravazzolo, F. (undated). Stock Market Linkages in Emerging Markets: Implications for International Portfolio Diversification. Unpublished working paper. http://www.staff.city.ac.uk/∼sj377/workingpapers/ working papers.html. Richards, A.J. (1995). Co-movements in National Stock Market Returns: Evidence of Predictability, But Not Co-integration. Journal of Monetary Economics, 36, pp. 631–654. Sharma, S.C. and Wongbangpo, P. (2002). Long-term Trends and Cycles in ASEAN Stock Markets. Review of Financial Economics, 11, pp. 299–315. Standard & Poor’s (2001). Emerging Stock Markets Factbook. New York: Standard & Poor’s.

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Sun, Q., Tang, Y.-K. and Tong, W.H.S. (2002). The Impacts of Mass Delisting: Evidence from Singapore and Malaysia. Pacific-Basin Finance Journal, 10, pp. 333–351. Tan, K.B. and Tse, Y.K. (2002). The Integration of the East and South-East Asian Equity Markets. International Center for the Study of East Asian Development Working Paper No. 2002–11. http://www.icsead.or.jp/indexe.htm. Wellons, P. (1997). Integration of Stock Exchanges in Regions in Europe, Asia, Canada, and the US. Consulting Assistance on Economic Reform II Discussion Paper No. 14, Harvard Institute for International Development. http://www.cid.harvard.edu/caer2/htm/framsets/fr auth.htm. World Bank (2002). World Development Indicators. Washington, DC: World Bank. Zhang, Z., Sato, K. and McAleer, M. (2001). Is East Asia an Optimum Currency Area? International Center for the Study of East Asian Development Working Paper No. 2001–37. http://www.icsead.or.jp/indexe.htm.

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Relations with Dialogue Partners

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Chapter 7

Integration Strategies for ASEAN: Alone, Together, or Together with Neighbors?∗

1. Introduction As noted in Chapter 2, the internationalization of the ASEAN economies has been proceeding at a rapid pace. Moreover, the direction of this internationalization is clearly in favor of East Asia. To complement and facilitate regional integration, ASEAN has been pursuing a multi-pronged approach, from deeper economic integration in ASEAN itself to bilateral and regional free trade areas (FTAs) and national policy reform. While the subject of monetary union continues to be a popular topic, in practical terms little has been done in the direction of its realization. There have been a number of initiatives (discussed below) in terms of financial cooperation but to date the most important accords have been in the real sector. In fact, although there were few FTAs in place in East Asia outside of the ASEAN Free Trade Area (AFTA) at the turn of the century, today there are many at fairly advanced stages of implementation, with numerous others being either negotiated or awaiting ratification. The latest FTA estimates from the ADB ARIC (www.aric.adb.org) show that, as of end-June 2007, there were 101 FTAs at different stages of development, including 36 concluded FTAs, 41 under negotiation and 24 proposed. Is there a case for wider FTAs and closer financial and monetary integration, perhaps even monetary union? This chapter attempts to address these questions through institutional, theoretical, and empirical analysis. ∗ This

chapter was originally an East-West Center Working Paper co-authored with Ganeshan Wignaraja of the Asian Development Bank. 253

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Section 2 considers the trade side of ASEAN integration. It uses a computational general equilibrium model to estimate the welfare implications of various FTA scenarios. We find that, while the current wave of integration accords will generate positive results, the region would gain more from a wider “ASEAN + 3” (the 10 ASEAN countries plus Japan, China, and South Korea) or, for some Member Countries, an APEC-wide FTA, which has come to be know as the “Free Trade Area of the Asia-Pacific” (FTAAP). Next, in Section 3 we analyze financial/monetary integration, including recent initiatives and their prospects. This is followed in Section 4 by an in-depth investigation as to whether or not closer monetary integration, a topic broached in Chapter 6, would make sense from an economic perspective in the long run. We conclude that, while there are no easy answers to this question, the ASEAN + 3 does meet the criteria of Optimum Currency Area (OCA) as well as Europe did before its monetary union; in fact, the ASEAN + 3 is exhibiting increasing convergence and growing symmetry since the Asian Crisis. Nevertheless, the political momentum to create a monetary union, which is an essential variable in the equation, does not exist at present in Asia. In addition, we consider possible policy convergence issues, using the EU’s Maastricht Treaty as a benchmark. While we conclude that ASEAN and the ASEAN + 3 actually come pretty close to meeting the European criteria in most cases, these criteria are insufficient, given the institutional differences that exist across the region. We propose instead some additional considerations that would be required beyond mere policy indicators, should ASEAN or the ASEAN + 3 decide to deepen monetary integration. Section 5 concludes.

2. ASEAN Trade Integration in the Asian Regional Context In the first decade following its creation with the Bangkok Declaration in 1967, ASEAN as an organization did precious little in terms of economic cooperation. Perhaps that was all for the better, as several of its member countries were pursuing inward-looking industrialization plans at the national level. More aggressive action may have put ASEAN on a very different track (and maybe it would have met the same sordid fate of the Latin American Free Trade Area, whose members also were fond of import substitution). Today, things could hardly be different; ASEAN has doubled in size from five to 10 and almost all of its member countries would be counted

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among the champion reformers in the developing world. Its approach to formal economic integration changed drastically in the early 1990s with the creation of the AFTA and has built up momentum ever since. In this section, we survey the literature regarding the (ex-ante) economic effects of various integration accords and estimate the welfare gains that would accrue from several scenarios of regional configurations. We conclude that the existing initiatives would yield generally positive effects on the member countries and on global welfare, but that it is inferior to an ASEAN + 3 or APEC-wide FTAAP approach. Indeed, for the ASEAN member countries, the gains from the ASEAN + 3 or FTAAP are on par with that of global free trade. The ultimate implications of formal trade accords for the welfare of participating countries are complicated, including the “static” effects of integration (i.e., trade creation and diversion), dynamic effects (e.g., FDI creation and diversion, productivity effects, economies of scale) and various political-economy implications of preferential trading arrangements. To the extent that FTAs change intra-regional real-sector integration, ceteris paribus, the FTA movement will be important in determining whether or not the FTA trend is consistent with the ultimate goal of outward-oriented policy reform. There is increasing academic interest in examining the economic effects of East Asian FTAs using global computable general equilibrium (GCGE) models. This interest stems from advances in GCGE model development and computing power as well as strong international policy attention on the implications of an East Asia FTA. Policy-makers are particularly interested in understanding the magnitude of the benefits of an East Asian FTA for member countries, the possible losses to non-members, and sector-level gains and losses for members and non-members alike. But they are also important to the analysis of the future of economic integration in the region, including proposals related to the “Asian Economic Community” and, of course, Asian monetary union, discussed later in the paper. By relying on a simulation approach to analyze the economic effects of policy changes due to the formation of an East Asia FTA, GCGE models can shed light on these issues. The GCGE models used in empirical studies have varied somewhat in their underlying economic structure, behavior of agents and focus but commonly use the Global Trade Analysis Project (GTAP) database to examine an ASEAN + 3 policy scenario or a FTAAP policy scenario. The primary focus of such policy scenarios is on the removal of price distortions against imports that arise from existing trade barriers

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and other sources. Most studies have used the standard GTAP model1 with constant returns to scale in production, perfect competition, and the Armington assumption (or some variant of GTAP) while a few have adopted GCGE models with firm-level imperfect competition. Four major findings from the formation of an East Asian FTA are indicated by GCGE studies (see Ballard and Cheong, 1997; Urata and Kyota, 2003; Gilbert et al., 2004; and Lee et al., 2004): 1) all the countries involved would collect welfare gains; 2) the countries that are excluded are much more likely to suffer welfare losses; 3) production in sectors with a comparative advantage increases; 4) an East Asian FTA is a step toward multilateral liberalization. Depending on the GCGE model used and data sources, studies, however, differ in their estimates of welfare gains to members and losses to nonmembers from an East Asia FTA. For example, Urata and Kyota (2003) estimate from GTAP simulations that an ASEAN + 3 FTA will generate welfare gains for members from the highest of 12.5 percent of GDP for Thailand and 6.6 percent for Vietnam to the lowest of 0.19 percent for Japan and 0.64 percent for the PRC. They find modest welfare loses for nonmembers of −0.02 percent for the EU, −0.09 percent for the USA and −0.29 percent for Australia/New Zealand. Also using GTAP, Gilbert et al. (2004) find that an ASEAN + 3 FTA will produce higher welfare gains for members than a PRC-Japan-Korea FTA indicating that broadening FTAs brings benefits. They report lower welfare gains from an ASEAN + 3 FTA for Vietnam (3.1 percent) and Thailand (1.6 percent) than Urata and Kyota (2003). From their LINKAGE CGE model, Lee et al. (2004) show significantly higher welfare gains from an ASEAN + 3 FTA for PRC+Hong Kong (4 percent) and Japan (1.6 percent), notable gains for Korea (3.7 percent) and ASEAN as a group (4 percent) and welfare losses for the rest of the world of under −0.2 percent. GTAP simulations by Zhang et al. (2006) estimate an ASEAN + 3 FTA to increase the overall GDP of East Asian countries by 1.2 percent and economic welfare by $104.6 billion. With the exception of Japan, all members witness increases in GDP in excess of 1.7 percent. Finally, using a GCGE model with firm-level imperfect competition, Ballard and Cheong (1997) indicate that both an APEC FTA and 1 See

Hertel (1997). For more details about the current standard GTAP model see www.gtap.agecon.purdue.edu.

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an East Asian FTA would generate gains for all members even without the participation of the United States and Japan. They show that developing nations of Asia are expected to gain more when the United States joins the FTA than when Japan joins. Furthermore, some studies point to how regional trade and country specializations could evolve in the future. One might expect, for example, that an East Asia FTA would increase the share of intra-regional trade as well as the degree of specialization of each country according to comparative advantage. In part this effect might arise from an enlarged regional market resulting from elimination of trade barriers that gives more scope for differentiated products. Nonetheless, the available CGE simulation studies indicate a mixed and inconclusive picture of the likely effects of an East Asia FTA on regional trade and country specializations. For instance, Urata and Kyota (2003) suggest that such effects may be small in the case of an ASEAN + 3 FTA. They argue that “the results show that the impact of an East Asia FTA are not large enough to change the composition of each country’s exports and imports substantially” (2003, pp. 12–13). They suggest that five percent changes in exports are indicated for a few sectors like mining and textiles in Vietnam and food and beverages in Korea and Thailand. For other sectors and countries, the changes in exports are found to be mostly less than one percent (with some are less than five percent). Likewise, Urata and Kyota argue that an ASEAN + 3 FTA may not significantly expand intra-industry trade. In contrast, Gilbert et al. (2004) looking at production effects (rather than exports) of an ASEAN + 3 FTA find large changes in value-added, including declines of between 13 percent to 42 percent in the automobile sector in most member countries, rises in the textile sector of between five–ten percent in many member countries, and increases in electronics of between two to eight percent in some member countries. If the changes in value added indicated by Gilbert et al. (2004) mirror changes in exports, then it is likely that an ASEAN + 3 FTA may have notable impacts on intra-industry trade and country specialization. Further work is needed on this important issue using a combination of CGE analysis and industry-level studies. Such an exercise is beyond the scope of the current study. Bchir and Fouquin (2006) use the CEPII Mirage model to create several scenarios of economic integration based on hub-and-spoke (ASEAN + 1 agreements) and Asian regional approaches, as well as whether or not the agreements will be all-inclusive or would exclude sensitive products. They find that ASEAN, for example, would be better off with a series of bilateral

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agreements than with an Asian-inclusive approach, as this would allow them better to exploit their comparative advantage in agriculture, which is characterized by much higher levels of protection in the region than manufactures. Previous GCGE studies provide valuable insights on the likely economic effects of an ASEAN + 3 FTA and an APEC FTA. There is a need to build on this literature and adopt a more comprehensive approach that incorporates the new reality of multiple FTA initiatives in East Asia, new data sources and recent modeling developments. Accordingly, the following four policy scenarios are considered in the GCGE modeling exercise: 1) a fragmentation scenario: a continuation of the current wave of bilateralism, including AFTA, where the region is fragmented by several bilateral or small regional FTAs; 2) an ASEAN + 3 FTA scenario: free trade among ASEAN countries, PRC+Hong Kong, Japan and Korea; 3) an APEC FTA: free trade among all APEC members; 4) a global trade liberalization scenario: complete abolition of import tariffs and export subsidies. Some comments on these scenarios are appropriate. Scenario 1 represents the current reality of multiple and overlapping bilateral/regional FTAs involving East Asian countries in general and ASEAN in particular. Scenario 2 is included because this seems to be gradually taking shape with ASEAN having signed liberalization of goods agreements with both PRC and Korea2 while negotiations with Japan are still on-going. Scenario 3 is provided to represent the discussions among APEC economic ministers on ways to improve trade relations and has received considerable attention on the part of the private sector and academics. Scenario 4 is included to enable comparisons of gains and losses relative to global free trade (our benchmark). The estimates of the economic impacts of FTA scenarios were prepared using the Asian Development Bank’s General Equilibrium Model for Asia’s Trade (GEMAT). GEMAT — which is an applied general equilibrium model of the global economy with a focus on Asia — extends the LINKAGE model developed at the World Bank (see ADB 2006 for details of GEMAT). It has strong micro-foundations and captures detailed interactions among industries, consumers and governments, across the global economy. It is 2 However,

negotiations on services with PRC and Korea are still on-going.

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ideally suited for the analysis of structural changes over periods that are sufficiently long to allow markets to adjust and rigidities to work themselves out. Among other assumptions, GEMAT incorporates firm heterogeneity, fixed trade costs and imperfect competition. Table 7.1 summarizes the results for GDP and welfare in terms of equivalent variation for the four policy scenarios. It comes as little surprise that scenario 1 — a fragmented reality of multiple bilateral and regional FTAs — is the least attractive for regions and most countries. Among others, this scenario may give rise to the famous “spaghetti” or “noodle bowl” effect which refers to higher transaction costs from multiple rules of origin and Table 7.1.

Impact of 4 FTA Scenarios: Real Income. (Equivalent Variation). (1) Fragmentation Scenario

In US$ Mn, 2001 prices ASEAN 8,869 Indonesia 712 Malaysia 1,753 Philippines 481 Singapore 1,833 Thailand 3,545 Vietnam 564 Northeast Asia −1,219 Rest of Asia −101 USA −1,371 Europe −1,021 ROW −555 World 4,401 In % of GDP ASEAN Indonesia Malaysia Philippines Singapore Thailand Vietnam NortheastAsia Rest of Asia USA Europe ROW World

1.72 0.51 2.04 0.71 2.25 3.22 1.81 −0.02 −0.01 −0.01 −0.01 −0.01 0.01

(2) ASEAN + 3 FTA

(3) FTAAP (APEC)

(4) Global Free Trade

10,375 523 3,941 350 1,240 3,305 1,016 21,724 −425 −2,362 −904 −464 27,546

8,341 702 3,084 −5 747 2,707 1,106 56,734 −1,560 12,035 −3,047 280 74,689

11,319 1,206 3,712 −136 1,409 3,866 1,263 72,944 4,288 22,884 25,325 14,861 153,718

2.02 0.38 4.62 0.52 1.52 3.00 3.27 0.37 −0.06 −0.02 −0.01 −0.01 0.09

1.62 0.50 3.62 −0.01 0.92 2.46 3.55 0.96 −0.22 0.12 −0.04 0.01 0.25

2.20 0.87 4.36 −0.20 1.73 3.51 4.06 1.23 0.61 0.24 0.30 0.34 0.51

Source: ADB Staff Estimates Using GEMAT.

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standards in the growing number of FTAs in East Asia. Global free trade (scenario 4) is the most attractive for most countries but unrealistic, bearing in mind that even the WTO process has been beset by uncertainties on the timing and depth of multilateral agreement to reduce trade barriers. The FTAAP brings gains to Northeast Asia and the United States but ASEAN witnesses less gains compared to scenario 1, with the exceptions of Malaysia and Vietnam. The rest of Asia and Europe, which would be outside an FTAAP, also lose relative to scenario 1. Under the ASEAN + 3 Scenario (scenario 2), the welfare of members increases with Northeast Asia and ASEAN witnessing gains of 0.37 percent and 2.02 percent, respectively. In fact, for ASEAN there is very little difference between the ASEAN + 3 scenario and global free trade (0.18 percent of GDP). The difference between the ASEAN + 3 scenario and the FTAAP is slightly more (0.40 percent) but global gains from the FTAAP are (slightly) greater than the ASEAN + 3 (0.16 percent of global GDP).3 Note that GCGE simulation studies are useful in indicating the channels by which the formation of an FTA translates into changes in the economy. Existing studies have focused on liberalization of import tariffs on goods trade. A major shortcoming of such studies is their inability to incorporate rules of origin and non-tariff measures (e.g. SPS and TBT), which are likely to afford more protection for domestic industries than tariffs. In addition, there are no GCGE studies on liberalization of barriers to services trade. Furthermore, in these approaches, it is unclear whether the members of an FTA ultimately realize potential effects. Thus, GCGE studies are best when used in conjunction with other empirical tools — notably analysis of the complex structure of FTAs and enterprise perception studies of the benefits of FTAs (Francois, McQueen and Wignaraja, 2005). 3. Financial and Monetary Cooperation Initiatives related to trade have by far the longest tradition in ASEAN and have been much more comprehensive relative to cooperation in financial and monetary matters. Moreover, economists have much better tools in analyzing the welfare implications of trade accords. Hence, the bias in the literature has heretofore been in the direction of trade analysis. However, as 3 Kawai

and Wignaraja (2007) focus on various configurations of FTAs in East Asia as well, and conclude that an East Asian FTA, combined with either an East Asian FTA with NAFTA or an Asia-Pacific FTA, would be the most advantageous for East Asia as a whole.

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argued above, since the Asian Crisis the need to move forward on financial and monetary matters has moved up the ladder of policy priorities, as discussed in Chapters 5 and 6. As ASEAN countries endeavor to deepen their national capital markets, they have been using both ASEAN-based and ASEAN + 3 approaches. In effect, most significant financial initiatives have been thus far at the ASEAN + 3 level. Hence, in what follows, we consider exchange-rate management and financial and monetary cooperation mainly from an ASEAN + 3 perspective. Section 4 considers whether or not the region would be a good candidate for very deep integration in the area (i.e., monetary union) in the long run. 3.1. Exchange-rate Management Exchange-rate regimes in Asia differ widely, from various degrees of managed floats (e.g., most ASEAN countries, Japan, and South Korea) to hard pegs (e.g., China and Hong Kong). There are many excellent reviews of exchange-rate regimes in the region (see, for example, ADB, 2006). However, they all have one common characteristic: the US dollar as the (explicit or implicit) reference currency or anchor. In reviewing the evolution of the roles of the US dollar, yen, and euro in East Asia, Kawai (2002) notes that the US dollar was either the de facto or de jure anchor in the region’s economies prior to the 1997–98 Asia Crisis. During the Crisis the role of the US dollar declined but in its aftermath the US dollar generally assumed its traditional role as anchor. Still, its importance diminished in certain countries (e.g., Indonesia) and there has been greater flexibility in exchange-rate management. As of early 2007, the role of the US dollar continues to be prevalent, but there are some indications of certain strains and a desire to diversify is in evidence. Weakness in the US dollar appears to have led some countries (e.g., China) to announce explicit reserve diversification strategies. Thailand in December 2006 even (briefly) imposed capital controls in order to prevent further appreciation of the baht against the dollar, reflecting problems associated with continued sterilization of foreign exchange interventions over a long period of time (holdings of US dollars by the region’s central banks are at historical highs). Numerous studies in the literature evaluate alternative exchange-rate regimes in the ASEAN + 3. Kwan (2001), for example, considers, from an institutional/political-economy perspective, the case for closer exchangerate management in Asia, with a focus on the potential role of the Japanese

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yen in future arrangements. McKibbin (2004) evaluates the performance of several potential Asian exchange-rate arrangements with respect to their effects on output and inflation variability in the presence of various shocks, and finds that no regime dominates in the presence of all shocks but the regimes of floating and a basket peg to the US dollar, euro and yen generally perform better than an Asian currency union or yen-zone regime. There continues to be a strong appetite in the region for various proposals regarding future exchange-rate management and cooperation, even if there has been little or no concrete progress in this regard at the policy level (as will be discussed below, various forms of monetary union in Asia have been tabled by academics but these have not been considered seriously in policy discussion). Arguably, this desire relates to the problems associated with the Asia Crisis. This “contagion” effect of the Crisis, which began in Thailand on July 2, 1997 and quickly spread to Malaysia, Indonesia, the Philippines, and ultimately South Korea and even Hong Kong, took the region by surprise, particularly since the potential for “real contagion” was thought to be small given the relatively low levels of trade integration between the affected economies at the time. However, the contagion effect was devastating. Kim et al. (2002) separate contagion into several separate categories, with bilateral real integration just being one (and a small part of it). 4 The others would include competition in third markets5 ; “financial contagion” which relates to international investor’s behavior during a crisis; and “pure contagion” which could be “herd behavior”, informational cascades, and the like. Kim et al. (2002) argue that all these channels played a role in the Crisis and survey the relevant literature. For Asian policymakers, this contagion effect clearly underscored the “policy externalities” associated with macroeconomic and financial policies in an increasingly integrated region, which in turn has given birth to a variety of approaches geared to endogenize, at least in part, these externalities. We discuss these initiatives below. Suffice it to note that the presence 4 Glick and Rose (1999), for example, examine five currency crisis episodes and find that countries affected by crisis have strong trade relations with the country that was the first victim of the crisis episode. But this effect is not important relative to other channels. Moreover, in the case of the Asian Crisis, Thailand accounted for only between one percent and 4.5 percent of the exports of the affected Asian economies. 5 That is, if a crisis hits Thailand and Malaysia and Thailand compete significantly in the US market, a strong devaluation of the baht would impact the competitiveness of Malaysia, which would lead investors to sell short Malaysian ringgit. For analysis of this type of competitiveness effect in the Asian Crisis context, see Kochar, Loungani and Stone (1998), who find that this type of trade channel played an important role in the Crisis.

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of contagion at higher levels of integration (see, for example, Candelon, Piplack and Straetmans, 2006; and Dungey et al., 2004) reinforces arguments in favor of monetary union. 3.2. Financial/Monetary Integration One might trace the first initiative in favor of monetary/financial cooperation in the ASEAN + 3 to be the original “Miyazawa Plan”, which was initiated by Japan during the Asian Crisis to create an Asian Monetary Fund to supplement the IMF. It was opposed by the IMF and the United States, but eventually led to the establishment of currency swap arrangements among East Asian countries (basically bilateral swaps between Japan and individual countries) during the annual meeting of the Asian Development Bank in May 2000 (the “Chiang Mai Agreement”). There have also been proposals to integrate capital markets in the region, from modest proposals to coordinate more closely existing national capital markets, to more ambitious proposals such as the creation of supranational regional bond and stock exchanges. The main issues relate to integration as opposed to capital market development more generally, although one motivation for integration is typically to foster development of the market. Interest in stock market integration arises primarily because financial theory suggests that an integrated regional stock market is more efficient than segmented national capital markets (Chapter 6). Capital market efficiency in Southeast Asia has become even more important after the Asian financial crisis. Southeast Asian countries are specifically seeking to reduce the traditional dependence of firms on bank loans rather than bond and stock issuances, and at the same time are seeking new capital from outside the region. With an integrated regional stock market, investors from all member countries will be able to allocate capital to the locations in the region where it is the most productive. With more cross-border flows of funds, additional trading in individual securities will improve the liquidity of the stock markets, which will in turn lower the cost of capital for firms seeking capital and lower the transaction costs investors incur. These suggest a more efficient allocation of capital within the region. With respect to fixed-income markets, the need to finance emerging government deficits in the region, robust demand for infrastructural projects, and ambitious business plans of many private-sector companies make the development of bond markets a natural priority, though a major challenge.

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As noted in Chapter 5, fixed-income instruments are important not only as an additional financial vehicle but also as a complement to equity markets. Firms may wish to raise medium- and long-term financial capital without relinquishing more control of the firm, or possibly as a complement to equity issuances (or vice versa; major corporate bond issues are often accompanied by warrants). Moreover, ASEAN governments in particular have recognized that a stronger and more extensive local bond market can be strong protection against maturity and currency “mismatches”. While ASEAN launched a study on the possibility of creating an ASEAN bond market in 2002–2003, the idea was essentially put on the back-burner in favor of an ASEAN + 3 framework, which would include the major financial players in Asia. For example, the December 2002 “Asian Bond Markets Initiative” established a (small but growing) bond pool under the auspices of the Bank for International Settlements. Nevertheless, financial and monetary cooperation in Asia continues to be at a conceptual stage. Even its most successful cooperative effect, the Chiang Mai Initiative, relatively lacks ambition if one considers that its swaps totaling $85 billion will be drawn from reserves that are currently at about $2.5 trillion. But the economics seem to support such initiatives. As noted in Chapter 5, the decision in October 2008 during an ASEAN + 3 meeting on the sidelines of the biannual Asia-Europe (ASEM) meetings to create a financial facility of $80 billion to help Asian national face liquidity problems suggests that such a need is in evidence.

4. Do Macroeconomic and Policy Trends in Asia Support Monetary Union? Ever since the World Bank’s publication of the East Asian Miracle (World Bank, 1993), the successful, export-oriented approach to economic development has been a model for developing countries. Of course, the region’s remarkable trade performance has been made possible by general political stability, stable macroeconomic policies, and market-oriented microeconomic reforms (see, for example, World Bank, 1993; World Bank, 2006; and ADB, 2006). While an exhaustive review of the determinants of the “East Asian Miracle” would go beyond the scope of this paper, suffice it to note that more than any other region in the developing world, Asia has been able to exploit to its advantage the global marketplace and globalization.

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As has been well-documented,6 over the past 20 years the region has been highly successful in raising living standards (and, with it, reducing poverty significantly) and in maintaining healthy macroeconomic indicators. Moreover, it exhibits a classic process of structural change as the economic development proceeds apace, with agricultural falling in importance while services (and, usually, manufactures) rise.7 There has also been a process of convergence at work. As Barro and SalaI-Martin (2004) show, while the hypothesis of global economic convergence (“beta” convergence) can be rejected with reasonable degrees of confidence, there is evidence of “conditional convergence”.8 But East Asia is the only region where economies are catching up unambiguously with each other and the OECD (World Bank, 2006). For example, while the per capita incomes of Singapore and Taipei, China were about half that of Japan in 1985, by 2004 they had almost caught up to Japan . . . and Hong Kong actually surpassed it.9 South Korea’s per capita GDP was still one-third lower than that of Japan in 2004 but its catching-up process has been impressive, with per capita GDP virtually quadrupling since 1985.10 Most ASEAN countries also exhibited notable catch-up relative to Japan (and other OECD countries). The most remarkable story, however, is that of China, which has been transformed from a poor, isolated, autarkic economy into an economic powerhouse in a generation. This dramatic transformation is attributable to a major overhaul of economic policy that has embraced (and, in some ways, is now leading) globalization, rather than resisting it as in the past. This outward-oriented approach to economic development, which has been a key engine of growth in Asia, has made it a natural candidate for regional economic integration initiatives in a world that is increasingly eschewing a multilateral approach to trade policy in favor of bilateralism 6 ADB (2006) and World Bank (2006) each give excellent reviews of these processes, but the literature is large. 7 The exception in terms of services is Thailand, whose share actually falls slightly. However, this reflects a problem with collection of services data in Thailand: in short, laborers who work only part-time in agriculture are included as agricultural workers, even if they generally rely on employment in services as their most important source of income. 8 In calculating “conditional convergence”, the authors only include countries that meet certain criteria, that is, countries with hyper-inflation, political instability, and the like are excluded from the database. 9 World Bank Development Indicators database; CEIC database. 10 Ibid.

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and regionalism. In addition to the need to reclaim most favored nation status in key markets (“defensive” regionalism), FTAs in Asia are being used as a means to address key areas that have been hitherto excluded in the WTO talks. 4.1. The Economics of Monetary Union: Is Asia an Optimum Currency Area? There exist several studies in the literature that attempt to address the question of whether or not some sort of Asian currency area would make sense, often using the experience of monetary union in Europe as a yardstick. Such comparisons are only natural. The theory of Optimum Currency Areas (OCAs) does not provide us with an optimal “threshold”; however, if it is assumed that the EU makes sense as a currency area, comparisons of indicators between what the EU was like prior to monetary union and what Asia is now would be appropriate. Perhaps the most comprehensive works on the subject have been undertaken by Bayoumi and Eichengreen (1999) and Bayoumi, Eichengreen and Mauro (1999). They use a variety of indicators consistent with the OCA literature, from analysis of intra-regional trade to correlations of aggregate supply shocks, to compare the EU prior to Maastricht and Asia/ASEAN today.11 They find that, in general, Asia comes as close to meeting OCA criteria as Europe did. However, they note that historically the essential pre-conditions for a durable regional monetary arrangement depend critically on politics rather than economics. In this sense, Asia looks much less like an OCA. Nicolas (1999) essentially comes to the same conclusion in terms of political limitations but is less sanguine with respect to the economics of a currency area in ASEAN. Tang (2006) focuses on symmetry of supply and demand shocks and speed of adjustment in evaluating possible configurations of monetary union across major Asian economies. He finds that smaller subgroupings of economies in Asia (e.g., Malaysia and Singapore; ASEAN more generally; Hong Kong and Taiwan) fit the OCA criteria better than a general Asian monetary union. 11 One

problem with the Bayoumi, Eichengreen, and Mauro (1999) paper is that they define ASEAN to include all of its official member states, including the most recent members, i.e., Vietnam, Laos, Cambodia, and Myanmar. None of these countries would be a candidate for monetary integration of various sorts in the short- or medium run, given their low level of economic and financial development, closed financial markets, and unconvertible currencies.

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One way to evaluate the OCA symmetry criterion is to estimate correlations of macroeconomic variables between members of a proposed currency group over time using high frequency data. The more highly correlated these variables are throughout the business cycle, the greater the implied symmetry of economic structures of the component members of the group, and the more likely the group would constitute an OCA. Kose et al. (2003) use overall output (real GDP) as the key macroeconomic variable for the ASEAN-5, Korea, and Taiwan. The results show fairly high (positive) cross-correlations of output between most ASEAN countries and between individual countries and the Asian aggregates. For example, correlations between the ASEAN-5 countries and the Asia Cycle 2 aggregate fall in the range of 0.36 (Philippines) and 0.49 (Singapore). Moreover, with the exception of Indonesia, correlation coefficients have generally been rising over time. Excluding Indonesia, they increased over time in all cases expect that of Malaysia-Philippines. The highest correlations in period 2 were found between Malaysia and Indonesia (0.73); Singapore and Thailand (0.63); and Singapore and Malaysia (0.58). In general, correlations between ASEAN countries are often higher than with the general Asia group aggregates. In short, it would be difficult to state unequivocally that East Asia constitutes an OCA. However, macroeconomic trends and symmetry analysis would suggest that at least it is moving in that direction, and if the EU is used as the benchmark, it already may be there. Moreover, the “endogeneity” process noted by Frankel and Rose (1998) would suggest that, should Asia join in monetary union, the convergence indicators would be reinforced. Nevertheless, the political status quo, particularly in Northeast Asia, would preclude such an arrangement . . . at least in the short run. But the confluence of closer trade integration and the emergence of an “Asian identity” could well enhance the potential for a removal of existing political obstacles. The Maastricht Treaty created considerable excitement in the discipline of international economics regarding the economic logic behind monetary union. Since then, there have been hundreds of studies estimating the economic effects of monetary union. Grubel (2006) gives an excellent survey of the economics of monetary union, using a framework that is highly relevant to the Asian case. A process of convergence appears to be in evidence. In order to gauge it, we calculate correlation coefficients between individual-country growth and the ASEAN + 3 for pre- and post-Crisis periods using annual (1980–2006,

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Table 7.2a. Correlation of GDP Growth Rates between Individual Countries and ASEAN + 3: 1980–2006.a

PRC Indonesia Japan Korea Lao PDR Malaysia Philippines Singapore Thailand Vietnam

1980–1997

1998–2006

−0.42 −0.22 −0.16 0.25 −0.38 −0.20 −0.17 −0.16 0.44 −0.27

0.61 0.9035* 0.8469* 0.57 0.7338* 0.8985* 0.9663* 0.7543* 0.8669* 0.7033*

Note: *Significant at 5 percent level. a ASEAN + 3 excludes Brunei, Cambodia, and Myanmar. Regional GDP growth is weighted by gross national income (atlas method, current US$). Sources: IMF World Economic Outlook Database, World Bank, Development Indicators Online. Table 7.2b. Correlation of GDP Growth Rates between Individual Countries and ASEAN5+3: First Quarter 1994 to First Quarter 2007.a

PRC Indonesia Japan Korea Malaysia Philippines Singapore Thailand

Q4 1997

Q1 1998–Q1 2007

−0.16 0.33 −0.08 0.08 0.35 0.33 −0.31 0.06

0.5240* 0.7690* 0.7729* 0.5169* 0.7918* 0.8532* 0.7294* 0.7868*

Note: *Significant at 5 percent level.

Table 7.2a) and quarterly (1994Q1 to 2007Q1, Table 7.2b) data. The results are illuminating. Table 7.2a shows that while in the pre-crisis period not one correlation coefficient was statistically significant (and many were negative), in the post-Crisis period all but two (China, Korea) were, and the magnitudes are positive and high (i.e., in the range of 0.7 to 0.97 for the statistically-significant coefficients). The same results generally obtain using quarterly data (Table 7.2b), with lower estimated coefficients (range: 0.52– 0.85) but all estimated coefficients are statistically significant.

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In combination with the existing literature summarized above, these results give strong support to the view that, while we do not know if East Asia constitute an OCA, we can be confident that symmetry in the region is increasing and is high for just about every country. But the literature points to two other possible criteria: factor flows and degree of interdependence. With respect to the former, the prognosis is less optimistic: intraregional labor flows are very small even by international standards (World Bank, 2006b) and intra-regional flows of FDI are relatively low.12 On the other hand, intra-regional trade shares are relatively high and growing (as noted in Chapters 2 and 3). No economy in the region undertakes less than 40 percent of its trade with other East Asian partners, and for most the share is 60 percent or more. This is especially impressive when one remembers from the above discussion that, unlike the EU, no preferential trading arrangements were really in place to influence these trade shares with the (theoretical) exception of AFTA. As Rana (2006) argues, this process of rising intra-regional trade is being led by intra-industry trade. He uses a gravity model to show that the rise in economic symmetry in the region derives from this increase in intraregional trade. The literature would suggest that this process would bode well for a continuing “endogenous” process of increasing symmetry.

4.2. Macroeconomic Policy Diversity in East Asia: Would Maastricht Criteria Be Possible? As part of the monetary union process in Europe, it became clear that some policy harmonization was necessary in order to ensure a stable regime. The famous “Maastricht Criteria”, later reinforced by the Stability and Growth Pact, had four principal requirements: (1) debt/GDP should be no greater than 60 percent (though this indicator was downplayed given the greater than 100 percent shares in Belgium and Italy); (2) any deficit/GDP should be no more than three percent; (3) the inflation rate and nominal interest rate of a country should be no greater than 1.5 percent higher than the average of the lowest three countries; and (4) there should be no realignment 12 UNCTAD,

FDI Statistics online. For example, intra-regional FDI in ASEAN comes to only 13 percent of the total. Singapore is an FDI hub in ASEAN (accounting for twothirds of FDI in the region) but its major sources are from outside the region, particularly the EU and the United States. Japan and South Korea only account for about one percent of global flows of FDI each. Only China really stands out as a major recipient of FDI flows from the region (mainly from Hong Kong, Japan, and Taipei, China).

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of a country’s exchange-rate peg in the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) for two years prior to acceding to monetary union. Thus, the main goal was macroeconomic policy harmonization and stability. There has been considerable debate on the economic logic of the Maastricht criteria in general, and the actual numeric criteria in particular. But if we were to subject East Asia to the same test, how would it fare? First, fiscal policy would generally receive high marks, especially relative to the EU. The share of government spending in GDP in the NIEs (less than 25 percent), ASEAN (11–30 percent range, save the peculiar cases of Brunei and Myanmar), and China (18 percent) are low relative to the EU average, even though, as developing countries, this is not a surprising outcome.13,14 Japan’s share is somewhat higher (37 percent) but this is among the lowest in the OECD (though, of course, its debt/GDP ratio of over 165 percent is the highest in the OECD). With respect to budget deficits, Table 7.3 shows that there is a good deal of variability across East Asia. Deficit/GDP ratios of the ASEAN countries were less than three percent for all original ASEAN countries save Malaysia (3.8 percent), but only Vietnam among the transitional economies would meet the Maastricht inflation criterion. Singapore actually had a surplus of eight percent of GDP. It is interesting to note that the Crisis-affected ASEAN countries had surpluses or essentially balanced budgets on the eve of the Crisis. Since then, they have tended to have modest deficits, with the occasional exception of Thailand. The deficits of China and Taipei, China (2004) came to approximately 1–2 percent, while South Korea and Hong Kong had surpluses. Only Japan, which currently has a deficit/GDP of about five percent and has not met the Maastricht criteria since 1993, would fail the test outright. Hence, with the exception of Japan and a few of the smaller, transitional ASEAN economies, reaching a three percent target would not be particularly difficult for East Asia. By developing-country standards, East Asia has been characterized by conservative monetary policies and price stability. Inflation rates in the ASEAN countries are in the zero to 10.5 percent range (with Indonesia defining the upper bound); China and the NIEs have inflation rates of less than three percent; and Japan continued to be in a deflationary state in 2005 (−0.3 percent). Thus, while inflation in the region is generally under 13 With

a smaller tax base, potential fiscal burdens are less. data for this section not included in Table 5 are taken from the IMF World Economic Outlook Database; World Bank Development Indicators Database; ADB Key Economic Indicators; or the OECD Statistics Database. 14 All

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Table 7.3.

271

Divergence in East Asian Macroeconomic Indicators (2005).

Japan PRC NIEs −3 Hong Kong Republic of Korea Taipei, China ASEAN Brunei Darussalam Cambodia Indonesia LAO PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam

Public Sector Debt (% of GDP)a

Fiscal Balance of Central Government (% of GDP)

Inflation Rate (%)

— 19.2

−5.2 −1.6

−0.3 1.8

0.1 2.5

— 22.0 30.3

0.3 0.8 −1.0

1.1 2.7 2.3

3.2 3.7 1.5

—

—

— 58.3 — 68.9 — 101.3 — 49.4 40.8

−3.1 −0.5 −6.0 −3.8 −6.0c −2.7 8.0 0.1 −2.3

0.9c 5.8 10.5 7.2 3 4.5c 7.6 0.4 4.5 8.3

Interest Rate (%)b

— — 10.3 — 2.9 — 7.0 2.3 3.3 —

Notes: a Refers to consolidated government debt except for Indonesia, Korea, and Taipei, China which refer to central government debt while Philippines refer to non-financial public sector debt. b Money market rate. c As of 2004. Source: Asia Economic Monitor (December 2006), Asian Development Outlook (2006), and Bloomberg.

control, there exists considerable disparity in terms of inflation rates. It is worth noting, however, that the inflation criterion for Maastricht has been a source of major disagreement: for example, if Luxembourg, the Netherlands, and Sweden were experiencing deflation, would it make sense to use their average as a reference point, given their relative sizes and falling prices? If we did the same for East Asia, we would calculate an average 0.3 percent (Singapore, Japan, and Brunei), meaning that all countries with inflation rates above 1.8 percent would be ineligible. While this would seem normal to the European Central Bank, whose inflation target is two percent or less, it would mean that 12 out of 15 countries would fail to meet the criteria. In any event, it would take some effort to force relative convergence of inflation rates, though this would not be a task that would be much more difficult

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than it was in Europe. The same story generally applies to interest rates, though divergence is much less than for inflation. However, as most East Asia countries have underdeveloped bond markets, it is unclear if economywide interest rates reflect the true price of risk in the economy, due to, inter alia, lack of liquidity in the market. In addition, there is no doubt a far greater spread of risk across bonds in East Asia than there was in the case of the EU. Finally, regarding exchange rates, Japan and the NIEs have been characterized by high trend volatility relative to each other and, particularly, compared to the ASEAN countries. This is a reflection of both institutional arrangements (e.g., pegs, managed float, and float) and underlying macroeconomic variables. ASEAN exchange rates, however, pretty much seem to move in step with each other since the early 1990s, reflecting in large part the implicit or explicit peg to the US dollar. In any event, these regimes have been developed in an independent context; certainly, prior to any movement toward monetary union, the regime would require an exchangerate mechanism (such as the ERM/EMS prior to monetary union). In short, while there is no magic number that one could assign to the degree of economic symmetry across these countries, in terms of basic macroeconomic variables, empirical assessments would support the view that ASEAN + 3 countries are increasingly symmetric, and the share of intra-regional trade in total trade is relatively high and rising. This process is being bolstered by increasing shares of intra-industry trade. Moreover, with respect to policy harmonization, the conclusion is mixed: fiscal policies could be fairly easily harmonized, whereas the monetary variables might take some doing. In any event, any policy decision to move toward monetary union in Asia would require a transitional period, as was the case in Europe. 4.3. Towards an Asian Maastricht The Maastricht criteria were set up for a group of developed countries whose “core countries” had among the most sophisticated economic and financial superstructure in the world. Given that institutional “best practices” were generally already in place in the countries determining the framework for monetary union, the choice for convergence criteria based on policy variables alone is understandable. However, this is not at all the case in the ASEAN + 3; while there are a few economies with sophisticated infrastructure, the region is highly diverse in terms of its financial and monetary-related institutions, including some countries with only elementary infrastructure and institutions. Hence, before moving in the

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direction of closer monetary integration, it will be necessary to come up with a set of both policy, institutional, and governance criteria.

5. Concluding Remarks In this chapter, we evaluated, inter alia, the economic prospects of economic integration in ASEAN and Asia more generally. We reviewed the literature on the economic viability of these accords, including some fresh simulations on the correlation of business cycles and the economic effects of potential trade groupings being considered. In general, the results suggest that the economic potential for closer economic integration is strong. In terms of trade, we noted that there would be positive gains from ASEAN integration and the current wave of bilaterals, but that these gains are much less significant for ASEAN than would be the case of other scenarios, such as the ASEAN + 3 or FTAAP. We also argued that the case for deepening financial and monetary integration in Asia is convincing, even though the political underpinnings of such an accord are not yet in place. In a related study (Plummer and Wignaraja, 2006), we argue that real integration has been taking place at the bilateral, multilateral, and regional levels, and note that the economic implications of these emerging agreements will actually reinforce the economic case for monetary union in Asia, in a similar way that real-sector integration did so in Europe. Hence, we conclude that, at present, the post-sequencing of economic integration in Asia is developing such that trade agreements, which are dominating the formal accords in Asia, will ultimately complement the movement toward financial and monetary integration, which will take a great deal more time and political will.

References Asian Development Bank (2006). Outlook 2006: Routes for Asia’s Trade. Manila: Asian Development Bank. Ballard, C. L. and Cheong, I. (1997). The Effects of Economic Integration in the Pacific Rim: A Computational General Equilibrium Analysis. Journal of Asian Economics, 8(4). Barro, R.J. and Sala-I-Martin, X. (2004). Economic Growth. Cambridge: MIT Press. Bayoumi, T. and Eichengreen, B. (1999). Is Asia an Optimal Currency Area? Can It Become One? Regional, Global, and Historical Perspectives on Monetary Relations. In Exchange Rate Policies in Emerging Asian Countries,

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Collignon, S., Pisani-Ferry, J. and Park, Y.C. (eds.), pp. 347–367. London: Routledge. Bayoumi, T., Eichengreen, B. and Mauro, P. (1999). On Regional Monetary Arrangements for ASEAN. Prepared for the ADB/CEPII/KIEP Conference on Exchange Rate Regimes in Emerging Economies, Tokyo. Bchir, M.H. and Fouquin, M. (2006). Economic Integration in Asia: Bilateral Free Trade Agreements versus Asian Single Market. CEPII Working Paper No. 2006–15. Click, R. and Plummer, M.G. (2005). Stock Market Integration in ASEAN. Journal of Asian Economics, 16(1), pp. 5–28. Candelon, B., Piplack, J. and Straetmans, S. (2006). On Measuring Synchronization of Bulls and Bears: The Case of East Asia. Mimeograph. De Grauwe, P. (2005). The Economics of Monetary Union. Oxford: Oxford University Press. Dungey, M., Fry, R., Gonzales-Hermosillo, B. and Martin, V. (2004). Empirical Modeling of Contagion: A Review of Methodologies. IMF Working Paper WP/04/78. Francois, J.F., McQueen, M. and Wignaraja, G. (2005). European UnionDeveloping Country FTAs: Overview and Analysis. World Development, October, 33(10), pp. 33–10. Frankel, J. and Rose, A.K. (1998). The Endogeneity of the Optimum Currency Area Criteria. Economic Journal, 108, pp. 1009–1025. Gilbert, J., Scollay, R. and Bora, B. (2004). New Regional Trading Developments in the Asia-Pacific Region. In Global Change and East Asian Policy Initiatives, Yusuf, S., Altaf, N. and Nabeshima, K. (eds.), Washington DC: World Bank. Glick, R. and Rose, A.K. (1999), Contagion and Trade: Why Are Currency Crises Regional? Journal of International Money and Finance, 18(4), pp. 603–617. Grubel, H. (2006). The Economics of Monetary Unions: Traditional and New, Paper presented at the joint Fraser Institute and Kiel Institute of World Economics conference, The Economics of Regional Monetary Integration, Kiel, Germany. Hertel, T.W. (ed.) (1997). Global Trade Analysis: Modeling and Applications. Cambridge: Cambridge University Press. Kawai, M. (2002). Exchange Rate Arrangements in East Asia: Lessons from the 1997–98 Currency Crisis. Monetary and Economic Studies (Special Edition). Kawai, M. and Wignaraja, G. (2007). ASEAN + 3 or ASEAN + 6: Which Way Forward? ADBI Discussion Paper No 77. Tokyo: Asian Development Bank Institute. Kim, S., Kose, A. and Plummer, M.G. (2002). Contagion or Simple Transmission of Business Cycles? In The Post-Financial Crisis Challenges for Asian Industrialization, Richard, H. and Yoo, J.-H. (eds.), pp. 43–93. New York: Elsevier. Kochar, K., Loungani, P. and Stone, M. (1998). The East Asian Crisis: Macroeconomic Developments and Policy Lessons. IMF Working Paper No. 98/128. Kose, A., Kim, S. and Plummer, M.G. (2003). Dynamics of Business Cycles in Asia: Differences and Similarities. Review of Development Economics, 7(3), pp. 462–477.

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Kwan, C.H. (2001). Yen Bloc: Toward Economic Integration in Asia. Washington, D.C.: Brookings Institution Press. Lee, H., Roland-Holst, D. and van der Mensbrugghe, D. (2004). China’s Emergence and the Implications of Prospective Free Trade Agreements in East Asia. Mimeograph, Kobe: Kobe University. McKibbin, W.J. (2004). Which Exchange Rate Regime for Asia? Brookings Discussion Papers in International Economics, No. 158. Mundell, R. (1961). A Theory of Optimum Currency Areas. American Economic Review, 51, pp. 657–665. Naya, S.F. and Plummer, M.G. (2005). The Economics of the Enterprise for ASEAN Initiative. Singapore: ISEAS. Nicolas, F. (1999). Is There a Case for a Single Currency within ASEAN? The Singapore Economic Review, 44(1), pp. 1–25. Ogawa, E. and Shimizu, J. (2006). Progress towards a Common Currency Basket System in East Asia. RIETI Discussion Paper Series 07-E-002. Plummer, M.G. (2007). Harnessing Productivity and Competitiveness in East Asia. Paper presented at the International Conference, Integrating Asian Economies: 10 Years after the Crisis, Bangkok. Plummer, M.G. and Wignaraja, G. (2006). The Post Crisis Sequencing of Economic Integration in Asia: Trade as a Complement to a Monetary Future. Economie Int´ernationale, 107, pp. 59–85. Rana, P.B. (2006). Economic Integration in East Asia: Trends, Prospects, and a Possible Roadmap. ADB Working Paper Series on Regional Economic Integration, No. 2. Tang, H.C. (2006). An Asian Monetary Union? CAMA Working Paper, 13/2006. Urata, S. and Kyota, K. (2003). Impacts of an East Asian FTA on Foreign Trade in East Asia. NBER Working Paper Series, Working Paper 10173. Mass: National Bureau of Economic Research. World Bank (1993). East Asian Miracle. Washington, DC: World Bank. World Bank (2006a). An East Asian Renaissance: Ideas for Economic Growth, Mimeograph. www.worldbank.org. World Bank (2006b). Global Economic Prospects 2006: Economic Implications of Remittances and Migration. www.worldbank.org. Zhai, F. (2006). Preferential Trade Agreements in Asia: Alternative Scenarios of Hub and Spoke. ERD Working Paper Series No. 83. Manila: Asian Development Bank. Zhang, Y. et al. (2006). Towards an East Asia FTA: Modality and Road Map. A Report by Joint Expert Group for Feasibility Study on EAFTA, Jakarta.

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Chapter 8

The ASEAN Economic Community and the European Experience 1. Introduction In November 2002, it was proposed at the ASEAN Heads of Government meeting in Phnom Penh that the region should consider the possibility of creating an “ASEAN Economic Community” (AEC) by 2020. The name is evocative, for an “Economic Community” immediately brings to mind the European experience. In fact, when APEC was “re-inventing” itself, it was proposed that the words behind the acronym for “Asia-Pacific Economic Cooperation” should be replaced with “Asia-Pacific Economic Community”. This idea was rejected explicitly because it would give the impression that APEC was intending to move in the direction of the EC model, which was thought to be too controversial. That the ASEAN Heads of Government should consider an “Economic Community”, even with the baggage the term brings, is in some sense nothing new. ASEAN has always studied carefully European economic integration and has seen it as a sort of “role model”, though certainly to be adapted in the Southeast Asian development context. In this chapter, we will consider what lessons the European experience might hold for ASEAN, as well as extending some suggestions — based in part on the EU experience — as to how ASEAN might evolve into an AEC. We begin with a contextual consideration of the EU-ASEAN economic relationship and determinants of trade flows in the EU-ASEAN in Section 2. The goal of this section will be to consider EU-ASEAN links as well as to underscore the importance of regional integration in stimulating global trade (and investment) flows, which after all is the main objective of the AEC. This is followed in Section 3 by a brief review of the evolution of ASEAN economic integration, culminating in the AEC. Section 4 then proceeds to delineate

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some salient lessons of the EU experience for ASEAN. Finally, we give some suggestions as to how the AEC might proceed in Section 5.

2. Determinants of Trade in the EU-ASEAN Context The EU has always been an important trade (and investment) partner of ASEAN, but its share of trade has been falling over time. Table 8.1 shows Table 8.1. Exports of ASEAN, EU, and Major Partner Countries. (Percentage of World Total). Exports of ASEAN-5

Korea

China

Japan

USA

DA*

EU-15

Japan 1990 2004

18.5 10.5

18.6 8.6

14.1 12.4

—

12.4 6.7

14.4 9.9

2.1 1.6

US 1990 2004

20.1 15.3

28.6 17.0

10.6 21.1

31.7 22.7

—

22.0 17.9

7.0 8.7

China 1990 2004

1.8 7.4

— 19.7

—

2.1 13.1

1.2 4.3

5.1 12.6

0.5 1.6

Korea 1990 2004

3.3 3.0

0.6 2.6

6.1 5.1

3.7 2.8

2.0 2.1

0.6 0.6

TO\

ASEAN-5 1990 2004

19.1 20.3

7.5 8.1

5.8 6.3

11.5 12.3

4.8 5.7

10.9 10.7

1.4 0.9

DA* 1990 2004

35.1 47.9

16.8 42.4

48.3 33.4

31.3 48.5

15.5 19.0

33.3 42.8

3.6 3.6

EU-15 1990 2003

16.0 13.5

15.4 12.9

10.0 16.5

20.4 15.3

26.3 20.8

15.3 14.5

Total 1990 2004

100.0 100.0

100.0 100.0

100.0 100.0

100.0 100.0

100.0 100.0

100.0 100.0

100.0 100.0

World* 1990 2004

138.8 514.6

67.8 253.1

69.5 593.2

287.7 565.5

393.1 816.4

451.9 1944.4

1492.2 2888.7

DA* = Developing Asian countries. *Figures are in US$ billions. Source: IMF, Direction of Trade Statistics, 2004.

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that approximately 14 percent of ASEAN exports were destined for the EU market in 2003, down from 16 percent in 1990. The 2003 share is less than the 15 percent accounted for by the United States but greater than the 11 percent going to Japan (for 2004). In fact, the shares of all Triad countries are significantly down since 1990, whereas the share of developing Asian countries in ASEAN exports has risen substantially, from 35 to 48 percent. Exports to China in particular have risen significantly, from a trivial two percent in 1990 to seven percent in 2004. At the bilateral level (not in table), the EU market was the most important for Vietnam and Laos and constituted a significant market for essentially all other ASEAN countries, save Brunei (the EU gets its energy imports mainly from the Middle East). Given the importance of the EU market (and the downward trend in export share), ASEAN countries have an incentive to ensure a level playing field for its trade. In this sense, the EU “pyramid of preferences”, that is, the hierarchy of preferential treatment that the EU accords its trading partners, is problematic, as many ASEAN countries stand close to the bottom of the pyramid, with the exception of the Least Developed Countries (LDCs) who benefit from the EU “everything but arms” initiative. In addition, ASEAN countries do compete with each other to varying degrees in the EU market. To capture the degree of competition, we correlate the exports of major ASEAN countries to the EU market using the Spearman Rank Correlations Coefficient (SRCC) technique, used in earlier chapters. It has a range of −1.0 (perfect negative correlation) to 1.0 (perfect correlations), in which 0.0 would suggest no correlation at all. Hence, we rank the exports of ASEAN countries to the EU market and compare the rankings using this technique. We do this at the 5-digit SITC level (2881 commodities possible) for the exports of Indonesia, Malaysia, the Philippines, Singapore and Thailand to the US and OECD markets for the years 1995 and 1999. The results are presented in Table 8.2. While we have no benchmark by which to judge which values are “high”, we note that there is positive correlation between the exports of each of these countries (all estimates are statistically significant). Moreover, with the exception of Thailand-Malaysia exports, all SRCCs have been rising over time, in some cases significantly (e.g., the Philippines-Indonesia SRCC increased by 50 percent). Interestingly, while there does exist significant intra-ASEAN competition, each ASEAN country competes more with China than it does with any other ASEAN country. Thus, coupled with the fact that ASEAN is currently competing in the EU market at a

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Table 8.2. Correlation of Selected ASEAN and Chinese Exports to the EU Market, 1999 and 1995. (Spearman Rank Correlation Coefficients). China

Indonesia

Malaysia

Philippines

Thailand

— —

0.24 0.22

0.21 0.20

0.35 0.33

0.31 0.29

Indonesia 1999 1995

0.24 0.22

— —

0.11 0.08

0.13 0.08

0.21 0.20

Malaysia 1999 1995

0.21 0.20

0.11 0.08

— —

0.11 0.12

0.19 0.21

Philippines 1999 1995

0.35 0.33

0.13 0.08

0.11 0.12

— —

0.21 0.19

Thailand 1999 1995

0.31 0.29

0.21 0.20

0.19 0.21

0.21 0.19

— —

China 1999 1995

Source: OECD, International Trade Statistics, CD-Rom; Author’s own calculations.

significant disadvantage, closer economic cooperation with the EU would have important advantages not only in leveling the playing field with countries currently receiving preferential treatment in the EU market but also in establishing a competitive edge over China. Next, it is, perhaps, useful to consider the most influential variables in determining EU-ASEAN trade flows. Such an exercise would allow us generally to identify some of the most salient considerations in regional integration. In particular, we are interested in the “revealed” effects of institutional regional integration in ASEAN and the importance of ASEAN in EU trade. Our approach is a standard augmented “gravity model” of international trade flows. This is an econometric procedure in which trade in a certain year is posited as a function of the GDP of the source and partner country (or their product) as a proxy for size, per capita income of the source and partner country (or their product) as a proxy for wealth,1 distance between the two countries as a proxy for transportation and other “costs”, and an “adjacency” binary (“dummy”) variable to control for whether or not the trading countries have a common border. Some models, as we discuss below, 1 Modern

international trade theory suggests that per capita income between countries is correlated positively with trade.

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use a number of other variables that might be “exogenous” factors relevant to trade flows. This is essentially the “benchmark” model, that is, it is what we would expect to determine trade flows if special relationships — say, in the form of a free trade area (FTA), or just a heightened tendency to trade with one another — did not exist. In order to test the hypothesis that the region really makes a difference, we add a regional dummy variable. For example, if we are interested in whether or not ASEAN as a group is significant for bilateral trade flows globally, we would include a dummy variable which would take on the value one if the two countries trading with each other are both members of ASEAN, and zero otherwise. If the dummy variable is statistically significant and positive, then we conclude that there does, indeed, exist a special ASEAN effect. If the estimated coefficient on the dummy variable is statistically insignificant, however, we conclude that ASEAN as a regional grouping made no difference, that is, being a member of ASEAN gives no additional explanatory power to the model in determining trade flows. The database provided by Rose (2003)2 includes international bilateral trade for almost the entire post-World War II period (1948–1999) for 178 (IMF-delineated) trading entities, and encompasses the standard gravity variables we mention above along with some additional ones, that is (we give the expected sign of the estimated coefficient in parentheses): currency union (+), common language (+), common land border (+), if one of the countries is landlocked (−), if one of the countries is an island (+), and whether or not the two countries were recently colonies of the same country (+).3 Regressions are first run using “pooled” (or panel) data, i.e., we model 2 In order to exploit data on bilateral flows for as many countries as possible over as long as possible in order to construct our “benchmark” and tests for US-EAI regional relationships, our primary data source is that constructed by Andrew Rose and available from his website as part of research for the article, “Do We Really Know that the WTO increases Trade”? recently published in the American Economic Review (March 2004). The database is available at http://faculty.haas.berkeley.edu/arose/ RecRes.htm#GATTWTO. 3 As Rose explains regarding his sources, the trade data come from the Direction of Trade Statistics CD-ROM data (IMF). Population and real GDP data (in constant American dollars) are obtained from the Penn World Table, the World Bank’s World Development Indicators, and the IMF’s International Financial Statistics. Rose uses the CIA’s World Factbook for a number of country-specific variables, including: latitude and longitude, land area, landlocked and island status, physically contiguous neighbors, language, colonizers, and dates of independence. He also adds information on whether pairs of countries were involved in a currency union and from the WTO to create his indicator of regional trade agreements.

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bilateral trade flows across countries and time. As the database features bilateral flows for 52 years between the 178 countries, this approach allows us to have almost a quarter of a million observations in the unrestricted (that is, the “full-blown”) model. Our main goals here are three-fold: First, we are interested in knowing to what degree ASEAN economic integration has revealed itself to be an important determinant of trade flows. Second, we can also gauge the degree monetary integration has been an important determinant of real-side (trade) flows. The importance of this latter relationship will be borne out when we discuss monetary cooperation in Section 4. Finally, since we are focusing on the EU and ASEAN, it would be useful to understand to what degree ASEAN has been important in EU trade flows, that is, whether or not a country’s being part of ASEAN has any importance with respect to its trade with the EU (and the United States). We begin by running three benchmark-model regressions, in which we add to the traditional approach of variables accounting for two specifications of ASEAN partnership: (1) Both trading partners for a given bilateral trade flow are in ASEAN (i.e., if so, the bilateral trade flow receives a “one”, zero otherwise); and (2) One of the two trading partners is an ASEAN member. We do this in order to capture not only ASEAN membership in which both ASEAN countries have been members but also to understand how well ASEAN countries have performed in general. We use 1992 as the starting date for the original ASEAN countries, since no major regional trade initiative had been undertaken in ASEAN before AFTA. Finally, we include a variable for participation in the Generalized System of Preferences (GSP) program, in which developed countries give preferential treatment to developing countries in certain manufactured and processed agricultural goods. We express the variables in logarithmic terms where possible (obviously, this is impossible with binary variables), which linearizes the equations and allows us to interpret the estimated coefficients as elasticities. The results of these first gravity specifications are provided in Table 8.3. The first column includes the results for the entire model, that is, all countries in the system (the “unrestricted” scenario). The model’s “fit” (i.e., how well the independent or right-hand-side variables explain variance in the dependent variable, i.e., bilateral trade flows) is strong, explaining almost two-thirds of bilateral trade flows (R2 = 0.64). All variables are of the expected sign (that is, they affect bilateral trade just as we thought they would), and all are statistically significant except the binary

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282 Table 8.3.

Gravity Trade Regression Estimates: Benchmark Tests. Baseline Model: All International Bilateral Trade

No Industrial Countries

Trade Post1970

Both in ASEAN

0.879 (3.68)∗∗

0.577 (2.32)∗

0.612 (2.58)∗∗

One in ASEAN

0.738 (12.98)∗∗

0.785 (10.86)∗∗

0.773 (13.58)∗∗

GSP

0.849 (26.22)∗∗

0.015 (0.15)

0.838 (24.79)∗∗

Log of Distance

−1.188 (53.80)∗∗

−1.296 (40.91)∗∗

−1.303 (53.81)∗∗

Log of Product of Real GDPs

0.917 (96.28)∗∗

0.934 (58.13)∗∗

0.947 (92.26)∗∗

Log of Product of Real GDPs per capita

0.316 (22.14)∗∗

0.196 (8.30)∗∗

0.320 (21.00)∗∗

Strict Currency Union

1.543 (12.75)∗∗

1.348 (9.44)∗∗

1.507 (10.01)∗∗

Common Language

0.536 (13.58)∗∗

0.367 (6.35)∗∗

0.574 (13.31)∗∗

0.502 (4.67)∗∗

0.667 (5.41)∗∗

0.663 (5.76)∗∗

−0.288 (9.03)∗∗

−0.281 (5.60)∗∗

−0.325 (9.54)∗∗

Land Border Landlocked Islands

0.073 (1.98)∗

−0.056 (0.92)

0.059 (1.49)

−0.108 (13.39)∗∗

−0.179 (13.22)∗∗

−0.111 (12.79)∗∗

1.744 (1.65)

0.000 (.)

1.677 (1.83)

Constant

−26.917 (73.55)∗∗

−23.419 (38.77)∗∗

−27.797 (68.86)∗∗

Observations

234597

Log of Product of Land Areas Same Nation/ Perennial Colonies

R-squared

0.64

114615 0.47

183328 0.64

Robust t statistics in parentheses. *Significant at 5%. **Significant at 1%.

variable capturing whether or not countries had common colonizers and two restrictive specifications (i.e., “no industrial countries” and “post-1970”) of the “island” variable. It is interesting to note that: (1) the largest effects are derived for the existence of a common currency. This supports the

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notion that financial integration realities do have an important bearing on the “real” sector (i.e., trade); extreme currency stability obviously has a very strong effect; and (2) distance is critical, supporting the literature on “economic geography”. With respect to our ASEAN binary variables, we note that being part of ASEAN as a regional grouping does indeed matter (the estimated coefficient on the ASEAN binary variable is 0.879); ASEAN countries do tend to trade more with each other, controlling for all other variables. This would suggest that both countries’ being in ASEAN, ceteris paribus, increases bilateral trade by approximately 140 percent (exp(0.88)−1 = 140 percent) than what we would have expected otherwise. Moreover, just being an ASEAN country makes a difference (estimated coefficient = 0.738), though this effect is somewhat less important than the “both in” effect. We also note that the ASEAN “one-in” coefficient estimate is statistically significant in all regressions, but is especially large in the case of US bilateral trade. This estimated efficient (1.222) in the US market is actually about two-thirds higher than for the unrestricted model (0.738) and about three-fourths higher than for the EU regressions (0.68–0.69). Hence, ASEAN countries as a group is an important determinant of both US and EU bilateral trade, but especially with respect to the former. Table 8.4 runs the same essential regressions but focuses on the determinants of individual country/country-group trade, i.e., US trade, NAFTA trade, two specifications of EU-15 trade, and ASEAN trade. Once again, the results are robust; the R2 is even higher in the individual-country and country-group regressions than in the benchmark test. The estimated coefficients are generally statistically significant and of the expected sign, with the same general exceptions of the benchmark regressions. Of particular interest to us here would be the estimated coefficient on the ASEAN binary in the EU regressions (0.698 and 0.683) and the ASEAN regression (0.959). Both results would suggest that the EU and the ASEAN countries each have a trade bias in favor of trade with ASEAN, with a much stronger favorable effect in the case of the latter (which is what one would expect, given the history of EU integration, which would tend to discriminate against ASEAN, and the history of ASEAN integration, which would tend to discriminate in favor of ASEAN). Our final series of tests regards how important ASEAN has been in the determinant of EU (and US) trade over time. To answer this question, we estimate our regressions on a yearly basis (rather than including all years at the same time, as in the regressions above) and then focus on our results

Gravity Trade Regression Estimates: Selected Major Markets.

Benchmark: All Countries

Trade with US

Trade with NAFTA Countries

Trade with Countries of EU-15, Any Year

Trade with EU, limited by Accession Date

ASEAN Trade

0.000 (.)

0.000 (.)

0.000 (.)

0.959 (4.12)∗∗

One In ASEAN

0.738 (12.98)∗∗

1.222 (4.12)∗∗

1.165 (5.67)∗∗

0.698 (8.40)∗∗

0.683 (7.82)∗∗

0.000 (.)

GSP

0.849 (26.22)∗∗

0.260 (1.85)

0.756 (8.58)∗∗

0.312 (7.22)∗∗

0.199 (4.19)∗∗

0.698 (5.38)∗∗

Log Distance

−1.188 (53.80)∗∗

−1.096 (7.82)∗∗

−1.362 (12.37)∗∗

−0.949 (28.63)∗∗

−0.948 (26.17)∗∗

−1.175 (11.77)∗∗

Log Product of Real GDPs

0.917 (96.28)∗∗

0.881 (16.94)∗∗

0.944 (30.49)∗∗

0.859 (55.89)∗∗

0.860 (47.33)∗∗

0.962 (21.97)∗∗

Log Product of Real GDPs per capita

0.316 (22.14)∗∗

0.392 (5.22)∗∗

0.594 (11.90)∗∗

0.385 (15.21)∗∗

0.339 (12.25)∗∗

0.287 (5.12)∗∗

Strict Currency Union

1.543 (12.75)∗∗

0.612 (2.29)∗∗

0.854 (2.64)∗∗

2.037 (7.75)∗∗

1.795 (3.39)∗∗

0.000 (.)

Common Language

0.536 (13.58)∗∗

0.588 (5.23)∗∗

0.875 (9.45)∗∗

0.879 (11.86)∗∗

0.909 (11.74)∗∗

0.436 (3.48)∗∗ 0.013 (0.03)

Land Border

−0.288 (9.03)∗∗

−0.287 (0.72)

−0.235 (0.48)

−0.231 (1.50)

−0.244 (1.93)

−0.531 (2.84)∗∗

−0.163 (1.29)

−0.440 (9.69)∗∗

−0.575 (9.86)∗∗

−1.015 (7.08)∗∗ (Continued)

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0.502 (4.67)∗∗

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ASEAN Economic Integration

Both In ASEAN

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Table 8.4.

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Trade with Countries of EU-15, Any Year

Trade with EU, limited by Accession Date

ASEAN Trade

0.128 (0.70)

0.434 (2.88)∗∗

0.004 (0.05)

−0.035 (0.45)

−0.459 (4.44)∗∗

Log Product of Land Areas

−0.108 (13.39)∗∗

0.024 (0.50)

0.064 (2.13)∗

−0.016 (1.11)

−0.017 (1.01)

−0.218 (7.00)∗∗

Same Nation/ Perennial Colonies

1.744 (1.65)

0.000 (.)

0.000 (.)

1.264 (1.47)

1.444 (1.68)

0.000 (.)

−26.917 (73.55)∗∗

−29.934 (16.16)∗∗

−36.347 (29.77)∗∗

−28.843 (50.18)∗∗

−28.136 (44.65)∗∗

−25.570 (13.41)∗∗

Constant Observations R-squared

234597

6077

15781

71979

42627

0.64

0.83

0.79

0.79

0.82

5478 0.68

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Benchmark: All Countries

(Continued )

Robust t statistics in parentheses. *Significant at 5%. **Significant at 1%.

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ASEAN Gravity Regression, Original Asean Countries.

-.5

Regression Coefficients 0 .5 1 1.5

2

Chart 8.1.

1950

1960

1970

1980

1990

2000

Year trade with EU (Significant) trade with EU (All)

trade with USA (Significant) trade with USA (All)

Source: Naya and Plummer (2005).

for the relevant binary variables. We report the magnitude of the estimate coefficients in these regressions over time in the form of a chart, in which the y-axis shows the magnitude of the estimated coefficients and the x-axis, the year for which a specific regression was run (we include either the entire sample of 1948–1999 for the ASEAN aggregates, and a somewhat shorter period for the individual countries), indicating whether the coefficient was statistically significant or not. This is done in Chart 8.1 for US and the EU yearly regressions. As expected (given the results of the pooled data above), the estimated coefficients are larger for the US market than for the EU market. Moreover, prior to 1970, there were no statistically significant ASEAN binaries for Europe, whereas they were statistically significant for most of the period 1948–1970 for the United States, albeit with considerable volatility. Since the mid-1980s, i.e., when ASEAN countries began to embrace an aggressive outward-oriented development policy, the magnitudes of the ASEAN binary coefficients have been rising for both the United States and the EU, peaking just before the Asian Crisis. Estimated coefficients for the EU and the United States tend to move together over time. In sum, ASEAN as a group has been a statistically significant determinant of international trade flows, including for ASEAN and EU trade. Whether or not this is due to ASEAN economic integration is not exactly

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clear, but the increase in magnitudes of the estimated coefficients on the ASEAN binary variables when serious ASEAN economic integration began to take off (interrupted by the Asian Crisis) would give some prima facie support to this argument. Second, we underscored the fact that monetary integration is one of the chief determinants of trade flows, a notion to which the Europeans have long subscribed. Finally, likewise with respect to trade over time, ASEAN has been an important determinant of European trade, though consistently to a less extent than in the case of US trade.

3. Evolution of ASEAN Economic Integration in a Regional Context There have been many excellent surveys of regional economic integration in Asia (e.g., Kawai, 2005; Naya, 2002; Asian Development Bank, 2002). We have also reviewed it in earlier chapters. Here we provide a stylized review of ASEAN integration in the more general Asian context. As noted before, ASEAN tends to stand at the core of Asian integration, at least from an institutional perspective. Briefly, we would first suggest a number of factors influencing the regionalism trend in East Asia that stem directly from the Asian Financial Crisis, including: (1) the obvious contagion relationships, which demonstrated the policy externalities across countries in ASEAN and the NIEs; (2) major disappointment with respect to the US reaction to the Crisis, leaving the feeling of “being in it alone together”; (3) disappointing progress in APEC in achieving closer trade and financial cooperation, as well as development assistance cooperation (“ECOTECH”); (4) Japan’s offer to create an Asian Monetary Fund during the Crisis — opposed by the IMF and the United States — gave the impression that Japan wanted to be pro-active in the region; (5) arguably, China’s decision not to devalue during this period also created a sense of solidarity; (6) the “New Miyazawa Plan”, launched in October 1998 which dedicated $30 billion to help spur recovery in East Asia (and deemed highly successful)4 ; and (7) the policies promulgated by the IMF to solve the Crisis were deemed inappropriate, giving greater credibility to the “Asian approach”. Hence, the Crisis itself set the stage for serious and durable East Asian regionalism. There are many other internal and external forces at work that 4 Kawai

(2005).

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have expedited the process, such as the rise of regionalism globally and its potential negative effects on the region; the successful example of the Single Market Program in Europe (discussed at length below) and, eventually, monetary union; general pessimism regarding what can be achieved at the WTO in light of failure to move forward at the Seattle and Cancun WTO Ministerial Meetings; and the potential inherent benefits of FTAs. With the exception of the Japan-Singapore FTA (“Japan-Singapore Economic Partnership Agreement”, or JSEPA), which began implementation over 10 years later, AFTA is the only example of cooperation in Asia that is similar in concept to NAFTA. However, in true ASEAN fashion, rather than overly commit to regional integration in sensitive areas, the specifics of AFTA were purposefully left somewhat ambiguous, with the agreement basically committing the ASEAN members to free trade in a 15-year timeframe. Also, the definition of “free trade” was somewhat loose, as it included tariffs in the range of zero to five percent, rather than the traditional zero percent.5 After the original agreement, ASEAN broadened the scope of goods covered by AFTA and the period of implementation has been shortened such that AFTA was technically in full effect at the beginning of 2004 for the original ASEAN countries and Brunei, though there are transitional periods for products on the temporary exclusion lists (e.g., sensitive products such as rice and automobiles in some cases) and some country-specific implementation problems in certain areas. As noted at length in Chapter 3, ASEAN has also made important strides in the area of investment cooperation, e.g., in the form of ASEAN “onestop investment centers”, the ASEAN Investment Area (AIA), and most recently the ASEAN Comprehensive Investment Area (ACIA), signed by the relevant ministers in August 2008 and to be signed by the ASEAN heads of government in December 2008. These efforts at industrial cooperation have been designed with essentially the same goal in mind as AFTA: reduce transactions costs associated with intra-regional economic interaction (Chapter 2). As was noted above, the AEC explicitly put the European experience front and center in terms of design, though clearly the ASEAN Leaders had in mind an Economic Community with ASEAN characteristics. The ASEAN leaders actually agreed, at the Bali ASEAN Summit in October 5 In fact, this range of tariffs probably contradicts the requirements spelled out in Article XXIV of the GATT/WTO, but as was noted earlier-ASEAN benefits from the Enabling Clause which has always freed it from these constraints.

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2003, to create a region in which goods, services, capital and skilled labor would flow freely, though the details remain to be worked out. We offer our own recommendations in this regard in the penultimate section, colored by the EU experience. The reasons behind the decision to create the AEC are many, including: (1) desire to create a post-AFTA agenda that would be comprehensive; (2) perceived need to deepen economic integration in ASEAN in light of the new international commercial environment, especially the dominance of free trade areas (FTAs); (3) given (2), the possibility that bilateral FTAs could actually jeopardize ASEAN integration since all member states were free to pursue their own commercial-policy agenda; and (4) the recognition since the Asian Crisis that cooperation in the real and financial sectors must be extended concomitantly, and that free flows of skilled labor will be necessary to do this.6 In addition to an ebb in progress related to the APEC “Bogor Vision” of open trade and investment, there have been several events that have shifted the ASEAN focus to its East Asian neighbors. First, even with the successful APEC Summits at Blake Island and Bogor, the East Asian Economic Grouping (EAEG) concept never faded away. On the contrary, it began to grow in substance. Strangely, the initiative came from ASEAN’s effort to expand economic cooperation with the EU, but the EU’s desire to deal with all of East Asia led to ASEAN’s asking China, South Korea, and Japan to participate. The first Asia-Europe Meeting (ASEM) was held in Bangkok in March 1996, and officials from ASEAN and the rest of East Asia met with EU representatives — a format which was regularized and has continued twice a year since. Even though the initial impetus for these meetings was economic cooperation with the EU, the significance for East Asian regionalism lies in that these meetings brought officials from ASEAN, China, South Korea, and Japan together, to discuss issues of economic cooperation. In 1997, these meetings culminated in an informal summit of the APT Heads of State in Kuala Lumpur. The original “Miyazawa Plan” was initiated by Japan during the Asian Crisis to create an Asian Monetary Fund to supplement the IMF. It was opposed by the IMF and the United States, but eventually led to the establishment of currency swap arrangements among East Asian countries (basically bilateral swaps between Japan and individual countries) during the 6 The

free flow of all labor, including unskilled labor, was deemed too politically difficult to consider in the AEC.

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annual meeting of the Asian Development Bank in May 2000 (the “Chiang Mai Agreement”). However, financial integration in general is a complicated process. Usually it occurs well into the process of regional integration, as suggested by the experiences of the EU and the creation of the euro (discussed below), which was only possible after decades of a customs union and a common market. Because the benefits of monetary cooperation are less clear — particularly in the Asian case, since exchange rate stability among Asian countries is of limited value for the many countries that trade heavily outside the region — and the political benefits are far less obvious than in the EU case, countries have begun to focus more on FTAs, at least as a first step. The lack of influence of APEC in the Asian Financial Crisis has served to solidify East Asia’s move in favor of an APT approach. The current spate of agreements, however, has not been extended to the entire APT but rather have come more from ASEAN to individual countries. For example, the completion of the China-ASEAN joint FTA study in the summer of 2001 prompted Japan to quickly initiate a study of its own with ASEAN. One month later, at the 2001 APT meeting in November, ASEAN and China announced their intention to negotiate an FTA within 10 years (the agreement was formalized in a Framework Agreement in December 2004). 4. Lessons from the EU In trying to glean EU lessons for the AEC, we might begin with several caveats regarding the differences in the subjective environments facing the EEC in the 1950s and ASEAN today: 1. The institutional environment facing ASEAN in the first decade of the 21st Century is much different than that of the EEC of the 1950s. European integration was clearly pushed both by memories of a devastating war and emerging Cold War concerns. Political and social motivations for economic integration were, thus, far different from those of ASEAN today, though, it should be added, ASEAN has been instrumental in keeping Southeast Asia a peaceful region, an important contribution that is often underestimated. The “European Good” is interpreted much differently in Europe than the “ASEAN Good” in ASEAN; this puts considerable limitations on institutional development at many levels. Importantly, it reduces the possibility of relinquishing power to supranational organizations. Besides, such institutional development is difficult in the ASEAN context anyway, given

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that: (1) nation-state formation is much younger than was the case in the European context, and in some countries this still requires a strong priority; (2) divergence in socio-political institutions are far greater than they were in the European context, especially since in some European countries these institutions were being created anew after the war; (3) it is not clear that European institution-building has been particularly successful in all areas, though it would receive high marks for economic-related matters (though this, too, is a testable hypothesis); and (4) these European institutions are quite expensive and ASEAN government budgets are much smaller (fortunately, ASEAN would not have to employ an army of translators, as the EU does). That said, it is important to note that the notion of the “ASEAN Good”, though viewed differently in the ASEAN context, has been changing over the past 10 years. For instance, 10 years ago, few in the region (or the rest of the world) knew what ASEAN was; today, it is well-known. 2. The international economic environment is far different today than it was in the 1950s. First, the contemporary global marketplace is extremely open relative to the past. This is true because of extensive reductions in trade barriers internationally, due to the GATT/WTO rounds as well as unilateral liberalization and huge increases in international capital flows (including foreign direct investment, or FDI), which have increasingly been knitting an integrated global marketplace. The costs of using regional integration as a form of “Fortress”, that is, to maximize trade diversion, are consequently much higher than they were in the past. Second, regionalism has grown by leaps and bounds recently; trade groupings reported to the WTO come to well over 200, with a majority being established after 1995. Some of these groupings include ASEAN’s most important trading partners and could potentially isolate ASEAN, as well as forcing it to pay costs of trade diversion. These trends further underscore the need for the AEC to be open as well as for the organization to be engaged in the regionalism movement. The more integrated the ASEAN marketplace is, the easier this will be. These considerations were far less important in the EEC context. 3. ASEAN features far greater diversity in terms of economic development. While the expansion of the EC to include the 10 Central and Eastern European countries in May 2004 increased significantly diversity within the EU, the region is still dominated by developed countries and is far more symmetrical than ASEAN which features developed; “dynamic Asian

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economies”; middle-income developing countries; and least developed countries. The Asian Development Bank in its Asian Development Outlook 2002 notes that the coefficient of variation (standard deviation divided by the mean) on income levels within ASEAN is 1.6 with a mean per capita income of $1975 in 2000, whereas the corresponding numbers for the EU were 0.6 and $20,747. Hence, the divergence within ASEAN is far greater than that of the EU, and the countries are far poorer. This suggests that matters related to the speed of implementation of AEC, and even the ability of ASEAN to be completely inclusive for all member states, will be complicated and difficult. Phased “10-X” strategies, which is what AFTA in effect embraces, may not only be desirable but necessary. 4. ASEAN countries are far more open than was the case of Europe in the 1950s. ASEAN countries are (economically) small and very open relative to the EEC of the 1950s (and even with respect to most EU countries today), with the exception of a few of the transitional CMLV (Cambodia, Myanmar, Laos, Vietnam) countries. ASEAN countries are closely integrated with international markets through international trade as well as multinational networks. Not only is this a reality but also a policy focus for ASEAN governments. This is another reason why one would expect the AEC to embrace openness much more than the EEC/EC might have. In addition, even as an integrated market, ASEAN countries together still could not influence international terms of trade (the AEC would still be relatively “small”), suggesting that the “optimal” Common External Tariff would be zero. This was not the case in the EEC. Having noted these caveats, we can delineate at least three major lessons that can drawn from the real-side integration experience of the EU. First, we might begin with a negative lesson: ASEAN should avoid some of the pitfalls of inward-looking discrimination from which the EU continues to suffer (especially in agriculture), but which would be potentially catastrophic in the context of the ASEAN countries. Intra-ASEAN trade is only about onefourth its global trade (compared to two-thirds in the case of the EU) and ASEAN member states are highly integrated globally. Hence, any real-side economic cooperation needs to be outward-looking. In fact, this approach is exactly what the ASEAN leaders ostensibly have in mind, that is, using ASEAN as a means of “going global”. Some scholars have noted that AFTA is actually more of an investment agreement than a trade agreement; free trade reduces intra-regional transactions costs and presents to multinational corporations a vertically-integrated market.

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The AEC should never lose this vision, even when, as in the European case, compromises may have to be made. The EU countries are developed, high-income countries that together form a large economic space. They were able to push economic integration behind relatively protected markets, in the context of an international economy that was still fairly closed. Today, the GATT/WTO has opened up markets considerably and most of the world, the EU and ASEAN included, have internationalized extensively. It could be argued that such a protected approach was not necessary to begin with and should have been avoided (the CAP has been, by many measures, a disaster); however, the cost of an inward-looking approach has increased exponentially. It is not a viable option for the AEC. Second, and partly related to the first, the European experience teaches us that trade-investment links matter and these relationships are shaping in large part the economic structure of the ASEAN economies. While the transitional ASEAN countries are still at early stages of the economic development process, the original ASEAN countries have experienced tremendous changes in their economic productive structures in general and trade in particular. Primary-based exports (roughly estimated as SITC 04) have fallen in all original ASEAN economies.7 Only Thailand of the original ASEAN countries continues to have a large agricultural-export base (it is, for example, the largest exporter of rice in the world) but it, too, is falling in importance. Energy (SITC 3) continues to be important to Indonesia and Malaysia, with the former being at present a marginal oil importer. The big change throughout the region has been the impressive — in some cases, spectacular — increases in the share of SITC 7, that is, electronics and transport equipment (for ASEAN, this means mainly electronics). Over the 1990s, the share of SITC 7 increased in all ASEAN countries. Indeed, in most countries it is the largest export sector; it constituted 58 percent, 41 percent, 72 percent, and 68 percent of total exports, in Malaysia, Thailand, the Philippines, and Singapore respectively.8 While economic reform has played an important role in this process of structural adjustment, so has foreign investment. Tamamura (2002) uses input-output analysis to capture the FDI-export link in East Asia, as well 7 Data

for this structural-change analysis comes from Plummer (2003). Philippines case is the most dramatic and surprising. The value of SITC 7 exports increased over this period by over 100 percent, with the largest changes in SITC 723 (civil engineering and contractor plants and parts), SITC 728 (machine & specialized equipment), 736 (machine tools), 751 (office machines), and 752 (automatic data-processing machines). 8 The

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as decompose the effect of external demand (by country) on production, using electric/electronics as a case study. He finds that, for 1995 (his latest year), in every (original) ASEAN country, external demand induced more production than domestic demand except (marginally) Indonesia, where, however, domestic demand fell in relative importance from 87 percent to 52 percent. Most countries followed a similar pattern of internationalization of electronics production. The most extreme case of the ASEAN countries was Malaysia, where domestic demand induced only six percent production. Next, it is noteworthy that most of the directives that led to the creation of a tightly integrated market for FDI in Europe came with the Single European Act, which commenced in 1986–87 and essentially created what is mostly a common market by 1994. The European experience teaches us that accomplishing such a feat goes well beyond mere national treatment/mostfavored-nation treatment in the regional marketplace: economic cooperation needs to reduce myriad transactions costs associated with FDI, including with respect to the labor market, mutual recognition of product standards, and the like. The AEC will have to focus per force on many of these areas. A third lesson relates to how the EU has been able to gain from intra-regional trade liberalization, though, as noted above, this could have been better organized to minimize trade diversion. The customs union was important in building a regional market; the Single European Act (SEA), by creating a Common External Commercial Policy, was able to do much more by keeping real-side transaction costs within the EU to a minimum, and producing a truly regional marketplace, resulting in a more efficient division of labor in most markets. It should be stressed, however, that, as we noted in earlier chapters, the AEC should be concerned not merely with increasing intra-regional but rather global economic interaction more generally, of which the ASEAN market is only one part; in fact, a part that can be used as an international springboard. Trade and investment integration policies in ASEAN should be expected to achieve the same general results as they did in the EU case, but this increased interaction might actually manifest itself in a different way, given the fact that ASEAN countries are so diverse and most are still developing countries. To reiterate: the AEC should be a means of increasing economic prosperity and the social good rather than focusing on, say, increases in (sometimes, misleading) indicators such as shares of intra-regional trade and investment. A successful integration program could

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theoretically lead to a decrease in regional integration, as measured by trade and investment shares, for example.9 A final point would regard the European experience with respect to financial and monetary cooperation and integration, though in part this goes beyond the traditional interpretation of the AEC (discussed below). Chapter 5 of this study notes that ASEAN Member Countries have considered the formation of an ASEAN Bond Market, though problems related to liquidity, potential market depth, and the like have led ASEAN to think more in terms of an Asian Bond Market. This will be a long process. Nevertheless, it is worthwhile considering the European experience as well, given that empirical studies (e.g., Frankel and Rose, 1998) have shown that monetary integration has strong effects on trade and investment flows. Other studies (e.g., EU Commission, 2001) have suggested specifically that monetary union would have a far more extensive effect on trade flows and economic integration than the SEA. In the past, just about every regional economic integration program has focused in the beginning almost exclusively on the real side of the economy. Financial integration was always treated as something separate, to be taken up at a later date. In many ways, this is less true for European integration, though the point is debatable. While the European Payments Union (EPU) was a financial arrangement, it was only ad hoc, and was quickly phased out, that is, as soon as European currencies became convertible. This was just as the Treaty of Rome actually began implementation. The EC did publish the Werner Report, which mapped out a plan for monetary union at a time of great turbulence in the Bretton Woods System (1968), and after the Bretton Woods System collapsed, it tried to create the (shortlived) European Snake and eventually the European Monetary System, 9 This is because, for example, a successful AEC that brings in higher FDI flows from abroad — a key aim of the AIA — will not only reduce intra-regional FDI but also could reduce intra-regional trade, if multinationals take advantage of the attractive regional division of labor offered by ASEAN. For example, suppose that, as a result of the AIA, a Japanese automobile multinational set up production stages in Indonesia and Singapore, whereby it exports $2 billion in car components to Indonesia; adds $100 million in laborintensive value-added to production in Indonesia before exporting the semi-processed product to Singapore for further $1 billion in processing and then finally exporting back to Japan. This means that ASEAN intra-regional trade would have changed at the margin by: exports to Singapore from Indonesia ($1.1 billion) divided by exports of Japan to Indonesia ($1 billion) plus imports of Japan from Singapore ($2.1 billion), or 35 percent, whereas extra-regional trade would have increased by 65 percent. The point is that this could be a successful economic activity for all parties involved, but intra-regional trade shares might fall anyway.

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which expanded the Snake in March 1979. These attempts at exchangerate cooperation were important because the “customs union plus” needed stable exchange rates in order to run well. Such cooperation was especially necessary for the CAP: the main goal of the CAP was to stabilize farmer incomes and flexible exchange rates put this at risk, as the country with a depreciating currency had an advantage over an appreciating-currency country, which was incompatible with the acquis communautaire. Hence, the EC had to develop a “green” exchange rate system, called “monetary compensation amounts” (MCAs), which prevented this “adverse” structural change from happening. However, this system was very expensive: Pomfret (1997) suggests that the MCAs constituted over 15 percent of the CAP’s huge budget. Nevertheless, European capital markets tended to be substantially segmented until implementation of the SEA was fairly advanced. There had been early attempts to create a single banking market as far back as 1972 (it was still-born), still 15 years after the Treaty of Rome, and in 1977 the European Council established the First Banking Directive (it did very little to integrate the markets10 ), but these and other attempts only marginally integrated the regional markets until the SEA initiatives. Today, the European banking system is far more integrated but some aspects of finance continue to be among the few areas in which the Single Market is still incomplete. Capital controls were removed as part of the SEA program. In sum, even in the case of the EU, financial integration did not keep pace with integration in the real sector. The tendency seems to be to let financial issues wait, but experience shows that this is an unwise policy. The Asian Crisis might also be seen in this light. Prior to the Crisis, APEC, for example, all but ignored financial and monetary cooperation, and ASEAN itself did little. In creating the AEC, therefore, ASEAN leaders would do well to focus on financial issues in tandem with real-sector integration. Regarding EU lessons in monetary cooperation, we must again emphasize that comparisons are difficult, as relative economic-divergence problems continue to be critical. Nevertheless, even the EU is a diverse group, especially if one considers regions rather than countries. Moreover, ASEAN’s needs in economic cooperation are obviously quite different from 10 Story and Walter (1997) note (p. 14) that of the EU’s 9,434 credit instutitions at that time, 429 were classified as foreign banks, and only 107 had a parent company based in a member state. Governments were reluctant to grant licenses.

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those of the EU. While ASEAN integration may be popular in the region, it is less than that in Europe, particularly among government leaders. In addition, various EU states had perennial macroeconomic (especially, fiscal) problems; Economic and Monetary Union (EMU) allowed these member states to implement necessary austerity measures in the name of European integration. Yet, the credibility of most of the original ASEAN countries in terms of monetary and fiscal policies is actually quite high, especially for developing countries: inflation tends to be quite low in the original ASEAN countries and most countries had either budget surpluses or essentially balanced budgets prior to the Crisis. Today most have large current-account surpluses. Hence, neither the political nor political-economy dynamics, which were favorable in the case of most Eurozone countries, could be considered as important in the case of ASEAN. Nevertheless, in the aftermath of the Asian Crisis, things are changing. It has been clear to ASEAN leaders that there exist “policy externalities”; some sort of restrictions on the conduct of monetary and fiscal policy could not only improve the macroeconomic environment in the ASEAN countries but also promote regional economic stability. Moreover, the possibility of competitive exchange-rate devaluations could be damaging to the implementation of the AEC. Political arguments for wanting to be part of Europe for European countries would be replaced in the ASEAN context by a fear to repeat the economic disaster of the Crisis. Such cooperation could be formally arranged within or outside the AEC framework, without any pretension to initiatives leading to monetary union. Based on the EU experience, closer financial and monetary cooperation in ASEAN could have the following benefits: (1) the necessary Maastrichttype agreements (e.g., restrictions on budget deficits, government debt, inflation, even foreign-currency exposure of the banking system), perhaps interpreted more liberally than in the EU context, that would go along with such cooperation would create a more stable macroeconomic environment in the region, thereby producing significant positive policy externalities; (2) as monetary policy would likely be driven by the most credible country/countries, less credible countries would be able to “import credibility”, much as, for example, Italy was able to import German monetary credibility; (3) interest-rate spreads would converge, making it easier to price risk at the regional level and lower the cost of capital; and (4) harmonization of rules, accounting standards, and the regulatory framework that might accompany regional integration as part of the AEC and in

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associated financial initiatives would render the region more attractive to foreign investors, as well as stimulate intra-regional capital flows. It would also make cooperation and even institutional integration of ASEAN equity and fixed-income markets easier, something that has happened partially in the EU (e.g., smaller stock markets have integrated but the larger markets continue to function separately). The process of financial and monetary cooperation is complicated, and effective integration demands a steady pace of progress, rather than abrupt changes, which can actually be counterproductive. The EU process of financial integration and exchange-rate cooperation, leading up to monetary union, is instructive. The European Currency Unit (ECU) was a basket of the currencies of the member countries of the EC, weighted in line with each country’s GDP and foreign trade (and therefore subject to change periodically). It was introduced in 1979 as part of the European Monetary System (EMS), to be used as the benchmark for determining the over-valuation/under-valuation of individual currencies and to serve as a unit of account among the central banks participating in the EMS. No physical ECU notes or coins ever circulated, so the ECU was strictly an artificial denomination. However, certain European banks established a banking product so that lenders and borrowers could carry out transactions in ECU. At first, an ECU transaction was just a portfolio of transactions in the separate underlying currencies; a deposit or loan in ECU typically was recorded as separate deposits or loans in the individual currencies. However, banks soon established a clearing mechanism for the ECU, thus enabling the transfer of ECU without necessarily having to make separate transactions in each of the component currencies. This facilitated growth of the ECU for private commercial transactions; residents could use the ECU as a unit of account for bank deposits and companies could use it for invoicing sales or maintaining their accounting records. The first ECUdenominated bond was issued in 1981, just two years after the introduction of the currency basket. The ECU subsequently became a significant “currency” denomination in the Eurobond markets, outranked only by the US dollar and the German mark. A substantial amount of ECU-denominated bonds were placed privately as well. The use of the ECU in private transactions developed rapidly because the ECU exchange rate tended to be more stable than those of its component currencies. For European investors and borrowers, a depreciation of an individual home currency against other European currencies is offset by an increase in the home-currency value of the ECU, so there is an incentive

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to hold ECUs to diversify a portfolio. Similarly, non-European investors and borrowers were drawn to the ECU because it was less risky than the underlying individual currencies. In short, the ECU was an attractive alternative to single foreign currencies because it was less sensitive to the volatility of a single currency. On January 1, 1999, the euro replaced the ECU on a one-for-one basis as part of the first stage of European Monetary Union (EMU). The fact that the ECU existed for 20 years prior to EMU suggests that the simple introduction of a currency basket serves as a useful precursor to closer monetary cooperation. The success of the ECU was partially because of its official status within the EMS binding the central banks of the participating countries together. Its success was also partially because the private sector found a pan-European currency denomination quite useful, and because the banking system was able to accommodate the demand.

5. On Building the ASEAN Economic Community Given the tremendous diversity of ASEAN, how will it be able to create its own “customs union plus”, even by 2020? Tariff dispersion rates across ASEAN countries are, indeed, impressive: while ASEAN members tend to have fairly low tariffs and NTBs relative to other developing countries (except for the transitional ASEAN economies), they still vary considerably across the region (see, for examples, Chapters 2 and 3). Moreover, Singapore is unique: it essentially has no tariffs. The EEC did not face this problem. Given the openness of its economy (over 300 percent of GDP), Singapore cannot raise tariff rates to accept an ASEAN Common External Tariff that is not equal to zero. Likely options here would include a complete freetrade zone in ASEAN, perhaps with some external tariff harmonization, or a “10-X” customs union, in which the Common External Tariff would be determined through negotiations similar to those of the EEC but not all ASEAN countries would join. These options were discussed at length in Chapter 3. We argued in Chapter 3 that, given the outward-oriented nature of the ASEAN economies and the economic logic associated with the need to create a customs union in order to advance the goals of the AEC, ASEAN should consider aligning tariffs such that it creates a Common External Tariff with applied zero tariffs (with, of course, some exceptions). In this sense, the AEC could be recognized as a purely outward-oriented endeavor.

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Fortress ASEAN was never an option. And why not create an essentially open region? The economic argument for protectionism is extremely weak, as ASEAN leaders have recognized. Some might continue to adhere to the infant-industry argument. But this argument has been more of an excuse for protection than a true means of efficient industrialization in ASEAN and elsewhere. The AEC is to be essentially completed by 2015 for the ASEAN-6 and 2020 for the CLMV countries; this is plenty of time for any industry to go through its transition. Besides, in order to make the infant-industry argument convincing, one must identify financial bottlenecks that prevent firms from setting up comparative advantage industries. Given the state of financial markets in at least the original ASEAN countries, this is not a problem, at least in the medium term (given the unfolding financial crisis beginning in September 2008, short-run liquidity has been in peril just about everywhere, including ASEAN). Moreover, this open-market solution does not mean that governments would have to throw away their ability to foster industrialization directly, should they desire to do so. Regardless of the merits of an active industrial policy, it is still possible even in an open customs union. This is something that the European experience clearly shows. Even today, almost a decade after the completion of the SEA and four years after monetary union, governments tend to have active industrial policies, e.g., through direct subsidies, special financial and tax credits, and even de facto administrative rules. The EU has formal restrictions on these but they are constantly tested (e.g., the EU market in financial services is far from complete). Tariffs have always been a clumsy way to foster industrialization, and NTBs tend to be even worse. Of course, the transitional economies pose an important problem here. Cambodia, for example, until recently received about 70 percent of its government income from import-related taxes. However, it is reducing reliance on international-trade-based taxes as part of its reform program, and this has also been the case in the other CMLV countries. Vietnam has made tremendous progress in its transition program and is now online with AFTA (though its exclusion lists have not been completely integrated yet). Allowing the logical progression of this reform program to continue to 2015/2020 will not be easy but would be quite desirable from an economic-development perspective. Again, 2020 is a long way off and much can happen; Vietnam has reinvented itself from a non-market, closed, and state-directed economy into an increasingly outward-looking, marketoriented economy in less time than than it will have for the AEC. It may

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even be possible for ASEAN to allow for a longer-term transition period for Cambodia, Myanmar, and Laos, especially since there remain political uncertainties in these countries. Regarding labor flows, it would be politically difficult to adopt the SEA approach of (technically) free labor mobility, which is why the AEC Blueprint only includes skilled labor. But including unskilled labor flows would not be necessary in the ASEAN context, at least from the point of view of multinationals and integrating the region with the global marketplace. However, the process will be difficult, as it was in the European case. Mutual recognition of professional qualifications, university and technical education preparation, and the like will require a great deal of work. Yet, this process actually presents a good opportunity for the region, and especially for the CLMV countries, to embrace “best practices”. It may well be that the process will be easier for ASEAN than it was for the EU, as fewer entrenched special interests and general resistance to reform in this area are present. Many would welcome this approach. The idea of adopting “best practices” also extends to other areas that were important in the SEA, e.g., product testing, technical standards, food/health-related standards, and the like. Mutual recognition will be necessary in these areas and, hence, harmonization of at least minimum acceptable standards will have to be developed. Codes should borrow from internationally-accepted standards wherever possible. As noted at length in Chapter 4, attracting FDI is an important priority of the ASEAN leaders. The usefulness of a regional approach has been recognized from the beginning, with the (generally, failed) attempts at industrial cooperation in the mid-1970s to the (marginally more successful) initiatives of the late 1980s, the AIA in 1998, and the ACIA in 2008. FDI is a high priority in the AEC, and the vision of an integrated market for FDI will not be attainable without the transaction-costs-reducing liberalization and facilitation initiatives under other aspects of the AEC. The AEC needs the ACIA just as the ACIA needs the AEC. Free flow of services is also necessary and is handled at length in the AEC Blueprint. The ASEAN Framework Agreement on Services (AFAS), which takes a “GATS-plus” approach, was an important step forward in creating an integrating market. Services in the AEC will not need to take a radical change in policy since the third round of AFAS negotiations, which began in 2001, should at least in theory cover all sectors and “modes” of service provisions defined by the OECD, that is: (1) cross-border supply,

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in which a company exports the service from home, e.g. by fax or email; (2) consumption abroad, in which the user of the service consumes it outside his/her home country, e.g., tourism; (3) commercial presence, in which a company directly supplies the service to foreign customers (this involves establishment of an affiliate abroad and constitutes over three-fourths of all trade in services); and (4) presence of natural persons, in which the service-exporting country sends personnel abroad to supply services. The AEC will ultimately have to ensure a generally open market in services, including no policy-induced discriminatory restrictions (including trade taxes), national treatment, mutual recognition, and the like. This was a difficult process in the EU, as some of these sectors remain quite sensitive. For example, in the financial services area, the SEA stipulated three principles for integration: (1) specific minimum requirements; (2) mutual recognition of member states’ legislation; and (3) the “home country principle” would prevail, in which regulations of the country in which business was taking place would take precedence (rather than the host country). (Story and Walter, 1997). However, not even the SEA has succeeded in fully integrating the financial services sector; retail banking services in particular continue to be segmented and protected on a national basis. Moreover, the “Services Directive”, which would service to create a more integrated market in EU services (particularly in light of the EU 2004 expansion), was rejected in early 2005. Developing appropriate institutions under which the AEC can evolve will be necessary. While the ASEAN Secretariat has come a long way since it was essentially a “post office” in the 1970s–1980s,11 it will have to be enhanced drastically in order to facilitate the creation of the AEC. It will need to have a much larger professional staff recruited from throughout the region and with a regional — rather than national — commitment, as is the case in the EU. Many of the directorates of the EU could be emulated in the ASEAN context. But it is our view the bureaucracy should be kept, to paraphrase Albert Einstein, “to the minimum possible but no less than that”. The first reason for this is that the EU bureaucracy is simply too big and expensive. Second, the drain on human capital in the ASEAN context would be detrimental to other domestic policy priorities, an important consideration especially for the CLMV countries. Third, at 11 The

Secretary General of the ASEAN Secretariat, as the position was known at the time, meant that the SecGen’s domain was confined to a building. It was not until reforms of the early 1990s that it would be known as “The Secretary General of ASEAN”, with ministerial rank.

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least in the first stages of creating the AEC, ASEAN could keep the “social bureaucracies”, which are fairly substantial in the EU, somewhat of a separate project. While these institutions were important in making the EU what it is today, ASEAN, as noted above, is characterized by a very different socio-political context. A fourth and related point relates to the creation of a “mini-state” in ASEAN, as has been done in the case of the EU, e.g., in developing an integrated executive, legislative, and judicial system. Because the willingness in the EU to develop supranational institutions is more the exception than the rule, in our view ASEAN should try to minimize the supranational character of AEC, taking the idea of “subsidiarity” to the greatest extent possible. The executive component of ASEAN integration would have to be enhanced considerably, but this could arguably be done by adapting and expanding current institutions. On the other hand, the creation of some sort of judicial authority to “enforce” (hitherto a bad word in ASEAN) AEC rules will be necessary. No doubt this will be difficult; the EU continues to have its own problems (e.g., the Alstom case in France is a good example but there are many more). As in the case of the EU, it would have to be an evolutionary process.

6. Concluding Remarks In this chapter, we have tried to consider what the objectives and substance of the AEC should be, using wherever possible, appropriate lessons from the world’s most successful example of regional economic integration: the EU. We note that while there is much that the EU can teach ASEAN, ASEAN leaders should not underestimate the differences between the regions and the differing historical contexts. The EU integration experience is remarkable. It took a great deal of time before it became a truly integrated market, that is, about 37 years, from the Treaty of Rome in 1957 until the implementation of the SEA, which was essentially complete in 1994. Once the process was given a big push in the mid-1980s, however, integration initiatives picked up steam, culminating in monetary union only five years after the completion of the SEA. At times, some leaders and experts gave up on the EC; the process certainly was familiar with “crisis”. In 1976, for example, France (temporarily) slapped import tariffs on Italian wine. In the early 1980s, market segmentation increased with the use of NTBs outside the purview of the EC, leading some to suggest that the EC was doomed to retreat. After the

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September 1992 Crisis in the EMS, it was very easy to be pessimistic about the future of monetary union. There were even skeptics up to the end. But the EU was able to persevere due to the commitment of its leaders and critical social elements. This is a very basic lesson: given the fact that the AEC will have to be far more comprehensive and “intrusive” in national markets than has ever been the case before, it will take strong commitment indeed in order to move the process forward. No doubt this is why there is much skepticism regarding the AEC. It was no different in the case of AFTA: in the late 1980s, many pundits were speculating that since the region’s political exigencies had changed, ASEAN had no future as a regional organization. Instead, the ASEAN leaders responded by pushing forward impressively on the economic front, and AFTA became the first major initiative in this process. Since then, AFTA has expanded and deepened; cooperation has advanced significantly in the area of investment (AIA); liberalization of services is being actively pursued in the AFAS; other “deepening” measures are being spearheaded; and horizontal integration has expanded about as far as it can go, as ASEAN is now composed of all 10 Southeast Asian nations. While the AEC will take a much more extensive commitment, it certainly is possible if the ASEAN leaders have the political will to see it through.

References Asian Development Bank (2002). Asian Development Outlook (2002). Manila: ADB. Bleaney, M.F., Greenaway, D. and Hine, R.C. (1995). The Impact of the 1992 Programme on Non-EC European Countries: An Overview. In Economic Integration in Europe and North America, Panic, M. and Vacic, A. (eds.), New York: United Nations. De Grauwe, P. (2000). Economics of Monetary Union. Oxford : Oxford University Press. Frankel, J. (1997). Regional Trading Blocs in the World Trading System. Washington, D.C.: Institute for International Economics. Frankel, J. and Rose, A.K. (1998). The Endogeneity of the Optimum Currency Area Criteria. Economic Journal, 108, pp. 1009–1025. Institute of Southeast Asian Studies (2003). Concept Paper on the ASEAN Economic Community. Mimeograph. Messerlin, P. (2001) Measuring the Costs of Protection in Europe. Washington, D.C.: Institute for International Economics. Naya, S.F. and Plummer, M.G. (2005). The Economics of the Enterprise for ASEAN Initiative. Singapore: ISEAS.

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Nicolas, F. (1999). Is There a Case for a Single Currency within ASEAN? The Singapore Economic Review, 44(1), pp. 1–25. Plummer, M.G. (undated). Toward Win-Win Regionalism in Asia: Issues and Challenges in Forming Efficient Free Trade Areas in Asia. Paper prepared for the Asian Development Bank. Plummer, M.G. and Click, R. (2005). Bond Market Development and Integration in ASEAN. International Journal of Finance and Economics, 10, pp. 133–142. Plummer, M.G. (2005). On the Creation of an ASEAN Economic Community: Lessons from the EU and Reflections on the Roadmap. In Roadmap for the ASEAN Economic Community, Denis, H. (ed.), Chapter 3, Singapore: ISEAS. Plummer, M.G. (2003). Structural Change in a Globalized Asia: Macro Trends and U.S. Policy Challenges. Journal of Asian Economics, 14(2), pp. 243–281. Plummer, M.G. (2002). EU and ASEAN: Real Integration and Lessons in Financial Cooperation. World Economy, 25(10). Pomfret, R. (1997). The Economics of Regional Trading Arrangements. Oxford: Oxford University Press. Rose, A. (2004). Do We Really Know that the WTO Increases Trade? American Economic Review. Sapir, A. (1997). The Effects of Europe’s Internal Market Program on Production and Trade: A First Assessment. Journal of Common Market Studies. Story, J. and Walter, I. (1997). Political Economy of Financial Integration in Europe: The Battle of the Systems. Cambridge: MIT Press. Tamamura, C. (2002). Structural Changes in International Industrial Linkages and Export Competitiveness in the Asia-Pacific Region. ASEAN Economic Bulletin, 19(1), pp. 52–82. Wellons, P. (undated). Integration of Stock Exchanges in Regions in Europe, Asia, Canada, and the U.S. HIID, www.hiid.harvard.edu/caer2/htm/framsets/ fr auth.htm.

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ASEAN and the United States: The Economics of the Enterprise for ASEAN Initiative 1. Introduction During the APEC Annual Summit in October 2002, President Bush announced his desire to pursue a series of bilateral free trade areas (FTAs) under the rubric of the “Enterprise for ASEAN Initiative” (EAI). In many ways, the EAI did not come as a surprise to most observers for a number of reasons. First, the Bush Administration had been actively pursuing FTAs with partners throughout the developing world. The US policy of uniquely supporting multilateral liberalization under the GATT/WTO framework changed in the 1980s, first with an FTA (in manufactures) with Israel and followed by an FTA-like agreement with the Caribbean Basin (1986), the US-Canada FTA (1989), and NAFTA (1994). When the Bush Administration received Trade Promotion Authority in 2002, it immediately began negotiating a number of bilateral FTAs with countries throughout the world. One of these FTAs was with Singapore, which leads us to our second reason why the EAI was expected: Singapore is a key member of ASEAN and it was believed that after cementing an agreement with Singapore, it would only make sense — from both the US and ASEAN points of view — to consider an accord with the other ASEAN member states. The US-Singapore FTA (USSFTA) is one of the most modern FTAs in the world today; it was explicitly mentioned in the EAI announcement that the USSFTA, finalized in 2003, would be used as a “model” for the other bilateral ASEAN accords. While the EAI framework would no doubt require diversity in substance given the diversity of ASEAN — and the fact that Singapore was an “easy” partner in that it is rich, developed, has no 306

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agricultural sector, and is uncompetitive in other “sensitive” areas — the USSFTA did mark which areas and sectors would be included in the EAI FTAs. Third, given the regionalism zeitgeist, ASEAN is a natural priority “target”. While ASEAN countries differ considerably in terms of per capita income, they are all important and — for most countries — growing trading partners of the United States. If one controls for their size, as discussed below, the US trade with these countries is several times more than one would expect if they were randomly-selected countries. Also, the ASEAN countries play host to a more than proportionate share of US multinational investment and have become key to the trade and investment strategies of many American companies. The major push towards greater economic integration in ASEAN over the past decade and a half — from the ASEAN Free Trade Area, or AFTA, to the decision in October 2003 to create the AEC, makes it an even more attractive region. Finally, the United States has long pondered a series of FTAs with the ASEAN countries. For example, in the late 1980s, the ASEAN-US Initiative (Naya, et al., 1989), which was a major study initiated by the US and ASEAN governments to explore new means of bilateral cooperation, concluded that before an FTA could be negotiated, ASEAN needed to deepen its own economic integration significantly, which it subsequently did. Coupled with the new US interest in bilateralism, “supply” and “demand” appear to be in place, making the moment propitious. As the proposal to form a series of bilateral FTAs between the United States and ASEAN countries has become a reality, the goal of this chapter is to consider the economics of the EAI from a quantitative perspective. The rest of this chapter is organized as follows. We begin with an analysis of bilateral commodity trade in a comparative perspective, including estimates of similarity of the export structures of the ASEAN member states’ (and China’s) exports to the US market using both rank correlation analysis and an export similarity index (Section 2). Next, Section 3 considers directly the economics of a series of US-ASEAN bilateral FTAs using three techniques: (1) a large econometric gravity model, the methodology of which was discussed in Chapter 8, in order to capture the degree of trade bias in the USASEAN economic relationship, with a view to ascertaining if these agreements would be characterized as “natural” economic blocs; (2) a review of economy-wide estimates of these FTAs based on the work of Gilbert (2003); and (3) a disaggregated technique to identify the sectors that will be most significantly affected by the EAI. Section 4 gives some concluding remarks.

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2. Analysis of Commodity Overlap in the Context of the EAI The United States is the largest export market for ASEAN as a whole and for most individual countries (with the notable exception of Indonesia).1 Exports to the United States comprised 16 percent of total ASEAN exports in 2003, though this share is slightly lower than the 20 percent share recorded in 1990. In 2003, Japan’s share of ASEAN exports was 12 percent, down from 18 percent in 1990, while China’s share grew spectacularly to seven percent, rising from less than two percent in 1990. This three-fold increase underscores the growing importance of the Chinese market to the ASEAN countries and signals a significant economic motivation for the FTA agreed to in November 2004. Intra-ASEAN trade rose marginally to 20 percent from 19 percent over the same period. ASEAN imports from the United States comprised 12 percent of total, down slightly from 15 percent in 1990. The ASEAN countries do constitute an important market for certain US exports, although obviously US trade destinations are fairly evenly distributed across Europe, the Americas, and Asia, and the relatively small size of the ASEAN markets naturally result in relatively low trade shares. Nevertheless, ASEAN’s share of US exports has gone up to six percent in 2002 from 4.8 percent in 1990, while the ASEAN share of US imports also rose from 5.6 percent to 6.4 percent during the same period. In sum, the United States is trading more with ASEAN and while the percentages are small, they derive from very large numbers. In terms of commodity trade patterns, ASEAN countries have achieved remarkable success in increasing their respective shares of manufactured goods in total exports. The United States has been a major catalyst in this process. Manufacture exports as a percentage of total exports in the ASEAN countries vary from 69 percent (Indonesia) to over 90 percent (Singapore and Malaysia). Electronics and electronic machinery have emerged as the dominant sector for the exports of Malaysia, the Philippines, and Thailand, as well as being the most dynamic area in Indonesia. This has resulted in a more pronounced role for the United States. It is useful to capture the dynamics of changing patterns of EAI trade by examining the extent to which commodity composition or make-up changed between the USA and ASEAN countries. We attempt to answer this question by examining the correlation of disaggregated commodity 1 Data

for this paragraph are taken from the IMF’s Direction of Trade Statistics, 2004.

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Table 9.1. Structural Change of EAI and Other Asian Trade with US. (Spearman Rank Correlation Coefficients, 3-digit SITC, 1990s). US Imports

US Exports

1990–95

1990–99

1990–95

1990–99

EAI Indonesia Malaysia Philippines Singapore Thailand

0.476 0.542 0.474 0.620 0.701

0.307 0.382 0.301 0.400 0.547

0.692 0.774 0.751 0.857 0.766

0.524 0.614 0.592 0.741 0.638

Other Asia Vietnam∗ China Hong Kong Taiwan South Korea

NA 0.887 0.764 0.895 0.819

0.097 0.828 0.597 0.831 0.706

NA 0.662 0.858 0.833 0.855

0.366 0.513 0.769 0.747 0.723

∗ For

US trade with Vietnam, 1995–1999. Source: United Nation’s Commodity Trade Statistics, Various Years; Author’s Calculations.

exports overtime. We use first the Spearman Rank Correlation Coefficient (SRCC) technique, which we have used in other chapters as well. As noted earlier, the value of this correlation ranges from −1 to +1: perfect (positive) correlation would be unity while complete lack of correlation is zero. Using 3 digit SITC trade data of the United States, we compute the rank correlation coefficients and present them in Table 9.1. US imports from Indonesia, Malaysia and the Philippines2 changed significantly over the 1990s; SRCC’s estimates are 0.307, 0.382, and 0.301. Hence, when ranking the exports of Indonesia to the United States in 1990 and 1999, we find that the correlation comes to only about 30 percent, suggesting considerable change (i.e., the ranking of export items is quite different). In fact, this change is even more pronounced than in the case of any other Asian country included in the sample with the exception of Vietnam, with which the United States was just beginning to establish normal diplomatic and, hence, a trade relationship (normal trade relations were only formalized in 2001 and Vietnam joined the WTO in 2005). 2 As

we use OECD data for this exercise, we use US imports from the ASEAN countries, rather than ASEAN exports to the United States.

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Regarding the change in structure of US exports to the ASEAN countries, one derives far less change. To some degree this is to be expected; as noted above, the United States is an advanced industrial country and one would expect its comparative advantage to be fairly stable. However, one could not say that the structure of US exports to the EAI countries was stagnant, as the SRCC’s are estimated to be 0.524, 0.614, 0.592 and 0.638 for Indonesia, Malaysia, the Philippines, and Thailand, respectively, over the 1990s, lower than for other Asian countries with the exception (once again) of Vietnam and, to some extent, China. Since the EAI negotiations are being done bilaterally and not with ASEAN as a whole, there is a possibility of negative effects of export diversion for those countries that are excluded from an FTA. The degree to which such countries are affected will depend critically on how much overlap there is between their exports and those of the countries that succeeded in obtaining preferential treatment through an FTA (and of course, the level of commodity-level protection in the export market). We determine the extent to which EAI exports are similar to each other using two fairly standard techniques. The first is the SRCC technique described above, but instead of ranking the structure of exports of the same country between two years, we rank the structure of exports of two countries (to a specific market) for the same year. A high estimated SRCC value would, therefore, suggest significant export overlap, whereas low values would mean not much competition at all. We do this at the 5-digit SITC level (2881 commodities) for the exports of Indonesia, Malaysia, the Philippines and Thailand to the US market for the years 1995 and 1999.3 The results are presented in Table 9.2. The SRCCs fall in the negative range for Singaporean competition with all ASEAN countries save Malaysia and are positive for the others, with a maximum value of 0.277 (Indonesia-Thailand, 1995). While we have no yardstick by which to deem what constitutes a “high” SRCC and a “low” SRCC, these values suggest that there is not a great deal of overlap across countries. However, it is noteworthy that competition between Malaysia and the Philippines in the US market has been rising over time, while there has been less overlap between the Philippines and Indonesia. Competition between Thailand and the Philippines has risen and is relatively high, but 3 We also calculate SRCCs for ASEAN exports to the OECD as a whole and other individual OECD markets (these are available from the authors upon request). However, the overall basic conclusions do not change with respect to export competition.

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Table 9.2. Correlation of ASEAN Exports to US. (Spearman Rank Correlation Coefficients, 5-Digit SITC). Indonesia

Malaysia

Philippines

Thailand

— —

0.2460 0.2128

0.201 0.268

0.21 0.277

−0.112 −0.15

Malaysia 1999 1995

0.2460 0.2128

— —

0.191 0.174

0.187 0.199

0.174 0.203

Philippines 1999 1995

0.201 0.268

0.191 0.174

— —

0.263 0.231

−0.105 −0.81

Thailand 1999 1995

0.21 0.277

0.187 0.199

0.263 0.231

— —

−0.024 −0.006

−0.112 −0.15

0.174 0.203

−0.105 −0.081

a. US Market Indonesia 1999 1995

Singapore 1999 1995

Singapore

−0.024 −0.006

— —

Source: OECD, International Trade Statistics, 2003; Authors’ Calculations.

it has fallen with respect to Malaysia and Indonesia. This is an important consideration given that the United States began FTA negotiations with Thailand in July 2004. Using this methodology, it would seem that Singapore’s partners have little to fear from the US-Singapore FTA (USSFTA), with the possible exception of Malaysia. In sum, the SRCC calculations suggest that some but not a considerable degree of export overlap exists between the EAI countries — and, hence, the risk of trade diversion due to being left out of an FTA would not be particularly high. We have also compared ASEAN and Chinese exports to the United States. If there is considerable overlap, then the EAI might even make more sense to ASEAN, that is, as a means of gaining a preferential edge over China’s exports in the US market. Our results suggest that China is consistently a greater competitor in the US market with individual ASEAN countries than they are with themselves; SRCCs in 1999 for Chinese exports competing with Indonesia (0.30), Malaysia (0.279), the Philippines (0.362) and Thailand (0.40) are always higher than the corresponding numbers in Table 9.2. We repeat these correlation exercises using a separate and equally popular export similarity technique, known as the Finger-Kreinin Index

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(FKI), as a check for the robustness of these results. The FKI endeavors to estimate export similarity by calculating the relative importance of various commodities in the export structure of pairs of countries, and then using a filtering technique, that is:   
  

Xia , Xib Xib , min Xia S= i

where: i = trade by disaggregated commodity a, b = two countries The first ratio is the share of product ‘i’ in country a’s total exports and the second ratio is the share of commodity ‘i’ in country b’s exports. If those shares are equal, then the ratio in the formula would sum to one, indicating perfect similarity. On the other hand, if they are totally different, the formula would be zero. Thus the index can range from zero to one. Like the SRCCs, this index is sensitive to the degree of disaggregation. In Table 9.3, we present FKI calculations for the same countries, with somewhat different results, particularly for Singapore. For the ASEAN-4, Table 9.3. Finger-Kreinin Measure of Export Similarity: EAI Exports to US Market. (5-digit SITC, Selected Years). Indonesia

Malaysia

Philippines

Thailand

Singapore

Indonesia 1999 1995

— —

0.3070 0.2950

0.266 0.261

0.393 0.376

0.144 0.149

Malaysia 1999 1995

0.3070 0.2950

— —

0.530 0.451

0.347 0.356

0.585 0.499

Philippines 1999 1995

0.266 0.261

0.530 0.451

— —

0.390 0.382

0.41 0.356

Thailand 1999 1995

0.393 0.376

0.347 0.356

0.390 0.382

— —

0.237 0.261

Singapore 1999 1995

0.144 0.149

0.585 0.499

0.41 0.356

0.237 0.261

Note: OECD Calculations are available from the authors upon request. Source: OECD, International Trade Statistics, 2003; Authors’ Calculations.

— —

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we note first that the range of the export similarity calculations is higher than in the case of the SRCCs, falling between 0.261 (Philippines-Indonesia, 1995) and 0.53 (Philippines-Malaysia, 1999) in the US market.4 Second, the FKIs increase over time in the case of every country pair with the exception of Malaysia and Thailand. Moreover, the trend is upward in all cases except one, but this time it is the Philippines and Thailand experiencing a slight decline in the index. Hence, while the SRCC rankings would have led us to believe that competition between Singapore and the rest of ASEAN was not very stiff, our export similarity indices present a different story. While the FKIs reveal only minor overlap with Indonesia and Thailand, Malaysia exports and, to a lesser degree, Philippine exports appear to compete significantly with Singapore in the US market. In fact, the export similarity between Malaysian and Singapore exports, already relatively high in the case of the SRCCS, is the highest of any two pairs of countries, coming to 0.585.

3. Empirical Estimates of the Effects of US-ASEAN FTAs under the EAI In our statistical review above, we were able to note that ASEAN countries compete with each other to varying degrees in the US market. These results give some idea as to the stakes involved in the bilateral FTAs; the extent of export similarity will determine the degree to which the successful negotiation of one FTA within the framework of the EAI might potentially impact negatively the others. Indeed, the decision to form an FTA with the United States is no longer a matter of weighing the costs and benefits of the FTA itself in terms of greater margins of preference in the US market, as might have been the case if FTAs were an “exception” (as in the past), but rather a question of preserving most favored nation status. In this section, we consider more directly the economic effects of this decision to form an FTA with the United States using three approaches: (a) a large gravity model; (b) a review of the results using a typical Computational General Equilibrium (CGE) Model; and (3) a disaggregated approach which, we 4 Once

again, we do this for exports to the OECD markets as well, and results are available from the authors upon request. Suffice it to note that the same picture generally emerges in the case of exports to the OECD, where the FKI falls in a slightly broader range of 0.257 (Philippines-Indonesia, 1995) and 0.592 (Malaysia-Philippines, 1999).

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would argue, is more useful in determining the economic effects of the EAI from the viewpoint of businesspeople. 3.1. Gravity Model Section 2 essentially gave an analytical statistical overview of the relationship between the United States and the EAI countries in a comparative context. But we were not able to say much about what drives that relationship. In this sub-section, we attempt to evaluate the relationship from an econometric (or “applied statistical”) perspective and ask the questions: “To what extent is the US/EAI economic relationship ‘special’ ? Does it form a ‘natural’ economic bloc”?5 In other words, is US-EAI economic interaction on the order of what one would expect from countries with the economic characteristics of the United States and EAI? We address these questions by using a “gravity model” of international trade flows. As noted in Chapter 8, this is an econometric procedure in which trade in a certain year is posited as a function of the GDP of the source and partner country (or their product) as a proxy for size, per capita income of the source and partner country (or their product) as a proxy for wealth,6 distance between the two countries as a proxy for transportation and other “costs”, and an “adjacency” binary (“dummy”) variable to control for whether or not the trading countries have a common border. Our results in that chapter yielded the following estimate coefficients on the US (and EU) binary variables (Chart 9.1): Clearly, the ASEAN binary variable in the US regressions are more frequently statistically significant (in fact, they are statistically significant in all years covered in this sample) and are higher, particularly in later years. They fell during the Crisis years but have recovered since. While one might be able to detect a fall in the ASEAN binary variable growth trend beginning in the early 1990s (that is, when the European Single Market came online for the most part), no such fall is evident in the US regressions, despite NAFTA. 5 For a review of the economics of what constitutes a “natural” economic bloc, see Frankel, 1993. We note here several possible measures that have emerged in the literature: (1) trade shares greater than 50 percent (Krugman, 1991); (2) double-density measures greater than 1 (Frankel, 1993; Petri, 1993); (3) an arrangement which preserves comparative advantage (Kreinin and Plummer, 1994); and (4) statistically significant binary coefficients on bilateral trade, which is what we focus on here. 6 Modern international trade theory suggests that per capita income between countries is correlated positively with trade.

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ASEAN Gravity Regression, Original Asean Countries.

-.5

Regression Coefficients 0 .5 1 1.5

2

Chart 9.1.

315

1950

1960

1970

1980

1990

2000

Year trade with EU (Significant) trade with EU (All)

trade with USA (Significant) trade with USA (All)

Source: Naya and Plummer (2005). 3.2. Aggregate Effects: CGE Models Computable general equilibrium (CGE) models are a standard tool for analyzing trade policy.7 Their attraction is the inclusion of multi-country and multi-commodity dimensions, along with strong theoretical foundations, and a consistent interaction between economic variables. Revolutions in computing technologies have facilitated CGE modeling.8 The Global Trade and Analysis Project (GTAP), which is used in the model applied in this section, is publicly available and is one of the most frequently used CGE models in the trade literature. CGE models tend to be static in nature, and the lack of more realistic assumptions, such as variety in market structure, economies of scale, and technological change, as well as the strong focus on trade, constrain the economic effects of any given policy change. These shortcomings become 7 For

an early literature survey, see Shoven and Whalley (1984). Kreinin and Plummer (2002) give a more updated review. 8 This is true, for example, in the case of the Global Trade Analysis Project (GTAP) under the direction of Thomas Hertel at Purdue University. See Hertel (1997).

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Table 9.4. CGE Estimates of Nominal GDP Changes by Bilateral FTAs Between The U.S. and ASEAN Countries (%).

ASEAN U.S.

Indonesia

Malaysia

Philippines

Singapore

Thailand

2.75 −0.02

0.46 0.03

3.1 0.01

0.66 −0.01

0.72 0.07

Source: Gilbert, J. (2003). CGE Simulations of US Bilateral Free Trade Agreements. As cited in DeRosa, D. (2004). US Free Trade Agreements with ASEAN. Washington, DC: Institute for International Economics.

particularly limiting when developing countries are involved, because, as noted above, dynamic aspects of development are the most sensitive to policy change, and dynamic elements of economic integration tend to be more important.9 These limitations may explain the alleged downward bias of the welfare effects of integration (e.g., Safadi and Laird, 1996, Kreinin and Plummer, 2002) obtained by this approach. We summarize in Table 9.4 the results from Gilbert (2003)’s GTAPbased CGE model, through which he estimates the effects of FTAs between the United States and ASEAN countries. We want to stress that this model: (1) does not explicitly incorporate non-tariff barriers but does try to include them by estimating a tariff-equivalent effect of various non-tariff barriers; (2) includes only one services sector, a limitation given that it will be an important area in the EAI negotiations; (3) does not include any effects that we listed as “dynamic”, that is, changes in investment flows, productivity spill-overs, economies of scale, and the like; and (4) as is the case with all CGE models, it cannot take into account additional policy dynamics (such as those discussed in Section 2). Hence, we would suggest that these effects have a strong downward bias, particularly in the case of the EAI. Clearly, the economic effects of the EAI using this approach generate extremely small results, with the possible exception of the Philippines, whose GDP would rise by 3.1 percent with a bilateral FTA (quite high by CGE standards and on par, essentially, with the results estimated to derive from the EU Single Market Program). It is interesting that the effect on the US economy is always less than one percent, and actually is negative 9 The

“externalities” of economic openness, for example, have been extremely important in the case of developing Asian countries, as has been noted extensively in the economic literature (see, for example, Sachs and Warner, 1995; World Bank, 1993; and Dollar, 1992).

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(albeit small) in the case of Indonesia and Singapore. This stems not only due to the large US market relative to ASEAN but also because the US economy is already substantially open, with a few exceptions (discussed below). These asymmetric gains resulting from traditional FTA liberalization (captured in this model) no doubt play a role in US demands for liberalization of “non-border” barriers, services, and the like (not captured in this model). Three additional interesting points from the Gilbert simulations might be mentioned.10 First, regarding the implications for factor returns in ASEAN, unskilled labor gains the most (sometimes, by far) due to the FTAs, and the owners of land (in most cases) and natural resource tend to be the losers. Land owners gain (marginally) but natural resources owners are affected negatively in the cases of Indonesia and Thailand; however, they both lose in the cases of Malaysia and the Philippines. The returns to capital and skilled labor are positive and fairly high in all cases, though always lower than the return to unskilled labor. Hence, one would anticipate that opposition to the EAI would tend to come mostly from owners of natural resources and, in some cases, land. Effects on factors in the United States are, of course, very small, but in no case does unskilled labor lose. Second, in the case of each bilateral FTA, the rest of ASEAN is negatively affected. While the values are not high, as a percentage of the gains to the ASEAN member state engaging in the agreement, they can be substantial, e.g., the loss to “other ASEAN” in the case of the US-Malaysia FTA is over one-third the gains to Malaysia. This trade diversion effect, which is inherent in these agreements, is one motivation for FTAs as a “defensive strategy”, noted above. Finally, with respect to sectoral effects, the Gilbert model is able to show changes in trade patterns in 18 different sectors, including one service sector. Again, the overall effects on sectoral production and trade are found to be small, though there are relatively large increases in bilateral trade in certain sectors. For example, the US motor vehicle sector is not affected much overall by the EAI FTAs, with the possible exception of the US-Thai FTA in which the sector would grow by two percent. However, in terms of changes at the bilateral level, the percentage changes tend to be extremely large, i.e., 600 percent, 1102 percent, 537 percent, and 1593 percent for FTAs with Indonesia, Malaysia, the Philippines, and Thailand, respectively. 10 For

details and the actual tables themselves, see Gilbert (2003).

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This is one reason why motor vehicles will be a “sensitive area” in future bilateral EAI negotiations. 3.3. Product by Product Trade Expansion: A Disaggregated Approach Thus, although the estimated effects of the CGE model on US and ASEAN aggregate welfare are low, the sectoral effects can be fairly substantial. As trade agreements are ultimately political agreements, it is useful to focus more specifically on the actual products that are being affected. After all, an ASEAN-based businessperson is not so much interested in overall protection in electronics in the United States; he or she is interested in exactly what the level of protection is for his or her electronics-related product. To arrive at this sort of detail, we need to work with the greatest degree of trade disaggregation possible. In this section, we develop a disaggregated approach to the potential economic effects of the EAI. The technique is fairly straightforward. We first gather SITC 5-digit data for the exports of the individual EAI countries to the United States, and from the United States to the EAI countries, for the latest year available (2001). As noted above, this level of disaggregation gives us a maximum of approximately 3000 commodities and is of the greatest detail available under the SITC system. We then rank these commodities by the value of exports to each market. This ranking system shows us clearly which individual products are the most important in bilateral trade. Next, we consider levels of protection. The higher the value of an export and the higher the level of protection facing the proposed FTA partner, the greater is the potential for trade expansion. Hence, we need to calculate protection at these high levels of disaggregation, which is difficult for two reasons: first, tariff levels of the United States and the EAI countries are published under the HS system and include an even higher level of disaggregation than the SITC. Hence, we had to produce a weighted average of HS-based tariffs for each 5-digit SITC commodity, using a correspondence table that maps out the comparable commodities. These are called the “MFN-based” tariffs in our analysis. However, for US protection, we also have to take into account the fact that the United States offers GSP and other forms of preferential treatment to Indonesia, the Philippines and Thailand), whereas Malaysia, Brunei, and Singapore do not qualify for this program. Therefore we had to go into each tariff line and assign a zero tariff

May 28, 2009 14:24

9in x 6in

B-753

ASEAN and the United States

b753-ch09

319

to any commodity receiving GSP treatment, and recalculate the average tariffs by commodity.11 Finally, we would like to estimate how much potential there is in each product for trade expansion under an FTA. We do this by multiplying the value of the product by the change in the tariff (which gives us our price change) and the elasticity of demand, using a rule-of-thumb estimate of −1.12 Such an approach has a long tradition in the empirical FTA literature (under the “price-elasticities” approach), though it has not been done before at this level of aggregation and in this sort of framework. Using −1 as an elasticity for all commodities is obviously a generalization, but there exist no estimates of elasticity demand at the 2-digit level, let along the 5-digit level. Moreover, in many CGE models, elasticities seem to be close to unity for many commodities, though they tend to be somewhat smaller in agriculture and higher in manufactured goods. However, we are interested in merely a general idea of how much an individual export could possibly expand, and this seemed to be the easiest approach. One can easily adjust these estimates for higher (lower) elasticities by just multiplying through by another parametric value. To give a concrete example of how this procedure works, let’s give an example from the Indonesian market. The most important Indonesian export to the US market in 2001 was video recording or reproducing apparatus, with a value of $588 million. How would a proposed FTA with the United States affect Indonesian exporters of this commodity? We first look at levels of protection. The United States does have certain tariffs in this area under the HS system, but they are obviously quite low, as the average tariff comes out to be less than one percent (0.0035 percent). Moreover, the products facing a tariff in the United States in this category are included under the US GSP program, so we assign a zero to them when calculating the applied tariff on Indonesian exports. Hence, the estimated trade expansion in this area will be zero; an FTA would have no effect because Indonesia is already accorded free access to the US market. 11 We are unable to also include NTBs, as information is insufficiently detailed and quantitative estimates of their effects on price are very difficult. We also leave out antidumping duties and other administered actions. This poses a problem for agriculture exports of the EAI to the United States, though one might argue that the other area most affected in the US market, textiles and clothing, will see its NTBs abolished in 2005 under its Uruguay Round commitments. 12 We also make the implicit assumption that the exporting country will be able to supply additional products to the target market at no additional costs, i.e., we assume that the export supply curve is flat (infinitely elastic).

May 28, 2009 14:24

320

9in x 6in

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ASEAN Economic Integration

However, this does not mean that exporters of this product should be indifferent to an FTA. This procedure is useful in terms of supplying information, first, in identifying which are the key sectors in bilateral trade (and now we know how important video recording or reproducing apparatus in nominal and relative terms) and second, in determining levels of protection. In addition, there could be many non-tariff and indirect aspects of the agreement that could benefit the sector. The increased certainty, transparency, and assurances created by the agreement could make Indonesia a less risky place in which to invest, perhaps bringing more resources to this sector. For example, better protection of intellectual property, which would likely be included in the agreement, would make multinationals less nervous about investing in high-tech areas in Indonesia, which may include video recording apparatus. Thus, our discussion below focuses on tariffs, but it is important to keep in mind that there is much more to the EAI than mere tariff-based trade protection. Our results for the top 40 ASEAN exports to the US market are presented in Tables 9.5–9.10 for Indonesia, Malaysia, the Philippines, Thailand, Brunei, and Singapore, respectively.13 3.4. Results Table 9.5 shows that, while video recording or reproducing apparatus is the most important Indonesian export to the US market, “other footwear” (SITC 85132) and “footwear” (SITC 85148) should be able to profit most from an Indonesian-US FTA. This is due both to their relative value ($203 million and $420 million respectively) and size of the US tariff, which is relatively high in both cases (26.8 percent and 7.4 percent, respectively). These items are excluded from the US GSP. Trade expansion should be on the order of $55 million and $31 million, respectively. The next five items with trade expansion potential include cotton shirts for men ($21 million), tennis shoes ($19 million), brasseries ($14 million), babies’ garments ($14 million), and plywood ($10 million). Hence, while there are a number electronic goods and other products that are more important than textile and clothing exports, the relatively elevated tariffs in this area in the United States, coupled with the fact that they are excluded from the US GSP, suggest that they stand to gain the most from a US-Indonesia FTA at the micro level. 13 A complete list of commodities for each country is available from the authors upon request. Moreover, we undertake this exercise for US exports to ASEAN as well.

May 28, 2009 14:24

Table 9.5. Indonesian Exports, US Protection, and Potential for Expansion: Top 40 Exports, 2001. (Ranked by Export Value).

0.0035 0.0743333 0 0 0.2683257 0 0.0611 0.145 0 0.0922308 0.03 0.01 0 0 0.13675 0.007 0.03 0 0 0.1841579 0.0535 0.1107999

0 0.0743333 0 0 0.2683257 0 0.056 0.145 0 0.0830769 0 0 0 0 0.13675 0 0 0 0 0.1841579 0.03 0.1107999

0 31171.91 0 0 54591.56 0 10202.16 21054.06 0 11601.13 0 0 0 0 14336.56 0 0 0 0 13786.8 2134.386 7723.84 (Continued)

321

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588254.7 419353.1 310743 206470.7 203452.6 196244.9 182181.5 145200.4 143649.9 139643.2 135062.2 134524.2 110505.2 108317.7 104837.7 102881.5 96740.3 96200.4 88633.8 74864 71146.2 69709.8

Expansion (US$1000)

B-753

Tariff on Indo (average)

9in x 6in

Video recording or reproducing apparatus Footwear, n.e.s., with outer soles of leather Technically specified natural rubber Parts, accessories of the machines of group 752 Other footwear, outer soles & uppers of rubber, pla. Other wooden furniture Plywood, sheets of wood, ply of tropi. or non-conif. Shirts of cotton, for men Shrimps and prawns, frozen Other holsters, cases bags & containers, n.e.s. Other radio-broadcast receivers, non-combined Radio, external source of power, vehicles, combined Digital monolithic integrated circuits Furniture, of wood, of a kind used in the bedroom Brassieres Papers & paperboard, for graphic purposes Crustaceans, prepared or preserved, n.e.s. Seats, n.e.s., with wooden frames Dolls representing only human beings Babies’ garments & clothing accessories, knitted Articles of apparel, of leather Coats, capes & similar of other materials, for men

US MFN Tariff (average)

ASEAN and the United States

76381 85148 23125 75997 85132 82159 63431 84151 03611 83199 76289 76211 77641 82155 84551 64248 03721 82116 89422 84512 84811 84119

Exports 2001 (US$1000)

Tariff on Indo (average)

Expansion (US$1000)

65054.8 59633.4 58427.6 58146.6 55102 53149 52835.7 52273.7 51969.2 49980.9 45957.7 45898.1 45604.9 44135.3

0.02 0 0 0.1550279 0.3465983 0.0628 0.027 0.0094444 0 0.0281667 0.05 0.1101079 0.080576 0

0.02 0 0 0.1550279 0.3465983 0 0 0.0005556 0 0 0 0.1101079 0 0

1301.096 0 0 9014.343 19098.26 0 0 29.04095 0 0 0 5053.744 0 0

42136.9 41046.9 38602.1 38134.8

0.0269 0.0566667 0.027 0.0972

0 0.0466667 0 0.0972

0 1915.522 0 3706.702

b753-ch09

Total Expansion Value for All Exports: $301.1 million. Expansion as a Percentage of Total Included Exports: 3%. Notes: 1. Difference between MFN and Applied Tariffs regards existing preferential treatment offered by the US (e.g., GSP).

B-753

US MFN Tariff (average)

9in x 6in

69741 84822 77261 84589

Contact lenses Pepper, neither crushed nor ground Non-digital monolithiques integrated circuits Babies’ garments & clothing accessor., not knitted Tennis shoes, training shoes & the like, rubber, pla. Articles of jewellery & parts of precious metals Primary cells & primary batteries Other parts & accessories of motor vehicles Coffee, not roasted, not decaffeinated Gloves, mittens & mitts, for use in sports Ignit. wiring sets & the like used in vehicl., etc. Wind-jackets, anoraks & similar articles, for women Polyethylene terephthalate Wigs, false beard & similar, art. of human hair, n.e.s. Household articles & parts, n.e.s, of iron or steel Rubber gloves Boards, panels for electric distribution 1w Other wooden furniture Other sound-reproducing apparatus Transmission apparatus Other telephonic or telegraphic apparatus Seats, n.e.s., with wooden frames Parts & accessories of 761, 762, 7643, 7648 Photosensitive semiconductor devices; light emitt. Shirts of cotton, for men Diodes, not photosensiti. nor light emitting diodes Toys, n.e.s. Static converters Ovens, cookers, cook. plates, boiling rings, roasters

US MFN Tariff (average)

ASEAN Economic Integration

77641 75997 76432 76381 77643 84822 76411 76281

Exports 2001 (US$1000)

324

Table 9.6. Malaysia Exports, US Protection, and Potential for Expansion: Top 40 Products. (Ranked by Export Value).

US MFN Tariff (average)

Tariff on Malay (average)

Expansion (US$1000)

85030.5 82691.4 80178.3 77708.6 74025.6 73582.6 70579.4 66579.2 65662.4 63808.2 54356.6 54123.6 53757.6 46576 45538 45367.5 44883.6

0 0 0.0589286 0.0611 0.01775 0.1841579 0.015 0.049 0 0 0 0.0316667 0 0.027 0 0 0.0025555

0 0 0.0589286 0.0611 0.01775 0.1841579 0.015 0.049 0 0 0 0.0316667 0 0.027 0 0 0.0025555

0 0 4724.792 4747.995 1313.954 13550.82 1058.691 3262.381 0 0 0 1713.914 0 1257.552 0 0 114.7

325

b753-ch09

Total Expansion Value for All Exports: $179.3 million. Expansion as a Percentage of Total Included Exports: 1%. Notes: 1. Difference between MFN and Applied Tariffs regards existing preferential treatment offered by the US (e.g., GSP).

B-753

Exports 2001 (US$1000)

9in x 6in

Parts & accessories for apparatus of heading 7641 Radio, without external source of power, combined Acycl., cyclan., cyclen., cyclo., arom ethers; derivat. Plywood, sheets of wood, ply of tropi. or non-conif. Photographic cameras Babies’ garments & clothing accessories, knitted Other radio receivers, combined with a clock Loudspeakers, mounted in their enclosures Transistors, dissipation rate < 1 w Sound-recording apparatus Palm kernel, babassu oil & their fractions, refined Fatty alcohols, industrial Electronic without external source of power Boards, panels for electric distribution < 1000 volts Palm oil and its fractions, refined Other instrum. & apparatus for telecommunications Glycerol (glycerine), glycerol waters & lyes

(Continued )

ASEAN and the United States

76491 76221 51616 63431 88111 84512 76282 76422 77632 76384 42249 51217 75121 77261 42229 87477 51222

May 28, 2009 14:24

Table 9.6.

0 0 0.05 0.006 0.0922308 0 0.012 0.145 0 0.127 0.1841579 0 0.006215 0.1550279 0 0 0.201 0 0.1107999 0.13675 0.0671335 0.1101079 0.1011256 0

0 0 0 0 0.0830769 0 0.0045 0.145 0 0.127 0.1841579 0 0.006215 0.1550279 0 0 0.201 0 0.1107999 0.13675 0.0671335 0.1101079 0.0925541 0

0 0 0 0 15269.6007 0 465.7014 14622.003 0 12083.2372 16389.1139 0 511.942602 12268.7685 0 0 12928.5813 0 6475.50072 7120.06653 3180.19446 4765.61305 3942.4437 0 (Continued)

b753-ch09

855309.8 412575.5 288219.3 222464.6 183800.8 124613.9 103489.2 100841.4 99113.5 95143.6 88994.9 86830.7 82372.1 79139.1 78184.6 75553.4 64321.3 62715 58443.2 52066.3 47371.2 43281.3 42596.1 42433.9

B-753

Expansion (US$1000)

9in x 6in

Tariff on Phil (average)

May 28, 2009 14:24

Non-digital monolithiques integrated circuits Parts, accessories of the machines of group 752 Ignit. wiring sets & the like used in vehicl., etc. Static converters Other holsters, cases, bags & containers, n.e.s. Wrist watches, electrically powered Transmission apparatus Shirts of cotton, for men Coconut oil, crude Satchels & simil., outer surface of plast. or text. Babies’ garments & clothing accessories, knitted Transmission apparatus with reception apparatus Pineapples, prepared or preserved, n.e.s. Babies’ garments & clothing accessor., not knitted Other wooden furniture Transistors, dissipation rate > 1w Shirts, of cotton, knitted or crocheted, for men Photosensitive semi-conductor devices; light emitt. Coats, capes & similar of other materials, for men Brassieres Pineapple juice Wind-jackets, anoraks & similar articles, for women Tunas, skipjack and Atlantic bonito, not minced Furniture of other materials (incl. bamboo)

US MFN Tariff (average)

ASEAN Economic Integration

77643 75997 77313 77121 83199 88541 76431 84151 42231 83122 84512 76432 05893 84511 82159 77633 84371 77637 84119 84551 05991 84219 03713 82179

Exports 2001 (US$1000)

326

Table 9.7. Philippine Exports, US Protection, and Potential for Expansion: Top 40 Products. (Ranked by Export Value).

US MFN Tariff (average)

Tariff on Phil (average)

Expansion (US$1000)

39317.4 38837.9 38445.1 37925.8 36606.2 36541 36290 33771.2

0.01775 0 0 0.0483333 0.027 0.870787 0.0972 0.0245

0 0 0 0.0246111 0 0.870787 0.0972 0

0 0 0 933.395656 0 31819.4278 3527.388 0

33367 32775.4 31956 31859 31569.1 31118.6 31076.1

0.0236 0.0217714 0 0.0281667 0.067 0.089 0

0 0.0108857 0 0 0 0.089 0

0 356.783172 0 0 0 2769.5554 0

327

b753-ch09

Total Expansion Value for All Exports: $212.4 million. Expansion as a Percentage of Total Included Exports: 3%. Notes: 1. Difference between MFN and Applied Tariffs regards existing preferential treatment offered by the US (e.g., GSP).

B-753

Exports 2001 (US$1000)

9in x 6in

77315 76493 77645 89477 66491 84282 82139

Photographic cameras Coconut oil and its fractions, refined Piezo-electric crystals, mounted Articles made directly to shape from plaiting mat. Boards, panels for electric distribution < 1000 volts Cane sugar, raw Articles of apparel, women’s or girls, n.e.s. Headphones, earphones & combined microphone/speaker Other elect. conductors, 80 volts < voltage < 1000 v Parts & accessories of 761, 762, 7643, 7648 Hybrid integrated circuits Gloves, mittens & mitts, for use in sports Glass of headings 6643, 6644 or 6645, worked Nightdresses & pajamas, for women Other furniture of metal

(Continued )

ASEAN and the United States

88111 42239 77681 89971 77261 06111 84589 76424

May 28, 2009 14:24

Table 9.7.

0 0.0628 0 0.03 0 0.0566667 0.1841579 0.006 0.127 0 0.1011256 0.0743333 0.0035 0.047

0 0.0033333 0 0 0 0.0466667 0.1841579 0 0.127 0 0.1011256 0.0743333 0 0

0 2163.404 0 0 0 13788.32 45583.18 0 25068.19 0 17852.46 12903 0 0

148056.1 140689.6 138146.5 137151.7 123143.7 122067.2 119543.3 117282.2

0 0.035 0.0922308 0.05 0.037 0.01 0.0156667 0.13675

0 0 0.0830769 0.05 0.037 0 0.0066667 0.13675

0 0 11476.79 6857.585 4556.317 0 796.9553 16038.34 (Continued)

b753-ch09

799810.1 649021.3 530565.7 526482.2 309631.3 295463.9 247522.3 233668.7 197387.3 192253.8 176537.5 173582.9 169288.8 162552.4

B-753

Expansion (US$1000)

9in x 6in

Tariff on Thai (average)

May 28, 2009 14:24

82159 66739 83199 77313 75132 76211 77586 84551

Shrimps and prawns, frozen Articles of jewellery & parts of precious metals Digital monolithic integrated circuits Crustaceans, prepared or preserved, n.e.s. Parts, accessories of the machines of group 752 Rubber gloves Babies’ garments & clothing accessories, knitted Static converters Satchels & simil., outer surface of plast. or text. Non-digital monolithiques integrated circuits Tunas, skipjack and Atlantic bonito, not minced Footwear, n.e.s., with outer soles of leather Video recording or reproducing apparatus Fans with self-contained electr. motor, output < 125w Other wooden furniture (semi-) precious stones, otherwise worked Other holsters, cases, bags & containers, n.e.s. Ignit. wiring sets & the like used in vehicl., etc. Electrostatic photo-copy. apparatus, indirect proc. Radio, external source of power, vehicles, combined Ovens, cookers, cook. plates, boiling rings, roasters Brassieres

US MFN Tariff (average)

ASEAN Economic Integration

03611 89731 77641 03721 75997 84822 84512 77121 83122 77643 03713 85148 76381 74341

Exports 2001 (US$1000)

328

Table 9.8. Thai Exports, US Protection, and the Potential for Trade Expansion: Top 40 Products. (Ranked by Export Value).

US MFN Tariff (average)

Tariff on Thai (average)

107192.4 105713.6 103622.1 100692.9 93911.9 89725.9 88467.2 82794.6 71146.2 82250 80214.4 78879.9 77402.3 76932.7 62428.7 59913.3 59119.9 57515.7 54901.7

0.031 0.0217714 0.0738965 0 0 0 0.00925 0 0.0535 0.1107999 0 0.201 0 0.039 0.0269 0.07725 0 0.0052 0.0094444

0 0.0108857 0.0178965 0 0 0 0 0 0.03 0.1107999 0 0.201 0 0 0 0.07725 0 0 0.0005556

Expansion (US$1000) 0 1150.768 1854.473 0 0 0 0 0 2134.386 9113.293 0 15854.86 0 0 0 4628.302 0 0 30.50095

329

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Total Expansion Value for All Included Exports: $338 million. Expansion as a Percentage of Total Included Exports: 1.8%. Notes: 1. Difference between MFN and Applied Tariffs regards existing preferential treatment offered by the US (e.g., GSP).

B-753

Exports 2001 (US$1000)

9in x 6in

Household articles & parts, n.e.s., of aluminum Parts & accessories of 761, 762, 7643, 7648 Rice, semi-milled, wholly milled (excluding broken) Technically specified natural rubber Portland cement Other telephonic or telegraphic apparatus Other sound reproducing apparatus Toys, n.e.s. Articles of apparel, of leather Coats, capes & similar of other materials, for men Wrist watches, electrically powered Shirts, of cotton, knitted or crocheted, for men Telephone sets Wooden frames for paintings, mirrors or similar Household articles & parts, n.e.s, of iron or steel Underpants & briefs, knitted or crocheted, for men Seats, n.e.s., with wooden frames Electric sound or visual signaling apparatus Other parts & accessories of motor vehicles

(Continued )

ASEAN and the United States

69743 76493 04231 23125 66122 76419 76383 89429 84811 84119 88541 84371 76411 63541 69741 84381 82116 77884 78439

May 28, 2009 14:24

Table 9.8.

May 28, 2009 14:24

330

9in x 6in

B-753

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ASEAN Economic Integration

textiles, and clothing agreement will be15 ), the trade expansion in these static calculations may even be more promising in the case of Thailand. Two of the top Thai exports to the United States were related to seafood, i.e., shrimps and prawns, which was the most important Thai export at $800 million, and crustaceans (prepared or preserved), at $526 million. These products had very low (or zero, in the case of the former) applied tariffs, and, hence, trade expansion is small. However, non-tariff barriers do exist, and the recent decision to place anti-dumping duties on Thai exports of shrimp to the United States in July 2004 suggest a much greater incentive for these sectors to advocate an FTA. Articles of jewelry ($649 million) and digital integrated circuits ($531 million) were number three and number four, respectively. The product line with the greatest potential for trade expansion ($46 million) would be, once again, babies’ garments, mainly due to the relatively high tariff (18 percent) in the US market. Table 9.9 underscores the relatively small amount of trade that Brunei does with the United States; total Brunei exports come to $86 million, mainly because petroleum exports dominate Brunei’s export regime and it exports very little in terms of energy-related projects to the United States. However, it is interesting to note that, since many of Brunei’s exports fall in relatively protected areas in the US markets (particularly textiles and clothing), the potential for trade expansion is actually quite high, at about 10 percent of total exports ($8 million). Finally, low tariffs on electronics products in the United States ensure that trade expansion in the Singapore market will be small as well (Table 9.10). Twenty-five out of the top 40 products that Singapore exported to the United States faced zero tariffs in 2001. This is even more impressive if one recalls that Singapore does not benefit from the US GSP program. Singapore exports are also fairly concentrated; the top five Singaporean exports (parts and accessories of machines, digital integrated circuits, non-digital integrated circuits, “other” instruments for medical and scientific purposes, and “other” radio receivers) constituted over 60 percent of the included exports in the database. The top four exports faced zero 15 In

the WTO agreement reached in Geneva at the end of July 2004, which created a framework within which the Doha negotiations will take place, liberalization of agriculture was a main theme, including phasing out of export subsidies and lowering of various non-tariff barriers as well. It is not clear exactly how much liberalization will ultimately take place in agriculture, but it is certain that some non-tariff barriers will continue to exist, unlike for textiles and clothing.

Brunei Exports, US Protection, and the Potential for Trade Expansion. (Ranked by Export Value). Exports 2001 (US$1000)

51122 84522 51124 84424 84591

0.201 0 0.1525

0.201 0 0.1525

8773.3

0

0

5286.1 5149.3 4184.3 2982.6 2058.4 1764.8

0.1841579 0.1562107 0 0.1561428 0.0828 0.0828

0.1841579 0.1562107 0 0.1561428 0.0828 0.0828

1591.1 1274.1 988.6 750.7 430.7

0 0.05675 0 0.1215 0.2086

0 0.05675 0 0.1215 0.2086

Expansion (US$1000) 3738.721 0 2065.384 0 973.4771 804.3759 0 465.7116 170.4355 146.1254 0 72.30518 0 91.21005 89.84402

B-753

84512 84324 51127 84599 84489 84483

18600.6 17220.2 13543.5

Tariff on Brunei (average)

9in x 6in

33541

Shirts, of cotton, knitted or crocheted, for men Petroleum coke Trousers, bib & brace overalls, shorts, knitted, women Petroleum bitumen, other residues; bitumin. mixtures Babies’ garments & clothing accessories, knitted Trousers, bib & brace overalls, shorts, knitted, men Cumene Garments, knitted or crocheted, n.e.s. Other night clothing or bodywear, knitted, women Nightdresses & pyjamas, knitted or crocheted, women Benzene, pure Men’s garments of fabrics of 65732 through 65734 Xylenes, pure Dresses, knitted or crocheted, for women Track suits

US MFN Tariff (average)

ASEAN and the United States

84371 33542 84426

May 28, 2009 14:24

Table 9.9.

(Continued)

b753-ch09

331

(Continued )

Exports 2001 (US$1000)

Expansion (US$1000)

0.142 0.085625 0.092 0.089 0.1107999 0.1064286 0.1550279 0.089 0.0185 0.0972 0.1074 0.145 0.1264022

0.142 0.085625 0.092 0.089 0.1107999 0.1064286 0.1550279 0.089 0.0185 0.0972 0.1074 0.145 0.1264022

43.8354 23.52118 25.2724 19.046 21.50626 20.55136 17.84371 6.3813 1.3135 6.73596 7.2495 8.787001 3.829988

B-753

308.7 274.7 274.7 214 194.1 193.1 115.1 71.7 71 69.3 67.5 60.6 30.3

Tariff on Brunei (average)

9in x 6in

Shirts, of other textile materials, knitted, for men Other vests, pyjamas & similar articles, for men Other night clothing & bodywear, knitted, for men Nightshirts & pyjamas, knitted or crocheted, men Coats, capes & similar of other materials, for men Skirts & divided skirts, knitted, crochet., for women Babies’ garments & clothing accessor., not knitted Nightshirts & pyjamas, for men Other inorganic oxygen compounds of non-metals Articles of apparel, women’s or girls, n.e.s. Brief & panties, knitted or crocheted, for women Shirts of cotton, for men Men’s shirts of textile mater. other than cotton

US MFN Tariff (average)

ASEAN Economic Integration

84379 84169 84389 84382 84119 84425 84511 84162 52239 84589 84482 84151 84159

May 28, 2009 14:24

332

Table 9.9.

Total Expansion Value for All Included Exports: $9 million. Expansion as a Percentage of Total Included Exports: 10%. Notes: 1. Difference between MFN and Applied Tariffs regards existing preferential treatment offered by the US (e.g., GSP).

b753-ch09

May 28, 2009 14:24

Table 9.10. Singapore Exports, US Protection, and Potential for Trade Expansion: Top 40 Products, 2001. (Ranked by Export Value).

Commodity

0 0 0 0 0.021 0 0.0131 0.0313 0 0.018171 0 0 0 0 0.003375 0 0.015667 0 0 0.016125 0.1525

0 0 0 0 4275.566 0 1711.553 3822.303 0 1726.467 0 0 0 0 200.2958 0 809.0062 0 0 585.4085 5522.574 (Continued)

333

b753-ch09

2144828 1307039 347783.2 246955.9 203598.4 165085.6 130652.9 122118.3 96037.6 95010 68384.4 62535.3 62042.4 61712.5 59346.9 51871.6 51638.7 46632.2 40368.1 36304.4 36213.6

B-753

Trade Expansion

9in x 6in

Parts, accessories of the machines of group 752 Digital monolithic integrated circuits Non-digital monolithiques integrated circuits Other instruments, appli. for medical, etc., sciences Other radio receivers, combined with sound reprodu. Transmission apparatus with reception apparatus Other heterocyclic comp. with nitrogen hetero-atom Heterocyclic compo. with ox. hetero-atom (s), n.e.s. Other books, brochures & simil., printed, excluding sheets Parts & accessories of 761, 762, 7643, 7648 Hearing aids Appliances, n.e.s., to compensate defect or disabil. Cash registers, incorporating a calculating device Other parts of aeroplanes or helicopters Recorded media, n.e.s. Other instruments & apparatus using optical radia. Ovens, cookers, cook. plates, boiling rings, roasters Parts for turbo-jets or turbo-propellers Photosensitive semiconductor devices; light emitt. Measuring or checking instruments, machines, n.e.s. Trousers, bib & brace overalls, shorts, knitted, women

US MFN Tariff

ASEAN and the United States

75997 77641 77643 87229 76281 76432 51577 51569 89219 76493 89961 89969 75124 79295 89879 87445 77586 71491 77637 87425 84426

Exports (US$1000)

(Continued )

Commodity

35147.2 28337.8 28061 26076.5 25081.1 24683.4 22061.6 21948.4 21703.6 21548.2 21132 20191.7 18048.6 16370.2 15989.5 15572.9 15420.7 14686.1 14644.9 14149.4

0.0035 0 0 0.0135 0 0 0.0124 0.009444 0.016143 0 0.01 0 0 0 0 0 0 0.145 0.00925 0

123.0152 0 0 352.0327 0 0 273.5638 207.2905 350.3581 0 211.32 0 0 0 0 0 0 2129.485 135.4653 0

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Total Trade Expansion for ALL Included Products: $44 million. Expansion as a Percentage of Total Exports: 0.7 percent. Source: Naya and Plummer (2005).

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Video-recording or -reproducing apparatus Penicillins, deriv. with penicillan. acid structure Syringes, catheters, needles, cannulae & the like Plugs & sockets, voltage < 1000 volts Starting equipm. for combustion engines; generators Instruments & apparatus for measuring the pressure Non-inflat. row. boats, vessels for pleasure, n.e.s. Other parts & accessories of motor vehicles Optical fibres, bundles, cables; polarising material Radar, radio-navigat. aid, remote control apparatus Radio, external source of power, vehicles, combined Parts of headings 71449, 71891, 71892 & 71893 Compressors of a kind used in refriger. equipment Parts of the articles of heading 7764 Hybrid integrated circuits Prepared unrecorded media, n.e.s. Static converters Shirts of cotton, for men Other sound reproducing apparatus Parts & accessoires for the instrument of 87455

US MFN Tariff

ASEAN Economic Integration

76381 54131 87221 77258 77831 87435 79319 78439 88419 76483 76211 71899 74315 77689 77645 89859 77121 84151 76383 87456

Exports (US$1000)

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tariffs in the US markets. The largest increase in trade expansion is expected to come in the knitted trousers and shorts for women (SITC 84426), but this is mainly due to the relatively high tariff in this sector (15 percent) rather than the sheer value of exports, which came to only $36 million in 2001. The “other” radio receivers sector, fifth in rankings in terms of exports, has a potential trade expansion of $4.2 million, followed by cotton shirts for men, which once again is low on the export-rankings list (exports came to less than $15 million) but relatively high in terms of trade expansion ($2.1 million) due to the tariff regime (14.5 percent). All in all, as in most of the EAI countries, Singaporean exports will not be affected much by direct tariff liberalization, though other aspects of the USSFTA could have major effects on economic integration with the United States. Aggregating the value of trade expansion for all Indonesian, Malaysia, Philippine, Thai, Brunei and Singapore exports to the United States, we calculate a possible trade expansion of about $300 million (three percent of total exports), $179 million (one percent of total exports), $212 million (three percent of total exports), $340 million (three percent of total exports), $8 million (10 percent of total exports), and $44 million (0.7 percent of total exports), respectively. Hence, trade expansion in Thailand would be the greatest among the ASEAN countries in terms of value but Brunei would gain the most in terms of relative gains. While these values are not high in the aggregate, they are significant at the product level in many cases. Note, however, that this figure would be much larger if we had used higher trade elasticities and had included other trade-expanding aspects of FTAs discussed above. Indeed, out of the top 40 products for each of these countries, half or more than half faced zero tariffs in the US market. This underscores the fact that the US market is very open to ASEAN exports; however, this does not mean that the potential for trade expansion is limited. On the contrary, it could very well be that electronics, for example, will be a prime beneficiary of the bilateral FTAs, through the positive effect that they will have on FDI and other dynamic effects.

4. Concluding Remarks In brief, the data and economic analysis of our study suggest that the United States is in many ways the region’s most important economic partner in terms of trade and investment and will continue to play a key role in the economic future of all ASEAN countries. Closer economic cooperation with the United States also holds the most hope for expediting necessary

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structural change in the region, as well as featuring inherent economic benefits. Moreover, we note that, while FTAs may not be optimal in a pure economic sense, the current general trend in regionalism increases the potential costs of remaining outside regional networks. An important motivation for ASEAN countries in seeking FTAs with the United States regards the need to “reclaim” MFN status in the US market, which has been eroded due to US FTA with other countries. Further, given that the United States is the region’s most important strategic partner and the EAI reinforces the long-term interest and commitment of the United States to engage in Southeast Asia, our economic results strongly support bilateral strategic interests as well. There will be many obstacles to be overcome if bilateral agreements are to be reached between the United States and the ASEAN member states. And this is true for both sides. Since the USSFTA will be used as a model for these negotiations, the ASEAN member states will find themselves having to adopt policies that are cutting-edge, and given that economic reform still has a considerable way to go in a number of sectors in all ASEAN countries, this will pose a great challenge. On the other hand, the United States will face liberalization of sensitive areas as well, including agriculture and labor-intensive sectors. But putting controversial issues on the table is not such a bad thing. If the EAI forces the United States to open up its protected sectors, we would argue that this is in the long-run interest of the US economy. The same is true of the Malaysian, Philippine, and, of course, Thai auto industries. Moreover, most ASEAN countries do not have a competition policy in place and, yet, it is clear that they need one: The EAI will help produce domestic regulation in this regard. Intellectual property protection in ASEAN tends to be strong on the books, but weak in implementation. The EAI will help here, too. It will also assist modernization of the financial sectors of the region — an important area, as the Crisis-induced reforms in ASEAN lost momentum with economic recovery — and create greater transparency in government procurement and corporate governance. It will no doubt lead to greater degrees of national treatment in the area of FDI, which is widely recognized to be an important obstacle to certain FDI flows. References DeRosa, D. (2004). The US Free Trade Agreements with ASEAN. In Free Trade Agreements: US Strategies and Priorities, Schott, J.J. (ed.), Washington, D.C.: Institute for International Economics.

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Dollar, D. (1992). Outward-oriented Developing Countries Really Do Grow More Rapidly: Evidence from 95 LDCs. Economic Development and Cultural Change, 40(3), pp. 523–544. Frankel, J.A. (1993). Is Japan Creating a Yen Block in East Asia and the Pacific? In Regionalism and Rivalry: Japan and the United States in Pacific Asia, Frankel, J. and Kahler, M. (eds.), pp. 53–88. Chicago: University of Chicago Press. Gilbert, J. (2003). CGE Simulations of US Bilateral Free Trade Agreements. Mimeograph. Washington, DC: Institute for International Economics. Kreinin, M.E. and Plummer, M.G. (2002). Economic Integration and Development: Has Regionalism Delivered for Developing Countries? London: Edward Elgar. Krugman, P. (1991). Is Bilateralism Bad? In International Trade and Policy, Helpman and Razing A. (eds.), pp. 9–23, Cambridge: MIT Press. Lee, C.H. and Plummer, M.G. (2004). “Economic Development in China and Its Implications for East Asia,” Paper presented at Miracle and Mirages in East Asian Economic Development Papers in Honor of Seiji F. Naya, 3–4 May, 2004, East–West Center, Honolulu, Hawaii. Naya, S.F. (2002). The Asian Development Experience. Manila: Asian Development Bank. Naya, S.F. and Plummer, M.G. (2005). The Economics of the Enterprise for ASEAN Initiative. Singapore: Institute of Southeast Asian Studies. Naya, S.F., Plummer, M.G., Akrasanee, N. and Sandhu, K. (1989). The ASEANU.S. Initiative: Assessment and Recommendations for Improved Economic Relations. Singapore: ISEAS. Petri, P. (1993). East Asian Trade Integration: An Analytical History. In Regionalism and Rivalry: Japan and the United States in Pacific Asia, Frankel, J. and Kahler M. (eds.), Chicago: University of Chicago Press. Plummer, M.G. and Click, R. Bond Market Development and Integration in ASEAN. To appear in International Journal of Finance and Economics. Pomfret, R. (1997). The Economics of Regional Trading Arrangements. Oxford: Oxford University Press. Rose, A. (2004). Do We Really Know that the WTO increases Trade? American Economic Review. Sach, J.D. and Warner, A. (1995). Economic Reform and the Process of Global Integration. Brookings Papers on Economic Activity, 1, pp. 1–95. Safadi, R. and Laird, S. (1996). The Uruguay Round Agreements: Impact on Developing Countries. World Development, 24(7), pp. 1223–1242. Shoven, J. and Whalley, J. (1994). Applied General Equilibrium Models of Taxation and International Trade: An Introduction and Survey. Journal of Economic Literature, 22(3), pp. 1007–1051. World Bank (1993). East Asian Miracle: Economic Growth and Public Policy. Washington, DC: IBRD.

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Index Anti-dumping duties, 49, 87, 319, 330 APEC (Asia-Pacific Economic Cooperation), 57, 65, 67, 70, 73, 94, 102, 105–107, 114, 116, 118, 124, 192, 197, 200, 205, 256, 258, 259, 276, 287, 289, 290, 296, 306 ASEAN+3, 198 ASEAN bond market, 15, 97, 190, 197, 199–203, 205, 209, 211, 212, 214, 215, 219–222, 264, 295 ASEAN Charter, 23, 83, 128 ASEAN community, 13, 79, 83 ASEAN comprehensive investment area, 14, 134, 174, 179–182, 288, 301 ASEAN Concord, 79, 81, 95, 99 ASEAN Coordinating Committee on Services, 173 ASEAN Customs Union (ACU), 79, 81, 82, 84, 86, 90, 96, 109, 118–127, 222 ASEAN dialogue partners, 2, 16, 180 ASEAN Economic Community (AEC), 1, 2, 6, 10, 13, 14, 23, 44, 46, 56, 67, 68, 79, 81–83, 94, 98–100, 105, 118, 119, 121, 122, 125–128, 130–135, 142, 160, 162, 171, 172, 180–182, 188, 198, 199, 218, 224, 229, 276, 277, 288–297, 299–304, 307 ASEAN economic cooperation, 1, 19, 78, 130, 148, 159, 172, 229 ASEAN economic development, 13 ASEAN Framework Agreement on Services (AFAS), 78, 173, 301, 304

ASEAN Free Trade Area (AFTA), 1, 22, 38, 57, 59, 63, 67, 72, 74, 78, 80, 81, 83, 91, 93, 94, 96, 99, 100, 107, 108, 118, 119, 121, 124–126, 131, 155, 159, 162, 171, 181, 184, 186, 198, 200, 222, 253, 255, 258, 269, 281, 288, 289, 292, 300, 304, 307 ASEAN Industrial Complementary (AIC), 130 ASEAN Industrial Joint Venture (AIJV), 95, 99, 131 ASEAN Industrial Projects (AIP), 95, 130 ASEAN investment area, 10, 22, 44, 78, 94, 95, 99, 100, 113, 131–135, 142, 146, 147, 155, 156, 158–160, 162, 170–173, 179–183, 186, 288, 295, 301, 304 ASEAN Secretariat, 29, 38, 96, 99, 100, 127, 128, 137, 162, 198, 302 ASEAN security community, 13, 79 ASEAN socio-cultural community, 13, 79 ASEAN stock market, 15, 224, 228 ASEAN trade, 15, 63, 83, 106, 107, 126, 139, 142, 254, 279, 283, 292, 308 Asia-Europe Meeting (ASEM), 107, 124, 195, 264, 289 Asian crisis, 3, 4, 6, 15, 19, 37, 50, 56, 67, 99, 113, 114, 118, 120, 132, 133, 135, 137, 139, 145, 169, 170, 189, 192–194, 197, 201, 202, 214, 217, 218, 232, 233, 254, 261–263, 286, 287, 289, 296, 297 339

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Asian Development Bank, 6, 15, 21, 89, 94, 100, 101, 190, 200, 253, 258, 263, 287, 290, 292 Asian integration, 15, 22, 57, 287 Asian Noodle Bowl, 66 Best practices, 1, 7, 14, 24, 53, 59, 61, 63, 64, 67, 69, 72–74, 95, 104, 115–117, 119, 120, 149, 172, 182, 191, 205, 222, 272, 301 Bilateral Investment Treaty (BIT), 134, 174–176, 178–180 Bogor Vision, 289 Brunei Darussalam, 7, 8, 22, 43, 44, 58, 138, 206, 214, 218 Building blocs, 72 Cambodia, 4, 5, 11–13, 26, 27, 35, 36, 39, 43, 46, 47, 50–52, 58, 59, 84, 85, 89, 96, 115, 126, 136, 138, 140, 141, 143–146, 162, 168, 173, 176–178, 201, 216, 218, 228, 266, 268, 271, 292, 300, 301 Capital markets, 69, 97, 98, 190, 194, 198, 199, 204, 205, 217–219, 221, 222, 224, 225, 231, 261, 263, 296 Chiang Mai Initiative, 97, 198, 199, 202, 264 China, 3–5, 9, 10, 20, 21, 24–34, 36–41, 44–46, 48–50, 52, 55–59, 67, 74, 85, 93, 97, 99, 104, 105, 107–109, 112–115, 124, 133–137, 139, 140, 143, 147, 159–161, 163, 165, 166, 169, 177, 187, 198, 200, 254, 261, 265, 268–271, 277–279, 287, 289, 290, 307–311 CLMV (Cambodia, Laos, Myanmar, and Vietnam), 59 Co-integration, 15, 225–228, 230–232, 235, 238–247 Commercial Policy, 14, 24, 25, 41, 45, 50, 52, 54, 64, 78, 79, 82–84, 86, 90, 105, 115, 118, 119, 121, 122, 124, 125, 162, 294 Common Agricultural Policy (CAP), 110, 153

Common Effective Preferential Tariff (CEPT), 80, 96, 99 Common External Tariff (CET), 14, 80, 84, 86, 120–124, 126, 292, 299 Computational General Equilibrium (CGE) Model, 108, 254, 313 Contagion, 6, 197, 230, 262, 263, 287 Correlation coefficients, 36, 52, 234, 245, 267, 268, 309 Customs Union (CU), 14, 33, 79–81, 83, 88, 90, 91, 104, 110, 118–122, 125, 126, 153, 154, 181, 290, 294, 296, 299, 300 Doha Development Agenda, 54, 70, 86, 88, 89, 93, 106, 124 Enterprise for ASEAN Initiative (EAI), 57, 105, 109, 112, 280, 306–314, 316–320, 335, 336 European Currency Unit (ECU), 215–217, 222, 298, 299 European Monetary Union (EMU), 297, 299 European Union, 39, 153 Export similarity, 307, 311–313 Foreign direct investment, 2, 20, 135, 138, 141, 143, 170, 232, 291 Fragmented trade, 14, 20, 21, 24, 25, 28, 33, 54, 55, 59, 61, 64 Free-Trade Area (FTA), 15, 24, 41, 52–63, 65–67, 70, 72–74, 80–83, 88, 90–94, 100–111, 114–121, 123, 124, 139, 160, 171, 174, 178, 179, 253–260, 266, 280, 288–290, 306–308, 310, 311, 313, 316–320, 323, 330, 335, 336 Free-Trade Area (FTA), 96 Free-trade area of the Asia-Pacific, 57, 254 General Agreement on Tariffs and Trade (GATT), 104, 111, 116, 117, 288

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General Agreement on Tariffs and Trade (GATT), 62, 70, 73, 80, 90, 93, 291, 293, 306 General Equilibrium Model for Asia’s Trade (GEMAT), 66, 74, 89, 258, 259 General Exclusion List (GEL), 96, 162, 172 Gravity model, 28, 156, 157, 160, 182, 186, 269, 279, 307, 313, 314 Hanoi Plan of Action, 78, 79, 81, 98, 99, 199 Hong Kong, 6, 20, 26, 27, 32, 39, 44, 46, 47, 50, 58, 85, 88, 89, 136, 140, 143, 200, 209, 213, 231, 232, 256, 258, 261, 262, 265, 266, 269–271, 309 Horizontal FDI, 33, 155 Indonesia, 4, 5, 8, 9, 26–29, 32, 36, 37, 39, 41–43, 47, 52, 58, 59, 84, 85, 93, 96, 98, 109, 115, 136, 137, 140, 141, 143, 145, 146, 162–169, 176–178, 192, 200, 201, 203, 204, 206, 214, 216, 218, 224, 226, 228, 231–234, 236, 240–246, 259, 261, 262, 267, 268, 270, 271, 278, 279, 293–295, 308–313, 316–320, 323 Integration for ASEAN Initiative, 1 Intellectual Property Rights (IPR), 1, 57, 74, 97, 102, 103, 106, 117, 150, 161 Intra-industry trade, 3, 21, 28, 30, 32, 59, 257, 269, 272 Japan, 3, 10, 20, 24, 26, 27, 30, 32, 36, 39, 44, 47–49, 57, 58, 62, 66, 84, 85, 91, 93, 97, 104–109, 115, 128, 135–137, 139, 140, 143, 145, 152, 158, 159, 165, 166, 176, 183–185, 193, 198, 200, 202–205, 207, 228, 231–233, 254, 256–258, 261, 263, 265, 268–272, 277, 278, 287–290, 295, 308

Lao PDR, 11, 12, 26, 27, 43, 58, 140, 141, 146, 173, 176–178, 268, 271 Maastricht Treaty, 127, 153, 191, 254, 267 Malaysia, 4, 5, 8, 9, 11, 12, 26–29, 32, 34, 36, 37, 39, 41–43, 46–48, 58, 59, 84–86, 91, 98, 106, 109, 111, 115, 123, 124, 136–141, 143–146, 162–165, 167–169, 173, 176–178, 192, 200, 201, 203, 204, 206, 216, 218, 224–226, 228–234, 236, 240–243, 245, 246, 259, 260, 262, 266–268, 270, 271, 278, 279, 293, 294, 308–313, 316–318, 320, 323, 324, 335 MERCOSUR, 120, 121, 125 Monetary Union, 15, 30, 54, 125, 127, 153, 181, 214, 253–255, 261–264, 266, 267, 269, 270, 272, 273, 288, 295, 297, 298, 300, 303, 304 Mutual recognition, 212, 213, 294, 301, 302 Myanmar, 4, 5, 7, 8, 11, 26, 27, 39, 42–44, 50, 58, 59, 84, 85, 96, 115, 136, 138, 140, 141, 143–147, 150, 167, 168, 173, 175, 177, 192, 201, 203, 206, 216, 218, 228, 266, 268, 270, 271, 292, 301 New Miyazawa Plan, 287 Newly-Industrial Economies (NIEs), 10, 28, 30, 44, 45, 52, 139, 270–272, 287 Non-tariff barriers, 49, 50, 65, 91, 92, 96, 101, 110, 120, 122, 123, 299, 300, 303, 316, 319, 323, 330 North American Free-Trade Agreement (NAFTA), 55, 62, 83, 85, 92, 93, 97, 111, 112, 183, 184, 198, 260, 283–285, 288, 306, 314 Optimum currency area, 254, 266 Organization for Economic Co-operation and Development (OECD), 5, 8, 21, 28, 34–36, 40, 42, 52, 59, 61, 64, 106, 107, 112,

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132, 135, 137, 148, 160, 163–166, 176, 184, 186, 218, 231, 265, 270, 278, 279, 301, 309–313 Pacific Economic Cooperation Council (PECC), 73, 116, 118, 123 Philippines, 4, 5, 8, 9, 26–29, 32, 36, 37, 39, 41–43, 47, 48, 58, 72, 84, 85, 92, 94, 96, 108, 109, 115, 126, 136–138, 140, 141, 143–146, 162– 165, 167–169, 173, 176–178, 190, 192, 200, 201, 203, 204, 206, 216, 218, 224, 226, 228, 231–234, 236, 240–243, 245, 246, 259, 262, 267, 268, 271, 278, 279, 293, 308–313, 316–318, 320, 323, 326, 335, 336 Policy externalities, 6, 120, 197, 262, 287, 297 Policy issues, 19 Portfolio investment, 15, 147, 148 Product life cycle hypothesis, 151 Production networks, 20, 21, 23, 28, 29, 37, 38, 40, 41, 55, 114, 155, 156 Regionalism, 1, 22, 23, 52–57, 59, 63–65, 67, 70, 72, 75, 78, 80, 84, 88, 90–94, 96, 107, 108, 111, 112, 115, 121, 126, 134, 171, 181, 266, 287–289, 291, 307, 336 Rules of origin, 54, 62, 64, 67, 73, 74, 81, 96, 102–104, 106, 116, 123, 259, 260 Sensitive List (SL), 162, 171–173 Sequencing, 207 Singapore, 4, 5, 8–10, 16, 23, 26, 27, 29, 32, 34, 36, 37, 39, 42–44, 46–48, 50, 57–59, 63, 65, 79, 84–86, 96, 98–101, 106–109, 112, 115, 121, 123, 125, 126, 136–146, 162–168, 173, 175–179, 190, 192, 196, 201, 203, 204, 206, 210, 212, 214, 216, 218, 219, 224–226, 228–234, 236, 240–243, 245, 246, 259, 265–271, 278, 288, 293, 295, 299, 306, 308, 309, 311–313, 316–318, 320, 330, 333, 335

Single European Act (SEA), 122, 153, 294–296, 300–303 South Korea, 3, 6, 20, 24, 32–34, 36, 39, 44, 47–49, 52, 57, 97, 108, 109, 111, 136, 137, 144, 178, 198, 200, 231, 254, 261, 262, 265, 269, 270, 289, 309 Spaghetti Bowl Effect, 59, 115, 116 Spearman rank correlation coefficients, 35, 144, 145, 163–165, 168, 278, 279, 309, 311 Structural Change, 13, 14, 19–21, 24, 25, 28, 33–37, 41, 75, 132, 145, 162, 167, 259, 265, 296, 309 Stumbling blocs, 72 Taiwan, 136, 140, 143, 165, 169, 177, 231, 266, 267, 309 Tariffs, 14, 38, 46, 47, 49, 50, 60, 63, 65, 70, 80–82, 84, 86–88, 91, 92, 96, 99, 101, 106, 118, 120–123, 125, 126, 131, 149–151, 155, 258, 260, 288, 299, 300, 303, 316, 318–335 Technical barriers to trade, 57, 73, 74, 117, 260 Temporary Exclusion List (TEL), 22, 96, 162, 171–173, 288 Thailand, 4–6, 8, 9, 26–29, 32, 34, 36, 37, 39, 41–43, 46, 48, 58, 59, 84, 85, 91, 103, 106–109, 115, 123, 136–141, 143–146, 151, 162–165, 167–169, 176–178, 192, 200–204, 207, 216, 218, 224, 226, 228, 229, 231–234, 236, 240–243, 245, 246, 256, 257, 259, 261, 262, 265, 267, 268, 270, 271, 278, 279, 293, 308–313, 316–318, 320, 323, 330, 335 Trade in services, 1, 88, 302 Unit root tests, 228, 235, 236 US-Singapore FTA (USSFTA), 57, 106, 306, 311 Vertical FDI, 33, 131, 155 Vientiane Action Plan (VAP), 79, 81, 98, 100, 119

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Vietnam, 4, 5, 8, 9, 11–13, 25–27, 29, 35–37, 39, 43, 46, 48, 50, 51, 58, 59, 84–86, 89, 96, 98, 115, 126, 127, 132, 136, 138–141, 143, 145–147, 155, 162, 167–169, 173, 175–178, 192, 199, 201, 207, 216, 218, 228, 256, 257, 259, 260, 266, 268, 270, 271, 278, 292, 300, 309, 310

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World Trade Organization (WTO), 25, 27, 36, 38, 49, 50, 52–56, 60–65, 67, 70, 72–75, 80, 82, 84, 86, 89–94, 102, 103, 105–107, 110, 112, 114, 116, 117, 121, 123, 124, 126, 127, 133, 174, 180, 200, 260, 266, 280, 288, 291, 293, 306, 309, 330

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