Prospects of an ASEAN-People's Republic of China Free Trade Area: A Qualitative and Quantitative Analysis

Park, Donghyun; Park, Innwon; Estrada, Gemma Esther B. Working Paper Prospects of an ASEAN-People's Republic of China Free Trade Area: A Qualitative and Quantitative Analysis ADB Economics Working Paper Series, No. 130 Provided in Cooperation with: Asian Development Bank (ADB), Manila Suggested Citation: Park, Donghyun; Park, Innwon; Estrada, Gemma Esther B. (2008) : Prospects of an ASEAN-People's Republic of China Free Trade Area: A Qualitative and Quantitative Analysis, ADB Economics Working Paper Series, No. 130, Asian Development Bank (ADB), Manila, https://hdl.handle.net/11540/1785 This Version is available at: https://hdl.handle.net/10419/109334 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Estrada No. 130 | October 2008 ADB Economics Working Paper Series No. 130 Prospects of an ASEAN–People’s Republic of China Free Trade Area: A Qualitative and Quantitative Analysis Donghyun Park, Innwon Park, Gemma Esther B. Estrada October 2008 Donghyun Park is Senior Economist and Gemma Esther B. Estrada is Economics Officer, Economics and Research Department, Asian Development Bank; Innwon Park is Professor of International Economics, Division of International Studies, Korea University. Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org/economics ©2008 by Asian Development Bank October 2008 ISSN 1655-5252 Publication Stock No.: _______ The views expressed in this paper are those of the author(s) and do not necessarily reflect the views or policies of the Asian Development Bank. The ADB Economics Working Paper Series is a forum for stimulating discussion and eliciting feedback on ongoing and recently completed research and policy studies undertaken by the Asian Development Bank (ADB) staff, consultants, or resource persons. The series deals with key economic and development problems, particularly those facing the Asia and Pacific region; as well as conceptual, analytical, or methodological issues relating to project/program economic analysis, and statistical data and measurement. The series aims to enhance the knowledge on Asia’s development and policy challenges; strengthen analytical rigor and quality of ADB’s country partnership strategies, and its subregional and country operations; and improve the quality and availability of statistical data and development indicators for monitoring development effectiveness. The ADB Economics Working Paper Series is a quick-disseminating, informal publication whose titles could subsequently be revised for publication as articles in professional journals or chapters in books. The series is maintained by the Economics and Research Department. Contents Abstract v I. Introduction 1 II. Existing Literature 2 III. Qualitative Analysis: Theory of Economic Integration and ACFTA 4 A. Types of Economic IntegrationA. Types of Economic Integration 4 B. Theory of Customs Union 4 C. Prospects of ACFTA 5 IV. Quantitative Analysis: Application of CGE Model 9 A. Model and DataA. Model and Data 9 B. Empirical Results 10 V. Concluding Remarks 16 References 17 Abstract The Association of Southeast Asian Nations (ASEAN) and the People’s Republic of China are economic partners as well as economic competitors. The ASEAN– People’s Republic of China Free Trade Area (ACFTA), which is set to come into effect around 2010, is designed to boost trade between the two sides. In this paper, we use insights from customs union theory for a qualitative analysis of whether ACFTA would be beneficial for both sides. We also apply a computable general equilibrium model to perform a quantitative analysis of the same issue. Both our qualitative and quantitative analyses provide grounds for guarded optimism about ACFTA’s prospects as a vehicle for strengthening economic partnership between ASEAN and the People’s Republic of China. Prospects of an ASEAN–People’s Republic of China Free Trade Area: A Qualitative and Quantitative Analysis | 7 the PRC. The PRC’s exports to ASEAN accounted for around 7.4% of its total exports, and imports from ASEAN accounted for around 11.3% of its total imports in the same year. Moreover, ASEAN–PRC trade is not only substantial but also growing rapidly, from US$39.5 billion in 2000 to US$160.9 billion in 2006. Such rapid growth has increased the share, and hence, relative importance of ASEAN–PRC trade in the trade of each individually. Our discussion clearly suggests that the size and growth of pre-integration trade between ASEAN and the PRC bodes well for ACFTA. d. Substitutability of Products The greater the substitutability of products of member-states for those of nonmemberstates, the greater the chances of trade creation. Substitutability means the production of similar but differentiated products. For example, the PRC can theoretically substitute semiconductors from Taipei,China with similar but slightly different semiconductors from Singapore. In practice, although the PRC and the ASEAN economies now export broadly similar goods, such as electronics products and components, the range of substitutable products remains relatively small. While ASEAN’s trade with the PRC is large and growing, most of ASEAN’s exports go to other markets, and most of its imports come from other sources. More specifically, ASEAN’s biggest trade partners are EU, US, and Japan. On the other hand, the PRC’s most important trading partners are the US; Japan; Hong Kong, China; and Korea. Around 90% of the trade of both ASEAN and the PRC is with third countries. Such trade pattern provides stylized evidence, suggesting limited substitutability of products. e. Disparity in Pre-integration Level of Development If the pre-integration levels of development and income are similar among members, the gain from integration will be larger and integration will be easier. Similar income levels mean that consumers buy similar baskets of goods and services, increasing the opportunity for intra-industry trade. Broadly speaking, if we view the 10 ASEAN members as a single economy, then the PRC and ASEAN are at similar levels of per capita income and economic development. According to World Bank data, the PRC’s 2007 per capita GNI was US$2,360 while ASEAN’s 2007 per capita GNI was US$2,160 (excluding Brunei and Singapore). However, ASEAN is far from being a homogeneous grouping. The range of income and economic development ranges from Singapore (a mature and developed economy) to Cambodia, Lao PDR, Myanmar, and Viet Nam, which are all among the world’s poorest economies. The heterogeneity of ASEAN economies notwithstanding, the income and economic development of the PRC and ASEAN seem to be broadly similar enough to provide many opportunities for intra-industry trade. 8 | ADB Economics Working Paper Series No. 130 f. Geographical Proximity and Transportation Infrastructure Economic integration is easier among geographically close countries due to lower transportation costs. However, geographical proximity translates into lower transportation costs if and only if there is a good transportation infrastructure of land, sea, and air links that connect the geographical neighbors, as is the case in the EU. ASEAN and the PRC are geographical neighbors, with Lao PDR, Myanmar, and Viet Nam sharing borders with the PRC. However, unlike in the EU, the land transport network of highways and railways connecting the ASEAN economies with the PRC is poor at present. Even the internal transportation infrastructure is inadequate in the parts of the PRC that border ASEAN, and even worse, in the peripheral ASEAN economies bordering the PRC. ASEAN members and the PRC will thus have to make major investments in their transportation infrastructure in order to fully realize the economic benefits of their physical proximity. g. Complementary or Competitive Economic Structures? Trade creation will be greater if the pre-integration economic structures are competitive but potentially complementary after integration (Meade 1955). This means that due to high tariffs and other protectionist barriers, countries within a group produce similar goods before integration. After integration, the more efficient producers will replace the less efficient ones, and the number of similar goods produced falls, producing welfare gains due to specialization and economies of scale. The more significant issue of whether they will become complementary after ACFTA so that ASEAN and the PRC produce less similar goods remains an open question. The most compelling indirect evidence of a potential complementary relationship between ASEAN and the PRC is the large and rapidly growing ASEAN–PRC trade in recent years. A specific example of a sector that has exhibited this complementarity in production is machinery and electrical equipment, whose products have become the major exports of ASEAN to the PRC, and vice versa. This rising two-way trade has been a result of intra-industry trade, made possible by the growth of production networks and supply chains (Yue 2004). 2. Dynamic Considerations While static benefits are clearly important, potentially large dynamic benefits provide an additional impetus for economic integration. Relative to static welfare gains, dynamic welfare gains are inherently harder to quantify and are usually overlooked. This does not, however, render them any less significant. If they are large enough, it is conceivable that they could justify economic integration even if the static welfare gains are uncertain or negligible. In particular, we have to take into account the greater competition and improved efficiency that will lead to positive welfare gains for the ASEAN economies as a result of ACFTA. The economic crisis that engulfed the entire region in 1997–1998 highlighted the need for the region’s economies to improve their competitiveness and efficiency in the global economy. Greater exposure to competition from the PRC─the factory of the world─will Prospects of an ASEAN–People’s Republic of China Free Trade Area: A Qualitative and Quantitative Analysis | 9 only add much-needed urgency to their efforts in this direction. In the long term, increased productivity and efficiency is their only route to sustainable economic growth for ASEAN. In this light, the dynamic benefits of economic integration are potentially large indeed. The scope for interand intra-industry specialization will also increase over time as ACFTA creates more interand intra-industry trade opportunities, producing further welfare gains. IV. Quantitative Analysis: Application of CGE Model Having qualitative analyzed the ASEAN free trade area’s prospects, we now turn to the quantitative analysis of those prospects. Our quantitative analysis is based on the application of a CGE model, as explained in detail below. A. Model and Data In the preceding section, we have seen that ACFTA holds out some promise as a vehicle for promoting trade between ASEAN and the PRC, which in turn, could lead to welfare and output gains. In this section, we attempt to quantify these potential gains. By applying a traditional static CGE model simulation technique, we estimate the size of ACFTA’s potential macroeconomic effects, more specifically the creation of trade among member countries and changes in their welfare and output. The CGE model used in this section is the GTAP6inGAMS1 model developed by Rutherford (2005). There are three economic agents in the model, namely, producer, representative consumer (private and public), and trading partners. The GTAP6inGAMS is a traditional static Arrow-Debreu type of general equilibrium model, in which a main assumption is that zero-profit condition and market clearance define the equilibrium. The GTAP6inGAMS is a modified version of the GTAP model version 6 developed for GAMS users (see Park 2006 for a discussion of the differences between the GTAP model and GAMS version). The model aggregates industries into seven broader sectors (see Table 1). The model solution is calibrated, with 2001 as the base year, using Global Trade, Assistance and Production: The GTAP 6 Database (see Dimaranan and McDougall 2006), and implemented using the GAMS MPSGE.2 Results are obtained for the region as a whole and for individual member countries. However, owing to data limitations, we will aggregate Cambodia, Lao PDR, and Myanmar into a single economy and exclude Brunei. 1 Global Trade Analysis Project model version 6 in General Algebraic Modeling System. 2 The MPSGE (Mathematical Programming System for General Equilibrium analysis) is a subsystem within GAMS. See gams.com/solvers/solvers.htm#MPSGE. 10 | ADB Economics Working Paper Series No. 130 Table 1: Sectoral Aggregation of the CGE Model Sector Commodities Agricultural Products Paddy rice, wheat, cereal grains nec, vegetables, fruit, nuts, oil seeds, sugar cane, sugar beet, plant-based fibers, crops nec, bovine cattle, sheep and goats, horses, animal products, raw milk, wool silk-worm cocoons, bovine cattle, sheep and goat, horse meat products Food Products Meat products nec, vegetable oils and fats, dairy products, processed rice, sugar, food products nec, beverages and tobacco products Extractive Industry Forestry, fishing, coal, oil, gas, minerals nec, petroleum, coal products Light Manufacturing Textiles, wearing apparel, leather products, wood products Heavy Manufacturing Paper products, publishing, chemical, rubber, plastic products, mineral products nec, ferrous metals, metals nec Technologyintensive Manufacturing Metal products, motor vehicles and parts, transport equipment nec, electronic equipment, machinery and equipment nec, manufactures nec Services Electricity, gas manufacture, distribution, water, construction trade, transport, financial, business, recreational services, public administration and defense, education, health, dwellings and services nec = not elsewhere classified. B. Empirical Results Overall, ACFTA is likely to result in positive net trade creation and higher output and welfare for its member-countries. The magnitude of gains, however, would vary for each country. Greater gains are expected to accrue to the more well-off members, namely, Malaysia, Singapore, and Thailand. A primary reason for this is that the level of preintegration trade matters, i.e., countries that trade heavily with each other stand to benefit the most from the removal of barriers to trade. Prior to ACFTA, the PRC’s trade with the three countries was more substantial compared to its trade with the rest of ASEAN. The reduction of tariff barriers serves to reinforce the strong pre-ACFTA trade linkages. The less developed member-countries may have more limited output or welfare gains, or even become worse off. The initial static effects may be painful, but these could be more than offset by dynamic long-run gains. 1. Trade Effects ACFTA is expected to increase trade among member countries, but divert trade from nonmember countries. Figure 1 illustrates the trade creation and trade diversion effects, which are computed as percentage deviations from the base value. Overall, total net trade creation is positive, at 3.6%. Although trade with non-ACFTA countries would decrease by 3%, trade among ACFTA members would increase by 32.5%. The PRC’s large market opens up considerable trade expansion opportunities for ASEAN member economies. For some individual countries such as Thailand and Viet Nam, trade with Prospects of an ASEAN–People’s Republic of China Free Trade Area: A Qualitative and Quantitative Analysis | 11 ACFTA member-countries is expected to increase by as much as 60%. For all ASEAN member economies except Cambodia, Lao PDR, Myanmar, and Viet Nam, trade with the PRC would expand by at least 38%. The PRC’s trade with ASEAN is expected to increase by more than 50%, which is much higher than the reduction of its trade with non-ASEAN members. Cambodia, Lao PDR, Myanmar Philippines Singapore Malaysia Indonesia ACFTA China, People’s Rep. of Viet Nam Thailand 020 40 60 80 Trade Creation −3 0 3 −6 −9 −12 Trade Diversion Figure 1: Trade Creation and Diversion Effects of ACFTA (percent) Figure 2 shows that trade links between ASEAN and the PRC would intensify under ACFTA. This is especially true for Thailand, whose exports to the PRC would rise by nearly 200%. All ASEAN economies are expected to increase their exports to the PRC by about 70–100%. Viet Nam is expected to double its exports to the PRC. Given the sharp expansion of exports to the PRC, ASEAN’s exports to key destinations such as Japan and the US may suffer somewhat. For example, the exports of Indonesia and Thailand to Japan and the US are expected to fall by about 10–15%. 12 | ADB Economics Working Paper Series No. 130 Figure 2: Effects of ACFTA on ASEAN’s Trade with the People’s Republic of China (percent) −12 −6 0 6 12 Imports from the PRC 100 150 200 50 0 Exports to the PRC Cambodia, Lao PDR, Myanmar Philippines Singapore Malaysia Indonesia ASEAN Viet Nam Thailand The PRC’s exports to ASEAN are not expected to increase by as much as ASEAN’s exports to the PRC, contrary to the popular perception that ACFTA would enable the PRC to flood ASEAN markets with cheap goods. In fact, for the less developed countries (Cambodia, Lao PDR, Myanmar, Viet Nam) imports from the PRC would fall. Imports from the PRC are expected to rise only in Indonesia, Philippines, and Singapore. Even though ACFTA has a positive effect on the PRC’s trade, the PRC’s main export markets will continue to be US; Hong Kong, China; Japan; and Korea. 2. Welfare and Output Effects Let us now discuss the issue of whether or not ACFTA would enhance welfare and total output. Figure 3 shows that the impact varies across countries, but generally appears more favorable for higher-income countries. The welfare of Malaysia and Singapore would increase by 11.1% and 4.2%, respectively. In contrast, the welfare of Cambodia, Lao PDR, and Myanmar would fall marginally, by 0.24%. Interestingly, the PRC is also expected to experience a drop in welfare, of 0.54%. The ACFTA as a whole and some of its members would gain modestly in terms of real gross domestic product growth. The total output growth gains of the more well-off members (Singapore and Malaysia) are more substantial, at 9.1% and 3.7%, respectively. For the others, output growth is less than 2% and, in the case of Cambodia, Indonesia, Lao PDR, Myanmar, and Philippines, Prospects of an ASEAN–People’s Republic of China Free Trade Area: A Qualitative and Quantitative Analysis | 13 marginally negative. In the next subsection, we examine how ACFTA affects the export, imports, and output of each sector. Figure 3: Welfare and Output Effects of ACFTA on Member-Countries (percent) −3 3 6 9 12 6 9 12 3 0 Cambodia, Lao PDR, Myanmar Philippines Singapore Malaysia Indonesia ACFTA Viet Nam Thailand Output Welfare China, People’s Rep. of 0 −3 3. Sectoral Impact Just as the impact of ACFTA is likely to differ across countries, it is also likely to differ across sectors. Identifying which sectors will gain or lose from opening up to trade helps inform policymakers to identify the sectors that require adjustment assistance. Vulnerable sectors may require government support to cushion the impact of trade liberalization on adversely affected firms and industries. Such support will facilitate the reallocation of resources toward areas of comparative advantage. Producers in those sectors should also make greater efforts to enhance their competitiveness to compete more effectively in the post-ACFTA period. Table 2 shows that the sectors that would benefit most ASEAN members are agricultural products, food products, and extractive industry. The same sectors are expected to contract in the PRC. The expansion of trade will also have diverse sector effects in individual countries, with some sectors gaining more than others. For example, in Thailand, output of agricultural products and extractive industries would rise by 10–20% while output of light manufacturing and food products would fall by 3%. In general, for ASEAN members, the output of most sectors is expected to increase. The exception 14 | ADB Economics Working Paper Series No. 130 is Cambodia, Lao PDR, and Myanmar, where most sectors are likely to contract. For the PRC, ACFTA is expected to have a negative effect on output of agricultural, food products, extractive, and service industries; and a positive effect on output of the three manufacturing sectors. Table 2: Sectoral Impacts of ACFTA on Output (percent deviation from the base) Member Total Output Agricultural Products Food Products Extractive Industry Light Manufacturing Heavy Manufacturing TechnologyIntensive Manufacturing Services Indonesia −0.17 2.78 4.99 0.91 1.19 −2.12 2.10 1.76 Malaysia 3.68 −8.81 23.45 3.22 6.76 −1.03 0.28 0.07 Philippines −0.33 5.04 0.46 1.89 −2.33 0.78 2.59 1.60 Singapore 9.07 0.27 58.59 13.60 3.07 2.11 2.24 1.61 Thailand 0.29 10.58 −3.24 21.11 −2.78 1.01 0.22 3.11 Viet Nam 1.92 2.10 −1.86 3.28 4.30 −0.20 9.78 0.11 Cambodia, Lao PDR, Myanmar −0.04 −1.15 −3.25 1.41 1.50 −1.06 −2.44 −0.80 China, People’s Rep. of 0.08 −1.16 −1.22 −1.33 0.31 0.33 0.17 −0.39 Tables 3 and 4 show that ACFTA is expected to benefit the manufacturing exports of poorer ASEAN members. More specifically, Cambodia, Lao PDR, Myanmar, and Viet Nam would increase their manufacturing exports by 11–15%, with the biggest jump occurring in technology-intensive products. On the other hand, the more established ASEAN members are likely to suffer a fall in manufacturing exports. This is especially true for Indonesia and Philippines, whose heavy manufacturing exports would fall. Our CGE simulations indicate that imports of heavy manufacturing products would grow faster than exports for many ASEAN members, while the reverse is true for the PRC. This confirms the conventional wisdom that improving manufacturing competitiveness remains an urgent structural challenge for ASEAN, in light of more competition from the PRC. The import growth of the PRC’s agricultural products, food products, and extractive industries would exceed the export growth of its manufacturing industries. Prospects of an ASEAN–People’s Republic of China Free Trade Area: A Qualitative and Quantitative Analysis | 15 Table 3: Sectoral Impacts of ACFTA on Exports (percent deviation from the base) Member Total Exports Agricultural Products Food Products Extractive Industry Light Manufacturing Heavy Manufacturing TechnologyIntensive Manufacturing Services Indonesia 1.45 −7.71 20.14 0.54 0.03 −3.95 3.70 −6.57 Malaysia 1.30 45.19 31.99 4.89 10.16 2.61 −0.72 −6.54 Philippines 2.83 64.81 −1.06 16.58 −3.77 −2.72 2.54 −5.91 Singapore 1.90 −0.77 90.34 15.65 1.84 0.84 1.19 −12.43 Thailand 4.63 27.30 −10.78 60.05 −8.65 5.88 1.24 −13.70 Viet Nam 15.28 12.55 34.90 15.76 8.03 −2.95 36.97 −3.23 Cambodia, Lao PDR, Myanmar 10.46 11.70 31.29 9.84 10.21 7.10 28.56 2.65 China, People’s Rep. of 3.44 −1.64 2.90 4.65 2.81 3.59 3.84 1.92 Table 4: Sectoral Impacts of ACFTA on Imports (percent deviation from the base) Member Total Imports Agricultural Products Food Products Extractive Industry Light Manufacturing Heavy Manufacturing Technologyintensive Manufacturing Services Indonesia 4.44 6.64 16.20 5.16 5.15 2.67 3.54 3.22 Malaysia 3.38 32.06 13.06 7.37 9.61 0.96 1.15 2.29 Philippines 2.82 10.29 17.92 2.54 1.10 3.89 1.59 3.34 Singapore 3.27 12.26 17.75 8.24 7.63 1.15 0.89 6.04 Thailand 9.28 15.07 40.71 16.87 15.23 1.13 4.41 8.30 Viet Nam 8.75 13.26 87.07 6.96 10.42 4.43 7.26 1.55 Cambodia, Lao PDR, Myanmar 10.86 −2.24 45.96 5.13 5.63 −0.57 12.04 −1.46 China, People’s Rep. of 3.57 4.79 11.97 7.04 3.28 −0.29 3.76 −1.16 16 | ADB Economics Working Paper Series No. 130 V. Concluding Remarks The economic rise of the PRC poses a competitive threat to ASEAN economies. At the same time, there are unmistakable elements of potential complementarity between ASEAN and the PRC. The PRC’s remarkable appetite for imports, especially intermediate and capital goods, agricultural products and raw materials, presents enormous potential opportunities for ASEAN exporters. From the PRC viewpoint, the sizable collective economic size of ASEAN means that the region offers a meaningful opportunity to diversify both its export markets and its import sources. In short, even though ASEAN and the PRC will continue to compete with each other for export markets and foreign investment, economic integration holds out the promise of substantial tangible benefits for both sides. In November 2002 ASEAN and the PRC agreed to form ACFTA as a concrete means of strengthening their economic partnership. Our paper has examined the economic feasibility of ACFTA as well as its desirability, especially from the ASEAN perspective, based on both qualitative and quantitative assessments. On balance, our examination of the extent to which ACFTA satisfies the theoretical static criteria for integration provides some support for ACFTA’s feasibility and desirability. On the other hand, our CGE simulation results show that while integration brings about net trade, output, and welfare gains for the region as whole, country-specific effects vary considerably. More precisely, ACFTA is expected to benefit the richer members of ASEAN such as Malaysia and Singapore more than the poorer members such as Cambodia, Lao PDR, and Myanmar. Overall, both our qualitative and quantitative analysis provides grounds for cautious optimism about ACFTA’s prospects. Furthermore, a number of additional considerations bode well for the success of ACFTA. In particular, ACFTA can help to bring about significant dynamic improvements in the productivity and efficiency of the ASEAN economies by subjecting them more fully to competitive pressures from the PRC. In the short run, competition from the PRC will undoubtedly lead to painful structural adjustment in some manufacturing industries where ASEAN has little comparative advantage. However, in the long run, such competitive pressures will force the ASEAN economies to invest more in human capital, physical capital, and technological upgrading, which will enable them to find new areas of comparative advantage. Last but not least, it is clearly in the geopolitical self-interest of both ASEAN and the PRC to engage the other side. As such, the governments of ASEAN and the PRC are likely to provide the political commitment, will, and leadership critical for the success of ACFTA.