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ASSESSING TRADE CREATION AND TRADE

DIVERSION EFFECTS OF ASEAN FREE TRADE AREA

Sharifah Azrin-Azalea Binti Wan Zawawie

Master of Science

(Economics)

2014

UN

IVE

RS

IT

IMALAYSIA

SA

RA

WA

K

U N I M AS

Faculty of Economics and Business

ASSESSING THE TRADE CREATION AND TRADE DIVERSION EFFECTS

OF ASEAN FREE TRADE AREA

SHARIFAH AZRIN-AZALEA BINTI WAN ZAWAWIE

(11021768)

A thesis submitted

In fulfilment of the requirements for the Master of Science (Economics)

Faculty of Economics and Business

UNIVERSITI MALAYSIA SARAWAK

2014

STATEMENT OF ORIGINALITY

The work described in this

is to the best of the author’s knowledge that of the author except

where due reference is made.

(Date Submitted) Sharifah Azrin-Azalea Bt

Wan Zawawie

(11021768)

iv

ACKNOWLEDGEMENT

First and foremost I offer my sincerest gratitude to my supervisor, Dr. Mohammad

Affendy Arip, who has been supported me throughout my research years with his

patience and knowledge whilst allowing me rooms to work in my own way. I attribute

the level of my Master’s degree to his encouragement and effort and without him this

would not have been completed or written. One simply could not wish for a better and

compatible supervisor.

I also would like to thank the Centre for Graduate Studies for granting me the

‘Zamalah Penyelidikan Naib Canselor (ZPNC)’ scholarship for my Master’s degree.

All the benefits and opportunities had eased up many difficulties and hiccups during

my research period in many ways.

Apart from that, I gratefully acknowledge my fellow research friends who in one

way or another were cooperative especially when there were difficult moments and

arguments during the course of learning and knowledge sharing.

In addition to that, I would like to convey special acknowledgement to my

lovely parents, my family members and above all of us, the omnipresent God, for

giving me the strength to plod on despite my constitution wanting to give up and throw

in the towel, thank you so much. Last but no t least, I would like to thank my

compassionate husband for continuously provides me with excellent technical and

moral supports. I could not ask for more. Thank you all.

v

ASSESSING THE TRADE CREATION AND TRADE DIVERSION EFFECTS

OF ASEAN FREE TRADE AREA

ABSTRACT

Over the last 22 years, intra-ASEAN trade has found to be liberalized through the formation

of AFTA. This study aims to investigate whether the formation of AFTA has strengthened the

intra-regional trade by empirically examine the impact of AFTA on intra-ASEAN trade

because the arguments still exist whether the formation of AFTA has strengthened the intra-

regional trade. In respond to the critics on many past studies that used only aggregate data that

provides no information on the nature of intra-trade activities at the commodity level, this

study employs the extended gravity model at disaggregated level using the two-digit Standard

International Trade Classification (SITC) Revision 2 for all commodities. Based on Hausman

specification test, the random effect model was selected for the panel analysis of AFTA

member exports for the period 1980 to 2012. Of 66 sets of regressions that I run, the

coefficients of AFTA were statistically significant in 55 cases. Income level, population,

transportation costs and AFTA effect have found to be significant with intra-ASEAN trade.

The results show that trade creation exists for SITC0 (live animals for food), SITC 2 (crude

materials), SITC 3 (mineral fuels), SITC 4 (animal and vegetable oils) and SITC 9 (other

commodities). This indicates that AFTA has been a successful in promoting intra-ASEAN

trade. However, ASEAN needs to improve its policies especially targeting on growth and

development as majority of the commodities being traded fell under electronics and

automotive categories. On the other hands, the AFTA member countries need to explore other

sectors that are available to them such as agricultural business to overcome problems with

food security and hunger problems.

vi

PENILAIAN IMPAK PENGWUJUDAN ATAU PELENCONGAN

PERDAGANGAN KE ATAS PENUBUHAN KAWASAN DAGANGAN

BEBAS ASEAN (AFTA)

ABSTRAK

Sejak penubuhan AFTA 22 tahun yang lepas, perdagangan intra-ASEAN telah berjaya

diliberalisasikan oleh negara-negara anggotanya. Oleh itu, kajian secara empirikal telah

dilaksanakan bertujuan untuk mengkaji impak penubuhan Kawasan Dagangan Bebas ASEAN

(AFTA) ke atas pengwujudan perdagangan atau pelencongan perdagangan kerana masih ada

pendapat yang mengkritik pembentukan AFTA dapat mengukuhkan perdagangan intra-

ASEAN sedangkan terdapat kajian yang menyokong bahawa penubuhan AFTA dapat

mewujudkan perdagangan sesama negara ASEAN. Oleh itu, kajian ini dilakukan berasaskan

penganggaran model graviti dengan menggunakan Standard International Trade Classification

(SITC) Revision 2 pada dua digit untuk kesemua komoditi sebagai respon kepada kritikan-

kritikan ke atas kajian-kajian lepas yang kebanyakkannya dilakukan secara aggregat yang

tidak memberikan maklumat mengenai kegiatan-kegiatan perdagangan intra-ASEAN di

peringkat komoditi. Berdasarkan ujian spesifikasi Hausman, model kesan rawak telah dipilih

untuk analisis secara panel ke atas jumlah ekspot ahli-ahli AFTA dari tahun 1980 sehingga

2012. Daripada 66 jumlah set penganggaran yang dilakukan, secara statistiknya pemboleh

ubah dami AFTA adalah signifikan untuk 55 kes. Tahap pendapatan, jumlah penduduk, kos

pengangkutan dan kesan AFTA juga didapati signifikan dengan perdagangan intra-ASEAN.

Keputusan menunjukkan bahawa pengwujudan perdagangan jelas bagi komoditi SITC 0

(Haiwan untuk dijadikan makanan), SITC 2 (bahan mentah), SITC 3 (bahan api, mineral),

SITC 4 (minyak haiwan dan sayur-sayuran) dan juga SITC 9 (komoditi-komoditi lain). Ini

menunjukkan bahawa AFTA berjaya meningkatkan aktiviti perdagangan intra-ASEAN.

Walaubagaimanapun, ASEAN seharusnya perlu meningkatkan lagi dasar-dasar yang

tertumpu kepada pertumbuhan dan pembangunan kerana majoriti komoditi yang didagangkan

terjatuh di bawah kategori elektronik dan otomotif. Dalam erti kata lain, negara-negara

anggota perlulah meneroka sektor-sektor lain, contohnya sektor pertanian. Sektor pertanian

dikatakan penting dalam mengatasi masalah keselamatan makanan dan kebulur

Table of Contents

ACKNOWLEDGEMENT……………………………………….………..…… iv

ABSTRACT………………………………………………………….………… v

ABSTRAK……………………………………………………………………. vi

LIST OF TABLES……………………………………………….…………... vii

LIST OF FIGURES………………………………………................................ viii

CHAPTER ONE: INTRODUCTION……………………………….……..... 1

1.1 Introduction…………………………………….…………………….. 1

1.2 Overview of ASEAN Free Trade Area (AFTA)………………..……… 7

1.3 Trade Performance of AFTA Member Countries………………........… 11

1.4 Problem Statement…………………………....…...………………….... 13

1.5 Motivation of the Study……………………………………………..... 15

1.6 Objectives of the Study…………………………….....................….... 16

1.6.1 General Objective……………………………........……….… 16

1.6.2 Specific Objectives………………………….…..…………… 17

1.7 Significance of the Study…………………………………………..….. 17

1.8 Limitations of the Study……………………….....………………..… 18

1.9 Structural of the Study………………………………………..…..……. 19

CHAPTER TWO: LITERATURE REVIEW……………………………. 20

2.1 Introduction……………………………………………………………. 20

2.2 Theoretical Framework for Trade Creation and Trade Diversion….… 20

2.2.1 Trade Creation……………………………………………... 22

2.2.2 Trade Diversion…………………………….......................… 24

2.3 Economic Integration and Gravity Model………………………….… 25

2.4 Economic Integration, Trade Creation and Trade Diversion………..… 27

2.5 Concluding Remarks………………………………………………….... 35

CHAPTER THREE: METHODOLOGY…………………….…................. 36

3.1 Introduction……………………………………………………..……… 36

3.2 Research Design………………………………………………….…... 36

3.2.1 Economic Integration and Gravity Model………….……… 36

3.2.2 Augmented Gravity Equation with Dummy Variables…….... 39

3.2.3 Panel Data Analysis………………………….....................…. 40

3.3 Data Collection…………………………………………………........... 49

CHAPTER FOUR: FINDINGS……………………………………..……….. 51

4.1 Introduction……………………………………………………………. 51

4.2 Gravity Model Results……………………………………………......... 52

4.3 The Impact of AFTA on Trade at Commodity Level………………… 68

4.4 Concluding Remarks………………………………………………….. 152

CHAPTER FIVE: CONCLUSION AND RECOMMENDATIONS…...… 154

5.1 Conclusion………………………………………………….…………. 154

5.2 Recommendations...……………………………………….…………… 156

5.3 Policy Recommendations………………………………………………. 158

REFERENCES……………………………………………………………….. 160

vii

List of Tables

Table 1.1 Trend of Intra-ASEAN Export: Priority Integration Sectors’ Products (in

US$Million………………………………………………………………… 6

Table 1.2 Timetable for Accelerating AFTA…………………………………………. 8

Table 1.3 AFTA Common Effective Preferential Tariff (CEPT) List for 2008……… 10

Table 1.4 Average CEPT-AFTA Tariff Rates (1993-2010)………………………….. 11

Table 1.5 Trade Performance of AFTA Member States by Commodity from 1990 to

2012 (SITC Revision 2 in US$ Million)……………………………………. 12

Table 2.1 Summary of Literatures……………………………………………………. 34

Table 3.1 Random Effect and Fixed Effect Model…………………………………… 44

Table 3.2 List of Bilateral Trade between ASEAN-4 Countries……………………… 50

Table 4.1 Estimation Results of Gravity Model Specification 1980-2012 (Random

Effect) – SITC 0……………………………………………………………. 55


Effect) – SITC 1……………………………………………………………. 56


Effect) – SITC 2……………………………………………………………. 57


Effect) – SITC 3……………………………………………………………. 58


Effect) – SITC 4……………………………………………………………. 59


Effect) – SITC 5……………………………………………………………. 60


Effect) – SITC 6……………………………………………………………. 61


Effect) – SITC 7……………………………………………………………. 62


Effect) – SITC 8……………………………………………………………. 63


Effect) – SITC 9……………………………………………………………. 64

Table 4.11 Top 10 Commodities……………………………………………………….. 68

Table 4.12 Bilateral Trade Code Description…………………………………………... 68

viii

List of Figures

Figure 1.1 ASEAN Total Trade, Intra-ASEAN Trade and Extra-ASEAN Trade from

1993 to 2012 (in US$ Million)……………………………………………..

2

Figure 2.1 Trade Creation Diagram…………………………..…………………….… 23

Figure 2.2 Trade Diversion Diagram……………………………………………….… 23

Figure 4.1 SITC00: Live animal chiefly for food…………………………..………..... 73

Figure 4.2 SITC01: Meat and preparations……………………………………...……. 74

Figure 4.3 SITC02: Dairy products and birds eggs………………………………...…. 75

Figure 4.4 SITC03: Fish, crustacean and molluscs………………………………...…. 76

Figure 4.5 SITC04: Cereals and cereals preparations………………………….…..…. 77

Figure 4.6 SITC05: Vegetables and fruits………………………………………...…... 78

Figure 4.7 SITC06: Sugar and honey……………………………………………...….. 79

Figure 4.8 SITC07: Coffee, tea, cocoa and spices…………………………………….. 80

Figure 4.9 SITC08: Feeding stuff for animals………………………………………… 81

Figure 4.10 SITC09: Miscellaneous edible products……………………………...…… 82

Figure 4.11 SITC11: Beverages…………………………………………………...…… 84

Figure 4.12 SITC12: Tobacco…………………………………………………..……... 85

Figure 4.13 SITC21: Hides, skins and fur skins………………………………..……… 86

Figure 4.14 SITC22: Oil seeds and oleaginous fruit…………………………..………. 87

Figure 4.15 SITC23: Crude rubber……………………………………………..……… 88

Figure 4.16 SITC24: Cork and wood…………………………………………...……… 89

Figure 4.17 SITC25: Pulp and waste paper……………………………………..……... 90

Figure 4.18 SITC26: Textiles fibres and their wastes…………………………………... 91

Figure 4.19 SITC27: Crude fertilizer and crude minerals………………………...……. 92

Figure 4.20 SITC28: Metaliferous ores and metal scarp………………………...……... 93

Figure 4.21 SITC29: Crude animal and vegetable materials…………………..………. 94

Figure 4.22 SITC32: Coal, coke and briquettes………………………………………… 98

Figure 4.23 SITC33: Petroleum, petroleum products………………………..…….…… 99

Figure 4.24 SITC34: Gas……………………………………………………..………... 100

Figure 4.25 SITC41: Animal and vegetable oils and fats………………………………. 102

Figure 4.26 SITC42: Fixed vegetable oils and fats……………………………………... 103

Figure 4.27 SITC43: Animal and vegetable oils and fats, processed and waxed……..... 104

Figure 4.28 SITC51: Organic chemicals………………………………………...……... 106

Figure 4.29 SITC52: Inorganic chemicals……………………………………...……… 107

Figure 4.30 SITC53: Dyeing, tanning and colouring materials………………..……….. 108

Figure 4.31 SITC54: Medicinal and pharmaceutical products…………………………. 109

Figure 4.32 SITC55: Oils and perfume materials………………………………………. 110

Figure 4.33 SITC56: Fertilizers……………………………………………...………… 111

Figure 4.34 SITC57: Explosives and pyrotechnic products…………………...……….. 112

Figure 4.35 SITC58: Artificial resins and plastic materials………………...………….. 113

Figure 4.36 SITC59: Chemical materials and products……………………..…………. 114

Figure 4.37 SITC61: Leather, dress fur skins………………………………..………… 117

ix

Figure 4.38 SITC62: Rubber manufactures………………………………..…………... 118

Figure 4.39 SITC63: Cork and wood, cork manufactures…………………..…………. 119

Figure 4.40 SITC64: Paper, paperboard and articles of pulp…………………………… 120

Figure 4.41 SITC65: Textile yarn, fabrics, made-up articles…………………………… 121

Figure 4.42 SITC66: Non-metallic mineral manufactures…………………...………… 122

Figure 4.43 SITC67: Iron and steel……………………………………………...……... 123

Figure 4.44 SITC68: Non-ferrous metals……………………………………...……….. 124

Figure 4.45 SITC69: Manufactures of metals………………………………...………... 125

Figure 4.46 SITC71: Power generating machinery and equipment…………………….. 128

Figure 4.47 SITC72: Machinery specialized for particular industries………………….. 129

Figure 4.48 SITC73: Metalworking machinery………………………………...……… 130

Figure 4.49 SITC74: General industrial machinery and equipment……………………. 131

Figure 4.50 SITC75: Offices machines and automatic data……………………..…….. 132

Figure 4.51 SITC76: Telecommunications, sounding recording…………………...….. 133

Figure 4.52 SITC77: Electric machinery, apparatus and appliances…………………… 134

Figure 4.53 SITC78: Road vehicles………………………………………………...….. 135

Figure 4.54 SITC79: Other transport equipment……………………………………….. 136

Figure 4.55 SITC81: Sanitary, plumbing, heating, lighting fixtures and fittings……… 139

Figure 4.56 SITC82: Furniture and parts thereof………………………………..…….. 140

Figure 4.57 SITC83: Travel goods, handbags and similar containers………………….. 142

Figure 4.58 SITC84: Articles of apparel and clothing accessories……………………... 143

Figure 4.59 SITC85: Footwear…………………………………………………..…….. 144

Figure 4.60 SITC87: Professional, scientific, controlling instruments…………………. 144

Figure 4.61 SITC88: Photographic equipment and supplies……………………...……. 145

Figure 4.62 SITC89: Miscellaneous manufactured articles……………………...…….. 146

Figure 4.63 SITC93: Special transactions………………………………………...……. 148

Figure 4.64 SITC94: Live animals……………………………………………...……… 149

Figure 4.65 SITC95: Armoured fighting vehicles, war firearms, ammunition…..……... 150

Figure 4.66 SITC97: Gold non-monetary………………………………………...……. 151

1

INTRODUCTION

1.1 Introduction

ASEAN Free Trade Area (AFTA) was first introduced during the Fourth ASEAN

Summit that took place in Singapore in January 1992 as an initial step towards the

formation of ASEAN Economic Community by 2015. To date, there are ten countries

that are actively participating under AFTA namely Brunei, Indonesia, Malaysia, the

Philippines, Singapore, Thailand, Vietnam, Laos, Myanmar and Cambodia. AFTA is

said to be the most solid symbol of ASEAN’s long-term commitment to economic

integration (Li & Park, 2004).

The ultimate objective of AFTA is to eliminate intra-regional tariffs and non-

tariffs barriers by 2010. In order to realize this objective, the Common Effective

Preferential Tariff (CEPT) Scheme was introduced to its member countries as a

systematic tax reduction system so as to prepare the member countries with zero to

five percent tariff band by January 1st, 2002. Due to several constraints and crises, this

time target for zero-tariffs rate was, however, being adjusted to 2010 for ASEAN-6

(Brunei, Indonesia, Malaysia, Singapore, the Philippines and Thailand) and to 2018 to

its latest member countries namely Cambodia, Laos, Myanmar and Vietnam

(Soesastro, 2005). Through the concept of CEPT Scheme, member states were given

the standardized preferential tariff treatments which covers almost all commodities.

According to Hapsari and Mangunsong (2006) and Ho (2010), tariff reduction

has greatly accelerated the figures of bilateral exports of ASEAN members. From the

2

ASEAN’s total trade pattern, we can see there is an escalating trend from US$615

million in 1995 to US$2.39 trillion in 2011 (The ASEAN Secretariat, 2012). Apart

from that, the average tariff rate of ASEAN countries have been remarkably trimmed,

where in 1993, the average tariff rate was 12.76 percent that further dropped to zero

percent in 2010 (Todsadee and Kameyama, 2010).

Figure 1.1: ASEAN Total Trade, Intra-ASEAN Trade and Extra-ASEAN Trade from

1993 to 2012 (in US$ Million)

Sources: ASEAN Community in Figures 2011 and 2012, ASEAN Secretariat (http:www.aseansec.org).

Based on Figure 1.1, we noticed that generally, ASEAN trade has shown a

positive growth since 1993. The trend is seen to be upward sloping. Specifically, we

are able to see that ASEAN is experiencing an impressive growth in trade particularly

under extra-ASEAN. However, the figure also depicts that there are several events that

were affecting trade activities throughout the years. When Asian crisis occurred in

1997, we evidenced a 17.5 percent drop in total trade; where extra-ASEAN and intra-

ASEAN trade were reported to have 17 percent and 19.4 percent dropped accordingly.

0

500000

1000000

1500000

2000000

2500000

3000000

(US

$ M

illi

on

)

Total Trade Intra-ASEAN Trade Extra-ASEAN Trade

3

Plummer (2009) mentioned that Asian countries were becoming too dependent

on net exports for driver of economic growth. Thus, the crises attack had provided a

good lesson to the Asian countries about the more open your country is, the more

vulnerable you are to external shocks. This crisis had led to a severe contraction in

production in Indonesia, Malaysia, the Philippines and Thailand.

In their study, Elliot and Ikemoto (2003) state that ASEAN members were facing

significant structural and financial difficulties such as declined in aggregate growth

and rise in unemployment rate during the crisis. These countries were also suffering

from large currency depreciations and capital outflows due to the Asian financial crisis

which originated from Thailand. Negative growth rates were all reported in AFTA

member countries, for instance, Indonesia’s gross domestic product (GDP) growth rate

was negative 13.7 percent and Thailand’s GDP had negative 10.2 percent growth rate

(Elliot and Ikemoto, 2003). While Malaysia’s real GDP growth rate was reported a

decline from 7.3 percent in 1997 to negative 7.4 percent in 1998. The Philippines’

GDP growth rate was also suffered a negative value from 5.1 percent in 1997 to

negative 0.5 percent in 1998 (Tuano, 2002).

It took one year for the ASEAN countries to recover as in 1999, total trade (both

intra- and extra-ASEAN) depicted a V-shaped graph. This positive growth remarked

of 8.2 percent was due to the exports of manufactured products. For Malaysia case,

Goh and Lim (2010) found that it was the expansion in global electronics cycle that

helped to recover from the crisis. The electronic and electrical exports were reported

to make up 66 percent out of total Malaysia merchandise exports.

4

Since then, ASEAN managed to regain its positive trend and was reported to

achieve its peak in 2000 with total trade of US$759 billion. Unfortunately, in 2001,

statistics reported that ASEAN trade experiences negative growth of 9 percent. This

was due to the United States and Europe economic slowdown, where the bursting of

the dot.com bubble had affected the trade growth. Besides, Japan was suffering from

recession. These three countries were among the top ASEAN trading partners.

Gradually, the trade started to gain its momentum where the graph shows an upward

trend starting 2002.

On 30th January 2003, the Protocol to Amend the Common Effective Preferential

Tariff-ASEAN Free Trade Area (CEPT-AFTA) Agreement for the Elimination of

Import Duties were signed by the ASEAN-6.1 AFTA participating countries have to

eliminate both tariffs and the non-tariff barriers (NTBs). The implementation had led

to an impressive growth in trade by 30 percent in 2004 (31.3 percent under extra-

ASEAN and 26.1 percent under intra-ASEAN trade).

In 2009, the trade growth was facing a negative growth again because of the

financial and economic breakdown in the developed countries such as the United

States. The trade growth rate dropped from 17.8 percent in 2008 to negative 19 percent

in 2009. In general, ASEAN countries GDP growth dropped from 4.3 percent in 2008

to 1.3 percent in 2009. It started off with a subprime mortgage collapse that badly

affecting the global financial institutions and instruments that somewhat affecting

ASEAN market as well.

1 Under the Protocol to Amend the Common Effective Preferential Tariff-ASEAN Free Trade Area

(CEPT-AFTA) Agreement, ASEAN-6 countries were committed to eliminate tariffs on sixty percent

of their products in the Inclusion Lists (IL) by the year 2003 (ASEAN Secretariat, 2014).

5

ASEAN was badly affected by the global downturn occurred, where the trade

experienced huge dropped by 19 percent. Major ASEAN trading partners like the US,

Japan and Europe countries were in recession. As we all know, ASEAN region had

been trading with these giants long ago. Therefore, as their business confidence and

consumption went down, ASEAN exports were also critically dropped. Besides,

commodity prices also declined and have negatively affecting the ASEAN export-led

economies.

Interestingly, it only took one year for ASEAN to compensate for the loss during

the crisis, where we notice that trade started to escalate starting 2009. Trade growth

was reported to increase by 33.1 percent. Plummer (2009) states that the economy

gained its momentum back because of the aggressive and unconditional

macroeconomic policies implemented by these countries that somewhat unblocked the

credit markets, improving the bank liquidity and increasing the aggregate demand. For

example, according to Ministry of International Trade and Industry Malaysia (2011),

Malaysian government interventions helped to boost the demand and reduced

uncertainty and systemic risks in the financial markets. This alone had resulted in

increase in exports.

One of AFTA’s targets is said to increase the intra-regional trade between

ASEAN countries. However, intra-ASEAN trade is increasing at a slower rate

compared to extra-ASEAN trade. Despite the huge gap between intra-ASEAN and

extra-ASEAN trade, we can see that as a whole, the formation of economic integration

helps in promoting economic growth of the participating members.

6

According to the ASEAN Secretariat (2012), electronics and automotive are the

top priority integration sectors’ products with electronics sectors experienced growth

about 44.5 percent in 2010 after facing the economic crisis in late 2008. Moreover, the

automotive managed to record growth of 38.8 percent (refer to Table 1.1). From Table

1.1, we can see that the top sectors, i.e. electronics and automotive, are from

technology-based sectors that usually associated with high capital-intensive industries.

Table 1.1: Trend of Intra-ASEAN Export: Priority Integration Sectors' Products (in US$

Million)

Priority Integration Sector 2003 2008 2009 2010 2011

Agro-based 1,268 4,405 3,566 5,514 8,138

Rubber-based 680 2,761 2,603 3,307 4,305

Wood-based 729 961 716 795 889

Fisheries 536 1,099 924 1,099 2,562

Textiles and apparel 2,052 3,689 3,186 3,933 4,618

Electronics 45,096 47,453 36,402 52,586 53,570

Automotive 3,827 13,939 11,344 15,738 19,707

Sources: ASEAN Community in Figures 2011 and ASEAN Community in Figures 2012, ASEAN Secretariat

(http:www.aseansec.org).

Empirical literature regarding international integration was pioneered by Viner

(1950) under his publication of “The Customs Union Issue”. He casted in the concept

of trade creation and trade diversion that explains how economic integration affects

the gain or loss in welfare and efficiency of the participating members. Trade creation

happens when producers change from reliance on high-cost domestic industry by

importing from lower-cost partner countries. However, trade diversion will cause

producers to shift from low-cost production with non-member countries to higher-cost

production in the partner country.

By studying the trade creation and diversion effects, we are able to assess how

efficient the integration is. Furthermore, Viner (1950) indicates that trade creation as

7

a situation that enhances welfare while trade diversion otherwise (Morais & Bender,

2006).

1.2 Overview of ASEAN Free Trade Area (AFTA)

The establishment of ASEAN Free Trade Area (AFTA) in the year 1992 acted as a

response to other emerging regional grouping namely European Union (EU) and North

American Free Trade Area (NAFTA). There were six founding members under AFTA

namely, Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand. Only

in 1995, Vietnam started to participate, while Laos and Myanmar joined AFTA in

1997. In 1999, Cambodia was the latest country involved with AFTA. Currently, there

are ten countries that make up AFTA. In 2012, the ASEAN Secretariat reported that

ASEAN consists about 604 million populations with 4.4 million total land area and

US$ 3,601 per capita gross domestic products (GDP).

There are three main objectives of AFTA. Firstly, to create a single market and

enhance ASEAN’s competitive edge as an international production base through

eliminating tariff barriers among member countries. Secondly, to expand intra-

ASEAN trade and investment and thirdly, is to attract foreign direct investment (FDI).

Under AFTA, the members had agreed upon with the Common Effective Preferential

Tariff (CEPT) Scheme that requires tariff rates imposed on a wide range of products

traded within the region, which meet a 40 percent ASEAN content requirement, to be

reduced to not more than 5 percent. It covers all manufactured and agricultural

products.

8

The CEPT Scheme is the key mechanism employed in achieving the objectives

of AFTA. Moreover, member countries need to eliminate quantitative restriction and

other non-tariff barriers as well. Table 1.2 shows the timetable for accelerating AFTA

among participating members. According to ASEAN Secretariat (2007), the original

six AFTA members agreed to accelerate many planned tariff cuts by a year ahead,

which is from 2003 to 2002. This was due to the financial crises 1997-1998 that were

badly affecting many Asian countries. So, all items under Inclusion List were reported

to have tariff lines between 0 to 5 percent for ASEAN-6 countries in the year 2002.

Table 1.2: Timetable for Accelerating AFTA

Year Commitment 2000 A minimum of 90 % of ASEAN-6 total tariff lines must be between 0 – 5 %.

Individually, each country must commit to achieve a minimum of 85 % of the

Inclusion List.

2001 Each ASEAN-6 achieve a minimum of 90% of the Inclusion List within 0-5% tariff

range.

2002 100% of items in the Inclusion List would have tariffs of 0-5%, but with some

flexibility for ASEAN-6.

2006 - 2010 Vietnam, Laos, Myanmar and Cambodia to reduce its tariffs on products under

Inclusion List within 0-5% tariff range.

2015 ASEAN-10 become a complete Free Trade Area.

Sources: ASEAN Secretariat (http://www.aseansec.org/11456) and Mohd Amin, Hamid and Md Saad (2009).

Under CEPT Scheme, there are two main lists, which are the Inclusion List (IL)

and the Exclusion List (EL). ASEAN members have the option to exclude products

from CEPT Scheme under three cases: (1) Temporary Exclusions; (2) Sensitive

Agricultural Products; and (3) General Exceptions. Inclusion List (IL) refers to

products that pass through immediate liberalization through reduction in tariff rates

imposed under CEPT, and also elimination of quantitation restrictions and other non-

tariff barriers. Whereas Temporary Exclusion Lists (TEL) refers to products that are

being protected temporarily by a delay in tariff reduction, but the tariff will be reduced

9

between 0 to 5 percent somehow. By 2000, there should consist 9,674 tariff lines under

TEL or 15.04 percent of all tariff lines in ASEAN.

The Sensitive Lists (SL) consists a few list of unprocessed agricultural products

that are given a longer time frame before transferred to IL. The commitment to tariff

reductions between 0 to 5 percent had been extended up to the year 2010. For new

members of ASEAN, the deadlines are longer: Vietnam in 2013, Laos and Vietnam in

2015 and Cambodia has up to 2017. ASEAN Secretariat (2007) states that tariff

produces reduction on SL was scheduled to begin from 2000 to 2005. It depends on

the country and the products. The General Exception List (GE) refers to products that

are permanently excluded from the free trade area. Those products are excluded due

to the protection of national security, public morals, human, animal or plant life and

health and articles of artistic, historic and archaeological value. In 2008, there are 673

products under GE, which is about 0.65 percent of all tariff lines in ASEAN.

By 1998, tariffs on these products were to be decreased to a maximum of 20

percent and as in 2002, it must be reduced not more than 5 percent. These were

imposed for the original six members. For the four new members, different deadlines

were levied, where Vietnam needs to meet the target by the year 2000, Laos and

Myanmar on 2008, where else Cambodia in 2010.

Table 1.3 shows that by 2008, tariff lines under IL for ASEAN-6 were already

about 99.42 percent and the new members; Cambodia, Laos, Myanmar and Vietnam

(CLMV) had about 98.95 percent. There are 0 percent reported to be under TEL and

0.65 percent of ASEAN-10 members’ tariff lines were still in the GE List. As for the

10

SL, tariff lines for ASEAN-6 were reported to have 0.34 percent and CLMV were

reported to have about 1 percent only.

From Table 1.3, we are able to observe that countries like Brunei, Malaysia,

Singapore, Thailand, Vietnam and Laos were reported to have no more products under

SL. Among the six original members, Brunei was reported to have 0.97 percent

products remain in GEL, whereas Vietnam had 1.03 percent. Overall, products under

IL have been significantly increased from 55,680 in 2001 to 102,246 in 2008. For

TEL, we can see that from 8,660 products being listed in 2001, it had decreased to 0

product listed. Whereas, GE list also reduced from 829 in 2001 to 673 in 2008, about

18.9 percent reduction reported and SL also was reported to decrease by 68 percent,

from 360 to 112 products being listed.

Table 1.3: AFTA Common Effective Preferential Tariff (CEPT) List for 2008

Country Inclusion List

Temporary

Exclusion

List

General

Exception

List

Sensitive List Total

2001 2008 2001 2008 2001 2008 2001 2008 2001 2008

Brunei 6,284 10,598 0 0 202 104 6 0 6,492 10,702

Indo 7,190 8,625 21 0 68 96 4 16 7,283 8,737

M’sia 9,654 12,236 218 0 53 96 83 0 10,008 12,332

Phil* 5,622 11,045 6 0 16 27 50 19 5,694 11,091

S’pore 5,821 8,316 0 0 38 0 0 0 5,859 8,316

Thai* 9,104 11,030 0 0 0 0 7 0 9,111 11,030

ASEAN-6

Total 43,675 61,850 245 0 377 323 150 35 44,447 62,208

% 98.62 99.42 0.55 0 0.85 0.52 0.34 0.06 100 100

Viet 3,115 11,030 3,523 0 134 115 50 0 6,822 11,145

Laos 1,673 8,214 1,716 0 74 86 88 0 3,551 8,300

M’mar 2,984 10,615 2,419 0 48 51 21 23 5,472 10,689

Cambo 4,233 10,537 757 0 196 98 51 54 5,237 10,689

CLMV

Total 12,005 40,396 8,415 0 452 350 210 77 21,082 40,823

% 56.94 98.95 39.92 0 2.14 0.86 1.0 0.19 100 100

ASEAN

Total 55,680 102,246 8,660 0 829 673 360 112 65,529 103,031

% 84.74 99.24 13.40 0 1.28 0.65 0.55 0.11 100 100

Note: * is based on Consolidated CEPT Package 2006; others based on Consolidated CEPT Package 2010.

Sources: Consolidated CEPT Package 2006 – 2008, ASEAN Secretariat (http://www.aseansec.org).

11

Referring to Table 1.4, it shows that starting 2005, the average tariff for

ASEAN 10 under the CEPT scheme is now down to 1.77 percent from 12.76 percent

when the reduction of tariff started in 1993. Starting 2005, we notice that all member

countries have tariff rates not more than 5 percent, as what being imposed.

Table 1.4: Average CEPT-AFTA Tariff Rates (1993-2010)

Year BN ID MY PH SG TH VN LA MM ASEAN-10

1993 3.78 17.27 10.79 12.45 0.01 19.85 n.a n.a n.a 12.76

2000 1.26 4.76 3.32 5.18 0 6.12 7.25 7.07 4.43 4.43

2005 0.76 1.59 1.43 2.81 0 3.4 4.72 4.31 3.39 1.77

2007 0.56 1.17 1.05 2.06 0 2.5 3.47 3.16 2.49 1.3

2008 0.48 1 0.9 1.77 0 2.14 2.97 2.71 2.13 1.12

2009 0.41 0.86 0.77 1.51 0 1.84 2.55 2.32 1.83 0.96

2010 0 0 0 0 0 0 0 0 0 0

Source: Todsadee and Kameyama (2010).

Note: BN = Brunei; ID= Indonesia; MY= Malaysia; PH = Philippines; SG= Singapore; TH=

Thailand;VN = Vietnam; LA = Laos; and MM = Myanmar.

Generally, ASEAN members had well achieved the targets of tariff reductions

levied to them, which is not more than five percent. Some countries were also

evidenced to successfully meet the deadlines earlier than expected. Moreover, in order

to achieve the aims of free flow of goods, the Work Programme on Elimination of

Non-Tariff Barriers (NTBs) was approved. This work programme targets to align the

elimination of both identified NTBs and the tariffs together.

1.3 Trade Performance of AFTA Member Countries

Trade studies had been long interpreted based on aggregate data. The findings are

found to generalize the overall trends in trade. Therefore, it is important to examine

the behaviour of trade based on disaggregate data. From there, we are able to identify,

which group of commodity really active or vice versa in trade activities. Table 1.5

described the trade performance of AFTA member countries at one digit using SITC

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(Revision 2) from 1990 until 2012. There are nine group of commodities namely SITC

0 (food), SITC 1 (beverages and tobacco), SITC 2 (crude materials), SITC 3

(minerals), SITC 4 (animal and vegetable oils), SITC 5 (chemicals), SITC 6

(manufactured goods), SITC 7 (machinery), SITC 8 miscellaneous manufactured

articles and SITC 9 (others).

Table 1.5: Trade Performance of AFTA Member States by Commodity from 1990 to

2012 (SITC Revision 2 in US$ million)

SITC

Code Description 1990 1993 1998 2001 2008 2009 2010 2012

0 Food 3,829 4,589 7,882 7,106 21,830 19,278 25,735 31,354

1 Bev &

Tobacco

271 593 1,002 1,858 3,624 3,579 4,338 6,200

2 Crude

Materials

2,981 3,376 2,923 3,550 10,553

8,905 11,570 13,623

3 Minerals 11,186 11,891 10,105 19,964 116,923 79,253 111,109 164,477

4 Oil (Animal &

Veg)

839 1,413 1,457 1,120 6,747 5,260 8,546 11,887

5 Chemicals 3,367 4,899 7,985 11,907 38,345 30,635 41,473 52,585

6 Manuf. Goods 5,908 9,920 11,525 13,711 49,820 38,887 49,570 57,568

7 Machinery 17,842 38,324 69,040 88,863 175,938 149,604 189,510 210,209

8 Misc. Manuf.

Articles

3,470 6,367 8,838 8,965 24,478 22,060 28,227 35,461

9 Others 1,235 2,277 3,086 3,019 17,955 8,558 18,587 7,244

Grand Total 50,932 83,653 123,848 160,067 302,651 366,021 488,669 590,613

Source: UN Comtrade Database.

From Table 1.5, we can see that SITC 7 (machinery) has been the most

significant commodity group since 1990s. In 1990, it had accounted for 35 percent of

ASEAN’s trade with US$17,842 million out of US$50,932 million. In 2012, this

commodity still held the largest portion in ASEAN’s trade with 35.6% percent, which

is US$210,209 million out of US$590,613 million. The rising trend in this commodity

is because of the rising pace of industrial restructuring in ASEAN countries (Cabalu

and Alfonso, 2007).

13

This somewhat had positively affecting ASEAN’s share of heavy equipment

trade. Apart from that, the heavy machinery and transport had progressively

transferred from the Temporary Exclusion List (TEL) to the Inclusion List (IL) under

the CEPT program. Thus, the heavy equipment/machinery subjected to became more

liberalized.

1.4 Problem Statement

According to Kien and Hashimoto (2005), the argument still exist whether the

formation of AFTA has strengthened the intra-regional trade. They have discovered

that there are few studies which doubt the significant impacts of AFTA on trade

expansion among its participating countries [see for examples; Pholphirul (2010),

Kim, et. Al (2009), Tran Van Tho (2002) and Endoh (2000)]. Although intra-ASEAN

are reported to have enjoyed trade growth (Tran Van Tho, 2002), the expansion of

ASEAN trade between non-partner countries are found to increase at a greater rate

compared to intra-ASEAN trade.

However, Lee and Plummer (2011) and Elliott and Ikemoto (2004) argued that

there is an impressive progression in intra-regional trade in ASEAN. Moreover, the

formation of AFTA has found to only create trades among its members rather than

divert trades (Kien and Hashimoto, 2005). Despite these conflicting reviews, we need

to refer back to the theory where, Cheong (2008) stated that the preferential trade

agreement (PTA) is discriminatory in nature. It can either lead to positive or negative

welfare effects. In other words, it can be either trade creating or possibly be trade

diverting.

14

The PTA creates a positive welfare effects when a member country substitutes

its domestic production with imports from member countries, also known as trade

creation. This contributes to positive welfare as the PTA member states change their

production structures to gain comparative advantages. On the other hand, PTA leads

to negative welfare because of the negative preference margins that PTA members get

from the integration leads to trade diversion. This situation occurs when one of the

PTA members replace its imports from non-member countries with imports from

within the PTA. The replacement leads to negative welfare effect because imports are

no longer from the most efficient supplier-country, where we refer to it as trade

diverting.

Previous literatures have suggested that intra-regional trade is trade creating

(Cabalu & Alfonso, 2009; Mohd Amin, Hamid & Md Saad, 2009; Plummer, 2006).

Interestingly, several other researches have reported contrary findings (Dissanavake

& Weerahewa, 2009; Morais & Bender, 2006; Fukao, Okubo & Stern, 2002).

Fundamentally, Krugman (1991) states that the formation of free trade area will

stimulate the intra-regional trade particularly, for geographically-close countries. In

other words, the closer the countries are to each other, the greater the volumes of trade

between them. Despite these varied reviews, most of the studies are based on aggregate

data where there is no information on the nature of intra-trade activities at the

commodity level. Those empirical works only provide us general findings2.

2 According to the World Bank’s International Trade Department publication titled ‘A Guide to Trade

Data Analysis’, aggregating is never innocent and it can hide interesting action. Thus, it clearly states

that from disaggregation, we will discover more precise findings.

s i t s a r m a l ays a i w n a u un m a s - ir.unimas.my trade creation and trade...tidak...

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