ASEAN enlargement : impacts and implications. 9789812300812, 9812300813, 9789812306036, 981230603X

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The Institute of Southeast Asian Studies (ISEAS) was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the many-faceted problems of stability and security, economic development, and political and social change. The Institute’s research programmes are Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), and Regional Social and Cultural Studies (RSCS). The Institute is governed by a twenty-one-member Board of Trustees comprising nominees from the Singapore Government, the National University of Singapore, the various Chambers of Commerce, and professional and civic organizations. An Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute’s chief academic and administrative officer.

© 2001 Institute of Southeast Asian Studies, Singapore

First published in Singapore in 2001 by Institute of Southeast Asian Studies 30 Heng Mui Keng Terrace Pasir Panjang Singapore 119614 Internet e-mail: [email protected] World Wide Web: http://www.iseas.edu.sg/pub.html All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies. © 2001 Institute of Southeast Asian Studies, Singapore. The responsibility for facts and opinions in this publication rests exclusively with the editors and contributors and their interpretations do not necessarily reflect the views or the policy of the Institute or its supporters. ISEAS Library Cataloguing-in-Publication Data ASEAN enlargement : impacts and implications / edited by Mya Than and Carolyn Gates. Papers originally presented at the ASEAN Transitional Economies Roundtable, Singapore, 20–21 November 1997. 1. ASEAN countries—Economic integration—Congresses. 2. ASEAN countries—Foreign relations—Congresses. 3. Investments, Foreign—ASEAN countries—Congresses. 4. Free trade—ASEAN countries—Congresses. 5. ASEAN countries—Foreign economic relations—Indochina—Congresses. 6. Indochina—Foreign economic relations—ASEAN countries—Congresses. 7. ASEAN countries—Foreign economic relations—Burma—Congresses. 8. Burma—Foreign economic relations—ASEAN countries—Congresses. I. Mya Than. II. Gates, Carolyn L. III. ASEAN Transitional Economies Roundtable (1997 : Singapore) HC441 A847 2001 sls2000038662 ISBN 981-230-081-3

Typeset by International Typesetters Pte. Ltd. Printed in Singapore by Seng Lee Press Pte Ltd.

© 2001 Institute of Southeast Asian Studies, Singapore

Contents

v

Contents List of Tables List of Figures Acknowledgements Contributors Glossary

vii x xi xii xiii

1.

ASEAN Enlargement: An Introductory Overview Carolyn L. Gates and Mya Than

2.

ASEAN’s Enlargement: Political, Security, and Institutional Perspectives Dewi Fortuna Anwar

26

3.

Impact and Implications of ASEAN Enlargement on Trade Nattapong Thongpakde

45

4.

ASEAN Enlargement and Foreign Direct Investment Nick J. Freeman

80

5.

European Union Enlargement: Lessons for ASEAN Rolf J. Langhammer

102

6.

The Greater Mekong Subregion: Co-operation in Infrastructure and Finance Mya Than and George Abonyi

128

7.

Cambodia’s Accession to AFTA: Impact, Challenges, and Policy Implications Toshiyasu Kato

164

8.

Implications of Joining ASEAN/AFTA for Cambodia You Ay

200

9.

Economic Effects of Joining AFTA: The Case of the Lao PDR Emiko Fukase and Will Martin

213

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Contents

10.

ASEAN Enlargement and Myanmar Tin Maung Maung Than and Mya Than

249

11.

ASEAN Enlargement: Economic and Financial Implications for Myanmar Khin Ohn Thant

262

12.

Vietnam’s Integration into AFTA: Theoretical and Empirical Perspectives Carolyn L. Gates

283

13.

The ASEAN Economic Model and Vietnam’s Economic Transformation: Adjustment, Adaptation, and Convergence Carolyn L. Gates

322

Index

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List of Tables

vii

List of Tables 1.1 1.2 1.3 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 4.12 4.13 4.14 4.15 5.1 5.2 5.3

Southeast Asia: Economic and Social Indicators 3 ASEAN-9 1998 CEPT Package 12 Initial CEPT Packages for Tariff Reduction: Vietnam, 13 Laos, and Myanmar ASEAN-10: Key Economic Indicators 47 ASEAN-10: Sectoral Share of GDP, 1995 48 Social Development Indicators 49 Intra-ASEAN Trade 51 Major Trading Partners of ASEAN’s New Members: Exports 52 Major Trading Partners of ASEAN’s New Members: Imports 53 Principal Exports of Selected ASEAN Countries 54 ASEAN-10: Export Products with a Revealed Comparative 56 Advantage Index Greater than 1, 1990–95 ASEAN’s Stock of Inward Foreign Direct Investment, 82 1980–97 Cambodia’s FDI Stock, by Country (as at November 1997) 84 Cambodia’s FDI Inflows, 1994–97 84 Laos’ FDI Stock, by Country (as at August 1997) 85 Laos’ FDI Inflows, 1994–97 85 Laos’ FDI Stock, by Sector (as at November 1997) 86 Myanmar’s FDI Stock, by Country (as at September 1997) 87 Myanmar’s FDI Inflows, 1989–97 87 Myanmar’s FDI Stock, by Sector (as at November 1997) 88 ASEAN’s FDI Profile in the “Greater Mekong” Subregion 88 ASEAN Countries in Vietnam’s FDI Rankings, 1994-97 96 ASEAN’s FDI in Vietnam, as a Percentage of Total FDI 96 Stock, 1994–97 Vietnam’s FDI Stock, by Country (as at November 1997) 97 Vietnam’s FDI Inflows, 1988–97 97 Vietnam’s FDI Stock, by Sector (as at November 1997) 99 Natural Resource Expansion resulting from EU and 105 ASEAN Enlargement, 1994–95 Human and Physical Resource Endowment and Standards 107 of Living Differentials in Europe and ASEAN Enlarged Tariff Reduction and Post-Uruguay Round Most-Favoured- 114 Nation Tariffs for the EU, ASEAN, and their Applicants

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6.1 6.2 6.3 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 7.12 7.13 7.14 7.15 7.16 8.1 8.2 8.3 9.1 9.2 9.3 9.4 9.5 11.1 11.2 11.3 11.4 11.5 11.6 12.1

List of Tables

Greater Mekong Subregion: Selected Social and Economic Indicators, 1996 Infrastructure Basic Energy Data Cambodia: Basic Macroeconomic Indicators Cambodia’s Trade Patterns by Industry, 1995 and 1996 Cambodia’s Trade Patterns by Country and Region, 1995 and 1996 Foreign Investment Projects Approved in Cambodia Skills–Land Ratio in Cambodia and Selected ASEAN Countries Revealed Comparative Advantage(RCA) of Exports Index: Cambodia and ASEAN Countries Inclusion List for CEPT/AFTA Cambodia: Structure of National Revenue, 1994–97 Share of Tariff Revenue for Major Commodities, 1995–97 Yields of Major Crops in Cambodia and ASEAN Countries, 1994/95 Intensity of Agricultural Input Utilization in Cambodia and ASEAN Countries, 1994/95 Distribution of Income, or Consumption in Cambodia and ASEAN Education Indicators in Cambodia and ASEAN Status of Health: Cambodia and ASEAN Investment Projects in Cambodia, 1994–98 Current Expenditure by Ministry Structure of Tax Revenue, 1995 Productivity for Natural Rubber, 1990 Yield of Natural Rubber in Cambodia The ASEAN-9 CEPT Package, 1998 Weighted Average MFN Tariff Rates for the ASEAN Countries Model Equations Variables and Parameters Key Results of Lao PDR Liberalization Foreign Direct Investment Inflow, 30 September 1997 Union of Myanmar: Distribution of Tariff Lines ASEAN CEPT Product Lines Myanmar CEPT Product Lists Exports of Myanmar by Country Imports of Myanmar by Country Commodity Composition of Vietnamese Exports, 1996

© 2001 Institute of Southeast Asian Studies, Singapore

134 140 141 167 168 169 171 173 174 177 179 180 183 184 186 187 188 190 194 206 208 208 215 216 224 227 232 266 271 272 273 275 278 285

List of Tables

12.2 12.3 12.4 12.5 12.6 12.7 12.8 12.9 12.10 12.11 12.12 12.13 12.14 12.15 13.1 13.2 13.3 13.4 13.5 13.6 13.7 13.8 13.9 13.10 13.11 13.12

Commodity Composition of Vietnamese Imports, 1996 Trade Intensity Index for Vietnam, ASEAN, and Selected Partners, 1990–94 Socio-economic Indicators, ASEAN-7 Vietnam-ASEAN Trade, 1990–96 Average Growth of Vietnam-ASEAN and Vietnam-World Trade, 1984–96 Vietnam’s Product and Tariff Lines in the CEPT, 1996 Package Features of Vietnam’s Trade and Tariff System, 1996 ASEAN-7 CEPT Tariff Packages (Lines and Average Tariff Rates), 1996 Projected Tariff Rates The ASEAN-9 CEPT Package, 1998 Effective Rates of Protection in Selected Vietnamese Industries, Before and After Liberalization Simple Revealed Comparative Advantages of Vietnam and its ASEAN-5 Bilateral Partners, 1995 Import–Export Duties as a Share of Tax and Government Revenues Import Revenues and Value Vietnam’s Imports from ASEAN by CEPT Lists, 1996 Key Macroeconomic Data of Vietnam and the ASEAN-5 ASEAN-5: Savings-Investment and Resource Gap, 1975–95 ASEAN-5: Annual Average Change in Consumer Prices, 1981–97 Trade and Current Account Balances of the ASEAN-5, 1975–95 ASEAN-5:Foreign Direct Investment–Gross Domestic Investment Ratio, 1965–90 ASEAN-5: Human Resource Development Indicators, 1975–95 ASEAN-5: Shift of Sectoral Distribution of GDP, 1970–95 ASEAN-5: Human Development Index, 1970–94 Vietnam’s “Big Bang”: Adjustment of the Dual Price System, 1988–89 Vietnam’s Foreign Direct Investment, 1988–95 Education and Human Development Index Indicators, Vietnam and ASEAN-5 Human Development Index, Vietnam and ASEAN-5, 1994

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286 289 289 292 293 294 296 298 299 306 311 315 315 315 327 331 332 333 334 336 339 339 343 347 355 355

x

List of Figures

List of Figures 6.1 7.1 8.1 9.1 9.2 9.3 12.1 12.2 13.1 13.2 13.3 13.4

Geopolitics and GMS Development Determinants of Comparative Advantage Tax Revenue by Sources Market for Goods Imported from ASEAN Market for Exports from the Lao PDR to ASEAN Market for Exports from the Lao PDR to its ASEAN Partners Vietnam’s Imports and Exports, 1985–97 Change in ASEAN-U.S. Dollar Exchange Rates, June 1997 Budget Deficit-GDP Ratio: Vietnam, 1985–95 Change of Money and Prices: Vietnam, 1985–95 Vietnam’s Trade, 1985–97 Savings-Investment Ratios in Vietnam, 1987–97

© 2001 Institute of Southeast Asian Studies, Singapore

131 172 210 219 220 221 302 305 344 345 348 353

List of Figures

xi

Acknowledgements The editors would like to express their sincere appreciation to all the contributors for their patience and close co-operation in the publication of this volume. They are also grateful to the Konrad Adenauer Stiftung (KAS), Germany, for its generous financial support for the ASEAN Transitional Economies Roundtable 1997, on “ASEAN Enlargement: Impacts and Implications”, from which this book has emanated.

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List of Figures

Contributors Dr George ABONYI is Senior Advisor at the Asian Development Bank, Bangkok, Thailand. Dr Dewi Fortuna ANWAR is Head of the Regional and International Affairs Division, Centre for Political and Regional Studies, Indonesian Institute of Sciences, Indonesia. Dr Nick J. FREEMAN is a Fellow at the Institute of Southeast Asian Studies, Singapore. Dr Emiko FUKASE is a Consultant at the World Bank, Washington D.C. Dr Carolyn L. GATES is Senior Economist at the Foundation for Indochina Studies, Faculty of Economics and Econometrics, University of Amsterdam. Dr Toshiyasu KATO is a Research Fellow at the Cambodia Development Resource Institute. Cambodia. Dr KHIN Ohn Thant is Advisor to the National AFTA Unit, Ministry of National Planning and Economic Development, Myanmar. Professor Rolf J. LANGHAMMER is Head of Department, The Kiel Institute of World Economics, Germany. Dr Will MARTIN is with the World Bank, Washington, D.C. Dr MYA Than is a Senior Fellow at the Institute of Southeast Asian Studies, Singapore. Dr Nattapong THONGPAKDE is Research Director of International Economic Relations at the Thailand Development Research Institute, Bangkok. Dr TIN Maung Maung Than is a Fellow at the Institute of Southeast Asian Studies, Singapore. Mrs YOU Ay is Secretary of State at the Ministry of Women’s Affairs and Veterans, Phnom Penh, Vietnam.

© 2001 Institute of Southeast Asian Studies, Singapore

Glossary

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Glossary AAA ADB AEMM AEMM AFTA AIA AICO AMM APEC ARF ASEAN ASEM BOT CAP CEEC CEFTA CEPT CES CET CIB CGE CIGE CLM CLMV CMEA DSM ECU EEA ERP EU EV FCDI FDI FEC FIL

Association of Association Agreements Asian Development Bank ASEAN Economic Ministers’ Meeting ASEAN-EU Foreign Ministers Meeting ASEAN Free Trade Area ASEAN Investment Area ASEAN Industrial Co-operation (scheme) ASEAN Ministerial Meeting Asia-Pacific Economic Co-operation ASEAN Regional Forum Association of Southeast Asian Studies Asia-Europe Meeting build-operate-transfer Common Agriculture Policy Central and East European Countries Central European Free Trade Area Common Effective Preferential Tariff Constant Elasticity of Substitution Constant Elasticity of Transformation Cambodia Investment Board computable general equilibrium computable inter-temporal general equilibrium (model) Cambodia, Laos, and Myanmar Cambodia, Laos, Myanmar, and Vietnam Council for Mutual Economic Assistance dispute settlement mechanism European Currency Unit European Economic Area effective rates of protection European Union equivalent variation Forum for the Comprehensive Development of Indochina foreign direct investment Foreign Exchange Certificates Foreign Investment Law

© 2001 Institute of Southeast Asian Studies, Singapore

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Glossary

FTA free trade area GATS General Agreement on Trade in Services GATT General Agreement on Tariffs and Trade GDP gross domestic product GEL General Exception List GMS Greater Mekong Subregion GSP Generalized System of Preferences GT Growth Triangle HPA Hanoi Plan of Action HS Harmonized System ICN Internal Co-ordination Network IDRC International Development and Research Centre IPP independent power producer (programme) JCC Joint Co-operation Council (ASEAN-EU) JSBs joint-stock banks KKN corruption, collusion and nepotism MBDP Mekong Basin Development Plan MCIL Myanmar Citizens Investment Law MFN most-favoured-nation MIC Myanmar Investment Commission MITI Ministry of Trade and Industry (Japan) MOU memorandum of understanding MRC Mekong River Commission NAFTA North American Free Trade Agreement NCGUB National Coalition Government of the Union of Burma NGOs non-governmental organizations NIEs newly industrializing economies NLD National League for Democracy NTR nominal tariff rates NTB non-tariff barriers ODA official development assistance PECC Pacific Economic Co-operation Conference PRC People’s Republic of China QRs quantitative restrictions RCA revealed comparative advantage RCAX revealed comparative advantage for exports RTA regional trade area SBV State Bank of Vietnam SEANWFZ Southeast Asia Nuclear Weapons Free Zone SEOM Senior Economic Officials Meeting (ASEAN) SITC Standard International Trade Classification SL Sensitive List

© 2001 Institute of Southeast Asian Studies, Singapore

Glossary

SLOCs SLORC SPDC TAC TEL TPRM UAPs UMCCI UNCTAD VAT WCO WTO ZOPFAN

xv

sea lanes of communications State Law and Order Restoration Council State Peace and Development Council Treaty of Amity and Co-operation Temporary Exclusion List Trade Policy Review Mechanism unprocessed agricultural products Union of Myanmar Chamber of Commerce and Industry United Nations Conference on Trade and Development value-added tax World Customs Organization World Trade Organization Zone of Peace, Freedom and Neutrality

© 2001 Institute of Southeast Asian Studies, Singapore

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ASEAN Enlargement: An Introductory Overview

ASEAN Enlargement: An Introductory Overview

1

1

CAROLYN L. GATES and MYA THAN

Initiating the long-awaited ASEAN enlargement process, Vietnam became the first of the four remaining mainland Southeast Asian countries to enter the Association of Southeast Asian Nations (ASEAN) in July 1995. Two years later, ASEAN admitted the Lao People’s Democratic Republic (Lao PDR or Laos) and Myanmar as full members of the regional organization. At that time, it postponed the entry of Cambodia because of contested changes in its government — notably, the ouster of First Prime Minister Prince Norodom Ranariddh by Second Prime Minister Hun Sen — and the outbreak of factional violence as a result. After the restoration of a legal government and a semblance of political stability, Cambodia was admitted to the organization on 30 April 1999. ASEAN’s historic decision to incorporate the new members was a paradigm shift in Southeast Asian affairs, although the door to membership had been (at least nominally) open for all countries in Southeast Asia from ASEAN’s inception. Indeed, during the period before the end of the Indochina War in 1975, Cambodia, Laos, and South Vietnam had attended some ASEAN Ministerial Meetings (AMM) as observers. More recently, ASEAN’s enlargement was endorsed by the heads of state of the ASEAN countries in the Bangkok Declaration of 1995: “ASEAN shall work towards the speedy realization of an ASEAN comprising all Southeast Asian countries as it enters the 21st century.” Because the new members have very different systems and levels of economic, political and institutional development than the ASEAN-6 1

© 2001 Institute of Southeast Asian Studies, Singapore

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Carolyn L. Gates and Mya Than

(Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand), their integration into ASEAN may have significant political and economic impacts and implications for both sides. The political implications of an enlarged ASEAN involve regional stability and security concerns as well as international relations. As members of the ASEAN Regional Forum (ARF), the new members are expected to play a positive role in regional and international political and security affairs. At the outset, the most important economic shift for the new members is their accession to the ASEAN Free Trade Area (AFTA). Soon after the new members joined ASEAN, they became subject to the Common Effective Preferential Tariff (CEPT) scheme, the key instrument to pace and sequence tariff reductions to achieve AFTA. In addition to the effects of adjusting to AFTA, the new members have experienced external shocks from the East Asian financial and economic crisis. At the time that Laos and Myanmar were accepted as new ASEAN members, the currency crisis had just struck Thailand and was about to spread to Indonesia and beyond. Contagion and its effects, which have touched all ASEAN members to one extent or another, were transmitted to the new members primarily through the extensive trade and investment links they have forged with the ASEAN-6 economies. The ASEAN-6 has clearly recognized the potential strategic advantages and political and economic benefits of expanding the organization to the whole of Southeast Asia. Thus, an enlarged ASEAN can increase its diplomatic and economic weight in the international community. Secondly, it is likely to beef up ASEAN’s strategic credibility, enabling it to address regional issues more effectively. Thirdly, ASEAN’s market size will increase by 38 per cent (in terms of population) with the entry of the four new members, which can expand regional economies of scale. Fourthly, the regional division of labour is likely to intensify, which may stimulate greater productive specialization and efficiency, potentially reduce inflation pressures, and affect Southeast Asian migration patterns. While the ASEAN-6 keenly appreciates the advantages of broadening the organization, it also fears the development of a dual-track system that could breed greater divisions and ignite latent animosities between the “haves” — the richer, more developed and older members of ASEAN — and the “have nots”, the newer members. With the emergence of the East Asian crisis from the second half of 1997, this previously simple equation has become complicated, as the growth path and political evolution of some of the older ASEAN members have been interrupted; and some like Indonesia and perhaps Malaysia are experiencing discontinuous change. Nevertheless, on the whole, the ASEAN-6 remains far ahead of the newer members in terms of economic development (gross domestic product per capita and general living standards), institutional development, technologies, integration in global trade and capital markets, among other things (see Table 1.1).

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TABLE 1.1 Southeast Asia: Economic and Social Indicators

Population Area (million) (’000 1995 sq km)

Year Brunei Indonesia Malaysia Philippines Singapore Thailand Cambodia Laos Myanmar Vietnam

0.28 195.3 20.1 70.3 3.0 59.4 10.2 4.7 44.7 74.0

Rural GNP Population Adult Life US$ in provertyb Literacy Expectancya Million a 1980–91 rate (yrs) 1994

— 1905 330 300 1 513 181 237 677 332

— 27 22 54 0 34 — 85 40 60

— 82.9 82.2 94.2 90.3 93.6 35.0 54.6 82.4 92.5

— 63.0 70.9 66.5 74.9 69.2 51.9 51.3 57.9 65.5

n.a. 167,630 68,670 63,310 65,840 129,860 2,360 1,500 n.a. 13,780

GNP per Capita (US$) 1994

GDP Growth Rates Average 90–95

14,420 880 3,520 960 23,360 2,210 240 320 n.a. 190

n.a. 8.0 8.8 2.4 8.6 8.9 5.2 6.3 5.9 7.7

TABLE 1.1 (continued)

GDP Sector Shares

Exports US$ M 1995

Trade External Exports Imports Debt 1994 Growth US$ M GNP Degree Rate 1995 Ratio of (1985–95) 1994 OpennessC

2.4 8.7 3.8 11.1 2.7 5.0 92.2 15.3 21.5 31.3

3,367 44,700 74,045 17,316 118,265 55,375 856 347 846 5,220

1,362 44,576 79,853 28,192 124,507 68,554 1,188 587 1,272 7,125

Agriculture Industry Services 1995 1995 1995

Year Brunei Indonesia Malaysia Philippines Singapore Thailand Cambodia Laos Myanmar Vietnam NOTES:

Inflation Rate Average 90–95

a b c

0.9 17.2 21.0 21.7 0.2 10.9 45.5 55.9 62.1 27.5

47.9 41.5 39.8 32.1 35.5 39.8 17.4 18.7 9.9 29.1

51.2 41.3 39.2 46.3 64.3 49.2 38.4 25.4 28.0 43.4

n.a. 57.4 36.9 59.3 11.9 43.1 83.5 135.6 n.a. 161.3

n.a. 0.39 1.71 0.56 2.88 0.68 0.55 0.62 0.04 0.87

–3.3 9.4 380 14.1 418 695 59.3 35.6 14.9 32.0

1993 data ESCAP Secretariat, January 1997 Exports + Imports)/GDP

SOURCES: ADB, Key Indicators of Developing Asian and Pacific Countries, 1996; and World Bank, Social Indicators of Development, 1996.

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Carolyn L. Gates and Mya Than

The two groups are also divided by geography — between mainland Indochina and Myanmar and archipelago Southeast Asia (excluding Thailand) — history, and political/economic systems, which had led to hostilities in the recent past. The rise of a dichotomized ASEAN would affect its ability to work as an organization and to move towards its shifting objectives. It would also further erode its international credibility, particularly after the organization’s ineffective handling of high-profile regional problems in the 1990s, such as the persistent cross-border “haze” outbreaks caused by fires in Indonesia, financial and economic crises, and its response to the challenges posed by Myanmar’s and Cambodia’s membership. The main concern of the older members about enlargement can be distilled into one fundamental question: Can an ASEAN-10 continue to function with a high (if not the same) degree of cohesion and trust built up among its original members in order to achieve its organizational objectives? Implicitly, the ASEAN-6 fear the evolution of a two-tier or dualtrack system, which would have negative consequences for the organization as a whole and for the realization of the objectives of individual members. To reduce the probability of such a development, the older members have recognized that they must help the new members to accelerate the processes of growth and structural change, and to move from a central management to a market system as quickly as possible. Consequently, initiatives have been taken by the organization and its older members to establish training and assistance programmes to integrate Cambodia, Laos, Myanmar, and Vietnam (CLMV) into ASEAN and to catalyse institutional change in and improve domestic conditions of the CLMV. However, the current crisis has taken its toll on the commitment of the ASEAN-6 to the newer members. To place in context some of the challenges and opportunities of ASEAN’s ongoing integration and enlargement process, we will first discuss relevant aspects of the organization’s thirty-year evolution and then look at the potential repercussions of injecting new members.

ASEAN’S ORGANIZATIONAL EVOLUTION Regional Co-operation and Cohesion: Political and Security Issues A movement towards co-operation has taken place among the original ASEAN members over the last three decades, as the five, then six countries (Brunei since 1984) learned to work with one another and overcome — or effectively suppress — historical, political, economic, and social rivalries and differences. While ASEAN eschewed institution-building, it did develop its own style of dialogue, consultation and consensus-forging; a code of

© 2001 Institute of Southeast Asian Studies, Singapore

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personal behaviour that can be interpreted as either congeniality or Janusfaced comportment; and organizational conduct known more for talk than action. With ASEAN’s largest member, Indonesia, implicitly accepting not to dominate the organization from its inception, ASEAN was able to develop into an organization of “unity in diversity” among its Southeast Asian members, and equality among an élite group of heads of states and foreign ministers. In the first twenty years of ASEAN’s existence, during the height of the Cold War, rigorous demands of regional political and security cooperation developed within the ASEAN framework, in its opposition to “international communism” of regional players such as China, Vietnam, Cambodia, Laos, and proxies in their own countries. A third leg of cooperation involved ASEAN economic collaboration, which did not keep pace with the first two. This imbalance persisted, even though ASEAN specifically linked political security with economic stability and development. Throughout the 1970s and 1980s, ASEAN introduced an impressive array of initiatives to expand intra-regional economic cooperation in the highly-championed areas of trade expansion, co-operation on basic commodities, industrial and technological development, resource management, and infrastructure development. On the whole, however, their advancement was slow, partly because the approaches were inappropriate and partly because ASEAN did not have the capacity to deal with myriad concerns at the same time. Compared with ASEAN’s political and security achievements, economic co-operation played a relatively small role in the organization’s first two decades of existence. It was only in the early 1990s — after the signing of the Paris Peace Accords ending the Cambodian conflict, and the demise of the Cold War — that ASEAN made significant headway in reshaping its identity into its long-held but nominal goal of a regional economic grouping, thereby expanding beyond its de facto security and political raison d’être. With a fundamental shift in the international strategic arena and greatly improved prospects for the region, a more confident ASEAN broadened its world-view. Despite its weak responses to Southeast Asian environmental problems (for instance, the so-called “haze” problem) and, more revealingly, the East Asian financial and economic crisis, ASEAN has reacted more vigorously to a new set of international demands of the 1990s: globalization, trade liberalization, and regionalism. For example, it has played high-profile roles in the Pacific Economic Co-operation Conference (PECC) and the Asia-Pacific Economic Co-operation (APEC). ASEAN’s new-found confidence to broaden its reach has also been demonstrated by its members’ participation in the birth and shaping of the World Trade Organization (WTO).

© 2001 Institute of Southeast Asian Studies, Singapore

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Carolyn L. Gates and Mya Than

Since the end of the Cold War, ASEAN has struggled to re-invent itself. It became apparent that under its old formula, the organization (and its regional niche) held little relevance to the post-Cold War world order. Among the most important decisions and initiatives that ASEAN has taken to restructure itself has been a shift towards economic issues and a movement towards including all of Southeast Asia in ASEAN. Both of these initiatives involve AFTA to some extent: AFTA is the most important and potent economic institution that ASEAN has ever introduced, and the association’s enlargement process potentially has the largest economic impact on and implications for AFTA.

Post Cold-War Redefinition of ASEAN: Economic Co-operation and the Establishment of AFTA In 1992, ASEAN formally initiated the ASEAN Free Trade Area. ASEAN had discussed the establishment of a free trade area for many years, but it became increasingly urgent as member states strove to make their economies globally competitive and as the organization began to redefine itself. At the outset, AFTA was to be realized within fifteen years from 1 January 1993. The main instrument to reduce tariffs imposed by members on all manufactured and processed agricultural products to 0 to 5 per cent by 2008 was the Common Effective Preferential Tariff. As such, the CEPT largely determines the pace (through normal and fast-track reduction of tariffs) and scope of trade liberalization within the group; and it provides for a phased reduction of tariffs. The CEPT consists of four lists. First is the Inclusion List (IL), which is composed of goods that are subject to immediate tariff reduction so as to fulfil the 0 to 5 per cent tariff target by the specified target date. Second is the Temporary Exclusion List (TEL) which permits a temporary exclusion of specified goods from tariff reduction, but they are to be transferred to the IL in stages, in five annual (and equal) instalments between January 1996 and January 2000, and reduced to the 0 to 5 per cent target range in the accelerated package by 2000. Third is the Sensitive List (SL) which is composed mainly of unprocessed agricultural products that are to be phased into the IL between 2001–2003 and reduced to the 0 to 5 per cent target range by 2010. Fourth is the General Exception List (GEL), which is consistent with World Trade Organization regulations (under Article XX of the General Agreement on Tariffs and Trade [GATT]). It permanently excludes from tariff reduction those goods that are of concern for national security, protection of public morals, health, human, animal and plant life, and protection of art, culture, environment, historical and archaeological heritage.

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Concessions within the CEPT are awarded on a reciprocal productby-product basis. A product must fulfil three basic conditions to be eligible for CEPT concessions: it must be included in the IL of both importing and exporting countries; it must have an internal tariff of 20 per cent or below to receive all concessions (if it is above 20 per cent, then it is eligible for concessions only in member countries that also impose a CEPT rate above 20 per cent); and it must satisfy the local content requirement of 40 per cent. These rules provide incentives for member countries to include goods in the IL and to reduce tariffs to below 20 per cent. In addition to mandating tariff reduction, the CEPT requires that ASEAN members eliminate quantitative restrictions on products at the moment it receives CEPT concessions and abolish other non-tariff barriers (NTBs) within five years of acquiring the concessions. ASEAN has agreed upon a working definition of NTBs based on the UNCTAD (United Nations Conference on Trade and Development) classification: measures concerning price controls, finance, monopoly, para-tariff and technical features. At the 26th ASEAN Economic Ministers Meeting (AEMM) in September 1994, the trade deregulation process was accelerated by five years, whereby a new target deadline for the realization of the free trade area was set at 2003. In addition, the AEM agreed to expand CEPT coverage by including all unprocessed agricultural products in the scheme. Under the revised fast track, for goods with import tariffs of more than 20 per cent, the tariff was scheduled to be reduced to 0 to 5 per cent by 1 January 1998, and under the revised normal track, to 20 per cent by 1 January 2000. Similarly, for items with tariffs of less than 20 per cent, under the revised fast track, the tariff was scheduled to be reduced to 0 to 5 per cent by 1 January 1998, and under the revised normal track, to 0 to 5 per cent by 1 January 2000. In December 1998, at the Sixth ASEAN Summit, measures to accelerate the CEPT process were pledged by the ASEAN leaders: “Statement on Bold Measures” (Hanoi, 16 December 1998), and the Hanoi Plan of Action (HPA). If these two are implemented — ASEAN member country pledges are voluntary, not binding — CEPT trade liberalization should be accelerated and deepened by 2000, as indicated by the leaders’ statement. To accelerate the ASEAN Free Trade Area, the Leaders agreed that the six original signatories to the Common Effective Preferential Tariff Scheme for the ASEAN Free Trade Area — Brunei, Darussalam, Indonesia, Malaysia, the Philippines, Singapore, and Thailand — would advance the implementation of AFTA by one year from 2003 to 2002. They also agreed to achieve a minimum of 90 per cent of their total tariff lines with tariffs of 0 to 5 per cent by the year 2000, which would account for 90 per cent of intra-ASEAN trade.

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Carolyn L. Gates and Mya Than Individually, each country would commit to achieve a minimum of 85 per cent of the Inclusion List with tariffs of 0 to 5 per cent by the year 2000. Thereafter, this would be increased to a minimum of 90 per cent of the Inclusion List in the 0 to 5 per cent tariff range by the year 2001. By 2002, 100 per cent in the Inclusion List would have tariffs of 0 to 5 per cent with some flexibility. Member countries also agreed to deepen, as soon as possible, tariff reduction to 0 per cent and accelerate the transfer of products, which are currently not included in the tariff reduction scheme, into the Inclusion List. The new members of ASEAN shall maximize their tariff lines between 0-5 per cent by 2003 for Vietnam and 2005 for Laos and Myanmar, and expand the number of tariff lines in the 0 per cent category by 2006 for Vietnam and by 2008 for Laos and Myanmar. (ASEAN Website, 1999; and ASEAN Economic Bulletin 16, no. 1 (1999): 99)

Preferential trade liberalization among the ASEAN members is viewed as a means to encourage regional trade, foreign direct investment (FDI), economic growth and co-operation. But perhaps most importantly, it is seen as a mechanism to increase the competitiveness of ASEAN firms “as a production base for the world market” (Baldwin 1997, p. 2), especially as they face wider trade liberalization under APEC and the WTO. Although there was concern that some ASEAN members that had been affected by the Asian financial crisis since 1997 might seek to slow AFTA tariff reduction and trade deregulation, ASEAN has called for the acceleration of AFTA implementation and the liberalization of financial and other services through the HPA.

ENLARGING AND BROADENING ASEAN As ASEAN began to redefine itself in the post-Cold War 1990s, it moved towards its original goal of including all ten Southeast Asian countries in the organization. The task of broadening the organization was accompanied by a number of political and economic consequences and implications to all involved. In this overview, we will first address the political impact and implications of ASEAN enlargement from the perspectives of both the ASEAN-6 and the CLMV. Secondly, we will examine the challenging issue of integrating ASEAN’s new members into AFTA. Despite ASEAN’s efforts to improve its investment climate by providing foreign investors additional incentives (see ASEAN Economic Bulletin 16, no. 1 [1999]: 106–9) and by launching or expanding the ASEAN Investment Area (AIA), and the ASEAN Industrial Co-operation

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(AICO) scheme (see ASEAN Website, 1999), among other things, AFTA has in fact evolved into the key economic institution of ASEAN. Moreover, AFTA is likely to have the biggest economic impact on the four new members and the enlargement process in general. Politics and Enlargement: The ASEAN-6 Perspective In the international political arena, there are two main areas that are or may be challenged by ASEAN enlargement: first, the ARF, a multilateral security dialogue composed of ASEAN and other Asia-Pacific countries; and second, the attitudes of ASEAN’s Dialogue Partners towards the new members. The entry of the four new members into ASEAN has not yet brought significant change to the first of these, the ARF organization. The integration of the new members into the ARF has been ad hoc and incremental, and all four joined before they were formally admitted to ASEAN: Vietnam and Laos in May 1993; Cambodia in August 1995; and Myanmar in July 1996. ASEAN has sought to use enlargement to address its own inherent problems within the ARF. Thus, within the post-Cold War strategic context, the enlargement may strengthen ASEAN, which has not been able to manage its own regional security order. Secondly, the enlargement helps to finesse the questionable notion that ASEAN comprises a significant and separate security challenge within East Asia, or the AsiaPacific, in the post-Cold War era. Similar to ASEAN participation in APEC, it has sought to ensure its weight and role within the ARF. But ASEAN went beyond its formula for participation in APEC (by obtaining guarantees of its centrality before agreeing to its formation): it chose enlargement as a key mechanism to reinforce its own identity and uphold its role in the ARF. Nevertheless, despite ASEAN’s objectives to use an enlarged organization to bolster its position and status in the ARF, it has so far made little if any difference to the structure and functioning of the ARF. In the second area, ASEAN’s relations with its Dialogue Partners and more generally its international standing, the enlargement process has imposed substantial costs and will continue to have significant implications for ASEAN. There is no doubt that the admission of Myanmar into ASEAN — without ensuring significant progress on its human rights situation and democratization — has reduced ASEAN’s reputation in the eyes of its western Dialogue Partners, particularly the European Union (EU) and the United States. Within a few months of its admission to ASEAN, a dispute developed between ASEAN and the EU over Myanmar’s participation in formal meetings between the two groupings. In preparatory negotiations for the annual ASEAN-EU Joint Co-operation Council meeting in Bangkok, scheduled for November 1997, the EU insisted that Myanmar’s attendance be downgraded to “passive presence”, a condition that was

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unacceptable to ASEAN. The impasse led to the postponement of the meeting and a chilling relationship between the two groupings. Throughout 1998 and 1999, Europe maintained such policies towards Myanmar because of a “lack of progress to break the [domestic] political stalemate, the harassment of pro-democracy activists and the poor human rights record in Myanmar”. Britain joined Denmark, Sweden, and Norway in refusing to allow Myanmar to attend an ASEAN-EU Foreign Ministers Meeting (AEMM) in Berlin on 30 March 1999. ASEAN responded by stating that “all the foreign ministers of ASEAN must be present” at the AEMM. Subsequently, no compromise was reached and the cancellation of the AEMM was announced by both sides. Despite affirmation that the ASEAN-EU dialogue is extremely important for both groups, it has come up against Myanmar’s domestic political problems, as perceived by strong advocates of human rights and democracy in the EU member states. EU– ASEAN and US–ASEAN relations are unlikely to improve with the passage of time because the United States and the EU have taken more sustainable actions against Myanmar: the United States imposed an embargo on new investments by American companies in Myanmar; and the EU has scrapped GSP (Generalized System of Preferences) benefits for Myanmar’s exports to the EU. The enlargement of ASEAN has thus injected a new negative element in its ties with traditional partners, as ASEAN becomes hostage to Myanmar’s domestic conditions. For ASEAN, this could not have come at a worse time, faced as it is with the East Asian financial crisis and its need for stronger economic, technological and commercial ties with Europe. On a regional level, the political situation is less complicated by enlargement. Nevertheless, there are political and ideological differences and latent disputes between the older and newer members that could provoke intra-ASEAN tension in the future. Vietnam and Laos are still self-avowed “socialist” countries ruled by single party systems, while Myanmar and Cambodia struggle towards greater democratization and stability. By contrast, the political economies of the ASEAN-6 are capitalist; and most are moving rapidly towards more open democratic systems. Such differences may cause mistrust and tension among the ASEAN-10, particularly as ASEAN is not a rules-based organization, but determines its actions through dialogue and consensus. Beyond ideology and politics, the ASEAN-10 members are divided over territorial disputes, environmental, refugee, and migration issues. Regional disputes and crises have broken out with a vengeance over the past few years, highlighting the institutional weaknesses of ASEAN. Some of these have involved the CLMV; others, the older ASEAN members. ASEAN was unable to deal effectively with the violent coup in Cambodia in July 1997, which caused the organization to delay Cambodia’s admission

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to ASEAN at the twelfth hour. It also showed that an enlarged ASEAN could not deal with sensitive issues within its conventional framework of consultation and consensus. This and other concerns led Thailand and the Philippines to press ASEAN to become more pro-active in an area designated as “internal affairs” of member states, but this was roundly rejected by the majority. Furthermore, ASEAN has been mostly an absent player in the East Asian financial and economic crisis that broke out in Thailand in July 1997. This comes on the heels of its failure to address other serious regional problems, most notably environmental pollution and degradation that have affected tourism, economic growth, health and other concerns in the majority of the ASEAN countries since the mid-1990s. Politics and Integration into ASEAN: The CLMV Perspective One important factor in the decisions of Cambodia, Laos, Myanmar and Vietnam to join ASEAN was their objective to gain greater international political credibility and legitimacy, which in turn, some assert, would promote internal stability and economic development. ASEAN membership can provide the new members a common regional identity and framework to develop and integrate into the region (East Asia Analytical Unit 1997, p. 321). Despite the negative factors discussed above, they can realistically expect better intra-ASEAN political relations, for several reasons. First, improved dispute resolution can be expected between the older and newer members as a result of the ASEAN organizational culture, which places strong emphasis on getting-to-know each other and confidence- and trustbuilding processes at the élite level. Secondly, with expanded cultural and informational exchanges at lower levels, the newer and older members are also likely to show greater tolerance for each other. Thirdly, the integration process is likely to have a positive impact on institutional change in the new member countries. Although the political systems vary significantly among the older ASEAN members, on the whole they are much more developed and open than those of the newer members. Through demonstration effects and quiet ASEAN internal pressure, the political institutions and behaviour of the newer members are likely to converge (albeit slowly) with those of the ASEAN mainstream. Moreover, the East Asian crisis — highlighting the downside of KKN (an acronym for corruption, collusion, and nepotism in Bahasa Indonesia) — has underscored the need for reform in the CLMV. At the international level, the CLMV (particularly Cambodia and Myanmar) also seek to gain greater legitimacy and weight through their association with ASEAN. It can be argued, however, that ASEAN is unlikely to play a major catalyst for that shift. The attitudes of most

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Western countries towards the CLMV will depend more on the extent of domestic reforms, or more specifically, on whether positive steps would be taken towards political pluralism and observance of human rights, as well as greater economic openness. Economic Impact and Implications: Integration of the CLMV into AFTA ASEAN is easing the newer members into the CEPT scheme through accommodation of their needs and permitting them a full decade to complete the tariff reduction process. Hence, the accelerated pace of tariff reduction adopted by ASEAN does not apply to the newer members. Based on their later dates of entry into ASEAN, Vietnam was given a target deadline of 2006 to accede to AFTA; Lao PDR and Myanmar, 2008; and Cambodia, 2010. Thus, the newer members have an additional four to eight years to liberalize trade, compared with the target of 2002 (or earlier) for the older members. Table 1.2 provides data on the 1998 CEPT packages presented by both the older and newer members. Vietnam was the first new member country to submit a package to the CEPT scheme: in 1996, it offered a list containing 857 tariff lines (some

TABLE 1.2 ASEAN-9 1998 CEPT Package (Number of tariff lines)

Brunei Indonesia Malaysia Philippines Singapore Thailand Vietnam Laos Myanmar Sub-total % of Total Tariff Lines

Inclusion*

Temporary Exclusion**

Sensitive

General Exception

Total

6,060 6,597 8,690 5,099 5,738 9,033 1,497 533 2,356

220 593 406 589 — 74 1,127 2,820 2,987

14 23 137 58 — 7 23 96 21

236 45 60 28 120 26 165 102 108

6,530 7,258 9,293 5,744 5,858 9,140 2,812 3,551 5,472

45,603

8,816

379

890

55,688

81.89

15.83

0.68

1.60

100

NOTES: *As of 10 October 1997 **As of 14 October 1997

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40 per cent) out of a total of 2,218 to the Inclusion List (see Table 1.3). Of these, 548 had zero tariffs and 309 were in the 1 to 5 per cent tariff range. There were 1,189 tariff lines placed under the Temporary Exclusion List, which will be phased into the CEPT in five annual instalments between 1 January 1999 and 1 January 2003. By 2003, more than 92 per cent of Vietnam’s tariff lines will be in the CEPT scheme. Most of its tariff lines in the Sensitive List comprise unprocessed agricultural products that will be phased into the CEPT scheme between January 2001 and January 2010. The obligations of Laos and Myanmar to AFTA began on 1 January 1998 and will conclude on 1 January 2008. In April 1997, ASEAN agreed on two groups of Sensitive Lists for the new members: Normal Sensitive and Highly Sensitive. Tariffs on products in the Normal Sensitive List will be reduced to 0 to 5 per cent by 1 January 2010, while those on the Highly Sensitive List will be reduced to 0 to 5 per cent by January 2015 (Menon et al., 1998). The Lao PDR submitted 533 tariff lines (about 15 per cent of the total) for goods already found in the tariff range of 0 to 5 per cent to an Immediate Inclusion List (see Table 1.3). Its TEL comprises 2,818 tariff lines or 80 per cent of all tariff lines; and these products will be phased into the IL between 1 January 2000 and 1 January 2005. The remaining lists show 119 tariff lines (or 3.35 per cent of all tariff lines) of unprocessed agricultural products in the Sensitive List; 112 tariff lines in the Normal Sensitive List; 7 tariff lines in the Highly Sensitive List; and 81 tariff lines in the General Exceptions List. Myanmar, which is also a founding member of GATT and WTO, offered 2,267 out of a total of 5,370 tariff lines (about 42 per cent of the total tariff lines) — for goods already found in the tariff range of 0 to 5 per cent — in the Immediate Inclusion List of the CEPT (see Table 1.3). TABLE 1.3 Initial CEPT Packages for Tariff Reduction: Vietnam, Laos, and Myanmar List

Tariff Lines Vietnam

Immediate Inclusion Temporary Exclusion Sensitive General Exception Total

Laos

% of Total Myanmar

Vietnam

Laos

Myanmar

857

533

2,267

38.6

15.0

42

1,189 26

2,818 119

2,960 16

53.6 1.2

79.5 3.4

55 —

146

81

127

6.6

2.2

3

2,218

3,551

5,370

100

100.1*

100

NOTE: *Due to rounding, total exceeds 100 per cent.

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The remaining lists show 2,960 tariff lines (55 per cent) in the TEL; 16 tariff lines (less than 1 per cent of total) in the Sensitive List and 127 tariff lines (3 per cent) in the General Exceptions List. Compared with other new members, “Myanmar has been more ambitious in its initial submission of product lists, although this is partly a function of tariff lines that already carry rates between 0-5 per cent prior to membership” (Menon et al., 1998); and it may gain admission to AFTA before its ten-year grace period expires in 2008 (Nation, 13 October 1997). Does Enlargement of AFTA Promote Trade and Competitiveness Goals of the ASEAN-6? The new members are very unlikely to derail AFTA’s trade deregulation process because their trade bureaucracies expect to gain more from regional free trade in the longer run than they give up. Constraints on tariff reduction and trade deregulation, however, focus on the short run: how to deal with the issues of fiscal and economic competitiveness arising from this process. Though tariff reduction may be more difficult for the newer members because of their rather large fiscal dependence on customs and related indirect taxes (see below), they are implementing administrative, tax, and fiscal reforms to adjust to the new conditions. In concert with their domestic reform programmes, the new members are attempting to tackle their problems at the source rather than prolonging adjustment by maintaining strong protectionism and import-substitution. Competition between highly inefficient state-owned enterprises in the new member states and more efficient and technologically-advanced firms in the ASEAN-6 may be a more protracted and difficult issue to address. However, the low competitiveness of these countries’ firms and industries involves many aspects of their reform process, which the governments are committed to continue. Unless there is a great shift in attitude towards reform, this issue is unlikely to have much effect on AFTA’s progress; and a dual-track system is unlikely to emerge in this area. Will AFTA benefit the future trade performance, welfare, and competitiveness of the ASEAN-10 as a whole? The answer must include an assessment of the free trade area’s trade creation and trade diversion effects: do the former exceed the latter? (See Viner 1950.) For the ASEAN6 economies, which trade overwhelmingly with countries outside the region, trade may be diverted in the transitional stage of deregulation. However, at the same time that CEPT tariff reduction is progressing, ASEAN members have been reducing tariffs on a product or sectoral basis for both ASEAN and non-ASEAN trading partners; and they are attempting to improve their trade position and relations with the world as well as the region. In 1994–96, for example, all the ASEAN countries announced one

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major and several minor packages of tariff reductions on a most-favourednation (MFN) basis (ASEAN Secretariat 1996). Moreover, with lower CEPT tariffs and strong economic growth until 1997, both intra-ASEAN and extra-ASEAN trade expanded. In 1995, intra-regional trade grew by a substantial 14.5 per cent to US$133 billion, but it remained overshadowed by the 19.4 per cent growth in extra-regional trade to US$651 billion (Baldwin 1997 p. 80). Consequently, unless there are substantial policy changes to the approach and implementation of AFTA trade liberalization, it is unlikely that trade diversion will dominate in the longer run. When new members are added to the equation, there are several possibilities regarding trade creation and diversion. Raychaudhuri (1996) argues that with the extension of AFTA to include the CLMV, significant trade and investment diversion is likely. Considering the comparative advantages of these economies in unskilled labour-intensive manufacturing and resource extractive industries, investment diversion with the freeing of trade flows in Southeast Asia may occur in garments, leather products, gems and jewellery, and agro-based process products, to name a few (Raychaudhori 1996 p. 20).

However, empirical evidence does not support this view. The trade of the CLMV with the ASEAN-6 has been growing faster than with the rest of the world: in 1985–95, CLMV’s trade with ASEAN grew at an average annual rate of 40 per cent, compared with 27 per cent with the rest of the world. During the same period, the volume of trade between the CLMV and ASEAN grew by US$6.6 billion, while that with the rest of the world increased by US$14.4 billion. Thus, although the rate of change in trade was substantially faster for CLMV–ASEAN trade than CLMV–rest of the world, in absolute volume terms, it remained far less, indicating that more trade was being created among the ASEAN-10 than diverted from traditional CLMV trading partners. This appears to be a typical outcome of the expansion of a “natural” free trade area of neighbouring regions, because trade is influenced by the realities of geography (transport and transaction costs, information, knowledge, etc.) as well as comparative advantage. Lowered tariffs under AFTA will affect member economies in different ways. For example, as Singapore already has very low tariff rates (close to zero), the effect on Singapore’s imports from its fellow AFTA members is not likely to be significant. However, for Malaysia, Indonesia, and particularly Thailand, which have higher protection (and have significant trade and investment ties with the CLMV), the effects could be large. With progressive trade deregulation under AFTA, Malaysia, Indonesia, and Thailand (and others from the ASEAN-6) can expect to export more

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manufactured goods and services, such as construction, engineering, transportation, telecommunications, consultancy, and education services (Sieh and Loke 1996) to the CLMV, but at the same time, they are likely to import much larger quantities of products that are currently heavily protected, including agricultural and lower value-added goods in which the CLMV have comparative advantage. CLMV Integration into ASEAN/AFTA: Economic Benefits and Costs to the New Members The CLMV anticipate general regional trade area (RTA) advantages from joining ASEAN and AFTA. These include greater trade and investment links with the region; increased foreign direct investment (FDI) as a result of greater attractiveness to non-regional investors; improved resource allocation from specialization according to comparative advantage; greater economies of scale in an enlarged regional market, which can enhance prospects for small and medium scale enterprises; the possibility of joint production of public goods; and spillover effects and infant industry learning effects resulting in improved quality control, design, and marketing and thus improved competitiveness in world markets (see Langhammer 1990). More specifically, they are likely to enjoy the following benefits: •

•

•

•

• •

•

as tariff rates and NTBs are reduced under the CEPT scheme, the CLMV should be able to export higher levels of agricultural goods to the ASEAN-6; foreign investment confidence in the CLMV may be positively influenced by the relatively good reputation of the ASEAN-6 host countries (despite the recent crisis); membership in ASEAN will support reform in the CLMV countries by providing assistance for — and potentially locking in — their current programmes, promoting continuation of the reform process, and providing support against some vested interests; membership in AFTA and ASEAN can contribute towards easier access to world markets for the CLMV, and assist in trade negotiations; the ASEAN-6 can provide relevant economic development and policy advice; co-ordination of economic policies among the ASEAN-10, particularly in export industries such as textiles, garments, rice production, and agri-products processing, can expand both intra- and extra-ASEAN trade; and the enlargement may encourage subregional co-operation, particularly the Greater Mekong Subregion initiative, in which the CLMV countries are members.

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The CLMV may also benefit from increased export competitiveness as a result of AFTA (Pham and Forbes 1996, p. 16). First, by lowering import tariffs, goods will be cheaper in ASEAN-10 markets and progressively replace inefficiently-produced domestic products. Resources would therefore be reallocated to more efficient and productive uses. The CLMV private and public sectors will be forced to focus their limited resources on (their natural comparative advantage of) labour-intensive, export-oriented manufacturing projects, thereby improving competitiveness with more advanced producers in the ASEAN-6. Secondly, with its enlarged market, AFTA will create greater opportunities for the exploitation of economies of scale. Thus, firms from the CLMV countries will be encouraged to invest in research and product innovation, or to specialize in production. Finally, as a result of free trade, the international competitiveness of CLMV firms will gradually increase, as they gain opportunities to compete with other ASEAN firms in the regional market before entering world markets. Some politico-economic interests in the CLMV countries, however, question such a positive projection. They argue that their inefficient stateowned enterprises (which dominate these economies) cannot compete with the ASEAN-6 in manufacturing. Under AFTA, they will not be able to protect infant industries, which are mainly owned by the state. Moreover, their small-scale private enterprises cannot fill this gap, as they face shortages of capital, raw materials, power supply, spare parts, and entrepreneurship. From this perspective, there will be a long time lag before CLMV firms can begin to compete with ASEAN firms in most areas of manufacturing and higher value-added goods. Some logically conclude that the CLMV countries may even become a “new periphery” of an ASEAN/ AFTA centre: they will become colonial suppliers of raw materials to the more industrialized ASEAN-6 economies. Though this is counterfactual to what has happened in the region during the past three decades when such economies have moved up the technological and value-added ladder, such fears are fuelling discontent among some industrial and state interests in the CLMV. However, the outcome of CLMV competition greatly depends on how these governments and economies respond to the new challenges. If they accelerate reform, improve the investment and market environment, create opportunities for entrepreneurs to renovate their firms and advance their competitive positions, the CLMV will be able to follow in the steps of — or even leapfrog — their regional competitors. If not, they are likely to lag behind. The CLMV economies are facing additional adjustment costs from AFTA integration. First, state enterprise reform, which is likely to be accelerated by AFTA-induced trade deregulation, is creating labour dislocations in economies where unemployment (and underemployment) is already high and few, or no, social safety nets exist. Secondly, AFTA

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requires significant fiscal adjustment in most of the CLMV countries, which have depended on customs revenues to finance a large part of the state budget. In 1996, Cambodian customs duties comprised 70 per cent of the government budget; in Laos, 31 per cent; in Myanmar, 16 per cent; and in Vietnam, 19 per cent. Consequently, they have little choice but to restructure tariffs, the overall tax base, and government expenditures so as to meet AFTA obligations, budget demands, and requirements to maintain macroeconomic stability.

THE CHAPTERS IN THIS VOLUME The CLMV stand to benefit from joining ASEAN/AFTA, but they also face numerous transitional and perhaps longer-term challenges from regional integration. Similarly, the ASEAN-6 are confronting both the positive and negative impacts and implications of this process. The chapters in this volume examine these issues from three different perspectives: the region, the subregion, and the new member countries. At the regional level, the contributions focus on political and security issues (authored by Dewi Fortuna Anwar); trade (Nattapong Thongpakde); foreign direct investment (Nick J. Freeman); and a comparative analysis of the enlargement processes of the European Union and ASEAN (Rolf Langhammer). Secondly, Mya Than and George Abonyi write on the development of the Greater Mekong Subregion. From the perspective of the new member countries, the volume includes seven chapters on the impact of ASEAN integration. In Chapter 2 “ASEAN’s Enlargement: Political, Security and Institutional Perspectives”, Dewi Fortuna Anwar reviews ASEAN’s very important political and security rationale and evolution and then looks to the future after enlargement. She examines the impact and implications of enlargement from the perspective of ASEAN’s three main political and security objectives and functions: to “promote regional harmony and maintain peace and stability in Southeast Asia”; “to enhance regional security and promote the establishment of a more autonomous and indigenous regional order”; and to serve as an “important international bargaining instrument, which enhances the members’ individual and collective stance vis-à-vis the outside world”. The author argues that enlargement will have positive political and security implications for regional peace and stability, but it will also make it “more difficult for ASEAN members to reach a consensus — the favoured way for making decisions… In fact, some difficulties may be more fundamental than formal style that can be overcome with time”. Morever, she states that enlargement can increase ASEAN’s bargaining position in the international world, but at the same time it has “brought new problems for ASEAN diplomacy, at least in the short run”. She concludes that while “the inclusion of all Southeast Asian countries within one regional

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organization…will benefit the region as a whole”, the main disadvantage is that it would be “much harder for ASEAN to reach a consensus because of the existing differences between the old and new members.” Nattapong Thongpakde writes on “ASEAN Enlargement and Trade” in Chapter 3. Because AFTA is ASEAN’s key economic and commercial institution, the author focuses on the integration of the new members into the Free Trade Area. To do this, he first compares various conditions and indicators of the old and new members: socio-economic development; ASEAN trade patterns, and comparative advantages. Nattapong then examines the potential impact of ASEAN enlargement on AFTA, first in terms of trade creation, then on trade diversion. He finds that enlargement should have positive effects on trade creation because of the expanded market size, but because of low endowment diversification in the ASEAN economies, “trading with non-member countries will remain important for the ASEAN-10”. He further argues that “trade diversion should not be a major concern in ASEAN enlargement” because “most tariff rates imposed on the products in the Inclusion Lists of the new members are less than 5 per cent and the impact of tariff reduction in the first stage is small.” In addition to AFTA’s objectives to increase intra-regional trade and international competitiveness, it aims to make ASEAN a more attractive investment and tourism area. The author argues that enlargement will contribute to the latter. Finally, he examines the potential adjustment problems for the new members as a result of their integration into AFTA. This includes negative fiscal effects (rising budget deficits owing to reduced tariff revenues); rising current account deficits; increasing foreign competition because of lower tariffs and protectionist measures. The author concludes that ASEAN enlargement will bring about complementary trade and investment activities between the old and the new members. However, he warns that any delay in market deregulation and institutional adjustment in the new member countries will undermine the process of ASEAN cooperation. Therefore, it is crucial for the new members to commit to AFTA and greater economic liberalization. The old members can assist the new members to pursue economic restructuring and reduce the adjustment costs to accelerate the deregulation process.

Nick Freeman’s contribution in Chapter 4, “ASEAN Enlargement and Foreign Direct Investment” first presents a baseline FDI profile of Cambodia, Laos and Myanmar (CLM), which shows that in all three countries, ASEAN-invested capital stock comprises a large share of total FDI. He then examines indirect factors by which ASEAN enlargement may augment investment inflows into the CLM countries: improved regional relations and understanding; improved information flows; “trickle down”

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business initiatives; “demonstration effects”; an ASEAN “conduit” role between the new members and the international community; the pull of AFTA; and the establishment of the ASEAN Investment Area. At the same time, there exist factors that may prevent enlargement from augmenting FDI inflows into the CLM. First, the domestic market environments of the CLM have not improved sufficiently to attract large investments. While ASEAN membership may encourage positive domestic institutional changes, the countries themselves must make the improvements. Secondly, the toll of the current economic crisis may prevent the ASEAN-6 countries from raising their investment in the CLM for a number of years, despite continuing interest in these markets. The author then presents evidence from Vietnam as “an interesting pilot case study for the CLM countries, on the likely impact that membership of the regional grouping may have on future FDI inflows”. Freeman concludes: that a number of relatively intangible ‘macro’ factors stemming from the enlargement of ASEAN may play a broadly indirect role in promoting foreign investment inflows into the CLM countries…they will probably not be as significant as a smaller number of — but more directly pertinent — FDIspecific factors that each of the CLM countries will need to embrace if they are to successfully increase their future inflows of foreign investment.

Rolf J. Langhammer contributes a comparative analysis of two regional groupings, in “European Union Enlargement: Lessons for ASEAN” in Chapter 5. He finds a persuasive parallel of the enlargement of the EU in ASEAN, based on the international political context: the demise of “USSRruled socialism” and the end of the Cold War “paved the way for enlargement of the two groupings”. However, there are very obvious differences between the two: “dissimilarities in growth and adjustment speed between allegedly sclerotic and overly-institutionalised continental Europe and dynamic, yet vulnerable Southeast Asia”. He proposes different analogies of the two integration processes: the integration of the Central and East European countries (CEEC) into the European Union is like “a long engagement without setting a wedding date”; by contrast, the entry of the CLMV into ASEAN has been a “Las Vegas jump-start wedding”. Furthermore, Langhammer finds key differences between the EU and ASEAN economies, which have different impacts and implications for enlargement. At the same time, he notes that there are important similarities among the new members of the EU and ASEAN: “they are low-income countries, have strong agricultural sectors and suffer from poor infrastructure”. Consequently, the entry of the CEEC in the EU and the CLMV in ASEAN will change the economic landscape of the two regions. He presents economic and social data to support these positions. In conclusion, he states that the experience of EU enlargement for ASEAN has become a moot point

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because political realities have overtaken the ASEAN integration process. In an ideal world, he argues, the two could have learned from each other because both enlargement experiments have shown positive and negative outcomes; and both were “economically flawed”. Therefore, he concludes: In the EU, greater speed and political determination in the integration of new members to the European family would have supported the reform momentum in the CEECs and put pressure upon the EU to reform itself. In Southeast Asia, less speed and more pre-accession preparation might have served both the interests of ASEAN and Indochina better.

Chapter 6, “The Greater Mekong Subregion: Co-operation in Infrastructure and Finance”, by Mya Than and George Abonyi focuses on subregional aspects of ASEAN enlargement. In the first part of the chapter, Mya Than presents an overview of the history, initiatives for cooperation, and infrastructure needs of the Greater Mekong Subregion (GMS). He argues that there are many potential implications of ASEAN enlargement on GMS countries, including greater political stability and confidence-building; expanded trade and investment flows within the region; higher FDI flows from outside the region; improved resource allocation from specialization; enhanced industrialization prospects of small and medium enterprises; spillover and learning effects. In part two, George Abonyi discusses a variety of financial and related microeconomic and technical issues involved in developing GMS infrastructure. He examines the impact of the regional economic crisis and ASEAN co-operation on financing the GMS development programme. Abonyi concludes that: regional and international institutions can play an important role as facilitators of subregional co-operation in infrastructure and finance. They may be a key source of technical and financial support, including helping to mobilize international financing, both official and private, and in helping to reduce risk to investors…Moreover, the joining of the six participating countries of the GMS in ASEAN will create a more conducive environment for such co-operation, and the credibility of ASEAN as a good place for investment will definitely complement and supplement it.

The third section of this volume, focuses on the integration of the new members into ASEAN and AFTA. It begins with Chapter 7, “Cambodia’s Accession to AFTA: Impact, Challenges and Policy Implications” by Toshiyasu Kato. The author argues that Cambodia’s integration into AFTA will have a significant impact on its trade, investment, and growth in the long run, but negligible effects in the short run. The short-term impact will be insignificant because the government is attempting to minimize the immediate loss of tariff revenues, which is viewed as a major short-term constraint of AFTA integration. Integration is anticipated to bring

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significant benefits to Cambodia: an enlarged market in one of the highest growth regions in the world; the potential of becoming a platform for FDI from non-ASEAN countries; and using its membership as a signal that it wants to integrate into the global economy, which should attract FDI. At the same time, integration poses five main challenges: 1) maintaining sound macroeconomic fundamentals; 2) eradicating poverty; 3) achieving equitable growth; 4) maintaining the momentum of growth; and 5) regenerating the environment. Employing a comparative analysis approach to examine Cambodia’s current conditions with respect to the ASEAN economies, the author then places into context Cambodia’s deregulation and integration process. After discussing Cambodia’s economic conditions, including its pattern of trade and investment, and comparative advantages, he examines, inter alia, Cambodia’s preparations and strategies for AFTA integration, including its approach to the five challenges noted above. The author goes on to look at some policy implications of integration: the demands of adjusting domestic expenditures; developing an appropriate institutional framework and legal system; establishing policy coherence and ministerial co-ordination. In concluding, the author recommends a number of policy reforms to confront these challenges and to further other Cambodian economic objectives. These include raising national expenditures for education, health, agriculture, and rural development and reducing defence spending; as well as “overhaul[ing] and upgrade[ing] the civil service and legal systems, by developing human resources, reforming incentive mechanisms, and mitigating pressures from politics and business”. A second contribution on Cambodia, “Implications of Joining ASEAN/ AFTA for Cambodia” is presented by You Ay in Chapter 8. This piece, which was written before Cambodia was admitted as a full member of ASEAN, examines Cambodia’s preparation process to enter ASEAN and AFTA. After providing a brief socio-economic background of Cambodia, the author discusses the measures Cambodia has been instituting to join the regional organization, including institutional and organizational arrangements, structural adjustments and legal reforms, technical and specialized tasks, and training activities. She then addresses the political, economic and security aspects of Cambodia’s integration into ASEAN. Similarly, You Ay discusses the implications of Cambodia joining ASEAN and the Free Trade Area, which pose both opportunities and challenges. The chapter concludes: “Cambodia cannot postpone these tasks. Its handling of these challenges could mean victory or defeat in the battlefield of development.” Next, Emiko Fukase and Will Martin write on the “Economic Effects of Joining AFTA: The Case of the Lao People’s Democratic Republic” in

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Chapter 9. To evaluate the AFTA integration process on the Lao economy, this chapter presents a simple computable general equilibrium model to quantify the gains from trade creation (additional trade with ASEAN partners, which is welfare improving) and losses caused by trade diversion. The model includes one productive sector and twenty-two trade sectors; and the welfare changes occurring with trade liberalization are decomposed into three components: “welfare gains resulting from efficient resource allocation, welfare loss with decreases in tariff revenues, and terms of trade gains provided by the ASEAN partner countries”. Before introducing the model, they discuss the evolution of AFTA and Laos’ adaptation to various phases and mechanisms of the CEPT process. From their model, they conclude that the Lao PDR will economically benefit from accession to AFTA. They argue “that the Lao PDR gains as the scope of AFTA widens and it gains the most if it expands the scope on a non-discriminatory basis.” Secondly, their results show (with other things being equal) that “AFTA has positive effects on the Lao PDR’s most important export industries, namely, wood and wood products and garment sectors”. Sectoral analyses presented in this chapter also reveal that AFTA integration presents substantial potential gains for sectors such as processed foods, apparel, and shoes, hats, and umbrellas. Finally, Fukase and Martin note that the “model used in this study is simple and subject to several limitations”. In particular, it is static and therefore does not capture the dynamic effects that the Lao PDR is likely to gain from increased foreign direct investments, improved productivity, and changes brought about by accelerated domestic reforms. Tin Maung Maung Than and Mya Than present “ASEAN Enlargement and Myanmar: An Overview” in Chapter 10. The authors discuss three main political implications of Myanmar’s entry into ASEAN: ASEAN’s relations with the West; ASEAN organizational matters; and the country’s domestic political development. They argue that the United States and the European Union have created obstacles to co-operation between ASEAN and them by trying to penalize Myanmar for alleged human rights violations and lack of progress in democratization. In particular, it has resulted in an impasse between ASEAN and the EU in their bloc-to-bloc meetings because the EU has repeatedly placed conditions on Myanmar’s participation. They also assess the economic implications of joining AFTA in terms of international trade, FDI, government revenues, and the country’s comparative advantage. They conclude that Myanmar’s membership in the regional grouping will have a positive impact in the short and medium term with regard to its economic development. To benefit it in the longer term, the country must deepen its reform programme and liberalization efforts.

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Khin Ohn Thant writes on “ASEAN Enlargement: Economic and Financial Implications for Myanmar” in Chapter 11. The author states that changing domestic as well as external conditions convinced Myanmar to join ASEAN, in contrast to its decision in 1967 to remain non-aligned. Although Myanmar expects significant benefits from regional integration, the author states that Myanmar “does not expect a hand-out”. She then reviews Myanmar’s economic reforms and how they will fit into the CEPT tariff reduction and trade liberalization schemes. She concludes that Myanmar can benefit from AFTA only if it is able to promote trade and foreign investments effectively. The author also calls for greater assistance by ASEAN and its Dialogue Partners — for example, in institutionbuilding, training and development policy advice — during Myanmar’s transition. Two chapters on Vietnam’s integration into ASEAN and AFTA are contributed by Carolyn L. Gates. In Chapter 12, “Vietnam’s Integration into AFTA: Theoretical and Empirical Perspectives”, the author examines various theoretical perspectives on trade and their applicability to Vietnam; Vietnam–ASEAN trade patterns; and Vietnam’s process of integration into AFTA. She then analyses the potential impact and implications of Vietnam’s accession to AFTA, broader-based trade liberalization on structural change; potential effects on Vietnam’s industrial competitiveness; and the fiscal impacts of tariff reduction. Gates concludes that: Vietnam is moving towards a more liberal trade regime, even as policy-makers are confronted with demands from the still powerful ‘import-substitution lobby’. While Vietnam cannot go back to the old CMEA days, there is still a question about whether it will be able to fulfil AFTA (and future trade liberalization) commitments, if investment patterns and industrial policies continue to favour import-substituting industries… . Vietnam must quickly remove its institutional bias towards import substitution in favour of more export-oriented development. The regional economic turmoil presents Vietnam both an ideal time and a demanding agenda to accomplish this challenge.

Chapter 13 on “The ASEAN Economic Model and Vietnam’s Economic Transformation: Adjustment, Adaptation and Convergence” is the second one on Vietnam. After discussing theoretical and empirical issues of convergence, Gates briefly compares the resources, fundamentals, and economic systems of Vietnam and the original ASEAN members. She then examines: the key factors that contributed to the ASEAN economic model; Vietnam’s market transformation process, which is now allowing it to compete and co-operate with ASEAN; and Vietnam’s market-based development strategy, comparing it with that of ASEAN. The chapter concludes:

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Vietnam remains very far from ASEAN’s average income levels, even though incomes in many of the ASEAN-5 plummeted in U.S. dollar terms in 1998, and many are likely to recover from the regional crisis only after four or five years or more. Even if Vietnam manages to sustain high growth rates of above 6 per cent, and investment ratios of more than 25 per cent per year, it will still take several decades to reach a standard of living acquired by Thailand in the mid-1990s. Vietnam is likely to face very strong challenges for many years to come in its efforts to converge with even a weakened ASEAN. It remains to be seen whether it can step up economic restructuring and institutional reform to accelerate its “catch-up” with its more developed ASEAN partners.

References ASEAN Economic Bulletin. “Hanoi Declaration of 1998, 16 December 1998”. Vol. 16, no. 1 (April 1999): 95–105. ASEAN Secretariat. AFTA Reader, Vol IV: The Fifth ASEAN Summit. Jakarta, 1996. ASEAN Website (1999). http://www.asean.or.id/ Asian Development Bank. Key Indicators of Developing Asian and Pacific Countries, 1996. Manila: ADB, 1996. Baldwin, P. Planning for ASEAN: How to Take Advantage of Southeast Asia’s Free Trade Area. London: Economic Intelligence Unit, April 1997. East Asia Analytical Unit. The New ASEANs: Vietnam, Burma, Cambodia and Laos. Barton, ACT (Australia): Department of Foreign Affairs and Trade, 1997. Langhammer, Rolf J. Regional Integration among Developing Countries: Opportunities, Obstacles and Options. Kiel Germany: Institut für Weltwirtschaft an der Universität Kiel, 1990. Menon, Jayant, Manuel Montes, and Joseph Tan. “Trade Patterns, Trade Cooperation and AFTA”. Unpublished paper. Singapore: ISEAS, 1997. Nation (Bangkok), 13 October 1997. Pham Hoang Mai and D. Forbes. “The ASEAN Free Trade Area and its Potential Impact on Vietnam’s Economy”. Paper presented at the conference on “Development Dilemmas in the Mekong Subregion”, Melbourne, 1–2 October 1996. Raychaudhori, B. “Probable Enlargement of the ASEAN Free Trade Area and Implications for Investment Flows in South-East Asia”. Paper presented at the Conference on “Enhancing of Trade and Investment Cooperation in South-East Asia: Challenges and Opportunities for ASEAN10 and Beyond”, organized by ESCAP, in Jakarta, 19–21 February 1996. Mimeographed. Sieh Lee M.L. and W. H. Loke. “Cambodia, the Lao PDR, Myanmar and Vietnam: Preparing for Cooperation in Trade and Investment within ASEAN”. Paper presented at the conference on “Enhancing Trade and Investment Cooperation in South-East Asia: Challenges and Opportunities for ASEAN-10 and Beyond”, organized by UN/ESCAP, in Jakarta, 19–21 February 1996. Mimeographed. Viner, Jacob. The Customs Union Issue. New York: Carnegie Endowment for International Peace, 1950. World Bank. Social Indicators of Development. Baltimore: Johns Hopkins University for the World Bank, 1996.

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DEWI FORTUNA ANWAR

Introduction As its name suggests, the Association of Southeast Asian Nations (ASEAN) was meant, from the very beginning, to encompass the whole of Southeast Asia. Nevertheless, when the Association was established in Bangkok on 8 August 1967 by five countries, comprising Indonesia, Malaysia, the Philippines, Singapore and Thailand, the ideal of one Southeast Asia seemed like an impossible dream. ASEAN was born at a time of intense conflict in Southeast Asia, much of which was an offshoot of the wider global confrontation between the communist and the Western blocs. While the Soviet Union was the superpower of the communist camp, the People’s Republic of China emerged as the dominant communist power in Asia. Following its radical policy at home during the time of its cultural revolution, China actively tried to export “national-liberation” movements overseas, by, for example, giving support to communist insurgencies in Southeast Asia. In Vietnam, the war between the communist North against the non-communist South was at its height, with the United States committing an ever greater number of troops to shore up the tottering regime in Saigon.1 Although it was not the intention, the establishment of ASEAN in fact divided Southeast Asia into two distinct, but not necessarily, antagonistic subregions. ASEAN was founded by five non-communist countries which shared common perceptions regarding the danger of communism to their 26

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internal stability, and the belief that the best way to combat this threat was through economic development. Many of these countries had been antagonists only a year earlier, and relations among them continued to be difficult during the first few years of ASEAN. Yet these countries were able to bury their differences in the face of what was perceived to be a much greater threat to their national and regional security, namely, the fear of communist expansion, whether through subversion and insurgencies or through more conventional means.2 On the other side of the divide were the rest of the Southeast Asian countries which remained outside ASEAN for various reasons. Despite the fact that ASEAN was founded by five non-communist Southeast Asian countries which had developed close relations with the West, ASEAN was not an anti-communist regional organization as such. ASEAN was established as a “non-denominational” regional organization, in which the criteria for membership was primarily geographical rather than political. Nevertheless, Vietnam was not invited to join in the first wave because the founding fathers of ASEAN believed that the war in Vietnam would make it impossible for that country to become a member of the Association. The same situation applied to Laos, which had become a party to the Indochina conflict since the early 1960s. In 1967, Brunei was not eligible for membership because it was still a British protectorate. Burma and Cambodia, however, were solicited to join the new regional body, but both countries refused the invitation. As members of the Non-Aligned Movement, Burma and Cambodia were afraid that participating in ASEAN would compromise their neutral status, despite the fact that Indonesia, a founding member of the Non-Aligned Movement, was one of the founders of ASEAN. The more important reason for Burma’s and Cambodia’s reluctance to be associated with ASEAN was their fear of offending China, the giant communist neighbour to their north, with whom both countries share a long border. China viewed the newly established ASEAN as nothing more than an American tool aimed at containing communism in Asia in general, and China in particular.3 Although ASEAN was not an anti-communist regional association, its members and main agenda clearly pushed the Association closer into the Western orbit, particularly as most of its members were parties to Western military alliances. The Philippines and Thailand were members of the Southeast Asian Treaty Organization (SEATO), an American-led defence pact created as part of a global strategy for containing communist expansion. Malaysia and Singapore had close military relations with Britain, Australia, and New Zealand, which in 1971 evolved into the Five Power Defence Arrangements. Although Indonesia was not a member of a defence alliance, the New Order government under President Soeharto

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was virulently anti-communist, banning the Communist Party at home, freezing its diplomatic ties with China and developing close relations with the United States and its allies.4 This pro-Western stance of ASEAN, on the one hand, and the increasing dominance of communism in Indochina, on the other, divided Southeast Asia into two separate subregions throughout the Cold War. But ASEAN had not wanted to maintain such a chasm. Soon after the communists won the war in Vietnam, ASEAN invited the victorious communist state to join the Association. Flushed with its victory, however, Vietnam refused the offer. In fact, Vietnam looked down on ASEAN, regarding the Association as less than independent vis-à-vis the major Western powers which provided it with political and economic support. While not wholly adversarial or antagonistic, it was unavoidable that relations between ASEAN and Indochina would be less than cordial, particularly during the Vietnamese occupation of Cambodia between 1979 and 1990.5 It must be admitted that ASEAN’s success as a regional organization, particularly in terms of promoting regional peace and stability, maintaining intra-regional harmony, and providing a conducive regional environment for economic growth, stood out in sharp relief against the conflict and underdevelopment in the rest of the region. Moreover, the events occurring in the neighbouring countries acted as a spur for ASEAN members to cooperate to achieve collective national and regional resilience. While ASEAN has always maintained its inclusive nature vis-à-vis the rest of Southeast Asia, for twenty-five years its raison-d’etre was to some extent defined by the existence of the other Southeast Asia, while its effectiveness was to a considerable degree measured by its success in dealing with the Indochina conflicts. The end of the Cold War has closed the ideological and political gaps that had existed between ASEAN and the rest of the region, and made it possible for the countries that had chosen to remain outside ASEAN finally to join the Association. The enlargement of ASEAN to encompass the whole of Southeast Asia will clearly have important implications for ASEAN co-operation as a whole. Given the fact that political and security considerations dominated the thinking behind the establishment of ASEAN, and until recently had continued to be the primary focus of ASEAN political co-operation (notwithstanding the fact that the Association does not carry out multilateral ASEAN security co-operation), the entry of Vietnam, Laos, Myanmar, and Cambodia into the Association will undoubtedly have wide-ranging political and security implications. ASEAN’s enlargement is also likely to have some impact on the Association’s institutional structure.

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The Political and Security Implications of ASEAN Enlargement In analysing the political and security implications of ASEAN enlargement, one must clearly identify the primary political functions or dimensions of the Association, and from there attempt to gauge the extent to which these functions will be affected by the expansion in membership. Seen from the political and security perspectives, which are closely interrelated, given the comprehensive nature of security, ASEAN has at least three main functions. The first and probably the most important function of ASEAN is to promote regional harmony and maintain peace and stability in Southeast Asia. Secondly, ASEAN is expected to enhance regional security and promote the establishment of a more autonomous and indigenous regional order. Finally, ASEAN serves as an important international bargaining instrument, which enhances the members’ individual and collective stance vis-à-vis the outside world.6 ASEAN and Regional Harmony The primary political function of ASEAN, and undoubtedly its most successful, has been its promotion of harmonious relations among its members, and maintaining regional peace and stability. ASEAN’s success in this field can be gauged by the fact that in the past thirty years, the ASEAN sub-region has been a haven of peace, particularly in comparison to the situation in Indochina, and in contrast to the earlier bilateral tensions and conflicts among some ASEAN members. Although many bilateral disputes remain unresolved — and bilateral relations have sometimes been strained by newly-arising bilateral disagreements — military clashes among the original members of ASEAN are becoming unthinkable. Most analysts agree that the ASEAN subregion has developed into a kind of security community, as embodied in the 1976 ASEAN Treaty of Amity and Co-operation in Southeast Asia, 7 in which the use or threat of force is no longer considered legitimate. ASEAN’s role in promoting regional harmony and in maintaining peace and stability have to a certain extent been executed through indirect means. Bilateral disputes have never been discussed in ASEAN fora, and the Association has never mediated in intra-regional conflicts, let alone become directly involved in settling disputes. Furthermore, ASEAN is not a security body which engages in regional defence and security co-operation. Despite the existence of the Treaty of Amity and Co-operation, which is the most important regional code of conduct, ASEAN cannot really enforce peace among the signatories, because the treaty has no such provisions. Nor has ASEAN economic co-operation developed to the extent of actually integrating the subregional economies so that it would be extremely costly for any member to risk breaking ties.8

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Nevertheless, the indirect role played by ASEAN in preserving regional harmony has been real and significant. Although it has not resolved conflicts, ASEAN has been mostly successful in defusing conflicts among its members, so that existing disputes have not on the whole disrupted regional co-operation. During the early years, open conflicts over longrunning bilateral disputes were mostly avoided through acts of self-restraint by members, since none of them wanted to endanger the survival of the new regional organization. Over time, growing familiarity and the habit of mutual consultation, as well as common participation in regional cooperation, helped to remove suspicion and build confidence among the members. As the value of the Association increased and members attached greater importance to their relations with each other, the ASEAN countries discovered that their unresolved bilateral disputes had become much less important and less intractable, so that on several important occasions they were able to arrive at mutually agreed solutions. Thus, growing ties between Manila and Kuala Lumpur led the Philippines to relinquish its claim to Sabah, while both Singapore and Malaysia as well as Indonesia and Malaysia have agreed to take their disputes over overlapping territorial claims to the International Court of Justice, and to abide by the Court’s decisions on the issues. In neither of these cases was ASEAN ever directly involved, yet the looming presence of ASEAN has clearly defused potential conflicts by transforming intra-regional relations from zero-sum to positivesum equations.9 It is clearly unrealistic to expect that the existence of ASEAN will remove all bilateral disagreements. In fact, besides bonding countries closer together, increasing interaction can also lead to more friction. Among the ASEAN countries, the growing movement of migrant workers from labour surplus to labour shortage members has been a major source of friction. This was clearly demonstrated by the diplomatic crisis between the Philippines and Singapore in early 1995, sparked by the execution of a Filipino maid accused of murder in Singapore, and the massive outcry from the Philippine public against both Singapore and its own government. This bilateral crisis was the worst in ASEAN since the 1968 crises.10 Yet, despite the seriousness of the situation, which led to the mutual recalling of the two countries’ ambassadors, ASEAN unity was never seriously jeopardized, and relations between Manila and Singapore returned to normal within a very short period, with no seemingly negative aftermath. This clearly proves that the ASEAN code of conduct for peaceful resolution of conflicts has become strongly embedded in the regional consciousness, and testifies to the growing resilience of ASEAN as a cohesive regional body. The enlargement of ASEAN to encompass the whole of Southeast Asia, a cherished ideal since the founding of the Association, will help to promote peace and stability in the wider Southeast Asian region. By becoming

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members of ASEAN, Vietnam, Laos, Myanmar, and Cambodia show that they share the Association’s commitment to regional peace and stability, seen as a prerequisite for economic development, which is the first national priority of all its members. Given the fact that ASEAN is already an established force at the time of its enlargement, and that the new members expect real benefits from their membership in the Association, one may be confident that the new members will abide by ASEAN’s rules and regulations, and more importantly by the unwritten norms and practices of the “ASEAN Way”, which has enabled the original members to live harmoniously together, notwithstanding their differences. This “ASEAN Way” includes the ability to disagree without being disagreeable, always striving to arrive at a consensus through deliberation, avoiding open conflict or confrontation, and giving as much importance to process as to outcome. The time-honoured “ASEAN Way” is also “to make haste slowly”. It is hoped that the new members will not find it difficult to adopt and adapt to this “ASEAN Way”, since this ensures that each member can have a voice and a veto in the organization. It is to be expected that the enlargement of ASEAN is closing the political chasm that has divided the two subregions of Southeast Asia for so long, so that we may look ahead to a more harmonious, peaceful and stable regional order. Of equal importance, common membership in ASEAN will undoubtedly stabilize relations among the mainland countries of Southeast Asia. Adherence to the ASEAN code of conduct, which includes respect for each other’s territorial integrity, non-intervention in each other’s internal affairs, and the renunciation of the use or threat of force, can be expected to transform bilateral relations among these new members of the Association. Smaller countries, which in the past had often been victims of aggression from their more powerful neighbours, will become more secure within the Association where every state, regardless of size, is treated as equal. Nevertheless, without diminishing the very positive political and security implications of ASEAN enlargement for regional peace and stability, the members should remain vigilant and not take the bright prospects for granted. Many have pointed to the fact that with a larger and more diversified membership it will be more difficult for ASEAN members to reach a consensus — the favoured way for making decisions within the Association. In fact, some difficulties may be more fundamental than formal style that can be overcome with time. As mentioned earlier, ASEAN’s role in preserving regional harmony has been largely indirect, and potential conflicts have been defused mostly through the exercise of self-restraint by the parties concerned, so as not to endanger ASEAN unity. While the Treaty of Amity and Co-operation binds the members to certain acceptable norms of behaviour, this code of

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conduct is still primarily based on the members’ goodwill to abide by the rules, with no provision for dealing with transgressions. Besides the natural attachment of the founding members to ASEAN so that they have always been careful to nurture it, the impetus for maintaining ASEAN unity had mostly emanated from the existence of common external threats. The situation has now changed, as there are no clearly defined threats which may act as a glue for the ASEAN members. Furthermore, the perceptions and expectations of the new members regarding the Association may be different from those of the original members. It should be kept in mind that the original members did not really expect ASEAN, as an association, to actually do something for them, beyond providing a conducive regional environment for their individual efforts to set their own house in order. In contrast, the new members see ASEAN as an influential and wealthy association, and they look to ASEAN to help them deal with their domestic problems, particularly in the economic field. The question is: will the new members become as committed to ASEAN as the original members, through thick and thin? Or will their support for ASEAN be conditioned upon concrete benefits that the Association is expected to yield? In other words, is ASEAN enlargement a marriage of minds and hearts, or is it just a marriage of convenience which may dissolve when the union is no longer beneficial? The test will come when national interests collide, such as the flaring of disputes over national boundaries between some of the mainland countries of Southeast Asia, and when regional interests seem to go against some members’ national interests. In such cases, goodwill and self-restraint may be severely tested, and it is a moot point whether a bilateral crisis of the same magnitude as the Manila–Singapore spat, involving a new member of ASEAN, will end as happily for the Association. There are also concerns that the historical suspicions that have characterized relations among some of the mainland countries of Southeast Asia will not be easily eradicated, and may in turn infect ASEAN, particularly given the large number of new members. At the same time, the habit of resorting to force to resolve conflicts, conditioned by prolonged involvement in wars, cannot be assumed to have been neutralized just because these countries have signed the Treaty of Amity and Co-operation, and that all members adhere to the ideals of ZOPFAN (Zone of Peace, Freedom and Neutrality) in Southeast Asia.11 It is important, therefore, that confidence-building measures and preventive diplomacy continue to be enhanced within the ASEAN family, and to inculcate a real sense of belonging towards the Association among the new members so that they do not feel like guests who can leave when they feel like it. Moreover, while cherishing the ASEAN ways of informality and emphasis on consensus, there is also a growing need for the ASEAN

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members to move towards more rule-based relations with each other, so that regional peace and harmony are not simply left to the goodwill of individual members. This means that ASEAN should be given the means to ensure that the regional code of conduct is strictly adhered to by all members. As Muthiah Alagappa argued: “Merely to urge states to renounce the use of force without giving sufficient teeth to the dispute resolution mechanism and not instituting arrangements for the collective management of power makes ZOPFAN vulnerable to the criticism of being a Utopian ‘fair weather system’”.12 In other words, the Treaty of Amity and Co-operation in Southeast Asia needs to be given more teeth, both in promoting compliance to the pacific settlement of disputes and in providing a mechanism for the resolution of conflicts. The time-honoured ASEAN way of sweeping problems under the carpet, and hoping that time will brush them away, will become increasingly untenable, given the growing diversity in membership and the emergence of new generations of leaders whose approach will be more straightforward and businesslike and, therefore, less patient with ASEAN’s indirect approach. ASEAN as a Promoter of Regional Security and Autonomous Regional Order Although ASEAN was never designed as a defence or security alliance, and in fact the founding members deliberately eschewed regional security co-operation, one of the most important functions of the Association was, nevertheless, to enhance regional security in the face of external aggression. Given the political and security environment surrounding the birth of ASEAN, it is not surprising that security concerns dominated regional thinking. While conventional military threats were not completely ruled out, most of the ASEAN countries were worried about non-conventional threats, particularly in the forms of communist subversion and insurgency. From the very beginning, therefore, the ASEAN countries developed the concept of comprehensive security, encompassing political, social, economic, and military aspects. Thus, the military component is only one of many aspects of security. ASEAN aims to develop national and regional resilience. To some extent, its objectives have been achieved by the members, despite the persistence of various internal weaknesses. Most of the ASEAN countries had been fragile entities with underdeveloped economies, facing both internal challenges and external threats. Over the past thirty years, the ASEAN states have become more resilient and self-assured, mostly because of the relative stability that the subregion has enjoyed and the great strides that the ASEAN countries have made in the economic field.

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The maintenance of harmonious relations among members of ASEAN has clearly been one of the most important components of regional stability. Such relations have not only removed the danger of political and military threats from fellow ASEAN members, but equally important, have ensured that other countries cannot employ one ASEAN state to threaten another ASEAN member. The presence of ASEAN, therefore, has to some extent acted as a cordon sanitaire insulating the members from external security challenges. Nevertheless, as long as Southeast Asia was divided into two different camps, the ASEAN subregion was never totally secure, particularly when there were continuing conflicts in Indochina which spilled over into ASEAN territory, notably into Thailand as the front-line state. These conditions also made it impossible for ASEAN to realize its ideal of creating a more autonomous regional order free from external interference as envisioned by the ZOPFAN concept. The ideal of a zone of peace, freedom and neutrality for the whole of Southeast Asia, first introduced in 1971, was aimed at reducing external interventions in the affairs of the region, as these interventions were mainly responsible for most conflicts and divisions that had taken place. Nevertheless, during the Cold War, this ideal remained a remote dream since the major powers with interests in the region opposed the ZOPFAN concept, while the other Southeast Asian countries did not share ASEAN’s vision. The ASEAN members themselves, moreover, also differed in their interpretations of ZOPFAN. The end of the Cold War has removed the obstacles that had divided ASEAN from other countries in the region. The entry of Vietnam, Laos, Cambodia and Myanmar into the Association will undoubtedly usher in a new era of security for Southeast Asia. By becoming members of ASEAN and adhering to the various rules, regulations and norms of the Association, these new members will be expected to uphold regional stability and maintain harmonious relations between one another and with the rest of ASEAN. Although some dangers remain, one may realistically hope that Indochina will no longer be a source of regional insecurity. In the past, ASEAN’s sense of insecurity was not only caused by the potential threat from a militarily powerful and expansive Vietnam, but equally or perhaps more urgently, the ASEAN countries felt threatened by China. There was, therefore, a considerable degree of apprehension that China would use the countries with which it had close relations, such as Cambodia under Pol Pot, and Myanmar, as a conduit for expanding its power and influence to Southeast Asia. With the enlargement of ASEAN, this fear has been considerably allayed. Common membership in ASEAN will lead to a greater homogeneity of the members’ perceptions regarding regional security. Although ASEAN does not have a common foreign and security policy

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like that in the European Union, in practice the members of ASEAN have developed the habits of close consultation with one another, regarding their respective external initiatives, so that their foreign policies are harmonized to a relatively high degree. This means that even in launching unilateral initiatives, an ASEAN state will normally seek the support of other members of the Association, ensuring that a unilateral initiative would not be detrimental to the regional interests as a whole. The enlargement of ASEAN will, therefore, spread the trend towards the harmonization of foreign and security policies from the ASEAN subregion to the whole of Southeast Asia. Such a situation will clearly reduce unpredictability and minimize the opportunities for foreign intervention, or for an external power to play one Southeast Asian state against another. The development of common security perceptions will also facilitate the efforts to realize the ideal of ZOPFAN in Southeast Asia. No longer divided among themselves, the Southeast Asian countries can now present a united front towards the outside world and seek international recognition for the realization of the zone of peace, freedom and neutrality in Southeast Asia, which is the primary objective of ASEAN’s political co-operation agreed upon in the 1976 Declaration of ASEAN Concord. In fact, a major step in this direction has already been taken. In December 1995, the heads of states/governments from all ten Southeast Asian countries met for an informal summit for the first time. The meeting, which took place in Bangkok, not only agreed on a tentative timetable for the entry of Cambodia, Laos and Myanmar into ASEAN, but of equal importance, the leaders also signed the Treaty on the Nuclear Weapon Free Zone for Southeast Asia (SEANWFZ), which is an important component of ZOPFAN. The end of the Cold War, however, may shift the relevance of ZOPFAN. ZOPFAN tends to be exclusionary vis-à-vis the major powers’ security involvement in Southeast Asia, while the reality is that the security of Southeast Asia cannot be separated from that of the Asia-Pacific as a whole. The trend is towards the development of a wider co-operative security structure, as manifested in the ASEAN Regional Forum (ARF). By forming the ARF, ASEAN implicitly recognizes that the major powers have a legitimate role to play in the security of Southeast Asia. Nevertheless, it can also be argued that the end of the Cold War and the establishment of the ARF do not necessarily make ZOPFAN irrelevant. For instance, Soedjati Djiwandono argued that “with the end of the Cold War, ZOPFAN in fact assumes even greater significance and has become even more relevant” for three major reasons. Firstly, there is uncertainty as to the emerging world order and the possibility that the new power constellation in the Asia-Pacific may create new security problems. Secondly, in the

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multipolar balance of power, the great powers are likely to continue to engage themselves in a competitive relationship because of the nature of international relations dominated by sovereign and independent states. Finally, seeds of domestic and regional conflicts remain. In Djiwandono’s view, ZOPFAN may be attained if it becomes more inward than outwardlooking. He stressed that the regional countries should put their own house in order, become less dependent on major powers for their security, and promote good neighbourly relations.13 The impact of ASEAN’s enlargement on regional security, particularly with regard to external threats and the ongoing development of a more autonomous regional order are overwhelmingly positive. Of course, it can be argued that the larger membership will make it more difficult for ASEAN to come to a consensus. Nevertheless, differences of opinion within a single ASEAN family are clearly qualitatively different from those between countries which are not members of the same grouping. The entry of new members into the Association, however, will bring additional challenges to security co-operation among the ASEAN members, which are currently being carried out at the bilateral or trilateral levels, outside the ASEAN context. Although there is no ASEAN-wide security co-operation, the existing bilateral security arrangements and military exercises have created a network of security relations which underpins ASEAN’s peace and stability. These multiple sets of dyadic relations have taken many years to nurture and cannot be easily duplicated by the new members. It will clearly take more time, effort and resources for the old and new members of ASEAN to create new sets of bilateral security cooperation which can be extended to all members. To facilitate closer security co-operation among all the ASEAN countries, both old and new, the time has come to consider the possibility of establishing ASEAN-wide security co-operation, without eliminating the existing bilateral and trilateral security ties. By establishing an ASEANwide security forum, all members can take part in various security-related activities, such as joint military exercises, military exchanges, and seminars. In such a way, efforts to build confidence will be greatly enhanced, as close co-operation among military personnel is the most effective way to remove mutual suspicions and promote transparency. By promoting closer security ties among themselves within a more cohesive framework, the ASEAN countries will also enhance their collective defence capability and strengthen their position in the ASEAN Regional Forum. Although the security of Southeast Asia is closely linked to that of the wider Asia-Pacific region, which explains the need for the ASEAN Regional Forum, there are nevertheless security issues which are intrinsically limited to the Southeast Asian region, and should be solved by these countries

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themselves. Moreover, to maintain its core position in the ASEAN Regional Forum, ASEAN also needs to develop and strengthen its own security core. One way to do this is to develop a framework for ASEAN security cooperation. To take an economic analogy, ASEAN needs to develop an ASEAN Free Trade Area as a preparation for participating in the much larger trade liberalization under APEC (Asia-Pacific Economic Cooperation). Unlike economics, where regionalism is always regarded as second best, and the first preference is for an unhampered global trading system, in security, the reverse is true. Internationalization is not always the best way to deal with a security problem. Instead, security problems should be localized as far as possible, thereby giving special importance to subregional organizations and other limited forms of security arrangements. Suggestions for ASEAN to include co-operation on regional security as part of its agenda are not new, although official response to these suggestions was mostly negative in the past. As early as 1990, for instance, Jusuf Wanandi wrote that there was a “need for ASEAN to develop a multilateral military cooperation which is defensive in nature”. Wanandi argued that ASEAN could seek assistance from Japan both in the acquisition of technology and financing. ASEAN military co-operation could be specifically directed to guard and secure the sea lanes of communication (SLOCs) in Southeast Asia from pollution, collision, or piracy.14 An ASEAN security arrangement, designed to address immediate ASEAN security concerns, can be viewed as a sub-system within the wider ARF, in the same way that the bilateral alliances between the United States and Japan or between the United States and South Korea, or the multilateral alliances of the Five Powers Defence Arrangement can be regarded as sub-systems within the wider regional framework. ASEAN as an International Bargaining Tool One of the greatest successes of ASEAN has been in the area of regional and international diplomacy. The collective weight of ASEAN has made this regional association a force that has to be taken seriously, even by the major world powers. ASEAN’s role as an international bargaining tool has not only benefited its members collectively, but the Association has also been deployed successfully to support individual member’s negotiating positions in the international arena. ASEAN’s international influence extends well beyond the cumulative power of its members, if judged by their economic and military capabilities alone. The increasing importance of ASEAN can be seen from its central role in the recently established ASEAN Regional Forum, the first forum for multilateral security dialogue in the Asia-Pacific. Within this forum,

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ASEAN is regarded as an actor that must be taken into account, alongside the major players in the Asia-Pacific region, which include the United States, China, and Japan. In Southeast Asia, ASEAN’s authority has mostly been unchallenged, as external powers defer to ASEAN’s positions on many crucial issues, including the Cambodian question. Similarly, ASEAN occupies an important position in APEC. APEC, which was first proposed by Australia, would not have taken off if ASEAN had remained opposed to the idea. The special position that ASEAN occupies in APEC can be gauged from the fact that the annual APEC meetings rotate from an ASEAN country to a non-ASEAN country. The launching of the Asia-Europe Meeting (ASEM) also enhances ASEAN’s international role, particularly in its dealings with the European Union. The enlargement of ASEAN to cover the whole of Southeast Asia, with a total population of around 500 million people, will undoubtedly add more weight to ASEAN and consequently enhance its position vis-à-vis the outside world. A united stance by the whole of Southeast Asia on various political and security issues, such as those involving Cambodia, the South China Sea, nuclear disarmament, or the security of the sea lanes, will strengthen ASEAN’s negotiating positions. External powers also need to pay much more attention to ASEAN, particularly on issues concerning the Asia-Pacific as a whole. Yet, the enlargement has also brought new problems for ASEAN diplomacy, at least in the short run. The controversy over Myanmar’s entry has affected ASEAN’s relations with its Western Dialogue Partners, since the latter have refused to deal with Myanmar before democracy is restored in that country. ASEAN’s insistence on admitting Myanmar at the same time as Laos in July 1997 drew sharp criticism from the United States, the European Union, and other Western Dialogue Partners of ASEAN. These Dialogue Partners insist that Myanmar be excluded from various ASEAN projects funded by the former. Britain, the host of a recent ASEM meeting, also excluded Myanmar from its invitation list. This was possible because participation in ASEM is based on individual country membership, despite the fact that most of the members belong to two regional organizations, ASEAN and the European Union. Until its international reputation is restored, which is dependent on its domestic political performance, Myanmar may prove to be a liability for ASEAN, particularly in the Association’s relations with the Western countries. At a time when international attention is focusing more and more on issues such as democratization, good governance, and the protection of human rights, ASEAN’s political image has been tarnished by its embrace of Myanmar, as it gives the impression that the Association is insensitive to these issues. Of equal importance, ASEAN has come under strong criticism from pro-democratic forces in the region, including from

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Aung San Suu Kyi and the opposition in Myanmar, who fear that Myanmar’s membership in ASEAN will only serve to strengthen the military regime by giving it regional legitimacy. For its part, ASEAN has a strong argument on these issues. ASEAN firmly believes that its policy of constructive intervention will speed up political and economic reform in Myanmar. After all, Myanmar had embraced self-imposed isolation for so long that further isolation of the country is unlikely to improve the situation there. By allowing Myanmar to participate in regional affairs and showing it the many advantages of regional co-operation, which in turn will open the door for wider international interaction, ASEAN hopes to induce the Myanmar Government to change its ways and adopt a more reconciliatory approach towards its political opponents. In the meantime, ASEAN’s reputation is on the line. The world is waiting to see whether ASEAN’s policy of constructive engagement will indeed bring about the desired results, or whether the sceptics will be proven right. It is now up to Myanmar, with active encouragement from ASEAN, to confound the sceptics and show that its membership in ASEAN will not only be beneficial for the region as a whole, but that it will usher in a new era of stability and prosperity for Myanmar itself. Otherwise, ASEAN’s hard-earned international standing may suffer irreparable damage from its close association with a country which is still viewed by many as a pariah state. The Institutional Implications of ASEAN’s Enlargement It is difficult to determine whether ASEAN’s enlargement will lead to significant changes in ASEAN’s institutional structure. Since its establishment as a loose regional association with limited forms of cooperation without any central body in 1967, ASEAN has gradually grown to become a much more structured organization with an ever widening and deepening area of co-operation. The ASEAN Secretariat, established in 1977 as nothing more than a glorified post office and headed by the Secretary-General of the ASEAN Secretariat, has been transformed into a much more influential body. Since 1992, the position of Secretary-General has been promoted to become the Secretary-General of ASEAN, with ministerial rank. To facilitate ASEAN economic co-operation and the establishment of an ASEAN Free Trade Area, the various ASEAN economic committees, which had formerly been overseen by the ASEAN Economic Ministers’ Meetings (AEMM), have been consolidated, and their activities are co-ordinated by the ASEAN Secretariat. This move has given more influence to the ASEAN Secretariat, although ASEAN is still a long way from becoming an integrated regional organization with supra-regional

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power like the European Union. The evolution of ASEAN’s institutional structure has been stimulated by the growing scope of ASEAN regional co-operation, particularly in the economic and functional fields. The enlargement of ASEAN, without a further intensification of ASEAN cooperation, will not necessarily lead to a strengthening of the organization. Nevertheless, certain changes are likely to occur as a consequence of ASEAN’s enlargement. In cognizance of the limited means of the new members, efforts are likely to be made to streamline ASEAN activities. Presently, there are well over 200 ASEAN meetings annually, reflecting the proliferation of ASEANrelated projects. Given their limited qualified manpower and financial resources, some new members will find it difficult to participate in every ASEAN meeting or project. Ways and means must, therefore, be found to enable the new members to benefit from the various ASEAN activities without being overburdened by their regional obligations. Yet at the same time, they must not be made to feel like second-class members. To increase ASEAN’s effectiveness, particularly during an economic crisis, not only should activities and programmes be streamlined, but ASEAN’s capacity for decision-making and collective action should be enhanced through procedural reform and institutional renovation. At the same time, special efforts are needed to encourage the participation of nonstate actors in ASEAN activities, particularly the private sector and nongovernmental organizations. Such participation would broaden and deepen ASEAN’s functional linkages. Although the preferred method of decision-making in ASEAN is deliberation to reach a consensus, ASEAN’s enlargement and increased diversity in membership will undoubtedly make that more difficult than before. To ensure that ASEAN does not become mired in endless talks in which agreements will be of the lowest common denominator, ASEAN may have to resort to voting more frequently in the future, applying the nine or ten minus x formula. ASEAN is, in fact, quite flexible in this respect, particularly on economic and functional issues. The staggered timetable for the new members’ obligation to join AFTA is an indication of that flexibility. Such flexibility, however, is unlikely to be extended to the political and security fields where consensus is likely to remain the rule. Furthermore, the ASEAN Secretariat is unlikely to play a role in this area. The enlargement process has, nevertheless, given a more central role to the ASEAN Secretariat in several fields. The Secretariat has been assigned the role of teacher and mentor to the prospective/new members, familiarizing them in the various aspects of ASEAN and inducting them in the ASEAN ways. Consequently, from the very beginning, the new members have been conditioned to become more dependent on the ASEAN Secretariat. This is a very different situation from the relations between

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the original members and the Secretariat. It took the original ASEAN members many years to agree to the establishment of the ASEAN Secretariat, and even then, they were reluctant to give any meaningful power to the Secretary-General. The ASEAN governments are happy that the Secretariat can now do most of the studies needed for implementing ASEAN co-operation, as few of the officials in the respective ASEAN countries have the continuity of assignments to develop expertise on ASEAN, or the time to prepare the paper-work for the numerous ASEAN meetings. Nevertheless, ASEAN is still regarded as a dependent variable, so that the ASEAN Secretariat is not allowed to assume a decision-making role, which remains the exclusive domain of the national governments. While it is also highly unlikely that the new members would wish to see a more supra-national role for ASEAN, their expectations of concrete economic benefits from the Association and the important role that the ASEAN Secretariat is playing in helping them cope with their new status, will probably mean that the former will be more sympathetic to the strengthening of the ASEAN Secretariat. The new members’ positive view of the active role of the ASEAN Secretariat, however, has mostly been due to the fact that the (then) Secretary-General, Dato Ajit Singh, was a strong champion of their early entry into ASEAN. However, if in the future, the Secretary-General were to support the policy of constructive intervention towards these countries, by calling for domestic political reforms, democracy and the protection of human rights, their enthusiasm for a more active ASEAN Secretariat may diminish. ASEAN is likely to continue to be a rather loose regional organization with no supranational authority, compared with the European Union, but the growing integration of the ASEAN region is probably unavoidable. The recent regional crises, such as the spread of haze from forest fires in Indonesia, and the contagion effect of the currency crisis in Thailand to other members of ASEAN and beyond, call for more concerted regional efforts to contain them. The political crisis in Cambodia has also led ASEAN into unchartered waters, with its policy of “constructive intervention”. Without too much fanfare and formal debate, the ASEAN institutional structure will very likely continue to evolve naturally, in response to various regional and international events, making ASEAN into an ever more structured and powerful organization than its original founders had ever conceived. In fact, the prolonged economic crisis can act as a powerful new glue bonding the ASEAN members closer together. As a way of reducing the members’ dependence on foreign currencies, particularly the U.S. dollar, the ASEAN Summit in Kuala Lumpur in December 1997 called for an increase in the use of local currencies in intra-regional trading. The ASEAN

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leaders even considered the possibility of introducing an ASEAN unit of payment as well as establishing an ASEAN Fund. To its Dialogue Partners, the enlargement of ASEAN is seen in mixed light. Now that the Cold War is history, and there is no longer any need for the major powers to foster proxy relationships among countries in Southeast Asia, ASEAN’s enlargement is viewed as inevitable and even welcomed. The prospect for greater peace and stability covering the whole of Southeast Asia encourages greater potential for economic development in areas that had in the past been ignored by foreign investors. The promise of a large ASEAN market of about 500 million people after AFTA is realized is another factor that makes the Dialogue Partners look favourably towards the enlargement. On the other hand, most of the Western countries have opposed Myanmar’s entry into ASEAN. ASEAN’s increasing assertiveness, mostly because of its past political and economic successes but also bolstered by its growing membership, has also led to some differences with Western Dialogue Partners over other issues, especially those on democracy and human rights. This may change as a result of ASEAN’s present economic predicament, which will make the ASEAN leaders less prone to preach about the superiority of “Asian values”. However, if the crisis were to deepen further — which ASEAN may blame on Western capital speculation and domination — the Association’s relations with its Western Dialogue Partners could come under further strain. Conclusion The enlargement of ASEAN brings about various political and security implications, and to some extent, may affect the Association’s institutional structure. On the whole, however, the inclusion of all Southeast Asian countries within one regional organization, as envisaged by the founders of ASEAN, will benefit the region. An expanded ASEAN will promote regional harmony by reducing intra-regional tensions and disputes. It will also enhance regional security as the members’ perceptions and policies on regional political and security issues become more convergent, which in turn will reduce the opportunities for external intervention in regional affairs. The enlargement of ASEAN also enhances the Association’s geopolitical weight in global and regional affairs, and increases its leverage in dealing with the major powers, such as the United States, China, Japan, and the European Union. All of these factors will forge a new sense of regional self-confidence and identity. The enlargement of ASEAN may also bring disadvantages to the Association. The most obvious disadvantage is the danger that it will become much harder for ASEAN to reach a consensus, because of the

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existing differences between the old and new members. The absence of a common external threat, which had acted as an effective glue for ASEAN during the Cold War, may also slow down the forging of a more cohesive ASEAN. There is also some danger that the historical suspicions between certain countries may infect ASEAN. The fact that many of the new members have been involved in protracted conflicts, in which threats and use of force were commonplace, throws some doubt on their ability to conform easily to the ASEAN code of conduct, which insists on the pacific settlement of disputes. On a more immediate basis, the enlargement of ASEAN to include Myanmar is causing some complications in ASEAN’s relations with its Western Dialogue Partners, particularly the United States and the European Union. To minimize the risks and capitalize on the gains, ASEAN should carry out certain measures to strengthen the Association and to ensure that regional stability is not totally dependent on the political will of the respective members. ASEAN needs to explore the possibility of expanding its political and security co-operation to enable the region to develop into a real security community with an assured, rather than a conditional, peace. Towards this end, there is a need to give more teeth to the Treaty of Amity and Co-operation in Southeast Asia so that its enforcement is not simply based on a best-case scenario situation as it is now. There is also a growing need to develop an ASEAN-wide security co-operation, not only to integrate the new members into the existing security networks among the ASEAN countries, but equally important, to strengthen the ASEAN core in the ASEAN Regional Forum.

Notes 1

2

3 4 5

Much has been written about the early days of ASEAN. See, for example, Bernard K. Gordon, “Regionalism in Southeast Asia”, in Man, State and Security in Contemporary Southeast Asia, edited by Robert O. Tilman (London: Pall Mall, 1969). See Michael Leifer, “Problems and Prospects of Regional Cooperation in Asia: The Political Dimension”, Indonesian Quarterly 4, Special Issue (1976): 92– 104. See also Charles E. Morrison and Astri Suhrke, Strategies of Survival: The Foreign Policy Dilemmas of Smaller Asian States (St Lucia: University of Queensland Press, 1978). Ulrich Grundler, “China’s Future Role in Southeast Asia”, in New Directions in International Relations in Southeast Asia, edited by Lau Teik Soon (Singapore: ISEAS, 1973), pp. 53–60. For Indonesia’s policy towards ASEAN, see Dewi Fortuna Anwar, Indonesia and ASEAN: Foreign Policy and Regionalism (Singapore: ISEAS, 1994). See Robert O. Tilman, The Enemy Beyond. External Threat Perceptions in the ASEAN Region, Research Notes and Discussion Paper no. 42 (Singapore: ISEAS, 1984).

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12 13 14

Dewi Fortuna Anwar See Anwar, Indonesia and ASEAN, especially chapter 5. Estrella D. Sollidum, Towards a Southeast Asian Community (Quezon City: University of Philippines Press, 1974). See Hans H. Indorf, Impediments to Regionalism in Southeast Asia. Bilateral Constraints among ASEAN Member States (Singapore: ISEAS, 1984). Dewi Fortuna Anwar, “Twenty-Five Years of ASEAN Political Cooperation”, in ASEAN in a Changed Regional and International Political Economy, edited by Hadi Soesastro (Jakarta: CSIS, 1995). Dewi Fortuna Anwar, “Maid Issue Tests ASEAN Unity”, Jakarta Post, 10 April 1995. For a discussion of the costs and benefits of an expanded ASEAN, see Carlyle A. Thayer, ASEAN’s Expanding Membership, Submission to the Foreign Affairs Sub-Committee, Joint Standing Committee on Foreign Affairs, Defence and Trade (ASEAN Inquiry), Vol. I, Nos. 1–7, Canberra, March 1997. Muthiah Alagappa, “Regional Arrangements and International Security in Southeast Asia: Going Beyond ZOPFAN”, Contemporary Southeast Asia 12, no. 4 (March 1991): 291. J. Soedjati Djiwandono, “ZOPFAN: Is It Still Relevant?”, Indonesian Quarterly 19, no. 2 (1991): 115–30. Jusuf Wanandi, “Peace and Security in Southeast Asia”, ASEAN ISIS Monitor, Workshop Report (Bangkok, 10–13 May 1990), pp. 12–13.

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Impact and Implications of ASEAN Enlargement on Trade

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3

NATTAPONG THONGPAKDE*

Introduction ASEAN (Association of Southeast Asian Nations) leaders proclaimed in the Bangkok Declaration of 1995 that “ASEAN shall work towards the speedy realization of an ASEAN comprising all Southeast Asian countries as it enters the 21st century.” This indicates clearly that the enlargement of ASEAN to cover the entire Southeast Asian region is a priority and the ultimate objective of ASEAN regional co-operation. Subsequently, in July 1997 ASEAN accepted the Lao People’s Democratic Republic (PDR) and Myanmar as full members of ASEAN. Owing to internal political conflict, Cambodia was not granted membership at that time, but was integrated later in April 1999. The new members joined the Common Effective Preferential Tariff (CEPT) scheme, which is the key mechanism to integrate the ASEAN economies into the ASEAN Free Trade Area (AFTA). However, they have been given additional time to adjust their tariff schedules: Vietnam started reducing tariff rates in January 1996 and will reach the target in 2006, while the Lao PDR and Myanmar will have to complete their tariff reduction by 2008, eight years after the ASEAN-6 members.

* The author would like to thank Dr. Srawooth Paithonpong and Dr. Wisarn Pubhavesa for helpful comments. 45

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AFTA has become a main instrument to fulfill ASEAN’s objective towards free trade and investment, and an easing on the movement of people. ASEAN is not a homogeneous group: there are considerable differences among the members with respect to size, history, and level of industrialization and development (Ariff 1995). The inclusion of the new members aggravates the differences. These new members are still in the process of adjusting their institutions towards market-orientation. Furthermore, they have limited experience in international economic fora. Although the enlargement of ASEAN can create trade and economic opportunities, the new members may have difficulty restructuring their economies to take advantage of them. Such problems could also delay greater resource mobility within ASEAN. To enhance ASEAN co-operation, it is important to assess the positive impact of incorporating the new members and to identify the obstacles to future co-operation. This chapter aims to examine both, with special reference to trade issues. It will explore economic structures, trade patterns, and comparative advantages of the ASEAN members in order to analyse the impact and implications on trade of an enlarged ASEAN, and the potential for the future co-operation of ASEAN. In this chapter, the term ASEAN-6 refers to the “old” members: Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand. The term “new members” refers to Cambodia, Lao PDR, Myanmar, and Vietnam. The term “ASEAN-10” is loosely used to include the present members.

COMPARISON OF SOCIO-ECONOMIC DEVELOPMENT Income, Population, and Structure of Production The economies of the new ASEAN members are much smaller compared with the older ones, although Vietnam and Myanmar have larger gross domestic product (GDP) than Brunei, the smallest economy in the ASEAN-6. In 1994, Vietnam’s GDP, the largest of the new members, was $15,570 million, compared with that of the Philippines, the smallest of the ASEAN-5, which was $64,162 million (Table 3.1). The Lao PDR’s GDP was only $1,534 million in 1994. Including new members, therefore, increases the variation of the size of the ASEAN economies. The coefficient of variation of GDP rises from 0.70 for the ASEAN-6 to 1.11 for the ASEAN-10. Table 3.1 shows the differences in per capita income. The Lao PDR’s per capita GDP was $320 in 1994, which was only one-fourth of the per capita GDP of Indonesia, and one-seventh of Singapore’s. The ASEAN-6 also show disparity of income per capita: the coefficient of variation of GDP per capita of the ASEAN-6 members is 1.19. The variation will be

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significantly reduced if Singapore is excluded. However, for the ASEAN10 the coefficient of variation rises to 1.67. The GDP growth rates of the ASEAN members were quite high compared with other developing countries. The average growth rate of GDP of Malaysia, for instance, was 8.4 per cent per annum during 1990–94. The growth rates were 8.3 per cent, 8.2 per cent, 7.6 per cent for Singapore, Thailand and Indonesia, respectively, during the same period. Only Brunei and the Philippines had disappointing growth rates of less than 2 per cent per annum. The growth rates of the new members were satisfactory although they were not as high as those of some older members. The GDP growth rates were: 8 per cent per annum for Vietnam, 6.2 per cent per annum for Lao PDR, and 5.7 per cent per annum for Myanmar. While the economies of these new members are small, their populations are not negligible. Myanmar, Vietnam, Thailand, and the Philippines have TABLE 3.1 ASEAN-10: Key Economic Indicators GDP Countries

(Mil. US$)

GDP per Capita (US$)

GDP Population Growth Rate 1990–94 1995

Brunei Indonesia Malaysia Philippines Singapore Thailand ASEAN-6 Coef. of variation Cambodia Laos Myanmar Vietnam ASEAN-10 Coef. of variation

3,900 174,640 70,626 64,162 68,949 143,209

17,000 880 3,480 950 22,500 2,410

0.3 7.6 8.4 1.6 8.3 8.2

... 195.3 20.1 70.3 2.99 59.4

0.7012424 2,376 1,534 10,368 15,570

1.196332497 241 320 236 200

... 6.2 5.7 8

10.2 4.71 44.74 73.96

1.1132822

1.668663991

SOURCE: World Bank, World Development Report, 1996 (New York: Oxford University Press, 1996). For Brunei, from John Andrew, The Economist Pocket Asia (UK: Profile Books Ltd, 1997). For Cambodia and Myanmar, from Asian Development Bank, Key Indicators of Developing Asian and Pacific Countries (New York: Oxford University Press, 1996).

© 2001 Institute of Southeast Asian Studies, Singapore

48

Nattapong Thongpakde

similar numbers of people. The population in the ASEAN-10 is 38 per cent larger than the ASEAN-6, amounting to 481.6 million persons. Regarding the structure of production in the ASEAN economies, agriculture is the dominant sector in the new members. The share of agriculture in GDP is as high as 63 per cent for Myanmar, 47 per cent for Cambodia, and 51 per cent in the case of the Lao PDR. The share of agriculture in Vietnam is only 28 per cent, but that is still higher than those of the older members. The shares of agriculture in Singapore and Brunei are negligible. The Philippines’ agricultural sector constitutes 22 per cent of GDP, the highest among the ASEAN-6, followed by Indonesia at 17 per cent (Table 3.2). Social Development Table 3.3 presents selected social indicators. Among the new members, Vietnam has better indicators on education and healthcare. Adult literacy rate in Vietnam was 94 per cent in 1995, the same ratio as Thailand’s and second to Singapore’s. Myanmar also has a high adult literacy rate. Vietnam’s gross secondary school enrolment ratio was better than that of Thailand, which has the lowest rate among the older members. The Lao PDR and Cambodia face problems in education as well as healthcare, while

TABLE 3.2 ASEAN-10: Sectoral Share of GDP, 1995 (In per cent) Agriculture

Manufacturing

Other Industry

Service

Brunei Indonesia Malaysia Philippines Singapore Thailand

2 17 14 22 0 10

46 24 32 23 27 29

8 17 12 10 9 11

44 42 42 45 64 50

Cambodia Laos Myanmar Vietnam

47 51 63 28

7 13 7 22

9 5 2 7

37 31 28 43

SOURCE: ADB, Key Indicators of Developing Asian and Pacific Countries (New York: Oxford University Press, 1996). For Brunei and Cambodia, from John Andrew, The Economist Pocket Asia (UK: Profile Books Ltd, 1997).

© 2001 Institute of Southeast Asian Studies, Singapore

© 2001 Institute of Southeast Asian Studies, Singapore

… 31 23 43

Cambodia Laos Myanmar Vietnam

… 19 23 40

39 61 75 71 37

Female

57 83 94

88 84 83 95 91 94

Rate**(1995)

Adult Litercy

49.5 50 54 63

72.6 61 69 65 73 66

Male

52.4 53 58 68

76.4 65 73 69 78 72

Female

Life Expectancy at Birth**(1995)

3040

27000 6495

1323 7238 2656 1016 753 4361

1995

Population per Doctor**

790 450 501 537

5.1 166 10.1 74 2.8 36.4

1995

No. of People per Telephone*

SOURCES: ADB, Key Indicators of Developing Asian and Pacific Countries (New York: Oxford University Press, 1996). * John Andrew, The Economist Pocket Asia (UK: Profile Books, 1997). ** United Nations, Statistical Yearbook for Asia and Pacific (New York: United Nations, 1996).

48 56 71 69 38

Brunei Indonesia Malaysia Philippines Singapore Thailand

Male

Gross Secondary School Enrolment Ratio (%) (1995)

TABLE 3.3 Social Development Indicators

Impact and Implications of ASEAN Enlargement on Trade 49

50

Nattapong Thongpakde

life expectancy at birth of these two countries are lower than that of Myanmar and Vietnam. The Lao PDR has 27,000 persons per doctor, while in Vietnam, there are 3,040 persons per doctor, which is high and comparable to some older members. From these indicators, one may conclude that Vietnam is not much different from some older members of ASEAN, while other new members are lagging behind. However, infrastructure in Vietnam is much less developed. Nevertheless, it had one telephone line for 537 persons in 1995, almost three times higher than Indonesia which had the highest ratio among the older members. The ratios in Cambodia, Lao PDR, and Myanmar were also very high. In summary, although the ASEAN-6 is not homogenous, the incorporation of new members widens the difference in social and economic characteristics. ASEAN TRADE PATTERNS Intra-ASEAN Trade Trade data in Table 3.4 show that intra-ASEAN trade is greater among the ASEAN-6 than with the new members, even though the share of trade with the new members rose between 1990 and 1995. Trade among the ASEAN-6 represented 93 per cent of exports and 97.7 per cent of imports in 1995. The corresponding shares were 98.3 and 97.5 respectively in 1990. The new members depend more on trade with the old members than among themselves. The ASEAN-6 are important to the new members for both markets and supplies. Thailand’s share of trade with the new members is higher than that of other old members, though it is not much higher than those of Indonesia and Singapore. Nevertheless, intra-ASEAN trade is moderate. Intra-ASEAN exports of the ASEAN-6 as a percentage of total exports was 23.6 per cent in 1995. The share was as low as 6 per cent in the case of Indonesia and as high as 30 per cent in the case of Singapore in the same year. Import dependence within ASEAN has been less than export dependence, with the exception of Brunei. Consequently, the ASEAN-6 have depended on imports of machinery and materials from the industrialized countries for production; and ASEAN does not provide major markets for the old members, although intra-ASEAN trade has been rising. Compared with the ASEAN-6, the new members depend more on the ASEAN market. For Cambodia, the share of exports to ASEAN was 64 per cent; while it was 54 per cent, 25.7 per cent, and 13.8 per cent for the Lao PDR, Myanmar, and Vietnam, respectively. Cambodia and the Lao PDR have stronger trade relations with ASEAN than Myanmar and Vietnam. The share of ASEAN imports of the new members was higher

© 2001 Institute of Southeast Asian Studies, Singapore

With New members (%)

© 2001 Institute of Southeast Asian Studies, Singapore

97.5

58.3 80.0 100.0 97.8

Total ASEAN-6 98.3

78.1 90.9 99.1 92.8

93.2

Cambodia Laos Myanamar Vietnam

Total New Members

6.8

21.9 9.1 0.9 7.2

1.7

0.0 1.6 0.7 1.8 1.9 4.6

4.8

41.7 20.0 1.0 2.2

2.5

0.0 2.4 1.4 9.8 0.6 6.4

% Intra-ASEAN Trade

With ASEAN-6 (%)

With New members (%)

1991 Value Intra-ASEAN Trade

% Intra-ASEAN Trade

541

32 44 116 349

26824

462 2556 8664 396 11796 2750

829

24 90 174 541

24039

422 1857 5561 1394 10436 4369

18.0

76.2 68.8 27.8 13.8

19.0

20.9 10.0 29.4 7.3 22.4 11.9

22.3

42.9 60.4 26.0 19.0

15.0

42.2 8.4 19.1 10.7 17.1 13.1

82.6

90.9 38.8 100.0 84.0

93.0

100.0 91.9 97.2 93.2 91.7 89.9

95.2

91.0 94.0 100.0 95.3

97.7

100.0 97.0 98.7 98.8 97.4 96.6

17.4

9.1 61.2 0.0 16.0

7.0

0.0 8.1 2.8 6.8 8.3 10.1

4.8

9.0 6.0 0.0 4.7

2.5

0.0 2.0 1.3 1.2 2.6 3.4

1473

219 188 312 754

73591

484 2536 20441 2306 35851 11973

5872

1162 464 1070 3176

57561

2006 2165 13537 2897 27704 9252

24.7

64.0 54.0 25.7 13.8

23.6

22.7 5.9 27.6 13.4 30.3 21.1

36.5

75.4 70.3 46.7 27.4

16.6

58.2 5.5 17.4 10.2 22.3 12.5

Export Import Export Import Export Import Export Import Export Import Export Import

Value Intra-ASEAN Trade

SOURCE: International Montary Fund, Direction of Trade (1996).

95.2

100.0 97.6 98.6 90.2 99.4 93.6

Export Import Export Import

With ASEAN-6 (%)

100.0 98.4 99.3 98.2 98.1 95.4

Brunei Darussalam Indonesia Malaysia Philippines Singapore Thailand

Countries

1990

TABLE 3.4 Intra-ASEAN Trade

Impact and Implications of ASEAN Enlargement on Trade 51

52

Nattapong Thongpakde

than that of exports, at 75.4 per cent, 70.3 per cent, 46.7 per cent and 27.4 per cent in the case of Cambodia, the Lao PDR, Myanmar, and Vietnam, respectively. Trading Partners of the New Members Tables 3.5 and 3.6 present data on the major trading partners of the new members. Within ASEAN in 1995, Singapore was the biggest market TABLE 3.5 Major Trading Partners of ASEAN’s New Members: Exports

Exporters

Year

Cambodia 1989 1990 1991 1992 1993 1994 1995

USA

Rest of the Japan Malaysia Singapore Thailand Vietnam World

0 0 0 0 0 1 5

2 3 5 8 79 8 7

7 15 9 13 12 24 13

0 0 0 7 19 29 38

2 9 10 85 95 115 146

4 7 5 6 7 16 20

6 8 28 46 51 47 113

Lao PDR

1989 1990 1991 1992 1993 1994 1995

1 0 2 6 8 9 10

7 5 4 11 11 28 27

0 0 0 0 0 1 0

0 0 0 0 0 3 10

40 40 43 37 57 63 63

3 4 33 7 38 94 115

44 15 0 43 70 239 123

Myanmar

1989 2 1990 9 1991 227 1992 38 1993 46 1994 66 1995 79

18 28 45 43 65 69 86

5 9 16 17 52 25 63

21 46 81 98 101 128 192

2 49 0 0 0 29 37

1 1 0 0 0 0 0

166 275 185 528 628 628 757

Vietnam

1989 0 1990 0 1991 0 1992 0 1993 0 1994 95 1995 191

261 340 719 834 937 1179 1560

2 5 14 68 56 65 115

71 195 425 402 380 593 408

15 52 58 71 72 98 39

SOURCE: IMF, Direction of Trade (1996).

© 2001 Institute of Southeast Asian Studies, Singapore

2122 1932 973 1543 1540 2024 3158

Impact and Implications of ASEAN Enlargement on Trade

53

TABLE 3.6 Major Trading Partners of ASEAN’s New Members: Imports

Importers

Year USA

Cambodia 1989 1990 1991 1992 1993 1994 1995

Rest of the Japan Malaysia Singapore Thailand Vietnam World

0 0 0 18 20 8 30

4 5 7 252 55 71 84

1 0 2 9 144 51 84

0 0 0 276 406 421 550

0 1 5 72 197 286 367

12 10 7 7 106 85 105

35 40 601 117 53 229 322

Lao PDR

1989 1990 1991 1992 1993 1994 1995

0 1 1 1 5 6 2

27 22 23 31 41 37 32

0 0 0 0 1 1 1

0 0 0 5 11 31 45

70 72 84 133 193 321 390

3 18 4 18 16 23 28

29 36 42 70 85 222 162

Myanmar

1989 1990 1991 1992 1993 1994 1995

12 19 26 5 14 12 18

76 111 91 106 110 75 173

5 32 74 99 114 244 255

11 119 296 289 368 430 701

1 20 4 0 0 98 63

0 0 0 0 0 0 0

89 367 577 559 642 730 1083

Vietnam

1989 0 1990 1 1991 1 1992 2 1993 4 1994 44 1995 278

106 169 158 239 452 586 1014

1 1 6 36 25 66 295

41 497 722 822 1058 1146 1969

2 17 14 41 100 226 515

2881 2156 1582 1887 2285 3758 7515

SOURCE: IMF, Direction of Trade (1996).

for Myanmar, followed by Malaysia and Thailand. Myanmar exports to the United States and Japan were larger than to Malaysia and Thailand. With respect to imports, Singapore and Malaysia were the two major suppliers to Myanmar, with an import value of US$701 million from Singapore and US$225 from Malaysia, which was greater than imports from Japan.

© 2001 Institute of Southeast Asian Studies, Singapore

54

Nattapong Thongpakde

In the case of Vietnam, Singapore and Malaysia were the principal ASEAN markets, although they were less important than Japan. However, with respect to import trade, Singapore was the largest supplier of Vietnam, while Japan was the second. Among ASEAN suppliers, Thailand was second, followed by Malaysia. The picture was quite different for the trading patterns of Cambodia and the Lao PDR. These two countries relied more on ASEAN markets, especially Thailand, which was the major market for Cambodia and second to Vietnam for the Lao PDR. Thailand was the major supplier for the Lao PDR, but second to Singapore in Cambodia. However, the trade statistics do not include informal cross-border trade, which is significant between Thailand and the new members, and also among the new members themselves. Major Exporting Products Table 3.7 summarizes the major exports of the new members. These include natural resources, especially wood products, rice, vegetable, fish, minerals, and agricultural products. Some countries have also begun to export manufacturing products, such as vehicle tyres and garments. Finally, electricity is a very important export for the Lao PDR.

TABLE 3.7 Principal Exports of Selected ASEAN Countries Countries

Major Export Products

Cambodia

Rice, fruit and vegetables, timber, vehicle tyres, gemstones, agricultural products, electronic equipment, cigarettes, alcohol, and construction materials

Laos

Timber and timber products, hand-made products, bamboo, coffee, tea, minerals, forest products, animal products, and electricity

Myanmar

Rice, tin, crude rubber, timber, precious stones, fibre and animal feeds, fish and fish products, vegetables, ores, manufactured goods, and telecommunications equipment

Vietnam

Oil, rice, peanuts, beans, rubber, steel, marine products, timber, corn, cashew nuts, black pepper, coal, tin, salt, cattle hide, rattan, jute, hand-made products, tea, fresh fruits, and vegetables

© 2001 Institute of Southeast Asian Studies, Singapore

Impact and Implications of ASEAN Enlargement on Trade

55

Comparative Advantage Analysis To examine the comparative advantage of the ASEAN members, revealed comparative advantage (RCA) indices were calculated at the two-digit standard international trade classification (SITC) level. RCA is defined as the share of a product group in one country’s exports divided by that group’s share of world trade. Thus, RCAij = (Xij/Xiw)/Xj/Xw) where X = i= j= w=

exports sector country world

A value of greater than one indicates that a country has revealed comparative advantage in that particular product, and vice versa. An increasing RCA value is interpreted as a country gaining advantage in that product, relative to the world market. Table 3.8 presents findings on the ASEAN-10 members for export products with an RCA value of greater than one for at least one year during 1990 and 1995. Brunei exports are very concentrated, with a strong advantage in natural gas and petroleum products, and, to a lesser extent, photographic equipment, and miscellaneous manufacturing products. In 1995, the products that showed comparative advantage for Cambodia were crude rubber, cork and wood, textiles and garments, crude animal and vegetable materials, and fish. Comparative advantage declined in coffee, hides, and minerals. The Lao PDR had strong competitiveness in cork and wood products, and in more recent years, garments. It also showed export advantage in other natural resources, such as coffee, animal hides, and crude animal and vegetable materials. Myanmar’s and Vietnam’s competitiveness was more diversified than those of Cambodia and the Lao PDR. Myanmar’s exports for which the RCA was greater than one in 1995 were cork and wood, vegetables and fruit, fish, oil seeds, sugar, crude rubber, cereals, animal feed, hides, oil seeds, minerals, and garments. In the same year, products that showed comparative advantage for Vietnam were resource-based products such as coffee, fish, cereals, oil seeds, crude rubber, minerals, crude animal and vegetable materials, coal and petroleum products; and labour-intensive products such as garments, travel goods, furniture, and footwear. From the RCA analysis, it is apparent that the new members had comparative advantage in resource-based industries and some labour-

© 2001 Institute of Southeast Asian Studies, Singapore

CAMBODIA

33

BRUNEI

© 2001 Institute of Southeast Asian Studies, Singapore

21 22 23

07

03

99

89 95

34 41 88

SITC

Export Countries

Fish (not marine mammals), crustaceans, molluscs and aquatic invertebrates, and preparations thereof Coffee, tea, cocoa, spices, and manufactures thereof Hides, skin and fur-skins, raw Oil seeds and oleaginous fruits Crude rubber (including synthetic and reclaimed)

Petroleum, petroleum products, and related materials Gas, natural and manufactured Animal oils and fats Photographic apparatuses, equipment and supplies, and optical goods, and watches Miscellaneous manufactured articles Armoured fighting vehicles, arms of war, and ammunition thereof Non-identified products

Description

1991 1992 1993 1994

1995

2.68

0.06 1.58 2.21

0.67

0.05 0.03 0.55 0.24 0.07 1.58

0.98 1.42

1.04 0.07 0.00 0.00

2.12 2.48 3.17 3.18

128.12 46.28 32.67 33.31 64.35

0.12 5.93 13.62 3.58 22.52 18.77

3.08

0.00 0.06 0.00 11.67

0.00 0.00

0.85 1.36

0.01 0.05

0.01 0.01

0.04 0.00

1.47 1.28

6.60 7.03 7.77 6.63 7.32 8.24 47.12 46.22 39.92 43.29 57.11 69.75 0.00 0.00 0.00 1.53 0.00 0.00

1990

TABLE 3.8 ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

56 Nattapong Thongpakde

© 2001 Institute of Southeast Asian Studies, Singapore

MALAYSIA

Export Countries

24 33

23

00 07

99

84 93

28 29 83

24 26

SITC

1991 1992 1993 1994

0.00 9.51

0.00 0.66

0.68 5.86

0.28 0.15 1.71

2.32 0.05 4.03 3.49

0.95 2.88 0.50 0.36 2.21 1.54

7.47 7.51 7.79 5.78 1.21 0.98

1.61

1.10 0.83

1.26 9.33 9.61

1.87 1.67

1.88

0.70 0.00 0.08 11.34 0.12 5.84 15.93 16.72 11.12 3.36

2.68 1.80 2.51

1.28 17.61 2.86

20.97 33.75 72.35 44.11 69.92

1990

Live animals other than animals of division 03 2.01 1.82 Coffee, tea, cocoa, spices, and manufactures thereof 1.79 1.46 Crude rubber (including synthetic and reclaimed) 14.03 11.43 Cork and wood 11.21 10.37 Petroleum, petroleum products and related materials 1.75 1.62

Cork and wood Textile fibres (other than wool tops and other combed wool) and their wastes (not manufactured into yarn or fabric) Metalliferous ores and metal scrap Crude animal and vegetable materials Travel goods, handbags, and similar containers Articles of apparel and clothing accessories Special transactions and commodities not classified according to kind Non-identified products

Description

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

0.94

7.93 4.98

0.64

1.49

1995

Impact and Implications of ASEAN Enlargement on Trade 57

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

84

79 82

77

76

75

62 63

43

34 42

SITC

1990

1991 1992 1993 1994

1995

Gas, natural and manufactured 4.04 3.68 3.25 2.97 2.71 3.20 Fixed vegetable fats and oils, crude, refined or fractionated 19.55 18.10 17.96 16.83 14.92 14.05 Animal or vegetable fats and oils, processed, waxes of animal or vegetable origin, inedible mixtures or preparations of animal or vegetable fats or oils 24.34 20.39 20.64 16.92 18.24 17.10 Rubber manufacturing 0.86 1.01 0.92 0.87 0.78 0.72 Cork and wood manufactures (excluding furniture) 3.10 3.39 3.94 5.29 4.88 4.46 Office machines and automatic data processing machines 0.62 1.03 1.45 1.64 1.92 2.06 Telecommunications and sound recording, apparatuses and equipment 3.50 3.94 3.98 4.29 4.45 4.45 Electrical machinery, apparatus and appliances, and electrical parts thereof 3.19 2.97 2.79 2.81 2.61 2.60 Other transport equipment 0.64 0.88 0.89 0.72 1.13 0.92 Furniture and parts thereof, bedding, mattresses 0.66 0.87 1.03 1.27 1.35 1.32 Articles of apparel and clothing accessories 1.41 1.30 1.26 1.14 0.99 0.95

Description

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

58 Nattapong Thongpakde

MYANMAR

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

24 28 29 56

12 21 22 23

09

08

04 05 06 07

03

SITC

Fish (not marine mammals), crustaceans, molluscs and aquatic invertebrates, and preparations thereof Cereals and cereal preparations Vegetables and fruit Sugars, sugar preparations and honey Coffee, tea, cocoa, spices, and manufactures thereof Feeding stuff for animals (not including unmilled cereals) Miscellaneous edible products and preparations Tobacco and tobacco manufactures Hides, skin and fur-skins, raw Oil seeds and oleaginous fruits Crude rubber (including synthetic and reclaimed) Cork and wood Metalliferous ores and metal scrap Crude animal and vegetable materials Fertilizers

Description

1991 1992 1993 1994

0.00

2.16

2.59

5.06

7.37 4.72 8.02 7.10 10.58 51.25 41.12 52.58 48.98 42.72 1.96 1.37 2.19 1.35 2.50 4.74 5.99 2.31 2.00 1.84 2.63 0.00 0.00 0.10 0.00

0.07 0.00 1.59 18.85

2.10 1.59

1.72 0.75

0.08 3.65 0.01 0.06 0.10 2.56 0.06 0.01 1.92 0.00 2.59 2.10 22.05 31.32 11.82 11.99

1.92

0.66

10.62 5.81 8.62 10.49 13.61 2.57 7.55 2.07 1.43 3.12 2.75 12.64 11.63 10.15 8.38 1.10 3.68 1.31 2.52 2.11

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95 1995

Impact and Implications of ASEAN Enlargement on Trade 59

INDONESIA

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

34

24 25 28 32 33

23

07

03

66 84 94 95

63

SITC

Fish (not marine mammals), crustaceans, molluscs and aquatic invertebrates, and preparations thereof Coffee, tea, cocoa, spices, and manufactures thereof Crude rubber (including synthetic and reclaimed) Cork and wood Pulp and waste paper Metalliferous ores and metal scrap Coal, coke and briquettes Petroleum, petroleum products and related materials Gas, natural and manufactured

Cork and wood manufactures (excluding furniture) Non-metallic mineral manufactures Articles of apparel and clothing accessories Animals, live (not classified elsewhere) Armoured fighting vehicles, arms of war and ammunition thereof

Description

4.45

3.48

3.12

0.00

0.44 3.46 1.28 1.02

1.74 3.05 2.31 0.32

3.94 4.52

3.53 3.60

0.00 0.00

1.30 4.55 1.63 1.32

4.01

3.72

1995

3.20 2.95 2.90 2.27 2.56 2.59 15.96 14.18 13.28 12.60 13.50 13.53

11.45 12.66 11.92 10.78 11.94 15.05 1.20 1.60 1.33 1.21 1.08 1.03 0.54 0.47 0.35 0.33 0.84 1.99 2.14 2.59 3.05 2.89 3.43 4.29 1.05 1.47 3.21 3.52 4.75 5.46

4.89

3.56

0.00

1.51

3.53

0.29 0.93 0.67 0.14

1991 1992 1993 1994

0.84 5.88 0.79 9.21

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

60 Nattapong Thongpakde

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

84

82

65

64

63

56 61

55

43

42

SITC

1990

1991 1992 1993 1994

1995

Fixed vegetable fats and oils, crude, refined or fractionated 4.14 5.08 6.11 6.23 7.15 5.64 Animal or vegetable fats and oils, processed, waxes of animal or vegetable origin, inedible mixtures or preparations of animal or vegetable fats or oils 4.91 4.62 3.75 5.17 7.41 8.31 Essential oils and resinoids and perfume materials, toilet, polishing and cleansing preparations 0.90 1.10 0.69 0.51 0.52 0.57 Fertilizers 1.78 2.42 1.40 1.26 1.42 1.94 Leather, leather manufactures, and dressed fur-skins 1.01 0.85 0.89 0.72 0.63 0.66 Cork and wood manufactures (excluding furniture) 20.95 20.13 19.07 21.72 18.75 17.05 Paper, paperboard, and articles of paper pulp, of paper, or of paperboard 0.30 0.47 0.52 0.75 0.80 1.00 Textile yarn, fabrics, made-up articles, and related products 1.57 1.88 2.48 2.21 1.92 1.93 Furniture and parts thereof, bedding, mattresses 1.22 1.40 1.45 1.87 1.94 1.96 Articles of apparel and clothing accessories 3.22 3.23 3.38 3.32 3.00 3.14

Description

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater Than 1, 1990–95

Impact and Implications of ASEAN Enlargement on Trade 61

LAOS

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

67 84 99

24 28 29 63

21

06 07

00

85 94 97

SITC

Live animals other than animals of division 03 Sugars, sugar preparations and honey Coffee, tea, cocoa, spices, and manufactures thereof Feeding stuff for animals (not including unmilled cereals) Cork and wood Metalliferous ores and metal scrap Crude animal and vegetable materials Cork and wood manufactures (excluding furniture) Iron and steel Articles of apparel and clothing accessories Non-identified products

Footwear Animals, live (not classified elsewhere) Gold, non-monetary

Description

0.79

4.38

4.93

2.61 2.55

4.15 0.44 1.02

6.65 2.81

2.52 0.53 0.00 0.00

4.64 5.02 0.56 1.20 0.85 0.69

9.58

0.04 0.00

5.26 1.21 0.23

1995

3.78 0.35 3.18 3.30 1.40 0.02 0.02 0.00 2.94 1.51 9.20 9.05 0.00 165.89 15.92 24.51

2.10 3.95 0.02 0.04 5.22 6.94 63.45 29.39

5.79 1.14 5.97 2.70 1.01 1.11 67.86 12.56 54.26 44.54 29.55 31.47 13.27 0.86 3.69 1.16 1.47 1.05 6.93 0.87 2.90 2.51 0.98 1.64

0.11 0.00

3.83 0.81 1.01

1991 1992 1993 1994

0.68 0.00

2.53 0.88 1.06

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

62 Nattapong Thongpakde

PHILIPPINES

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

68

56 63

43

12 28 29 34 42

05 06 08

03

SITC

Fish (not marine mammals), crustaceans, molluscs and aquatic invertebrates, and preparations thereof Vegetables and fruit Sugars, sugar preparations, and honey Feeding stuff for animals (not including unmilled cereals) Tobacco and tobacco manufactures Metalliferous ores and metal scrap Crude animal and vegetable materials Gas, natural and manufactured Fixed vegetable fats and oils, crude, refined or fractionated Animal or vegetable fats and oils, processed, waxes of animal or vegetable origin, inedible mixtures, or preparations of animal or vegetable fats or oils Fertilizers Cork and wood manufactures (excluding furniture) Non-ferrous metals

Description

1.25 1.43 3.57 1.38 0.68

1.37 1.12 4.19 1.83 0.70

1.18 0.74 3.67 1.14 0.91

3.39 3.64

3.80

0.92 0.58 2.21 1.21 0.97

0.99 0.47 2.14 1.23 1.09

3.58 2.86 3.83 1.96

4.01 3.78

1.13 0.34 1.80 1.44 0.99

2.37 1.42

3.04

1995

1.97 3.26 3.62 1.29

2.44 2.21 1.64 0.87

2.72 1.30

1.78 2.44

1.79 1.71 1.46 1.24

1.27 1.39 2.46 2.51

1.47 1.31

1.18 2.30

14.41 10.80 15.62 10.60 9.02 12.10

3.56 5.11

4.92

1991 1992 1993 1994

3.46 5.02

4.79

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

Impact and Implications of ASEAN Enlargement on Trade 63

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

94 97

84 85 89 93

83

82

77

76

SITC

1990

1991 1992 1993 1994

1995

Telecommunications and sound recording, apparatuses, and equipment 1.41 1.07 1.27 1.27 1.32 1.24 Electrical machinery, apparatus and appliances, and electrical parts thereof 2.66 1.42 1.56 1.57 1.67 1.56 Furniture and parts thereof, bedding, mattresses 2.13 2.24 1.97 1.90 1.85 1.69 Travel goods, handbags, and similar containers 2.63 1.97 1.87 1.62 1.87 2.13 Articles of apparel and clothing accessories 1.14 2.35 2.36 2.09 1.93 1.93 Footwear 1.00 1.53 1.34 1.35 1.47 1.08 Miscellaneous manufactured articles 16.11 0.99 0.98 0.93 0.87 0.76 Special transactions and commodities not classified according to kind 0.95 16.09 14.81 14.57 17.81 17.03 Animals, live (not classified elsewhere) 0.06 3.09 2.33 2.04 2.76 1.68 Gold, non-monetary 0.00 0.03 0.87 2.64 3.09 2.70

Description

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

64 Nattapong Thongpakde

SINGAPORE

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

24 25

12 21 22 23

08

04 06 07

01 02 03

00

SITC

Live animals other than animals of division 03 Meat and meat preparations Dairy products and birds’ eggs Fish (not marine mammals), crustaceans, molluscs and aquatic invertebrates, and preparations thereof Cereals and cereal preparations Sugars, sugar preparations and honey Coffee, tea, cocoa, spices, and manufactures thereof Feeding stuff for animals (not including unmilled cereals) Tobacco and tobacco manufactures Hides, skin and fur-skins, raw Oil seeds and oleaginous fruits Crude rubber (including synthetic and reclaimed) Cork and wood Pulp and waste paper

Description

2.27 0.28 0.06

5.59 0.61 0.08

1.23

1.32

0.10 2.02 0.08 0.14

0.54 0.17 0.10

0.78 0.18 0.16

0.12 1.76 0.17 0.25

0.07 0.04 0.15

1.31 0.09 1.05 0.05 1.08 0.15

2.07 1.42 1.29

1.10 0.66 1.74 1.86

2.15

0.10 2.14 0.07 0.15 1.83 2.22 1.03 0.25 1.59 0.06

1.22 0.79 1.77 2.18

1.60 1.09

0.67 0.72 0.56 1.67 20.50 0.20 2.04 2.19 0.10

1.12 0.97 1.00

1991 1992 1993 1994

0.05 0.08 0.26

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

2.11 0.21 0.08

0.13 1.82 0.08 0.14

0.97

0.52 0.18 0.09

0.02 0.03 0.14

1995

Impact and Implications of ASEAN Enlargement on Trade 65

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

52

43

34 35 41 42

28 32 33

27

26

SITC

Textile fibres (other than wool tops and other combed wool) and their wastes (not manufactured into yarn or fabric) Crude fertilizers, other than those of division 56, and crude minerals Metalliferous ores and metal scrap Coal, coke and briquettes Petroleum, petroleum products and related materials Gas, natural and manufactured Electric current Animal oils and fats Fixed vegetable fats and oils, crude, refined or fractionated Animal or vegetable fats and oils, processed, waxes of animal or vegetable origin, inedible mixtures, or preparations of animal or vegetable fats or oils Inorganic chemicals

Description

0.57

1.23

3.96 0.19

1.27 0.15 0.00 0.04

2.14 0.16 0.00 0.21

7.18 0.19

0.30 0.19 0.01

0.16

1.11 1.24

1.38

3.33 1.64 0.78 2.46

1.65 1.81 1.71

1.75

1.67 0.22 0.00 0.03

0.90 2.92 1.23 0.23

1.35 0.47

3.22 2.01 1.05 2.48

1.77 0.36 1.75 0.24 1.80 0.01

1.96 0.18

1991 1992 1993 1994

0.13 0.33 0.00

0.13

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

3.04 0.21

0.43

1.28 0.20 0.00 0.04

0.22 0.25 0.01

0.16

1995

66 Nattapong Thongpakde

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

97

95

93

79 88

77

76

56 66 67 68 69 72 73 75

SITC

Fertilizers Non-metallix mineral manufactures Iron and steel Non-ferrous metals Manufactures of metals Machinery specialized for particular industries Metal working machinery Office machines and automatic data processing machines Telecommunications and sound recording, apparatuses and equipment Electrical machinery, apparatus and appliances, and electrical parts thereof Other transport equipment Photographic apparatus, equipment and supplies and optical goods and watches Special transactions and commodities not classified according to kind Armoured fighting vehicles, arms of war, and ammunition thereof Gold, non-monetary

Description

0.00 0.48

0.00 0.38

0.55

1.03

1.01 0.59

3.14 0.32

2.03 0.48

3.98

6.11

4.76 3.92

0.05 0.24 0.23 0.52 0.48 0.54 0.41

1.21 1.14

0.86

0.84

0.51 0.78

0.61

0.34

1.43 1.05 1.30 1.42 0.95 0.96 1.11

0.07 0.24 0.25 0.58 0.49 0.56 0.51

1.46 0.00 0.81 0.34

0.68 0.56

0.85 1.04

0.47 2.40 1.00 0.40

0.63 3.38

0.34 5.34

1.60 0.86 1.27 1.15 1.00 1.01 1.24

1991 1992 1993 1994

0.09 0.26 0.23 0.49 0.62 0.51 0.37

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

0.00 0.43

1.00

1.09

2.55 0.36

2.95

5.21

0.04 0.27 0.25 0.84 0.50 0.55 0.52

1995

Impact and Implications of ASEAN Enlargement on Trade 67

THAILAND

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

62

29 53 61

27

23

09

04 05 06 08

01 03

SITC

Meat and meat preparations Fish (not marine mammals), crustaceans, molluscs and aquatic invertebrates, and preparations thereof Cereals and cereal preparations Vegetables and fruit Sugars, sugar preparations and honey Feeding stuff for animals (not including unmilled cereals) Miscellaneous edible products and preparations Crude rubber (including synthetic and reclaimed) Crude fertilizers, other than those of division 56, and crude minerals Crude animal and vegetable materials Dyeing, tanning and colouring materials Leather, leather manufactures, and dressed fur-skins Rubber manufacturing

Description

1.37

1.19

3.64 3.85 7.22

8.97

1.34

1.33 1.45

1.13 1.01

3.34 3.62 2.93 2.21 4.48 5.24

8.73 8.80

1.14 1.10

1.38

1.02

3.38 1.88 6.24

8.31

1.03

1995

1.00 0.94 0.33 2.32 0.95

1.09 1.06 0.23 2.56 1.00

2.19 1.00

0.96 0.90 0.43

2.03 1.90 1.07 1.03

1.06 0.97 0.81 0.67 0.71 0.70

1.84 1.02

0.91 0.58 1.42

14.74 13.81 14.33 13.21 14.41 15.77

1.24

1.43

1.43 1.29

4.06 3.77 6.98

9.44

9.61 4.35 4.38 9.37

1.45

1991 1992 1993 1994

1.34

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

68 Nattapong Thongpakde

Export Countries

© 2001 Institute of Southeast Asian Studies, Singapore

89

83 84 85 88

82

77

76

66 75

65

SITC

Textile yarn, fabrics, made-up articles, and related products Non-metallic mineral manufactures Office machines and automatic data processing machines Telecommunications and sound recording, apparatuses and equipment Electrical machinery, apparatus and appliances, and electrical parts thereof Furniture and parts thereof, bedding, mattresses Travel goods, handbags and similar containers Articles of apparel and clothing accessories Footwear Photographic apparatus, equipment and supplies and optical goods and watches Miscellaneous manufactured articles

Description

1.61 3.63 3.75 3.63 0.87 1.56

0.73 1.67

1.23

1.53 4.06 3.84 3.81

1.25

1.68

1.77

1.82 1.47

1.19 1.96

1.06 1.58

1.59 3.28 3.17 3.29

1.31

1.80

1.81

1.16 1.73

1.61 3.05 2.82 3.66 0.94 1.07 1.85 1.52

1.69 3.26 3.10 3.01

1.41 1.40

1.52 1.56

1.71 1.97

1.14 1.12 1.84 1.67

1991 1992 1993 1994

1.24 2.14

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

1.05 1.78

1.42 2.69 2.75 4.51

1.33

1.43

2.08

1.10 1.53

1995

Impact and Implications of ASEAN Enlargement on Trade 69

03

VIETNAM

© 2001 Institute of Southeast Asian Studies, Singapore

24 28 29 32 33

21 22 23

09

04 05 07

SITC

Export Countries

Fish (not marine mammals), crustaceans, molluscs and aquatic invertebrates, and preparations thereof Cereals and cereal preparations Vegetables and fruit Coffee, tea, cocoa, spices, and manufactures thereof Miscellaneous edible products and preparations Hides, skin and fur-skins, raw Oil seeds and oleaginous fruits Crude rubber (including synthetic and reclaimed) Cork and wood Metalliferous ores and metal scrap Crude animal and vegetable materials Coal, coke and briquettes Petroleum, petroleum products and related materials

Description

1991 1992 1993 1994

1995

3.18

3.24

4.18

1.49 3.53 0.90 2.66 6.21

1.95 8.64 1.70 4.79 8.05

5.22 7.05 3.29 5.61 1.72

5.28 0.73 1.53 5.03

4.76

6.11

6.08 1.83

1.10 0.98 6.51 5.31 8.22 13.13

7.39 2.00

9.67 1.99

4.84 0.89

4.36 1.03 0.43 1.77 4.62 3.78 3.61

3.37 2.61 0.40 2.88 4.83

0.53 0.54 1.12 1.12 7.31 7.72

3.54

5.29 1.25 0.26 1.89 4.23

0.63 0.98 5.46

7.87 14.66 21.51

3.49 6.93 1.33 1.66

19.48 15.60 11.64 11.09 11.81 11.06

1990

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

70 Nattapong Thongpakde

© 2001 Institute of Southeast Asian Studies, Singapore

83 84 85 94 99

82

61

42

SITC

Fixed vegetable fats and oils, crude, refined or fractionated Leather, leather manufactures and dressed fur-skins Furniture and parts thereof, bedding, mattresses Travel goods, handbags and similar containers Articles of apparel and clothing accessories Footwear Animals, live (not classified elsewhere) Non-identified products

Description

0.48

0.25 0.21

1.25

0.32

0.91

1995

1.02 1.50 7.42 8.66 4.07 4.65 8.26 11.89 4.19 3.40 7.53 2.90

0.22 0.21

0.48 0.54

1991 1992 1993 1994

0.15 0.19 0.29 0.61 0.42 1.59 3.38 6.13 1.58 2.29 3.67 3.81 0.18 0.49 1.51 4.85 0.13 0.22 1.23 4.76 0.00 14.47 25.88 22.53

1.36

0.74

1990

NOTE: Criterion for selection was on RCA of greater than one for at least one year during 1990–95. SOURCE: Calculated from Queens’ University Trade Data.

Export Countries

TABLE 3.8 (continued) ASEAN-10: Export Products with a Revealed Comparative Advantage Index Greater than 1, 1990–95

Impact and Implications of ASEAN Enlargement on Trade 71

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Nattapong Thongpakde

intensive industries, especially garments. For the old members, the advantage was in manufactured products. Singapore had the advantage in high-technology products, such as computer and telecommunications equipment, electrical machinery, and photographic equipment. Malaysia showed competitiveness in manufacturing products, such as computer goods, electrical machinery, furniture, telecommunications equipment; and in some resource-based products, such as crude rubber, wood, vegetable fat, and petroleum. Thailand, the Philippines and Indonesia had similar patterns in export comparative advantage, showing comparative advantage in agriculture, resource-based, and labour-intensive products. In addition, Indonesia showed strong competitiveness in petroleum products. Table 3.8 shows that Thailand’s export products whose RCA values were greater than one in 1995 were crude rubber, fish, garments, sugar, meat, cereal, vegetables and fruit, dyeing materials, leather, yarn, computer goods, telecommunications equipment, electrical machinery, furniture, and travel goods. The Philippines had a variety of products that showed an RCA greater than one in 1995. They included vegetable fats, fish, vegetables and fruit, sugar, animal feed, minerals, crude animal materials, fertilizer, telecommunications equipment, electrical machinery, furniture, and travel goods. In addition to petroleum, Indonesia had a comparative advantage in the following exports: fish, coffee, crude rubber, cork and wood, pulp and paper, metals, coal, animal and vegetable fat, fertilizer, cork and wood manufacturing, yarn, garments, footwear, and furniture. Even among the older ASEAN members, export comparative advantage was not unique. Singapore showed strong comparative advantage in hightechnology products while Malaysia showed strong advantage in highskilled industries and some natural resources. Thailand, the Philippines, and Indonesia had stronger agricultural sectors than Singapore and Malaysia, and were also competitive in labour-intensive products. Thailand also exports some high-skilled products, such as computer parts and electronics.

ASEAN ENLARGEMENT AND AFTA This section discusses the potential impacts of ASEAN enlargement on the ASEAN Free Trade Area. This issue can be viewed in two ways. On the one hand, it increases economic opportunities and activities within ASEAN. On the other hand, it may undermine the process of the implementation of AFTA. Both issues will be investigated below.

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Trade Creation Increasing Market Size and Resource Endowment Diversification ASEAN enlargement will raise the population from 355.2 million, for the ASEAN-6, to 481.6 million for the ASEAN-10. This expanded market size will raise intra-ASEAN trade. While the average income in each new member is still low, their GDP growth rates are satisfactory. Therefore, the prospect of trade creation, taking advantage of the market size, is quite good. Another factor that will stimulate intra-ASEAN trade is resource diversification. The structure of the ASEAN-6 economies is quite similar, and thus the scope of exchange is limited. By contrast, the new members differ from the ASEAN-6 with respect to factor endowment and pattern of production. These new members are rich in natural resources and have low-wage labour, while the older members have higher-skilled labour and more capital. Classical trade theory suggests that trade between two countries stems from the differences in comparative advantage, which is determined by factor endowment. For example, countries with abundant natural resources will export resource-intensive products, and countries where capital is relatively abundant will export capital-intensive goods. Economic integration has stronger trade creation effects when the resource endowment is more diversified among members because the patterns of production are complementary among them. In the previous section, the analysis showed that new members have comparative advantages in agriculture, processed agricultural commodities and raw materials; while the older members show a strong comparative advantage in manufactured goods. Therefore, AFTA integration can widen the scope of exchange and raise intra-ASEAN trade. The volume of trade of the new members is relatively small. Therefore, its impact on intra-ASEAN trade will not be significant after integration. The trade data in 1995 (Table 3.4) show that the new members have stronger trade linkages with ASEAN than the older members. However, the share of intra-ASEAN exports in total exports rose from 23.6 per cent for the ASEAN-6 to only 25 per cent for the ASEAN-10; and the corresponding share of intra-ASEAN trade (exports and imports) increased from 20 per cent to 21 per cent. One can see that even with enlargement, trading with non-member countries will remain important for the ASEAN-10. The formation of a free trade area can also create trade diversion. This occurs when a country imports a good from a member country which was previously imported from the outside world because of the shift in tariffs, quotas or other trade barriers. Joining AFTA will, to some extent,

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Nattapong Thongpakde

divert the trade of the new members towards the old members. The net welfare gains will depend on the share magnitude of trade creation and trade diversion. In the case of the ASEAN-10, it is likely that trade diversion and its effects will be small since their shares of trade with the old members are already large. In 1995, the old members supplied more than 70 per cent of the Lao PDR’s and Cambodia’s imports; while intra-ASEAN imports for Myanmar and Vietnam were 46 per cent and 27 per cent, respectively, which were higher than the intra-ASEAN trade of the old members. Moreover, most tariff rates imposed on the products in the Inclusion Lists of the new members are less than 5 per cent and the impact of tariff reduction in the first stage is small. Therefore, trade diversion should not be a major concern in ASEAN enlargement. AFTA, which entails the elimination of tariff and non-tariff barriers, was launched in 1993, and the main mechanism of AFTA is the Common Effective Preferential Tariff scheme. At the beginning, the AFTA agreement had a timetable of fifteen years for tariff reduction; it was shortened to ten years at the fifth meeting of the AFTA Council in 1994. That meeting also admitted unprocessed agricultural products into the CEPT scheme. Under the present scheme, the fast-track tariff reduction will be completed by the year 2000 and the normal-track tariff reduction will end in 2003. AFTA allows sensitive items to be excluded from these two tracks. Products in the Temporary Exclusion List have been transferred to the Inclusion List in five equal instalments annually since 1 January 1996 to allow sufficient time for tariff adjustment. Besides the Temporary Exclusion List, there is a permanent Exclusion List for sensitive products (ASEAN Secretariat 1995). According to the agreement, the old members will reduce tariff rates to 0 to5 per cent by 2003. New members must commit to AFTA within the same time-frame (ten years) of the previous agreement. Therefore, Vietnam will lower tariff rates to 0 to 5 per cent in the year 2006 and the Lao PDR and Myanmar in 2008. The total number of tariff lines in the Inclusion List is 44,642, while there are 3,685 tariff lines in the Temporary Exclusion List. Vietnam placed 857 tariff lines in the Inclusion List, the smallest of the ASEAN-7. Its Temporary Exclusion List includes 1,189 tariff lines, the second largest after Indonesia. The products in the Temporary Exclusion List will be phased in from 1 January 1999. Vietnam’s CEPT package consists of 70 per cent of the total tariff lines, with an average CEPT tariff rate of 0.88 per cent, which is lower than those of the old members, with the exception of Brunei and Singapore. In the Inclusion List, Vietnam has included products whose tariff rates were already less than 5 per cent. Similarly, most products in Myanmar’s and Lao PDR’s Inclusion Lists have

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tariff rates already under 5 per cent. Therefore, tariff reduction with respect to the Inclusion List will not be a problem for the new members. However, a large number of products are on the Exclusion Lists (2,818 tariff lines for the Lao PDR, and 2,722 tariff lines for Myanmar) and some products have very high tariff rates. The next stage of tariff reduction will therefore be more difficult. Regional tariff reduction should increase trade among members based on comparative advantage. However, to get the most from tariff reduction, the ASEAN members should commit to accelerate the pace of tariff reduction. In addition, because new members’ major exports are unprocessed agricultural products, primary materials and labour-intensive goods, the ASEAN-6 should lower tariffs on major products which the new members export. For example, the tariff rates on many goods that new members export are higher than 20 per cent, including live animals, food, furniture, footwear, vegetables, and fruit (Vu Tuan Anh and Bui Tat Thang 1997, pp. 54–55). For agricultural products, 20 per cent of tariff lines is in the Temporary Exclusion List and 12 per cent is in the Sensitive List. In addition, the timetable for tariff reduction on these goods can surpass 2003, and the final rates may be greater than 5 per cent. Furthermore, some major agricultural products are on the Sensitive List (ASEAN Secretariat 1995). Therefore, the scope of tariff reduction for agricultural products should be expanded to provide market access for new members. Trade Diversion Tariff reduction will also decrease informal trade since it makes smuggling less attractive. Reported border trade between Thailand and the neighbouring countries will increase, although real activity may not change significantly. While data on informal trade are not reliable, some studies estimate that it may be as much as 40 per cent higher than official border trade data. Enhancing Investment and Tourism The principal objective of AFTA is not to increase intra-regional trade. Rather, it is to make ASEAN an attractive investment area. The new members present new opportunities to expand investment and tourism: they offer a larger market, more diversified natural resources, abundant labour, lower wage costs, and additional tourism sites. Investment in these countries will stimulate trade through imports of materials and machinery, and exports of finished products. Infrastructure development, which requires large investments, is needed in these countries. It also creates

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demand for raw material imports. For example, investment in construction in the Lao PDR increases the export of cement and petroleum from Thailand. Tourism creates trade in services and demand for locallyproduced souvenirs. Stimulating the Process of Liberalization and Internationalization of New Members The Indochinese countries are transforming their economies from socialism to capitalism. AFTA forces the new members to adjust trade practices up to international standards; and it makes tariffs uniform in term of rates and classification. Non-tariff barriers must be reduced and conform to international regulations. The AFTA agreement also includes co-operation in customs by, for example, formulating a uniform ASEAN tariff list, building a green corridor for commodities participating in the CEPT, and co-ordinating customs procedures. Entry into ASEAN is a first step for new members to participate in other international fora, as it assists them in institutional adjustment. Vietnam has joined the Asia-Pacific Economic Co-operation (APEC) forum; Cambodia and the Lao PDR have clearly stated that they wish to join the World Trade Organization (WTO) (AFTA Monitor, July 1997). The enlargement also helps ASEAN in trade negotiations, as ASEAN always seeks to negotiate as a group. Representing a larger number of countries and population, ASEAN’s negotiating position is strengthened. AFTA will also increase competition in ASEAN, particularly for the newer members, whose economies have been closed for many years. Competitive external forces will promote greater efficiency and more competitive goods and services in these economies in the long run. However, the adjustment process of deregulating domestic markets may prove difficult in the short run. Potential Obstacles to AFTA Concerns over Tariff Revenue and Current Account Deficit In the new member countries, there is a concern that reduction of tariff rates will decrease customs revenues, as the state budgets are highly dependent on these taxes. In the Lao PDR the percentage of customs revenue in government revenue was 20.1 per cent in 1995. The corresponding shares were 28.3 per cent for Vietnam, and 54.1 per cent for Cambodia (Motoyoshi Suzuki 1997, pp. 17–18). For this reason, policymakers may delay tariff reduction, which will then undermine regional trade creation. They are also concerned that tariff reduction will stimulate imports and worsen their trade and current account deficits. In 1997,

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Vietnam increased tariff rates on automobiles, motor-cycles, and consumer goods to reduce imports and improve its trade position. However, it is important to recognize that tariff reduction may actually increase government revenues. The government can collect more taxes if economic activities are increased. A study by Vietnam’s Ministry of Finance indicates that if import value remains the same, the CEPT agreement will lower import–export tariff revenues by 9.4 per cent in 2006 from the 1995 level. However, if imports continue to grow at the current level of 20 per cent per annum, tariff revenues in 2006 will rise despite the reduction. Resistance from Domestic Producers Trade liberalization is typically resisted by domestic producers who seek protection. Even in the old member countries, some producers lobby the government to put their industries on exclusion lists and delay tariff reduction. The problem for the new members is more serious, however, because the domestic producers include public enterprises, which are still important to these economies’ output and labour. The share of public enterprise production in GDP was 40.2 per cent, 22.2 per cent, and 15 per cent in Vietnam, the Lao PDR, and Myanmar, respectively. Moreover, public enterprises are often managed by well-connected people who are able to influence government decisions. The process of liberalization depends on political will to overcome the resistance from actors and organizations that benefit from trade protection. Difficulty in Liberalizing Trade in Services and Investment ASEAN’s Vision 2020 advocates regional co-operation by creating the ASEAN Investment Area (AIA) by 2010 and creating an integrated ASEAN Economic Region by 2020, with zero tariffs and a free flow of capital and services. To achieve the goal of Vision 2020, the liberalization of investment and trade in services is necessary. ASEAN has set up the Coordinating Committee on Services to negotiate trade in services; and it has employed the WTO’s General Agreement on Trade in Services (GATS) framework. Members will present a Schedule of Commitments, listing sectors and activities that provide market access, and national treatment to other members according to the mode of supply. Any limitations will be indicated in the Schedule of Commitments. The ASEAN framework will be GATS-plus (that is, the scope and coverage of the commitments must be an improvement over the GATS commitments). ASEAN members, excluding the Lao PDR and Myanmar, have presented initial Schedule of Commitments. The scope of this process is still limited because under GATS there are still many constraints on both market access and national

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Nattapong Thongpakde

treatment; and the coverage of negotiations includes only tourism, telecommunications, finance, maritime transport, air transport, construction and professional services, with an emphasis on the first three sectors. The negotiations on trade in services and investments are more difficult than trade in goods issues. The CEPT scheme on tariff reduction is well established and under implementation, while the framework on trade in services and investment is at an early stage in ASEAN (as well as in other international fora). Because trade in services usually requires the establishment of foreign firms and movement of people, significant adjustment is necessary, especially with regard to laws, accounting systems, government regulations, and tax systems, and visa procedures, among others. Because prevailing institutions under socialist systems are very different from market-oriented systems, time is required for these countries to adjust to international practices. Conclusion With ASEAN’s enlargement, new members will complement old ones in trade and investment. This should enhance intra-ASEAN trade, even though the volume of trade of the new members is still small. Therefore, ASEAN trade and economic activities with non-members will remain important, perhaps even dominant, in the foreseeable future. Because extra-ASEAN trade is important, unilateral liberalization is a key strategy for economic development in the ASEAN-10. AFTA must be viewed as an instrument to increase ASEAN member competitiveness in international markets and to attract foreign investment. Therefore, most-favoured-nation (MFN) tariff reduction will benefit members more than preferential tariff reduction in ASEAN. To achieve the goals of ASEAN’s Vision 2020, the CEPT will not be adequate. Further liberalization in trade in services and investment is critical, especially because ASEAN lags behind other regional groupings in these areas. However, ASEAN enlargement may also make it more difficult to advance in these areas because of the differences in development and institutions between the two groups. Any delay in market deregulation and institutional adjustment in the new member countries will undermine the process of ASEAN co-operation. Therefore, it is crucial for the new members to commit to AFTA and greater economic liberalization. The old members can assist the new members to pursue economic restructuring and reduce the adjustment costs to accelerate the deregulation process.

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References AFTA Watch. “Regional Cooperation: Vision 2020 Plan Takes Shape”. AFTA Monitor 5, no. 7 (July 1997): 1–3. Andrew, John. The Economist Pocket Asia. UK: Profile Books Ltd, 1997. Ariff, Mohamed. “The Prospects for an ASEAN Free Trade Area”. WorldEconomy: Global Trade Policy 1995, pp. 53–64. Oxford: Blackwell Publishers, 1995. ASEAN Secretariat. AFTA Reader: Questions and Answers on the CEPT for AFTA. Jakarta: ASEAN Secretariat, 1995. Asian Development Bank (ADB). Key Indicators of Developing Asian and Pacific Countries. New York: Oxford University Press, 1996. Bank of the Lao PDR. Annual Report, 1995. International Monetary Fund (IMF). IMF Economic Review 1994. Washington, D.C., 1994. . Government Finance Statistics Yearbook. Washington, D.C., 1995. . Direction of Trade. Washington D.C., 1996. McCarty, Adam, and Vu Quoc Huy.“Vietnam’s Economic Reform, 1986–95”. Paper prepared for the Sectoral Economic Program, Thailand Development Research Institute, 1997. Suzuki, Motoyoshi. “Laos: Challenge for Development — Cost and Benefit Analysis of Joining ASEAN”. Paper presented at the 5th Joint Research Conference on Asia-Pacific Relations, organized by the Foundation for Advanced Information and Research and Thammasat University, 26–28 February 1997. United Nations. Statistical Yearbook for Asia and Pacific. New York: United Nations, 1996. Vu Tuan Anh, and Bui Tat Thang. “ASEAN Economic Cooperation and Vietnamese Economy: A Country Study”. Mimeographed. Thailand Development Research Institute, 1997. World Bank. World Development Report 1996. New York: Oxford University Press, 1996.

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ASEAN Enlargement and Foreign Direct Investment

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NICK J. FREEMAN

Introduction In late July 1997, Laos and Myanmar were permitted to upgrade their status within the Association of Southeast Asian Nations (ASEAN), from that of being observers — a position held by Laos since 1993, and Myanmar since 1996 — to full members. An earlier decision to also admit Cambodia as a full member of the regional grouping was postponed at the eleventh hour, following the outbreak of civil conflict in the country’s capital in early July. As a consequence of Laos’ and Myanmar’s entry, the ASEAN market adopted a further 52 million people and expanded by about 913,000 sq km. Cambodia gained full membership in April 1999, resulting in the ASEAN market growing by an additional 10.5 million people and 181,000 sq km. This most recent enlargement process is in addition to the 75 million people and roughly 330,000 sq km. that entered the regional grouping in 1995, when Vietnam joined ASEAN. The inclusion of Cambodia fulfilled ASEAN’s long-held aspiration that the regional grouping should ultimately span the entire ten countries of the Southeast Asian region. With the ASEAN enlargement process fully completed, the regional grouping has grown by a cumulative “Greater Mekong” market of 138 million new citizens (albeit of low average per capita gross national product), representing an increase in ASEAN’s total citizenry of almost 40 per cent.1 Quite clearly, this is a substantial enlargement in a relatively short space of time, and may well have marked implications for various fields of 80

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economic and business endeavour in the Southeast Asian region, including foreign direct investment (FDI) activity. The growth of FDI flows and venture capital activity across the globe in recent years has been quite remarkable.2 Between 1980 and 1995, the cumulative stock of FDI in the world blossomed from about US$514 billion to US$2,658 billion, a more than fivefold increase in just fifteen years. Pacific Asia’s share of this rapidly expanding global FDI “pie” has also grown more than twofold, from 6.7 per cent to 13.6 per cent over the same time period. However, ASEAN has seen its own share of Asia-Pacific FDI drop from 71 per cent in 1980 to 47 per cent in 1995, largely as a result of greater flows heading for mainland China, following the latter’s opening up to foreign venture capital in 1979. Nonetheless, ASEAN’s total stock of FDI grew more than sixfold over the same fifteen-year period (1980–95), and by just over 75 per cent in the first five years of the 1990s. Furthermore, in recent years we have witnessed burgeoning FDI outflows from Malaysia, Singapore — and to a lesser extent Thailand, Indonesia, and the Philippines — to neighbouring countries within Southeast Asia (that is, intra-ASEAN FDI flows), and beyond. For example, Vietnam has been a notable recent recipient of substantial FDI inflows from Singapore, so that the island city-state now ranks as the largest single foreign investment source (as measured by capital inflow pledges), ahead of such regional rivals as Hong Kong, Taiwan, Japan, South Korea, as well as the United States and the Eurpean Union (EU) member states. The development of such intra-ASEAN FDI flows has been cited as an indication of the growing economic maturity of the Southeast Asian region — no longer solely the passive recipient of investment flows from the industrialized countries, but an economic and business force in its own right. However, ASEAN should not be complacent for the emerging markets of Eastern Europe and the former Soviet Union, Latin America, and even Sub-Saharan Africa are posing increasingly convincing challenges as worthy host regions for new overseas venture capital flows. Furthermore, the most recent figures indicate that whilst FDI flows to Asia continue to increase — by 25 per cent between 1995 and 1996 — the rate at which global flows of FDI increased between 1995 and 1996 declined to 10 per cent (compared with an average of 17 per cent over the last five years). Moreover, FDI flows to Asia are increasingly less equitably distributed. Within Asia, China alone was the recipient of 52 per cent of the entire region’s total FDI inflows in 1996, followed by Singapore and Indonesia. Together, these three countries took a staggering 79 per cent of total FDI flows in Asia in 1996. Whilst it remains far too early to tell what the full impact of ASEAN’s recent enlargement will be, both for ASEAN’s long-standing members and its newest recruits, this chapter attempts to give an overview of the likely

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TABLE 4.1 ASEAN’s Stock of Inward Foreign Direct Investment, 1980–97 (In US$ millions)

Brunei Indonesia Malaysia Philippines Singapore Thailand Vietnam

1980

1990

1995

1996

1997

19 10,724 6,078 1,225 6,203 981 7

26 38,883 14,117 2,098 32,355 7,980 216

62 50,603 36,778 7,158 58,622 17,236 4,096

71 56,797 41,450 8,678 68,062 19,504 6,252

76 62,147 45,203 9,931 78,062 23,104 7,452

SOURCES: Mirza, Bartels and Hiley (1997); and UNCTAD, World Investment Report 1996, and 1997.

implications for FDI flows and venture capital activity in the region. First, the current FDI profile in Cambodia, Laos, and Myanmar (CLM) will be examined, followed by the factors, mostly indirect, stemming from ASEAN enlargement that may augment FDI inflows into the CLM countries. The analysis then takes a somewhat contrary perspective, and assesses the, arguably more direct, factors which would act to ensure that ASEAN’s recent enlargement has relatively little impact on the CLMs’ ability to attract greater foreign investor interest. Evidence in support of these views will be cited from the precedent set by Vietnam’s entry into ASEAN in 1995, and the impact this has had on the former’s FDI inflows. Given the constraints of space, this work is almost wholly written from the perspective of the CLM countries, and does not involve itself with the likely impact of ASEAN enlargement on the FDI profiles of the more established ASEAN member countries. It perhaps goes without saying, therefore, that the focus will be on FDI inflows into CLM, as there is relatively little in the way of intra-CLM investment flows at present, and even fewer investment outflows from the CLM to other, more affluent, members of ASEAN. But this may change over time. Current FDI Profile in Cambodia, Laos, and Myanmar All four “Greater Mekong” countries have witnessed dramatic increases in foreign venture capital activity since they commenced a transitional process, away from less centrally-planned and towards more marketoriented economies, in the late 1980s. The promulgation of a foreign

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investment law has been a key pillar for each of these countries in supporting their transition process, and drawing in crucial inputs of capital, technology, expertise, and other valuable inputs commonly associated with FDI inflows. As the cumulative quantity of FDI disbursements has grown in each of these countries, the contribution that foreign venture capital is making to their national economies (for example, industrial output, export earnings, and so forth) has grown considerably. In the case of Vietnam, industrial output from foreign-invested businesses is currently growing at around 21 per cent per annum; markedly ahead of output growth in both the country’s private and state domestic enterprises. In Cambodia, despite the continued political tensions that overshadow the country, FDI inflows had, until relatively recently, increased markedly in recent years. In the three years between 1994 and end-1996, the cumulative stock of pledged foreign venture capital increased more than sevenfold. Indeed, in 1995, cumulative foreign investment pledges were almost four times greater than the equivalent figure for the previous year, although they then dropped in 1996, and new FDI pledges have come to a virtual halt since the destabilizing events of mid-1997. ASEAN has been the primary source for much of Cambodia’s FDI inflows, representing about 80 per cent of total pledges, with Malaysia alone pledging an astounding 73 per cent of total foreign investment in the country (or 91 per cent of total ASEAN investment). Among the CLM, Cambodia’s reliance on one country, Malaysia, as the dominant source of foreign venture capital is unrivalled.3 There is scant data on the sectoral breakdown of FDI stock, although it is believed that the garment and textile industry has witnessed some foreign venture capital input, as has the hotel and tourism sector. An estimate of the disbursement rate for FDI (that is, the proportion of total pledged or approved investment that has actually been invested in tangible projects) in Cambodia is, however, relatively low, at around 25 per cent. For Laos, ASEAN has been the source of about 44 per cent of the country’s total FDI inflow pledges, with Thailand representing 41 per cent of all approved foreign venture capital (or 93 per cent of total ASEAN investment). The rate of FDI inflows into the country since 1988 has been erratic, with 1994 being the peak year for FDI pledges, to date. As of mid-August 1997, Laos had approved cumulative FDI inflow pledges of around US$6.8 billion (spanning 656 projects), which on a per capita basis is three times greater than that of Vietnam. However, the energy sector has been the principal recipient of foreign venture capital attention by far (66 per cent of total FDI pledged), with a heavy emphasis on a series of planned hydropower projects. As most of these hydropower projects have yet to start, the proportion of disbursed capital as a percentage of pledged inflows in Laos is perhaps as low as 10 per cent. The second largest

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TABLE 4.2 Cambodia’s FDI Stock, by Country (as at November 1997) (In US$ million) FDI Stock Malaysia USA Singapore Taiwan Korea Hong Kong Thailand France China Britain Australia Sweden Indonesia Others

3,222 407 233 207 198 127 120 115 92 68 22 12 1 216

Total

5,039

SOURCE: Council for the Development of Cambodia.

TABLE 4.3 Cambodia’s FDI Inflows, 1994–97

FDI inflows (US$m) Cumulative FDI stock (US$m)

1994

1995

1996

Nov 97

585 585

2250 2835

1530 4365

674 5039

SOURCE: Council for the Development of Cambodia.

recipient of FDI inflows in Laos has been the hotels and tourism sector, accounting for just under 9 per cent of total approved overseas venture capital stock. Finally, among the CLM countries, Myanmar has also experienced an erratic flow of FDI pledges since foreign venture capital activity commenced in the late 1980s. However, the broad trend has been one of growing FDI stock, from a mere US$450 million in 1989/90 to US$6,440 million

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TABLE 4.4 Laos’ FDI Stock, by Country (as at August 1997)

Thailand US South Korea France Australia Malaysia Taiwan Norway China Britain Hong Kong Canada Russia Singapore Japan Indonesia North Korea Sweden Germany Vietnam Macau

US$m

No. of FDI Projects

2,377 1,736 592 318 303 189 65 54 39 29 28 18 17 12 8 5 3 3 3 3 3

233 40 16 68 42 11 31 n.a. 60 13 23 14 15 16 16 n.a. n.a. 7 7 10 n.a.

SOURCE: Foreign Investment Management Committee.

TABLE 4.5 Laos’ FDI Inflows, 1994–97

FDI inflows (US$m) Cumulative FDI stock (US$m)

1988–90

1991

1992

1993

1994

1995

1H96

129

1,586

328

355

2,598

615

200

129

1,715

2,043

2,398

4,996 5,611

SOURCE: Foreign Investment Management Committee.

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TABLE 4.6 Laos’ FDI Stock, by Sector (as at November 1997) Sector Electricity power Hotels, tourism Telecommunications, transport Industry, handicrafts Wood processing Mining, oil exploration Banking, insurance Garments Trading Construction Agri-business Services Consultancy

Capital Pledged (US$m)

Percentage of Total FDI

4,500.8 605.5 561.6 476.8 165.6 125.6 73.8 72.6 62.5 60.0 59.3 34.6 5.0

66.1 8.9 8.3 7.0 2.4 1.8 1.1 1.1 1.0 0.9 0.9 0.5 0.1

SOURCE: Foreign Investment Management Committee.

by mid-1997, a more than fourteenfold increase in roughly eight years. ASEAN has contributed about 49 per cent of Myanmar’s FDI inflow pledges, with Singapore and Thailand being the second and third largest investor sources, respectively. Britain’s ranking as the largest single investor in Myanmar is somewhat misleading, as it includes investments pledged by venture capitalists of various origins, but registered in the British Virgin Islands. Therefore, it is quite likely that Singapore is actually the largest single source of FDI inflow pledges in Myanmar, thereby duplicating its pole position in Vietnam’s foreign investment rankings. Broken down by sector, the oil and gas industry has been the primary recipient of foreign investment interest (36 per cent of total FDI stock), followed by the manufacturing, property development, and hotel sectors. Given the above FDI profiles for the CLM countries, it is interesting to note that in all four countries of the “Greater Mekong” subregion, an ASEAN member is the largest single source of FDI: Singapore in the case of Myanmar and Vietnam; Thailand in the case of Laos; and Malaysia in the case of Cambodia. Furthermore, in both Laos and Myanmar, the ASEAN-6 countries are the source of just under half of the total FDI inflow pledges, whilst in Cambodia they account for a significant majority of total foreign investment pledges. It is clear that the “Greater Mekong”

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TABLE 4.7 Myanmar’s FDI Stock, by Country (as at September 1997)

Britain Singapore Thailand US France Malaysia Netherlands Indonesia Japan Austria Korea Hong Kong Australia Canada Panama China Germany Denmark Philippines Bangladesh Macau Sri Lanka

US$m

No. of Projects

1,322 1,226 1,157 582 470 524 238 236 203 72 83 111 76 35 31 29 15 13 7 3 2 1

30 57 42 16 3 23 5 8 16 2 15 19 13 11 1 9 1 1 1 2 1 1

SOURCE: ING Barings.

TABLE 4.8 Myanmar’s FDI Inflows, 1989–97 1989/ 1990/ 1991/ 1992/ 1993/ 1994/ 1995/ 1996/ 1H97 90 91 92 93 94 95 96 97 FDI inflows (US$m) Cumulative FDI stock (US$m)

449

281

6

449

730

736

104

377 1,352

668 2,814

387

840 1,217 2,569 3,237 6,052 6,439

SOURCE: ING Barings.

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Table 4.9 Myanmar’s FDI Stock, by Sector (as at November 1997) Sector

Percentage of Total FDI Stock

Oil and gas Manufacturing Real estate Hotels Mining Transport Fishing Industrial estates

36 19 14 12 8 4 4 3

SOURCE: Myanmar Investment Commission.

TABLE 4.10 ASEAN’s FDI Profile in the “Greater Mekong” Subregion Percentage of Total Registered FDI sourced from ASEAN Cambodia Laos Myanmar Vietnam

80 44 49 28

per per per per

cent cent cent cent

Notes: Malaysian FDI = 73 per cent Thai FDI = 41 per cent SOURCE: ING Barings.

countries are enjoying the fruits of the recent trend, noted above, that has seen the more advanced members of ASEAN beginning to enact fairly considerable FDI outflows. Positive Impact of ASEAN Enlargement on FDI Inflow into Cambodia, Laos, and Myanmar There is a spectrum of broadly indirect factors, stemming from ASEAN enlargement, that could cumulatively act as a fillip to FDI flows within the region, and in particular, increase foreign venture capital inflows into

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the CLM countries. On the broadest possible level, any degree of greater understanding and improved relations between the ten ASEAN memberstates, as a result of increased collaboration within the regional grouping, will provide a more conducive environment within which FDI flows can burgeon. A tangible example of this would be Laos’ decision, in anticipation of its subsequent entry into the regional grouping, to establish diplomatic representation in those ASEAN member states with which it previously had none. Any reduction in political risk factors should also have a positive impact on FDI flows in the region, thereby making the cost of investment capital cheaper; permitting acceptable internal rates of return to become longer; and the overall volition of venture capitalists to invest in other emerging markets should become greater. Furthermore, any process by which ASEAN enlargement improves the quantity and accuracy of information flow between the member countries should reap some rewards in terms of the scale, quality, and cost of foreign venture capital for the CLM countries. Whilst ASEAN remains a relatively informal organization, and its structures (such as the Jakarta-based Secretariat) are relatively small in scale, the regional grouping does provide an effective series of fora for government officials from the member countries to meet and discourse on a wide range of issues. Given the close relations between the respective governments and state- and quasi-state firms in both the CLM and most other ASEAN countries, the potential for “trickle down” effect of business initiatives from ASEAN gatherings to the business community may be considerable. It does not require a giant leap of imagination to conceive that some FDI projects initiated by major ASEAN corporates in the region — particularly those with links to their respective state leaderships — have at least partially stemmed from governmental “encouragement”, even though they may be wholly commercial enterprises. Conversely, host country licensing approval for some FDI projects by ASEAN corporates may have been assisted in part by discreet lobbying from the home country government of the foreign investor. Therefore, it is reasonable to argue that the enlargement of ASEAN to include the CLM countries will move these countries further towards the process of such networking. The ASEAN fora could also play an extremely useful role in what might be termed the “demonstration effect”. Through the interface of numerous ASEAN meetings, the government leaders of the grouping’s newest members will see at first hand, from the experience of the ASEAN-6, the utility — and some potential adverse side-effects — of FDI inflows. In particular, it will enable them to further appreciate some of the crucial non-financial inputs that also tend to follow such FDI inflows, as well as gain added insight into the means by which foreign venture capital can be

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best attracted and fully harnessed. Moreover, foreign investment does not solely result in an inflow of foreign capital per se, but also provides a chance for a developing country to garner equally important inputs of expertise and training, new technology and know-how, employment, and assistance in accessing new export markets, among various other factors. A number of the ASEAN-6 countries now have a wealth of knowledge on the motivations, consequences, and benefits of FDI inflows, which the CLM countries can tap, as part of their effort to integrate better with the global business community.4 Taking this argument one step further, ASEAN may also have the potential to provide a useful conduit role, both between the CLM countries and the international business community beyond Southeast Asia, and even within the domestic frameworks of the CLM countries themselves. Whilst much emphasis has been given recently to ASEAN’s apparent long-held reluctance to interfere in the domestic affairs of member states, the grouping arguably has an even more consistent track record as being a pragmatic organization, able to re-orientate its medium-term strategies and objectives as and when circumstances warrant (and the grouping has the consensus to do so). For example, any positive role that ASEAN could play to promote an improvement in the strained domestic political situations in Cambodia and Myanmar should ultimately translate into greater venture capital activity by foreign investors in these two countries. Similarly, it appears that the considerable natural reserves of Myanmar have sparked immense interest among various Japanese corporate entities, quite possibly greater than has been evident in Vietnam in the last ten years. Yet to date, partly in order not to provoke the ire of the United States, Japanese firms have largely held back from investing substantial sums in Myanmar. However, should a resolution of domestic issues in Myanmar permit Washington to re-appraise its stance towards the country, a surprisingly substantial inflow of FDI would follow from Japan, as well as the United States itself. In the case of Cambodia, FDI inflows in the second half of 1997 all but dried up, following events in June that year. Yet the resolution of domestic issues in Cambodia would also permit a resumption of foreign venture capital activity in what many observers view to be the most liberal foreign investment regime among the “Greater Mekong” countries.5 In both cases — Myanmar and Cambodia — ASEAN could play an important role in improving the host country environments for foreign capital inflows. If that were achieved, ASEAN could then play the role of introducing U.S. and EU corporates to the host country attractions of these countries, notably through the process of seeking coinvestors for projects. Indeed, ASEAN’s enlargement could provide the CLM states with an opportunity to increase their exposure to the wider

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global business community, and thereby dilute their current dependence on a small number of neighbouring Southeast Asian countries for much of their trade and investment flows. Although this factor may have been perceived to be of limited utility prior to mid-1997, the adverse regional economic events of 1997–99 will have served to make this point of markedly greater relevance now. For example, Laos’ very considerable exposure to Thailand for venture capital inflows and external trade flows means that it will be adversely affected by the economic recession that is under way in its southern neighbour. Similarly, any further downturn in the Malaysian economy could pose considerable problems for Cambodia, given its heavy reliance on this country for much of its FDI inflows (and a reliance that has arguably increased since the termination of most external assistance to Cambodia). Therefore, the enlargement of ASEAN may have a positive impact in improving the scale, diversity, and quality of FDI inflows into the CLM countries. Another factor that might possibly act as a fillip in encouraging greater FDI flows into the CLM countries from outside Southeast Asia is the prospect of the ASEAN Free Trade Area (AFTA), whereby import tariffs across a range of goods (and eventually services) within ASEAN will be brought below a 5 per cent ceiling, by a set date. That set date for most ASEAN members is 2003, for Vietnam it is 2006, and for Laos and Myanmar it is 2008. As Cambodia only joined ASEAN as a full member in April 1999, Phnom Penh might expect to be given a deadline of 2010. Of all the “Greater Mekong” countries, complying with AFTA would arguably be the most challenging for Cambodia, as the country’s dependence on import tariffs for budget revenues is believed to be markedly greater than the other countries. (In 1996, a remarkable 48 per cent of Phnom Penh’s total government revenues was reportedly sourced from customs duties.) Clearly, if intra-ASEAN trade is conducted at low tariff rates, then the attractiveness of serving the cumulative ASEAN market from one or two sites — as opposed to having a presence in each separate member-country — becomes a far more feasible proposition for major companies. However, although ASEAN as a whole may benefit from this move towards encouraging a greater flow of trade, it does not automatically mean that the cumulative stock of FDI in the regional grouping will increase markedly, or that greater FDI flows will target the CLM states — with their relatively poor infrastructure — as the chosen sites to service the wider ASEAN market. Indeed, it is conceivable that the CLM countries and Vietnam could lose out in any such consolidation of venture capital as a result of AFTA, as non-ASEAN investors seek to service these markets from sites in other ASEAN countries where infrastructural support is more advanced. Similarly, ASEAN venture capitalists might see less utility in

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investing in the CLM countries after 2008, as servicing these markets from the home country becomes a cheaper process after the elimination of tariff barriers. Whilst the recent trend towards vertical and horizontal integration of production within multinational enterprises across national borders means that decision-making on which host countries to inject investments has become a complex process, it should be recognized that a relatively large proportion of FDI projects in the “Greater Mekong” countries have been undertaken in order to service these domestic markets, as opposed to being export-oriented. Some of these investments would have been undertaken solely in order to circumvent punitively high tariff barriers.6 Thus, the dismantling of these tariff barriers would certainly prompt a reevaluation of project viability for at least a share of proposed FDI projects in the CLM countries. Furthermore, the relatively high rates of return still expected by most venture capitalists entering the “Greater Mekong” region mean that AFTA deadlines of 2006 or 2008 are still a sufficiently distant prospect for them to have little immediate impact on foreign investor sentiment. Finally, it should be noted that the fifth ASEAN summit, held in 1995, had proposed the establishment of an ASEAN Investment Area (AIA). The proposed AIA remains an unknown entity, as does its launch date. Therefore, it is hard to envisage how this might impact on FDI flows within ASEAN in general, and towards the CLM countries in particular, beyond suggesting that it would be designed to act as a fillip for investment activity within the Southeast Asian region. Negative Impact of ASEAN Enlargement on FDI Inflows into Cambodia, Laos, and Myanmar Having discussed the various factors stemming from ASEAN enlargement that may have a beneficial impact on FDI flows to the CLM countries, let us now examine the extent to which other factors can act to ensure that ASEAN’s recent enlargement will have relatively little impact on the “Greater Mekong’s” ability to attract, receive and harness greater foreign investor interest. It is valid to argue that the inclusion of the CLM countries into ASEAN may provide increased investment opportunities for major companies in the ASEAN-6 to enter markets at a notably different (lower) level of economic development, and thereby attempt to harvest any apparent business synergies. Such a move will also allow ASEAN-6 investors to gain exposure to the relatively rapid economic growth rates currently being recorded in the “Greater Mekong” sub-region. However, whilst it is possible that ASEAN enlargement may prompt the governments of the

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ASEAN-6 to promote FDI ventures more actively in the CLM countries, motivated in part by a sense of pan-ASEAN solidarity, the same business synergies and growth opportunities should have been evident in the CLM countries even before ASEAN enlargement. Beyond some of the more intangible issues discussed in the previous section, the CLM countries’ entry into ASEAN does not now qualify ASEAN-6 corporates for new or greater political risk guarantees, better access to debt financing, wider export credit cover, or other forms of incentive that would be of practical support in conducting FDI in the “Greater Mekong” subregion. Although the volition of the ASEAN-6 governments to increase their respective countries’ investment activities in the CLM countries still persists (and may have grown as a consequence of the enlargement process), the considerable battering that their domestic currencies, stock markets, companies, and overall economies have taken since mid-1997 will undoubtedly have reduced their ability and appetite to do so. For example, despite having been a major source of venture capital in the “Greater Mekong” subregion in recent years, Thailand is now unable to greatly increase its corporate exposure to the CLM countries. Indeed, quite the reverse. A fair number of approved FDI projects by Thai companies in the CLM countries are now unlikely to be taken to fruition, and ambitious investment plans for the power, telecommunications, building materials, and various other industry sectors in Laos and Myanmar will have to be scaled back significantly, at least in the short term. Foreign investment in the power sector of the CLM countries is likely to be hit by a double blow. First, some Thai companies will find it hard to have access to the necessary scale of financing required to start many ambitious power projects. And secondly, even if this first hurdle is overcome, the intention had been to export the power generated back to Thailand, which may now be revising downwards its future energy demands as a result of the economic downturn. This is potentially very alarming for Laos, where Thailand represents just over 40 per cent of all foreign investment, and where the power sector is the recipient of two-thirds of total FDI inflow pledges. Quite clearly, foreign investors have a range of perceived and real host country risks that they encounter when assessing the merits and opportunity costs of investing in emerging and transitional markets, such as the CLM countries. A desire to take advantage of the business opportunities that are apparent in these exciting new markets will be offset in part by foreign investor anxiety over typically excessive bureaucracy and red tape; foreign exchange convertibility constraints; high corruption levels; political risk; a paucity of infrastructural support; inadequate and evolving business legislation, and the associated peril of arbitrary decision-making by host

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country authorities; infant financial sectors and the lack of financial instruments; and so on. Although the “Greater Mekong” countries have made very significant strides in many of these respects in the last ten years, there remains a great deal of work to be done to further improve what are still extremely opaque business environments, as they can greatly undermine the recognized competitive advantages of the CLM countries, such as cheaper labour, untapped natural resources, virgin consumer markets, and so forth.7 Potential foreign investors must evaluate this dichotomy of domestic host country factors, in order to decide whether or not to invest (and the opportunity costs of selecting one host country over another). These host country factors are by far the most important determinant in the FDI or market entry decision-making process for foreign venture capitalists, above and beyond the regional affiliations that a host country may enjoy, or may recently have acquired. How then can ASEAN’s enlargement assist the CLM countries in reducing their host country liabilities and enhancing their host country competitive advantages? For this author, ASEAN enlargement does not appear to contribute much, beyond the broad factors discussed in the previous section. Whilst participation within ASEAN may grant the leaders of the CLM countries an opportunity to better understand the dynamics of foreign investment, as experienced by their ASEAN-6 counterparts, the act of improving their own host country business environment is something that they can only do themselves. Having joined ASEAN as a full member in mid-1995, Vietnam provides an interesting pilot case study for the CLM countries, on the likely impact that membership of the regional grouping may have on future FDI inflows. According to Hanoi’s own official figures, Vietnam’s new FDI inflow pledges had consistently increased each year — measured both by the number of individual projects and the cumulative quantity of capital approved — from their commencement in 1988, through to 1996. In that period, foreign capital inflow pledges rose from a mere US$363 million in 1988 to US$8,538 million in 1996, a twenty-threefold increase in just nine years. In fact, total FDI inflow pledges for Vietnam actually began to decline marginally in 1996, if one discounts two mega-property projects that were licensed in the final week of that year (in what some observers have postulated was a rather jaundiced attempt by the Ministry of Planning and Investment to buoy-up that year’s foreign investment figure, which was about to register a figure below that of 1995).8 In 1997, Vietnam recorded its first ever official decline in FDI inflow pledges since the country promulgated its foreign investment law — a decline by about a third. It should be noted, however, that actual disbursements of foreign venture capital continued to rise in Vietnam, as earlier foreign investment pledges

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began to materialize. Interestingly, the downturn in FDI pledges for Vietnam occurred in the two years immediately following the country’s acceptance as a full member of ASEAN, in mid-1995. Whilst it would be wholly disingenuous to postulate that entry into the regional grouping would result in a drop in FDI inflows, based on the evidence from Vietnam, it can be suggested that ASEAN membership is no automatic guarantor of greater cumulative foreign investment inflows for new members. Furthermore, the volume of FDI inflows that Vietnam sourced from the ASEAN countries did not pick up markedly after the former’s entry into the regional grouping. Rather, the established (that is, pre-ASEAN membership) trend of slowly rising ASEAN-sourced FDI inflows into Vietnam continued throughout the entry period and the subsequent eighteen months. Figures for ASEAN-sourced FDI into Vietnam only began to measure a significant rise in early 1997, almost wholly as a result of increased venture capital activity by Singapore alone. Although the relatively recent rise of Singapore to the top of the ranking of foreign investors in Vietnam might suggest that greater FDI inflows sourced from within the regional grouping can be attained after membership, the figures for FDI activity by the other ASEAN member countries is far more lukewarm. Finally, the events of late 1997 and early 1998 have undoubtedly taken their toll on the corporate and macroeconomic health of some of the ASEAN-6 members, which in turn has impacted on investor confidence levels — both within Southeast Asia and outside — as to the region’s shortand medium-term future. Although much of the region may well begin recording relatively impressive gross domestic product (GDP) growth numbers again within just a few years, it is not inconceivable that the very high growth rates of the recent past may be a matter of history for some Southeast Asian countries. What this means for the CLM countries and Vietnam, in terms of FDI inflows, is that they will have to gird themselves for what is likely to be a period of reduced cumulative foreign investment flows within Southeast Asia. Therefore, the “Greater Mekong” countries might be best advised to contain any lingering sense of euphoria at having joined ASEAN, and rapidly focus attention on increasing the proportion of FDI inflows from beyond ASEAN. In addition, the recent currency turmoil in the region has left some of the ASEAN-6 with local currencies that are now markedly lower in value against the U.S. dollar.9 This in turn may have some knock-on effects for the structure of their domestic economies, and the export competitiveness of certain industries. In particular, some industries in the ASEAN-6 that were deemed to have become “sunset” may be about to enjoy a new dawn, instead of relocating to other economies further down the value-added chain, such as the CLM

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3 7 13 14 19

© 2001 Institute of Southeast Asian Studies, Singapore

4 8 14 17 20

4 7 13 17 20

5 7 13 18 17

4 7 12 18 17

3 7 9 17 19

3 7 9 17 19

4 7 9 16 18

Feb-96 May-96 Aug-96 Nov-96 Feb-97 1 7 8 17 18

1 7 8 18 17

May-97 Aug-97

6.3 6.1 2.4 1.7 n.a. 16.6

9.5 5.2 2.1 1.4 0.5 18.7

10.3 4.6 2.1 1.3 0.4 18.3

8.6 4.1 2 1.2 0.4 16.4

9 4.7 2.4 1.1 0.4 17.6

7.9 4.5 2.5 1.1 1.1 17.2

9 4.5 2.4 1 1.1 18.1

11 4.3 3 1.1 1 20.5

10.9 4.3 3 1 0.9 20.3

9.7 4.1 3.7 0.9 0.8 19.3

17.4 4 3.6 0.9 0.9 26.9

18.2 4.2 3.8 0.8 1.3 28.4

Aug-94 Dec-94 Apr-95 Aug-95 Nov-95 Feb-96 May-96 Aug-96 Nov-96 Feb-97 May-97 Aug-97

SOURCE: ING Barings.

Singapore Malaysia Thailand Indonesia Philippines ASEAN-6

3 7 13 19 22

Aug-95 Nov-95

TABLE 4.12 ASEAN’s FDI in Vietnam, as a Percentage of Total FDI Stock, 1994–97

SOURCE: ING Barings.

Singapore Malaysia Thailand Indonesia Philippines

Dec-94 Apr-95

TABLE 4.11 ASEAN Countries in Vietnam’s FDI Rankings, 1994–97

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TABLE 4.13 Vietnam’s FDI Stock, by Country (as at November 1997)

Singapore Taiwan Hongkong Japan South Korea France Malaysia US Thailand BVI Switzerland Australia Britain Germany Netherlands Sweden Philippines Indonesia Russia Denmark China Canada New Zealand Others

US$m

No. of Projects

5,300 4,134 3,724 3,448 3,142 1,411 1,347 1,228 1,075 1,020 754 675 493 404 403 379 291 242 110 104 88 55 52 636

172 306 196 216 197 91 61 72 77 52 19 51 19 18 27 9 17 13 30 2 47 14 8 89

SOURCE: ING Barings.

TABLE 4.14 Vietnam’s FDI Inflows, 1988–97

FDI inflows (US$m) Cumulative FDI stock (US$m)

1988 1989 1990 1991 1992 1993

1994

1995

1996

1997

363

538

3,705

6,610

8,538

5,700

363

901

596 1,288 1,938 2,777

1,497 2,785 4,723 7,500 11,205 17,815 26,353 32,053

SOURCE: ING Barings.

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countries (or Vietnam and China). However, this trend will be mitigated, at least in part, by a parallel depreciation in the local currencies of the CLM countries. Going forward, competition among the developing countries for muchsought-after venture capital is likely to increase, not only among the ASEAN members, but also other regions, such as Latin America, Eastern Europe, and the republics of the former Soviet Union. In this context, being a new member of a regional grouping may not account for much in the big scheme of things, unless it is backed up with a markedly more attractive host country environment. Looking ahead, Myanmar will be able to promote its immense reserves of natural resources and under-utilized agricultural potential, whilst Vietnam will be able to trumpet its admirable human resource base. Similarly, the small and undeveloped economies of Cambodia and Laos will have to highlight their own, less immediately obvious, competitive advantages. One distinct advantage that these latter two countries do have is that their small economies only require relatively small quantities of FDI for such venture capital (and its associated inputs) to have an immediately beneficial impact on their economies, if harnessed correctly.

Conclusion The two main sections above have discussed the various factors likely to work both in favour of, and against, any expectation that ASEAN enlargement will have a positive impact on FDI inflows into the CLM countries. Comparing the two sets of counterveiling factors, it is this author’s opinion that the factors covered in the latter section are likely to be more significant determinants of future venture capital activity in the “Greater Mekong” subregion than the former. While it appears that a number of relatively intangible “macro” factors stemming from the enlargement of ASEAN may play a broadly indirect role in promoting foreign investment inflows into the CLM countries (and perhaps FDI flows across Southeast Asia as a whole), they will probably not be as significant as a smaller number of — but more directly pertinent — FDI-specific factors that each of the CLM countries will need to embrace if they are to successfully increase their future inflows of foreign investment. For example, recognition of a country’s acceptance within a promising regional association cannot compensate for a local market where foreign venture capital is unable to freely and confidently convert and repatriate earnings, nor nullify a widely-held perception by foreign investors (deserved or not) that a host country’s business environment closely resembles that of a minefield. Although one should not wholly discount the impact that

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TABLE 4.15 Vietnam’s FDI Stock, by Sector (as at November 1997)

General industry Hotels and tourism Industrial zones Oil and gas Transport, communications Agriculture & forestry Finance & banking EPZs Services Housing development Fisheries Others

Capital Pledged (US$m)

Percentage of Total FDI

14000 7600 4000 1200 1100 419 265 203 168 106 65 251

47.6 25.8 13.6 4.1 3.7 1.4 0.9 0.7 0.6 0.4 0.3 0.9

SOURCES: Ministry for Planning and Industry; and ING Barings. ASEAN enlargement may have on foreign investment in the region, at this stage the impact and implications for FDI flows look relatively humble. From the perspective of the CLM countries, ASEAN membership in itself will probably reap relatively few rewards in terms of FDI inflows per se, although the opportunity that membership provides for its newest members to learn and harness the past experience of the ASEAN-6 in the field of FDI should be seized with both hands. If such an opportunity is taken, it could ultimately lead to improved FDI inflows for the “Greater Mekong” subregion. Consequently, the short-term impact of ASEAN enlargement for FDI flows will be slight, at best. Indeed, the positive consequences that one might have anticipated prior to mid-1997 are likely to be discounted, in large part by recent downward revisions in collective economic and corporate growth for the ASEAN states in 1998 and 1999. In discussing recent events in Southeast Asia, the Secretary General of Thailand’s Board of Investment was quoted in the local press as saying, “If you brake when you’re driving at very high speed, some passengers will be injured”. Adopting this analogy, the ASEAN-6 countries could be viewed as having been in the driving seat of recent Southeast Asian growth, with the CLM countries as back-seat passengers. Yet, the full impact, in terms of declining FDI inflows sourced from the surrounding region, may only be really felt by the CLM countries as we enter the next decade.

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Notes 1

2

3

4

5

6

7

8

The per capita gross national product (GNP) of the “Greater Mekong” countries are low. Prior to the currency turmoil of late 1997, the nominal per capita GNP figures for each of the countries were roughly: US$270 for Cambodia, US$370 for Laos, US$765 for Myanmar, and US$270 for Vietnam. However, these are median figures for what tend to be quite diverse spectrums of income in each of the countries, the poorest of whom live at semi-subsistence level. For FDI data provided in this paragraph, see Hafiz Mirza, Frank Bartels and Mark Hiley, “The Promotion of Foreign Direct Investment Into and Within ASEAN”, Report of a survey conducted by the Asia-Pacific Business & Development Research Unit, University of Bradford, for the ASEAN Secretariat, 1997; and “Asia’s Share of FDI Shrinks as Growth in Supply Slows”, Asian Wall Street Journal, 22 September 1997. The cumulative figures for Malaysian investment in Cambodia are somewhat inflated by a single property and port development project proposed for the southern town of Sihanoukville, which has been approved with a capital pledge of US$1.2 billion. Some of the ASEAN-6 countries might be able to provide guidance to the “Greater Mekong” countries on the utility of encouraging more vigorous private-sector activity and permitting a greater degree of competition with the state sector. Cambodia’s foreign investment law, and associated legislative framework, permits foreign investors to participate in a far wider range of business activities than is currently the case in Vietnam, Laos, and Myanmar. This liberal view towards FDI activity has partly been adopted in order to compensate for some of the added difficulties that foreign venture capital must face in starting projects in this extremely challenging market. See Cambodia & Laos Review, ING Barings, February 1997. This aim of investing to better service domestic markets, rather than for export, is particularly true in the case of Vietnam, which houses the world’s twelfth largest population. To date, fourteen foreign motor manufacturers have gained various forms of investment licences to assemble or manufacture automobiles in Vietnam, in a market that will only be able to sustain such a large number of companies in the very long-term. See special “Auto” feature in Vietnam Investment Review, 28 September–5 October 1997, and “Auto Focus” in Vietnam Economic Times, October 1997. For example, anyone who has sought accurate data on a spectrum of macroeconomic measures in the “Greater Mekong” subregion will concur that finding detailed and consistent figures on which to undertake host country market research can be extremely difficult. This not only stems from a lack of adequate resources for data collection, but a lingering unwillingness by some authorities to provide information on various issues. Such a paucity of information adds to the perceived level of risk for overseas investors, which translates into greater costs of capital and more demanding rates of return, among other factors, which is often to the detriment of the host country. Approximately 40 per cent of Vietnam’s total FDI projects approved in 1996 were licensed in the final month of that year. It was reported that one of the two mega-property projects referred to was subsequently postponed indefinitely. See Vietnam Update, ING Barings, May 1997.

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The recent financial market turmoil in the Asia-Pacific may also make it more difficult for regional corporates to secure lending in order to finance large projects in the “Greater Mekong” subregion.

References “Asian Economic Survey 1997–98”. Asian Wall Street Journal, 20 October 1997. East Asia Analytical Unit. The New ASEANs. Australian Department of Foreign Affairs and Trade, June 1997. Goad, G. Pierre. “Asia’s Share of FDI Shrinks as Growth in Supply Slows”. Asian Wall Street Journal, 22 September 1997. ING Barings. ASEAN’s Newest Members. July 1997. ING Barings. Cambodia & Laos Review. February 1997. ING Barings. Indochina in 1998: Expecting Some Turbulence. January 1998. ING Barings. Myanmar Update. May and November 1997. ING Barings. Vietnam Update. May and November 1997. Mirza, Hafiz, Frank Bartels and Mark Hiley. “The Promotion of Foreign Direct Investment Into and Within ASEAN”. Report of a survey conducted by the Asia-Pacific Business and Development Research Unit, University of Bradford, for the ASEAN Secretariat, 1997 (unpublished). United Nations Conference on Trade and Development (UNCTAD). World Investment Report 1996: Investment Trade and International Policy Arrangements. New York: United Nations, 1996. . World Investment Report 1997: Transnational Corporation, Market Structure and Competition Policy. New York: United Nations, 1997.

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European Union Enlargement: Lessons for ASEAN

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ROLF J. LANGHAMMER

Introduction “Integration deepening” breeds “integration widening”. For very different reasons, forty years of “deep” integration in Europe and thirty years of “shallow” integration in the Association of Southeast Asian Nations (ASEAN) have been effective in dismantling internal and external market barriers and establishing a nucleus of political integration (European Union or EU) and political co-operation (ASEAN). The two regional groups border on Central and Eastern Europe and Indochina, respectively; and traditionally they have been the main goods, capital and knowledge markets for these much poorer economies. Income differentials between member countries of the two schemes and their neighbours grew immensely during the last twenty years (Fischer et al. 1997; and Langhammer 1997), as political isolation did not allow Indochina and the Central and Eastern European countries (CEECs) to capitalize on natural trading partnerships. After the demise of USSR-ruled socialism, political isolation was rapidly eliminated (in the case of the CEECs), or is currently eroding (Indochina). This has paved the way for the enlargement of the two regional groupings. Yet, these seem to be the only parallels between the EU and CEECs, on one hand, and ASEAN and Indochina, on the other. There are obvious dissimilarities in growth and adjustment speed between allegedly sclerotic and over-institutionalized continental Europe and dynamic, yet vulnerable Southeast Asia. Furthermore, there are key differences between the CEECs 102

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and Indochina: for example, unlike Indochina, the CEEC economies have advanced industrial sectors, which, prior to the demise of the old system, were thought to be comfortably placed in the middle-income group. This assessment had to be fully corrected after 1989, as the capital stock of the CEECs had been valued using widely distorted input and output prices. As a result, after adjusting domestic prices to world market prices, the CEECs found themselves trapped in an obsolete industrial division of labour. Consequently, they incurred substantial income losses because of an unprecedented depreciation of their physical capital stock before enjoying recovery. Additional strains have come from the public sector which is still large and burdened not only by political pressure to continue subsidizing non-competitive sectors and industries, but also by claims to finance pension expenditures of an ageing population in a way that their Western neighbours do, that is, by pay-as-you-go schemes. Indochina, on the other hand, has none of these problems. It is a typical low-income developing area without institutional overheads; and in its early stage of development, it is exploiting abundant natural resources and unskilled labour. In short, in the case of the CEECs, transformation has meant moving through a j-curve; while in the Indochina case, transformation has been equivalent to mobilizing idle resources in the primary sector and initiating spillovers to the industrial processing of primary resources. There are also critical differences in implementing the procedures of membership in the two regional organizations. With regard to the EU, the December 1995 Madrid European Council Summit Meeting stated that the Council, based on opinions and reports from the European Commission, would after concluding the so-called Intergovernmental Conference, “at the earliest opportunity, take the necessary decisions for launching the accession negotiations”. This means that practical lessons from the official enlargement process cannot be drawn, as neither the negotiations nor the accession period had started. The Council expressed “hopes that the initial phase of negotiations would coincide with the start of negotiations with Cyprus and Malta” (that is, the two Mediterranean economies with the status of associates and long-standing prospects for membership). Such vague and long-winded diplomatic phrasing has induced Baldwin (1997, p. 97) to argue that the “CEECs and the EU are engaged, but the wedding date has not been set and bride price could pose a problem”. One could add that even the selection of appropriate first round wedding partners on the CEEC’s side is subject to controversy among the member states. In contrast, one could describe the accession into ASEAN of Vietnam (in 1996), and Myanmar and Lao PDR (in 1997), as a “Las Vegas jump-start wedding”, or, put differently, more a club accession than a wedding.

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This chapter will depart from the state of integration of the member states and the economic conditions facing the applicants by discussing what statistical data reveal about the patterns of resources and production of the two enlarged areas. The next section looks at how differences and similarities in resource disparities between the EU/CEECs and ASEAN/ Indochina can be interpreted. The following section will present a road mapping various paths, stop-overs, and bumps between the current status quo and full membership after the EU Eastern enlargement, and discuss possible lessons for phasing ASEAN’s northern enlargement. The chapter then draws on the empirical experiences of the 1981–86 EU southern enlargement and the theoretically possible impact of the Eastern enlargement on intra-area and extra-area trade and factor flows. It goes on to analyse the relevance of such experiences for ASEAN and Indochina’s position in regional and international markets. The concluding section criticizes both paths of accession in the EU and Southeast Asia as inappropriate, given economic and political conditions in the two areas. EU Enlargement versus ASEAN Enlargement: Lessons and Fallacies Profound Changes in Economic Structures The CEECs and Indochina share three main characteristics with respect to the regional groups they have joined. They are low-income countries, have strong agricultural sectors and suffer from poor infrastructure. Enlarging the schemes will thus profoundly shape the economic landscape in Europe and Southeast Asia. Enlargement will also raise a number of thorny policy issues for the old members: for example, natural resource endowment. Table 5.1 stylizes the expansion of natural resources as a result of EU and ASEAN enlargement. Given that the number of applicants to the EU amounts to at least ten countries with very different economic, political and historic preconditions,1 Table 5.1 differentiates between three sub-groups of CEEC candidates: — the Visegrad-4 countries (Czech and Slovak Republics, the successor states of former Czechoslovakia, Poland and Hungary) which are relatively advanced in both economic transformation and trade liberalization; — the so-called Baltic-3 countries, comprising Estonia, Latvia and Lithuania. Of these countries, Estonia has progressed most in economically delinking from Russia and implementing market-oriented reforms, including a currency board system; — the so-called Balkan-3 countries (Bulgaria, Romania and Slovenia). In this group, Slovenia has largely remained unaffected from the shocks following Yugoslav decay and enforced market-oriented reforms, whereas Romania and (especially) Bulgaria are still coping with severe transformation problems.2

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Table 5.1 suggests that the main economic effects of EU enlargement will come from the Visegrad countries, and that all will be reinforced by bringing the Baltic-3 and Balkan-3 into the EU. In detail, Visegrad enlargement will boost: — cropped land in the EU by 28 per cent (with another 23 per cent if all ten countries were to join); — labour-force employed in agriculture by 37 per cent (by more than half of the EU-15 figure if the Baltic and Balkan countries were to join); — cereal production by more than one-fourth (and by more than 40 per cent, including the Balkan and Baltic states).

TABLE 5.1 Natural Resource Expansion resulting from EU and ASEAN Enlargement, 1994–95 (In per cent)

Indicators

Land area Cropped land Population Labour force employed in agriculture Cereal production Rice production Cattle stock Beef and veal production Commercial energy use Merchandise exports GNP (current dollar)

EU Enlargement

ASEAN Enlargement

Expansion over EU-15

Expansion over ASEAN-5

EU-19

EU-22

EU-25

ASEAN-9

+17 +28 +17

+22 +35 +19

+34 +51 +28

+47 +30 +37

+37 +26 — +13 +9 +9 +3.3 +2.7

+41 +28 — +16 +12 +12 +3.6 +2.9

+55 +42 — +21 +16 +17 +4.6 +3.8

+50 +50 +75 +74 +31 +8 +2 +6

EU-19 = EU-15 plus Visegrad-4 (Czech Republic, Hungary, Poland, Slovak Republic); EU-22 = EU-19 plus Baltic-3 (Estonia, Latvia, Lithuania); EU-25 = EU-22 plus Balkan-3 (Bulgaria, Romania, Slovenia); ASEAN-9 = ASEAN-5 (excluding Brunei) plus Cambodia, Lao PDR, Myanmar, Vietnam. SOURCES: Calculated from World Bank, World Development Report 1997; ADB, Key Indicators of Developing Asian and Pacific Countries 1996; FAO, Production Yearbook 1995; ADB, Asian Development Outlook 1996–97.

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Similarities to the Indochina enlargement are striking; and they are even more pronounced in Southeast Asia, given that only four (although populous) countries are under consideration. Like the CEECs, the Indochinese countries boost ASEAN labour-force employed in agriculture, as well as cereal production by 50 per cent, cropped land by 30 per cent and, most notably, rice production by three-quarters of the ASEAN-5 level. On the other side of the coin, neither the CEECs nor the Indochinese countries add more than 6 per cent to economic performance if 1995 figures are taken as the benchmark. Such performance criteria comprise gross national product (GNP) and merchandise exports. Finally, energy seems to be inefficiently used in both areas (albeit more in the CEECs than in Indochina) if incremental commercial energy use is compared to much lower increments in national product and exports. Being populous, poor and agrarian there are sizeable lags between the core and the periphery with respect to human and physical stock endowment and standards of living. However, while the direction of the lags is the same for both regions, absolute magnitudes differ between Europe and Southeast Asia. Table 5.2 highlights such lags which are much larger in the ASEAN-Indochina context than in Europe. For instance, communication endowment (measured by main telephone lines per capita) in Indochina is only 3 per cent of the ASEAN-5 average level, while it is 36 per cent in the Visegrad countries, relative to the EU-15 average: This is an extreme case but, for almost all other indicators, the endowment in Indochina is further behind ASEAN than in the CEECs relative to EU-15. One should note that this lag is aggravated by the fact that the ASEAN-5 average endowment is generally lower than the EU level. If the composite Human Development Index is taken as the yardstick, then Indochina is at 50 per cent of the EU level and not higher than 60 per cent of the lowest EU applicant level (Baltic-3). In brief, the CEECs are less behind the Western European human capital stock than the Western European physical stock and, interestingly enough, the Indochina-ASEAN comparison would support the same finding, albeit with much larger disparities. The last indicator in Table 5.2 mirrors the prevalence of substantial social tensions in Indochina. Poor as the countries are, in 1995 they spent one-and-a-half times as much on the military as the average ASEAN country. In Europe, the Baltic states seem to have followed the Indochina example, basically because of Estonia’s tensions with Russia. All other countries have strongly redressed their military expenditures so that the Visegrad countries are now almost at the EU level.

© 2001 Institute of Southeast Asian Studies, Singapore

© 2001 Institute of Southeast Asian Studies, Singapore 76.8 100 0.93 100 18 965 100 0.927 100 48.7 100 11.4 100 2.2 100

A B A B

Average

A B A B A B A B A B

Group

+9.9 187 +0.18 108

–6.1 92 –0.03 97 –12 207 36 –0.066 93 –31.2 36

Visegrad-4

+27.6 342 +1.43 165

–7.7 90 –0.04 96 –15 086 20 –0.177 81 –23.7 51

Baltic-3

+45.3 497 +0.43 120

–5.6 93 –0.07 92 –14 118 26 –0.122 87 –25.2 48

Balkan-3

Deviation from EU-15

244 100 3.2 100

69.7 100 0.81 100 8 675 100 0.781 100 13.6 100

Average

ASEAN-5

+307 235 +1.64 151

–12.6 82 -0.19 77 –7 218 17 –0.321 59 –13.3 3

Indochina average

Deviation from ASEAN-5

SOURCE: Calculated from UNDP (1997).

The HDI is based on three indicators: Longevity (life expectancy), educational attainment (adult literacy and school enrolment), and standard of living (real GDP per capita. For details, see UNDP (1997), p. 122. The education index is a combination of primary, secondary and tertiary enrolment ratio index and an adult literacy index. For details see UNDP (1997), p. 122. A = absolute values; B = in per cent of EU-15 average and ASEAN-5 average, respectively.

Life expectancy at birth Education Index Real GDP per capita (PPP 1994) Human development index (HDI) 1994 Communication endowment (main telephone lines per 100 people, 1994) Maternal mortality rate (per 100,000 live births 1990) Military expenditure per GDP 1995

Indicators

EU-15

TABLE 5.2 Human and Physical Resource Endowment and Standards of Living Differentials in Europe and ASEAN Enlarged

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Fallacies of Transposition: Similar Disparities Impact Differently upon Integration Farmers and poor regions within the EU are eligible for substantial transfers from the EU budget. The Common Agriculture Policy (CAP) and structural spending (for regional funds) account for 80 per cent of the EU budget. Given that CEECs are agrarian and poor but enjoy strong comparative advantages in agricultural production vis-à-vis many EU-15 producers, an enlargement under an unchanged CAP would imply an intolerable increase in agricultural expenditure. European Commission estimates are in the range of 28 per cent increase (a lower bound estimate) and 12 billion ECU (European Currency Unit) in absolute terms if the EU is enlarged by the ten CEECs (Tangermann 1997). While this would be equivalent to only 0.2 per cent of the 1996 EU gross domestic product (GDP), it would strongly exceed the agreed upper limit of budgetary expenditures for agriculture. This limit is linked to the GDP growth rate and is estimated at about 5 per cent if some assumptions on growth differentials between the CEECs and the EU-15 are made (ibid.) Hence, to spend an additional 28 per cent, instead of 5 per cent, signifies the burden upon EU taxpayers owing to enlargement, without taking into account expenditures for structural spending. It is evident that the rising incomes of the CEEC farmers might never change this (Baldwin 1997, p. 81). Apart from the EU internal limits, there are external institutional limits under the World Trade Organization (WTO) commitments to phase out public subsidies for the agricultural sector. Under these premises, four strategies are possible: raise national expenditures for poor regions and farmers, reform all transfers to drastically harden the criteria of eligibility to transfers, enact discriminatory second-class treatment of CEEC farmers and regions and, finally, postpone enlargement. It is evident that the second strategy is economically the best and that the third or fourth strategy is politically likely. In ASEAN, there is no CAP. Nor is there structural spending for poor regions. In this respect, nothing can be learnt from the EU and its distribution targets. However, it would be misleading to argue that backwardness and the agrarian structure of Indochina do not impact upon ASEAN. It does so in an indirect way. First, membership will raise pressure to relax the ASEAN-5 countries’ barriers against migration from Indochina. This is similar to Europe and the Europe Agreements in which quotas for guest workers were made possible for individual EU member states. With free mobility within those EU member states which have abolished person controls at internal borders (Schengen countries), migrants can illegally (but easily) move to other EU

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member states. While it is evident that the ASEAN countries are much stricter in controlling the movement of persons, a process to open borders gradually has been set in motion. Secondly, pressures to include rice and other sensitive agricultural products in the ASEAN Free Trade Area (AFTA) liberalization process will also increase. ASEAN-5 rice farmers, producing under marginal conditions, will have to adjust to the superior competitiveness of Indochina in these agricultural items, and this challenge will add to Asia-Pacific Economic Co-operation (APEC) liberalization pressures. Should liberalization of world agricultural trade induce price increases for products like rice (Brandão and Martin 1993), it might stimulate ASEAN-5 private capital and know-how to invest in Indochinese rice production and would therefore aggravate adjustment pressure upon ASEAN-5 farmers. In brief, an increase in rice production by 75 per cent as a result of moving from ASEAN to ASEAN plus Indochina is very unlikely to remain without any impact upon competing ASEAN domestic supply, even if the implications are much smaller than under the EU type of common policy which aims at guaranteeing a certain level of income. Thirdly, if it is true that the disparities in infrastructure endowment are larger between ASEAN and Indochina than between the EU and the CEECs, this might turn out to be a blessing for Indochina. Instead of responding to incentives to repair or upgrade an existing network (for instance, a cable-based telephone network), the Indochinese countries, starting from scratch, may simply leap-frog dated technological stages and become endowed with state of the art technology (mobile cellular phones or Internet use, for instance). Fourthly, existing gaps in living standards between the CEECs and the EU-15 will release political initiatives to close the gaps with public money. Under the so-called PHARE programme (the OECD-sponsored and EU-administered assistance programme for the CEECs), investment in personal infrastructure plays an important role. Again, this is taxpayers’ money. Yet, given that the gaps are not very large (Table 5.2), private and social returns to investment in education might not be as sizeable as in Indochina where primary education will (as in other developing countries) promise the largest returns. Such positive perspectives of income gains might trigger private investment into education, which is already more common in ASEAN than in Europe with its strong public dominance in education. Hence again, responses to resource gaps would differ between Indochina and ASEAN with their smaller public sectors, on the one hand, and the CEECs and EU, on the other hand, both of them hosting strong public sectors.

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The Paths of EU Enlargement and Potential Lessons for ASEAN Enlargement: The Maze of Options The Road to Full Membership and its Bumps EU Member Targets As discussed above, EU enlargement by admitting new full members is a process like that of an engagement and wedding in which a well-settled family screens a prospective member on its current status and perspectives. Apart from accepting all EU external commitments (for instance, the Uruguay Round or UR), full compliance of the national law with the achievements in community law and jurisprudence at the EU level is required, and will be painstakingly checked. These achievements are called acquis communautaire. For the CEECs, this means that membership is not possible unless discrepancies are removed in individual national regulations which violate the free mobility of persons, capital, companies and goods (including services) as well as the principle of non-discrimination among EU residents. In recent years, compliance with basic human rights and democratic principles have been added to the accession agenda. If policies have become common, such as in agriculture, trade, competition, fishery and industry, competence would have already shifted to the Brussels level. New members must also be prepared for additional common policies in the making (in security and defence, for example) and to further curtail the national scope for policy manoeuvring. In other words, the acquis leaves candidates with a zero-one option. They either adjust or are disqualified for membership. Candidates do not shape the acquis but the acquis will shape the candidates. Essential implications from the acquis requirement seem to have arisen for a candidate such as the Slovak Republic which a few years ago was rated as an almost 100 per cent first-round member. Since that time, however, the country has pursued economic and general policies which, in the assessment of the EU, deviate from the EU norm more than the other CEECs do. Yet, being in a customs union with its twin partner from former Czechoslovakia, the Czech Republic, it is likely to be treated on equal terms with the Czech Republic. The Cambodian case in Indochina and its pending membership in ASEAN come to mind as a parallel, but would not lead us far. The EU acquis approach is ex ante and micro-oriented, and thus requires substantial ex ante harmonization to be done by the candidate prior to its accession. Without doubt, there is something like an ASEAN acquis, but it is a minimum prescription in the sense that no civil war or similar hostilities can prevent the ASEAN authorities from identifying and committing the

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ruling government of the candidate. In principle, the ASEAN approach is ex post and macro-oriented and leaves the new member with minimal requirements for harmonization in the post-accession period. Quantifiable harmonization is still basically restricted to the phasing of AFTA trade liberalization. Beyond that, a broad qualitative commitment to co-operation in all ASEAN institutions, including dialogues with foreign partners, is required. This commitment, however, should not be underrated as far as pressure on new members to comply with ASEAN solidarity and identity is concerned. It remains to be seen whether such peer pressure can shape the internal policies of those Indochinese countries which are internationally isolated. Beyond the comparison of prerequisites for EU and ASEAN enlargement, there are implications of the EU acquis requirements for ASEAN as a group as far as penetration into EU markets is concerned. It will be discussed below whether EU enlargement is a gain or loss for ASEAN. However, irrespective of the different ways of assessing the effects, one can argue that the EU acquis hurdle has a built-in tendency to postpone the membership of very poor countries with serious internal bottlenecks to catch up. In other words, countries with the largest degree of similarity in resource endowment to the EU will be preferred. This could mean that in the process of accession, factor prices of candidates will somewhat converge towards EU levels (for instance, as a result of harmonization of standards and common competition policies in order to avoid anti-dumping procedures). Consequently, if we can assume that ASEAN and EU comparative advantages differ because of differences in resource endowment and factor prices, EU enlargement will push the export supply of the accession countries more towards complementarity to ASEAN supply rather than to substitutability. In concrete terms, one should expect higher trade overlaps between the export supply of the ASEAN countries and potential EU member states (those which are on the waiting list) than between ASEAN countries and those CEECs which qualify for membership in the first round. At least, we could expect trade overlaps between ASEAN supply and EU-15 supply to become closer to overlaps between ASEAN supply and the supply of first-round accession countries. Of course, this only holds for manufactured goods and not for commodities or processed goods made of tropical raw materials. If testing does not confirm this hypothesis, it might be due to the fact that availability of abundant unskilled labour is a necessary but not sufficient condition for success in penetrating foreign markets. This may hold true especially for the CEECs with their obsolete capital stock, as a minimum of fresh capital injection is required to mobilize idle domestic resources. Such injection either through foreign investment, foreign loans, or domestic savings mobilization may

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be discouraged because of internal economic disorder. Bulgaria and Albania have recently experienced such a stalemate situation. Under such conditions, there might be little overlap of their export supply with ASEAN supply, simply because of limited export capacities. In spite of the CEEC factor endowment converging to EU levels as a result of full membership, the ASEAN countries will, in relative terms, still compete more with EU “Eastern periphery” supply than with supply from the EU core. On the other hand, an enlarged ASEAN is likely to move the export supply of the Indochinese countries towards unskilled manufactures. Let us assume for the moment that the EU will extend the dialogue system and the conditions of the EU–ASEAN co-operation scheme to all Indochinese countries (including Myanmar). Then, in the future, an enlarged EU (EU-19, EU-22, EU-25) will meet the ASEAN-10 in bilateral dialogues on market access and business co-operation. Will such a dialogue differ from the old EU-15–ASEAN-6 dialogue scheme? One can speculate about the possibility that an enlarged EU will be less prepared to open their sensitive sectors to competing supply from the ASEAN-10 and that the EU, under pressure from its Eastern members, will closely monitor minimum social standards to be maintained in the Indochinese economies. Under such premises, the dialogue is unlikely to become “smoother”. Stopovers It is unknown today how long the accession period in the EU will last. This period is defined as the time-span between signing the accession to the EU and full compliance with the acquis and all external commitments of the EU. Spain and Portugal required seven years, and the two economies had already made significant preparations before signing the accession. This experience suggests that a minimum of 7–10 years will be necessary for the CEECs and will require much deeper intervention into the domestic economies than in the case of Indochina which is expected to meet the AFTA commitments in ten years’ time. During this process, there will be stopovers. In terms of stages of economic integration, the first stopover is the fulfilment of the bilateral free trade arrangements (FTAs) under the Europe agreements. The second stopover could be a customs union between the accession countries and the EU-15. This would include a common external tariff and subordinate national trade policies of the CEECs against third countries under the Brussels rule. This stopover would also encompass free trade among the accession countries, which is currently under the Central European Free Trade Area (CEFTA). To facilitate trade liberalization between the spokes and to redress current hub-and-spoke bilateralism, all bilateral schemes

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could be merged to what Baldwin (1997, p. 76) calls an Association of Association Agreements (AAA). An AAA would liberalize trade between the spokes and would bring each spoke into the same free trade position as the EU-15 countries. Parallel to this process of trade liberalization and trade policy harmonization, a final stopover could be the extension of the European Economic Area (EEA, initially framed for the remaining nonEU EFTA member states — Norway, Iceland, Liechtenstein, but not Switzerland which opted out) to the CEECs. The EEA fixes the four freedoms (capital, labour, rights of establishment, goods and services) and provides access to EU regulations concerning mutual recognition of some standards and ex ante harmonization of most standards. An important improvement in the EEA, compared to the Free Trade Areas (FTAs), is seen in the fact that EEA members are exempted from anti-dumping procedures as a result of harmonization of national competition policies. Furthermore, other contingent protection measures, such as escape clauses and countervailing duties, would also be dismantled after joining the EEA. At the final point of the stopovers, there would be an EU-EFTA-CEEC zone guaranteeing free mobility of all factors (perhaps excluding migration) plus a common external trade policy. The final step to full membership would be to extend the early elements of political integration (common security, defence and foreign policies) to the first round CEEC candidates. To highlight the concrete requirements for accession candidates in a specific stopover and to discuss what such a stopover could mean for Indochina’s phasing into the AFTA process, one may implement the customs union step. This step is relatively easy to demonstrate. For this purpose, Table 5.3 presents average post-UR applied and bound import tariffs on industrial goods and on all trade (including agriculture), for both the EU-15 and the accession candidates, as well as the ASEAN-4, Singapore and Vietnam, the last representing Indochina. Given that the Indochinese economies were non-contracting parties by the time of the UR conclusion, there is no information on applied and bound rates for these countries. As usual, bound rates are higher than applied rates but this difference is relevant only for non-EU countries. To form a customs union, candidates from the Visegrad countries would have to lower their average applied rate from 5.8 per cent by about 50 per cent, to arrive at the EU-15 average of 2.8 per cent. For a less advanced candidate like Romania, a cut of about 75 per cent based on the average applied rate would be required. Such cuts would be much higher than the 30 per cent offered by the countries in the Uruguay Round (Hoda 1994, p. 53). The CEEC governments might come under pressure from import competing industries and thus would claim for adjustment periods before joining the common external tariff. On the other hand, the majority of CEEC imports originates from the

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EU-15 countries, which will receive duty-free access to Visegrad markets shortly before the end of the ten years adjustment time, as agreed upon in the bilateral FTAs. Hence, one can question the concern of protected industries that it is an additional burden to lower tariffs on imports from the United States, Japan, or ASEAN. Suppliers from the ASEAN region would certainly benefit from easier access to the CEECs, after these countries join the EU customs union. Data for ASEAN in Table 5.3 suggest problems which have already been solved long ago in the EU. The main problem is high import tariff disparity between the ASEAN-4 countries, with Malaysia at the lower end and Indonesia at the higher end. Singapore is taken as a special case. In Table 5.3, import tariff disparity is shown by high coefficients of variation, which even exceed the Visegrad-4 coefficients of variation. Hence, forming a customs union for the core ASEAN member states will expose the

TABLE 5.3 Tariff Reductiona and Post-Uruguay Round Most-Favoured-Nation Tariffsb for the EU, ASEAN, and their Applicants Industrial Goods

EU-15 Visegrad-4 average Coefficient of variation Baltic-3 Romania ASEAN-4 average Coefficient of variation Singapore Vietnam

All Trade

Post-UR applied rate

Tariff reduction

2.9

2.9

3.2

2.8

3.1

3.2

5.8

2.8

6.1

5.8

2.8

7.6

0.31 n.a. 11.4

0.52 n.a. 3.6

0.39 n.a. 34.4

0.30 n.a. 11.7

0.50 n.a. 1.8

0.56 n.a. 45.1

23.6

15.6

10.3

0.56 1.3 33.5c

0.34 14.9 n.a.

16.4 0.55 0.4 n.a.

10.0 0.26 9.3 n.a.

Post-UR Post-UR Post-UR bound applied Tariff bound rate rate reduction rate

0.50 6.9 n.a.

NOTES: a Measured as dt/1 + t; b Excluding tariffs under free trade arrangements; c Average tariff rate on major imports (WTO 1996, p. 35). n.a. = not available. SOURCE: Finger et al. (1996); author’s calculations.

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countries to true challenges to negotiate an average external tariff. Unless this challenge is solved, ASEAN cannot embark upon the next step to integrate Indochina into the union. It is very likely that these very poor countries will seek tariffs not only as a protection instrument for infant industries, but also as a budgetary mechanism because of the narrow domestic tax base. The only data available for Vietnam supports this assumption. Even if the newer members succeed in implementing the AFTA agreement, a large share of their total imports is still likely to come from non-ASEAN sources. Hence, they can be expected to examine the implications of a prospective customs union more critically than the CEECs for which non-EU trade is less important. Admittedly, this scenario of an ASEAN-Indochina customs union is far away. Yet, it shows how much preparation and further integration would be required among the ASEAN-6 before they (ASEAN-6) could commit the Indochinese countries to advanced steps of integration. Bumps The EU road to enlargement is not only made of cobbled stones, but it has bumps which require deceleration in the speed of integration. One bump has already been mentioned: reform of the CAP is indispensable, if agrarian poor areas join the Union. Perhaps more serious is the reform of internal decision-making, which comprises two aspects. One is the size of the Commission in an enlarged Union. The Commission, combining the roles of watchdog, initiator and executive body, now has twenty commissioners and will become ineffective and over-bureaucratic if the existing conditions (two commissioners each for the four large member states, one commissioner each for the small member states) continue to apply for a Union with more than twenty members. The second aspect is politically sensitive as it refers to the voting weights in the legislative body, the Council. Current voting weights provide two large member states (with 10 votes each) plus two small member states (with 5 votes each) a socalled “blocking minority” (27 votes out of 87 votes). With the exception of Poland, all prospective member states are small and thus, they would be able to overrule the large member states, which are also the net financial contributors to the budget (and also the largest beneficiaries of the internal market). Hence, a change in voting weights and the transition from unanimity and qualified majority voting towards simple majority voting is required. The June 1997 Amsterdam Summit modified the Maastricht Treaty in many aspects without framing a new treaty, but it failed to agree upon internal reform regarding the above two points. This shows that enlargement pressures were not yet intense in Amsterdam. But as the President of the Commission argued, there was the risk that the Union might be perceived

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as incapable of launching such reforms to prepare for enlargement. Those who will be disadvantaged because of the failure of reform are the candidates which did their homework but were not rewarded. Another bump could be the failure to fight mass unemployment and to regain the growth momentum. It should be noted here that in 1991–96, real investment growth in the EU was zero. A sclerotic Union will certainly postpone enlargement as far as possible. Finally, even if one assumes that the third stage in the process of European Monetary Union (EMU) will run smoothly with a critical mass of first-round participants, problems for the CEECs could become paramount. It is likely that the European Central Bank will attempt to gain the same respect as the Central Bank of the anchor currency, the deutschmark. This would require restrictive monetary policies to exert discipline and policy consistency for both EMU members and those CEECs which peg their currencies to the Euro. Policy-makers in the CEECs trying to facilitate transformation with a more accommodative monetary policy would have to pay a price for exchange rate flexibility in terms of devaluation risk premia vis-à-vis bond rates in local currency. Thus, investment in those CEECs decoupling from the Euro would probably be burdened by higher interest rates, while those pegging to the Euro would “run a tiger” (that is, exert high policy discipline and consistency). Lessons for Indochina from European Paths to Enlargement? The three issues discussed above for the EU — commitments at the end of the process, stopovers and bumps — can also be raised for the ASEANIndochina case. Phasing the Schedules of Commitments With regard to commitments, the Indochinese member states will have to implement the AFTA trade liberalization schedules within ten years. Other elements of economic and political co-operation are qualitative in nature, but can be monitored too (for instance, active participation in partner dialogues). The question is whether ASEAN/AFTA will consider the differences in income levels when phasing the schedules for achieving the ten-year deadline, or whether different schedules will continue to apply for industries, but not for member states. Experiences from other integration schemes show that both options can be adopted. The North American Free Trade Agreement (NAFTA) did not provide special treatment to Mexico as a developing country, which in the meantime had “graduated” to the OECD. By contrast, Latin American integration agreements (ALADI) gave poorer member states (for instance, Bolivia) additional time to dismantle tariffs on imports from partner countries. In

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the Asia-Pacific Economic Co-operation (APEC), the timespan allowed for dismantling intra-area trade barriers is longer for developing countries (year 2020) than for developed countries (2010). In the bilateral Europe agreements with the CEECs, there is asymmetry in trade liberalization, with the poorer CEECs committed to liberalize only at the end of the transition period of ten years, unlike the EU which liberalized first. Finally, in the Marrakesh commitments of the UR, developing countries (and additionally, least developed countries) are allowed to liberalize later than developed countries. Such differentiation on developmental grounds has not been explicitly agreed upon in ASEAN/AFTA. Implicitly, and perhaps unintentionally, there might be differences, if industries liberalizing later than others are clustered among individual member states. The economic case for allowing poorer member states to protect their industries and sectors longer than their higher-income neighbours goes back to the infant-industry argument. However, this argument has been convincingly refuted as a means to address the real problem of poor latecomers, that is, the imperfectness of capital markets, which are incapable of prefinancing positive external effects. Conceding different schedules of tariff cuts for countries with different levels of per capita income would introduce an allocative distortion without ensuring efficient production of public goods. ASEAN/ AFTA would be well advised not to pursue such a policy which would create vested interests and moral hazard on both sides: those defending their privileges and those claiming similar privileges. Beyond the formal fulfilment of AFTA schedules, the major requirement which the Indochinese economies must meet, is to create additional scope for the private sector and to minimize unequal treatment between domestic and ASEAN investors. Stopovers For the time being, the AFTA target is a free trade area. Hence, institutionalized stopovers, like an ASEAN Economic Area, do not exist as they cover more advanced stages of integration than AFTA. AFTA itself is a stopover before further stages are envisaged. Within the ten-year transition period to ASEAN-Indochina free trade, there could be “ministopovers” in terms of permanent monitoring of achievements and lags. The EU displays its monitoring process in annual reports on common policies like CAP, competition and structural funds. Interestingly, there has never been such a report for trade policy (Pelkmans 1997, p. 209); and it required an outside institution, the General Agreement on Tariffs and Trade (GATT) with its Trade Policy Review Mechanism (TPRM), to establish such a screening process. AFTA could consider dividing the transition

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period into five sub-periods and give the ASEAN Secretariat the mandate to prepare and publish bi-annual reviews on the state of implementing the entire AFTA process in each member state. With the TPRM, member states should be allowed to give their own views on achievements and to comment on the Secretariat’s report. In the EU, the lack of reporting on trade policy has prevented the development of transparency on common trade policy. Bumps Any bumps in the process towards free trade within an enlarged ASEAN are likely to be primarily of political origin. Vulnerable Indochinese political systems (relative to ASEAN) can lead to policy reversals, which have been observed in Europe. In the EU-CEEC context, normal pre-World War II trade intensities between the two regions emerged very soon after the demise of the socialist system, long before the asymmetric preferences in the Europe agreements could have triggered exports from the CEECs to the EU (Piazolo 1997). In Indochina, on the other hand, the prerequisites of market-friendly institution-building could lead to higher risk-aversion of domestic and foreign investors. In doing so, the market would follow policies. In other words, the private sector would wait for clear signals from the political arena concerning stability and credibility. If property rights are not safe, investors may react either by postponing investments or preferring investments with quick returns in order to minimize risks. In both cases, the developmental effects would likely to be small. The interesting question is whether such potential bumps are exogenous and thus outside the realm of ASEAN integration policies or whether they are endogenous in the sense that they arise because of the specific policies of the older ASEAN member states towards Indochina. Again, the European experience is telling. The CEECs have complained about anti-dumping procedures against their exports, a surge of subsidized agricultural exports from the EU to CEECs, and a number of restrictive measures against manufactured imports from CEECs which (as they argued) damaged at least the spirit of the Europe agreements. Translated into the Indochina context, any approach from the ASEAN-6 to decelerate competitive Indochina export growth may support political groups in Indochina that favour isolation and similarly impede the development of coalitions supporting more openness. In the EU-CEEC context, such problems were ultimately marginal compared to the overriding objective of becoming full members; and hence, they accepted the conditions set by the EU. It is unlikely that the Indochinese political leaders would have accepted a similar “take it or leave it” stance from ASEAN.

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Economic Effects of ASEAN Enlargement: Lessons from the CEECs and Mediterranean Enlargement Factor Movements and Trade Capital (unskilled labour) is relatively abundant (scarce) in the ASEAN core group and relatively scarce (abundant) in Indochina. Higher marginal capital productivity in the periphery and the competitiveness of unskilled labour-intensive production could therefore be expected to stimulate private capital exports from the ASEAN core group to Indochina, and unskilled manufactured exports from Indochina to the ASEAN core group. This has already been observed for Vietnam (see Dollar 1996). Both theory and experience, however, tell us that such movement is by no means automatic. Joining an integration scheme is neither sufficient nor necessary to attract capital inflows. Theory recognizes centripetal forces, which lead to economic activities clustered in the core because of economies of scale, low political risks, proximity to consumers, low transaction costs and, finally, spillovers between relatively immobile human capital accumulated in the core, and quality of an institutional setting, on one hand, and investment, on the other (Fujita and Thiesse 1996). Centripetal forces can compensate for capital productivity differentials between periphery and core. Only in the medium term will centripetal forces be gradually substituted by centrifugal forces if, for instance, congestion effects raise the costs of economic activities in the core area (Junius 1996). Capital flows following the Mediterranean enlargement and the early experiences of CEEC economic transformation underline the importance of the applicants’ domestic policies to attract private capital inflows. Two entirely different patterns of development after accession emerged in the EU. Spain (and, to some degree, also Portugal) launched credible reforms of their domestic policies prior to the enlargement by running restrictive monetary policies to anchor their currencies to those of the EU, imposing discipline upon their budgets, privatizing their state-owned enterprises, and by following moderate wage policies which were in line with productivity increases. In response, massive private capital flowed in after 1986. Spain experienced a high and virulent real appreciation of its currency, which fuelled a consumption boom. After 1990, Spain became a victim of the well-known experience following a sequence of exchange rate targeting, capital inflows, and a strong rise in the price of non-tradables. As a result, the non-tradable sector expanded; rigidities in labour markets prevented a downward adjustment in real wages; and Spain was forced to lift the anchor by depreciating against the currencies of the European Exchange Rate Mechanism (ERM). Painful structural adjustment, especially to gain

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greater flexibility in the labour market, was necessary to regain growth momentum and reduce a high level of unemployment. The experience of Greece is quite different. Although being an EU member state since 1981 and a privileged recipient of EU structural funds, the country never succeeded in becoming an attractive host of private foreign capital. This can be explained by its unsound monetary policies and lack of convincing policy reforms in factor markets. It was only in 1994 that Greece showed progress in reducing macroeconomic and policy imbalances. Such progress was stimulated by growing political will to become qualified for the second group of applicants for the EMU, which requires a reduction of public borrowing and double-digit inflation, and maintaining exchange rate stability. Lessons from the CEECs’ economic transformation are similar. The positive experiences of Poland, the Czech Republic, Slovenia, Estonia, and the early starter Hungary contrast visibly with the negative experiences of Bulgaria, Romania, and the Slovak Republic. The message is very clear: the consistency and credibility of domestic reform packages determine the benefits which can be drawn from EU accession. One could argue that natural disadvantages, such as remoteness from the European core, play a role; and, in fact, geographic proximity to Western Europe correlates positively with the speed of transformation (Fischer et al. 1997). But there are also positive outliers like Portugal, Estonia, and to some extent, Slovenia, which are far from the EU economic centre, defined as the Rotterdam-Brussels-Duesseldorf-Frankfurt strip. What lessons can be drawn for Indochina? First, the attractiveness of the Indochinese economies for risk capital from ASEAN and non-ASEAN sources primarily depends on domestic policies. If domestic policies do not instill confidence in investors, then Indochinese policy-makers should “tie their hands externally” by signing credible international commitments. This can be done regionally within ASEAN/AFTA, but even more effectively, supra-regionally within the World Trade Organization (WTO) and the Bretton Woods institutions. Secondly, in later stages, it is of utmost importance to enhance international commitments by instituting domestic policy reforms. Exchange rate anchors can be helpful at an early stage, but given recent experiences of currency crises, such anchors are high-risk strategies in the longer run if domestic policy reforms are insufficient. Increasing exchange rate flexibility (for instance, through crawling pegs with flexible central parities and moving bands) provides a lower-risk strategy, and it does not impede commitments to fulfil the AFTA liberalization agenda. Thirdly, it is important to maximize the real sector effects of capital inflows in order to dampen the effects of rapid real appreciation and to improve and expand the local capital stock through

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technology incorporated in capital goods imports. Positive signals from ASEAN enlargement would, for instance, include the return of flight capital to Indochina. Fourthly, economic growth in Indochina can be stimulated, if the accession is accompanied by opening domestic financial markets to ASEAN banks. Hence, liberalizing trade in goods should be accompanied by commitments to liberalize trade in services; and as a by-product of service trade, by commitments that allow ASEAN suppliers to service Indochina through branches and subsidiaries. The European experience of applying the home country rule in banking services3 serves as an example. Fifthly, the ASEAN countries should not frustrate the Indochinese governments by imposing restrictive technical standards upon Indochina products. Sixthly, in the short run, capital inflows will not relax migration pressures. On the contrary, any institutionalized form of integration will be perceived by potential migrants from labour-abundant Indochina as a signal that the costs of migrating to ASEAN will decline, even though this signal may be misleading. ASEAN-10 Internal Income Differentials: Can Integration Induce Convergence? Growth differentials are determined by differences in factor stocks (endowment) and in investment in physical and human capital. Crosscountry regressions estimating the impact of endowment and investment on growth in Indochina show that some 30 years (as a minimum) is required for the Indochinese economies to catch up to the average ASEAN income level, similar to that required for the CEECs to converge with the much higher EU level (Langhammer 1997). The question whether regional integration induces convergence cannot be answered satisfactorily simply because the so-called antimonde (the situation without integration) cannot be modelled. What can be shown for the EU is that Greece over more than fifteen years failed to catch up in spite of full membership. In 1980, the year before accession, its per capita income (PPP rates) was 64.1 per cent of the EU-15 level; in 1996, it remained at a similar level (64.6 per cent). For Portugal and Spain, progress in catching up was much more pronounced: for Spain, the per capita income level was 69.9 per cent in 1986 and 76.6 per cent in 1996; for Portugal, it was 54.0 per cent in 1986 and 69.0 per cent in 1996 (European Economy 1997, pp. 208–9). Again, integration, even in a “deep” form, is not sufficient for catching up. What is the situation for Indochina? Indochina has a much lower initial income level than European accession countries. Thus, as the Chinese post1978 experience has shown, catching up should be easier simply because

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of factor accumulation and resource mobilization from the rural sector. ASEAN membership can help Indochina by opening the gates to technology embodied in foreign capital and by facilitating the use of export earnings to purchase technology, embodied in imported capital goods. On the other hand, Indochinese institutional structures are still unsettled and volatile; policies are sometimes more destabilizing than stabilizing; and the leverage of ASEAN to shape domestic policies is certainly weaker than the EU leverage. Hence, more responsibility rests with the new members themselves and their policies. The higher initial degree of flexibility in all sectors and the risk-accepting attitude of the private sector in Southeast Asia, however, may allow ASEAN to stimulate reform initiatives more rapidly in Indochina than it would have achieved in institutional isolation. EU-CEEC Enlargement: Losses for ASEAN? One further question is whether the ASEAN-6 might suffer from EU-CEEC enlargement as a result of the high overlapping ASEAN and CEEC supply, and the privileged treatment of the latter. In fact, so-called trade overlap analysis suggests that the export structures of the CEECs (including both food and non-food sectors) have unequivocally become more similar to those of the ASEAN economies after the latter began economic transformation in 1989. Hence, the CEECs could increase their exports to the West European markets at the expense of ASEAN suppliers (Agarwal et al. 1995, pp. 32–33). Yet, except for a few products which are still subject to quantitative restrictions (mainly textiles and garments) and where Eastern Europe might be privileged vis-à-vis ASEAN suppliers (provided that quotas for both were binding), there is little evidence that discriminatory policies are primarily responsible for shifts in CEEC trade shares. The major counter-argument is that trade between the EU and CEECs had already normalized before trade privileges became effective (Piazolo 1997). The static Vinerian trade diversion argument has been found relevant in multi-region computable general equilibrium models to assess percentage changes of trade volumes and welfare for Southeast Asia based on different scenarios of CEEC integration (Horne and Huang 1996). This study shows losses in export volumes and welfare for ASEAN. Losses are the lowest if the EU removes tariffs on all imports from the CEECs except “sensitive” quota-restricted products (such as agriculture, textiles, garments, iron and steel). They are the highest if the EU removes tariffs on all imports from the CEECs on a reciprocal basis (with the CEECs removing tariffs on imports from the EU and from within the CEE). As with all static effects, losses are not larger than fractions of a percentage point of trade and GDP. Apart from the static nature of the model, which ignores dynamic effects

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of liberalization, including possible externalities, there are further caveats. First is the assumption of immobility of fixed capital across regions. Secondly, the implications of pressures to product innovation because of rising real wages in the CEECs (a phenomenon particularly relevant in those CEECs having monetary policies with exchange rate targeting) is ignored. So are WTO commitments of CEECs to lower their external tariffs. The Computable General Equilibrium (CGE) analysis suggests that EU-CEEC enlargement protects East European unskilled labour manufacturing from Asian competition in general, and Southeast Asian competition in particular. Three arguments against this pessimistic view can be raised. First, specialization patterns are likely to diverge so that in the future advanced CEECs (as the first candidates of accession) will focus more on human capital-intensive products. Secondly, moving from the free trade area to the customs union (as implied by full membership) would immediately reduce trade diversion, given that the CEECs would have to lower their external tariffs to the EU level. In addition, it is very likely that accession to the EU would contribute to a partial convergence of CEEC real wages to the higher EU level. Thirdly, the successful integration of the CEECs is likely to offer new buoyant markets for ASEAN suppliers, not only because of the dismantling of CEEC trade barriers, but also because of the growth momentum inherent in the accession process. As for the prospects of penetration of Indochinese products in an enlarged EU, there is probably little overlap between CEEC and Indochina supply because of larger differences in resource endowment between these regions than between the ASEAN core group and the CEECs. Again, there is much evidence to assume that Indochinese supply conditions will matter more for successful penetration of European markets than European demand conditions (including EU trade policy). Concluding Remarks Are there lessons from EU enlargement for ASEAN’s enlargement process? To some extent, the answer is a moot point, as politics have already set the conditions by initiating different enlargement procedures. ASEAN has chosen what I call a “jump-start” “Las Vegas” wedding. Only a minimum of similarity in political and economic institutions between ASEAN member states and Indochinese countries is required for accession. The EU, on the other hand, insists upon a long period of engagement before the partner qualifies for the wedding and a wedding date is fixed. The EU enlargement process is not a love affair; it is an in-depth examination of whether the prospective partner is worthy of being united with the European family. Examination coincides with long-term adjustment to the Western European family habits.

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As the jeux sont faites et rien ne va plus, it does not make much sense to discuss hypothetical paths to enlargement. However, given European conditions, it could be argued that the EU might have benefited from partially following the ASEAN path. Similarly, under ASEAN conditions, ASEAN could have benefited from a partial adoption of EU mechanisms. Why? In Europe, there is a great need to reform the EU internally. Such reforms include the CAP, structural funding, the decision-making process, and political integration, the latter lagging far behind economic integration. Pressures for change would have been even stronger, if all accession candidates had been simply invited to join. Then, the CAP in its traditional form, for instance, would have ultimately become non-financeable. Instead, the EU has frustrated the CEECs (and thereby faces the risk of weakening their transformation process) by postponing accession and burdening the poorer countries with harmonization requirements without forcing the old members to incur similar adjustment. In short, while far-reaching preaccession adjustment requirements are imposed upon the CEECs, the old members are postponing restructuring. As for ASEAN enlargement, some arguments can be made against a “jump-start” wedding and for a pre-accession period of engagement similar to the EU process. First, there are internal concerns. Having established AFTA, ASEAN is no longer a loose grouping based on consensus, mutual consultation, and co-operation. Instead, it has become a club offering services to members only. With firm commitments and timetables, there are now risks of losing credibility once commitments are ignored and timetables are missed. Club members can produce negative externalities for other members if some do not fulfil their commitments. Under such conditions, their marginal value-added to the grouping would be negative. What are the risks or uncertainty of new or prospective member states with respect to their commitments to AFTA? The difference between risk and uncertainty is important. Risks can be translated into probabilities that a certain event will occur and thus can be rated by markets. Uncertainty is worse, as there is no probability that the event will occur at all. A priori reasoning that in Indochina uncertainty and volatility play a larger role than risks does not emanate from the economic realm stating that these are low-income countries. In fact, low incomes might be conducive to liberalization because large numbers of vested interests against liberalization often do not exist. However, uncertainty and volatility in Indochina are politically rooted: political leaders facing internal opposition as well as external isolation and non-acceptance (by the G-7) have long time preference rates; and they are unlikely to pay great attention to commitments covering a decade. Should the spread in time preference rates of ASEAN political leaders increase as

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a result of the accession of Indochina, AFTA as a club could face a discount concerning its international credibility. ASEAN resources and efforts would have to be mobilized to mediate in the political arena. Economically, the costs of failure to meet commitments are low if the ability of ASEAN to enforce sanctions against those violating the rules is unclear and if the economic dependence of Indochina on ASEAN is marginal. Secondly, there are externally-rooted concerns against a “jump-start”. ASEAN is strongly integrated into international commitments and partner dialogues. Years ago, I argued that co-operation between the EU and ASEAN can carry exclusive benefits to ASEAN (Langhammer 1985). Whether the EU and other partners are right or not to oppose an ASEANIndochina “jump-start” wedding is a value judgement and thus beyond scholarly debate. Yet, if such opposition is a fact and if threats of external sanctions are credible, the ASEAN core countries (and their private sectors) will have to weigh the costs and benefits of a “jump-start” wedding (and potential losses from external disputes). In summary, both a “jump-start” wedding and a “long engagement without setting a wedding date” can be criticized for being economically flawed. In the EU, greater speed and political determination in the integration of new members to the European family would have supported the reform momentum in the CEECs and put pressure upon the EU to reform itself. In Southeast Asia, less speed and more pre-accession preparation might have served both the interests of ASEAN and Indochina better. Thus, the lessons run in two directions, and the ideal path to accession strategy would have been perhaps the average of the two paths. However, as the antimonde of an ideal accession path can never be shown empirically, those who bear responsibility for implementing the two accessions can easily ignore these concerns. Notes 1

The Baltic states, as former republics of the Soviet Union, are probably facing similar reluctance from the Russian side concerning accession to the EU, as in the case of acceding to NATO. This holds as the EU heads towards a common foreign and security policy that might include military co-operation which is a very sensitive issue for Russian political circles (which still look upon the Baltics as “near abroad”). Even stronger resentment from Russia can be expected visà-vis the Ukrainian interest to join the EU. Except for the Baltics, which are economically divorced from Russia, other former Soviet Union republics (including Russia) are not included in the following analysis. Nor are the three Mediterranean associates — Cyprus, Malta and Turkey — which share the same institutional legitimacy. Therefore, in the following, only the so-called Eastern enlargement (excluding the twelve successor states of the Soviet Union) is analysed.

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This classification follows geography, and the probability of becoming first-round new members. In July 1997, the EU Commission, in its Agenda 2000 (EU 1997), proposed to initiate negotiations on accession — for the time being — only with Poland, Hungary, Czech Republic, Slovenia, and Estonia (apart from Cyprus). This proposal was immediately questioned by Scandinavian member-states which wanted all the Baltic states as first-round candidates. Other member-states endorsed the EU proposal in principle, but argued that to prevent political conflicts between preferred and less preferred candidates, a Permanent Conference should include all candidates which would not qualify for the first-round of official negotiations. Banks which are audited by their home country authorities and have a proven record in their home markets are allowed to offer their services in partner country markets. Partner country authorities will then recognize the auditing rules of the home countries.

References Agarwal, Jamuna P., Rolf J. Langhammer, Matthias Lücke, and Peter Nunnenkamp. “Export Expansion and Diversification in Central and Eastern Europe: What Can be Learnt from East and Southeast Asia?” Kiel Discussion Papers, No. 261. Kiel Institute of World Economics, November 1995. Asian Development Bank. Key Indicators of Developing Asian and Pacific Countries, Vol. 27. Manila: ADB, 1996. . Asian Development Outlook, 1996 and 1997. Oxford: Oxford University Press, 1996a. Baldwin, Richard E. “Concepts and Speed of an Eastern Enlargement”. In Quo Vadis Europe? edited by Horst Siebert, pp. 71–86. Kiel Symposium 1996. Tübingen: J.C.B. Mohr, 1997. Brandão, Antonio S., and Will Martin. “Implications of Agricultural Trade Liberalization for the Developing Countries”. Agricultural Economics 8, no. 4 (1993): 313–43. Dollar, David. “Economic Reform, Openness and Vietnam’s Entry into ASEAN”. ASEAN Economic Bulletin 13, no. 2 (1996): 169–84. European Economy. Annual Economic Report for 1997. Brussels: EU Commission, Directorate-General for Economic and Financial Affairs, 1997. European Union, Agenda 2000. For a Stronger and Wider Union. Doc/97/8 15, July 1997. Finger, J. Michael, Merlinda D. Ingco, and Ulrich Reincke. The Uruguay Round. Statistics on Tariff Concessions Given and Received. Washington D.C.: World Bank, 1996. Fischer, Stanley, Ratna Sahay, and Carlos A. Vegh. “How Far is Eastern Europe from Brussels — How Long a Catching Up Process?” In Quo Vadis Europe? edited by Horst Siebert, pp. 97–122. Kiel Symposium 1996. Tübingen: J.C.B. Mohr, 1997. Fujita, Masahisa, and Jacques-Francois Thiesse. Economics of Agglomeration. Discussion Paper Series, 1344. London: Centre of Economic Policy Research, 1996. Hoda, Anwarul. “Trade Liberalisation”. In OECD: The New World Trading System: Readings, pp. 41–56. Paris: OECD, 1995.

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Horne, Jocelyn, and Yiping Huang. “East Asia and Eastern Europe: A Global Trade Analysis”. Paper presented at the Conference on Europe, East Asia and APEC, organized by the Australia-Japan Research Centre, Australian National University, Canberra, 28–29 August 1996. Mimeographed. Junius, Karsten. “Economic Development and Industrial Concentration: An Inverted U-Curve”. Kiel Working Papers, No. 770. October 1996. Koester, Ulrich. “EU Agricultural Policy Towards CEECs: The Impact on LDCs”. In Arie Kuyvenhoven, Olga Memedovic, and Nico van der Windt, eds., Transition in Central and Eastern Europe. Implications for EU-LDC Relations, pp. 163–86. Dordrecht: Kluwer Academic Publishers, 1996. Langhammer, Rolf J. “The Economic Rationale of Trade Policy Cooperation between ASEAN and the EC: Has Cooperation benefited ASEAN?” ASEAN Economic Bulletin 2, no. 2 (1985): 107–17. . “How Far is Indochina from ASEAN?” ASEAN Economic Bulletin 14, no. 2 (1997): 159–75. Pelkmans, Jacques. European Integration. Methods and Economic Analysis. Heerlen and Harlow: Open University of the Netherlands, and Longman, 1997. Piazolo, Daniel. “Trade Integration Between Eastern and Western Europe: Policies Follow the Market”. Journal of Economic Integration 12 (1997): 259–97. Tangermann, Stefan. “Reforming a CAP: A Prerequisite for an Eastern Enlargement”. In Quo Vadis Europe? edited by Horst Siebert, pp. 151–79. Kiel Symposium 1996. Tübingen: J.C.B. Mohr, 1997. United Nations Development Programme. Human Development Report 1997. New York: Oxford University Press, 1997. World Bank. World Development Report 1997. Oxford: Oxford University Press, 1997. World Trade Organization. “Accession of Vietnam. Memorandum on the Foreign Trade Regime, 24 September 1996.” WT/ACC/VNM/2, 1996. Mimeographed.

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The Greater Mekong Subregion: Co-operation in Infrastructure and Finance

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MYA THAN and GEORGE ABONYI

PART I Introduction The Greater Mekong Subregion (GMS) is one of the most recent Growth Triangles (GT) to be established in Southeast Asia. The main objective of the GMS is to jointly develop natural resources and infrastructure by exploiting geopolitical interest and geographical proximity for the development of the Mekong basin subregion. It comprises the Yunnan province of the People’s Republic of China (PRC), where the 4,200-kmlong mighty Mekong river has its source, and the five countries (Myanmar, Lao People’s Democratic Republic [PDR] or Laos, Thailand, Cambodia, and Vietnam) through which it passes before it enters the South China Sea (see map). With the length of the waterway of the Mekong within Yunnan being 2,130 km, 31 km within Myanmar, 789 km within Laos, 490 km within Cambodia and 230 km within Vietnam, it is Southeast Asia’s most substantial single water resource. The Mekong accounts for 31 km of the border between the PRC and Myanmar, 235 km between Myanmar and the Lao PDR, and 975 km between the Lao PDR and Thailand. It is interesting to note that along the Mekong, the political and natural borders coincide for about 1,600 km (Prachoon 1995). About 475 trillion cubic metres of the Mekong’s water flow through the Mekong Delta into the South China Sea. 128

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The aim of this chapter is to study the extent of co-operation in infrastructure development and financing of development projects possible in the GMS in the light of the implications of five out of the six riparian countries joining ASEAN. This chapter is divided into two parts. In Part I, the first section briefly presents the background history of the development of cooperation initiatives in the Mekong basin together with the salient economic and social indicators of the subregion. The second and third sections examine co-operation among the participating countries in infrastructural development and financing of development projects. Co-operation from multilateral as well as bilateral initiatives, including the United Nations (UN) agencies, the Asian Development Bank (ADB), the Association of Southeast Asian Nations (ASEAN), the European Union (EU), and some East Asian countries are also discussed. In addition, the participation of the private sector in developing the GMS is addressed. As Vietnam, Myanmar, Laos and Cambodia have recently joined ASEAN, the implications and impact of their ASEAN membership are highlighted in the fourth section. Finally, the issues of regional and international co-operation in infrastructural development and financing of the GMS development projects are discussed. History and Initiatives of Co-operation in the Greater Mekong Subregion The history of the Mekong is the history of its six riparian countries: the mighty Mekong served as the boundary line between these riparian countries long before borders were established by French and British colonialists in the first half of the nineteenth century. Throughout history, as riparian states, war and peace alternated over time across the Mekong river. In times of peace, they traded with one another, and with mountain passes, the Mekong served as a trade route. The history of these six riparian countries, therefore, is a history of war, peace and trade among themselves across the Mekong. In brief, the GMS has a long history of both conflict and co-operation. The first formal subregional economic co-operation among the states goes back to the later half of the nineteenth century and the first half of the twentieth century when treaties were concluded between Siam (Thailand in pre-1939 days) and France, on behalf of its protectorates in Indochina, to regulate the navigational use of the lower Mekong. But “it may thus be said that the non-navigational utilization of the transboundary water resources of the Mekong basin has been characterised throughout by a virtual absence of hard and fast rules derived from international law” (Prachoon 1995, p. 1). Post-war GMS co-operation began in 1957 when the Mekong Committee was established with initiatives from the United Nations and four riparian countries of the lower Mekong basin, namely, Cambodia,

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Laos, Thailand, and South Vietnam. Since the Cold War was at its peak, Burma (now Myanmar) and China were left out, probably for political reasons. The objective of the Mekong Committee was to promote, coordinate, supervise, and control the Lower Mekong Basin (Statute, 1957, Article 4). Hence, it sought to commonly exploit the waterway for energy, irrigation, transportation, and fisheries for the benefit of the riparian states. However, only a few co-operation and co-ordination projects were carried out as many political changes were occurring in the area (see Figure 6.1). To implement its objectives, an Interim Mekong Committee was formed in January 1978 with the three founding nations, Laos, Thailand, and FIGURE 6.1 Geopolitics and GMS Development Year 1953 1954 1956 1957 1964 1965 1967 1970 1971 1973 1975

1978 1979 1986 1987 1988

1991 1992 1993 1995 1996 1997

Geopolitics

GMS Development

Independence of Laos & Cambodia Fall of Dien Bien Phu, Independence of Vietnam Partition of Vietnam Formation of Mekong Committee (MC) “Tonkin incident” US commits ground troops in Vietnam ASEAN established End of Cambodia’s neutrality

Indicative Basin Plan Nam Ngum Dam completed

US withdrawal from Vietnam Communist regimes take power in Cambodia, Laos and Vietnam Cambodia withdraws from MC Interim MC established Khmer Rouge toppled. Border war between Vietnam and China Vietnam’s doi moi commences Revised Indicative Basin Plan Thailand’s “battle field to market place” call. Change of regime in Myanmar. Border conflict between Laos and Thailand Paris Peace Accord on Cambodia ADB commences GMS initiative Elections in Cambodia; end of China’s support for Khmer Rouge Vietnam joins ASEAN

Mekong River Commission established. Revised workplan for Mekong River Commission

Laos and Myanmar join ASEAN

SOURCE: Modified from Hirsch (1996), p. 32.

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Vietnam. The participation of Cambodia was postponed because of political and social upheaval at that time; only in 1991 did Cambodia rejoin the group (after which development activities were undertaken there). A new phase of subregional co-operation was initiated when the old Mekong Committee was reorganized by the original four members — and formally renamed the Mekong River Commission (MRC) — in April 1995 as an intergovernmental organization with the aim of stimulating regional economic and social development among the riparian countries in the Lower Mekong Basin. Only in 1995 did the last two of the riparian states, Myanmar and China, agree to establish a dialogue mechanism with the MRC, and the first dialogue session was held in July 1996 in Bangkok. This was made possible by developments in China, Myanmar, and the Indochinese nations, especially the opening up of their economies and thawing of Cold War political tensions. As the MRC’s activities have focused primarily on the inventory of resources, environmental monitoring, small-scale irrigation, inter alia, the Nam Ngum Dam in Laos is the only significant hydroelectricity project of the MRC today. The MRC has formulated the Mekong Basin Development Plan (MBDP) to make “reasonable and equitable use” of Mekong water (for details, see Samran 1996). The most effective initiative, so far, has come from the Asian Development Bank (ADB). In 1992 it initiated a regional Technical Assistance Programme designed to promote and facilitate economic co-operation among the six riparian countries. The role of the ADB is largely that of a catalyst: it encourages dialogue, provides fora for that dialogue, and assists if requested, in the subregional co-operation through project identification and development. Its longer term objective is “to contribute to an ongoing process that will build confidence and trust among the participants and help provide an enduring framework for development assistance with a regional focus” (ADB, February 1993). The ADB programme was initially focused on seven specific areas of co-operation, such as transport, energy, environment, human resource development, tourism, trade and investment, and telecommunications. As a result of the agreement among the six countries, more than 100 priority projects were identified; and five road-upgrading projects were put at the top of the priority list. Apart from the MRC and the ADB, there exist at least four international initiatives to develop the Greater Mekong Subregion. They are as follows: 1. The Forum for the Comprehensive Development of Indochina (FCDI). This initiative addresses the needs and opportunities for co-operation and is concerned mainly with infrastructure and tourism development, primarily in the countries of Cambodia, Laos, Vietnam and Myanmar. Japan co-ordinates the funding for this initiative.

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2. The ASEAN–Mekong Basin Development Co-operation (ASEAN– MBDC). This framework was initiated by the ASEAN nations, particularly Malaysia and Singapore, in 1995 with the aim of promoting the wellbeing of the people of the Mekong Subregion. In fact, the Malaysian Government prepared a study for consideration at an ASEAN Ministerial Meeting in June 1996 in Kuala Lumpur. It agreed on seven areas of cooperation: agriculture, minerals and forestry, industry, transport, telecommunications and energy, education and training, tourism, and trade and investment. Malaysia also prepared a project feasibility report on transAsian railway links between the ASEAN countries, the GMS countries, and China. Thailand is also preparing an ASEAN Mekong Fund. Moreover, ASEAN is seeking support from other countries outside the region, such as Japan, Korea, the European Union (EU), and Australia. 3. The Golden Quadrangle (Quadripartite Economic Co-operation). This 1992 initiative came from Thailand with the objective of strengthening economic co-operation and peaceful relations based on the concept of “turning battlefields into market places”. This links Thailand, Myanmar, Laos, and the Yunnan province of China. It concentrates primarily on infrastructural development and tourism. Yunnan is very active in pursuing co-operation among the four participating countries in the transport sector. 4. The AEM-MITI Initiative. The ASEAN Economic Ministers Meeting (AEMM) together with the Japanese Ministry of Trade and Industry (MITI), in 1994, developed an initiative to maintain and promote dynamic economic growth in Asia as a whole, and strengthen economic linkages between ASEAN and Indochina. This focuses on issues of transition to a market economy in the Indochinese countries and Myanmar, with an emphasis on infrastructure development, investment, trade and industrial policies. There also exist other initiatives such as the Mekong Fund, Mekong Development Bank, Thailand’s Indochina Fund; and the International Development and Research Centre (IDRC)-initiated Mekong Development Research Network. Because many of these initiatives overlap, more co-ordination is needed. Selected Economic and Social Indicators The total area of the Mekong subregional growth zone is more than 2,423 sq km and the total population is about 238 million, with a population density of about 98 per sq km. All the subregional economies, with the exception of Thailand, are primarily agricultural, with low per capita income. In 1996, total gross domestic product (GDP) amounted to some US$237.5 billion, with per capita incomes varying from US$250, in the case of Myanmar (Burma), to US$3,110, in the case of Thailand (see Table 6.1). At that time, the

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GDP level US$ billion GDP/per capita (US$) Real GDP Growth (%) Agriculture Industry Services Savings (% of GDP) Investment (% of GDP)

Access to safe water (% of population)

Infant mortality rate (per 1,000 live births) Maternal mortality rate (per 100,000 live births) Adult literacy (% of adult population)

Population million growth (% p.a., 1990–96) Life expectancy at birth (years)

3.1 295 6.0 1.5 13.5 7.7 5.7 19.6

10.6 3.4 38 (1992) 38 (1992) 700 1500d 38 (1992) 37 (1995)

Cambodia

1.8 390 7.5 3.0 14.5 10.7 13.6 30.3

4.7 2.2 55 (1992) 55 (1995) 656 na 50 (1992) 36 (1995)

Laos

10.0 250 6.0 na na na na 23.9

45.5 1.9 62 (1992) 62 (1992) 123 na 82 (1992) 32 (1992)

Myanmar (Burma)

TABLE 6.1 Greater Mekong Subregion: Selected Social and Economic Indicators, 1996

184.0 3,100 6.7 3.1 8.2 6.1 34.5 42.8

60.1 1.2 69 (1990) 69 (1993) na na 93 (1990) 72 (1991)

Thailand

24.0 320 9.5 4.5 13.3 11.1 17.6 29.5

75.6 2.2 65 (1992) 65 (1994) 110 na 92 (1992) 30/70e (1992)

Vietnam

14.6 355 11.2 6.5 na na 39.3c 39.6c

41.0 1.6 69c (1990) 69c (1993) na na 63c (1990) 71c (1991)

Yunnan

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–9.5 15.1 17.9 43.3 –9.1 13.0 22.1

5,181 287 12.8 23.1

Laos

9.0 6.0 6.4a 70.0a –4.3a 6.0a 8.6a

na na 25.2a 41.4a

Myanmar (Burma)

-0.1 3.3 8.2 44.0 2.5 18.3 16.0

33,523b 7,142b 5.9 15.0

Thailand

30.4 35.2 11.9 38.2 –0.9 22.5 23.4

24,445 5,920 6.0 22.3

Vietnam

1.5c 5.1c 0.3c 13.3c –0.2c 10.8c 11.0c

na na 6.1c 26.8c

Yunnan

SOURCE: Asian Development Bank (1997); East Asia Analytical Unit (EAAU) (1997), Table 15.1; and Yunnan Statistical Yearbook, 1996.

b

Figures are for 1995; Commitments for 1992 to 1996 are to the end of October 1996. Disbursements are to the end of 1995; c Figures for the People’s Republic of China; d AusAID estimates; e 30 per cent for rural and 70 per cent for urban residents. Figures may differ from those used elsewhere in this publication because of the different data sources used in each case.

a

13.6 16.8 13.9 20.7 –7.0 9.0 16.0

Foreign trade Export growth (%) Import growth (%) Current account deficit (% of GDP) External debt (% of GDP) Fiscal balance (% of GDP) Revenue (% of GDP) Expenditure (% of GDP)

NOTES:

na 402 10.0 33.0

FDI ($million) Committed (1992–96) Disbursed (1992–96) Inflation rate (%) Money supply, M2(%)

Cambodia

TABLE 6.1 (continued) Greater Mekong Subregion: Selected Social and Economic Indicators, 1996

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economies of the subregion were growing very rapidly at rates ranging from 6.0 to 11.2 per cent, making it one of the world’s fastest growing regions. Total export and import values of the Mekong Subregion in 1995 amounted to US$62.4 billion and US$79.3 billion, respectively. As all but one of the six participating riparian countries of the subregion are transforming from centrally planned economies into market-oriented systems, they are open to foreign trade and investment. Borders have been opened, and cross-border trade has mushroomed to such an extent that in some places unrecorded trade is estimated to equal or exceed official trade. The population of the subregion consists mainly of Chinese, Tai, Tibeto-Burman, Mon-Khmer, Karen, Hmong-Yao, and Vietnamese. The majority religion in Myanmar, Thailand, Laos, and Cambodia is Buddhism. As the region has a large pool of relatively educated and disciplined labour, it has a strong comparative advantage in labour-intensive industries. These resource-rich economies have already been integrated into the dynamic economies of East Asia, like China and the ASEAN nations, which are somewhat complementary to the Mekong economies. The dominant characteristic of this subregion, which is highlighted here, is the lack of infrastructure. Implications and Impact of ASEAN Enlargement on GMS Countries Out of the six participating countries in the GMS, Thailand is an original member of ASEAN, while Vietnam, Laos, Myanmar and Cambodia are new members. This section will look at the implications and impact of new members joining ASEAN/AFTA (ASEAN Free Trade Area) on the GMS, especially co-operation in infrastructure development and finance. Politically, there is peace and stability in the subregion where there was none for many years. Hence, a source of conflict among the participating countries in the past can become a source of co-operation. There is also likely to be better confidence-building among the participating countries together with improved dispute resolution. This will enhance the development of all the participating countries and GMS co-operation. As far as economic implications are concerned, generally speaking, members of any regional free trade area can potentially enjoy (1) more trade and investment links within the region; (2) increased attractiveness to foreign direct investment (FDI) from outside the region; (3) more secure access to the greater market of the region; (4) improved resource allocation from specialization according to comparative advantage and economies of scale in an enlarged regional market; (5) enhanced industrialization prospects of small and medium-scale enterprises; and (6) especially for less developed members, spillover effects and infant industry learning effects

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with improved quality control, design, and marketing, and thus improved competitiveness in the world market, among others. The existing ASEAN-6 members can benefit from an enlarged ASEAN-10 consumer market by about 38 per cent in terms of population. The promotion of freer trade in the region means the creation of an environment with greater competition among the firms, and this will lead to increased efficiency, which will benefit all participating members. Moreover, more exports of labour-intensive products from the less developed member countries to more developed members are expected because of the tariff reduction. On the other hand, more imports of capitalintensive products from the ASEAN-6 to the new member countries may also be increased. Furthermore, the lower cost of labour-intensive products may deflate inflation in the existing members of ASEAN. Owing to the lower costs of production, and if “national treatment” is confined to intrasubregional investments, more FDI originating from the ASEAN-6 is expected to flow into Cambodia, Laos, Myanmar, and Vietnam (CLMV countries). This can lead to greater economic co-operation among the ASEAN-10. As far as the CLMV countries are concerned, it will be easier for them to sell agricultural products to the ASEAN-6 as tariff rates and non-tariff barriers will be reduced under the Common Effective Preferential Tariff (CEPT) scheme. However, more imports of manufactured goods from the ASEAN-6 can also be expected in the CLMV countries. This means that the CLMV can anticipate greater trade competition, particularly in manufactures, from the ASEAN-6. As new members of AFTA, these countries will have to accelerate economic reform, and tariff and non-tariff barriers must be reduced. As a result, cross-border smuggling will gradually decline. As one of the objectives of AFTA is to create a unified market to attract FDI, multinational corporations will be encouraged to invest more in the region by taking advantage of low tariffs and an enlarged market. Moreover, it is likely that ASEAN’s reputation as a good investment area will spread to the new members. ASEAN can also provide the new members with capital, technology, expertise and linkages to the global economy. These factors will encourage foreign investors from inside and outside ASEAN to invest more in the CLMV countries, which in turn, will spill over to the GMS. Another way of assessing the likely impact of the ASEAN Free Trade Area on future trade performance and welfare of the ASEAN-10 countries is to examine whether trade creation effects will outweigh trade diversion effects, or vice versa. According to Viner (1950), a regional trading agreement (RTA) such as a free trade area (FTA), or a customs union can confer net benefits to its members if trade creation effects outweigh trade diversion effects. For the ASEAN-6, whose trade has been conducted

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overwhelmingly with countries outside the region, substantial trade diversion is expected. However, as the ASEAN members have been reducing tariffs in not only intra-ASEAN but also extra-ASEAN trade, and AFTA’s objective is to increase the trade welfare of ASEAN without affecting its trade with the world, the scenario of trade diversion effects outweighing trade creation effects is unlikely in the long run. In the case of the CLMV, their trade with the ASEAN-6 has been growing without affecting their trade with the world; and trade creation is expected to supersede trade diversion. Thus, there could be more trade creation than diversion in the GMS, as a result of the CLMV countries joining ASEAN/AFTA. China is the only country in the grouping which is not a member of ASEAN. The GMS is the only formal economic link that China has with ASEAN, although it borders two of the ten ASEAN nations and is a Dialogue Partner of ASEAN. Thus, China is institutionally and physically plugged into ASEAN for trade and investment enhancement. Hence, more economic and political co-operation can be expected from China. All in all, as trade and investment links in and outside ASEAN increase, more international and intra-regional co-operation in infrastructure and finance is expected in the GMS. However, it is important to note that there are conditions for the CLMV countries of the GMS to enjoy benefits from the ASEAN enlargement. First, these new member countries must have industries that possess comparative advantages — for example, industries processing agricultural products. Secondly, state-owned-enterprises (SOEs) in these countries must increase their efficiency in order to take advantage of the new opportunities. The new members will also need to improve the quality of human resources and initiate qualified and less corrupt bureaucratic systems. Fourthly, they need to establish a strong legal framework and regulations to attract FDI. These should be accompanied by adequate infrastructure. Finally, it is essential for new members to enhance production and exports. The East Asian crisis has hit the riparian countries to some extent. They have suffered from devaluation effects and declining trade, caused especially by the Thai economic crisis. There is also a sharp decline in demand for their exports, decrease in tourist arrivals, and fall in technical assistance from the more developed ASEAN countries. Moreover, FDI inflows into the new member countries from the Mekong Subregion are slowing down; and many projects are being postponed indefinitely. A few examples of the postponement of GMS infrastructure projects can be cited. Laos granted a concession to a Thai company to renovate a 250 km road between Huaisai and Boten in Laos to link with the Muang La-Chiang Rung-Kunming road on a build-operate-transfer (BOT) basis. Construction was carried out on only a small section of the road because

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of a shortage of funds resulting from the financial crisis in Thailand. Myanmar experienced a similar problem. The renovation of the 164 km road between Tachilek and Kengtung was not implemented because of the financial crisis in Thailand. Although Myanmar received a loan of 300 million baht from Thailand, the Thai firm, to which the concession was granted by Myanmar in 1997 on a BOT basis, stopped renovation work because that amount was no longer sufficient to complete the project (because of the depreciation of the Thai baht). Furthermore, the renovation of the road linking Kengtung, Talua, and Xishuangbanna was not started at all. Another important issue is whether the GMS co-operation arrangement will be overtaken by ASEAN. Stensholt (1996, pp. 145–146) has suggested, “The overriding future relationship is likely to be encompassed in ASEAN. It is possible to argue that Mekong cooperation or indeed the Mekong subregion is merely a passing phase or fad to be totally replaced or engulfed by the wider ASEAN”. However, the other growth triangles in Southeast Asia suggest that this is not the case. This is because investment in growth triangles will not be at the expense of the other areas of ASEAN, but will eventually generate benefits which will spill over elsewhere in ASEAN. As for the growth triangles’ relationship with larger groupings and the free trade area, both AFTA and APEC would enshrine an overall environment where there were low barriers to trade and more opportunities for investment cooperation (Baldwin 1997, p. 78).

Furthermore, the subgroupings are a product of geographical proximity, historical links, and economic complementarity, with the aim of developing infrastructure to enhance trade and investment opportunities. Co-operation in Infrastructural Development Current Status One of the main objectives of the development strategy of the GMS is to improve its members’ infrastructure, which is inadequate for their development needs. In particular, the poor state of infrastructure limits their trade activities and opportunities, and creates other undesirable political and social problems. Although there are overland roads between Myanmar and Yunnan, and between Myanmar and Thailand, they are in poor shape, and are not all-weather roads. There are also overland roads between Vietnam and Cambodia, Cambodia and Laos, and Laos and Vietnam, but these are few and need to be upgraded. The road density ranges from 1,206 km and 841 km per person, respectively, for Yunnan and Thailand to 516 km,

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210 km and 200 km per person, respectively, for Laos, Myanmar and Vietnam. Except for Laos, the rest have solid railway systems built during the colonial days, although there is no direct link with one another. One positive development in this area is that the rail link between China and Vietnam was reopened in 1996. In 1994, the first bridge across the Mekong linking Thailand and Laos was completed with Australian development aid, making transportation between the two countries easier. The opening of the bridge provides a key link between China (Yunnan) and Southeast Asia for the first time in this region. Following the example of the Thai–Laos “Friendship Bridge”, the construction of another cross-border bridge between Myanmar and Thailand near Maesot was completed in August 1997. However, these bridges are still underutilized because of the lack of appropriate political and economic “software”. Air links in the countries have been improved since the early 1990s. Thai Airways flies to Kunming from Yunnan, to Yangon from Myanmar, to Vientiane from Laos, and to Ho Chi Minh City and Hanoi from Bangkok. There are also regular flights between Mandalay (Myanmar) and Kunming (Yunnan); Phnom Penh and Bangkok; and Hanoi and Vientiane and Phnom Penh. These countries are also connected to the other ASEAN countries (especially Singapore and Malaysia) by regular air flights. In the mid-1990s, Thailand produced 1,000 kwh of electricity per person; Yunnan 331 kwh, Laos 178 kwh, Vietnam 128 kwh, and Myanmar 61 kwh, all of which are low compared to their consumption

TABLE 6.2 Infrastructure Yunnan* Myanmar Production of electricity (kwh/person) People/telephone Paved road per million person (km) Per cap. annual water withdrawal (cu m)

Laos

Thai

Cambodia

Vietnam

331 210

61 348

177 282

1,000 24

na 1,212

128 164

1,206

210

516

841

na

200

462a

1,028

259

606

69

81

NOTES: * For 1990 a For China SOURCE: Asian Development Outlook 1995–96; World Development Report 1991, and 1995; Yunnan Statistics 1991.

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TABLE 6.3 Basic Energy Data Country

Catchment Area (‘000 Km3) (Mekong)

Average Flow (m3/sec) (Mekong)

Hydropower Resource (TWh/a)

Demand by 2020 Power Energy (GW) (TWh)

Yunnan Myanmar Laos Thailand Cambodia Vietnam

165 24 202 184 155 65

2,410 300 5,270 2,560 2,860 1,660

450 370 100 50 40 80

11.2 2.5 0.3 61.8 0.8 15.8

72.0 14.4 1.8 411.0 4.5 93.0

Total

795

15,060

1,090

91.6

596.7

NOTE: * For year 2003 SOURCE: ADB, Subregional Energy Study, 1994.

requirements. However, there is a large potential for developing hydropower in these countries, as shown in Table 6.3. The sale of electricity from Laos to Thailand and the sale of gas from Myanmar to Thailand reflects economic co-operation among the participating countries based on complementarity. With regard to telecommunications, the area, with the exception of Thailand, is underdeveloped, compared with other regions (see Table 6.2). International/Multilateral Co-operation The ADB is initiating the development of infrastructure projects in the GMS by persuading international agencies, donor countries, and foreign investors to co-operate in its proposed projects. Out of the 100 proposed priority projects in seven sectors, 74 projects are in infrastructure alone — that is, 34 projects in transport, 12 in energy, and 18 in telecommunications. The most important among the infrastructural projects are those providing transport infrastructure, especially, roads, ports, and airports to facilitate cross-border movement of goods and people. Most of these projects concentrate on upgrading existing roads rather than building new ones. The road projects given priority are as follows: —

upgrading a road linking Vung Tau and Ho Chi Minh City in Vietnam with Bangkok (Thailand) and Phnom Penh (Cambodia) at an estimated cost of US$490 million;

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developing the Thai–Laos–Vietnam East–West transport corridor project at an estimated cost of US$130 million; building roads linking Chiang Rai in Thailand with Kunming in Yunnan, via both Myanmar and Laos, at an estimated cost of US$829 million and US$507 million, respectively; upgrading the existing Kunming–Lashio (Myanmar) road system at an estimated cost of US$629–US$909 million

As far as rail projects are concerned, two top priority projects which are under way include the upgrading of the Kunming–Hanoi rail link at an estimated cost of US$65 million, and the building of a 150 km long railway line across the Thailand–Laos “Friendship Bridge” at an estimated cost of US$210 million. There are also other rail project proposals, such as the Yunnan or Myanmar–Thailand (US$1.2 billion) project, the Thai– Laos–Vietnam rail link (US$550 million) project, and the Yunnan– Myanmar railway (US$0.7–US$1.2 billion) project. Energy sector development in the GMS is also a priority area because of its great potential: only one per cent of its total energy potential is produced in the Mekong basin. According to an MRC report, Thailand will require over 88 per cent of its power to be generated from planned developments in the Lower Mekong subregion, but 84 per cent of the potential lies in Laos and Cambodia (EAAU 1997, p. 338). The energy sector is a remarkable example of how co-operation among the participating countries can be developed. For example, about 30 per cent of Laos’ annual export earnings come from electricity exports to Thailand, and since 1998, Myanmar has sold US$150 million worth of gas to Thailand. The area also has abundant coal deposits and potentially large oil and gas reserves. The ADB has established a priority list of hydroelectricity projects, as follows: — — — — — —

the Xe Kong and Se San subregion project in Cambodia, Laos, and Vietnam, including transmission interconnection with Thailand; a feasibility study of the Nam Tha project in Laos, including transmission interconnection with Thailand; the Jinghong project in Yunnan, including transmission interconnection with Thailand; the Nam Theun subregion development in Laos, including transmission interconnection with Thailand and Vietnam; the Than Lwin subregion development in Myanmar and Thailand, including transmission interconnection between the two countries; the Theun Hinboun project in Laos, with interconnection between Laos and Thailand. This project is being implemented.

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Telecommunications is an important infrastructural requirement for business but it is the weakest sector in all the participating countries (see Table 6.2). This is because much foreign investment and assistance are needed to develop good communications systems, and all the riparian countries except Thailand lack these resources. The ADB has adopted eighteen priority projects (thirteen institutionbuilding projects and five study projects), as a basis for the subregional telecommunications network. Institution-building projects include the following: — — — — — — —

Thai–Laos–Vietnam #1 Optical Fibre Cable Link Cambodia–Vietnam Optical Fibre Cable Link Thailand–Cambodia Optical Fibre Cable Link Myanmar–Thailand #1 Optical Fibre Cable Link Yunnan–Vietnam Optical Fibre Cable Link Myanmar–Yunnan Optical Fibre Cable Link Laos–Cambodia Optical Fibre Cable Link.

Another international agency overseeing the GMS is the MRC. As of 1996, it had implemented fifty projects and programmes, at a cost of more than US$200 million, half of which had been secured (EAAU 1997, p. 334). The MRC received another fifty proposals seeking donor support, and it was working closely with the ADB. The MRC-sponsored projects cover environment protection, irrigation, hydroelectric power, hydrology, and human resource development. As far as co-operation from ASEAN is concerned, except for the activities of the ASEAN-MBDC and AEM-MITI, there is not much cooperation in infrastructural development. The most outstanding infrastructural project initiated by ASEAN is the Trans-Asia Railway project. Worth US$1.5 billion, the Trans-Asia Railway project links all the riparian countries with Singapore and Malaysia. It was initiated by the Malaysian Government and funded by the ADB, the World Bank and through loans from Japan and the European countries. This Singapore– Beijing Trans-Asia Railway line will eventually link up with European rail lines. Although feasibility studies have been done and Route 1 has been selected for implementation, no other ASEAN countries are supporting it financially, which may slow down its development. Co-operation from the Private Sector Experiences in subregional economic co-operation show that it is often driven by the market, with the private sector providing capital, technology, training, and marketing channels. Because infrastructure projects need

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enormous capital and most participating countries of the GMS are poor, the governments alone cannot afford to bridge the resource gaps of about US$9 billion for the ADB’s transport and communications projects alone. Thus, the private (domestic and foreign) sector’s role has become more significant. “Under the GMS project, there has been a recent focus on enhancing the role given to the private sector and to working to integrate private sector concerns and perspectives more closely into the process of subregional economic cooperation” (UN/ESCAP 1997, p. 122). Since 1996, the ADB has taken the following initiatives in order to enhance the involvement of the private sector: —

—

— —

organized several high-level symposia to bring together private sector parties, government officials and the ADB to discuss business opportunities of the subregional co-operation exercise; formed a GMS Investment Working Group to enhance co-operation in the areas of investment promotion, investment facilitation, and investment regulations; facilitated tourism co-operation agreements and fora; financed infrastructure projects and initiatives to increase and promote private sector participation in large projects. PART II

Public/Private Co-operation: Financing Infrastructure in the GMS The second part of this chapter consists of four sections. The first section focuses on general infrastructure financing considerations in the context of economic co-operation in the GMS, independent from the present regional economic crisis. The second section brings in the regional economic crisis from the micro perspective of project financing considerations. The third and fourth sections address the fundamental issue of the implications of the regional economic crisis for the continuation of GMS subregional co-operation, which is a necessary condition for subregional infrastructure financing needs in the first place. Before the Regional Economic Crisis (REC) It is perhaps useful to recall once again that the concept of a “Greater Mekong Subregion” did not exist until very recently. Although the Mekong Committee was established in 1957 as a United Nations initiative, it was limited in scope, with its focus on the Mekong River, and excluding Burma (now Myanmar) and China. In the prevailing and subsequent political climate, economic interaction among the countries of the subregion remained limited.

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In recent years, political and economic developments have created an environment in the GMS conducive to subregional economic co-operation. The remarkable economic performance and increasing integration of Southeast and East Asia (at least until July 1997) have expanded the scope for co-operation. Within the GMS, conflict has given way to peace, and former centrally-planned economies are at various stages of transition to more open and market-based systems, spurred in part by the collapse of the former Soviet bloc and the resulting need to find new trading and investment partners. Interest in greater economic co-operation among the GMS countries has emerged as a practical response to international competitive pressures and opportunities, and to evolving domestic priorities, including interest in private sector participation in this process. With technical assistance and co-ordinating support from the Asian Development Bank, the six GMS countries entered into an extensive programme of subregional economic co-operation in 1992. Guided by the pragmatism of enlightened self-interest, the countries have focused on creating specific linkages of complementary economic activities across borders. The purpose is to support the development process beyond the limits of national boundaries, and to enhance the investment attractiveness of the GMS countries as a group. Co-operation in the GMS reflects a recognition that the economic potential of the subregional whole can be greater than the sum of the individual national parts. Given the modest level of development of most of the participating countries, the GMS programme has emphasized concrete projects in common priority areas, in order to build and sustain the momentum of co-operation. Supported by the ADB’s technical assistance, close to 100 subregional projects and initiatives have been endorsed by the GMS governments at the senior ministerial level, in seven sectors: transportation, energy, telecommunications, environment protection, human resource development, trade and investment, and tourism. Well-defined projects of common priority interest allow the GMS governments to experiment with subregional co-operation in a tangible way, with defined and expected benefits, but limited overall risk. At the same time, projects can also be used to address broader issues in economic co-operation. For example, road projects can be (and indeed are being) used to address fundamental “software” issues relating to non-physical barriers restricting the movement of goods and people across borders, such as transit, customs, and pricing policies and regulations. In this way, the GMS co-operation process is building the foundations and confidence for expanding subregional co-operation beyond individual projects and sectors. To ensure effective project implementation and sustain regional cooperation, the GMS countries have established a flexible co-ordinating

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framework as part of the ADB-facilitated programme. Senior officials’ forums and working groups oversee developments in specific sectors, including implementation of projects, and a steering group composed of senior ministers provides overall policy guidance. The very senior level of participation also signals (particularly to potential investors) the strong and sustained commitment of the participating countries to the subregional co-operation process, as well as to specific projects. A central issue facing economic co-operation in the GMS at this stage is the mobilization of the extensive resources required for project implementation, especially for infrastructure-related projects. For example, financing needed for priority subregional transport and telecommunications projects alone is estimated at around US$9 billion. The GMS governments, even supported by official assistance from bilateral and multilateral donors, have neither the finances nor the managerial resources to meet these needs. Reflecting broader trends in Asia, they will have to rely increasingly on private sector participation in the financing and provision of infrastructure-related services: this is the central challenge of capital mobilization in the GMS. Given the extensive needs and significant investor interest, a number of innovative financing mechanisms have been put forward to involve the private sector in infrastructure-related projects, such as build-operate-transfer projects. These provide a wider range of options for both governments and private investors. Utilizing these and similar approaches, many privately sponsored projects are at various stages of preparation throughout Asia, including in the GMS. However, only a small fraction is under implementation, and an even smaller fraction in operation. A number of major infrastructure funds have also been established, but their utilization also lags behind their promise. Understanding this gap between promise and present reality has important implications for effective capital mobilization for the GMS. Innovative financing mechanisms generally involve the application of project finance principles, where expected performance is the key project asset. Project cash flow, or the revenue generating potential of the project, is the fundamental basis for financing, with investors aiming to achieve full recovery and a reasonable return on their investments. Perceived benefits of approaches such as the BOT scheme for government include the following: —

— —

expanding the potential financing and borrowing capacity of the government, since these mechanisms seem to provide off-budget financing, not requiring sovereign borrowing or budgetary resources; tapping private sector resources which would otherwise be unavailable for infrastructure projects; off-loading project risks to the private sector;

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bringing private sector efficiency and commercial discipline to project preparation, implementation and operations; accelerating the implementation of priority projects that otherwise would have to wait, given scarce budgetary and technical resources; and government retaining strategic control over project focus and scope.

Potential costs or constraints of BOT-type mechanisms include the following: —

— — —

generally higher financing costs in terms of the returns on both equity and debt demanded by investors — as a kind of risk premium — compared with interest and fees governments would usually have to pay on sovereign borrowings; usually lengthier and more complex project preparation process; constraints on project sponsors’ flexibility under a strict set of agreements (contracts) that define the project; and limits to the government’s ability to change the business environment for the project (for example, to effect the revenue-generating capacity of the project).

Fundamentally, BOT-type financing for infrastructure projects is attractive to governments because it seems to transfer to the private sector both project risks and costs. However, there are two types of factors essential to the successful implementation of infrastructure projects. For the private sector, the key factors relate to the perceived revenue generating capacity of projects, and the associated risks. For governments, the key consideration is to ensure that these projects ultimately serve the public interest. The challenge is to balance the two. The central issue is whether or under what conditions a project will generate a reliable and sustained cash flow. In this context, many infrastructurerelated projects in the GMS are unlikely to be implementable at this time on a “purely commercial” basis because of project economics, or because of noncommercial project risk. Projects characterized by high economic returns, but marginal financial returns, are good for the economy — but not necessarily attractive to private investors. As a consequence, they are likely to require public/private co-operation in some form, including support from host governments and/or multilateral institutions. This is not unique to the GMS. To assure investors of a reliable cash flow, governments often shoulder certain project risks (such as performance guarantees; off-take agreements); use national resources to offset private risk (such as real estate or resource concessions); or introduce (or relax) legislative

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measures to facilitate project completion or operation. These are, in effect, forms of public/private sector co-operation, with an associated distribution of benefits and costs, obligations and risks to the participants — government and private investors. In this way, governments have increasingly taken on risks in privately financed infrastructure projects, through often implicit government obligations and commitments, incurring “public risk”. Conceptually, governments taking on project risks to facilitate private investment in infrastructure is not inappropriate. If an infrastructure project is fully publicly financed, the government bears 100 per cent of the risk. When a government provides a guarantee for 90 per cent of expected toll revenue, for example, it transfers some of that risk to the private investors. Therefore, private participation in infrastructure, even with considerable public risk, may be more desirable than having the government shoulder all the project risk through public investment, or having no project at all. However, in the “rush to privatize”, governments often assume infrastructure project risks without a full understanding of and accounting for their costs and implications (for example, as hidden “contingent liabilities” that become real costs as conditions change). These hidden costs and unknown risks are then incorporated into the projects, and borne by a given country’s citizens. Governments must therefore be explicit in their understanding and decisions to bear specific risks with respect to particular infrastructure projects, and must reflect these risks explicitly in their accounts and budgets. This is especially relevant in the context of most GMS governments which are relatively inexperienced in public/private cooperation in any form, and whose institutional frameworks, risk profiles, and financing capacity for private participation in infrastructure projects are at a relatively early stage. The central issue in most infrastructure-related projects is then the allocation of risk between the government and the private sector. This in turn affects project costs, and investor returns. If the government accepts more of the risk (for example, through a “minimum ridership guarantee” for a toll road; “take or pay” agreement for power; real estate concessions for a rapid transit system), the cost — as the return on equity and debt demanded by the private sector — may go down. If the private sector has to take more of the risk, the costs increase. In general, the perception, allocation, and management of risk affects how a project is designed and managed, its total cost structure, and its revenue-generating capacity — or whether it will be implemented at all. Ultimately, it is the fundamental responsibility of governments to ensure that infrastructure-related services serve the public interest: in this, they must balance resource mobilization needs with equity considerations. In

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each instance, governments must weigh the benefits of private financial participation against the real costs to the economy of the public obligations and commitments likely to be incurred. GMS projects are further complicated by their subregional or transborder nature. If the success of a project is dependent on activities in two or more economies, with different political and legal jurisdictions, the risks associated with project preparation and implementation may increase. However, the subregional nature of projects may also be used to reduce risk (or increase the potential returns). For example, it may allow for “internalizing” and therefore better management of some of the usually external risk factors (for example, a power or road project in a given country as part of a subregional, transborder network); introduction of more stable rules of the game (for example, third country language and governing law more acceptable to investors than those of the participating countries); and reducing the risk profile of particular “high risk” countries through a kind of subregional “pooling” of country risks for specific projects. In this context, at the macro or institutional level, the key challenge for GMS governments is formulating effective policies and procedures for facilitating private investment in infrastructure-related projects. This is essential to the successful implementation of subregional projects since it is governments that set the rules of the game for the private sector: defining legal, regulatory, and policy frameworks, including transborder agreements. At the micro, or project level, the challenge of resource mobilization for the GMS involves (to a large extent) addressing the issue of risk management within an explicitly subregional context, especially to help bring about stable public/private partnerships in subregional projects. Negotiating clearly understood, mutually acceptable, and enduring agreements between the government and private investors on the allocation of risks and obligations is a key to the successful implementation of infrastructure-related projects in the GMS. This will greatly facilitate private capital mobilization for subregional projects. Given these complexities, multilateral institutions, such as the ADB, can play a key role in resource mobilization, beyond that of traditional lenders. They can assist in the preparation of “bankable” subregional projects that reflect both public policy and commercial considerations; use their financing increasingly as a catalyst to leverage private resources to meet the specific needs of subregional projects, giving a level of comfort to both participating governments and private investors; use guarantees to cover “policy risk” arising from government actions (especially those related to subregional projects), thereby stimulating private resource flows; and build on their impartiality and technical competence to play a dispute

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resolution role between governments and private investors in a subregional context. A further key role for multilateral institutions such as the ADB involves assisting GMS governments in formulating effective policies and procedures for facilitating private investment in infrastructure-related projects, in areas such as stable policy and regulatory framework; transparency and information disclosure; and the development of domestic capital markets and financial instruments. This is essential to the successful implementation of subregional projects since it is governments that set the rules of the game for the private sector: defining legal, regulatory, and policy frameworks, including transborder agreements, thus creating the enabling conditions for private infrastructure investment. The result can be a convergence of government policies and programmes, and private sector capital and technical expertise, with the experience and facilitating role of multilateral institutions, to provide an effective framework for resource mobilization for GMS projects. After the Regional Economic Crisis (REC): The “Revised ASEAN Factor” in Financing GMS Infrastructure Projects The impact of ASEAN membership on infrastructure financing and development in the GMS is likely to evolve over time, as ASEAN and AFTA evolve, and as the new GMS member countries become increasingly active partners. The recent regional economic crisis (REC) is likely to have a significant impact on GMS infrastructure financing over the medium term. Therefore, we may think of the “ASEAN Factor” in financing GMS infrastructure projects in two dimensions: “traditional ASEAN factors”, and “revised ASEAN factors” (after the REC). The first relates to membership in ASEAN and its general implications. The second relates to the new and emerging conditions in the region, as a consequence of the regional crisis. Traditional ASEAN Factors With expanding membership, the general knowledge and interest of the ASEAN business community in investment in the GMS countries are likely to increase. Over the longer term, increasing familiarity is expected to lead to increased involvement and investment, including in infrastructure projects. Secondly, as part of ASEAN and AFTA, the rules and regional institutional frameworks for investment and trade are to be adjusted to facilitate crossborder investment and linkages. Over the longer term, investment in infrastructure in the GMS is likely to benefit both directly — easier framework for investment — and indirectly — increasing the need for such

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investment with expanding economic/trade relations within the region. Thirdly, ASEAN may become more effective in developing mechanisms specifically focused on mobilizing and channelling resources to GMS development, for example, through the ASEAN-MBDC, and ASEAN-MITI programmes, and the increasing partnership with the ADB. Revised ASEAN Factors The revised ASEAN factors are related to recent developments in Southeast Asia. The regional economic crisis and the associated uncertainty (and devaluation) of most ASEAN currencies have cast a cloud over projects in the region. The fundamental issues pertain to country (or regional) risk and domestic liquidity. The perceived risk of doing business in the region has increased significantly, reducing the availability (and increasing the cost) of foreign financing, including for infrastructure projects. At the same time, under the pressures of the economic crisis, many of the countries of the region do not have the domestic resources necessary to finance the investment needed to ensure transition from stabilization to sustainable growth. However, it may be a cloud with a silver lining once the dust settles. The crisis may serve as a “wake-up call” on the basic principles of project financing and investment, especially on the analytic conditions for crossborder financing. It may be useful to enter from the “currency” side of the picture, which signalled the onset of a new era in Asia. During the financial crisis, the value of regional currencies, many of which had been pegged directly or indirectly to the U.S. dollar, was driven down significantly, and became subject to continuing uncertainty and turbulence. The reasons for this included weaknesses in the financial sectors, excessive lending to real estate, rising current account deficits, and large short-term foreign borrowings. Sponsors, financiers, and governments will now look much more closely at the basic economics of infrastructure projects, and everyone in the infrastructure business will re-evaluate the risks they are willing to bear. More importantly, the crisis underscores the need for local capital markets in the region, and could speed up their development. Furthermore, the devaluations and uncertainty will contribute to a prompt and much-needed analysis of what constitutes viable public–private partnerships. A fundamental issue is that infrastructure, by definition, serves domestic needs, and in almost all cases generates revenues collected in local currency. The appropriate financing method is therefore primarily from domestic sources and through domestic debt and equity markets. With foreign currency financing, foreign exchange risks must be covered by tariff adjustments, such as having the project revenues indexed to foreign currency, and therefore

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shifting of the risks away from the private investor/financier towards government and/or local consumers of the services. In principle, countries that will have the most difficulty in financing infrastructure projects are those that have insisted on the private sector bearing the exchange rate risks; where domestic capital markets and financial institutions are insufficiently developed to support infrastructure projects; and where the private sector borrows offshore. Thailand’s independent power producer (IPP) programme, as well as some of Indonesia’s KSO telecom projects (where KSO is Indonesia’s version of BOT) are examples. Most infrastructure projects in Malaysia have been funded locally; while the Philippine and Indonesian governments have taken exchange rate risk for private power projects. In these countries, the impact on new project financing will be less, from this particular perspective. However, these factors pale beside a more fundamental reassessment of future projects throughout the region, as lenders reconsider country risks and project costs increase, reducing the revenue generating capacity, and therefore the attractiveness of these projects. The key issue is that investment opportunities are assessed by international investors on a comparative basis: the international investment community has other options, both within Asia and outside. Before the REC, most countries were unwilling to offer exchange rate risk protection (for example, Indonesia for water and transport; Thailand and China for power). This had been a natural trend, as foreign investors became increasingly more comfortable and knowledgeable about a country and developed a project track record. They became increasingly ready and able to bear risks. The recent economic crisis and currency instability in the region have reversed this trend. In this environment, it is much more difficult to raise foreign debt without exchange rate protection in some form (for example, indexation, guarantees). However, such protection cuts both ways. With indexation, when the local currency depreciates against the foreign currency, consumers of infrastructure services such as electricity, could find their electric bills rising for no reason other than foreign exchange movements. This may result in politically highly sensitive situations for both the government and the private investor/operator. This could force governments to subsidize such services, affecting their fiscal position and/or their general capacity to borrow (that is, credit ratings). Therefore, over the longer term the key to financing infrastructure projects in the ASEAN region is to do so increasingly from domestic sources, and through debt and equity markets. For the region’s economies, this is viable over the longer term, given traditionally high savings rates, a tradition and skill in managing public finances prudently, and a visible desire to reduce the influence of and dependence on foreign financing sources.

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Therefore, the current crisis should emphasize the need for the region’s economies to develop and deepen their capital markets so that the reliance on foreign capital can be reduced in areas such as infrastructure financing. In practice, the opposite is likely to happen over the short term. The perceived need to prop up local currencies and the fear of inflation is driving up interest rates in the region, making domestic financing more expensive relative to foreign capital. Furthermore, the crisis has hit the region’s stock markets heavily, sending investors looking for safety. Thus, equity project finance in the region — including the listing of infrastructure projects — is likely to be limited until the markets settle down and domestic liquidity is restored. Therefore, project financing over the shorter term is even more likely to require and seek offshore financing — with relatively fewer takers. The pace of projects coming to the market is likely to slow down significantly over the medium term. Once the region’s economies put their houses in order, domestic interest rates are likely to fall, opening the door to more local and capital market financing of projects. Fundamentally, when growth once again becomes robust (that is, at 6 per cent or more), demand for infrastructure will also rebound. However, the banking system has longer memories, and it will take more time to recover, reinforcing the need for non-bank sources of debt (such as bonds). Over the longer term, the economic crisis may therefore result in net gains for infrastructure project financing in the region in three ways: —

—

—

increasing the role and ability of regional capital markets to finance regional infrastructure projects, with appropriate instruments and institutions; refocusing on and increasing the capacity with respect to the basic principles of project finance, especially the conditions for cross-border financing within the region — a more realistic position for both private investors and governments in terms of expected revenues and allocation of risks; and the present crisis may produce viable opportunities for serious project developers and strengthen their capabilities in project analysis and preparation through a “shakeout” of projects and developers, reducing the gap between the number of memorandums of understanding (MOUs) and implemented projects (on both sides of that equation).

Implications for GMS Infrastructure Financing To some extent, most GMS countries are likely to face the above issues and constraints, but even more so, given their basically still fragile economic and financial structures. Over the longer term, however, as the expanded

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ASEAN region’s capacity and participation in internal infrastructure financing recovers and expands, the GMS are likely to benefit, mainly in three ways: — — —

the necessary financing mechanisms and institutions that can support GMS-related project finance are likely to develop in the region; the flow of intra-regional infrastructure investment within the broader ASEAN framework will increase; in turn, the attractiveness of projects in the region to offshore investors will be enhanced.

Thus, the economic crisis should also be seen as the beginning of recovery and restructuring and an opportunity for developing the necessary institutions and mechanisms, and the associated capacity for sound infrastructure project finance, as well as for stable and effective public/ private partnerships. Reassessing Economic Co-operation in the GMS The preceding discussion of the impact of the regional economic crisis on the GMS was focused on micro or technical issues related to infrastructure financing. These are generally relevant to both national infrastructure projects in the GMS, and to the financing of transborder projects, assuming that such transborder infrastructure projects continue to be a priority of the GMS economies. The more fundamental issue, the impact of the regional economic crisis on the future of economic co-operation in the GMS, was left conveniently unexamined. However, in many ways the present crisis could have significant, far-reaching implications for subregional co-operation in the GMS. To put this in context, it may be useful to revisit briefly the rationale of the ADB-facilitated GMS programme, again as a proxy for subregional co-operation in general. Rationale of the GMS Programme The basic economic purpose of the GMS programme is to help bring about a subregional “growth zone” by making the GMS more attractive primarily as an investment (that is, production) location, and secondarily as a market. The basic strategy of the GMS programme is to directly change the economic structure of the subregion through co-operation in specific, tangible initiatives and projects, in order to improve economic performance. The key focus of the GMS programme implementation has been on the central role of infrastructure as a “necessary condition” for transforming geographic proximity to economic linkages, as a means to facilitate

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subregional investment/trade linkages, both within the GMS, and between the GMS and the external economy. The key assumptions of the existing GMS programme have been that financing will be available for priority subregional projects, including from the private sector; and that FDI, together with growing domestic investment, will build on these projects for subregional production restructuring and trade expansion. Implications of the Regional Economic Crisis for GMS Co-operation As a consequence of the regional economic crisis, the external environment of the GMS has become more complex and uncertain, creating new hurdles for both subregional co-operation, and for the domestic economic reforms and restructuring of the participating economies. In particular, neither of the key assumptions of the GMS programme are likely to hold over the medium term. That is, external and domestic sources of capital — both public and private, for both project financing and direct investment — will shrink over the medium term, especially from the Asia-Pacific region (“investment impact”), the primary source to the GMS. Furthermore, there is likely to be a more severely competitive export environment in traditional industries and markets (“trade impact”) in terms of both increased price competition, and perhaps market capacity constraints. As a consequence, the implications of the regional economic crisis go beyond the nature of “transient shocks”, and could alter fundamentally the evolution of subregional economic relationships over the medium term in the following ways: —

—

—

Reduction in available resources is likely to lead to the postponement of key subregional initiatives, potentially changing/constraining longer-term subregional economic linkages and structures; Given short-term domestic pressures in the “crisis atmosphere” of most GMS countries, unless the potential contributions of subregional projects to domestic economic restructuring and growth are clear, there is likely to be a “crowding out” of policy attention and focus (that is, significantly reduced commitment) away from subregional initiatives. More fundamentally, there may be a temptation for the GMS economies to step back from both subregional economic cooperation, and domestic economic reforms and restructuring (for example, in the form of increasing non-tariff barriers), restricting further the relative attractiveness of these economies to external sources of capital, and constraining further available financing for priority projects.

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Therefore, there may be more at risk for GMS subregional co-operation from the regional economic crisis than financing for infrastructure projects. The very essence of economic co-operation in the GMS may be under pressure. Reinforcing Co-operation in Hard Times: The Fundamental Strategic Challenge There is a silver lining. The regional economic crisis is not only a threat, but also provides potential opportunities to strengthen and refocus subregional co-operation, including in support of externally oriented domestic economic restructuring. It could provide even stronger rationale for co-operation at both the programme and project levels to address common threats and constraints in a more complex and uncertain global environment. However, the rationale for co-operation in hard times is perhaps more difficult to recognize and accept, and more in need of the external “facilitator” role and resources of international institutions such as the ADB. Economic relationships among countries, as in the GMS, are simultaneously competitive and co-operative. In good times, that is, before the regional economic crisis, the pressure for competition in the GMS was generally less intense, given a growing (foreign) investment pie for the subregion as a whole. However, the perceived payoff from co-operation was also likely to be less significant. In hard times, that is, during the economic crisis, when the investment pie to the GMS was shrinking, there was a bias towards seeing every other player as a competitive threat both for this smaller investment pie and in external markets. Paradoxically, the pay-off from co-operation is likely to be significantly more important at this time, given that the perceived investor risk of the individual GMS countries has increased, and expected returns decreased. Subregional co-operation can be an effective strategy to “grow a relatively larger economic pie” for the GMS — or at least minimize the “shrinkage”. This involves focusing clearly on areas of economic complementarity among participating countries. Thus, the subregion as a whole becomes a relatively more attractive investment target, with potentially larger pay-offs for the GMS countries as a group. This is not to say that the competition among the GMS countries will not be present, but that the competitive element to subregional economic relations may be focused more on “dividing up the larger pie”. The key is to generate subregional investment opportunities — including through potential production linkages — and widen investor perceptions of the scope of subregional economic opportunities. The fundamental challenge to the GMS programme then is to make clear the pay-offs from subregional

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co-operation in “hard times”, and to refocus the programme to support this — for example, create subregional investment opportunities, and effectively market these opportunities to the investment community (foreign and domestic). The requirements of infrastructure financing in the GMS must now be viewed in this broader context. Refocusing Economic Co-operation in the GMS: Strategic Issues and Options This section is speculative in nature. It presents three examples of strategic issues and associated options that may be considered for refocusing economic co-operation in the GMS in order to strengthen its longer-term sustainability. Significant Constraints on Financing Subregional Infrastructure Projects Resource mobilization for subregional infrastructure projects was the central challenge identified at the outset, even in the “best of times”. The constraints for mobilizing private participation noted earlier related to the preparation of “bankable” projects with a clear basis for commercial participation; and the management or allocation of risk, especially between firms and governments. The role of international financing institutions such as the ADB was seen perhaps less in the provision of project financing, and more in facilitating private project finance. However, in the present economic climate, money matters more. The regional economic crisis has complicated the environment for infrastructure financing by first reducing drastically the subregional governments’ capacity to undertake priority investment projects; weakening substantially confidence in local currency-denominated assets (most infrastructure projects); creating a much higher level of perceived non-commercial risk associated with investment in the countries of the subregion; and reducing the availability of financing, especially from within East Asia. In this context, without access to additional financing for the GMS governments, participation in public–private projects, whatever their priority, is likely to be difficult at best. Therefore, external funds from international financial institutions such as the ADB, earmarked specifically for subregional projects, and the leveraging role of these institutions noted earlier, including technical support, are now equally important. Basis for Attracting and Sustaining Investor Interest, and Commitment to Subregional Co-operation Sources of capital for the GMS (external/domestic; public/private) for both project financing and direct investment will shrink over the medium term, especially from the Asia-Pacific region. In particular, the private sector will

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be much more careful about investment in Southeast/East Asia in general, in terms of both project financing, and production-related investment (for example, FDI). As noted earlier, infrastructure projects are generally not easily bankable in the best of times because of project economics and noncommercial risk. They are even less bankable in the region in the medium term. Therefore, in the GMS the assumed link of direct investment building to project finance (that is, infrastructure projects) is likely to have been substantially weakened. It is therefore important to establish a much clearer economic relationship between production restructuring and expansion and infrastructure project finance, in order to attract and sustain investor interest for both infrastructure finance and direct investment. Infrastructurerelated services and production opportunities are then mutually reinforcing, with a clear economic and commercial rationale, that is, expected returns. Operationally, one approach may be to move from individual infrastructure projects to “economic corridors”, expanding both the physical project concept (hardware), and non-physical enabling conditions necessary for generating expected benefits (software). This could include co-operation in transborder production linkages aimed at external markets, in areas such as agro-industry, and light manufacturing, where justified by sound economic logic. It may be supported by an increasing emphasis on co-operation in “software”, such as trade facilitation — especially important in an atmosphere of increasing risk of non-tariff barriers — and new types of “hardware”, such as special economic zones, both domestic/national and transborder. Rapid Increase in Subregional Poverty It is now increasingly clear that the regional economic crisis has led to a significant increase in subregional poverty. The impact on income and employment will strain both the resources and the social and political fabric of the countries of the region, especially the poorer economies of the GMS. Therefore, to the extent possible, linking the GMS programme to poverty alleviation will provide important support to the participating countries in addressing a central subregion-wide domestic concern, and sustain continued interest in co-operation. Poverty alleviation, however, is traditionally a domestic issue. Nonetheless, there may be means to link subregional co-operation to poverty alleviation in effective and nationally acceptable ways. In particular, a focus on feeder roads — linked to the priority subregional road projects — and (related) co-operation in the agricultural sector have been identified by the GMS countries as potential priorities. In the present climate, this is likely to get strong support from the participating governments, and from the

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international donor community. One approach may be to expand the concept of “subregional priority road projects” to include feeder roads. These, in turn, may be linked to rural employment and income generation considerations through co-operation, to the extent feasible, in areas such as agriculture and agro-industry. Conclusion: Prospects, Obstacles, Issues and Challenges The potential longer-term impact of the regional crisis on economic cooperation in the GMS countries cannot be ignored and require a cooperative response. However, within a longer historical context, the prospects for further economic integration in this subregion continue to be strong for political and economic reasons. Political tensions that had existed for more than four decades along with the Cold War have subsided. Economic development has become a priority, replacing ideology. All six participating countries have agreed to development projects initiated by the ADB with financial assistance from donor countries, participating countries, international agencies and the private sector, and many of these projects are under way. In addition, borders have been thrown open for the movement of people, goods, and investment. Moreover, all except Yunnan have been integrated into ASEAN. Since these countries have become the new members of ASEAN, they will automatically have to join the ASEAN Free Trade Area. By doing so, they will be gradually integrated into ASEAN’s economic sphere. In terms of economic growth, this area is one of the fastest growing regions in the world, with an average annual growth rate of about 8 per cent. Statistical evidence shows that intra-subregional trade and investments are growing very fast, and many European and East Asian countries have shown interest and support for further economic integration in this area. Tourism is already showing signs of further growth. Moreover, many road projects linking Laos, Thailand, Myanmar, and Yunnan will be completed soon and the road from Chuxiong to Dali in Kunming (Yunnan)-Lasio (Myanmar) is being upgraded. In addition, a feasibility study of the Thailand–Laos–Vietnam East–West Corridor is under way and the ADB has given approval for regional technical assistance for the conduct of detailed engineering design for the Phnom Penh (Cambodia)-Ho Chi Minh City road project. More importantly, the private sector is already active in conducting business in this area, even with minimum help from the governments. In sum, because of the political will of the participating governments and the private sector, together with assistance from international agencies, the opening of borders in the region as a result of liberalization policies of all the riparian countries, and abundance of natural and human

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resources, prospects for further economic integration in the region are ensured. Hence, the prospects for ASEAN co-operation in infrastructure and finance are likely to be bright. The evidence shows that even before the four new member countries joined ASEAN, co-operation in infrastructure development, and financing of development projects within and outside the subregion, was impressive, although the experience of ASEAN suggests that economic integration among the developing countries of the region is a slow process. For example, it took ASEAN twenty-five years to reach agreement on the establishment of AFTA. It is more difficult for the six riparian countries in the Mekong group because of the differences in political, economic, accounting, and legal systems, as well as the level of development. Moreover, it is important to note that although China and Myanmar have agreed to ADB-initiated development projects in the Mekong region, they are yet to become members of the Greater Mekong Commission. Politically, China, Vietnam and Laos are still “communist” countries ruled by a single party respectively; Myanmar is still under a military regime which is under attack by the West for alleged human rights records; Cambodia is still struggling to become a fully democratic society; while Thailand, on the other hand, is a democratic country by any standard. These ideological differences could create mistrust among the participating countries, not to mention the historical confrontations among them. And there is, at least in theory, a possibility that hard-liners in the ruling communist parties of these countries may come back and reverse the course. Another political issue is the relationship between Myanmar, on one hand, and the United States and the EU, on the other. Since Myanmar is one of the participating countries, some potential financial sources from the United States and the EU may shun the subregion because of the West’s hostility towards the ruling regime. Another obstacle for economic co-operation in the region might be the riparian states’ natural resistance to giving up part of their national sovereignty over shared resources. This may create a stumbling block for cross-border infrastructural and financial co-operation. Given the complexity of the multi-country, transborder nature, and context of projects, and given that implementation of the projects is occurring in two or more different political, legal and economic environments, the risks associated with project preparation and implementation may increase. The different economic systems might also pose obstacles. All the economies of the riparian countries, with the exception of Thailand, are transforming from a rigid centrally planned economy to a market-oriented one whereas Thailand is fully a market economy. The legal systems in these transitional economies are very ambiguous and clear-cut property

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rights and transparent laws relating to companies, bankruptcy, and antimonopoly are needed. In addition, there are different accounting systems in the Mekong region which are difficult for foreign investors to adjust to. Despite all efforts, it will take time to overhaul the existing legal and institutional framework, and to enact new legislation to smooth the transition process. Furthermore, the differences in the level of development can create problems for economic integration, as the ASEAN experience has shown. It could take a long time to agree on the extent and speed of trade and financial liberalization and industrial co-operation. This is because the pace of the grouping can only be as fast as the weakest members. Another issue to address is the risk of severe debt associated with major development assistance from multilateral development banks since large amounts of capital would have to be pumped in to finance infrastructural and other development projects. Hence, there is an urgent need for debt management by these participating countries. There also exist fundamental flaws, including the clash of developmental objectives among the participating countries themselves. For example, Thailand, a buoyant economy, is keen to harness the hydropower potential of the Mekong for its enormous energy needs and to divert water for irrigation. On the other hand, Vietnam is determined to guard its fragile Mekong delta (Sunday Times, 8 September 1996). To conclude, as the past experience of the GMS suggests, regional and international institutions can play an important role as facilitators of subregional co-operation in infrastructure and finance. They may be a key source of technical and financial support, including helping to mobilize international financing, both official and private, and in helping to reduce risk to investors (Abonyi 1996, p. 36). Moreover, the joining of the six participating countries of the GMS in ASEAN will create a more conducive environment for such co-operation, and the credibility of ASEAN as a good place for investment will definitely complement and supplement it. References Abonyi, G. The Institutional Challenges of Growth Triangles in Southeast Asia. Centre for Advanced Studies Working Paper Series. Singapore: National University of Singapore, August 1994. . “Financing the Greater Mekong Subregion”. In ISEAS Trends, Supplement of Business Times, Weekend Edition, 25–26 January 1997. Abonyi, G., and F. Pante, Jr, “Capital Mobilization for Financing Projects in GMS: An Overview”. Paper presented at the Indochina Roundtable on Capital Mobilization for the Development of the GMS, Singapore, 29–30 November 1996.

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Abonyi, G., and F. Pante, Jr. “Economic Cooperation in the Greater Mekong Subregion: The Challenges of Resource Mobilization”. In Growth Triangles in Asia: A New Approach to Regional Co-operation, edited by Myo Thant, Min Tang, and Hiroshi Kakazu. 2nd ed. Oxford Uniersity Press and Asian Development Bank, 1998. Asian Development Bank (ADB). Subregional Economic Co-operation: Initial Possibilities for Cambodia, Lao PDR, Myanmar, Thailand, Vietnam and Yunnan Province of the PRC. Manila, 1993. . Asian Development Outlook, 1997–98. Manila, 1997. . Asian Devleopment Outook, 1995–96. Manila, 1995. . Subregional Economic Co-operation. Proceedings of the Fourth Conference. Manila, 1996. . Economic Co-operation in the Greater Mekong Subregion: Facing the Challenges. Manila, 1996. . Unpublished papers from the Sixth Conference on Subregional Economic Co-operation in the Greater Mekong Subregion, Kunming, China, 28–30 August, 1996. Baldwin, P. Planning for ASEAN: How to Take Advantage of Southeast Asia’s Free Trade Area. London: Economic Intelligence Unit, April 1997. Bradley, D. “Languages: The Tool of Trade in the New Circles of Growth”. Paper presented at a Conference on Asia’s New Growth Circles, Chiang Mai, 3–6 March 1994. Chia, S.Y. “Economic Co-operation and Interdependence in the SIJORI Growth Triangle”. Paper presented at the Joint ISEAS-Pacific Forum CSIS Conference on Economic Interdependence and Challenges to the Nation State: The Emergence of National Economic Territories in the Asia-Pacific, Singapore, 27–28 October 1994. . “Progress and Issues in ASEAN Economic Integration”. In East Asian Economies: Transformation and Challenges, edited by Toshihiko Kawagoe and Sueo Sekiguchi. Tokyo: Centre for Asia and Pacific Studies, 1995. Chia, S.Y., and Lee T.Y. “Subregional Economic Zones: A New Motive Force in Asia-Pacific Development”. In Pacific Dynamism and the International Economic System, edited by C.F. Bergsten and M. Noland. Washington D.C.: Institute of International Economics, 1993. Cho, G., and S.W. Williams. “Trade and Regional Integration”. In Southeast Asian Development: Geographical Perspectives, edited by D. Dwyer. New York: Longman Scientific and Technical, 1990. East Asia Analytical Unit (EAAU). The New ASEANs: Vietnam, Burma, Cambodia and Laos. Australia: Department of Foreign Affairs and Trade, 1997. Hirsch, P. et al. Natural Resource Management in the Mekong Basin, Perspectives for Australian Development Co-operation. University of Sydney, 1996. Irwin, Timothy; M. Klein, G. Perry, and M. Thobani. Dealing with Public Risk in Private Infrastructure: An Overview. World Bank, 1997. Lee, T.Y. Growth Triangle: The Johor-Singapore-Riau Experience. ISEAS, 1991. Lim, J.J. “Geopolitics and Asian Growth Circles: An Example in between Southeast Asia and China”. Paper presented at the Conference on Asia’s New Growth Circles, Chiang Mai, 3–6 March 1994. Low, L. “Government Approach to SIJORI.” Paper presented at the Joint ISEASPacific Forum CSIS Conference on “Economic Interdependence and Challenges to the Nation State: The Emergence of National Economic Territories in the Asia-Pacific”, Singapore, 27–28 October 1994.

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Matic, K.T. “Development of the Mekong River and Law: Some Environmental Problems”. Paper presented at the Conference on International Boundaries and Environmental Security: Framework for Regional Co-operation, Singapore, 14–17 June 1995. Mya Than. “The Golden Quadrangle of Mainland Southeast Asia: A Myanmar Perspective”. ISEAS Working Paper No. 5 (96). Singapore: ISEAS, 1996. . “Economic Cooperation in GMS: An Overview”. Paper presented at the Indochina Roundtable on Capital Mobilization for the Development of the GMS, Singapore, 29–30 November 1996. Myo Thant. “Growth Triangles in Southeast Asia: Perspectives and Opportunities for Economic Co-operation”. Paper presented at the Fourth Southeast Asia Roundtable on Economic Development — Growth Triangles in Southeast Asia: Strategy for Development, Kuala Lumpur, 27–28 June 1994. Myo Thant et al., eds. Growth Triangles in Asia: A New Approach to Regional Economic Co-operation. Manila: ADB, 1995. Prachoon Chomchai. “Transboundary Protection of the Environment: A Mekong Perspective”. Paper presented at the Conference on International Boundaries and Frameworks for Regional Co-operation, RELC, Singapore, 14–17 June 1995. Rajan, R.S. Asia Pacific Co-operation: A Post-Cold War Paradigm for Regional Economic Co-operation Involving Developing Countries. Centre for Advanced Studies Working Paper Series. Singapore: National University of Singapore, 1995. World Bank. World Development Report, 1991. Washington D.C., 1991. . World Development Report, 1995. Washington D.C., 1995. Samram, C. “The Mekong Basin Development Plan”. In Development Dilemmas in the Mekong Region: Workshop Proceedings. Clayton, Vic.: Monash Asia Institute, Monash University, 1996. Stensholt, B. “Development Dilemmas in the Mekong Region”. Workshop Proceedings, Monash Asia Institute, Monash University, Melbourne, 1996. UN/ESCAP. Strengthening Capacities in Trade, Investment and the Environment for the Comprehensive Development of Indochina. New York, 1995.

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Cambodia’s Accession to AFTA: Impact, Challenges, and Policy Implications

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TOSHIYASU KATO*

Introduction The Association of Southeast Asian Nations (ASEAN) agreed to accept Cambodia as a full member at the Hanoi Summit in December 1998. After completing constitutional amendments needed to establish a new coalition government, Cambodia entered ASEAN on 30 April 1999. The process of Cambodia’s accession to ASEAN has been protracted and difficult. A decade earlier in 1989, Cambodia was still a mono-party socialist regime with a command economy; and it remained isolated from the regional economies, except for Vietnam and the Lao People’s Democratic Republic (PDR). The civil war between the government and resistance forces, including the Khmer Rouge, continued along the Thai–Cambodian border, and nearly 300,000 Cambodians were living in refugee camps in Thailand. The last decade witnessed a dramatic change in Cambodia’s political and economic systems. A new coalition government was formed in 1993 after national elections were held under the United Nations Transitional Authority in Cambodia (UNTAC), following the Paris Peace Accords in 1991. This marked a turning point in the emergence of a multi-party political system and the transition to a market-oriented economy. The new government viewed economic integration into the regional and world economies as a key national strategy for reconstruction and development. Accordingly, the new government submitted its formal application for full membership in ASEAN in April 1996, and it started to prepare for accession to the ASEAN Free Trade Area (AFTA). 164

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Economic integration into AFTA is expected to bring economic benefits to Cambodia. First, AFTA will enable enterprises located in Cambodia, both local and foreign, to have preferential access to ASEAN markets, which comprise a combined population of 480 million. Even with the economic slowdown precipitated by the Asian financial crisis in 1997–98, the ASEAN market is likely to return to one of the highest growth areas in the world. Secondly, Cambodia could become a platform for foreign investment from non-ASEAN countries aiming to penetrate the ASEAN markets. Low preferential tariffs on Cambodia’s exports to ASEAN, coupled with low labour costs and liberal investment laws, are expected to increase incentives to locate factories and firms in Cambodia. Finally, by joining AFTA, Cambodia will send a signal of its commitment to integrate itself into the global economy, thereby giving foreign investors greater confidence to invest in Cambodia. Although Cambodia’s accession to AFTA is expected to bring these economic benefits, it poses several problems and enormous challenges as well. The benefits from AFTA will not be fully achieved without identifying and examining the potential problems arising from regional economic integration and taking appropriate policy measures to meet those challenges. This chapter seeks to contribute to these objectives by examining Cambodia’s accession to AFTA, its potential impacts, challenges, and policy implications. It will attempt to answer the following questions. First, what economic impact will AFTA accession have on Cambodia’s trade, investment and growth? Secondly, what challenges will Cambodia face in translating the benefits of economic integration into long-term sustainable development? Thirdly, what policy implications can be drawn from these analyses? For this purpose, data, indicators and other information are compiled from official statistics and several recent studies in Cambodia on this topic. A comparative analysis approach is employed to understand Cambodia’s current conditions relative to the ASEAN economies. This chapter is organized as follows. The next section reviews the recent performance of foreign trade and investment in Cambodia. This provides important information to assess the potential impact of AFTA on Cambodia, as foreign trade and investment are two major factors that will impinge on Cambodia’s economy. The following section discusses the Cambodian Government’s preparation and strategies to integrate into AFTA, and gives an overall assessment on AFTA’s potential impact on trade, investment, and growth in Cambodia. Next, five major challenges to long-term sustainable development are examined: 1) maintaining sound macroeconomic fundamentals; 2) eradicating poverty; 3) achieving equitable growth; 4) maintaining the momentum of growth; and 5) regenerating the environment. Policy implications for meeting these five challenges are then drawn. The chapter concludes with a summary of the findings.

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Patterns of Foreign Trade and Investment The essence of the Common Effective Preferential Tariffs (CEPT) scheme under the AFTA agreement is the reduction of import tariffs and the elimination of non-tariff barriers on trade in goods within ASEAN. This implies that joining AFTA will affect the relative prices of Cambodia’s traded products with the ASEAN countries, as well as incentives for foreign investors in Cambodia, as Cambodia could potentially be a platform for foreign investment aimed at the ASEAN markets. It is therefore useful to first analyse the patterns of Cambodia’s foreign trade and investment to assess the potential impact of joining AFTA. Trade Patterns Cambodia’s trade liberalization started in the late 1980s, and its pace was accelerated in the 1990s, particularly after a new coalition government was established in 1993. The new government took several steps to streamline tariff lines and to abolish quantitative restrictions. The liberalization measures stimulated an expansion of trade in goods during the 1990s. Cambodia’s exported goods quadrupled from US$101 million in 1992 to US$404 million in 1997 (Table 7.1). Its imports expanded even more greatly from US$160 million in 1992 to US$710 million in 1997. The current account deficit increased over the same period, however, and reached 11 per cent of gross domestic product (GDP) in 1997. Despite the relatively short history of trade liberalization, Cambodia has already achieved a fairly open trade regime that is comparable with the regional economies. Cambodia’s exports and imports reflect a production structure that is predominantly agrarian, with a narrow and weak industrial base. Overall, Cambodia exported primary and unskilled labour-intensive products, and imported manufactured products and mineral fuels (Table 7.2).1 Rubber and wood (SITC 2) comprised the largest share of Cambodian exports. The export of unskilled labour-intensive manufactured products such as garments increased its share in total exports (18 per cent in 1996), reflecting the rapid expansion of direct foreign investment in the garment sector.2 Because of its weak industrial base, Cambodia’s imports of manufactured products (SITC 5, 6, 7) accounted for about 60 per cent of total imports in 1996. The ASEAN countries have been by far the largest trade partners for Cambodia after its trade liberalization. Imports from Singapore, Thailand, and Vietnam have accounted for about 70 per cent of total imports to Cambodia (Table 7.3). They were followed by imports from other Asian countries, such as Taiwan, China, Hong Kong, and Japan. Imports from the European Union (EU) made up only 4 per cent of total imports in

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TABLE 7.1 Cambodia: Basic Macroeconomic Indicators 1992 Growth rate of real GDP (1989 constant prices) Agriculture Industry Service Gross domestic savings (% of GDP) Gross domestic investment (% of GDP) Growth rates of CPI (final quarter basis) Growth rates of money supply (M2) Exchange rates (riels/US$) Central government operations (% of GDP) Expenditure Revenue Overall budget surplus(+)/deficit(–) External transaction Exports of goods ($ million)** Exports of goods (% of GDP) Imports of goods ($ million)*** Imports of goods (% of GDP) Balance of current account ($ million) Balance of current account (% of GDP) Foreign direct investment, net ($ million) Foreign direct investment, net (% of GDP) Memorandum items Nominal GDP ($ million)

1993

1994

1995

1996

1997

1998*

7.1 1.9 15.7 11.2

4.1 –1.0 13.1 7.0

4.0 0.0 7.5 7.5

7.6 6.5 9.9 7.8

7.0 2.4 18.2 7.0

1.0 1.2 –2.9 2.6

0.0 — — —

7.3

5.6

4.8

5.4

4.9

4.7

—

9.8

14.3

18.5

21.2

20.4

16.1

—

112.5

41.0

17.9

3.5

9.0

9.1

15.0

209.0

40.0

29.4

44.3

40.4

16.0

—

1253

2470

2543

2462

2624

2989

3700

9.8 6.2

11.2 5.4

16.5 9.6

16.7 8.9

16.3 9.1

13.9 9.7

11.7 8.1

–3.6

–5.8

–6.9

–7.8

–7.2

–4.2

–3.6

101

168

234

269

298

404

—

5.1

8.3

9.7

9.2

9.5

13.3

—

160

361

509

673

749

707

—

8.1

17.9

21.1

22.9

23.8

23.2

—

–50

–190

–329

–474

–485

–346

–329

–2.5

–9.4 –13.7

–16.1

–15.5

–11.4

–11.6

33

54

69

151

294

204

—

1.7

2.7

2.9

5.1

9.4

6.7

—

1981

2013

2409

2938

3144

3044

—

NOTES: *Estimates; **Excluding re-exports; ***Retained imports. SOURCE: World Bank (1999).

© 2001 Institute of Southeast Asian Studies, Singapore

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TABLE 7.2 Cambodia’s Trade Patterns by Industry, 1995 and 1996 (In US$ thousands) SITC 0 1 2 3 4 5 6 7 8 9

0 1 2 3 4 5 6 7 8 9

0 1 2 3 4 5 6 7 8 9

Sector Food and live animals Beverages and tobacco Crude materials (excluding fuels) Mineral fuels, etc. Animal, vegetable oil, fat Chemicals, related products Basic manufactures Machines, transport equipment Miscellaneous manufactured goods Goods not classed by kind Total Food and live animals Beverages and tobacco Crude materials (excluding fuels) Mineral fuels, etc. Animal, vegetable oil, fat Chemicals, related products Basic manufactures Machines, transport equipment Miscellaneous manufactured goods Goods not classed by kind Total Food and live animals Beverages and tobacco Crude materials (excluding fuels) Mineral fuels, etc. Animal, vegetable oil, fat Chemicals, related products Basic manufactures Machines, transport equipment Miscellaneous manufactured goods Goods not classed by kind Total

1995

Share (%)

1996

Share (%)

IMPORTS 77,108 41,767

7.2 3.9

70,062 46,553

7.0 4.7

24,444 127,001 3,785 57,811 161,946

2.3 11.8 0.4 5.4 15.1

29,785 142,700 6,669 75,227 197,005

3.0 14.3 0.7 7.5 19.7

249,750

23.2

341,466

34.1

45,915 285,898 1,075,425

4.3 26.6 100.0

51,151 39,984 1,000,602

5.1 4.0 100.0

EXPORTS 7,027 3,415

4.5 2.2

5,644 6,521

3.5 4.0

97,326 — — 591 12,676

62.2 0.0 0.0 0.4 8.1

75,236 60 5 194 18,222

46.1 0.0 0.0 0.1 11.2

6,068

3.9

6,286

3.9

29,460 1 156,564

18.8 0.0 100.0

29,115 21,911 163,194

17.8 13.4 100.0

0.0 81.6

20 205,405

0.0 89.2

17 — — 10 —

0.0 0.0 0.0 0.0 0.0

— — — 114 —

0.0 0.0 0.0 0.0 0.0

46,083

18.3

24,772

10.8

3 — 251,255

0.0 0.0 100.0

— — 230,311

0.0 0.0 100.0

RE–EXPORTS 7 205,135

SOURCE: Robertson and Pohoresky (1998).

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TABLE 7.3 Cambodia’s Trade Patterns by Country and Region, 1995 and 1996 (In US$ thousands) Imports 1996

Exports % 1996

%

74.3 300,814 45.7 173,475 13.7 107,265 12.0 13,674 2.0 2,163 0.9 2,757 0.0 764 0.0 — 0.0 717

80.3 254,351 46.3 116,832 28.6 109,167 3.7 24,425 0.6 3,127 0.7 532 0.2 130 — 84 0.2 55

66.5 30.5 28.5 6.4 0.8 0.1 0.0 0.0 0.0

133,131 42,925 32,619 28,409 23,833 5,210 136

13.3 4.3 3.3 2.8 2.4 0.5 0.0

38,194 21,197 7,854 3,548 5,288 308 —

10.2 5.7 2.1 0.9 1.4 0.1 —

30,306 11,508 7,601 5,534 5,037 617 9

7.9 3.0 2.0 1.4 1.3 0.2 0.0

1.6 1.6

15,495 15,495

1.5 1.5

4,379 4,379

1.2 1.2

2,066 2,066

0.5 0.5

44,772 34,443 405 7,747 2,177

4.2 3.2 0.0 0.7 0.2

42,660 18,835 14,840 2,581 6,405

4.3 1.9 1.5 0.3 0.6

24,566 8,913 9,429 3,433 2,791

6.6 2.4 2.5 0.9 0.7

92,224 39,613 30,568 12,926 9,116

24.1 10.3 8.0 3.4 2.4

2,603

0.2

1,524

0.2

499

0.1

924

0.2

Subtotal Discrepancy

1,019,898 55,528

94.8 5.2

921,044 79,558

97.2 377,804 2.8 4,962

98.7 1.3

Total

1,075,426

100.0

1995

%

ASEAN Singapore Thailand Vietnam Malaysia Indonesia Philippines Laos Myanmar

798,799 529,727 133,728 109,086 15,462 9,091 1,705 1 —

74.3 49.3 12.4 10.1 1.4 0.8 0.2 0.0 0.0

743,728 457,689 137,009 119,630 19,714 9,313 316 47 12

Other Asia/Pacific Taiwan Japan China Hong Kong Australia New Zealand

173,725 9,186 64,112 28,401 58,179 13,598 249

16.2 0.9 6.0 2.6 5.4 1.3 0.0

North America United States

17,406 17,406

European Union France Italy Germany Other EU Other

%

1995

92.0 364,073 8.0 10,440

1,000,602 100.0 374,513

SOURCE: Robertson and Pohoresky (1998)

© 2001 Institute of Southeast Asian Studies, Singapore

100.0 382,766 100.0

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1995 and 1996. As for the destination of Cambodia’s exports, the ASEAN countries again accounted for the largest shares, with 80 per cent and 67 per cent in 1995 and 1996, respectively. Exports to Thailand were the largest (31 per cent in 1996), followed by Singapore’s 29 per cent in the same year. A notable change in 1995 and 1996 was the expansion of exports to the EU, increasing from 7 per cent in 1995 to 24 per cent in 1996. This reflected the development of the garment industry, which expanded rapidly after Cambodia received the Generalized System of Preferences (GSP) status from the EU. Garment exports increased even more rapidly in 1997 and 1998, reflecting the grant of most-favourednation (MFN) and GSP status from the United States in 1997. Foreign Investment Patterns Cambodia’s liberalization policy was extended to foreign investment in the early 1990s. Cambodia’s new Law on Investment was implemented in 1994, offering among the most generous incentives to investors in the region. The liberal investment regime attracted a significant amount of foreign direct investment (FDI) in the 1990s. The total amount of FDI in Cambodia increased by six times from US$33 million in 1992 to US$200 million in 1997. In percentage terms relative to GDP, it increased from 1.7 per cent in 1992 to 6.7 per cent in 1997. Available investment data indicate that the ASEAN countries, particularly Malaysia and Singapore, have been major investors in Cambodia since it adopted the new investment regime in 1994. Table 7.4 summarizes foreign investment approvals by country and region since 1995.3 ASEAN’s share of FDI, however, appears to have declined from 1995 to 1998 because investments from China, Hong Kong, Taiwan, and Korea (a large proportion of their investments flowing into the garment sector) increased rapidly during that period. An Analysis of Comparative Advantage The Heckscher-Ohlin theory of international trade is employed to analyse Cambodia’s comparative advantage in the ASEAN countries. The current study uses Wood’s (1994) approach which considers skills (or human resources) and land as primary factor endowments. Using empirical evidence from a cross-country study, he showed that the share of manufacturing exports relative to primary exports was positively correlated with a skills–land ratio. Based on the findings, he argues that a skills–land ratio is a critical factor in determining the potential comparative advantage of countries. Wood’s approach is relevant in the context of AFTA because there exist wide variations in endowments of skills and land among the member countries.

© 2001 Institute of Southeast Asian Studies, Singapore

© 2001 Institute of Southeast Asian Studies, Singapore

277

60 1 21 25 12 1 61 15 12 19 4 11 23 12 0

1995

358

60 6 25 19 10 0 107 31 22 34 7 13 17 7 0

1996

431

47 4 16 17 10 0 150 31 34 63 12 10 20 16 1

1997

Investment Projects (number)

SOURCE: Cambodia Investment Board.

Total

ASEAN Indonesia Malaysia Singapore Thailand Vietnam Other Asia-Pacific China Hong Kong Taiwan Korea Others Europe America Middle East

Country of Origin

279

33 4 8 13 6 2 96 41 20 10 6 19 11 10 0

1998

3,049

1,429 2 1,361 44 23 0 37 10 6 13 4 3 71 46 0

1995

634

104 3 54 35 12 0 172 23 12 125 5 8 67 14 0

1996

569

76 2 53 14 7 0 193 22 18 48 71 34 13 16 1

1997

Registered Capital (US$ millions)

614

90 3 21 13 53 0 210 77 48 58 4 24 8 5 0

1998

TABLE 7.4 Foreign Investment Projects Approved in Cambodia

286 13 191 35 46 0 251 37 26 164 5 19 69 8 0

1996

3,571 1,150

1,566 1 1,421 108 36 0 38 6 13 14 3 2 213 149 0

1995

1,067

111 1 66 16 27 0 364 36 71 44 189 23 21 97 0

1997

Fixed Assets (US$ millions)

1,182

231 6 142 50 33 0 349 108 91 114 5 32 10 11 0

1998

Cambodia’s Accession to AFTA 171

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His approach is also practical for an analysis of the new ASEAN members, including Cambodia whose data availability is extremely limited. Figure 7.1 illustrates relative endowments of cultivable land and skills in Cambodia and selected ASEAN countries (Table 7.5).4 The Y-coordinate axis indicates the average years of schooling of the working-age population as a proxy for skills per worker. The X-coordinate axis indicates cultivable land (cropland and permanent pasture) per working-age population.5 It is clear from this figure that Cambodia is a country which has the most abundant cultivable land in the region, but is most scarce — next to Laos — in skills. The skills–land ratio is shown by the straight line from the origin, in Figure 7.1. As the line from the origin becomes steeper, a country’s factor endowments become relatively more skills abundant, and indicate a stronger comparative advantage in manufacturing exports relative to primary exports. As Figure 7.1 clearly shows, skills–land ratios in Cambodia and Laos are the lowest in the region, indicating that these countries have potential comparative advantage in the export of primary products.

FIGURE 7.1 Determinants of Comparative Advantage 8

Average skills-land ratio

Philippines

Skills per worker (years of schooling)

7 6

Malaysia

5

Average Vietnam

4

Indonesia

3

Cambodia Thailand Laos

2 1 0 0

0.002

0.004

0.006

Cultivable land per worker (sq km)

© 2001 Institute of Southeast Asian Studies, Singapore

0.008

0.01

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TABLE 7.5 Skills–Land Ratio in Cambodia and Selected ASEAN Countries (1) Cultivable Land (thousands of sq km) Cambodia Laos Vietnam Indonesia Philippines Thailand Malaysia Total

(2) Population aged 15–64

(3) Skills per Worker (year)

(4) Cultivable Land per Worker (sq km)

(millions)

(5) Skills–Land Ratio (year/sq km)

54 17 73 457 105 221 79

6 2 41 111 37 37 11

3.5 2.9 4.9 4.1 7.6 3.9 5.6

0.0091 0.0083 0.0018 0.0041 0.0028 0.0060 0.0072

387 350 2,751 995 2,678 654 778

1,006

245

4.8

0.0041

1,163

NOTES: (1) 1994 figures. Cultivable land includes cropland and permanent pasture. It excludes forest, wetlands, residential and industrial sites and roads. (3) 1992 figures. Skills per worker is proxied by average years of schooling received by a person aged 25 or above. (4) The ratio of column (1) divided by column (2) (5) The ratio of column (3) divided by column (4) SOURCES: UNDP (1994); World Bank (1997).

Although this analysis of factor endowments is useful in identifying potential comparative advantage, actual trade patterns often diverge from potential comparative advantage for various reasons, such as trade and industrial policies, domestic regulations, and incompleteness of domestic markets. Indicators of revealed comparative advantage, which are constructed from actual trade data, help to show the difference between actual and potential comparative advantages. Table 7.6 summarizes the index of revealed comparative advantage for exports (RCAX) of the top ten export commodities in Cambodia and the ASEAN countries.6 The figures in Table 7.6 indicate that Cambodia’s comparative advantage was revealed primarily in natural resource-based products (rubber, wood, timber — SITC 2) and unskilled labour-intensive manufactured products (SITC 8) such as garments in 1995 and 1996. The above analysis raises an important issue regarding Cambodia’s agricultural sector. Despite the fact that Cambodia is richly endowed with cultivable land relative to other regional economies, it exported few

© 2001 Institute of Southeast Asian Studies, Singapore

Shellfish: fresh, frozen Fish: prepared, preserved Rice Vegetables: fresh, preserved Fruit, nuts: fresh, dried Coffee and substitutes Seeds for “soft” fixed oil Seeds for other fixed oils Natural rubber, gum Rubber: synthetic, reclaimed Fuel wood, charcoal Wood: rough, squared Wood: shaped, sleepers Waste of textile fabrics Base metal ores Coal, lignite and peat Crude petroleum Petroleum products: refined Gas: natural, manufactured Fixed vegetable oil: non-soft Veneers, plywood Woven man-made fibre fabrics Pearl, precious, semi-precious stones

036 037 042 054

© 2001 Institute of Southeast Asian Studies, Singapore

667

634 653

341 424

245 247 248 269 287 332 333 334

057 071 222 223 232 233

Industry items

SITC

175 12

94

12

3

8

63 59 23 14 15

10

‘92 95/96

Cambodia

13

71 12

12

9 6

7

4 11 9

65

60 30

38

Vietnam

12

Myanmar

5

37

43

3

18 7

22

2 13

4

30

6

33

13

6

Malaysia Singapore

2

34

6

9 20

Philippines Thailand

4

7

27

7

Indonesia

TABLE 7.6 Revealed Comparative Advantage (RCA) of Exports Index: Cambodia and ASEAN Countries*

0

2 41

10

Brunei

174 Toshiyasu Kato

Automatic data processing equipment Office machines: parts, accessories Television receivers Radio broadcast receivers Sound recorders, phonographs Telecom equipment, parts, accessories Switch gear, parts Electrical distributng equipment Transistors, valves Electrical machinery Men’s outerwear, not knitted Womens outerwear, not knitted Undergarments, not knitted Outerwear, knitted non-elastic Undergarments, knitted Footwear Works of art Special transactions

752

© 2001 Institute of Southeast Asian Studies, Singapore

4

45

5

16

18

11 5

‘92 95/96

Cambodia

8

9

3

Myanmar

6

8

Vietnam

5

3

Indonesia

8

4 8

4

5 5

2

4

4

2

3

Philippines Thailand

7

2

12

3

Sources: Robertson and Pohoresky (1998); and UNCTAD (1996).

4 1

2 1

4

3 5 8

7

Malaysia Singapore

NOTE: * The average of RCA indexes in 1995 and 1996 for Cambodia; the RCA indexes in 1992 for the ASEAN countries

846 851 896 931

845

844

843

776 778 842

772 773

764

761 762 763

759

Industry items

SITC

TABLE 7.6 (continued) Revealed Comparative Advantage (RCA) of Exports Index: Cambodia and ASEAN Countries*

0 0

1 1

0

0

Brunei

Cambodia’s Accession to AFTA 175

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agricultural commodities in 1995–96. This contrasts sharply with Thailand, where resource endowments are similar to Cambodia and where a variety of agricultural products reveal strong comparative advantage. This seems to suggest that Cambodia has potential comparative advantage in agricultural products, but this has been neither revealed nor developed. Potential Impact of AFTA To assess the impact of AFTA on the various member economies requires an analysis of government policies, because the impact depends critically on government approaches towards AFTA. The first part of this section discusses the preparation and strategies of the Cambodian Government for integration into AFTA. The second part combines the analyses of trade and investment patterns and government policies to fully assess the potential impact of AFTA on Cambodia’s trade, investment, and growth. Preparation and Strategies of the Government The Cambodian Government started to prepare for AFTA integration in 1996. The selection of product lists under the CEPT scheme has been one of the most critical issues for its consideration. The National AFTA Unit, which was created in the ASEAN Department at the Ministry of Economy and Finance, prepared the CEPT product lists in collaboration with line ministries. The initial package of the Inclusion List was submitted to the ASEAN Senior Economic Officials Meeting (SEOM) in late July 1997.7 The initial Inclusion List package suggests that the Cambodian Government has been pursuing a more comprehensive approach to tariff reduction than other new members of ASEAN. For instance, the Cambodian Government proposed 3,149 tariff lines in the Inclusion List, comprising 47 per cent of total tariff lines in Cambodia. This figure exceeds those of the other new ASEAN members: 15 per cent for the Lao PDR, 28 per cent for Vietnam, and 43 per cent for Myanmar (Kun 1998, Table 3.7). At the same time, however, the government appears to have taken cautious strategies to minimize the short-term impact of AFTA, particularly on national revenues. The number of tariff lines in the Inclusion List is summarized in Table 7.7. According to the initial proposal, only 556 tariff lines whose tariff rates are above 20 per cent will be reduced by 10–15 per cent immediately after entry into the CEPT process; they will be further reduced to 0–5 per cent in seven years for the fast track, and in ten years for the normal track. The remaining 2,593 tariffs lines whose current tariff rates are below 20 per cent will remain at their current levels for a few years after integration begins.

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TABLE 7.7 Inclusion List for CEPT/AFTA Base Rate of Tariffs (%)

Number of Tariff Lines in the Inclusion List (IL) Fast track

Normal track

Total

0 0.3 7 10 15 20 30 35 40 50

90 3 697 0 63 0 0 153 0 111

105 0 603 14 1009 9 283 2 7

195 3 1300 14 1072 9 0 436 2 118

Total

1117

2032

3149

SOURCE: Keat and Aun (1998).

Potential Impact on Trade, Investment and Growth An overview of foreign trade and investment patterns has revealed that the ASEAN countries were by far the largest trading partners as well as primary investors in Cambodia. It was also observed that, while the Cambodian Government took a more comprehensive approach for tariff reduction than other new ASEAN members, the implementation of the CEPT was envisaged to minimize short-term adverse impact on Cambodia’s economy, particularly national revenues. It can thus be inferred that joining AFTA and implementing the CEPT scheme will have few effects on Cambodia’s economy in the short-term. And yet, the comprehensive reduction of tariffs indicate that in the long-term, the accession to AFTA is likely to have significant implications for Cambodia’s trade, investment, and economic growth. The long-term impact of joining AFTA on trade may be discussed within the framework of trade diversion and creation. The large share of ASEAN in Cambodia’s international trade indicates that the potential for trade diversion will be low in the medium-to-long run. Cambodia’s comprehensive approach to tariff reduction relative to those of Laos,

© 2001 Institute of Southeast Asian Studies, Singapore

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Myanmar, and Vietnam also means that Cambodia will be able to enjoy lower tariffs in a much wider range of products than the other new member countries. Cambodia is thus likely to have a high chance of benefiting from trade creation through induced consumption, demand for intermediate inputs, and hence international trade with the ASEAN countries. It is therefore likely that the benefits from trade creation outweigh the costs of trade diversion in the long term as Cambodia implements the proposed package of tariff reduction under the CEPT scheme. Cambodia’s entry into AFTA is also likely to stimulate certain types of foreign investment in Cambodia. As Robertson and Pohoresky (1998) argue, joining AFTA will increase incentives for foreign investors from nonASEAN countries to establish their production base in Cambodia to supply their products to the ASEAN markets. This is because exports from Cambodia to other ASEAN countries will enjoy lower tariffs under the CEPT than exports from non-ASEAN countries. Cambodia’s comprehensive approach to tariff reduction should give it an additional competitive edge in attracting foreign investment as the other new ASEAN members provide lower incentives to foreign investors. Menon (1997) has highlighted some “indirect” benefits of joining AFTA which are unique in the case of transitional economies such as Laos. These indirect benefits are also relevant for Cambodia. First, joining AFTA will send a signal to foreign investors that administrative, legal and bureaucratic systems will have to be changed to satisfy the obligations of membership. This will not only create a positive image of Cambodia’s investment environment, but will also force the government to actually reform its governing systems to comply with the requirements of membership. Secondly, a small country with weak bargaining power in trade negotiations, such as Cambodia, could benefit from joining ASEAN perhaps more than large developing countries. ASEAN’s dispute settlement mechanism (DSM) established in 1996 may enable a small country like Cambodia to negotiate on an equal footing with larger ASEAN countries. In addition, with improved governance there are indirect benefits for Cambodia which are intangible yet significant in establishing a market economy. All these factors will eventually stimulate economic growth in Cambodia. The benefits will become more apparent in the long term, as Cambodia’s economic integration with the regional economies through AFTA deepens. Challenges of AFTA Besides the potential benefits of Cambodia’s integration into AFTA discussed above, it also faces problems and challenges from this process. This is the subject of this section.

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Maintaining Sound Macroeconomic Fundamentals: National Revenue Concern Tariff reduction under the CEPT has raised serious concerns among government officials and experts regarding its negative impact on national revenues in Cambodia. This is understandable as nearly half of Cambodia’s national revenues were derived from tariffs in 1994 and 1995 (Table 7.8). The decline in national revenues would make it difficult for the government to maintain fiscal discipline. If the government compensated for the loss of national revenues by monetary financing, inflation would be reignited, the economy would be destabilized, and economic fundamentals undermined. For these reasons, this issue was discussed extensively when Cambodia began to prepare for membership in ASEAN.

TABLE 7.8 Cambodia: Structure of National Revenue, 1994–97 (In billions of Cambodian riels) 1994 Total revenues Tax receipts Direct taxes Indirect taxes Tax on international trade Non-tax receipts Receipts on public property Other non-tax receipts Capital revenue

590 365 9 75 281 225 149 76 1

1995

1996

1997

643 446 21 104 321 190 121 69 8

755 534 27 164 344 181 97 84 39

881 597 44 207 347 271 134 138 12

(Percentage in total revenues) Total revenues 100.0 100.0 Tax receipts 61.8 69.3 Direct taxes 1.5 3.3 Indirect taxes 12.7 16.1 Tax on international trade 47.6 49.9 Non-tax receipts 38.0 29.5 Receipts on public property 25.2 18.7 Other non-tax receipts 12.9 10.8 Capital revenue 0.2 1.2

100.0 70.8 3.5 21.7 45.6 24.0 12.8 11.2 5.2

100.0 67.8 4.9 23.4 39.4 30.8 15.2 15.6 1.4

SOURCE: World Bank (1999).

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Toshiyasu Kato

A recent study by Robertson and Pohoresky (1998) shows, however, that the revenue concern is not as serious as it first appeared, and suggested ways to mitigate the problem. The authors pointed out that a large share of tariff revenues in Cambodia was raised from a small number of imported commodities. According to their estimates, tariff revenues from the top five commodities — petroleum, cigarettes, beer, automobiles and motor-cycles — comprised 71 per cent of total tariff revenues in 1995 and 1996 (Table 7.9). They suggest that Cambodia could maintain similar levels of national revenue by placing a majority of goods in the Inclusion List, while making upward adjustments in excise taxes on domestic consumption of cigarettes and alcohol. They also pointed out that tariff revenues would be favourably affected by increased imports as a result of

TABLE 7.9 Share of Tariff Revenue for Major Commodities, 1995–96* HS

2710 2402 2203 8703 8711 6309 2523 2208 8528 2103 1701 5515 8503 3004 8704 8465

Commodity

Share in Total Revenues (%)

Revenue Share by the Origin of Imports (%) Singapore

ASEAN-4**

Import Tariffs

Rest of the world

(%) 20 50 50 50 35 7 7 50 35 7 7 7 15 7 15 15

Petroleum Cigarettes Beer Automobiles Motor-cycles Used clothing Cement Alcohol Electronics Food (condiments) Cane sugar Woven fabrics Electronic components Medicines Trucks and components Machine tools

41.9 15.7 4.6 4.3 4.1 1.0 0.7 0.6 0.5 0.5 0.5 0.5 0.5 0.5 0.4 0.4

58.3 82.6 97.4 53.1 76.4 87.8 0.3 73.2 93.2 56.6 5.2 65.1 5.6 67.1 28.4 1.7

3.2 5.9 0.8 2.6 4.0 0.1 83.9 6.2 0.6 27.0 94.7 11.4 0.2 13.2 20.8 0.2

38.5 11.5 1.9 44.3 19.7 12.1 15.8 20.5 6.2 16.4 0.1 23.6 94.1 19.7 50.8 98.1

Total

76.7

65.4

5.3

29.3

NOTES: * 4-digit Harmonised System (HS); Average percentages of 1995 and 1996. ** Thailand, Malaysia, the Philippines, and Indonesia. SOURCE: Robertson and Pohoresky (1998).

© 2001 Institute of Southeast Asian Studies, Singapore

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the expansion of domestic economic activities. The compliance with customs duties may also be improved as the across-the-board tariff reductions would reduce the incentives to smuggle. The recent measures in tax reform aiming to broaden the tax base and improve the administration of tax collection will also contribute to mitigating the adverse impact of tariff reductions on national revenues.8 The efforts of the government in this regard appear to have borne fruit in the last few years. For instance, the proportion of tariff revenues in total revenues decreased gradually from 48 per cent in 1994 to 40 per cent in 1997, whereas the shares of indirect and direct taxes increased from 14 per cent to 28 per cent during the same period (Table 7.8). In January 1999, the value added tax (VAT), aiming at enhancing national revenues, entered into force. The revenue losses associated with AFTA are likely to be minimal in the short run. It is also unlikely that revenue concerns will become a major challenge in the long run, if tax reforms successfully enhance national revenues as projected. Eradicating Poverty: Agricultural Development in Rural Areas Agricultural development in the rural areas is of paramount importance to eradicate poverty in Cambodia. For instance, about 87 per cent of total households was located in the rural areas, and 88 per cent of rural employment was involved in agriculture in 1996 (Royal Government of Cambodia 1996). Their living standards have been extremely low compared with those of the urban population. A recent study by the World Bank reported that 40 per cent of the rural population lived below the poverty line in 1997, far exceeding the 11 per cent in the Phnom Penh area.9 Targeting the rural poor involved in agriculture is the most effective and efficient approach to eradicate poverty in Cambodia. This raises the question of how and to what extent the accession to AFTA will affect agricultural development in Cambodia. The CEPT scheme includes both processed and unprocessed agricultural products within its coverage, in addition to all manufactured products. In particular, unprocessed agricultural products (UAPs) were newly included in the CEPT scheme in 1994. However, the new ASEAN members tend to put UAPs in the Sensitive Lists (SL) or Temporary Exclusion Lists (TEL) that require decade-long periods for tariff reductions (Menon 1998). Thus, in the short run, the AFTA integration process will have little impact on agricultural development in Cambodia. In theory, tariff reduction on agricultural products under the CEPT scheme should be of great advantage to Cambodia in the long run for at least two reasons. First, the elimination of tariffs and non-tariff barriers

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(NTBs) in the ASEAN countries will maximize Cambodia’s gains from specialization in producing and exporting agricultural products. This is because Cambodia’s potential comparative advantage exists in landintensive products, such as agriculture. Secondly, the reduction of tariffs on agricultural products in Cambodia will have little effect on domestic producers because tariffs on agricultural products are already quite low or non-existent.10 Current conditions in the agricultural sector in Cambodia are alarmingly precarious and vulnerable. This raises serious concerns about whether Cambodia will be able to fully develop its potential comparative advantage and maximize the gains from specialization. First, Cambodia’s agricultural performance has been among the poorest in the region. This is due primarily to its two decades of civil war and international isolation. Among the major crops produced in Cambodia, a majority showed the lowest yields relative to the ASEAN countries (Table 7.10). The yield of rice (tons per hectare) in Cambodia was only 31 per cent of that in Indonesia, the best performer in the ASEAN region in 1994/95. In addition, the use of agricultural inputs such as fertilizer, irrigation, and tractors was the lowest among the ASEAN countries (Table 7.11). Furthermore, access to formal credit for farmers is severely limited. Commercial bank credits for agriculture continued to comprise only 5 per cent of total commercial bank credit as at November 1998.11 Rural micro-credit schemes developed by official donors and non-governmental organizations (NGOs) are limited because of their small scale. Informal credit exists in rural Cambodia, but there is evidence that this informal credit market is fragmented, and interest rates tend to be considerably higher for the poorest people with few assets than for better-off farmers (Murshid 1998). Farmers’ lack of access to technical advice, management expertise, and market information was also documented as comprising a severe constraint.12 The above analysis suggests that AFTA integration will pose enormous challenges to agricultural development in Cambodia in the long term. Cambodia has to fully develop its potential comparative advantage by easing and removing various constraints in the agricultural sector if it is to maximize benefits from AFTA. If the agricultural sector fails to improve its performance and penetrate regional markets, agricultural development will stagnate, and many rural Cambodians will have to continue their struggle against poverty. On the other hand, if Cambodia can successfully eliminate these constraints, accession to AFTA will become a powerful vehicle to eradicate poverty in Cambodia. Raising the performance of the agricultural sector is therefore one of the highest priorities in the process of economic integration with the regional and world economies in the coming decade.

© 2001 Institute of Southeast Asian Studies, Singapore

Laos 3.1 1.7 0.8 9.3 5.5 9.4 1.0 41.0 0.7

Myanmar

© 2001 Institute of Southeast Asian Studies, Singapore

SOURCE: CDRI calculation based on FAO(1996).

84 78 48 63 55 61 33 66 36

3.6 2.2 1.0 8.9 6.1 9.6 1.2 49.7 0.7

Vietnam

II. Index of Yields of Major Crops (highest yield country = 100) Rice Paddy 31 62 72 Maize 59 77 59 Soybean 100 40 39 Cassava 43 98 67 Sweet potatoes 55 70 50 Potatoes — 43 60 Groundnuts in shell 17 25 27 Sugar Cane 45 40 55 Pulse 33 100 35

I. Yields of Major Crops (ton per hectare) Rice Paddy 1.4 2.7 Maize 1.7 2.2 Soybean 2.2 0.9 Cassava 6.0 13.7 Sweet potatoes 6.0 7.7 Potatoes — 6.7 Groundnuts in shell 0.6 0.9 Sugar Cane 33.3 29.9 Pulse 0.6 1.9

Cambodia

100 80 52 87 86 100 36 100 47

4.3 2.3 1.1 12.2 9.5 15.6 1.3 74.7 0.9

Indonesia

61 55 62 62 43 85 22 89 42

2.7 1.5 1.3 8.7 4.8 13.4 0.8 66.8 0.8

Philippines

TABLE 7.10 Yields of Major Crops in Cambodia and ASEAN Countries, 1994/95

54 100 63 100 92 59 41 73 43

2.3 2.8 1.4 14.0 10.1 9.3 1.5 54.8 0.8

Thailand

72 64 15 75 100 — 100 91 —

3.1 1.8 0.3 10.5 11.0 — 3.7 68.0 —

Malaysia

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3.3 17.2 13.3 1.2

2.3 17.2 1.0

Myanmar

3.7

Laos

174.5 26.6 0.5

7.4

Vietnam

84.8 15.2 1.8

3.2

Indonesia

© 2001 Institute of Southeast Asian Studies, Singapore

SOURCE: CDRI calculation based on FAO (1996).

II. Index of Input per Agricultural Land Area (highest intensity country = 100) Agricultural population (person/ha) 26 51 45 100 43 Mineral fertilizers consumption (kg/ha) 2 1 10 100 49 Irrigated land (%) 17 65 50 100 57 Tractors (unit/1000ha) 6 17 21 9 32

I. Input per Agricultural Land Area Agricultural population (person/ha) 1.9 Mineral fertilizers consumption (kg/ha) 3.3 Irrigated land (%) 4.5 Tractors (unit/1000ha) 0.4

Cambodia

21 35 87 100

38 65 22

61.5 23.1 5.8

1.6

Thailand

42

65.5 17.2 1.3

3.1

Philippines

TABLE 7.11 Intensity of Agricultural Input Utilization in Cambodia and ASEAN Countries, 1994/95

91 17 88

8

158.6 4.5 5.1

0.6

Malaysia

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Achieving Equitable Growth: The Necessity of Social Development Cambodia’s accession to AFTA is expected to promote economic growth and raise incomes at the national level in the long term. However, there is no guarantee that these benefits will be shared broadly. One scenario suggests that a small number of rich people in Cambodia may enjoy a large portion of benefits from economic integration, while the living standards of the poor and the vulnerable will improve only marginally or remain at the same level. Achieving equitable distribution is important for sustainable development for at least three reasons. First, the eradication of poverty will be most effective and efficient if the benefits from economic growth actually reach the poor. Secondly, equity tends to curb social tensions, which often cause political and economic instability and consequently undermine the potential for economic growth (Alesina and Perotti 1994). Thirdly, it is not ethical to impoverish already poor people for the benefit of the rich. Some recent studies on the equity of distribution in Cambodia raise a serious concern. According to these studies, the Gini index of Cambodia, measured by consumption expenditure per individual, increased from 37 points in 1993–94 to nearly 40 points in 1996 (Table 7.12). The most recent estimate of the Gini index in 1997 points to a further increase up to 42 points (Royal Government of Cambodia 1998). Compared with the other ASEAN countries, expenditure distribution in Cambodia has already become far more unequal than that in Laos, Vietnam, and Indonesia. What policy interventions could mitigate this unfavourable trend? Recent empirical studies on economic growth and human capital provide useful insights for policy-making in Cambodia. It was found in crosscountry studies that human capacity development through education has had a significantly positive impact on economic growth, in addition to mitigating income inequality.13 It was also found in various studies that improving health and nutrition contributes to human capacity development, and have positive impacts on economic growth. Thus, both education and health will not only improve the living standards of the Cambodian people directly, but are likely to contribute to broad-based economic growth in the long term. The experience of development in East Asia provides ample evidence to support this argument. Cambodia’s current status of education and health has alerted policymakers to the pressing needs for policy interventions. According to a recent study, Cambodia’s adult literacy rate was only about 66 per cent in 1997 (UNDP 1998a). This is much lower than that in the other regional countries, which, except for Laos, recorded more than 80 per cent. In 1997, Cambodia’s combined enrolment ratio at primary, secondary, and tertiary

© 2001 Institute of Southeast Asian Studies, Singapore

© 2001 Institute of Southeast Asian Studies, Singapore 7.0 8.6 — 4.2 5.6 5.1 8.4 9.4 11.7

7.0 5.8 — 9.6 7.8 8.4 5.9 5.6 4.6

Lowest 20%

b

Refers to expenditure shares by percentiles of population. Ranked by per capita expenditure. c Refers to income shares by percentiles of population. d Ranked by per capita income.

a

37.2 39.4 42.0 30.4 35.7 34.2 42.9 46.2 48.4

1993/4 a,b 1996 a,b 1997 a,b 1992 a,b 1993 a,b 1995 a,b 1994 a,b 1992 a,b 1989 c,d

Q5/Q1 Ratio

10.6 9.9 — 12.9 11.4 12.0 9.6 8.7 8.3

Second 20% 14.0 14.1 — 16.3 15.4 15.5 13.9 13.0 13.0

Q1 Q2 Third 20% 19.4 20.7 — 21.0 21.4 21.0 21.1 20.0 20.4

Q3 Q4 Fourth 20%

Percentage Share of Income or Consumption

49.0 49.6 — 40.2 44.0 43.1 49.6 52.7 53.7

Q5 Highest 20%

SOURCE: UNDP (1997); and Royal Government of Cambodia (1998) for Cambodia; World Bank (1998) for the rest of the countries.

NOTES:

Lao PDR Vietnam Indonesia Philippines Thailand Malaysia

Cambodia

Gini Index

Survey Year

TABLE 7.12 Distribution of Income, or Consumption in Cambodia and ASEAN

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levels was 52 per cent, which was lower than most other ASEAN member countries (Table 7.13). The average years of schooling of adults aged 25 years and over was only 3.5 years in Cambodia in 1993 (Table 7.5). This level was the lowest, except for Laos, among the ASEAN countries in 1992. These data indicate that there is a large gap in educational background between Cambodia and the other ASEAN countries. Health indicators reveal an even larger gap. Cambodia has one of the poorest standards of health in the ASEAN region. For instance, only 69 per cent of the population had access to health services, 37 per cent to safe water, and 14 per cent to sanitation in 1997 (Table 7.14). Cambodia’s life expectancy at birth in 1997 was only 54 years, which was far below the other ASEAN countries, except for Laos. Furthermore, Cambodia’s infant mortality rate was 108 per 1,000 live births, much higher than the rates in other regional countries. This sends a clear signal to Cambodia’s policy-makers that Cambodia urgently needs to improve education and health standards. Otherwise, the benefits from economic growth stimulated by the accession to AFTA will

TABLE 7.13 Education Indicators in Cambodia and ASEAN

Adult Literacy Rate (%) 1995 Male Female Total Cambodia* Laos Myanmar Vietnam Indonesia Philippines Thailand Malaysia Singapore Brunei

79 69 89 97 90 95 96 89 96 93

55 44 78 91 78 94 92 78 86 83

66 57 83 94 84 95 94 84 91 88

Combined Primary, Secondary and Tertiary Gross Enrolment Ratio (%) 1995 Male Female Total 58 58 46 58 61 71 49 60 58 72

45 42 48 56 59 82 56 62 67 74

52 50 48 55 62 80 55 61 68 74

NOTE: *1997. SOURCE: UNDP (1998a) for Cambodia; UNDP (1998b) for the other countries.

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TABLE 7.14 Status of Health: Cambodia and ASEAN Life Infant Percentage of Population Expectancy Mortality Rate with access to at Birth (per 1000 (years) live births) Health Services Safe Water Sanitation 1995 1996 1990–95 1990–96 1990–96 Cambodia* Laos Myanmar Vietnam Indonesia Philippines Thailand Malaysia Singapore

54 52 59 66 64 67 70 71 77

108 102 105 33 47 32 31 11 4

69 67 60 90 93 71 90 88 100

37 44 60 43 62 84 89 90 100

14 18 43 21 51 75 96 94 100

NOTE: *1997. Source: UNDP (1998a) for Cambodia; UNDP (1998b) for the other countries.

likely not be broadly shared, particularly by the poor. This will undermine the potential for sustainable economic growth in the long run. A major challenge to the government is, therefore, to allocate the limited public resources to improve the standards of education and health most effectively and efficiently. Maintaining the Momentum of Growth: Industry and Service Sector Development The growth of the industrial and service sectors have been gathering momentum since the beginning of Cambodia’s transition to a market economy. Between 1992 and 1996, industry grew by 10–18 per cent annually, and services by 7–11 per cent (Table 7.1). As the market mechanism has been working reasonably well in those sectors, state intervention in the markets should be minimized, and protection for these sectors reduced. The elimination of trade barriers under the AFTA/CEPT scheme is an important step towards this end. The Asian financial crisis in 1997–98, however, has underscored the growing necessity to improve the functioning of the market mechanism in Cambodia. The majority of the crisis-hit neighbouring countries have cut

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back their demand for Cambodia’s exports and investments in the country sharply. Thus, Cambodia cannot expect a rapid expansion of foreign demand in the coming few years. Improving the functioning of the market in the domestic economy is thus critical in stimulating domestic consumption and investment and hence restoring the momentum of economic growth. A major challenge for the government is to help markets work better. Certain types of government interventions can be useful for this purpose. The first is to set quality standards for products and services, which are virtually non-existent in Cambodia. It is well known that the market mechanism does not work properly in the presence of asymmetric information about the quality of products and services between producers and consumers. For instance, Cambodia could potentially produce and export processed foods such as fruits and vegetables. These products are not likely to become marketable in either domestic or foreign markets, however, unless they meet adequate quality standards and requirements such as hygiene conditions. As Klitgaard (1991) points out, quality standards set and enforced by the government can provide incentives for producers to improve the quality of products and services. It can also help inform consumers, both domestic and foreign alike, about the quality of Cambodia products. The second type of intervention is to facilitate the development of industries that have strategic national importance to Cambodia. Agriculture-related industries, such as food processing, may fall into this category. Currently, Cambodia remains a net importer of processed and unprocessed agricultural products. However, our analysis has made it clear that Cambodia has potential comparative advantage in land-intensive products, such as agriculture. The industrial development that is linked to the agricultural sector thus entails several advantages. First, it can create employment and substitute imports for domestically processed agricultural products. In addition, it can stimulate the demand for domestic raw agricultural materials. This will increase incentives for farmers to expand production and improve productivity, thereby contributing to eradicating poverty and achieving equitable distribution of income. Finally, income growth in the rural areas can create demand for domestic manufactured goods and services produced in urban Cambodia. Despite its potential, Cambodia’s agricultural and food-processing industries have not attracted much investment to date. Among total investment projects approved by the Cambodia Investment Board (CIB) between 1994 and 1998, agricultural investment accounted for only 11 per cent of total registered capital, 5 per cent of total fixed assets, and 6 per cent of total employment created (Table 7.15). The market does not appear to have given sufficient incentives for entrepreneurs to invest in this sector.

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TABLE 7.15 Investment Projects in Cambodia, 1994–98 (Approval basis)

1994a

1995

1996

1997

1998

Agriculture Industry Of which: Garment Service Total

7 27 12 5 39

Number of Investment Projects 32 33 27 6 91 135 170 132 27 42 105 92 40 24 9 12 163 192 206 150

Agriculture Industry Of which: Garment Service Total

119 97 76 7 223

Registered Capital (US$ millions) 70 82 93 18 357 332 306 337 20 40 103 102 1,574 76 22 74 2,001 489 421 429

Agriculture Industry Of which: Garment Service Total

60 487 29 50 597

70 593 27 1,859 2,521

Agriculture Industry Of which: Garment Service Total

1,709 17,222 12,828 2,883 21,814

8,775 32,669 14,557 6,271 47,715

Total Sectoral Between Share (%) 1994–98 1994–98 105 555 278 90 750

14 74 37 12 100

383 1,429 339 1,752 3,564

11 40 10 49 100

275 2,541 285 2,350 5,166

5 49 6 45 100

Manpower, full production 8,523 4,187 2,874 26,068 57,219 123,545 148,231 378,886 25,326 82,565 99,362 234,638 5,769 1,171 2,448 18,542 71,511 128,903 153,553 423,496

6 89 55 4 100

Fixed Assets (US$ millions) 96 30 26 551 642 636 45 110 135 171 113 204 818 784 866

NOTE: a August – December SOURCE: CDRI calculation based on data from Cambodia Investment Board.

Some key issues need to be addressed to facilitate development in the agriculture-related industries. First are property rights. The procedures and public services for land entitlement need to be significantly improved by making them simple, transparent, accountable, and efficient. This will not only protect land ownership of small-scale farmers, but also increase incentives for entrepreneurs to invest in land-intensive industries, such as

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food processing. Secondly, key social infrastructure such as transportation and ports should be developed. The extremely poor conditions of roads and ports severely constrain the development of agriculture-related industries that require a large volume of shipment in a short period of time. The third type of intervention is related to unskilled labour-intensive manufacturing, particularly the garments industry. Garments accounted for US$340 million of registered capital and created 235,000 jobs between August 1994 and December 1998 (Table 7.15). This sector has already revealed strong comparative advantage in the ASEAN region, although preferential treatment for Cambodia, such as GSP and MFN by the EU and the United States, was a major determinant for its recent development. Growing investment in this sector is expected to expand Cambodia’s exports, create jobs, and generate income for a large number of Cambodians. Thus, the government’s role in these sectors is to ensure that development will actually contribute to raising the living standards of the Cambodian people by maximizing the number of jobs created, exports of products, earnings of foreign currency, and tax payments for government revenues. No less important is that the labour standards set out in the labour law be strictly implemented to protect workers’ living standards. Regenerating the Environment: Environmental Standards and Regulations The implications of AFTA on Cambodia’s environment have so far received little policy attention. This may partly reflect the fact that accession to ASEAN and AFTA does not require any agreement on the environment. In addition, the extent of environmental degradation in Cambodia has so far been modest relative to that in other ASEAN countries, because of its early stage of industrialization. Furthermore, the awareness about environmental issues among the Cambodian people, including government officials, is in general very low.14 This does not mean that environmental issues in Cambodia are neither important nor relevant. On the contrary, there are a number of critical issues that call for urgent policy actions to meet the challenges. As numerous studies indicate, trade liberalization has been associated with environmental degradation in the ASEAN countries. 15 The expansion of trade and investment stimulated by the accession to AFTA is likely to increase the amount of hazardous wastes that pollute air, soil, and water in Cambodia. This will have severe health consequences unless they are controlled properly. The increased energy consumption spurred by economic growth will also contribute to the degradation of the environment. Furthermore, Cambodia’s

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6.5 per cent average annual growth of the urban population between 1990 and 1995, the highest in the region, raises the concern that urbanization will cause additional environmental problems, such as traffic congestion, air pollution, and waste collection. This by no means suggests that the Cambodian Government should restrict trade and investment to reduce hazardous wastes and pollution in Cambodia. The expansion of trade and investment is without doubt necessary for the government to raise financial resources for the development of technical capabilities and government institutions that manage environmental problems. The best approach for the Cambodian Government is to establish and enforce environmental standards and regulations that are simple, transparent, and non-discriminatory, while promoting liberal trade and investment regimes. Some might argue that any environmental standards and regulations imposed on investors in Cambodia might increase production costs, push up the prices of their products, and undermine their competitiveness in the market place. This might discourage foreign investors from establishing their production facilities in Cambodia. There are at least two reasons that counter this argument. First, as Repetto (1995) argues, the costs of installing environmental controls in new plants are in general lower than those of attaching pollution abatement equipment into old plants. Cambodia’s early stage of industrialization is advantageous in this regard because it can save substantial costs by installing new plants that are environmentally sound and energy efficient from the outset. Secondly, little empirical evidence supports the argument that lax environmental standards have been a major determinant of foreign investment and the location of production (Dean 1992). Thus, setting and enforcing reasonable environmental standards are unlikely to become a major factor that discourages foreign investment in Cambodia. Policy Implications Some key challenges of Cambodia’s integration into AFTA have been identified and examined in the previous section. The government has already taken, or will be required to take, policy actions to meet those challenges. The following will highlight some implications for policy-making at the national level if Cambodia is to effectively face up to those challenges. Adjusting the Allocation of National Expenditures Despite the ongoing efforts to enhance national revenues, the Cambodian Government is likely to face a shortage of public financial resources in the coming decade. This will require the government to adjust the allocation

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of national expenditures, if it is to meet those challenges in an effective and efficient manner. Cambodia simply cannot afford to waste a dollar of public expenditure to address these issues. Our analysis in the previous section made clear that the government has to allocate more public expenditures on agricultural and rural development, health and education, and the environment. This is expected to help eradicate poverty, mitigate income inequality, and make growth and development sustainable in the long term. The allocation of current expenditures has so far been far from satisfactory in this regard. More than 50 per cent of total expenditures were allocated for defence and security until 1998 (Table 7.16). In contrast, expenditures on education, health, and agricultural and rural development accounted for only 20 per cent in 1998. This was to some extent understandable before the collapse of the Khmer Rouge. Now that most of the Khmer Rouge have defected to the government, there is no longer any justification to maintain high defence expenditures. Developing an Institutional Framework and Legal System The Cambodian Government must develop new institutions and legislation to handle various ASEAN initiatives. For instance, a number of major economic initiatives, such as the ASEAN Investment Area (AIA) and the ASEAN Industrial Co-operation (AICO) venture will necessitate the development of new institutions within the government. In addition, Cambodia’s legal system needs to be upgraded substantially to properly handle various new laws associated with ASEAN initiatives. These requirements imply that the government also needs to overhaul and upgrade the civil service and legal systems. At least three issues need to be addressed towards this end. First is developing human resources. As Kaplan (1998) points out, effective participation in ASEAN initiatives requires sufficiently qualified human resources in the civil service and legal systems. Cambodia thus needs to train competent technocrats and lawyers who have both the expertise in ASEAN issues and English language skills. Second is reforming incentive mechanisms. Currently, unduly underpaid civil servants and lawyers are not given positive incentives to execute their assignments properly. The current civil service system in Cambodia also creates wrong incentives, as a large number of “ghost” civil servants are paid who do not actually work. Under these circumstances, competent and motivated civil servants and lawyers are discouraged from fulfilling their missions. Lastly are mitigating pressures from politics and business. Politicians and large-scale business place pressures on technocrats to execute laws in

© 2001 Institute of Southeast Asian Studies, Singapore

386 74 26 15 165 667

1995 Actual 435 81 44 19 248 827

1996 Actual

SOURCE: Ministry of Economy and Finance, Cambodia.

NOTE: * Based on the projection for 1998.

Defence & Security Education Health Agriculture &Rural Development Other Ministries Total Current Expenditure

Ministry

425 91 61 24 270 870

Budget Law 440 80 46 18 231 816

1997 Actual 384 94 62 24 445 1009

486 110 54 20 260 931

58 11 4 2 25 100

53 10 5 2 30 100

54 10 6 2 28 100

52 12 6 2 28 100

1998 1995 1996 1997 1998* Budget ProjectActual Expenditure as % Law tion in Total Expenditure

TABLE 7.16 Current Expenditure by Ministry (In billions of riels)

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favour of their interests. Judges are also subject to similar pressures when they rule on court cases. The current administrative and judiciary systems do not appear to provide honest technocrats and judges with adequate institutional support, such as job security and physical safety. Pursuing Policy Coherence and Ministerial Co-ordination Although government policies should be coherent, this is often not the case in Cambodia. Incoherent policies tend to prevail on a larger scale in developing countries than in developed countries, as governments in developing countries are generally subject to stricter financial and human resource constraints. The economic and social costs of incoherent public policies are tremendous. Incoherent government policies waste a huge amount of scarce human and financial resources without achieving their objectives. Developing countries with strictly limited resources, such as Cambodia, simply cannot afford this. Thus, it is imperative for the Cambodian Government to investigate whether, and to what extent, new policy measures are consistent with, and complementary to, other government policies. By so doing, the objectives of the new policies are achieved effectively without undermining the goals of other government policies. Policies towards Cambodia’s accession to AFTA should be considered in this context. Policy coherence will never emerge without a high level of coordination among government ministries. As Kaplan (1998) notes, one of the ongoing challenges in the Cambodian Government is “building interministerial arrangements that can effectively and efficiently co-ordinate to generate policy options, develop and share information, and provide technical input to guide Cambodia’s participation in ASEAN’s various economic initiatives.” Institution-building and legal reform are preconditions for enhancing the co-ordination capability of the Cambodian Government. The roles of the National AFTA Unit and Internal Coordination Network (ICN), which were created for inter-ministerial coordination purposes, are critical for generating a coherent set of policy packages geared towards regional economic integration. Co-ordination may also be necessary between the public and the private sector. Preparations so far appear to be limited to those within the government. It is not clear to what extent the private sector in Cambodia has been informed about AFTA itself or about the government’s policy stance towards AFTA. As the private sector will be exposed to stiff competition within the region, information of this sort will be helpful for its decision-making in preparation for AFTA. The public sector should also benefit from exchanging views with the private sector to generate a coherent policy package for accession to AFTA.

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Conclusion The foregoing has argued that in the long term, Cambodia’s accession to AFTA will have significant impact on its trade, investment, and growth, despite its negligible effects in the short term. The short-term impact is insignificant because of the government’s cautious strategies to minimize the immediate loss of tariff revenues. In the long term, however, AFTA is likely to positively affect trade, investment, and growth as integration within ASEAN through comprehensive tariff reduction deepens. Comprehensive tariff reduction will also put Cambodia in an advantageous position, compared to the other new members, in attracting non-ASEAN investors aiming at the ASEAN markets. Indirect benefits such as “signalling effects” to investors are also indicated as an advantage for Cambodia. Having considered all these points, accession to AFTA has significant potential to boost Cambodia’s economic growth in the long term. Despite its potential, accession to AFTA poses challenges as well. The government is urged to face up to those challenges if it is to translate AFTA’s potential benefits into long-term sustainable development in Cambodia. The first challenge is to eradicate poverty. While agricultural development contributes to eradicating poverty most effectively, Cambodian farmers are subject to serious constraints. The liberalization of agricultural trade under AFTA could be a powerful vehicle for eradicating poverty if these constraints are eased in the coming decade. The second challenge is to achieve high economic growth with equity. Cambodia’s development will not be sustainable unless the benefits from growth are broadly shared. Public investment in education and health, a key policy to mitigating inequity, has been far from sufficient so far. The third challenge is to maintain the momentum of growth in the industrial and service sectors. As the market mechanism has been working reasonably well, intervention by the government should be minimized, except in some strategic sectors such as food processing. Setting quality standards for goods and services by the government would also help the market to work better. The fourth challenge is to regenerate the environment. Economic growth promoted by AFTA will inevitably increase hazardous wastes and pollution, and will have serious health consequences. Enforcing environmental standards and regulations from the early stage of industrialization is cost-saving compared with taking measures after hazardous wastes and pollution have caused devastating problems. Some policy implications at the national level have been drawn from the above analysis. First, raising expenditure allocation for education, health, agricultural and rural development is strongly recommended to face up to the challenges discussed above. There is no single justification in the post-

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Khmer Rouge era to maintain a high level of defence spending. Secondly, effective participation in AFTA requires the development of an appropriate institutional framework and legal reform. In order to meet these requirements, the government is advised to overhaul and upgrade the civil service and legal systems, by developing human resources, reforming incentive mechanisms, and mitigating the pressures from politics and business. Finally, the government is urged to pursue coherent policies by improving coordination among government ministries and the private sector. Economic integration into ASEAN is a process that will continue for many years. Cambodia has still sufficient time to tackle the many challenges although they may appear largely time-consuming. Several reforms proposed above are indeed difficult, and will require commitment for a long period of time. Yet, they are possible if strong political will and support are provided. Cambodia has made remarkable progress in its transition to a multi-party political system and a market economy that nobody predicted a decade ago. This certainly generates a reason for hope for Cambodia in the coming decade. Notes *

1 2

3 4 5 6

7

The author wishes to thank Martin Godfrey for valuable comments on an earlier draft of this paper. Financial support from the Swedish International Development Authority (SIDA) that enabled the research project on ASEAN at the Cambodia Development Resource Institute is gratefully acknowledged. Robertson and Pohoresky (1998) classified customs data in 1995 and 1996 in Standard International Trade Classification (SITC) for the first time in Cambodia. More recent data in 1997 and 1998 are not yet available. The value of re-exports from Cambodia, mainly shipped to Vietnam, accounted for about US$230 million in 1996. This was even larger than the US$160 million of (domestic) exports in 1996. The items re-exported were highly concentrated in two sectors: beverages and tobacco (SITC 1), and machines and transport equipment (SITC 7). The available data from the Cambodia Investment Board (CIB), which compiles investment projects approved by the government, should be read with caution as these approved investment projects may not be actually implemented. The analysis presented here is based on Godfrey (1997). Areas excluded from cultivable land are forest, woodland, uncultivated land, wetlands, built-up areas (residential, recreational, industrial lands), and areas covered by roads and other fabricated infrastructure. Revealed comparative advantage for exports (RCAX) is defined as RCAX≡Xij/ Xiw, where Xij is the export share of commodity i in total exports of country j, and Xiw is the export share of commodity i in world exports. A country has a comparative advantage in a commodity if the RCAX of that commodity is greater than one. The submission of the initial package was based on the assumption that Cambodia would become a full member in July 1997, and initiate the tariff reductions under the CEPT scheme in January 1998. Detailed accounts of the preparations can be found in Keat and Aun (1998).

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Toshiyasu Kato

Detailed discussions about the recent measures can be found in Chan et al. (1999). Head count index in percentage. Table 1.4 in World Bank (1999). Menon (1998) rightly argues that Cambodia should transfer UAPs from the Sensitive List to the Inclusion List as import tariffs are already very low, if it wants to maximize the benefits from joining AFTA. “Economy Watch” in CDRI (1999). For instance, see FAO (1994); and ADB (1996). See, for instance, Barro and Sala-I-Martin (1995); and Sachs and Warner (1997). For a study of the relationship between growth and income inequality, see Persson and Tabellini (1994). A recent incident of mercury-laden hazardous wastes dumped at Sihanoukville, a major seaport and resort area, by a Taiwanese company was indicative of the poor awareness of the government about hazardous wastes and pollution. See, for instance, Repetto (1995).

References Alesina, Alberto, and Roberto Perotti. Income Distribution, Political Instability and Investment. NBER Working Paper Series No. 4486. Boston: National Bureau of Economic Research, 1994. ADB. Agricultural Sector Program. Manila: Asian Development Bank, May 1996. Barro, Robert, and Xavier Sara-I-Martin. Economic Growth. New York: McGraw Hill, 1995. Chan, S., T. Kato, Long V.P., So S., Tia S., Hang C.N., Kao K.H., and Chea V. “The Asian Financial Crisis and Southeast Asian Transitional Economies: The Cambodian Perspective”. Paper presented at the Conference on Asian Financial Crisis and Southeast Asian Transitional Economies, held in Phnom Penh on 21–22 January 1999. CDRI. Cambodia Development Review 3, no. 1 (Phnom Penh: Cambodia Development Resource Institute, March 1999). Dean, J.M. “Trade and Environment: A Survey of the Literature”. Background paper. World Development Report 1992. Washington D.C.: World Bank, 1992. FAO. Agricultural Development Options Review (Phase I): Sectoral Review (Volume 1). Rome: Food and Agriculture Organisation, 1994. . Selected Indicators of Food and Agriculture Development in the AsiaPacific Region 1985–1995. Rome: Food and Agriculture Organisation, 1996. Godfrey, Martin. “Cambodia: Skill Development for Sustainable and Competitive Livelihoods”. Background paper for the Consultative Group meeting on Cambodia, Paris, 1–2 July 1997. Kaplan, Jeffrey. “Cambodia’s ASEAN Membership: The Institutional and Legal Challenges”. In Cambodia: Challenges and Options of Regional Economic Integration — Conference Papers. Phnom Penh: Cambodia Development Resource Institute, October 1998. Kato, Toshiyasu, Chan Sophal, and Long Vou Piseth. Regional Economic Integration for Sustainable Development in Cambodia. Working Paper no. 5. Phnom Penh: Cambodia Development Resource Institute, September 1998. Keat, Chhon, and Aun Porn Moniroth. Economic Development of Cambodia in the ASEAN Context: Policies and Strategies. Phnom Penh: Cambodian Institute for Cooperation and Peace, July 1998.

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Klitgaard, Robert. Adjusting to Reality: Beyond “State Versus Market” in Economic Development. San Francisco: ICS Press, 1991. Kun Nhem. “Membership in ASEAN: Public Finance and Tax Reform in Cambodia”. In Cambodia: Challenges and Options of Regional Economic Integration — Conference Papers. Phnom Penh: Cambodia Development Resource Institute, October 1998. Menon, Jayant. “Lao PDR in the ASEAN Free Trade Area: Trade, Revenues and Investment Implications”. Paper presented at the CDRI international conference on “Cambodia: Challenges and Options of Regional Economic Integration”, held in Phnom Penh, from 27–28 October 1997. . “Cambodia: ASEAN Membership and Macroeconomic Policy Issues”. A report for the Royal Government of Cambodia and Asian Development Bank (ADB T.A. No. 5713 — CAM/LAO). Murshid, K.A.S. Food Security in an Asian Transitional Economy: The Cambodian Experience. Working Paper No. 6. Phnom Penh: Cambodia Development Resource Institute, December 1998. Persson, Torsten, and Guido Tabellini. “Is Inequality Harmful for Growth?” American Economic Review 84, no. 3 (Nashville: American Economic Association, June 1994): 600–21. Repetto, Robert. “Trade and Sustainable Development”. In Critical Issues in Asian Development: Theories, Experiences, Policies, edited by M.G. Quibria. Oxford: Oxford University Press, 1995. Robertson, James, and Harold Pohoresky. “Cambodia: Strengthening the Foundation for Trade and Industrial Development”. In Cambodia: Challenges and Options of Regional Economic Integration — Conference Papers. Phnom Penh: Cambodia Development Resource Institute, October 1998. Royal Government of Cambodia. Demographic Survey of Cambodia 1996. Phnom Penh: Ministry of Planning & UNFPA, October 1996. . The Poverty Profile in Cambodia. Phnom Penh: Ministry of Planning, 1998. Sachs, Jeffrey, and Andrew Warner. “Fundamental Sources of Long-Run Growth”. American Economic Review 87, no. 2 (Nashville: American Economic Association, May 1997): 184–88. UNCTAD. Handbook of Economic Integration and Cooperation Groupings of Developing Countries, Volume 1. Geneva: United Nations Conference on Trade and Development, 1996. UNDP. Human Development Report 1994. New York: United Nations Development Programme, 1994. . Cambodia Human Development Report 1997. New York: United Nations Development Programme, 1997. . Cambodia Human Development Report 1998. New York: United Nations Development Programme, 1998a. . Human Development Report 1998. New York: United Nations Development Programme, 1998b. Wood, Adrian. Skill, Land and Trade: A Simple Analytical Framework. IDS Working Paper No. 1. Brighton: Institute of Development Studies, University of Sussex, 1994. World Bank. World Development Report 1997. Washington D.C.: World Bank, 1997. . World Development Indicators 1998. Washington D.C.: World Bank, 1998. . Cambodia: Public Expenditure Review. Washington D.C.: World Bank, January 1999.

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Implications of Joining ASEAN/AFTA for Cambodia

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In this chapter we will discuss the implications of Cambodia’s recent entry into the Association of Southeast Asian Nations (ASEAN) and the ASEAN Free Trade Area (AFTA). It will examine both the opportunities and challenges of Cambodian membership in the Southeast Asian regional grouping. At least six major advantages for Cambodia can be identified. First, ASEAN membership will bestow a collective vote of confidence on Cambodia’s political and economic future. So far, many have stayed away from Cambodia because of the uncertain political climate in the country, especially with the rising tensions between the two main political parties sharing power. If Cambodia’s ASEAN partners have enough confidence to accept the country into their fold, this should dispel some of the gloomy predictions about Cambodia’s future. Secondly, it will increase investor confidence. Although the Cambodian economy has made some progress in recent years in attracting foreign investment, it still has a long way to go. With a population of 10.7 million, the domestic market is small. However, membership in the ASEAN Free Trade Area could make Cambodia a more attractive investment destination. Thirdly, joining ASEAN will address Cambodia’s external security interests. It will remove any future prospect for interference in the country by any neighbouring state, thereby putting to an end one of Cambodia’s most serious security concerns. As members of ASEAN, both Vietnam and Cambodia will have to strictly adhere to the principle of non-interference 200

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in the internal affairs of each other, one of the most important principles of ASEAN. By joining ASEAN, Cambodia will be an equal partner with its neighbours. Fourthly, ASEAN membership will promote Cambodian internal stability. In the past, political groups challenging the central authority in Cambodia had been able to secure sanctuary in the neighbouring states. Under the ASEAN framework, however, the neighbours will be obliged to refuse such access to any rebel group fighting the Cambodian state. Moreover, bilateral security co-operation against transborder insurgencies have been a common feature of intra-ASEAN security relationships. Thus, the Royal Government of Cambodia can expect security co-operation with its neighbours to stamp out the insurgencies. Fifthly, as an ASEAN member, Cambodia will be able to operate more effectively on the international stage. Over the years, the ASEAN members have developed a co-ordination and collective bargaining capacity within the United Nations and other multilateral institutions. This will help Cambodia in securing greater access to these institutions, including access to resources that will help its reconstruction and development efforts. Finally, Cambodia will be able to engage more effectively with the major powers through the ASEAN framework. ASEAN’s annual PostMinisterial Consultations (ASEAN-PMCs) with a number of major countries, including the United States, Japan, Canada, Australia, the European Union, Russia, and India will provide Cambodia with an opportunity to learn more about these countries’ policies and seek their support for its own development and well-being. As a small country with poor resources, it is difficult for Cambodia to develop such contacts with the major powers on its own. The ASEAN-PMC process provides it with a ready-made framework for consultation and co-operation. Similarly, Cambodia can draw upon the collective clout and bargaining potential of ASEAN to pursue its security interests in the ASEAN Regional Forum (ARF), which includes all the major players affecting regional security and stability in the Asia-Pacific region. What can Cambodia learn from ASEAN? We would argue that it is the “ASEANization” process in foreign relations and its domestic politics. The “ASEAN Way” of socialization involves participating in a continuous process of consultation and consensus. The primary goal of the “ASEAN Way” is the management of diversity. It is often described as the search for a common ground that preserves a measure of harmony while allowing individual members to retain and pursue their specific, and sometimes divergent, interests. Cambodia must learn to emulate the “ASEAN Way” not only in its foreign relations, but also in its domestic sphere. After decades of conflict, Cambodia’s social fabric providing for indigenous

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modes of conflict resolution has been destroyed. It is significant that despite their many differences, the ruling Cambodian political parties have reached a consensus on the need for joining ASEAN. As they have been welcomed into the ASEAN fold, they have an obligation to learn from its process of consultation and consensus and to apply it to resolve their domestic disputes. The “ASEAN Way” involves a high degree of discreteness, informality, pragmatism, expediency, consensus-building, and non-confrontational bargaining styles. These principles are important not only in the context of regional co-operation, but they could also be cultivated internally as a way of revitalizing Cambodia’s fragile political process. Cambodia’s Preparation to Join AFTA For several years, Cambodia made preparations not only to join ASEAN, but also to enter the ASEAN Free Trade Area and participate in the implementation of the Common Effective Preferential Tariffs (CEPT) scheme. The following gives an overview of Cambodia’s preparation to join the free trade area. The Essence of AFTA/CEPT The ASEAN Free Trade Area, or AFTA, was established at the meeting of the ASEAN heads of government in Singapore in January 1992. AFTA has three main economic objectives. The first is to allow ASEAN to adapt and respond to changes in world economic conditions, in particular, the process of globalization and the creation of regional trading arrangements by the developed countries. This is to ensure ASEAN’s competitiveness in the international market in order to become a major production base, particularly for manufacturing, processing industries, agro-industries, and agriculture. The second aim is to liberalize trade in ASEAN by reducing customs tariffs and eliminating non-tariff barriers. The third is to attract investments by expanding its economies of scale, and improving the creation and co-ordination of markets in the region. Based upon the size of the ASEAN market and its competitive dimensions, it can be concluded that attracting foreign investment is the main objective of AFTA. The core instrument of AFTA is the agreement on Common Effective Preferential Tariffs. This agreement was signed by the ASEAN Economic Ministers in January 1992 in Singapore. The CEPT covers manufactured goods, including capital goods, processed agricultural products, and other non-agricultural goods. In September 1994, the ASEAN Economic Ministers Meeting (AEMM) in Changmai decided to include unprocessed agricultural products in the CEPT.

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There are exceptions in the CEPT scheme, that is, certain goods may be excepted from the CEPT. These exceptions may be classified into two categories: general exceptions and temporary exclusions. General exceptions are permitted for products which may affect national security, public morals, the lives and health of human beings/ animals/plants, as well as articles of artistic, historic, or archaeological value. Temporary exclusions are permitted for products which are sensitive in terms of domestic production. Member countries shall transfer products from the Temporary Exclusion List to the CEPT Inclusion List in equal stages from 1 January 1996 to 1 January 2000. For unprocessed agricultural products, the exclusions are divided into two categories: Temporary Exclusion List and the Sensitive List. Temporary exclusions shall be transferred to the Inclusion List in equal stages by 2003; and Sensitive List products shall be transferred to the Inclusion List through separate agreements. There also exist eligibility criteria for concessions under the CEPT. According to these criteria, the member countries of ASEAN may enjoy tariff concessions from other ASEAN countries on a particular product if (a) the product satisfies the ASEAN content requirement of 40 per cent; (b) the product is in the Inclusion Lists of the exporting and importing countries and has a tariff rate of 20 per cent or below; and (c) the product has a schedule of tariff reductions approved by the AFTA Council. After registering goods in the CEPT list, member countries shall not increase the tariff rate of such goods. There is a schedule of tariff reductions under the CEPT scheme. According to this schedule, the reduction of tariff rates under the CEPT shall be made in two sub-schedules: the fast track and the normal track. Under the first track, for goods whose tariff rates are above 20 per cent, the rates shall be reduced to 0–5 per cent by 1 January 2000; and for goods whose tariff rates are below 20 per cent, the rates shall be reduced to 0–5 per cent by 1 January 1998. Fifteen products, including vegetable oils, chemicals, fertilizer, rubber products, pulp and paper, wooden and rattan furniture, gems and jewelry products, cement, pharmaceuticals, plastics, leather products, textiles, ceramics and glass products, copper cathodes and electronics, are included in the fast track. In the normal track, for goods whose tariff rates are over 20 per cent, the rates shall be reduced to 20 per cent by 1 January 1998, and further reduced from 20 per cent to 0–5 per cent by 1 January 2003. For goods whose tariff rates are below 20 per cent, the rates shall be reduced to 0–5 per cent by 1 January 2000. It is also important to note that member states shall immediately eliminate all quantitative restrictions (licences, quotas, etc.) on any goods

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which receive CEPT concessions, and shall gradually eliminate all other non-tariff barriers (NTBs) within a period of five years after the enjoyment of concessions under the CEPT scheme. Finally, to facilitate and speed up commercial liberalization in the region, member countries have agreed to improve economic co-operation in other important areas, including the harmonization of tariff nomenclature, customs valuation and procedures, harmonization of standards, reciprocal recognition of product tests and certificates, elimination of investment barriers, consultation on macroeconomic issues, preparation of rules for fair competition, and the promotion of venture capital. Cambodia’s Strategy and Preparation for Joining AFTA/CEPT In the long run, trade liberalization and tariff reductions in connection with the CEPT will create an opportunity for Cambodia to attract foreign direct investments and ensure its competitive advantages. At present, Cambodia is building on and strengthening its agricultural and industrial base, through the establishment of a competitive environment to secure the competitiveness of its agricultural and industrial sectors in the international arena. To achieve this, an international trade liberalization policy will be essential. As domestic industries remain small and few in number, Cambodia does not need to resort to protectionist policies to safeguard its “infant industries”. On the negative side, the slow process in reducing tariff rates, relative to the neighbouring countries like Vietnam and Thailand, may result in increased smuggling. Furthermore, over the short and medium term, tariff reductions may negatively affect Cambodia’s national budget, its balance of payments, and certain agricultural and industrial sectors that are weak. Thus, in theory at least, the faster the implementation of the CEPT agreement takes place, the better it is for Cambodia. However, with regard to tariff reductions, they need to be carried out in conjunction with reform measures to support the budget, in particular tax reform to increase domestic tax revenues, and structural adjustment programmes in other sectors to strengthen the economic system and infrastructure, as well as the domestic production base. These factors should determine the speed of Cambodia’s implementation of the CEPT scheme. A review of the current tax system reveals some concerns for the medium and long term, namely: —

international trade taxes will decrease as a result of tariff reductions and customs duty exemptions for investment companies approved pursuant to the Investment Law.

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potential revenues from income taxes will be limited because of the low income of Cambodians and the high tax incentives given to investors, which place a ceiling rate of 9 per cent for corporate income tax. In addition, a number of investors conveniently pretend to be confused between customs duties and taxes, and constantly try to lobby the government for special treatment. the potential for expanding the tax base on goods and services is reasonably good, particularly through value-added taxes, taxes on services, and excise taxes. But the expansion of these categories of tax may affect Cambodia’s domestic consumption profile. Moreover, according to the principles of fairness, taxes on goods and services may be considered indirect taxes that ultimately affect all consumers, as opposed to income taxes which can directly tax those in the higher income brackets more heavily. property taxes and other taxes can also be sources for increasing public revenues. Nevertheless, based on the experiences of other countries, such taxes will not be the main sources for increased revenues.

In the medium and long term, domestic taxes must be increased to represent a larger share in the revenue structure of the state. However, the potential for expanding the domestic tax base is limited, prompting the government to immediately approve specific policies and strategies. The political will to implement tax reform policies and strategies is a crucial factor. The incentives provided in Article 14 of the Investment Law may also negatively affect national revenues over the medium and long term. Thus, the government should re-examine its incentive policies on investment. Most experts assert that tax incentives are not a major factor that attracts investors in the long term. Instead, it is security, political stability, the legal and institutional framework, macro-economic stability, and a sound physical infrastructure. If Cambodia can ensure a sound investment environment comparable to other countries, market conditions will reflect “the comparative advantages” of Cambodia, prompting investors to invest. Theoretically, in the next ten years, Cambodia needs to reform its tax structure to resemble more closely the profile of Singapore, that is, Cambodia needs to reduce customs revenues to 1 per cent of the total gross domestic product (GDP). Perhaps the most important issue to address in order to determine the speed of the liberalization programme is the competitiveness of Cambodian industries. The government must determine which sectors need to open first, at what speed such liberalization should occur, and which sectors require continued protection. Such assessments are directly connected to

© 2001 Institute of Southeast Asian Studies, Singapore

Cambodia Indonesia Laos Malaysia Philippines Singapore Thailand Vietnam

Country

5.9 15.3 10.4 16.3 12.0 17.3 16.2 19.7

Total Tax Revenue

0.3 8.0 4.0 8.0 3.6 7.9 5.4 5.5

Total

0.0 1.5 0.4 2.1 1.5 3.9 1.8 1.1

Individual

0.2 6.5 3.7 5.8 2.1 3.9 3.6 4.4

Corporate

Income Taxes

1.2 5.7 1.7 3.9 3.4 4.6 6.9 6.0

Total

1.1 4.8 1.7 1.9 1.6 3.7 3.2 4.1

Turn-over Sales & VAT 0.1 0.8 0.0 2.0 1.8 1.0 3.8 1.9

Excise

Taxes on Goods and Services

TABLE 8.1 Structure of Tax Revenue, 1995 (In % of GDP)

4.2 1.1 3.3 3.2 4.5 0.5 3.2 5.3

Total

3.9 1.1 1.7 2.7 4.5 0.5 3.2 —

0.2 0.0 1.7 0.5 0.0 0.0 0.0 —

Import Export

International Trade Taxes

0.0 0.4 0.0 0.1 0.0 1.8 0.4 1.4

0.3 0.1 1.3 1.1 0.4 2.5 0.1 1.5

Property Other Taxes Taxes

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the government’s ability to conduct statistical data collection and monitor private and public investments. Cambodia holds competitive and comparative advantages in the agricultural sector and land and labour-based resources, notably rice, rubber, forestry and fishery sectors. When comparing Cambodian rice output with regional producers, Cambodia still lags far behind. This suggests that the potential for rice production has not yet been fully realized. In the past, most efforts to grow rice were based on extensive cultivation, such as the restoration and expansion of the cultivable land area, as Cambodia still possesses great potential to develop this method. For the long-term, development using the intensive cultivation method will be the key to establishing Cambodia’s competitive advantages in the agricultural sectors, in particular, for rice production. The government is taking the first step towards intensification by implementing agricultural policies to increase the frequency of cultivation through the restoration and construction of irrigation systems. Increased productivity is the core of agricultural development. It is also the key to competitive advantage. Over the long-term, low productivity will lead to difficulties in protecting Cambodia’s domestic agricultural production when competing in the international markets. In economic terms, the switch from the extensive to intensive method of agricultural development is critical to acquiring long-term competitive advantage. The government needs to consider this issue seriously. Estimates indicate that Cambodia has the potential to double its rice output within the next ten years, that is, achieving an output of 3 tons per hectare. The quality of rice is also an important factor in determining Cambodia’s success in the international market. Rubber is another a product in which Cambodia has a competitive advantage, even though the rubber sector has shown a constant decline in productivity in recent years, which is of great concern. According to expert studies, Cambodia is well endowed, in terms of climate and soil conditions, to develop its rubber sector. Reorganization, management, and seed selection are the weakest aspects of Cambodia’s rubber sector as a result of wars and long-term neglect. This asset needs to be revived to produce an output of 3 tons per hectare within the next ten years. In short, to reinvigorate Cambodia’s “competitive advantages” in the agricultural sector, the government needs to prepare and adopt a “master plan” to rehabilitate and redevelop the rice and rubber sectors. Failure to do so may be detrimental to Cambodia’s long-term prosperity. In summary, to assess Cambodia’s capacity to implement the CEPT agreement, the government needs to tackle the three special areas mentioned above, in which much detailed work remains. The preparation

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TABLE 8.2 Productivity for Natural Rubber, 1990 Country Thailand Indonesia Malaysia China Sri Lanka Ivory Coast

Planted Area (ha)

Yield per Year

1,844,000 3,155,300 1,866,700 803,200 199,100 57,100

850 680 800 440 780 1,717

TABLE 8.3 Yield of Natural Rubber in Cambodia

Year

(tons/ha) Yield/ha

1988 1989 1990 1991 1992 1993 1994

0.75 0.73 0.68 0.68 0.60 0.48 0.49

of a programme for tariff reduction needs to be completed, taking into account different options identified by the studies referred to earlier. The second step is to assess the impact of each option on state revenues and the national economy. Once these assessments are complete, the government should introduce measures to manage the potential budget and sectoral impact. Finally, the government needs to make the political decisions to determine the appropriate options and to prepare itself for the negotiation and implementation of the CEPT.

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AFTA/CEPT: Opportunities and Challenges for Cambodia Cambodian membership of AFTA can create a number of opportunities for its economy. First, participation in free trade activities in the region may allow Cambodia to maximize its economies of scale through increased access to regional and international markets (the market of the ASEAN-10 will encompass about 500 million persons). Geographically, Cambodia is centrally located between ASEAN and the Mekong-6 (Cambodia, Laos, Myanmar, Thailand, Vietnam, and Yunnan province of China). The combined market of these two subregions is more than 600 million persons. Cambodia can use its strategic geography together with the opportunities for economies of scale to attract foreign direct investment (FDI) and pursue its development objectives. Secondly, AFTA membership, through expanded trade and investment, may allow Cambodia to reduce unemployment as jobs are created. Moreover, Cambodia may acquire technological advantages, information and know-how, as well as the consequences of trade and FDI growth. Thirdly, the free exchange of goods and services may allow Cambodia to participate widely in the process of international labour specialization. In other words, Cambodia may be able to devote its physical and mental energy to the production of goods and services where it has comparative advantages to exchange for goods and services from other countries. International labour specialization may offer Cambodia the opportunity to maximize its comparative advantages, as well as allocate and utilize appropriately its domestic and foreign resources. Finally, Cambodia may use opportunities created by international competition to stimulate its productivity and improve the quality of domestic goods and services in order to assure its competitiveness in the international arena. What are the challenges of joining AFTA? These will be discussed in greater detail below. Impact of Tariff Reductions on the National Budget The core of AFTA is the tariff reduction scheme in accordance with the principles of the CEPT agreement. Even though Cambodia’s tariff rates are already low, for the medium term additional reductions in these rates may affect the economy, with the immediate impact being felt by the national budget. At present, Cambodia’s state budget is heavily dependent on customs revenues: in 1995 custom revenues represented about 72 per cent of total tax revenues. The reduction of tariff rates, currently the main revenue earner of the Cambodian economy, may severely affect the public revenue

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FIGURE 8.1 Tax Revenue by Sources (Outturn-95)

Other Tax Revenue 4.31%

Payroll Tax 0.24%

Profit Tax 3.91% Turnover Tax 3.81% Consumption Tax 13.44% Excise Duties 2.09%

Customs Duties 72.20%

stream. By contrast, in the neighbouring ASEAN countries, the share of customs revenues in total tax revenues is not more than 40 per cent. Thus, the Royal Government of Cambodia is committed to reduce the customs revenues to 40 per cent of the total tax revenue by 2000. It is an ambitious undertaking which requires strong political will and profound tax reform. Impact of Tariff Reductions on Trade and Balance of Payments As Cambodia opens its doors, goods and services will flow in through the market stream. Presently, the production base and the economic structure of Cambodia are still very weak. These are key factors in determining Cambodia’s competitiveness. The integration and liberalization of the economy may affect Cambodia’s economy, particularly its balance of payments and its natural resources if the production base and economic structure remain weak. The elimination of trade barriers between the ASEAN countries will cause an increasing amount of industrial products and other goods to flow into Cambodia, resulting in higher demands for foreign exchange to support the purchase of such goods. Theoretically, each country can earn foreign exchange through the export of its goods and services, as well as raw materials and natural resources. Presently, external assistance is a

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source of foreign exchange for Cambodia, but this source of assistance cannot be used for international trade outside the context of donorsupported development projects. Without a sound production base and services for export, the settlement of balance of payments will have to be done through an increase in the export of raw materials and natural resources to make up for the trade deficit. Such a situation is not sustainable in the long run. The government has set out its principles for becoming an outward-looking and export-driven economy. The key to resolving balance-of-payment and trade issues will be through the attraction and promotion of FDI to establish and strengthen Cambodia’s production base and the mobilization of official development assistance (ODA) through grants or concessional loans. Competitiveness To achieve greater economic competitiveness, Cambodia must liberalize its domestic market and international trade. It needs to maximize its own comparative advantages and development factors and turn them into national competitive advantages. Cambodia currently has comparative advantages within some sectors of its economy, in particular, the agricultural sector (rice, rubber, and wood, within the limit of sustainable exploitation), the agro-industrial field, labour-intensive manufacturing sectors, and tourism. However, the growth and productivity of such sectors are still low. Therefore, Cambodia needs to rehabilitate and quickly develop these sectors. In short, Cambodia should take maximum advantage of the globalization momentum that is currently taking place in the world economy. It should not miss this timely opportunity as it did over the past thirty years. Organization and Institutional Reform To meet the challenges of ASEAN and AFTA, the Cambodian Government needs to organize new mechanisms and institutional structures to handle and co-ordinate its activities. The implementation of the AFTA/CEPT framework will compel Cambodia to re-examine and adjust its existing institutional structures, laws and procedures, especially for sectors related to trade and customs. Important tasks include the finalization of the commercial code, including laws on intellectual property protection, the establishment of rules of origin, the harmonization of standards and quality with other ASEAN countries, the reciprocal grant of MFN status to other ASEAN countries, the ratification of treaties on double taxation avoidance with other ASEAN countries, the reform of customs institutions at the organizational level, the harmonization of tariff nomenclature, customs

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valuation and procedures, and the computerization of customs activities. All these undertakings need to be closely linked to human resource development, which is the key to establishing the country’s competitiveness in the international arena. Conclusion After the Cambodian Government decided to join ASEAN, it began to prepare for the implementation of the CEPT scheme to accede to AFTA as one of the main conditions of ASEAN membership. Apart from the opportunities ensuing from joining ASEAN and AFTA, the implementation of the CEPT agreement will challenge Cambodia to face several economic difficulties that affect the national budget, the balance of payments, and its competitiveness because of its weak production base. Nevertheless, readiness to implement tariff reduction under the CEPT agreement is a core objective for Cambodia. The key to a successful implementation will be the pacing of tariff reductions. In brief, Cambodia has concluded that it needs to reduce tariffs as soon as possible, but to do that, it must accomplish certain tasks. The government must: — assess the impact of tariff reductions on national revenues. — formulate and approve policies and strategies for domestic tax reform, and assess their consequences. — make long-term economic forecasts and assess the competitive advantage of each sector of the Cambodian economy, including the consequences of tariff reductions on the main sectors of the national economy. Cambodia cannot postpone these tasks. Its handling of these challenges could mean victory or defeat in the battlefield of development.

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Economic Effects of Joining AFTA for the Lao PDR

Economic Effects of Joining AFTA: The Case of the Lao PDR.1

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9

EMIKO FUKASE and WILL MARTIN

Introduction On 23 July 1997, the Lao People’s Democratic Republic (Lao PDR) became a full member of ASEAN. The Lao PDR also joined the ASEAN Free Trade Area (AFTA) and began implementing the Common Effective Preferential Tariff (CEPT) scheme in January 1998. It is likely that AFTA will create additional trade for the Lao PDR with the ASEAN partner countries and this is clearly welfare improving. AFTA will also provide increased access to the markets in the ASEAN partner countries which will, in turn, provide opportunities for the Lao PDR’s exports. However, the discriminatory nature of trade liberalization also leads to welfare-reducing trade diversion. A simple Computable General Equilibrium (CGE) model enables these gains and losses to be quantified in order to make an overall evaluation. Given the very limited information on the Lao PDR’s domestic production structure, the model presented in this chapter is much less demanding in terms of data requirements than conventional general equilibrium models. Only a single productive sector is included. However, we include twenty-two traded sectors because there is substantial variation in protection rates and in the changes in protection by sector and by trading partner. In addition, the welfare changes which occur with trade liberalization are decomposed into three components: welfare gains resulting from efficient resource allocation, welfare loss with decreases in tariff revenues, and terms of trade gains provided by the ASEAN partner countries. 213

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The objective of this chapter is to make a preliminary assessment of the effects of AFTA accession by the Lao PDR using a simple CGE model. The following section summarizes the nature of the Common Effective Preferential Tariff scheme under the AFTA agreement. The current AFTA commitments by the Lao PDR and the other ASEAN partner countries are also reviewed. This is followed by an outline of a simple general equilibrium model for a small open economy like the Lao PDR. First, the theoretical framework for preferential trade liberalization and the model structure are reviewed. Then, a series of simulations is conducted to examine how AFTA liberalization will change its trade pattern, tariff revenues, and welfare under the AFTA commitments, and plausible alternative scenarios are put forward. Evolution of the ASEAN Free Trade Area Common Effective Preferential Tariff Scheme The ASEAN Free Trade Area was formally established in 1992 in order to realize a Free Trade Area (FTA) within fifteen years beginning on 1 January 1993. The Common Effective Preferential Tariff scheme was designed to bring down tariffs on all manufactured and processed agricultural products to 0–5 per cent within the fifteen-year time-frame. In September 1994, during the 26th ASEAN Economic Ministers Meeting (AEMM), the time-frame was shortened from the original fifteen years to ten years, with the aim of achieving AFTA by the year 2003 .2 Another important accomplishment of that meeting was that the AEMM agreed to include all unprocessed agricultural products in the CEPT scheme. Under the CEPT scheme, four lists — the Inclusion List (IL), the Temporary Exclusion List (TEL), the Sensitive List (SL), and the General Exceptions List (GEL) — are used as key instruments to determine the pace and scope of the liberalization. The IL consists of those items subject to tariff reductions immediately to bring them down to the range of 0–5 per cent by the year 2003. The items in the TEL are initially excluded from tariff reductions, but these items are to be transferred to the IL by 2000 in five equal instalments beginning from 1996 and then reduced to 0–5 per cent by 2003. The SL is the list of unprocessed agricultural products which are to be phased into the IL between 2001 and 2003, and to be reduced to 0–5 per cent by 2010. The GEL consists of the items which satisfy Article XX of the General Agreement on Tariffs and Trade (GATT) and are permanently excluded from tariff reductions for reasons of national security, protection of public morals, protection of human, animal and plant life and health, and the protection of articles of artistic, historic, and archaeological value.

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A key feature of the CEPT is that the concessions are granted on a reciprocal, product by product basis. There are three conditions for a product to be eligible for concessions under the CEPT. Firstly, the product has to be included in the IL of both the importing and exporting countries. Secondly, to receive all concessions, the product must have an internal tariff of 20 per cent or below. Thirdly, it has to satisfy the local content requirement of 40 per cent. Another important feature of the CEPT is that the member countries are required to eliminate quantitative restrictions on products immediately upon enjoyment of CEPT concessions, and to eliminate other non-tariff barriers within a period of five years after the enjoyment of the concessions.3 Liberalization Schedules of ASEAN Member Countries Unlike the former Preferential Trading Arrangements (PTA) scheme, the ASEAN members have made substantial commitments to the AFTA/CEPT scheme in terms of scope and degree of liberalization. Table 9.1 shows the number of tariff lines that the member countries included in each list. Overall, 54,367 tariff lines out of 55,525 lines are either in the IL or the TEL. This means that 97.9 per cent of tariff lines will be 0–5 per cent by 2002 (by 2006 for Vietnam, 2008 for the Lao PDR and Myanmar, and 2010 for Cambodia).4

TABLE 9.1 The ASEAN-9 CEPT Package, 1998 IL

TEL

SL

GEL

Country

Tariff Lines

Share (%)

Tariff Lines

Share (%)

Tariff Lines

Share (%)

Tariff Lines

Share (%)

Total

Brunei Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam

6105 6622 533 8648 2356 5221 5739 9040 1718

94.0 91.8 15.0 95.1 43.1 91.6 98.0 99.1 57.0

135 545 2831 276 2987 385 0 79 1147

2.1 7.6 79.7 3.0 54.6 6.8 0.0 0.9 38.0

14 4 96 104 21 68 0 7 23

0.2 0.1 2.7 1.1 0.4 1.2 0.0 0.1 0.8

239 45 91 63 108 28 120 0 127

3.7 0.6 2.6 0.7 2.0 0.5 2.0 0.0 4.2

6493 7216 3551 9091 5472 5702 5859 9126 3015

45982

82.8

8385

15.1

337

0.6

821

1.5

55525

SOURCE: ASEAN Secretariat, CEPT Product Lists (December 1998).

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TABLE 9.2 Weighted Average MFN Tariff Rates for the ASEAN Countries

Indonesia Malaysia Philippines Singapore Thailand Vietnam

1988–90 (%)

1991–93 (%)

1995 (%)

1997 (%)

18.0 11.5 n.a. 1.9 38.0 n.a.

12.6 11.2 n.a. 1.9 36.9 n.a.

11.9 8.4 18.2 0.1 14.7 19.0

7.8 3.6 10.9 0.0 13.7 19.4

SOURCES: UNCTAD (1994) ; 1995 COMTRADE System; ASEAN Secretariat (1997); Centre for International Economics (CIE) (1998). The data are not strictly comparable.

How much benefit the Lao PDR is likely to receive depends on the difference between the current MFN protection level of the ASEAN countries5 and the concessions given by them. Table 9.2 presents the recent trends of MFN tariff rates for the ASEAN-6 countries. Since the late 1980s, the ASEAN countries have lowered their MFN rates substantially. However, the aggregate tariff averages mask important differences in protection across sectors. Appendix 1 shows both simple and weighted tariff averages by sector. There is a general tendency for the protection rates for agricultural commodities and labour-intensive industries to be still high in the ASEAN countries. The Lao PDR’s Protection and Phase-in Lists The Lao PDR’s tariff rates imply a relatively low level of protection, with a simple average of 9.6 per cent and weighted average of 14.7 per cent. Average tariffs differ slightly between ASEAN and the rest of the world, with duties on imports from ASEAN averaging 15.2 per cent compared with 13.4 per cent from the rest of the world. The structure of the Lao PDR’s phase-in lists released at the 29th ASEAN Economic Ministers Meeting in October 1997 is summarized in Appendix 2. The import and export values and weighted tariff averages by sector are also shown. The Lao PDR is taking a relatively cautious approach with AFTA. The items included in the initial Inclusion List (IL) already have 5 per cent MFN tariff rates (see Box 1).

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BOX 1 Analyses of the Lao PDR’s Phase-in Lists While the Lao PDR’s immediate liberalization package is small, a large number of commodities are in the Temporary Exclusion List (TEL). Since the nature of the TEL is indeed temporary, this implies that AFTA membership requires substantial AFTA-consistent reforms in all areas, including measures to provide macroeconomic stability, to formulate legal and regulatory frameworks, to strengthen basic infrastructure, and to develop human resources. The impact of tariff reductions on the balance of payments and on tariff revenues are two immediate issues that appear to have motivated the initial modest inclusion. The Lao PDR faces a balance of payments constraint since exports covered, on average, only 52 per cent of imports between the years 1993–96. The current account deficit widened from 13 per cent of GDP in 1995 (–$278 million) to 16.5 per cent of GDP (–$367 million) in 1996. In the 1995/96 fiscal year, tariff revenues, at about 2.5 per cent of GDP, represented 23 per cent of the total revenue. Their medium and long-term issues are related to the overall development strategy. The Lao PDR’s gross national product (GNP) per capita of US$350 is clearly low relative to its main trading partners.6 The Lao PDR’s production base is still weak and its major industries are limited to a relatively small range of sectors, such as electricity, wood, and the garment industry. Apart from these, there are large numbers of very small and micro enterprises which are distributed throughout the country. The effects of increasing competition resulting from liberalization on small agriculture and manufacturing is a major factor to determine the speed of liberalization. The structure of the Lao PDR’s phase-in lists is summarized below. 1. The Inclusion List (IL). The Lao PDR’s IL contains 533 tariff headings. All the items included have a 5 per cent MFN tariff rate. However, the remaining 1,287 items with 5 per cent tariff rates are excluded from the list because of the difficulty of eliminating existing quantitative restrictions (QR), and other non-tariff barriers (NTBs). The import values of the items in the IL, estimated by the 1995 COMTRADE data, are US$18 million, corresponding to 5 per cent of the Lao PDR’s total imports from ASEAN. The export value of the items in the IL represents only 0.07 per cent of the Lao PDR’s total exports to ASEAN and this implies that the Lao PDR did not include export-oriented commodities in the IL. Clearly, this reduces the scope for the Lao PDR to obtain significant increases in market access and the terms of trade. 2. The Temporary Exclusion List (TEL). The TEL includes 2,831 items which are to be included in the IL between the year 2001 and 2006 and for which tariff rates are to be reduced to a maximum rate of 5 per cent by the year 2008. The items in the TEL are estimated to correspond to US$327 million, or 84 per cent of the Lao PDR’s total imports from ASEAN. The average

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tariff rate weighted by ASEAN imports is 13 per cent. On the export side, a large amount of export-oriented items are included here, with US$72 million of corresponding export values, or 90 per cent of total exports to ASEAN. 3. The Sensitive List (SL). The SL consists of 96 items of unprocessed agricultural products. Tariff reductions in this list may be phased in at any time, beginning in 1998 until 2015. The items in the SL correspond to US$7 million, which is equivalent to 2 per cent of the Lao PDR’s total imports from ASEAN. The average weighted tariff rates is 10 per cent. On the export side, the items in the list represent US$8 million, which is 10 per cent of the Lao PDR’s exports to ASEAN. 4. The General Exceptions List (GEL). The items in the GEL include 91 items, which make up a proportion larger than the other ASEAN members. It is observable that the items included differ from the definition of Article XX of the GATT. Many of the commodities in the list, such as beer, cigarettes and tobacco, are typically import-substituting commodities directed towards the domestic market. The commodities in the list account for about 10 per cent of import values from ASEAN, amounting to US$39 million. The average weighted tariff rate of 37 per cent is high and this implies that a large portion of tariff revenues from ASEAN comes from the commodities in the list. The major part of the commodities belong to the “processed foods, drinks & tobacco” category. The other major items are “transport equipment” such as motor-cars. The items in the list represent only 0.04 per cent of the Lao PDR’s recorded exports to ASEAN.

Modelling Approach Economics of Preferential Trade Liberalization In this section, a simple, diagrammatic framework is used to evaluate the effects of preferential liberalization under AFTA for the Lao PDR. The first consideration is the effects of changes in the rates of protection that the Lao PDR levies on its imports. Then the implications of changes in the protection imposed by the Lao PDR’s trading partners are assessed. Following Armington (1969), it is assumed that Lao consumers distinguish between imported and domestic goods, and between imports by country of origin. For simplicity, and because of the Lao PDR’s small size in the world market, it is assumed to be a price taker in the markets for its imports and exports.7 A very simple diagrammatic approach is used to illustrate; however, this approach can be shown to provide a second order approximation to a rigorous estimate derived from the balance of trade function approach.

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The market for goods imported from ASEAN is illustrated in Figure 9.1.

FIGURE 9.1. Market for Goods Imported from ASEAN

Pd

a b

Pasean Pw

d

c e Dasean

0

Q0

Q1

The units of each product are chosen so that its world price is unity in the initial equilibrium (Pw = 1). In the initial equilibrium, the Lao PDR imposes a tariff t from the ASEAN members (Pd = Pw + t). Let us now introduce preferential tariff rate tasean through a reduction in the tariff on imports from the ASEAN partners. This reduces tariff revenues on initial imports from ASEAN by Pd abPasean. However, the gains to consumers are greater since they are able to increase the quantity of ASEAN goods that they purchase. Following the decline in the domestic price, consumers move down the (compensated) demand curve for ASEAN goods, Dasean from initial quantity Q0 to final quantity Q1. Consumer surplus increases by the area Pd abPasean + abc. In addition, with the increase in the imports from ASEAN, the loss of revenues is partially compensated by the area bced. In sum, the net gain to the Lao PDR in this market is approximated by the area aced. This is the welfare benefit from trade creation. However, since the formation of AFTA liberalizes imports only from partner suppliers, there are likely to be continuing distortions against imports from other suppliers. Figure 9.2 shows the market for goods

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imported from the rest of the world. In the diagram, the initial demand for imports from the rest of the world is shown by the curve Drow. Following the fall in the price of imports from ASEAN, the demand for imports from the rest of the world falls to D’row. The welfare loss to the Lao PDR is the loss in tariff revenues, shown by the area abcd. This is the welfare loss from trade diversion.

FIGURE 9.2 Market for Exports from the Lao PDR to ASEAN

Pd

a

d

Pw

b

c

D’row 0

Drow Qty

Whether there is a net gain or loss to the Lao PDR depends on the relative sizes of the gain in Figure 9.1 and the losses in Figure 9.2. Clearly, the gains from trade creation will be larger, the higher the rate of protection initially applied on these trade flows, and the more price responsive is the total domestic demand for these goods (particularly the more substitutable domestic and imported goods), and if the size of the increase in trade is proportional to the initial trade volume, the larger the initial trade volume. Trade diversion costs are likely to be greater the higher the tariffs applied in the non-partner markets, and the greater the reduction in the quantity of imports from these markets. Two comparisons that are likely to be instructive are the relative heights of trade barriers against the partner and the rest of the world, and the substitutability of imports relative to domestic

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goods (that determines net trade creation) versus the substitutability between imports from different sources (that determines trade diversion). The fact that the Lao PDR’s tariffs on imports from the other ASEAN countries exceed those on imports from non-ASEAN sources increases the initial gains from intra-ASEAN trade creation. On the export side, countries entering free trade agreements typically benefit from the improved market access provided by reductions in their partners’ trade barriers. Since we treat the Lao PDR as a small country in its export markets, this benefit takes a very simple form. The supply of exports from the Lao PDR to its ASEAN partners is shown by the supply curve, Sasean in Figure 9.3. Prior to the formation of the free trade agreement, the price received by the Lao PDR was the price in the partner country, ppartner , less the tariff applied by the partner country, tpartner , so that the net price was (ppartner – tpartner). This price is equal to the world price pw , of the good since the domestic price is assumed to be equal to the world price plus the tariff. With the agreement, the price received by the Lao PDR is ppartner. The benefit to the Lao PDR is the increase in the price, tpartner , times the initial quantity of exports, Q0, plus the gains resulting from the Lao PDR’s ability to increase its export supply to this market, shown by area abc in Figure 9.3. In the figure, the total gains to the Lao PDR are represented by tpartner*Q0 + abc. This is the welfare benefit from improvement in the terms of trade.

FIGURE 9.3 Market for Exports from the Lao PDR to its ASEAN Partners

S asean

a

ppartner

b pw

c

0

Q0

Q1

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As long as the Lao PDR imposes no other distortions in its export markets, this terms of trade gain is a net gain to the Lao PDR. In contrast with the case of trade creation on the import side, no offsetting loss must be considered. The specification of the gains to the Lao PDR from increased access to its partner markets assumes that the partner’s external trade barriers remain the same, and that the additional exports supplied by the Lao PDR, and other countries given preferential access to this market, are not sufficient to reduce the price in the partner market below pw + tpartner. If sufficiently large suppliers obtain access to this market, this price will fall, reducing the gains to the Lao PDR. Clearly, this analysis of the export side suggests that what happens to trade barriers in the Lao PDR’s trading partners should be an important consideration in the evaluation of the proposed free trade agreement. The gains are positively related to the size of the initial barriers imposed against the Lao PDR, the price responsiveness of the Lao PDR’s exports, and also to the magnitude of the initial trade flows between partners. Thus, each of these factors should be taken into account in the assessment. Model Structure A single country multi-sector computable general equilibrium model was developed to assess the key effects of AFTA accession by the Lao PDR. The model is an extended version of a model developed by Martin (1996b) for Lebanon which is, in turn, an extension of the 1-2-3 general equilibrium model (Devarajan et al. 1994). It is disaggregated in the sector of primary interest, international trade, and highly aggregated in the domestic non-traded sector. This strategy makes greatest use of the available data and modelling resources, and allows full general equilibrium modelling to be undertaken for countries like the Lao PDR where data availability is limited. It requires an estimate of GDP and trade and tariffs by direction of trade at the level of disaggregation desired. In order to facilitate further analysis on the sources of welfare changes, a decomposition of the equivalent variation (EV) is introduced to decompose the welfare change into components as a result of trade creation, trade diversion, and the terms of trade. Consumers in the Lao PDR use 23 types of goods, of which 22 are imported and one is produced and sold domestically. The 22 composite imported commodities correspond to the sections of the HS Convention and one of the goods is a composite non-traded good. Manufacturers in the Lao PDR also produce 23 goods. One of these is a domestic nontraded good while the other 22 are composite export commodities identified on the consumption side. The production function is assumed to exhibit

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constant returns to scale technology. For non-traded goods, all output is produced and sold in the domestic market and the price of output is endogenously determined by equating local production to domestic demand. Traded goods can be sourced or sold both on the domestic and the world markets. With a small country, it is assumed that the prices of traded goods are exogenously given. Data. Since trade data by the Harmonized System (HS) and source and destination countries are not available from national sources, the data were estimated using partner data obtained from the UN COMTRADE System for the year 1995.8 Throughout the analyses, the products have been classified by the 21 sections of the Harmonized System Convention plus one additional sector resulting from the separation of textiles and clothing.9 This classification was chosen since it is consistent with the ASEAN nomenclature, which is, in turn, based on the 8-digit Harmonized Commodity Description and Coding System of the World Customs Organization (WCO). Imports, exports, and tariff matrices were created by these 22 sectors and by the Lao PDR’s 17 main trading partners for the experiments. However, the results will be reported as ASEAN and ROW as groups in order to facilitate the presentation. ASEAN represents 75 per cent of the Lao PDR’s imports and 45 per cent of its exports. To evaluate the full effects of AFTA, it is necessary to take into account the simultaneous impact of the change in protection in the Lao PDR and its partner countries. Thus, the change in protection levied by the Lao PDR on imports from different sources, and the change in protection levied on the Lao PDR by its trading partners were computed based on the Lao PDR CEPT Schedule (Government of the Lao PDR 1997) and the CEPT Product Lists (ASEAN Secretariat, July 1997) respectively. The shocks were computed on an item by item basis and then averaged over the 22 HS sections. Equations of the Model. The model focuses on the real side of the economy, with particular emphasis on the response of the economy to trade policy changes. Using duality, prices are set as independent variables; consumer behaviour is modelled by means of an expenditure function whereas producer behaviour is specified by means of revenue functions. The set of equations used in the model are presented in Table 9.3. Variables and model coefficients are defined in Table 9.4. The equations are partitioned into six groups. They are expressed in linear percentage change from a baseline, except for the equation block (5). For convention, lower case lettering is used for the variables representing percentage changes and upper case lettering is employed for the levels of variables or coefficients.

© 2001 Institute of Southeast Asian Studies, Singapore

(m – 1)n

m–1

i = 1,… ( m – 1) imports j = 1,… n countries k = 1,… n countries

i = 1,… ( m – 1) imports j = 1,… n countries

 qm i j = q i – σ source  pm ij – 

© 2001 Institute of Southeast Asian Studies, Singapore

8. The output supply function

7. The revenue function

2. Output Supply

6. The composite for price imports

5. The import demand functions

n

i = 1,… m outputs

i = 1,… m outputs j = 1,… m outputs

m   qx i = capacity + σ prdn  p i – ∑ SX j p j  j =1  

i =1

r = ∑ SX i p i + capacity

m

j =1

p i = ∑ SM ij pm ij

n

j =1

 ∑ SM ik pm ik   k =1

m–1

j = 1,… ( m – 1) demands j = 1,… n countries

em i = ∑ SM ij pm ij + q i

4. The import expenditure function

i =1

m

m

1

j = 1,… m demands

pc = ∑ SC i p i

3. The consumer price index

m

1

m

i = 1,… m demands j = 1,… m demands

m   q i = u – σ cons  p i – ∑ SC j p j  j=1  

i =1

2. The demand equations

1

Number

j = 1,… m demands

m

Subscript Range

e = ∑ SC i p i + u

Equation

1. The expenditure function

1. Final Demand

Description

TABLE 9.3 Model Equations

224 Emiko Fukase and Will Martin

(m – 1)n

m–1

i = 1,… ( m – 1) exports j = 1,… n countries k = 1,… n countries

i = 1,… ( m – 1) exports j = 1,… n countries

 qdx ij = qx i + σ destn  pdx ij – 

n  ∑ SDX ij pdx ik   k =1

m–1

i = 1,… ( m – 1) exports j = 1,… n countries

n

© 2001 Institute of Southeast Asian Studies, Singapore i=1,...(m – 1) imports j=1,...n countries i=1,...(m – 1) imports j=1,...n countries

powtauij = TAUCONVij tauij

pmij= pcifij+ powtauij

15. The power of the import tariff

16. The domestic prices of imports

(m – 1)n

(m – 1)n

1

e = SEreven(SYprdnr + SYtariff trev) + SEforeignf

14. The income expenditure condition

4. Miscellaneous Equations

1

qnontrad = qxnontrad

j =1

p i = ∑ SDX ij pdx ij

j =1

n

i =1

revx i = ∑ SDX ij pdx ii + qx i

Number 1

Subscript Range i = 1,… m outputs

Equation

px = ∑ SX i p i

m

13. The market clearing condition for non-traded goods

3. Equilibrium Conditions

12. The composite price for export

11. The export supply function

10. The export revenue functions

9. The composite price for output

Description

TABLE 9.3 (continued) Model Equations

Economic Effects of Joining AFTA for the Lao PDR 225

trev =

i =1

∑

j =1

∑ STR ij ( tau ij + qm ij + pcif ij )

(m – 1) n

Equation

© 2001 Institute of Southeast Asian Studies, Singapore

Total equations = 4mn + 6m – 4n + 7

CNT _ TOT = 0.01

21. The contribution of terms of trade changes

∑ MTAX ij qm ij

j =1

i =1

∑

j =1

∑ VX ij pdx ij

(m – 1) n – 6

i =1

∑

(m – 1) n – 6

CNT _ TD = 0.01

20. The contribution of trade diversion

6

∑ MTAX ij qm ij

j =1

∑

i =1

CNT _ TC = 0.01

(m – 1)

(m – 1) n  (m – 1) n  EV = 0.01  ∑ ∑ MTAX ij qm ij + ∑ ∑ X ij pdx ij  i =1 j =1  i =1 j =1 

19. The contribution of trade creation

18. The Equivalent Variation (EV)

5. Decomposition of the Equivalent Variation (EV)

17. The changes in tariff revenue

Description

TABLE 9.3 (continued) Model Equations

1

7,… n

i = 1,… ( m – 1) imports j = 1,… 6 ( 6 ASEAN countries ) i = 1,… ( m – 1) imports j = 1,… ( n − 6 ) ( ROW countries ) i = 1,… ( m – 1) exports j = 1,… n countries

1

1

Number

i = 1,… ( m – 1) imports j = 1,… n countries

i = 1,… ( m – 1) imports j = 1,… n countries

Subscript Range

226 Emiko Fukase and Will Martin

© 2001 Institute of Southeast Asian Studies, Singapore m 1 m–1 (m – 1)n (m – 1)n (m-1)n

1 m m–1 (m – 1)n 1

Demand for consumer goods i

Consumer price index Expenditure on imports of goods i

Imports of goods i from region j

Power of tariff on goods i from country j

Domestic prices of imports of goods i from country j Price of composite output

Revenue from production

Output of composite goods i

Revenue from exports of goods i Exports of goods i to country j Total tariff revenue

qi

pc emi

qmij

powtauij

pmij

r

qxi

revxi qdxij trev

1

2m – 1

Domestic prices of composite goods i

pi

px

1

Utility index

u

VMij VXij MTAX

ij

TAUCONVij

SYi

SEi

STRij

SDXij

SXi

SCi SMij

σdestn

σsource

σprdn

σcons

1

Expenditure function

Variable

e

Number Parameters

Description

Endogenous Variables

Variable

TABLE 9.4 Variables and Parameters

Elasticity of substitution between consumer goods Elasticity of transformation between producer goods Elasticity of substitution between import sources Elasticity of substitution between export markets Share of goods i in final consumption Share of imports of goods i from country j at domestic prices Share of producer goods i in total production Share of goods i in market j in total exports Share of goods i from country j in total tariff revenue Share of revenue or foreign inflow in total expenditure Share of production or tariff revenue in GDP Conversion factor from base tariff tauij to power of tariff tauij/(1+tauij) Value of imports of goods i from country j Value of exports of goods i to country j Incremental tariff revenue from commodity i from country j

Description

Economic Effects of Joining AFTA for the Lao PDR 227

C.i.f. prices of imports i from country j Tariff rates of goods i from country j Export prices of goods i to country j Foreign inflow Output capacity of the economy Export prices of goods i to country j

Endogenous variables = 4mn + 6m - 4n + 7

pcifij tauij pdxij f capacity pdxij

Description

Equivalent variation Contribution of trade creation Contribution of trade diversion Contribution of terms of trade changes

Exogenous Variables

EV CNT_TC CNT_TD CNT_TOT

Variable

(m (m (m 1 1 (m

1 1 1 1

– 1)n

– 1)n – 1)n – 1)n

Number

Variable

TABLE 9.4 (continued) Variables and Parameters Description

228 Emiko Fukase and Will Martin

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1. Final Demand. Consumers choose their purchases to minimize their expenditures subject to two-level Constant Elasticity of Substitution (CES) utility functions. The first level of demand is represented by a CES expenditure function describing substitution between 23 composite commodities, including both domestic and imported goods. The model was implemented by specifying CES functions for the expenditure function for total expenditure (equation 1). The demand equations (equation 2) are derived by differentiating the expenditure function with respect to the prices of the commodities. There is an associated composite price, which is the consumer price index (equation 3). At the second level, there are expenditure functions on imports defined by imports from different sources (equation 4). When there is preferential trade liberalization, consumers substitute between different import sources. For each import expenditure function, there are corresponding import demand equations (equation 5) and composite import prices (equation 6). 2. Output Supply. There is an exogenous level of output determined by factor endowments and technology. Producers maximize revenue, subject to two-level Constant Elasticity of Transformation (CET) functions. At the total revenue stage, producers choose their inputs between 23 commodities, subject to a given output (equation 7). The optimally chosen supplies of goods are obtained by differentiating the revenue function with respect to their prices (equation 8). Equation 9 is the composite price of output. Symmetrically with the import side, an additional level was incorporated in the nest for output. Equation 10 specifies the export revenue functions for each exported commodity i. There are associated export supply functions (equation 11) and the composite price for exports (equation 12). 3. The Market Equilibrium Conditions. The supply of non-traded goods must be equal to the demand in order to maintain balance in the market for non-traded goods (equation 13). The income expenditure condition, or alternatively, the balance of trade constraint, requires that expenditure must equal the sum of revenue from production, tariff revenue, plus any financial inflows from abroad (equation 14). 4. Miscellaneous Equations. If there is trade liberalization, the domestic prices of imports will decrease (equations 15-16), and there will be a change in tariff revenues (equation 17). 5. Decomposition of the Equivalent Variation. Finally, in order to facilitate analysis of the sources of welfare changes, a decomposition of the equivalent variation is introduced, following Huff and Hertel (1997). The total equivalent variation (equation 18) is broken down into three

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component parts on a money metric basis. The welfare benefit from trade creation is measured by the equilibrium quantity change in imports qmij of goods i from country j (where j = ASEAN countries), multiplied by the corresponding tariff revenue MTAXij summed over all the sectors and ASEAN countries (equation 19). Going back to Figure 9.1, the welfare gains are approximated by area aced. Similarly, the welfare loss from trade diversion is measured by the equilibrium quantity change in imports qmij of goods i from country j (where j = ROW countries), multiplied by the corresponding tariff revenue MTAXij summed over all the sectors and ROW countries (equation 20). The loss is measured by the area abcd in Figure 9.2. Equation 21 approximates the contribution of the terms of trade where VXij represents the value of exports at world prices. pdxij is the percentage change in the f.o.b. price. Thus, the welfare benefits resulting from the improvement of terms of trade are measured by area PpartnerbcPw in Figure 9.3. Since the Lao PDR faces a balance of payments constraint, foreign borrowing (f) is assumed to be constant. The production capacity is fixed. Under the assumption that the Lao PDR is small, both import price (pcif) and export price (pdx) are given exogenously. The nominal exchange rate is chosen to be the numeraire, which is equal to unity throughout the simulation. The model contains 4mn + 6m – 4n + 7 equations and 4mn + 6m – 4n + 7 endogenous variables. The model was solved using the GEMPACK programme. Through GEMPACK’s non-linear solution procedures, tariff revenues and trade values are updated over the course of the simulation and the model is solved using a series of steps and extrapolations (Codsi and Pearson 1988). Liberalization Scenarios Three scenarios depicting “gradual” preferential liberalization under the AFTA schedule are presented below (Scenarios 1–3). Given the reciprocal approach of the CEPT, it is assumed that both the Lao PDR and the ASEAN partner countries liberalize their lists: the IL (Scenario 1), the TEL (Scenario 2), and the SL (Scenario 3). The Lao PDR will reduce its tariff rates to 5 per cent, which is the lowest tariff band of the Lao PDR and the highest of the 0–5 per cent range permitted by AFTA. On the export side, the terms of trade gains are measured by the margin of preference given by the ASEAN partner countries, which are weighted by the Lao PDR’s exports.10 Scenario 4 assumes that the Lao PDR liberalizes all the items including the GEL. In principle, the items in the GEL are permanently excluded from the liberalization scheme. However, given the large share of the items in the GEL for the Lao PDR, it is assumed that the items of the GEL might

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be moved to the CEPT scheme. Scenario 5 investigates a policy of nondiscriminatory liberalization on an MFN basis, under which the Lao PDR liberalizes all the lists under AFTA (Scenario 4) and then extends the same liberalization to all of its trading partners. However, the Lao PDR does not receive reciprocal trade concessions from non-ASEAN members under this scenario. One additional simulation is implemented to investigate the effects of the loss of the Lao PDR’s GSP status for its garment industry in the EU-15 market (Scenario 6)11. It is assumed that the Lao PDR pays an import duty of 12.112 per cent for its exports of garments to the EU market. Sensitivity experiments are conducted in order to test the effects of the changes in the key parameters (Scenario 7–8). Assuming that Scenario 3 is the most likely plan under AFTA, it is used as a baseline for the sensitivity analyses. Scenario 7 tests the case in which the elasticity of substitution between commodities takes the higher value. The value is doubled from σ cons = 1.5 to σ cons = 3.0. Scenario 8 investigates the case in which the elasticity of substitution between source countries takes a higher value, changing it from σsource = 3.0 to σ source = 6.0. Results of the Experiments Table 9.5 provides the economy-wide results, and Appendix 3 shows the sectoral results of the IL/TEL liberalization.13 Column 1 of Table 9.5 reports the results of IL liberalization. It is hardly surprising that the liberalization shows practically no effects on the key variables (Scenario 1). Since the tariff rates are already 5 per cent, there is no change on the import side and the gains from the export side are minimal because of the very limited inclusion of export-oriented commodities. Column 2 of Table 9.5 summarizes the results of the IL and TEL liberalization (Scenario 2). While total imports from ASEAN increase by 10.3 per cent, imports from the rest of the world fall by –10.5 per cent. Overall, imports rise by 5.0 per cent. The welfare gains from trade creation appear to outweigh the welfare loss from trade diversion; the EV resulting from the increase in imports from ASEAN registers US$6.4 million (0.37 per cent of base-period GDP), which is larger than the welfare loss of US$3.1 million (0.18 per cent of GDP) because of the decrease in imports from the rest of the world. There is an associated loss of tariff revenues, which decrease by 35.6 per cent. Since some part of the loss of revenue is compensated by the overall increase in imports, the revenue falls less than proportionally. The combination of a fall in the price of imports and a fall in the price of non-traded goods leads to downward pressure on the

© 2001 Institute of Southeast Asian Studies, Singapore

Utility Index (%) Consumer Price Index (%) Tariff Revenue (%) Total Imports (%) Imports from ASEAN (%) Imports from ROW (%) Total Exports (%) Exports to ASEAN (%) Exports to ROW (%) TOT gains (%) Price of Non-Tradable Goods (%) Output of Non-Tradable Goods (%) EV ($1,000) % of GDP Contribution of Trade Creation ($1,000) % of GDP Contribution of Trade Diversion ($1,000) % of GDP Contribution of Terms of Trade ($1,000) % of GDP

0.62 –2.4 –35.6 5.0 10.3 –10.5 5.9 15.8 –2.4 2.7 –1.0 –1.5 12106.9 0.70 6447.6 0.37 –3075.7 –0.18 8735.1 0.50

0

0 0.4 0

0 0

0 0

0.4 0

IL/TEL Liberalization

IL Liberalization

0 0 0 0 0 0 0 0 0 0

Scenario 2

Scenario 1

© 2001 Institute of Southeast Asian Studies, Singapore 9607.0 0.55

–3078.1 –0.18

6583.8 0.38

–1.5 13112.7 0.76

–0.9

0.67 –2.3 –35.9 5.2 10.6 –10.5 6.1 16.6 –2.7 2.9

IL/TEL/SL Liberalization

Scenario 3

10469.3 0.60

–4474.1 –0.26

10753.8 0.62

–2.0 16748.9 0.97

–1.9

0.86 –3.7 –51.5 6.6 13.8 –14.5 8.2 19.5 –1.3 3.1

IL/TEL/SL/GEL Liberalization

Scenario 4

10560.2 0.61

2658.5 0.15

7306.6 0.42

–2.5 20525.6 1.18

–2.9

–7537.8 –0.43

–451.5 –0.03

–1305.6 –0.08

0.3 –9294.8 –0.54

0.0

–0.47 –1.1 –2.1 –2.1 –2.1 –2.1 –1.3 3.6 –5.4 –2.4

Loss of GSP

Non– discriminatory Liberalization 1.06 –5.1 –64.4 7.6 7.9 6.9 9.9 21.4 0.2 3.1

Scenario 6

Scenario 5

TABLE 9.5 Key Results of Lao PDR Liberalization

9725.5 0.56

–1980.6 –0.11

9131.3 0.53

–2.2 16876.3 0.97

–2.4

0.87 –3.4 –33.5 6.8 12.2 –9.1 8.8 19.5 –0.3 2.9

σcons = 3

Scenario 7

9625.3 0.56

–7456.9 –0.43

9073.8 0.52

–1.6 11242.3 0.65

–1.2

0.57 –2.6 –41.1 5.6 15.8 –24.5 6.6 17.2 –2.2 2.9

σsource = 6

Scenario 8

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overall level of consumer prices, lowering the consumer price index by 2.4 per cent. The overall increase in exports by 5.9 per cent is slightly greater than the increase in imports.14 However, since the initial value of exports is smaller than the initial level of imports, the increase in exports allows only a relatively small percentage increase in imports, given the balance of payment constraint. As expected, the increase in exports to the ASEAN countries is especially significant, registering 15.8 per cent. The welfare gains resulting from improvements in the terms of trade are US$8.7 million, or 0.50 per cent of GDP. Overall, the welfare gains from Scenario 2 are US$12.1 million or 0.70 per cent of base-period GDP. This is equivalent to an increase of 0.62 per cent of real expenditure. The terms of trade component contributes the most to the total EV, accounting for about 72 per cent of total welfare gains. Appendix 3 presents the sectoral results of the IL and TEL liberalization. The results reveal that, on the import side, some sectors generate slight welfare losses under the AFTA plan. For instance, for vegetable products and processed foods, drinks and tobacco, the trade diversion effects are larger than trade creation on monetary terms, perhaps because the initial tariffs against the rest of the world are higher than those against the ASEAN members. Appendix 3 also shows that the rises in export volumes measured by percentage changes to ASEAN for plastic and rubber products, apparel, shoes, hats, umbrellas, stone, ceramic and glass products are substantial. They register 149.5 per cent, 271.5 per cent, 125.0 per cent, and 365.1 per cent respectively. It is likely that the Lao PDR will receive a substantial margin of preference for these commodities, mainly from Thailand. The current MFN rates of Thailand for these categories are high, with a range of 20–45 per cent for the weighted average (Appendix 1). However, if the welfare changes are measured by EV for these commodities, the gains are relatively small and even negative for stone, ceramic and glass products. This is because the initial level of exports of these commodities to ASEAN is low both relative to the rest of the world (apparel) and relative to the other categories of the Lao PDR’s exports. In contrast, the terms of trade gains from wood and wood products, with US$7.8 million of EV, is striking, accounting for 64.5 per cent of the total EV. The gains come from both the improvement in the terms of trade (4.3 per cent for total exports) and the increase in exports to the ASEAN markets (16.6 per cent). The gains are particularly attributed to the high initial volume of exports to the ASEAN partners (78 per cent of total exports to ASEAN). The third column of Table 9.5 shows the results of the Sensitive List (SL) liberalization in addition to the IL and TEL liberalization (Scenario 3). Overall, the results of the liberalization of unprocessed

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agricultural commodities, both by the Lao PDR and its ASEAN partners, appear to be relatively small.15 The total imports and exports increase only slightly by 5.2 per cent and 6.1 per cent, respectively from the base-period. Since the commodities in the SL represent only about 2 per cent of the total imports from ASEAN (see Appendix 2) and its tariff rates are relatively low at about 10 per cent in weighted average, the impact on tariff revenues is marginal, decreasing by only 0.3 percentage points relative to Scenario 2. Overall, the total EV increases by US$13.1 million from the base-period. This corresponds to 0.76 per cent of GDP and 0.67 per cent of real expenditure. The sectoral results reveal that imports of vegetable products from ASEAN increase by 5.9 per cent whereas the imports from the rest of the world decrease by 6.7 per cent. On the export side, the increase in exports to ASEAN, 27.1 per cent for “animal & animal products”, is a positive sign, with the terms of trade increase at 7.3 per cent. The exports of processed foods, drinks and tobacco to ASEAN increase substantially from 30.1 per cent (Scenario 2) to 101.9 per cent (Scenario 3). Again, the Lao PDR is likely to gain mainly from the concessions by Thailand, whose MFN rates are high in this sector, registering 23.5 per cent in weighted average. The terms of trade gain in this category improves from 13.3 per cent (Scenario 2) to 40.8 per cent (Scenario 3) Column 4 of Table 9.5 shows the results of the GEL liberalization in addition to the IL, TEL, and SL liberalization (Scenario 4). The commodities in the GEL represent about 10 per cent of total imports from ASEAN, and the list includes commodities with relatively high tariff rates — 37 per cent in weighted average. As expected, imports from ASEAN increase by 13.8 per cent, and this in turn leads to an increase in total imports by 6.6 per cent. The loss of tariff revenues of 51.5 per cent is especially significant relative to Scenario 3, because of the initial high tariffs. However, consumers are likely to gain from the trade creation which is equivalent to US$10.8 million, or 0.62 per cent of GDP. The total EV increases from US$13.1 million (Scenario 3) to US$16.7 million (Scenario 4), and the large portion of welfare gain relative to Scenario 3 comes from the trade creation component. The total EV is equivalent to 0.97 per cent of GDP and 0.86 per cent of real expenditure. The sectoral results show that liberalization causes the surge of imports from ASEAN in the processed foods, drinks, and tobacco category, from 11.1 per cent (Scenario 3) to 35.7 per cent (Scenario 4) from the base period. This is not surprising since the GEL includes many alcoholic beverages and tobacco. The trade creation measured by EV is especially huge, jumping from a minus sign (Scenario 3) to US$4.4 million (Scenario 4). However, the other sectors might cut back scarce foreign

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exchange. Except transport equipment, of which some of the items are also subject to liberalization, the imports of the other sectors decrease relative to Scenario 3. Column 5 of Table 9.5 deals with the results of non-discriminatory liberalization which assumes that the Lao PDR reduces unilaterally all of its non-partner tariffs to 5 per cent in addition to exchanging “reciprocal” concessions with the ASEAN partners (Scenario 5). The increases in imports and exports are the highest, registering 7.6 per cent and 9.9 per cent respectively; the imports from both ASEAN and the rest of the world increase by 7.9 per cent and 6.9 per cent respectively, and the exports increase as well in order to finance the increased imports. The tariff revenues decrease by 64.4 per cent and the consumer price index decreases by 5.1 per cent. The results show that the welfare gains are the greatest under this scenario, with an increase in EV of US$20.5 million, or 1.06 per cent of the real expenditure (1.18 per cent of GDP). When the scope of the liberalization widens, the Lao PDR gains from a wider variety of sources, and the relative importance of wood and wood products becomes smaller. For instance, since a large portion of transport equipment is sourced from the rest of the world, consumers benefit greatly from a comprehensive rather than a partial liberalization. In contrast, the total EV in electrical and mechanical machines decreases slightly, relative to Scenario 4. This is because the commodities in this category are mainly capital goods for foreign direct investments and the initial tariff rates are very low. Since the decrease in prices in this sector is small relative to the other sectors, the resources might be moved into other sectors. Column 6 of Table 9.5 simulates the case in which the Lao PDR fails to obtain GSP status in the EU-15 market for its garment sector. With the loss of GSP status, the export of garments to the EU-15 drops by 27.5 per cent, and this in turn leads to a substantial welfare loss; real expenditure drops by 0.47 per cent, which is equivalent to a welfare loss of US$9.3 million (0.54 per cent of GDP). Columns 7–8 of Table 9.5 show the results of the sensitivity analyses. The results suggest that they do not show significant changes in the relative positions of the liberalization scenarios. Relative to the base-period (Scenario 3), the magnitude of the change in overall welfare is not very large, with an increase in real expenditure from 0.67 per cent to 0.87 per cent (Scenario 7), and a decrease to 0.57 per cent (Scenario 8). However, the effects on trade creation and trade diversion are sensitive to the parameter values. If domestic goods and imports are good substitutes (Scenario 7), it is more likely that preferential trade arrangements will be beneficial. Going back to Figure 9.1, with high substitutability among commodities, the demand curves Dasean will be relatively flat and the area

© 2001 Institute of Southeast Asian Studies, Singapore

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Emiko Fukase and Will Martin

of trade creation will be greater, following a reduction of tariffs to the ASEAN countries. In this experiment, the magnitude of trade creation increases from US$6.6 million to US$9.1 million, and the magnitude of trade diversion is smaller. In contrast, if the elasticity of substitution between ASEAN and the rest of the world imports is larger (Scenario 8), the rectangle of trade diversion will be larger. Although trade diversion does not outweigh trade creation in this experiment, the magnitude of trade diversion increases substantially, from US$3.1 million to US$7.5 million. Conclusions and Limitations of the Experiments The following conclusions emerge from the experiments. First, the simulation results showed that AFTA accession by the Lao PDR is economically beneficial. A series of experiments showed that the Lao PDR gains as the scope of AFTA widens and it gains the most if it expands the scope on a non-discriminatory basis. This qualitative assessment is robust, although the magnitudes of gains are sensitive to the key parameter values. On the import side, the effect of reducing tariffs for the Lao PDR is trade creating rather than trade diverting. This reflects the high share of ASEAN countries in the Lao PDR’s total imports and the slightly higher initial tariff rates levied on ASEAN. However, the gains from the import side (defined as the contribution of “trade creation” minus that of “trade diversion”) are relatively small, varying from US$3.4 million (Scenario 2) and US$6.3 million (Scenario 5). This is because the benefit obtained from “trade creation” is partially offset by the loss of tariff revenues. On the export side, the Lao PDR gains substantially from the improvement in the terms of trade resulting from tariff cuts in the partner countries. The magnitude of the gains vary from US$8.7 million (Scenario 2) to US$10.5 million (Scenario 5). This reflects the current relatively high protection in the ASEAN partner countries against the Lao PDR’s exports. However, since it is likely that the ASEAN countries will give concessions to the other members and reduce their MFN protection against the rest of the world, the resulting decrease in prices might erode the gains to the Lao PDR. Secondly, the exports of the Lao PDR are concentrated in a few commodities and its economy is sensitive to external shocks. The simulation results showed that, other things being equal, AFTA has positive effects on the Lao PDR’s most important export industries, namely, wood and wood products, and the garment sector. The results revealed that a large portion of gains from AFTA come from the terms of trade gains of wood and wood products as a result of the concession by ASEAN partners. However, these gains owe a great deal to the large share of the wood and wood products sector in the total share of exports to ASEAN. This implies

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that any negative price shock of the same magnitude on this sector might erode relatively easily the gains received from the ASEAN partners’ concession.16 The simulation result also revealed the importance of the preferential access to the EU market by the Lao PDR’s garment industry. This appears to be important since the Lao PDR has very few exportoriented manufacturing industries other than garments. The EU GSP privileges are subject to strict rules of origin. With ASEAN membership, however, the Lao PDR is eligible for the “regional cumulation of origin provisions” 17 applied to ASEAN when the requisite administrative conditions have been met. It is likely that GSP status and the absence of quota restrictions in the EU market would compensate to some degree the adjustment costs at the early stage of the AFTA reform. However, since the Multi-Fibre Arrangement (MFA) is scheduled to be phased out of existence in 2005 under the Uruguay Round agreement, the Lao PDR will face more competition with the other emerging markets in the near future. In sum, it would be desirable for the Lao PDR’s export structure to become more diversified as it integrates into ASEAN. Thirdly, the sectoral analyses reveal the substantial potential of AFTA in such sectors as processed foods, apparel, and shoes, hats, and umbrellas. Whereas the increases in the exports of these industries are substantial, the gains evaluated in monetary terms are modest; these reflect the large potential gains induced by greater access to the ASEAN markets and the low level of current exports respectively. Although there is a tendency that the ASEAN countries will lower their MFN protection at the aggregated level, the protection of many labour-intensive and agriculture sectors remains high. The reduction of partners’ tariffs against the Lao PDR is important since it has potential comparative advantages in these sectors. Finally, the model used in this study is simple and subject to several limitations. In particular, the nature of the model is static and it does not capture the dynamic gains that the Lao PDR is likely to get from increased foreign direct investments, improved productivity, as well as from changes induced by accelerated domestic reforms.

© 2001 Institute of Southeast Asian Studies, Singapore

HS

1–5 6–14 15 16–24 25–27 28–38 39–40 41–43 44–46 47–49 50-60 61–63 64–67 68–70 71 72–83 84–85 86–89 90–92 93 94–96 97–98

Section

1 2 3 4 5 6 7 8 9 10 11.1 11.2 12 13 14 15 16 17 18 19 20 21

Animals & animal products Vegetable products Animal & vegetable oils Processed foods, drinks & tobacco Oil and mineral products Chemical products Plastic & rubber products Skins & furs and their products Wood & wood products Pulp of wood & paper Textiles Apparel Shoes, hats, umbrellas, etc. Stone, ceramic & glass products Jewelry & precious metal products Base metals & their products Electrical & mechanical equipment Transport equipment Photographic, optical, precision instruments Arms & munitions Miscellaneous articles Objets d’art Total

Description

Indonesia

Malaysia

Philippines

10.2 14.3 6.1 28.5 10.4 10.8 11.7 22.5 28.8 5.4 15.1 20.7 19.8 11.7 22.2 12.6 13.8 22.8 8.2 18.8 15.0 0.8 13.9

6.7 9.0 5.6 28.3 21.5 6.7 10.6 27.5 28.4 5.6 13.2 12.5 10.3 7.6 0.0 6.7 11.8 21.6 4.1 12.3 15.3 0.0 14.9

15.9 12.2 8.3 26.6 4.6 6.4 15.6 10.7 10.6 9.3 17.4 27.8 21.9 10.2 12.0 9.8 5.5 25.6 9.3 12.6 20.1 14.1 12.3

10.8 3.6 3.8 5.6 3.1 5.3 14.9 0.9 5.3 5.8 9.6 28.2 15.7 7.0 8.4 6.3 4.9 26.0 7.7 11.1 19.1 8.9 7.8

8.9 2.3 1.6 6.4 1.9 1.1 12.4 4.0 16.1 8.9 10.5 14.2 13.1 10.0 3.5 5.0 4.0 11.3 2.7 n.a. 10.3 4.4 6.2

1.7 3.1 0.7 3.0 1.1 1.2 9.7 2.5 18.9 6.8 10.0 11.9 15.7 7.2 0.3 5.6 2.1 9.5 2.2 n.a. 10.0 2.2 3.6

23.6 22.1 20.4 26.7 4.7 6.4 13.5 18.4 20.9 15.5 16.2 27.4 29.5 20.1 8.0 14.4 8.5 13.5 10.3 28.0 21.8 30.0 15.2

14.2 37.6 17.7 21.1 8.0 7.5 13.9 19.8 15.0 14.3 15.4 27.1 23.7 19.2 3.6 12.8 5.7 17.3 7.3 25.9 23.0 30.0 10.9

Simple Weighted Simple Weighted Simple Weighted Simple Weighted Average Average Average Average Average Average Average Average (%) (%) (%) (%) (%) (%) (%) (%)

Cambodia

APPENDIX 1 MFN Tariff Rates for ASEAN Countries

238 Emiko Fukase and Will Martin

© 2001 Institute of Southeast Asian Studies, Singapore

© 2001 Institute of Southeast Asian Studies, Singapore

1–5 6–14 15 16–24 25–27 28–38 39–40 41–43 44–46 47–49 50-60 61–63 64–67 68–70 71 72–83 84–85 86–89 90–92 93 94–96 97–98

1 2 3 4 5 6 7 8 9 10 11.1 11.2 12 13 14 15 16 17 18 19 20 21

Animals & animal products Vegetable products Animal & vegetable oils Processed foods, drinks & tobacco Oil and mineral products Chemical products Plastic & rubber products Skins & furs and their products Wood & wood products Pulp of wood & paper Textiles Apparel Shoes, hats, umbrellas, etc. Stone, ceramic & glass products Jewelry & precious metal products Base metals & their products Electrical & mechanical equipment Transport equipment Photographic, optical, precision instruments Arms & munitions Miscellaneous articles Objets d’art Total

Description 13.9 22.7 10.7 24.5 5.1 8.9 11.7 12.2 27.6 7.4 9.2 10.7 12.1 5.9 5.0 5.9 6.8 17.9 6.2 30.0 13.4 5.0 9.6

7.1 13.0 10.1 30.7 5.0 10.5 12.1 13.7 31.0 8.8 9.5 10.3 10.1 5.2 5.0 5.9 7.7 26.9 6.0 30.0 13.2 5.0 14.7

Weighted Average (%) 39.4 30.4 17.4 38.2 10.8 15.8 31.1 27.4 21.6 23.4 28.1 45.0 43.6 39.9 17.3 15.7 12.6 18.9 15.5 30.0 33.9 17.1 23.3

Simple Average (%) 34.2 13.3 16.1 23.5 5.7 14.7 28.0 8.3 9.2 14.6 20.0 42.3 37.3 29.5 2.0 9.6 11.7 19.6 14.0 30.3 34.1 15.3 13.7

Weighted Average (%)

Thailand

11.5 17.2 12.1 34.0 4.3 5.2 9.5 11.6 16.1 16.2 23.3 48.9 40.5 22.9 16.7 9.2 6.4 10.3 8.8 11.0 27.7 6.5 15.6

Simple Average (%) 13.7 11.5 19.5 43.6 41.2 5.1 8.5 6.2 9.7 19.0 27.8 46.3 21.9 28.6 6.3 9.2 9.1 27.8 4.0 14.9 28.9 5.5 19.0

Weighted Average (%)

Vietnam

SOURCES: ASEAN Secretariat, CEPT Product Lists (July 1997); Center for International Economics; 1995 COMTRADE System; the government of the Lao PDR; Cambodia Customs House 1996.

Note: Singapore’s tariff rates are close to zero although some specific tariffs are collected from such items as automobiles and petroleum oils.

HS

Section

Simple Average (%)

Lao PDR

APPENDIX 1 (continued) MFN Tariff Rates for ASEAN Countries Economic Effects of Joining AFTA for the Lao PDR 239

HS

1–5 6–14 15 16–24 25–27 28–38 39–40 41–43 44–46 47–49 50–60 61–63 64–67 68–70 71

Section

1 2 3 4 5 6 7 8 9 10 11.1 11.2 12 13 14

Animals & animal products Vegetable products Animal & vegetable oils Processed foods, drinks & tobacco Oil and mineral products Chemical products Plastic & rubber products Skins & furs and their products Wood & wood products Pulp of wood & paper Textiles Apparel Shoes, hats, umbrellas, etc. Stone, ceramic & glass products Jewelry & precious metal products

Description 0.0 1.5 0.0 20.9 0.0 192.6 2173.2 0.0 0.0 0.0 23.4 0.0 0.0 309.7 0.0

Imports ($1,000) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Exports ($1,000) n.a. 5.0 n.a. 5.0 n.a. 5.0 5.0 n.a. n.a. n.a. 5.0 n.a. n.a. 5.0 n.a.

Weighted Average (%)

Inclusion List (IL)

APPENDIX 2 The Structure of the Lao PDR’s Phase-in Lists

6021.8 2864.3 1469.9 31234.9 57078.6 23477.0 12817.7 199.3 607.8 4611.0 34312.6 5271.6 4079.5 16014.5 1460.5

Imports ($1,000) 49.0 7381.2 3.5 0.8 2503.4 3988.0 15.3 1176.3 55633.8 92.7 176.5 100.8 8.6 1.8 1.6

Exports ($1,000)

6.5 8.1 10.1 18.8 5.0 11.1 13.5 13.5 31.1 9.0 9.5 10.1 10.1 5.1 5.0

Weighted Average (%)

Temporary Exclusion List (TEL)

240 Emiko Fukase and Will Martin

© 2001 Institute of Southeast Asian Studies, Singapore

72–83 84–85 86–89 90–92 93 94–96 97–98

15 16 17 18 19 20 21

4.7

18283.3

Total

% Share

1452.8 10877.3 1425.3 1798.6 0.0 8.0 0.0

Imports ($1,000)

Base metals & their products Electrical & mechanical machines Transport equipment Photographic, optical, precision instruments Arms & munitions Miscellaneous articles Objets d’art

Description

0.07

53.2

37.6 15.5 0.0 0.2 0.0 0.0 0.0

Exports ($1,000)

5.0

5.0 5.0 5.0 5.0 n.a. 5.0 n.a.

Weighted Average (%)

83.6

327119.4

28218.9 40336.8 51514.2 918.0 0.0 4599.9 10.6

Imports ($1,000)

90.2

71995.3

582.7 48.6 69.7 1.0 0.0 159.5 0.6

Exports ($1,000)

13.3

6.1 9.8 33.8 9.1 0.0 13.8 5.0

Weighted Average (%)

Temporary Exclusion List (TEL)

© 2001 Institute of Southeast Asian Studies, Singapore

SOURCES: Government of the Lao PDR, CEPT Phase-in Lists, 1997; and 1995 UN COMTRADE System.

NOTE: About a quarter of tariff lines recorded by the Lao PDR’s partners to COMTRADE do not have corresponding tariff lines in the Lao PDR’s schedule at the 6-digit level. In this case, the tariff rates and the phase-in lists prevailing at the 4-digit level in the Lao PDR’s phase-in lists are assigned.

HS

Section

Inclusion List (IL)

APPENDIX 2 (continued) The Structure of the Lao PDR’s Phase-in Lists

Economic Effects of Joining AFTA for the Lao PDR 241

HS

1–5 6–14 15 16–24 25–27 28–38 39–40 41–43 44–46 47–49 50–60 61–63 64–67 68–70 71

Section

1 2 3 4 5 6 7 8 9 10 11.1 11.2 12 13 14

Animals & animal products Vegetable products Animal & vegetable oils Processed foods, drinks & tobacco Oil and mineral products Chemical products Plastic & rubber products Skins & furs and their products Wood & wood products Pulp of wood & paper Textiles Apparel Shoes, hats, umbrellas, etc. Stone, ceramic & glass products Jewelry & precious metal products

Description 575.6 6370.3 0.0 0.0 0.0 0.0 0.0 0.0 1.9 0.0 0.0 0.0 0.0 0.0 0.0

Imports ($1,000) 31.5 56.5 0.0 967.3 0.0 0.0 0.0 0.0 6658.1 0.0 0.0 0.0 0.0 0.0 0.0

Exports ($1,000) 10.1 10.2 n.a. n.a. n.a. n.a. n.a. n.a. 10.0 n.a. n.a. n.a. n.a. n.a. n.a.

Weighted Average (%)

Sensitive List (SL)

APPENDIX 2 (continued) The Structure of the Lao PDR’s Phase-in Lists

0.0 0.0 0.0 29918.5 0.0 11.5 0.0 0.0 0.0 0.0 0.0 1.7 0.0 0.0 0.0

Imports ($1,000) 7.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3.7 0.0 0.0 0.0

Exports ($1,000)

n.a. n.a. n.a. 39.8 n.a. 10.0 n.a. n.a. n.a. n.a. n.a. 10.0 n.a. n.a. n.a.

Weighted Average (%)

General Exception List (GEL)

242 Emiko Fukase and Will Martin

© 2001 Institute of Southeast Asian Studies, Singapore

72–83 84–85 86–89 90–92 93 94–96 97–98

15 16 17 18 19 20 21

% Share

Total

Base metals & their products Electrical & mechanical machines Transport equipment Photographic, optical, precision instruments Arms & munitions Miscellaneous articles Objets d’art

Description

1.8

6947.8

0.0 0.0 0.0 0.0 0.0 0.0 0.0

Imports ($1,000)

9.7

7713.4

0.0 0.0 0.0 0.0 0.0 0.0 0.0

Exports ($1,000)

10.2

n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Weighted Average (%)

10.0

39031.6

0.0 935.0 8145.7 0.0 0.0 19.3 0.0

Imports ($1,000)

0.04

32.3

0.0 0.2 21.2 0.0 0.0 0.0 0.0

Exports ($1,000)

37.0

n.a. 7.4 30.2 n.a. n.a. 30.0 n.a.

Weighted Average (%)

General Exception List (GEL)

© 2001 Institute of Southeast Asian Studies, Singapore

SOURCES: Government of the Lao PDR, CEPT Phase-in Lists, 1997; and 1995 UN COMTRADE System.

NOTE: About a quarter of tariff lines recorded by the Lao PDR’s partners to COMTRADE do not have corresponding tariff lines in the Lao PDR’s schedule at the 6-digit level. In this case, the tariff rates and the phase-in lists prevailing at the 4-digit level in the Lao PDR’s phase-in lists are assigned.

HS

Section

Sensitive List (SL)

APPENDIX 2 (continued) The Structure of the Lao PDR’s Phase-in Lists

Economic Effects of Joining AFTA for the Lao PDR 243

1 2 3 4 5 6 7 8 9 10 11 11 12 13 14 15 16 17 18 19 20 21

Section

1–5 6–14 15 16–24 25–27 28–38 39–40 41–43 44–46 47–49 50–60 61–63 64–67 68–70 71 72–83 84–85 86–89 90–92 93 94–96 97–98

HS

© 2001 Institute of Southeast Asian Studies, Singapore

Total

Animals & animal products Vegetable products Animal & vegetable oils Processed foods, drinks & tobacco Oil and mineral products Chemical products Plastic & rubber products Skins & furs and their products Wood & wood products Pulp of wood & paper Textiles Apparel Shoes, hats, umbrellas, etc. Stone, ceramic & glass products Jewelry & precious metal products Base metals & their products Electrical & mechanical equipment Transport equipment Photographic, optical, precision instruments Arms & munitions Miscellaneous articles Objets d’art

Description

5.0

–1.0 –2.0 4.2 7.2 –2.9 3.8 5.5 5.5 16.7 1.8 2.6 3.1 3.6 –2.8 –2.9 –1.7 0.5 20.2 –2.0 –2.9 6.4 –2.9

Total

10.3

–1.0 –1.2 4.2 11.0 –2.9 7.7 9.1 12.9 57.9 3.7 4.2 5.8 4.9 –2.8 –2.9 –1.2 4.3 45.0 0.0 0.0 13.0 –2.9

ASEAN

Imports (%)

–10.5

–4.7 –3.7 –9.5 –10.3 –2.9 –9.2 –10.6 –10.5 –18.8 –7.3 –8.1 –8.5 –9.0 –3.0 –2.9 –4.1 –6.2 –21.2 –3.8 –2.9 –11.2 –2.9

ROW

APPENDIX 3 Scenario 2 (IL and TEL Liberalization)

5.9

14.3 1.4 28.7 29.0 4.8 0.5 9.5 2.5 9.4 13.5 30.2 0.9 2.0 37.4 3.3 1.3 1.5 13.4 1.3 0.5 0.5 0.5

Total

15.8

25.1 5.8 28.7 30.1 6.9 0.5 149.5 3.3 16.6 21.0 55.2 271.5 125.0 365.1 77.4 14.7 13.9 16.4 70.2 0.5 0.5 0.5

ASEAN

–2.4

–11.6 –0.3 0.0 –21.7 –3.6 0.5 –7.8 –1.4 –7.6 –11.0 –22.4 0.2 –0.9 –26.5 –2.2 –0.3 –0.4 –10.9 –0.3 0.5 0.5 0.50

ROW

Exports (%)

2.7

6.6 0.4 13.1 13.3 2.1 0.0 4.4 1.0 4.3 6.3 13.8 0.2 0.7 16.9 1.4 0.4 0.5 6.2 0.4 0.0 0.0 0.0

Terms of Trade Gain

244 Emiko Fukase and Will Martin

HS

1–5 6–14 15 16–24 25–27 28–38 39–40 41–43 44–46 47–49 50–60 61–63 64–67 68–70 71 72–83 84–85 86–89 90–92 93 94–96 97–98

Section

1 2 3 4 5 6 7 8 9 10 11 11 12 13 14 15 16 17 18 19 20 21

© 2001 Institute of Southeast Asian Studies, Singapore

Total

Animals & animal products Vegetable products Animal & vegetable oils Processed foods, drinks & tobacco Oil and mineral products Chemical products Plastic & rubber products Skins & furs and their products Wood & wood products Pulp of wood & paper Textiles Apparel Shoes, hats, umbrellas, etc. Stone, ceramic & glass products Jewelry & precious metal products Base metals & their products Electrical & mechanical equipment Transport equipment Photographic, optical, precision instruments Arms & munitions Miscellaneous articles Objets d’art

Description

12106.9

12.2 82.2 6.2 –271.0 33.4 108.6 99.0 28.3 7844.2 22.4 152.3 167.7 16.2 –21.4 –27.9 11.0 60.9 3763.8 –6.8 –3.2 28.7 0.0

Total EV

6447.6

–3.9 –10.6 5.2 –42.6 –89.8 161.3 129.7 2.6 64.2 13.4 115.5 25.4 16.7 –24.7 –2.3 –20.7 175.7 5871.0 0.2 0.0 61.3 0

Contribution of Trade Creation

–3075.7

–1.2 –38.0 0.0 –518.1 –1.5 –52.8 –44.7 –1.4 –30.1 –6.7 –41.7 –11.9 –4.8 –2.2 –26.3 –13.6 –117.8 –2120.1 –7.2 –3.2 –32.6 0.0

Contribution of Trade Diversion

Equivalent Variation ($1,000)

APPENDIX 3 (continued) Scenario 2 (IL and TEL Liberalization)

8735.1

17.3 130.8 1.0 289.7 124.8 0.1 14.0 27.19 7810.1 15.7 78.6 154.2 4.2 5.4 0.7 45.3 3.0 12.9 0.2 0.0 0.0 0.0

Contribution of Term of Trade

Economic Effects of Joining AFTA for the Lao PDR 245

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Notes 1

2

3

4

5 6

7 8

This chapter was prepared in collaboration with the East Asia Poverty Reduction and Economic Management Sector Unit. We are grateful to the Lao PDR government officials for useful conversations and information; Linda Schneider for excellent support during two missions; and Alan Winters for guidance and helpful comments. The original members of ASEAN and AFTA were Brunei, Indonesia, Malaysia, Singapore, the Philippines, and Thailand. Vietnam became a full member on 28 July 1995. It commenced the implementation of the CEPT scheme on January 1996 and set a target deadline of 2006 to complete this process. The Lao PDR and Myanmar started the process in January 1998 and will complete it by 2008. Based on the UNCTAD classification of non-tariff barriers (NTBs), a working definition of NTBs has been agreed upon in ASEAN. This covers para-tariff measures, price control measures, finance measures, monopolistic measures, and technical measures (ASEAN Secretariat, 1995). However, some commodities with high trade value and/or high tariff rates have been excluded from the current AFTA commitments. For instance, Indonesia included a high proportion of unprocessed agricultural products in the SL, including rice, wheat, and soy beans. The 23 tariff lines alone represent about 11 per cent of import values from ASEAN. For the new members, the proportions of the GEL are typically higher relative to the other members. For Vietnam and the Lao PDR, for instance, the import values in the GEL correspond to 10 per cent and 37 per cent of total imports from ASEAN respectively. In addition, the GEL contains some commodities with high tariff rates and these items are generating considerable tariff revenues for them. MFN status, national treatment, and transparency are the three preconditions of ASEAN accession. These principles are consistent with those of the World Trade Organization (WTO). GNP per capita of the ASEAN countries vary widely: Singapore (US$26,730); Indonesia (US$980); Thailand (US$2,740); the Philippines (US$1,050); Malaysia (US$3,890); Vietnam (US$240) in 1995 (World Bank 1997). For Brunei and Myanmar, GDP per capita are US$20,400 and US$300 respectively (http://www.aseansec.org). The Lao PDR’s trade with its main trading partners is indeed small. For instance, the Lao PDR’s trade with Thailand was 0.3 per cent of total Thai trade, and 0.02 per cent of total Singapore trade in 1995. Three limitations should be borne in mind in this approach. Firstly, Vietnam, and other smaller trading partners are not reporting to the COMTRADE system, and hence data are not available. However, Vietnam was incorporated in the empirical analyses for completeness, assuming that it represents 5 per cent of the Lao PDR’s imports and 20 per cent of its total exports. As a very rough proxy, the composition of trade is assumed to be the same as that of Thailand. Secondly, the analyses do not include trade in electricity since the COMTRADE data do not include it. In 1995, electricity accounted for about 7 per cent of the Lao PDR’s total exports. Taking into account additional facilities now under construction, it is projected that electricity exports will increase to 55 per cent of total exports by 2020 (Finger and Castro 1997). Thirdly, given the long border with China, Vietnam, and Thailand, the unofficial trade between the Lao PDR and these countries is estimated to be at about 25–30 per cent of total trade. But this trade is not incorporated into the analyses because of the unavailability of data.

© 2001 Institute of Southeast Asian Studies, Singapore

Economic Effects of Joining AFTA for the Lao PDR 9 10

11

12 13 14

15

16

247

Given the importance of the garment industry for the Lao PDR, section 11 is split into the “textile” (HS 50–60) and “apparel” (HS 61–63) industries. It is assumed that the Lao PDR faces the concessional rate if the commodity that the Lao PDR is liberalizing is in the IL (Scenario 1) or TEL (Scenario 2) or SL (Scenario 3) of the importing partner country, otherwise it faces the MFN rate. For the items which are in the partner countries’ IL, the concessional rates agreed by AFTA (the rates in 1998 for Scenario 1 and the rates in 2003 for Scenarios 2–3) are applied. Since the concessional rates for the TEL, SL, and GEL are not determined in the partner countries, it is assumed that they will offer the rates of 2.5 per cent when they move the items to the IL. The importance of the Lao PDR’s garment industry to the EU-15 is striking. In 1995, it totalled US$67.2 million; thus, the EU received 78.9 per cent of the Lao PDR’s exports of garments, representing about a quarter of the Lao PDR’s exports. The performance of the garment industry until 1995 was largely owed to the General System of Preferences (GSP) status and the absence of quota in the EU market. However, the GSP privileges for the EU market ended at the end of the year 1995 when the Lao PDR was unable to meet the rules of origin requirement. Currently, about 90 per cent of the fabric and yarn used in the production of garments is imported mainly from Thailand. Simple average MFN rates for the garment category (HS 61–63) in the EU market was computed based on the EU 1997 tariff (Source: UNCTAD). The sectoral results of the other experiments are not reported but are available upon request. A well-known consequence of trade liberalization is the depreciation of the real exchange rate, or a reduction in the price of non-traded goods relative to world prices (Martin 1996b). The fall in the price of non-traded goods resulting from liberalization reduces the incentives for consumers to substitute domestic goods with the now-cheaper imports. This fall in the price of non-traded goods (relative to exports) increases the incentive to export, and leads to a percentage increase in exports. There are several factors which might underestimate the impact of agricultural liberalization. First, the analyses do not include the effects of removal of the quantitative restrictions and other non-tariff barriers which persist in the agricultural sector. Secondly, a large portion of the current trade occurs unofficially along the long border with Thailand, Vietnam, and China and it is likely that the official trade will increase when trade barriers are reduced at the borders. Finally, many commodities in this sector are now facing prohibitive tariffs and the model does not capture what would happen when protection is removed, since our model is based on the 1995 export data. For instance, whereas coffee is one of the most important export commodities for the Lao PDR, it did not export this to Thailand in 1995, mainly because of the high tariffs (40 per cent ) and other non-tariff barriers. Today, timber royalties represent a significant part of the government’s fiscal revenues, accounting for 20 per cent of tax revenue in 1995/96 (Bank of the Lao PDR 1996). However, its sustainability is uncertain owing to the degradation of forestry resources in the Lao PDR. The current rates of logging are some 2–3 times the sustainable yield level and deforestation is occurring at the rate of 1–2 per cent annually (ADB 1996). Recently, the Lao PDR’s exports of wood and wood products were negatively affected by the falling demand in Thailand as a result of the financial crisis and the collapse of the timber price.

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17 There are special provisions allowing derogations from the EU rules of origin in cases where a series of processing operations is carried out within the same regional grouping of beneficiary countries.

Reference Armington, P.S. “A Theory of Demand for Products Distinguished by Place of Production”. IMF Staff Papers 16. Washington, D.C.: International Monetary Fund, 1969. ASEAN Secretariat. AFTA Reader, Volume I-IV. Jakarta, 1993–96. . CEPT Product Lists. Jakarta, 1997 and 1998. Asian Development Bank (ADB). The Lao PDR and the Greater Mekong Subregion: Securing Benefits for a Small Country. Manila, 1996. Bank of the Lao PDR. Annual Report 1996. Vientiane, 1996. Centre for International Economics. Vietnam’s Trade Policies 1998. Canberra, 1998. Codsi, G. and K. Pearson. “GEMPACK: General-purpose Software for Applied General Equilibrium and Other Economic Modellers”. Computer Science in Economics and Management I. 1988. Devarajan, S., G. Delfin, J. Lewis, S. Robinson, and P. Sinko. “Policy Lessons from a Simple Open-Economy Model”. Policy Research Working Paper 1375. Washington, D.C.: World Bank, 1994. Finger, J. M., U. Reincke, and M. Ingco. The Uruguay Round: Statistics on Tariff Concessions Given and Received. International Trade Division, World Bank, 1996. Finger M. J. and A. Castro. “Integrating Lao Enterprises into the Regional and World Economy”. Mimeographed. Washington, D.C.: World Bank, 1997. Hertel, T., and A.M. Huff. “Decomposing Welfare Changes in the GTAP Model”. Global Trade Analysis Project Technical Paper No.5. 1997. www.gtap.org IMF. Lao People’s Democratic Republic: Recent Economic Development. International Monetary Fund, May 1997. Martin, W., P.A. Petri and K. Yanagishima. “Charting the Pacific: An Empirical Assessment of Integration Initiatives”. International Trade Journal 8, no. 4. (Winter, 1994). Martin, W. “Measuring Welfare Changes with Distortions”. In Applied Methods for Trade Policy Analysis: A Handbook, edited by J. Francois, and K. Reinert. Cambridge, U.K.: Cambridge University Press, 1996a. . “Assessing the Implications for Lebanon of Free Trade with the European Union”. Mimeographed. Washington, D.C.: World Bank, 1996b. Mya Than, and Tan J. L.H. Laos’ Dilemmas and Options: The Challenges of Economic Transition in the 1990s. Singapore: Institute of Southeast Asian Studies (ISEAS), 1997. UNCTAD. Directory of Import Regimes, Part I: Monitoring Import Regimes. New York: United Nations Conference on Trade and Development, 1994. UNDP and AusAid. “The Economic and Financial Impact on the Lao PDR of Participation in the ASEAN Free Trade Area (AFTA)”. 1997. World Bank. World Development Indicators, 1997. Washington D.C.: World Bank, 1997.

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ASEAN Enlargement and Myanmar

10

TIN MAUNG MAUNG THAN and MYA THAN

At the special ASEAN Ministerial Meeting (AMM) in Kuala Lumpur on 31 May 1997, Myanmar was accepted as a full-fledged member of the Association of Southeast Asian Nations in July 1997, along with Laos. Despite strong indications from the United States and its allies to defer this decision because of Myanmar’s alleged human rights violations, Myanmar was formally admitted at a special ceremony held in Subang Jaya, Malaysia, on 23 July, during the celebrations for the 30th anniversary of ASEAN’s founding.1 This historic decision by ASEAN was in line with the Bangkok Declaration of 1995, which was issued after the Fifth ASEAN Summit, to which Myanmar’s Prime Minister Senior General Than Shwe was invited by the host country for the first time.2 Myanmar’s process of joining ASEAN, which was initiated by the country’s accession in July 1995 to the Treaty of Amity and Co-operation (TAC) at the 28th ASEAN AMM in Brunei, was probably triggered by political considerations. However, there are both political and economic factors accruing from Myanmar’s membership in ASEAN. Before we explore the implications and impact of Myanmar joining ASEAN, it may be worthwhile to consider whether Myanmar was really ready to join the Association. Was Myanmar Ready to join ASEAN?3 According to the ASEAN Secretariat, the answer was a resounding “yes”; it was “technically ready” in terms of obligations for political, economic, and functional co-operation. The conditions for “technical readiness” include 249

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acceding to basic agreements and declarations of ASEAN documents including the Bangkok Declaration of 1967, the Zone of Peace, Freedom and Neutrality (ZOPFAN), the TAC, the Southeast Asian Nuclear Weapons Free Zone (SEANWFZ), the ASEAN Free Trade Area (AFTA), and all other agreements that ASEAN has established. In this aspect Myanmar would have no difficulty in acceding to all of them. In fact, Myanmar had already acceded to some of these, including SEANWFZ. Myanmar could also meet the financial obligations for membership, such as sharing equally the cost of running the Secretariat and subscribing to various ASEAN funds and covering the costs to attend some 300 ASEAN meetings a year. In addition, it had already met a few other conditions, such as locating embassies in all the ASEAN capitals (which were established long before Myanmar applied for membership) and having a large pool of government officials who can communicate in English. Myanmar’s accounting system is also similar to many of the older member countries of ASEAN. Moreover, a national ASEAN secretariat and an ASEAN Free Trade Area unit had already been established in Yangon. As a member of ASEAN, all countries must become a member of AFTA, with its attendant privileges as well as obligations. In this aspect, Myanmar was in a far better position than other new members like Cambodia and Laos. All of Myanmar’s economic laws have English versions and are easily accessible. Regarding the question of granting mostfavoured-nation (MFN) status to other ASEAN members, Myanmar would have no problem, as it is a founding member of the World Trade Organization (WTO) and has granted MFN status to other countries. On the other hand, Vietnam, Laos and Cambodia are not members of the WTO yet. Apart from that, Myanmar was prepared to give national treatment to ASEAN products on a reciprocal basis. Obligatory to AFTA membership, Myanmar has to reduce its tariffs to 0–5 per cent by the year 2008. In this regard, unlike the other new members, the country has less problems as more than half of its tariffs are already 5 per cent or less (see Table 10.1). Cambodia’s customs duties are mostly between 7 and 50 per cent whereas those in the Lao PDR are mostly between 5 and 20 per cent. The impact of joining AFTA on Myanmar’s state budget is marginal compared with the other new member countries. This is because Myanmar’s customs duties comprise, on average, about 16 per cent of total government revenues, while those of Cambodia and the Lao PDR are 72 per cent and 30 per cent, respectively. In this sense, Myanmar was more ready than the other new members. Moreover, Myanmar’s dual exchange rate system seems to be a blessing in disguise, as it will buffer the impact on the state budget, at least in the short term. However, in the long run, it may affect its balance of payments negatively.

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TABLE 10.1 Myanmar’s Trade and Approved FDI with ASEAN (In US$ million) Trade* Exports Indonesia Malaysia Philippines Singapore Thailand ASEAN Total World Total ASEAN/World (%)

22 46 — 157 37** 272 1178 23.9

Imports 132 409 — 777 63** 1318 2675 49.3

FDI# 237.4 587.2 146.7 1356.9 1140.2 3468.4 6829.5 50.8

Notes: * for 1997, # as of 31 December 1998 ** for 1995 SOURCES: IMF, Direction of Trade (Washington D.C., 1998), and Myanmar Investment Commission, 1999. In short, Myanmar was more ready to join ASEAN than other new members like Cambodia and Laos, at least, from the technical, economic, and financial aspects. To achieve the goal of creating a free trade area, based on 0–5 per cent tariffs on goods traded among ASEAN members, the new members have been given a grace period of ten years to comply; for Myanmar, the time frame appears to be more than adequate. In fact, the latest tariff lists presented by the Myanmar delegation at the ASEAN Economic Ministers meeting in Kuala Lumpur in October 1997 confirmed this. A Myanmar delegate said that about 68 per cent of products from Myanmar were already within the 0–5 per cent tariff rate at present. She said that only 10 per cent of products and services had a tariff rate of between 30 per cent and 40 per cent, as the government was trying to discourage certain activities. They included businesses based on gambling, liquor, antiques, imported cars, and others. “Of the 5,400 tariff lines (in Myanmar’s product list for the AFTA), about 2,400 products are in the inclusion list. Over 2,900 are in the temporary exclusion list, 108 in the general exception list, and 21 in the sensitive list” (Star, 14 October 1997). As such, then ASEAN Secretary-General Ajit Singh remarked that Myanmar could enter the AFTA member group even before its stipulated deadline of 2008 (Nation, 13 October 1997).

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Political Implications During the months of July and August 1997, the government-owned newspapers carried a series of boxed inserts entitled “Facts about ASEAN” to highlight Myanmar’s admission to the regional grouping. One stated that “Myanmar, through ASEAN, can now meet the groups wishing to pose a threat to her collectively, and make her attitude known to them in specific and precise terms and act accordingly”, and new opportunities would open up “with the help, understanding and sympathy of fellow ASEAN members”.4 On the other hand, critics of the ruling State Peace and Development Council (SPDC, formerly known as the State Law and Order Restoration Council or SLORC) maintained that by joining ASEAN, Myanmar’s military junta hoped to gain legitimacy at home and abroad.5 To some, it was seen as a calculated move by the SPDC to counter Western sanctions, criticisms, and condemnations spearheaded by the United States Government, as well as various pro-opposition lobbies and the so-called government-in-exile in the form of the National Coalition Government of the Union of Burma (NCGUB). On the other hand, Myanmar authorities adamantly insist that this is not a reactive process, but a pro-active one based on changing domestic and international circumstances. In addressing the appeal of ASEAN to Myanmar, Foreign Minister U Ohn Gyaw alluded to the ending of the Cold War and referred to the “shared destiny” of the ten Southeast Asian nations and added that Myanmar “feel[s] that we are a Southeast Asian nation and we would like to aspire to the prosperity of Southeast Asian nations” and since “ASEAN is now very much solid in a leading role … we would like to be part of it” (Nation, 16 December 1995). The political implications of Myanmar’s entry into ASEAN may be identified in three areas: ASEAN’s relations with the West; ASEAN organizational matters and intra-ASEAN relations; and Myanmar’s domestic political development. From the very beginning, Myanmar’s ruling SPDC was ostracized by the Western powers, while the regional states and ASEAN have co-operated with Myanmar in its efforts to end its economic and political isolation. The United States and its European allies persistently accused the SPDC of human rights violations and suppression of democratic activists, and sought punitive measures to advance their vision of democracy. On the other hand, the ASEAN states constructively engaged Myanmar in the belief that a gradual exposure to the market economy and regional cooperative efforts would be the best way to ensure regional security and the socio-economic development of Myanmar itself. The stark contrast between these two approaches had never been clearer than when the U.S. Government imposed sanctions, and together

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with its European allies tried to block Myanmar’s early entry into ASEAN. However, ASEAN decided to accord full membership to Myanmar in July, in time for the Association’s 30th anniversary. In fact, on 22 April 1997 President Bill Clinton announced a ban on new American investments in Myanmar, citing “large-scale repression of the democratic opposition”. This was followed on 20 May by an executive order “prohibiting United States persons from new investments in Burma” which formalized the earlier pronouncement (Myanview, July 1997, p. 4). Despite efforts by the Clinton Administration to garner strong support from its allies, countries such as Japan, Australia, France, and Germany did not join in the U.S. censure effort. The U.S. sanction came at a time when selected purchase laws and bans on companies doing business with Myanmar by states such as California and Massachusetts, as well as cities like New York, had become the bane of both the United States and foreign companies. The European Union (EU) had withdrawn the community’s generalized system of preferences (GSP) benefits from Myanmar’s industries, and also imposed a ban on junta members and senior military and government officials from obtaining visas.6 Such tensions between Myanmar and the United States, as well as the EU, suggest that discrimination against Myanmar because of its relations with ASEAN would go against the grain of the grouping’s stand on non-discriminatory treatment of its members. One example of a potential conflict is the current controversy over Myanmar’s participation in the bloc-to-bloc meetings between ASEAN and the EU, and Myanmar’s membership in the Asia– Europe Meeting (ASEM) process. The confrontational stage with regard to the former was set with the EU’s statement on 26 June 1997, which stated: the Council considers that the presence of Burma/Myanmar at the forthcoming ARF/PMC Ministerial Meetings does not prejudge in any way its participation as observer at the upcoming EU-ASEAN Joint Cooperation Committee in November 1997 and other meetings in the institutional EUASEAN framework (Myanview, July 1997, p. 5).

Moreover, British Foreign Secretary Robin Cook’s remarks during his Southeast Asian tour in late 1997 that Myanmar would not be invited to attend the forthcoming second ASEM in London, elicited strong reactions from some ASEAN leaders. In particular, Prime Minister Dr Mahathir Mohamad of Malaysia gave a “warning of a possible ASEAN boycott of the gathering” if the latter’s members are discriminated against.7 In preparatory negotiations for the annual ASEAN-EU Joint Co-operation Council (JCC) meeting in Bangkok, scheduled for November

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1997, the EU demanded that Myanmar’s attendance be downgraded to that of a “passive presence”. This condition was unacceptable to ASEAN, which insisted on the granting of full observer status for Myanmar. The EU maintained that the 1980 agreement, which established the JCC, was not a “bloc-to-bloc” accord, and a non-signatory like Myanmar could not be accommodated. The impasse led to the postponement of the meeting and resulted in, what was described by EU diplomats as, a “chilly” relationship between the two blocs.8 Meanwhile, Myanmar officially applied, in December 1997, to join ASEM (a top-level forum composed of fifteen EU member countries, seven ASEAN member states, China, Japan, and South Korea, which held its first meeting in March 1996 in Bangkok, with a wider membership than the ASEAN-EU co-operative process). However, at the March 1998 meeting of senior ASEAN officials, held in the Philippines, it was announced that ASEM had a moratorium on new participants, and the countries would be participating individually and not as a group. This effectively ruled out Myanmar’s participation in the second ASEM in London in April 1999. 9 On 26 October 1998, the EU General Affairs Council issued a press release stating that it had decided to extend and strengthen “the EU Common Position through a widening of the visa ban by explicitly including transit visas under the current ban and its extension to cover Burmese [Myanmar] authorities in the tourism sector”. It also concluded that “although Burma [Myanmar] has become a member of ASEAN, the EU cannot agree to Burmese [Myanmar’s] accession to the … Agreement”. Nevertheless, “it [the EU] has decided to accept a Burmese [Myanmar] presence under special conditions, to be agreed upon at the next meeting of the Joint Committee”, despite the EU contention that the foregoing “is without prejudice to Burmese [Myanmar] representation at future meetings held under” the ASEAN-EU Agreement “which will need to be decided in the light of the [domestic political] situation in Burma [Myanmar].”10 On its part, ASEAN apparently agreed to an arrangement whereby the Myanmar delegates would attend as observers and not participate on issues involving inter-group co-operation. This ASEAN concession, together with a consensus to display only the ASEAN and EU flags and not the country flags, seemed to have paved the way for a re-scheduled meeting at Bangkok on 25 January 1999. However, a few days before the Bangkok meeting of senior officials, the EU introduced a new condition, stipulating that Myanmar and Laos be identified by plaques as “new members”. This move, which appeared to have been an afterthought, designed to appease anti-Myanmar elements in the European Parliament that was in session, proved to be unacceptable to ASEAN and Myanmar. This led to the second postponement of the

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JCC meeting (according to Thai Foreign Ministry deputy spokesperson Kiti Wasinondh) because “the two sides cannot find a resolution on the meeting formality”.11 Despite this setback, the German ambassador to Thailand (Germany was then holding the six-months rotating presidency of the EU from the beginning of 1999) reiterated the importance attached by the EU to the ASEAN-EU relationship. Both he and the Thais (who co-ordinated the ASEAN side) expressed the hope that the ASEAN-EU Ministerial Meeting (of foreign ministers or AEMM) in Berlin, scheduled for 30 March 1999 would still take place.12 However, it was not to be. As pointed out by an editorial in the Singapore Straits Times (1 February 1999), the problem in essence has been “not about seating arrangements for Myanmar” but the EU’s perception of “the lack of progress to break the [domestic] political stalemate, the harassment of pro-democracy activists, and the poor human rights record in Myanmar”. Despite the Myanmar Foreign Minister’s expressed willingness to “discuss any matter which the European side may wish to address”, the EU refused to relax the standing visa ban on Myanmar officials that would allow them to attend the Berlin AEMM. Moreover, in early February 1999, Britain joined Denmark, Sweden, and Norway in refusing to allow Myanmar’s attendance at the Berlin meeting. This affront was anathema to Myanmar; and Myanmar’s Foreign Minister U Win Aung was reported to have retorted that “our mentality is not to succumb to any pressure. If there is pressure put upon us, we become more resistant” to it.13 Towards the end of February, ASEAN officials, meeting in Singapore, came up with an agreed position that “all the foreign ministers of ASEAN must be present” at the AEMM.14 Subsequently, no compromise was reached and the cancellation of the AEMM was announced on 16 March by both sides. Even then, there were eleventh-hour efforts to salvage the interaction, with the EU proposing a meeting between a “troika” representing the EU and ASEAN without Myanmar. This was also unacceptable to the ASEAN side which stood firm on its principle of equal treatment for its members.15 There was, however, a positive footnote to this sorry tale when it was announced in Berlin at the conclusion of the ASEM foreign ministers meeting (that went on as scheduled despite the cancellation of the backto-back AEMM) that the twice-postponed JCC meeting would take place in May 1999 based on the format that was agreed upon in October 1998 before the EU introduced the ill-fated “new members” identification proposal for Myanmar and Laos.16 Since November 1997, despite affirmations by both sides that the ASEAN-EU dialogue process was and still is extremely important for the two groupings, it appears that it has been held hostage to Myanmar’s domestic political problems, as perceived by the more ardent advocates of

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human rights and democracy among EU member states. The ASEAN states, faced with the Asian economic crisis, would do well to have stronger economic and technological ties with Europe. On the other hand, Europe will be better off if it can enhance its relationship with ASEAN whose potential for absorbing innovative investments and providing markets for Europe remains, notwithstanding the economic crisis. As for Myanmar, it has everything to gain in terms of international standing and economic growth if it could manage to convince the EU that its efforts in economic and political restructuring are in the right direction and moving at a satisfactory pace. Apparently, ASEAN seems to be determined to pursue its constructive engagement strategy by welcoming Myanmar warmly and to continue its helping hand for the transition period, even to the extent of challenging its Western partners’ decisions in inter-group relations. As such, the impasse appears to persist, but the hope is that in the long run, as Myanmar’s membership of the regional grouping matures, there would be convergence between ASEAN and its Western partners over the Myanmar issue. ASEAN, though not highly institutionalized as in the case of the EU, has its unique modus operandi known as the “ASEAN Way”. This has been characterized by informal interaction, quiet diplomacy, non-binding agreements, consensus-based decision-making, and non-interference in the internal affairs of member states.17 As such, the mindset of Myanmar “will not make things easier” for ASEAN’s smooth integration. 18 More specifically, as Noordin Sopiee wrote: It is a different thing to generate consensus amongst a group of ten, many of whom have little experience in the Asean tradition of “agreeing to disagree without being disagreeable”, while working very hard to secure the highest possible common denominator.19

Nevertheless, given Myanmar’s past record in international relations and its political culture, it seems unlikely that Myanmar would be out of its depth in adapting to the ASEAN way. Myanmar’s comfort level with such an operational procedure is likely to be comparable to those of the older ASEAN members. Moreover, Myanmar’s bilateral relations with all the other member countries have been very good. Although the lack of a comprehensive border demarcation between Myanmar and Thailand has given rise to some disagreement over territory along the Thaungyin/Moei River in southeastern Myanmar, it is not expected to escalate. Furthermore, as both are members of the same regional grouping, they may be able to resolve this problem amicably. ASEAN membership will probably strengthen

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Myanmar’s bilateral relationships with other member countries through the diffusion of the ASEAN spirit, first among the ruling élites and then trickling down to the polities. On the other hand, there are suggestions to change the manner of engaging Myanmar, as the latter becomes a full-fledged member of the grouping. The desire to deepen and extend the “constructive engagement” concept by introducing a proactive element of a more comprehensive “constructive intervention” was mooted by several regional thinkers, including Malaysia’s (former) Deputy Prime Minister Anwar Ibrahim.20 The aim seems to be to help Myanmar achieve a more rapid transition towards internationally acceptable behaviour and norms not only in international relations but also in tackling national economic and political issues. It is too early to say what will come out of such ideas, but one can be assured that any change would be made in a way that would not put undue pressure on Myanmar to accommodate them and that the grouping would not in any way jeopardize the cohesion and amity among its members by introducing changes that are not undergirded by consensus and practicality. As for the implications on Myanmar’s domestic political issues, the country’s political temperature has been lowered by government conciliatory gestures towards the opposition National League for Democracy (NLD) and its leader Daw Aung San Suu Kyi.21 Though cynics have commented that the SPDC was introducing cosmetic changes and restoring some rights, which should have been granted in the first place, one cannot deny that these are positive signs.22 Although the Myanmar authorities would most probably deny that such acts were the result of Myanmar’s membership in ASEAN, there are evidently some grounds to believe that the timing is not entirely coincidental. One would tend to agree with the Straits Times editorial comment that “Yangon would not have gone even to this trouble [of allowing the NLD congress to convene] if it were not responsive to ASEAN expectations”.23 Hence, Myanmar’s ASEAN membership seems to imply a trend towards a more relaxed political atmosphere that would be conducive to bringing about a genuine reconciliation between the SPDC and its political opponents. Economic Implications for Myanmar On the whole, Myanmar can enjoy greater trade and investment links within the region, increased attractiveness to foreign investors from outside the region and more secure access to a larger ASEAN market. In addition, it may benefit from improved resource allocation from specialization according to comparative advantage, greater economies of scale in an enlarged regional market, enhanced industrialization prospects of small

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and medium enterprises, greater spill-over effects, and infant industry learning effects with improved quality control, design, and marketing. Consequently, it may improve its competitiveness in the world markets. We will assess the impact of Myanmar’s joining ASEAN/AFTA in terms of international trade, government revenues, foreign direct investment (FDI) and comparative advantage. Myanmar’s trade with ASEAN has been growing since it opened up its economy. As for the country’s exports, ASEAN is one of the main export markets for Myanmar, comprising about 24 per cent of Myanmar’s total exports to the world in 1997 (Table 10.1); and it grew at an average annual rate of 6.4 per cent between 1985 and 1995. Most of its export items are agricultural products, which are outside the Common Effective Preferential Tariff (CEPT) scheme,24 and they appear in either General or Temporary Exclusion Lists (TEL). Therefore, the impact of reduced tariffs on such goods (through the CEPT scheme) is unlikely to be significant; and the revenues from exports to ASEAN will not be significantly affected. ASEAN is also a very significant source of imports for Myanmar. It accounts for more than 49 per cent of Myanmar’s total imports, increasing at an average annual rate of 45.3 per cent between 1985 and 1995. As most imports are capital goods (about 30 per cent of the total) and consumer goods (about 40 per cent of the total) — most of whose tariffs have been reduced to 20 per cent or less — the impact of CEPT will not be very significant in terms of tariff reduction. On the contrary, it could boost imports and may reduce smuggling of consumer goods. However, there exists a possibility that Myanmar’s balance of payments may be negatively affected. This is because, even with the various nontariff barriers, the country’s balance of trade was (on average) in deficit by about 3.5 billion kyat between 1990/91 and 1995/96 (equivalent to about US$600 million at the official rate). Given the present situation, its exports cannot be expanded or diversified significantly. Therefore, with the removal of tariff and non-tariff barriers, the balance of payments may deteriorate further. With respect to government revenues, the potential impact of AFTA causes some concerns, as customs duties form 16 per cent of total government revenues. Nevertheless, the impact will be much less than for Cambodia (where customs duties constitute over 70 per cent of government revenues), Laos (31 per cent of the government revenues), and Thailand (18 per cent). Myanmar’s dual exchange rate system may work in the government’s favour by increasing revenues through the tariff reduction process. This is similar to 1996 when the government changed the assessment of customs duties from the official exchange rate of 6 kyat per U.S. dollar to a more realistic market-based effective rate of about 100

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kyat per dollar, thereby raising revenues (in kyats per imported dollar terms) by about sixteen times, while at the same time reducing the duty rate by ten times. The net result was higher revenues for the same quantum of imports (in dollar terms) in spite of tariff reduction. In other words, as one economist said, “Myanmar is already on the fast track without having any detrimental effect to its revenue”. However, the dual exchange rate may affect the balance of payments. Foreign direct investments will be indirectly affected by Myanmar’s entry into AFTA. Since the promulgation of the Foreign Investment Law in 1998, FDI has been growing fast and it reached the level of more than US$6.8 billion by the end of 1998. ASEAN’s share in Myanmar’s total FDI is very significant, accounting for more than 51 per cent, with Singapore being the largest investor among the ASEAN countries (Table 10.1). (For detailed information on Myanmar’s FDI, see Khin Ohn Thant’s chapter in this volume.) Since one of the main objectives of AFTA is to establish a unified market to attract foreign investment, multinational corporations will be encouraged to invest in the ASEAN countries by taking advantage of low tariffs and an enlarged market. Moreover, ASEAN’s reputation as a good place for investment will spread to the new members. These factors, together with the spillover effects, will encourage foreign investors from inside and outside ASEAN to invest more in Myanmar. However, FDI has slowed since the second half of 1997 mainly as a result of the regional financial crisis. The most significant impact of AFTA will be to enhance the ability of Myanmar to exploit its comparative advantage of abundant natural resources and its cheap but literate labour, English-speaking urban populace, and a strategic location between India and China. Conclusion: Issues and Challenges There exist many unresolved issues surrounding Myanmar’s joining ASEAN/AFTA. The first issue is whether Myanmar will once again become a supplier of raw materials as in the colonial period. Such an effect is unlikely to take place for the following reasons. Owing to rising wages and labour shortages, most of the ASEAN countries are moving from less capital-intensive to more capital-intensive manufacturing. In the case of Singapore, it is moving towards skill-intensive high-technology manufacturing. Myanmar is expected to fill the vacuum left by the advanced ASEAN countries. In addition, there are many projects to enhance ASEAN economic co-operation. Another problematical issue is that Myanmar, with its inefficient stateowned enterprises, will have to compete with ASEAN in manufacturing. Currently, its small-scale enterprises in the private sector are facing a

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shortage of raw materials, power supply, capital, and spare parts. Only with the government’s further liberalization of financial, banking, and trade sectors can this issue of tough competition be overcome. Even in the areas where competition between Myanmar and ASEAN exists, there are still opportunities for co-operation. It is important to note that even between similar economies, a complementary relationship can be achieved if they agree on free trade among themselves. In sum, Myanmar’s membership in ASEAN/AFTA will have a positive impact in the short to medium term on its economic development. The economic potential of the ASEAN whole can be greater than the sum of the individual parts; and more importantly, AFTA is not a zero-sum game. However, in the longer term, unless the government of Myanmar is committed to more economic reforms and “carefully ascertain what is in her best interests in order to take advantage of flexibilities” accorded under AFTA regulations, the country will lose out in this competition. In the political sphere, one hopes that, as stated by Myanmar’s Foreign Minister U Ohn Gyaw in his address at the admission ceremony at Subang Jaya on 23 July 1997, Myanmar will be able to get its “own house in order” with the support of ASEAN friends and “contribute towards order for the community” as well. Notes 1. Although Laos was admitted simultaneously with Myanmar, Cambodia’s entry was “delayed until a later date” (ASEAN Update, February 1997, p. 1) 2. It was stated that “ASEAN is committed to the establishment of an ASEAN comprising all countries in Southeast Asia” (ASEAN Update, January 1996, p. 1). The first meeting of the leaders of the ten Southeast Asian countries took place during this summit. 3. For details, see Mya Than and Tin Maung Maung Than, “Implications of Joining ASEAN for Myanmar” (Paper presented at the Seminar on 30 Years of ASEAN, organized by the Division of Geography, School of Arts, Nanyang Technological University, Singapore, 11 November 1997). 4. See the highlighted box, “Facts about ASEAN-8”, in New Light of Myanmar, 7 August 1997, p. 7. 5. See, for example, the comment by Professor James Guyot on the Voice of America (VOA) background report dated 7 July 1997 (Burmanet posting of 8 July 1997 on the Internet). 6. See Myanview (January 1997), p. 7; and EIU, Country Report Myanmar (Burma) (3rd quarter 1997), p. 21. 7. See “Its Our Party”, Far Eastern Economic Review, 25 September 1997. 8. See Nation, 15 December 1997. 9. See Nation, 22 March 1998. 10. Press release No. 12274/98, dated 26 October 1998, of the Council (General Affairs) at Luxembourg; Internet posting on soc.culture.burma (28 October 1998). 11. Bangkok Post, 23 January 1999; see also, ibid., 21 January 1999.

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12. See, for example, Nation, 26 January 1999; and Bangkok Post, 28 January 1999. 13. Reuters’ interview with Myanmar’s Foreign Minister U Win Aung (Singapore, 19 February 1999), Internet edition. See also, Nation, 6 and 9 February 1999. 14. Business Times (Singapore), 26 February 1999. 15. Nation, 15 March 1999. 16. Straits Times, 31 March 1999. 17. Personal communications with ASEAN scholars and officials from member states. 18. See “Retooling ASEAN”, Asiaweek, 27 June 1997, p. 14. 19. See Noordin Sopiee, “Fulfilling Dream of Regional Unity”, New Straits Times, 6 June 1997. 20. See, for example, “The word is ‘constructive intervention’”, Straits Times, 15 July 1997; and Jusuf Wanandi, “Partners Should Nudge Burma”, International Herald Tribune, 5 June 1997. 21. The government allowed the NLD to hold a congress at the premises of Daw Aung San Suu Kyi on 27–28 September and allowed her to travel to the suburbs of Yangon to address a party grouping. These were unprecedented moves, given that the government had prevented similar gatherings in the past two years, and restricted the movement of Daw Aung San Suu Kyi as well. 22. For critical comments, see “Myanmar: A Glimmer of Hope?”, The Economist, 4 October 1997, p. 33–34; and Kavi Chongkittavorn, “Slorc under pressure to repay Asean’s faith”, Nation, 30 September 1997, p. 4. Even Daw Aung San Suu Kyi herself has acknowledged the government gestures and thanked the authorities, expressing hope that “one day, the present authorities and members of the” NLD “will work hand in hand for the good of the country” (English translation of the transcript of Daw Aung San Suu Kyi’s speech at the closing ceremony of the Ninth NLD Party Congress, on 29 September 1997). 23. See “Signs of thaw in Myanmar”, Straits Times, 13 October 1997, p. 38. 24. CEPT is the basis of AFTA, with the goal of reducing tariffs and removing non-tariff barriers on all intra-ASEAN trade in manufactured and processed goods. It will be accomplished through two different tracks — a “fast track” and a “normal track”. Under the “first track”, the import tariffs for products with tariffs below 20 per cent will be reduced to below 5 per cent by 1 January 2000, and for other products by 1 January 2003. Under the “normal track”, those with tariffs above 20 per cent will be reduced to 20 per cent within five to eight years in the first stage, and to below 5 per cent in the following seven years.

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ASEAN Enlargement: Economic and Financial Implications for Myanmar

11

KHIN OHN THANT

Introduction Since Myanmar became a member of ASEAN in July 1997, many analysts and others have speculated about the implications and impact of this new relationship. This chapter presents the Myanmar perspective on this topic. In particular, it examines how Myanmar can meet the new obligations and challenges of ASEAN membership, as well as how it can exploit the opportunities and privileges presented by the ASEAN grouping. Before going to the main subject, however, we will first provide an overview of Myanmar’s economy. Myanmar is the largest country on mainland Southeast Asia, with a total land area of 676,577 sq km. It has a long international border of 5,858 km with Bangladesh, India, China, Lao People’s Democratic Republic (Lao PDR), and Thailand. This long border is both an asset and a liability to the country. Myanmar also has a coastline of 2,832 km. Within the country, it has three river systems, with the Ayeyarwaddy running right through the country from north to south. This facilitates trade, transport, and communication. Myanmar’s population was estimated at 46.4 million in 1997/98, with an average annual growth rate of 1.84 per cent. Most of its population, 67 per cent, are employed in the agricultural sector. Myanmar attained an average economic growth rate of 7.5 per cent during 1992/93 – 1995/ 96. The provisional figure for 1996/97 was 6.4 per cent. The savings 262

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and investment ratios were almost 10 and 15 per cent of gross domestic product (GDP) respectively. Myanmar’s GDP at current prices was K792 billion1 in 1996/97, with agriculture contributing a little over 36 per cent. Agricultural products constituted a major share of exports at almost 38 per cent, followed by forest products at 22 per cent. The country’s economy continued to be exceptionally closed, with imports and exports comprising 1.7 per cent and 0.8 per cent of GDP respectively in 1996/97. Both the balance of trade and the terms of trade have been unfavourable for the past decade. Myanmar’s trade balance in 1996/97 ran a deficit of K5.6 billion, and the terms of trade for the same period was K61.5 million. Foreign direct investment (FDI) is equally important to Myanmar. Oil and gas offer the most significant development potential and accordingly attracted the most foreign direct investment, accounting for almost 36 per cent of the total investments of US$6.44 billion, as at 30 September 1997. FDI in manufacturing comprises 19 per cent of the total, followed by real estate, and hotel and tourism, with 14 per cent and 12 per cent of the total respectively. The United Kingdom, Singapore, and Thailand are the three top investors in Myanmar, with more than US$1.3 billion committed for 29 projects; US$1.2 billion for 55 projects; and US$1.1 billion for 41 projects, respectively, as at 30 June 1997. Myanmar’s private sector has expanded in most areas of the economy. The country witnessed most private sector growth in the form of Myanmar limited companies, which comprised 8,000 enterprises in December 1996, a 24 per cent increase over 1995. The next most important area in the private sector was the export/import business, with almost 7,000 enterprises, a 27 per cent growth over the previous year. Inflation has been a serious problem in Myanmar in the 1990s. The annual percentage has hovered between 20 and 30 per cent. Its dual exchange rate is another problem for the business sector. The parallel exchange rate had been stable in the past, but recently the gap has been widening at an increasing rate. This may be partially due to the fallout from the currency crisis in the region. Myanmar’s external indebtedness is very low in comparison with its neighbours. The level of external debt is also static. In brief, Myanmar is not a rich country, but it offers substantial economic opportunities. Furthermore, its long-term strategic importance must be considered. Compared with its significant resource base, however, its level of investment and manufacturing activity is low. Myanmar’s Foreign Investment Law, bolsterd by its increased credibility as a result of ASEAN membership, provide a friendly environment to foreign investors. Moreover, its expanding reform programmes — particularly privatization — are improving Myanmar’s market environment.

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Decision to Join ASEAN As one of the founding members of the Non-Aligned Movement, Myanmar has strictly adhered to the principles of non-alignment. Consequently, it did not join ASEAN when the organization was first formed in 1967. Although it did not identify itself with any grouping, as a non-aligned nation, it was on friendly terms with all groups, including the Southeast Asian nations. At the end of the millennium, internal and external conditions have changed in Myanmar. Internally, Myanmar has expended large resources on quelling rebellious tribes for many decades on the eastern, northern, and western fronts. The government has now signed peace treaties with most of the rebels, who have laid down their arms. This now allows the Myanmar Government to devote more attention to external matters, including ASEAN membership. A second factor that led to the decision to join ASEAN is that, in this age of globalization and regionalism, the country realizes that it cannot continue to isolate itself. It needs to identify with a sympathetic group, which will treat it as one of them, and a group that will not exploit Myanmar’s weak situation. However, Myanmar does not want to be a burden to other ASEAN members: it wishes to contribute its fair share towards the attainment of the grouping’s goals. Questions have been raised as to what Myanmar expects from ASEAN and whether Myanmar’s enthusiasm for ASEAN membership has waned since the outbreak of the economic crisis. What Myanmar expects from ASEAN can be seen from “Facts about ASEAN-8” published in an August 1997 issue of The New Light (Myanmar), which states: Myanmar enjoys the following benefits as a member of ASEAN: —

—

—

—

Myanmar, through ASEAN, can now meet the groups wishing to pose a threat to her collectively, and make her attitude known to them in specific and precise terms and act accordingly. Opportunities emerge to open the door wider politically and economically with the help, understanding and sympathy of fellow ASEAN members. With greater co-operation with the friends in the region in various sectors, Myanmar does not have to place more emphasis on investments from the other parts of the world (Western hemisphere) than that from its own region. With more contacts and communications among the peoples of the region in multifarious fields, the ten nations, with a common historical background, sharing common cultural traditions and colonial experience, can now formulate specific characteristics of ASEAN.

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The short answer to the second question is that the East Asian crisis has not reduced Myanmar’s enthusiasm for ASEAN. But Myanmar expects help from the ASEAN-6 and its Dialogue Partners, although it does not expect a hand-out. Rather, Myanmar wants to earn external assistance, and it knows that it must “clean up its act” before it can expect such. However, Myanmar is not short-sighted, and it recognizes that the ASEAN economies will eventually recover and will then be in a better position to help Myanmar and other new ASEAN members. Myanmar Economic Reforms The authorities in Myanmar announced in late 1988 a completely new economic framework, representing a move towards a more market-oriented system. Since then, there have been a number of reforms, pursuing four national economic objectives: 1. Development of agriculture as the base, and balanced development of other economic sectors; 2. Proper development of the market-oriented economic system; 3. Encouraging foreign technical know-how and investment to develop Myanmar’s economy; 4. Maintaining state and domestic control over national economic development Investment To promote the expansion of exports, foreign investment has been encouraged. The most significant law promulgated on foreign investment is the Union of Myanmar Foreign Investment Law (FIL) of November 1988, which is managed by the Myanmar Investment Commission (MIC). The law permits the establishment of joint ventures as well as wholly-owned foreign enterprises for a wide range of economic activities, from agriculture, livestock, and fisheries, to iron and steel, machinery, and plants. It provides for a number of incentives and guarantees to promote foreign investment. Incentives include three-year tax holidays, exemption from income tax on reinvested profits within one year, and accelerated depreciation, among others. The FIL provides an irrevocable state guarantee that an enterprise, permitted by the MIC under the FIL, shall not be nationalized during the permitted or extended period. The Law also permits the repatriation of profits and legitimate salaries (net of taxes); and if the company is terminated or dissolved, its capital may also be repatriated. As at 30 September 1997, approved foreign investment stood at US$6.44 billion, for 279 projects (Table 11.1). Singapore, Thailand, and

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TABLE 11.1 Foreign Direct Investment Inflow, 30 September 1997 (In US$million ) Sr. No.

Country

I

Investment by Country

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

UK Singapore Thailand USA Malaysia France The Netherlands Indonesia Japan Hong Kong Republic of Korea Australia Austria Canada Panama China, Republic of Germany Denmark Philippines Bangladesh Macau Israel Sri Lanka

II

Investment by Sector

1 2 3 4 5 6 7 8 9 10 11

Oil and Gas Manufacturing Real Estate Hotel and Tourism Mining Transport & Communication Livestock & Fisheries Industrial Estate Construction Other Services Agriculture

No. of Projects

Approved Amount

Percentage

279

6439.08

100.00

30 57 42 16 23 3 5 8 16 19 16 13 2 11 1 9 1 1 1 2 1 1 1

1321.92 1225.81 1157.16 582.07 524.17 470.37 237.84 236.37 202.63 110.54 82.72 76.26 72.50 35.13 30.53 29.26 15.00 13.37 6.67 2.96 2.40 2.40 1.00

20.53 19.03 17.97 9.04 8.14 7.30 3.69 3.67 3.15 1.72 1.28 1.18 1.13 0.55 0.47 0.46 0.23 0.21 0.10 0.05 0.04 0.04 0.02

279

6439.08

100.00

45 98 14 39 42 13 17 3 1 5 2

2295.92 1229.95 874.95 762.56 498.03 275.39 269.54 193.11 17.27 13.68 8.68

35.66 19.10 13.59 11.84 7.73 4.28 4.19 3.00 0.27 0.21 0.13

SOURCE: Directorate of Investment and Company Administration, Ministry of National Planning and Economic Development, Myanmar

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Malaysia are the second, third and fifth largest investors in Myanmar with US$1.2 billion, US$1.1 billion, and US$0.5 billion for 57, 42, and 23 projects, respectively. Almost 36 per cent of the investments are made in the oil and gas sector, followed by 19 per cent in the manufacturing sector. The third largest investments are made in the real estate sector, with 14 per cent of the total investments. Of the existing foreign enterprises, 39 per cent are wholly foreign-owned, 38 per cent are joint ventures, and the remaining 23 per cent are on a production-sharing basis. The joint ventures are mostly with the state economic enterprises (29 per cent), Myanmar Economic Holdings Ltd (5 per cent), and private enterprises (3 per cent). Other forms of joint ventures are with Myanmar Economic Corporation (a co-operative society), Yangon City Development Committee, and Joint Venture Corporation. Myanmar also promulgated the Myanmar Citizens Investment Law (MCIL) in October 1994 to regulate the investment activities of Myanmar citizens, so that they benefit the state. Similar to the FIL, the CMIL provides tax exemptions on foreign-exchange earnings, import-substitution activities, technology transfer, and the like. It also guarantees that an economic enterprise, set up under this law, shall not be nationalized during the tenure of the permit. As of 30 September 1997, total investments by Myanmar citizens in the country stood at K11.7 billion, for 90 projects. Most investments flowed into the real estate sector, with K3.3 billion for 10 projects. This was followed by the manufacturing sector, with K2.6 billion for 54 projects; and the construction sector with K2.3 billion for 2 projects. Trade As a founding member of the GATT/WTO, Myanmar’s trade policies comply with the rules and regulations of these organizations. Myanmar has particularly strong ties with its neighbours, and border trade accounts for some 40 per cent of the total trade. The government’s trade policy is to give priority to conventional trade transactions. However, because of the national programmes and limited resources, other forms of trade are also conducted in the country. Thus, foreign companies can freely enter into counter-trade agreements with Myanmar companies, or in joint ventures. Another way of conducting trade is on an import first, export later basis. Myanmar companies can apply for an import licence with an obligation to export back. The company has the obligation to export US$110 worth of goods for each US$100 of imports. To facilitate trade, Myanmar permits a foreign company to appoint a business representative or an agent, or it may open a branch office. To set up a branch office, a minimum capital level is required: the hard currency equivalent of K1 million for local manufacturing and marketing of

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products; K500,000 for marketing activities alone; and K300,000 for service activities. Privatization The role of the private sector in the economy is growing. It contributes more than 75 per cent of GDP, and some 60 per cent of trade. By contrast, in fiscal 1988/89, the public sector contributed some 96 per cent of GDP, and the remainder originated from the co-operative sector. The growth of the private sector is due to two factors. The first is that agriculture, which accounts for more than 36 per cent of GDP, has been privatized. The government no longer dictates to the farmers what crops to grow, and how much, nor does it establish a price. Secondly, a privatization programme was launched under Section 4 of the State Economic Enterprise Law promulgated in 1989. A Privatization Commission at the national level was formed with five modes of privatization. At that time, there were 1,760 state economic enterprises. Myanmar citizens have individually bought over the small enterprises; and they can form companies to buy out the medium-sized enterprises. For the larger enterprises, they may be owned in partnership between the state and the private sector. There is an option for the private sector to buy out the public sector at par value (utilized in the case of joint ventures). In addition, foreign companies may participate in the privatization progamme through joint ventures with the state or domestic private sector. Financial Reform Myanmar has progressed significantly in its financial and economic reform programme, but it still has much more to do in order to integrate completely with AFTA and ASEAN. However, similar to other transition economies, Myanmar has no precedents or prescriptions to carry out this process. To a certain extent, Myanmar is learning from other faster-moving transition economies, but it is also learning by “trial and error”. The remainder of this section gives an overview of Myanmar’s financial reforms in four different areas: structure and liberalization; fiscal policy; monetary policy; and foreign exchange policy. Structure and Liberalization As part of its commitment to develop a market-oriented economy, the government has taken measures to reform the financial and fiscal system. The Central Bank of Myanmar Law, the Financial Institutions of Myanmar Law, and the Myanma Agriculture and Rural Development Law were

© 2001 Institute of Southeast Asian Studies, Singapore

ASEAN Implications for Myanmar

269

enacted in 1990. The Savings Bank Law was promulgated in 1992, followed by the Myanmar Insurance Law in 1993. The structure of the banking system is composed of the Central Bank of Myanmar, four state-owned banks, twenty-one domestic private banks, forty-eight representative offices of foreign banks, a state-owned finance company, and a state-owned insurance institution. The four state-owned banks are the Myanma Economic Bank, Myanma Foreign Trade Bank, Myanma Investment and Commercial Bank, and Myanma Agriculture and Development Bank. Domestic private banks were permitted for the first time from 1970, under the Financial Institutions of Myanmar Law. Of the twenty-one domestic private banks, eight are allowed to transact in foreign exchange, and five are permitted to issue credit cards. It is estimated that domestic private banks hold 21 per cent of total savings and 20 per cent of foreign currency loans. With regard to the foreign banks, financial liberalization will occur through a step-by-step process in three stages. The first stage will allow foreign banks to establish representative offices. Secondly, the establishment of joint-venture banks, between foreign and private domestic banks, will be permitted. Foreign banks must have a representative office in Myanmar and own at least 55 per cent equity. In the third stage, foreign banks will be permitted to set up branches. Fiscal Policy On the fiscal side, tax and tariff rates have been reduced, while the base has been broadened, resulting in a 125 per cent increase in tax revenues over the past five years. Monetary Policy The government has progressively raised interest rates since 1989, from 11 to 12.5 to 15 per cent. The interest rates on savings deposits and savings certificates were raised from 8 and 10 per cent, to 10 and 12 per cent, and later, to 12 and 15 per cent, respectively. The private savings and fixed deposit rates average 13.5 per cent. The government bank lending rates range from 15 to 18 per cent, depending on the type of loan. The interest rate charged by the private banks averages 19.7 per cent. Foreign Exchange Policy Foreign Exchange Certificates (FECs) were introduced in 1993, with the value of one FEC equal to one U.S. dollar. In 1995, counters were opened for trading FECs at the market rate.

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Myanmar’s Common Effective Preferential Tariff (CEPT) Reduction under AFTA Myanmar is more prepared to implement the CEPT Product Lists and Tariff Reduction Plans compared with the other new ASEAN members, Cambodia, Laos, and Vietnam. In fact, Myanmar is on par with some of the ASEAN-6 with respect to its Unprocessed Agricultural Products (UAP) List and Tariff Reduction Plans for the UAP List and Sensitive List. This readiness is primarily due to Myanmar’s membership in the GATT/WTO. From 1 April 1992, Myanmar, as a member of GATT, adopted the Harmonized Commodities Description and Coding System (HS). Then, with effect from 1 January 1997 it introduced the 1996 HS version at the eight-digit level. The number of tariff lines stood at 5,472. Myanmar has also reduced its tariff rates to 10 per cent of the previously existing rates for most tariff lines. For those items with a tariff rate of 500 per cent, the rate was reduced to 40 per cent, that is, to 8 per cent of the existing rate. The reduced rates took effect on 1 June 1996. Before this reduction, the tariff rates ranged from 0 to 500 per cent. Now the tariff rates stand at 0–40 per cent. This will greatly facilitate tariff reduction to 0–5 per cent in ten years, as required by the CEPT scheme. CEPT Product Lists At the time of Myanmar’s admission into ASEAN, Myanmar had fourteen tariff rates, ranging from 0 to 40 per cent, with an average tariff of 10 per cent. As shown in Table 11.2, tariffs on 68 per cent of the tariff lines are levied at rates of 0–5 per cent. Furthermore, only 52 tariff lines (less than 1 per cent of the total) carry rates higher than 20 per cent, the rate at which concessions commence. In preparing the CEPT product lists, Myanmar took into consideration national sensitivities, economic factors, and requirements of the scheme. With respect to economic factors, Myanmar has weighted potential dynamic gains against tariff revenue losses. The Myanmar economy is likely to gain from lower import costs and technology transfer. The government also considers sectoral effects. For example, if it wishes to promote the garment industry, then imports of cutting, sewing and related machinery and equipment must be encouraged through lower tariffs. The CEPT scheme requires the removal of quantitative restrictions (QRs) and non-tariff barriers (NTBs); disclosure of trade data; elimination of customs surcharges; and placing a growing number of products on the fast track. If QRs, NTBs and customs surcharges cannot be removed in the near future, these products are put in the Temporary Exclusion List (TEL). Of the 15 products encouraged to be placed in the fast track, Myanmar included as many products as possible in the Inclusion List (IL).

© 2001 Institute of Southeast Asian Studies, Singapore

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TABLE 11.2 Union of Myanmar: Distribution of Tariff Lines No.

Tariff Rates (per cent)

No. of Tariff Lines

Percentage of Total

1 2 3 4 5 6 7 8 9 10 11 12 13 14

0 0.5 1.0 1.5 2.0 3.0 4.0 5.0 7.5 10.0 15.0 20.0 30.0 40.0

209 107 1723 600 170 410 50 453 413 336 700 249 39 13

3.8 2.0 31.5 11.0 3.1 7.5 0.9 8.3 7.5 6.1 12.8 4.6 0.7 0.2

Total

5472

100

SOURCE: Customs Tariff of Myanmar, Harmonized Commodity Description and Coding System, 1996 Version, January 1997.

As a primarily agricultural economy, unprocessed agricultural products, such as rice, are sensitive to Myanmar. Thus, it has placed 21 unprocessed agricultural products, in the Sensitive List (SL). Myanmar has also drawn up a list of unprocessed agricultural products (UAP). This list, excluding the SL, consists of some 570 tariff lines. Although Myanmar was initially slated to start reducing tariffs on these products in the year 2002, it accelerated the scheme and started reducing tariffs on 305 products in 1998. This left 265 tariff lines as UAP in the TEL. ASEAN CEPT product lists are shown in Table 11.3, for comparison. Article 9 of the CEPT agreement allows member-states to protect national security; public morals; human, animal or plant life and health; and articles of artistic, historic and archeological value. Myanmar took advantage of this clause and has 108 tariff lines in the General Exception List (GEL). Tariffs on these products will not be reduced. Table 11.4 provides data on the distribution of the CEPT Product Lists.

© 2001 Institute of Southeast Asian Studies, Singapore

© 2001 Institute of Southeast Asian Studies, Singapore

6,060 6,440 8,580 4,949 5,731 8,996 1,497

42,253

2,571 533 2,356

47,713

Brunei Indonesia Malaysia Philippines Singapore Thailand Vietnam

ASEAN-7

Cambodia* Laos* Myanmar

ASEAN-10

78.9

53.6 15.0 43.0

90.6

93.2 88.7 92.3 85.7 97.8 98.4 53.2

%

10,383

1,642 2,818 2,722 17.2

34.2 79.4 49.8

6.8

1.2 40.7

111 1,143 3,201

3.4 9.6 3.9 11.6

%

220 697 362 668

Tariff Lines

Manufactured

TEL

SOURCE: ASEAN Secretariat.

Note: * TEL, SL and GEL are tentative for both countries.

Tariff Lines

Country

IL

574

265

309

55 154 100

Tariff Lines

UAP

1.0

4.8

0.7

0.8 1.7 1.7

%

TABLE 11.3 ASEAN CEPT Product Lists

512

136 119 21

236

7 26

14 23 137 29

Tariff Lines

SL

0.8

2.8 3.3 0.4

0.5

0.1 0.9

0.2 0.3 1.5 0.5

%

1282

451 81 108

642

209 45 60 28 128 26 146

Tariff Lines

2.1

9.4 2.3 2.0

1.4

3.2 0.6 0.6 0.5 2.2 0.3 5.2

%

GEL

60,464

4,800 3,551 5,472

46,641

6,503 7,260 9,293 5,774 5,859 9,140 2,812

Total

272 Khin Ohn Thant

ASEAN Implications for Myanmar

273

TABLE 11.4 Myanmar CEPT Product Lists Product List

Tariff Lines

Percentage

Inclusion List (IL) Temporary Exclusion List (TEL) Sensitive List (SL) General Exception List (GEL)

2,356 2,987 21 108

43.0 54.6 0.4 2.0

Total

5,472

100.0

SOURCE: Union of Myanmar, CEPT Product Lists and Tariff Reduction Plan (Ministry of National Planning and Economic Development, June 1997).

Tariff Reduction Plan In drawing up a tariff reduction plan, Myanmar has agreed to abide by the decisions of the AFTA Council. It began reducing the tariffs in IL from 1 January 1998, and the maximum period for tariff reduction was to be 3 years. By the year 2008, all tariffs on products in the IL and TEL lists will be reduced to 0–5 per cent. For those tariff rates at 7.5 per cent and above, Myanmar has decided to reduce them to 5 per cent. Of the 2,356 tariff lines in the IL, 1,691 are on the fast track. Tariffs on this track will be reduced to 5 per cent by the year 2003. Products in the TEL will be phased into the IL through five equal instalments, beginning on 1 January 2001 and ending on 1 January 2005. UAPs in the TEL will be phased into the IL beginning on 1 January 2002. Myanmar will phase in products which are considered sensitive, starting 1 January 2003 (although ASEAN had set the requirement of 2006) and ending at a tariff rate of 5 per cent on 1 January 2015. Myanmar has already drawn up tariff reduction plans for these three categories of products. Quantitative Restrictions and Non-Tariff Barriers However, Myanmar still needs to remove significant QRs and NTBs. The most outstanding QR in Myanmar is the licensing system. It has existed since Myanmar gained independence in 1948. No matter how rooted the system may be, the Ministry of Commerce will dispense with the licence requirement for the ASEAN countries. As for the elimination of NTBs, Myanmar is in the process of identifying the NTBs. Various economic ministries have identified the rules, regulations or measures that their

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Khin Ohn Thant

ministries have adopted which can deter trade. They are now in the process of taking remedial action. The weak link here is the private sector. The focal point for the private sector is the Union of Myanmar Chamber of Commerce and Industry (UMCCI). In order to involve the private sector in the AFTA process, the Chairman of the UMCCI has been made a member of the policy-making committee of the Myanmar-ASEAN Economic Minister. Nevertheless, the private sector is moving slowly, and it has not contributed towards identifying NTBs. Impact of the CEPT on Myanmar We will examine the direct and indirect effects of the CEPT process on Myanmar. Direct effects include those on exports, imports, and revenues. Indirect effects cover those on FDI and the overall comparative advantage of Myanmar. Exports Myanmar’s exports to the ASEAN countries constitute a little more than 40 per cent of the total exports, as indicated in Table 11.5. Myanmar does not export to Laos, but it has donated rice, glutinous rice, seed paddy, salt, and water pumps to that country during the past two decades. Singapore and Thailand are major buyers of Myanmar’s agricultural and forest products. The majority of the tariff rates on agricultural and forest products are already at 5 per cent and below. For those products with a tariff rate higher than 5 per cent, the maximum rate is 15 per cent. Myanmar’s exports to other ASEAN countries are already on a rising trend and they are expected to rise in the near future. How much of this increase is due to the CEPT scheme will be difficult to delineate. Myanmar has a potential to export value-added products rather than exports in unprocessed form. For example, instead of exporting wood, it can export furniture, and instead of exporting raw fruits and vegetables, it can export processed food. The manufacturing share of Myanmar’s GDP has averaged 9 per cent in recent years. The 40 per cent content requirement of the Certificate of Origin under the CEPT scheme, and a minimum 30 per cent national equity as eligibility criteria for the ASEAN Industrial Co-operation (AICO) scheme can help promote the manufacturing sector. The upside for Myanmar is that it has abundant cheap and effective labour resources and under-utilized land (50 per cent utilization rate). It can fill the vacuum left by other ASEAN countries which are moving into capital-intensive industries. Myanmar has bilateral trade agreements with Asian and East European (former socialist) countries. However, the lack of trading agreements with

© 2001 Institute of Southeast Asian Studies, Singapore

© 2001 Institute of Southeast Asian Studies, Singapore

28.13 12.86 4.55 6.37 6.40 5.20 0.36 10.81

800.85 366.04 129.59 181.33 182.06 147.96 10.20 307.86 2961.90

396.29 524.18 223.01 248.04 108.37 92.31 4.21 90.64

40.87 0.22 845.80 387.97

1274.90

Value

%

100.00

13.38 17.70 7.53 8.37 3.66 3.12 0.14 3.06

1.38 0.01 28.55 13.10

43.04

1990–91

2931.80

438.34 323.65 190.08 217.25 188.10 63.66 12.43 133.22

10.41

53.39 39.01 4.55 683.03 574.69

1354.70

Value

%

100.00

14.95 11.04 6.48 7.41 6.42 2.17 0.42 4.54

0.36

1.82 1.33 0.16 23.30 19.60

46.21

1991–92

3655.40

338.60 615.67 150.43 329.27 343.85 105.97 74.41 420.52

14.15 59.90 0.43 601.69 600.28 0.24

9.26 16.84 4.12 9.01 9.40 2.90 2.04 11.50

0.39 1.64 0.01 16.46 16.42 0.01

34.93

%

100.00

1992–93

1276.70

Value

SOURCE: Central Statistical Organization, Ministry of National Planning and Economic Development, Myanmar.

100.00

0.65

18.42

2846.50

0.13 0.46 0.11 9.10 14.87

3.61 13.12 3.15 258.89 423.40

Total

24.67

702.17

ASEAN 1 Brunei 2 Indonesia 3 Malaysia 4 Philippines 5 Singapore 6 Thailand 7 Vietnam Cambodia Laos China, Republic of India Japan Hong Kong Rest of Asia EEC United States Rest of the World

%

Value

Country

1989–90

TABLE 11.5 Exports of Myanmar by Country (In million kyat)

ASEAN Implications for Myanmar 275

© 2001 Institute of Southeast Asian Studies, Singapore 5405.17

277.48 695.42 261.95 269.12 233.74 96.05 273.03 924.95

842.62 101.99 2.46 883.49 542.75 0.12

2373.43

Value

%

100.00

5.13 12.87 4.85 4.98 4.32 1.78 5.05 17.11

15.59 1.89 0.05 16.34 10.04

43.91

1994–95

5017.25

195.14 1036.78 256.31 321.08 293.45 151.81 216.20 442.20

2103.20 1.59 299.57 147.48 133.10 986.80 533.69 0.97 1.09

Value

100.00

3.89 20.66 5.11 6.40 5.85 3.03 4.31 8.81

41.92 0.03 5.97 2.94 2.65 19.67 10.64 0.02 0.02

%

1995–96 (p.a)

5242.24

282.24 953.99 382.18 361.40 302.79 270.89 257.53 418.93

2012.29 0.10 142.14 305.94 63.64 944.43 556.04

100.00

5.38 18.20 7.29 6.89 5.78 5.17 4.91 7.99

2.71 5.84 1.21 18.02 10.61

38.39

%

1996–97(p) Value

SOURCE: Central Statistical Organization, Ministry of National Planning and Economic Development, Myanmar.

100.00

4.97 15.89 4.44 11.00 7.36 2.93 3.62 7.65

210.06 671.75 187.64 465.13 311.10 123.68 153.16 323.68

4227.80

1.67 2.34 0.06 19.66 18.41

70.80 98.73 2.49 831.07 778.52

Total

42.14

1781.6

ASEAN 1 Brunei 2 Indonesia 3 Malaysia 4 Philippines 5 Singapores 6 Thailand 7 Vietnam Cambodia Laos China, Republic of India Japan Hong Kong Rest of Asia EEC United States Rest of the World

%

Value

Country

1993–94(r)

TABLE 11.5 (continued) Exports of Myanmar by Country (In million kyat)

276 Khin Ohn Thant

ASEAN Implications for Myanmar

277

Western countries may continue to constrain Myanmar’s access to other markets and trading blocs. Imports Myanmar’s imports from the ASEAN countries average about 35 per cent of total imports, as shown in Table 11.6. Singapore and Thailand are Myanmar’s major suppliers, but Malaysia is quickly rising as a major source of supply. Myanmar imports electrical goods, machinery, transport equipment, and consumer goods. These products are included in the IL and TEL, with a few telecommunications products in the GEL. Again, the tariff rates on many items are within the 0–5 per cent range. For others, the highest rate is 20 per cent, the rate at which a country can start enjoying concessions. Motor vehicles and tractors, which are in the “transport equipment” category, have tariff rates as high as 30 and 40 per cent. However, these products are not imported from the ASEAN countries. Although Myanmar’s exports to the ASEAN countries average about 40 per cent of the total, and its imports from the ASEAN countries average about 35 per cent of the total, Myanmar has a trade deficit with all the ASEAN countries. A preliminary study by a Myanmar economist found that Myanmar’s trade with ASEAN is characterized less by competition than by complementarities. Myanmar’s membership in ASEAN may be expected to improve the trade complementarity of AFTA, and hence also result in trade creation. He further argued that only 5 out of the 15 Myanmar products to be placed on the fast track need tariff reduction. Tariffs on the remaining 10 products are already in line with the CEPT scheme. These low rates also apply to the rest of the world (MFN basis). This means that there should be no trade diversion effects (U Myat Thein 1997). Revenue The effect of the CEPT scheme on government revenue will be insignificant. Custom duties account for 23 per cent of total revenue in the state budget — less than one per cent of GDP. It is estimated that the revenue loss on the products in the IL over the ten-year period will be about one per cent of the total tariffs collected in fiscal 1996/97. The negative effect of the CEPT scheme on revenue is reduced because of the change in assessment value. The official exchange rate was 6 kyat to a U.S. dollar, but the government changed the assessment basis of custom duties to 100 kyats to a U.S. dollar in 1996, and then to 150 kyats to a U.S. dollar in 1997. This is a more realistic exchange rate and increases the revenue in kyats per dollar worth of tariffs by 25 times.

© 2001 Institute of Southeast Asian Studies, Singapore

© 2001 Institute of Southeast Asian Studies, Singapore

100.00

5522.76

1205.39 37.23 902.92 32.22 208.28 583.57 678.23 385.90

0.01

1489.01 0.04 17.17 383.52 1.06 532.44 554.78

Value

100.00

21.83 0.67 16.35 0.58 3.77 10.57 12.28 6.99

5336.71

894.97 147.79 1167.61 25.30 170.39 578.33 165.64 285.60

55.65 383.28 0.05 663.68 797.73 0.62 0.07

0.31 6.94 0.02 9.64 10.05

Value 1901.01

%

%

100.00

16.77 2.77 21.88 0.48 3.19 10.84 3.10 5.35

12.44 14.95 0.01

1.04 7.18

35.62

1991–92

26.96

1990–91

5365.31

0.25 945.96 123.75 1536.13 40.05 238.31 248.70 224.31 286.08

17.63 2.31 28.63 0.75 4.44 4.64 4.18 5.33

0.07

10.73 12.97

2.18 6.14

32.02

%

100.00

1992–93

1718.25 0.01 116.95 329.36 0.22 575.83 695.64 0.24 3.52

Value

SOURCE: Central Statistical Organization, Ministry of National Planning and Economic Development, Myanmar.

3395.00

15.26 1.35 23.77 0.26 4.47 21.20 1.82 3.29

0.02 517.97 45.87 806.96 8.71 151.83 719.92 61.80 111.68

Total

28.58 0.03 0.32 2.36 0.04 9.33 16.5

970.24 0.98 10.94 80.06 1.48 316.69 560.09

ASEAN 1 Brunei 2 Indonesia 3 Malaysia 4 Philippines 5 Singapore 6 Thailand 7 Vietnam Cambodia Laos Rest of SEA China, Republic of India Japan Hong Kong Rest of Asia EEC United States Rest of the World

%

Value

Country

1989–90

TABLE 11.6 Imports of Myanmar by Country (In million kyat)

278 Khin Ohn Thant

© 2001 Institute of Southeast Asian Studies, Singapore

2576.9 0.01 321.57 567.3 2.32 820.26 865.42 0.02

0.03 17.5 1261.43 281.35 2020.15 134.94 577.26 455.89 282.8 315.09

7923.34

ASEAN 1 Brunei 2 Indonesia 3 Malaysia 4 Philippines 5 Singapore 6 Thailand 7 Vietnam Cambodia Laos Rest of SEA China, Republic of India Japan Hong Kong Rest of Asia EEC United States Rest of the World

Total

100.00

8332.33

320.04 781.89 13.00 1215.68 830.18 0.21 6.60 0.09 9.33 1019.38 308.65 1962.7 253.00 548.83 334.84 102.18 625.73

4.06 7.16 0.03 10.35 10.92

0.22 15.92 3.55 25.5 1.70 7.29 5.75 3.57 3.98

3161.00

Value

32.52

%

%

100.00

0.11 12.23 3.7 23.56 3.04 6.59 4.02 1.23 7.51

0.08

3.84 9.38 0.16 14.59 9.96

37.93

1994–95

10301.62

0.88 1433.82 344.85 2505.76 169.44 532.16 668.6 360.13 165.81

4120.16 0.02 350.26 615.9 4.85 1819.69 1318.84 10.6 0.01

Value

100.00

0.01 13.92 3.35 24.32 1.64 5.17 6.49 3.50 1.61

3.40 5.98 0.05 17.66 12.80 0.10

39.99

%

1995–96 (p.a)

11343.00

1.68 1067.38 585.41 2553.89 149.09 553.36 294.96 560.46 1226.47

295.76 847.46 4.69 2122.78 1079.61

4350.3

100.00

0.02 9.41 5.16 22.52 1.31 4.88 2.60 4.94 10.81

2.61 7.47 0.04 18.71 9.52

38.35

%

1996–97(p) Value

SOURCE: Central Statistical Organization, Ministry of National Planning and Economic Development, Myanmar.

Value

Country

1993–94

TABLE 11.6 (continued) Imports of Myanmar by Country (In million kyat)

ASEAN Implications for Myanmar 279

280

Khin Ohn Thant

FDI Although FDI has been increasing in Myanmar since the FIL was promulgated in late 1988, it is unlikely that low CEPT tariffs will contribute much to that trend. AFTA and the CEPT process will not have much impact on Myanmar’s FDI primarily because tariff rates are already relatively low. According to Dataconsult, in Survey Results, the long-term strategic importance of the country, the potential domestic markets, natural resources, and low-cost labour are Myanmar’s biggest advantages in attracting investment from abroad. However, there are constraints that reduce or offset these advantages, such as foreign exchange management, a bloated bureaucracy, lack of telecommunications facilities, infrastructure weaknesses, power problems, and recruiting and retaining managers (Dataconsult 1996). Myanmar needs to solve these problems, which will have a much greater effect on FDI than the low tariff rates offered by the CEPT scheme. Comparative Advantage According to Zhang (1996), AFTA’s rules of origin will produce trade and investment diversion in the agricultural and manufacturing sectors of the ASEAN members. If we accept this argument, foreign firms will be encouraged to make physical investments in Myanmar. As Myanmar already has comparative advantage in labour- and land-intensive activities, the effects of tariff reduction in AFTA may intensify this advantage and contribute to Myanmar’s economic development. Furthermore, these effects, together with the potential impact of the AICO scheme, can help Myanmar integrate into the region with increased export competitiveness. This can be a launching pad for competition in a wider Asia market, and thereafter an entrance into the world market. Conclusion From Myanmar’s point of view, the impact of AFTA will depend primarily on how it benefits from trade and foreign investment. However, these benefits depend more on what Myanmar does to promote trade and attract investments. Myanmar’s economy is still constrained by many weaknesses. First, its private sector is weak and not even regionally competitive. Close cooperation between the government and the private sector is needed to identify barriers and seek ways of removing them. Secondly, it has set up the legal framework to encourage investment, but the laws need to be buttressed by improved mechanisms for dispute settlement and arbitration; rules and regulations need to be simplified to reduce rent-seeking behaviour;

© 2001 Institute of Southeast Asian Studies, Singapore

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281

and institutions need to make trade transactions more transparent. Thirdly, Myanmar requires a stable macroeconomic environment with prudent policies to ensure full integration of local firms into the foreign sector. Fourthly, Myanmar’s dual exchange rate is distorting trade and investments. Though some have argued that the cost of realigning the exchange rate will not be high, as many transactions are carried out at the parallel exchange rate, the difference between the official and parallel exchange rates is very high — about 45 to 50 times. The government would like to reduce these distortions but “with a human face”. Myanmar hopes that by joining ASEAN and AFTA external assistance will be furthcoming. It requires help in institution-building and confidencebuilding exposure. Training programmes can assist both the public and private sector to develop skills and expertise, so that they can implement and effectively participate in all ASEAN economic agreements. Finally, to maximize its benefits in joining ASEAN, Myanmar needs to address a set of development and reform policy issues,2 for the immediate term, and for the long run. For the immediate term, three priority areas for policy reforms are: 1. exchange rate and trade policies; 2. levelling the playing field for the private sector; and 3. property rights — land ownership and tenure. For the long run, it is essential that: 1. the government undertakes appropriate macroeconomic management which will enable a non-inflationary high rate of economic growth, while simultaneously reducing the twin deficit on the budget and current account; 2. the government proceeds with foreign trade and investment liberalization; privatization of state economic enterprises; fiscal and financial sector reforms; and private sector development, especially the promotion of small and medium enterprises; 3. infrastructure is improved; and 4. the government intensifies domestic savings mobilization and develops a domestic capital market.

© 2001 Institute of Southeast Asian Studies, Singapore

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Khin Ohn Thant

Notes 1. Figures are expressed in the local currency, the kyat (K). 2. The change in the name of the government indicates a shift of emphasis on development. Having attained peace with about 90 per cent of the rebels, the government can now devote more resources for development than on restoring law and order. Thus, a change of name from State Law and Restoration Council to State Peace and Development Council.

References Dataconsult. Survey Results, Myanmar Business Roundtable. Yangon, March 1996. Review of the Financial, Economic and Social Conditions. Planning Department, Ministry of National Planning and Economic Development, various issues. U Myat Thein. “AFTA and Myanmar: Challenges and Prospects”. Unpublished paper, April 1997. Union of Myanmar. CEPT Product Lists and Tariff Reduction Plan. Ministry of National Planning and Economic Development, June 1997. Zhang, Zhoyong. “Implications of AFTA and APEC for Myanmar’s Trade and FDI”. April 1996.

© 2001 Institute of Southeast Asian Studies, Singapore

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Vietnam’s Integration into AFTA: Theoretical and Empirical Perspectives1

12

CAROLYN L. GATES

Since the introduction of doi moi (renovation) in 1987, Vietnam has progressively opened itself to international market economies. Trade reform in Vietnam has been accelerated by its integration into the Association of Southeast Asian Nations (ASEAN) and the ASEAN Free Trade Area (AFTA). By January 2006, Vietnam will acquire full accession to AFTA, which requires all ASEAN members to reduce tariffs to 0-5 per cent on all goods traded among member economies, eliminate non-tariff barriers, and dismantle obstacles to trade among ASEAN in other ways. Vietnam’s trade deregulation is prompting disparate responses from various segments of the economy and state. One prevalent reaction is that trade deregulation and restructuring are no more than external obligations that are essential to further other Vietnamese objectives. They are rarely viewed as opportunities to increase the competitiveness of domestic enterprises and industries. These attitudes derive partly from the reality that trade reform and economic opening entail demanding changes in a relatively short period of time and sometimes high immediate adjustment costs, while the realization of potentially substantial benefits from the process is likely to require a much longer time horizon. The impact of trade deregulation on the economy in the medium run is more difficult to assess. It can be assumed that Vietnam will be very different in six to seven years from today: it is likely to have enjoyed real economic growth of 4–5 per cent per annum for more than a decade and half; it can be expected to produce more 283

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competitive and diversified goods in a marketized economy; and it will comprise a market of at least 85 million people, inter alia. Trade reform, therefore, must be placed in the context of Vietnam’s dynamic economic environment. This chapter will examine theoretical and empirical issues salient to Vietnam’s trade liberalization under AFTA, the potential adjustment costs and dislocationary effects of trade restructuring, and the long-run opportunities and challenges that this openness may present. It is organized as follows. The first section examines various theoretical perspectives on trade and their applicability to Vietnam. The following two sections discuss Vietnam–ASEAN trade and Vietnam’s integration into AFTA. The issue of trade deregulation and its impact on structural change in Vietnam is the subject of the fourth section. The chapter continues by discussing the potential effects of trade liberalization on Vietnam’s industrial competitiveness. The fifth section examines the relationship between fiscal performance and tariff reduction in Vietnam. Concluding remarks are presented in the final section. Trade Theory, Models, and Approaches We will first examine theories and methodologies which are most appropriate to analyse Vietnam’s trade policies, liberalization process, and their effects on the economy. Is traditional trade theory most suitable for this task? Is new trade theory germane to Vietnam’s conditions? While the grand tradition of trade theory has embraced Ricardian comparative advantage, new trade theory concentrates on Smithian specialization and increasing returns. Traditional trade theory answers the basic question on the “why” of international trade in a way that was generally accepted as conventional wisdom until the 1980s: nations trade because they are different, whether in resources, technology, tastes, or other variables. New trade theory does not reject that answer, but adds other reasons for trading: firms may wish to trade to take advantage of specialization, because of economies of scale and increasing returns in production, inter alia. Paul Krugman argues: conventional trade theory views world trade as taking place entirely in goods like wheat; new trade theory sees it as being largely in goods like aircraft. Since a good part of world trade is in goods like wheat, and since even trade in aircraft is subject to some of the same influences that bear on trade in wheat, traditional theory has by no means been disposed of completely. Yet the new theory introduces a whole set of new possibilities and concerns (Krugman 1994, pp. 1–2).

It is evident in the case of Vietnam, however, that most of its trade at its current stage of development is in goods such as wheat rather than

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aircraft, as Tables 12.1 and 12.2 show. Nevertheless, new trade theory may inform analysis of Vietnam’s trade in several areas: the influence of “home market effects” on trade (that is, effects from the tendency of countries to export goods for which they have a relatively large domestic market); the development of two-way trade; the roles of economies of scale and increasing returns in technological innovation and their relationship to trade; and the impact of imperfect competition on trade. But traditional trade theory is more promising to assess the principal current factors related to the expansion of Vietnamese trade and the potential effects of greater openness. Thus, our analysis will primarily employ traditional tools and concepts like comparative advantage to examine the responsiveness of, and impact on, Vietnam’s industrial producers, consumers, and the state to trade liberalization and tariff reduction (see Greenaway and Milner 1987; and Kirkpatrick 1987). As Vietnam accelerates trade and other market reforms, it will become increasingly important to model the multi-varied effects of the process on trade levels, patterns, employment, incomes, and general welfare. Economists have developed computable general equilibrium (CGE) models to analyse trade-related issues. However, they have been fraught with methodological problems, especially first generation models, which were static and assumed

TABLE 12.1 Commodity Composition of Vietnamese Exports, 1996 Exports

US$ million

Heavy Industrial Goodsa Light Industrial/Handicraft Goodsb Agricultural Goodsc Forest Goods Aquatic Goods Other

2,085.0 2,101.0 2,159.6 212.2 696.5 1.5

Total

7,255.8

NOTES: a Heavy industrial products composed mainly of petroleum crude, coal, tin. b Light industrial and handicrafts composed mainly of garments. c Agricultural products composed mainly of rice, rubber, coffee, cashew nuts. SOURCE: CEIC Database.

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TABLE 12.2 Commodity Composition of Vietnamese Imports, 1996 Imports Production Goodsa Fuel and Raw Materialsb Consumer Goods Food Foodstuffsc Intermediate Goods Other Consumer Goods Total NOTES:

a

b

c

US$ million 9,660.6 6,585.6 1,483.0 100.1 319.2 216.5 847.2 19,212.2

Production goods mainly composed of automobiles and motorcycles. Fuel and raw materials mainly composed of petroleum products, iron, steel, and cement. Foodstuffs mainly composed of sugar.

SOURCE: CEIC Database.

perfect competition. Some deficiencies of the perfect competition hypothesis were addressed by the introduction of imperfect competition in later CGE models, which showed much greater benefits from trade liberalization than traditional CGE models (see Harris 1984). The constraints of the static nature of the early CGE models were confronted by a more rigorous formulation of inter-temporal effects through the specification and resolution of dynamic models. One such effort, undertaken by Jean Mercenier et al. (1992), was the specification of a computable inter-temporal general equilibrium (CIGE) model, which was applied to Brazil and examined the dynamic effects of change in tariff rates. Undoubtedly, this debate will continue, and new models will be developed to improve trade analysis (see Packard and Thurman 1996; and McKibben 1993). CGE models have been developed for Vietnam’s economy, but “data availability and experience transferability” remain serious constraints on such analysis (Truong, Parmenter and Horridge 1995, p. 19).2 Although the CGE-variant models comprise potentially powerful techniques for policy analysis, it is likely that the state of Vietnamese data will influence the speed of their development and acceptance. A gravity model can be employed to examine the determinants of trade levels between partners, measuring the potential of, and obstacles to,

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bilateral trade. Pioneered by Jan Tinbergen (1962), the gravity model made bilateral trade levels dependent upon two trade variables (gross national product [GNP] of importing and exporting economies) and three resistance variables (distance, and two dummy variables for adjacent countries, and membership of a common preferential area). Tinbergen specified the model as follows: Eij = aoYia1Yja2Dija3Na4Pa5 where ao Eij Yi Yj Dij N P

is a constant, is exports from country i to country j, is GNP of exporting country, is GNP of importing country, is distance between country i and country j is a dummy variable for adjacent countries, is a dummy variable for common membership of a preferential tariff area.

During the past four decades, the model has been elaborated to include additional trade and resistance variables, and modified in other ways.3 Applying gravity methodology to Vietnam in the context of Asia-Pacific trade, Le, Nguyen and Bandara (1996) found that as the model predicts, economic size, economic development level, and distance are major determinants of bilateral trade between the Asia-Pacific economies; and that Vietnam shifted from an “under-performer” in 1989 to an “average” performer in 1994 (Le, Nguyen and Bandara 1996, p. 196). The major determinants of the substantial growth of Vietnam–Asia-Pacific trade in recent years are now the same factors that are important in determining the intra-regional trade levels of other Asia-Pacific countries, namely, GNP, GNP per capita, and distance. Therefore, barriers to trade, which seriously hampered Vietnam’s foreign trade before 1990, now appear to affect it no more than they do other Asia-Pacific economies (ibid.). Unlike the gravity model, the trade intensity approach — pioneered by A. J. Brown (1949) and further developed by Kiyoshi Kojima (1964) — accepts as a given the level of import and export trade between two economies and then seeks to explain variations in trade flows as a function of barriers, or resistances, to trade. Two types of resistances to bilateral trade can be identified: objective resistances which require resources to surmount identified obstacles (which can be divided into two basic types — the first comprises transport and other costs required to overcome geographic distance, and the second includes costs to overcome official barriers like

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protection); and subjective resistances that stem from imperfect information, internal constraints on profit-maximization, and decisionmaking of firms engaged in international trade, which affect the volume or commodity composition of trade (Drysdale and Garnaut 1982, p. 62). The trade intensity approach is often employed to investigate the effects of policies and institutions on bilateral trade levels and the trade potential of bilateral trade partners, if resistances are equal in bilateral trading relationships across the board. Kojima specified the intensity of trade index, Iij , as: Iij = (Xij /Xi))(Mj /[Mw – Mi ]) where Xij Xi Mj Mi Mw

is is is is is

country i’s exports to country j, i’s total exports j’s total imports, i’s total imports, total world imports.

If the index is greater (less) than unity, a country is exporting more (less) to another country, compared with the latter’s share in world imports. Although the trade intensity approach is somewhat rough,4 it provides a good starting point to analyse the nature and importance of various forms of trade resistances that influence bilateral trade flows (Drysdale and Garnaut 1982, pp. 80–81). Hence, this index and its elaborations — for example, complementarity and country bias indices — shed light on the character of resistances to trade flows, their impact on size, commodity composition, and gains from foreign trade, and the policy implications derived from such analysis. This approach has been applied to Vietnam, ASEAN, and selected bilateral trade partners by Piei and Khalifah (1996). As Table 12.3 shows, Vietnam’s trade with Singapore, Malaysia, and Indonesia was intensive for the years 1990–94, while ASEAN’s trade with Vietnam was highly intensive for 1993 and 1994. This indicates that resistances to bilateral trade between Vietnam and these three ASEAN members were low, resulting from such factors as short distances, relatively cheap transport costs, and better information flows between Vietnam and these countries. At the same time, it also shows a very high trade intensity between Vietnam and Japan, and somewhat less intensity between Vietnam and the developing countries. By contrast, one finds low trade intensity between Vietnam and Europe, Vietnam and the United States, and Vietnam and other industrial countries. This low intensity reflects objective resistances such as high transport costs and the U.S. embargo (until 1994), and

© 2001 Institute of Southeast Asian Studies, Singapore

1990 1993 1994 1990 1993 1994

0.51 3.74 4.20

0 0 0 15.52 5.76 5.88

Vietnam Brunei

1.01 1.24 1.11 0.60 0.49 0.57

Indicator

© 2001 Institute of Southeast Asian Studies, Singapore

12,121 170 71.3 215 6.4* Low 51 12 139

Vietnam

4.73 3.77 3.66 4.17 3.70 2.71

2.30 1.67 0.74 3.54 2.46 2.40

Brunei 3,800** 15,390** 0.274 46.8** n.a. High n.a. n.a. n.a.

59,660 3,140 19 58 6.2 Upper middle n.a. 22 1,612

Malaysia 138,528 740 187.2 98 5.8 Lower middle 15 23 233

Indonesia

0 0 0.07 1.26 1.17 1.19

55,080 850 64.8 216 1.4 Lower middle 21 10 419

Philippines

2.71 1.23 1.11 1.50 1.27 1.27

55,580 19,850 2.8 2,800 6.9 High n.a. 60% 0–200%

Import Commodities Raw materials and investment goods Essential consumer goods Standard consumer goods Motor vehicles