Journal of Current Southeast Asian Affairs

Transcription

1 Journal of Current Southeast Asian Affairs Pholphirul, Piriya (2010), Does AFTA Create More Trade for Thailand? An Investigation of Some Key Trade Indicators, in: Journal of Current Southeast Asian Affairs, 29, 1, ISSN: (online), ISSN: (print) The online version of this article can be found at: < Published by GIGA German Institute of Global and Area Studies, Institute of Asian Studies and Hamburg University Press. The Journal of Current Southeast Asian Affairs is an Open Access publication. It may be read, copied and distributed free of charge according to the conditions of the Creative Commons Attribution-No Derivative Works 3.0 License. To subscribe to the print edition: For an alert please register at: < The Journal of Current Southeast Asian Affairs is part of the GIGA Journal Family which includes: Africa Spectrum Journal of Current Chinese Affairs Journal of Current Southeast Asian Affairs Journal of Politics in Latin America <

2 Journal of Current Southeast Asian Affairs 1/2010: Does AFTA Create More Trade for Thailand? An Investigation of Some Key Trade Indicators Piriya Pholphirul Abstract: This paper examines whether the ASEAN Free Trade Agreement ( AFTA ) creates trade for Thailand or actually diverts it away from the country. It does this by analyzing various trade indicators: the Export Similarity Index, the Intra-Industry Trade Index, and Revealed Comparative Advantage (RCA) rank correlation. By examining the patterns of trade between Thailand and other members of ASEAN, it reveals a high degree of similarity regarding the trade structure between Thailand and AFTA, which indicates that there will be fewer trade-creation benefits from AFTA and a greater likelihood of trade diversion once the AFTA scheme has been fully implemented. This similarity pattern explains the reasons for future collaboration among member countries and supportive arguments for the future extension of ASEAN ( ASEAN+ ). Market-penetration and development strategies should be employed by Thai exporters when accessing the ASEAN market. Manuscript received October 30, 2009; accepted February 22, 2010 Keywords: Thailand, free trade agreements, ASEAN, AFTA, trade creation, trade diversion Piriya Pholphirul, Ph.D., Graduate School of Development Economics, National Institute of Development Administration, Bangkok, Thailand. <piriya.p@nida.ac.th>

3 52 Piriya Pholphirul 1 Introduction Having the fourth-highest GDP per capita in ASEAN (USD3,740 of the constant price in 2007), Thailand has maintained its commitment to free trade liberalization by believing that free trade agreements can be an effective catalyst promoting long-term economic growth. The country s foreign policies are therefore focused on strengthening regional links with its immediate neighbors and deepening ties through free trade agreements in the wider Asian region, such as ASEAN, BIMSTEC, and the further extension of the ASEAN Free Trade Area (known simply as ASEAN+ ). The ASEAN Free Trade Area (AFTA) was established in 1992 by six ASEAN members: Indonesia, Malaysia, the Philippines, Singapore, Brunei, and Thailand. It aims to be the most influential preferential trade arrangement (PTA) concerning the regional trade structure. The agreement recently became active (in January 2010) to allow zero tariffs. Even though AFTA s main objectives are to develop competitive industries within ASEAN by promoting intra-asean trade, there are also other factors that have contributed to the formation of the Free Trade Area. One of these is the realization of the need to capture export markets in the face of increasing PTAs in other parts of the world. Another factor is the emergence of China and other emerging economies, such as India and South Korea, as competitors for foreign direct investment. Besides making the AFTA agreement, ASEAN s members have also been active in seeking additional free trade agreements with other countries 1 both as a group and individually. The mere fact that free trade agreements between countries increase the flow of trade between them does not necessarily mean that it will enhance the welfare of the trading partners, however. From the perspective of a traditional theory of international trade, the increase in trade volume is achieved at the expense of domestically produced goods in a process known as trade creation, but this happens at the expense of imports from other countries outside the FTA bloc, which is known as trade diversion. In terms of Viner s classic analysis (1950), trade creation (or trade enhancement) improves economic efficiency and welfare status because the partner countries in the FTA bloc turn out to be lower-cost producers of the product compared with producers at home, with the goods being imported more as a result of trade liberalization. Trade diversion (or trade inhibition), however, 1 Nevertheless, compared to other regional trade agreements around the world, AFTA is claimed to reduce trade without changing intra-trade within the region. The literature on the matter includes a host of voices criticizing AFTA s failures. One of the main reasons for this is that AFTA is reportedly driven by bureaucrats rather than the market (see Low 2004, for example).

4 Does AFTA Create More Trade for Thailand? 53 is detrimental not only to the welfare of the world, but to the importing country as well because the increased imports may not actually be the best choice due to price discrimination from the countries that are in the bloc. Nevertheless, since trade liberalization has both trade-creation and trade-diversion effects, a comparison between these effects can be used to identify possibly ambiguous effects on the economic welfare of the Thai people that might make them reluctant to join the free trade agreement. The impact on efficiency and welfare enhancement depends on which effect dominates. In practice, however, it is rather difficult to accurately measure the magnitude of effects caused by trade creation and trade diversion. What is more important, and, indeed, necessary for an evaluation, is the sectoral pattern of trade between the prospective partners making the free trade agreement. A number of scholars have used the gravity model to quantify the trade creation/ diversion effect in major PTAs. 2 For AFTA, Hapsari and Mangunsong (2006) investigated the determinants of trade flows of AFTA members, including the impact of AFTA s creation on the intra-regional and extra-regional trade flow by comparing trade patterns of AFTA countries with AFTA members and non-members. They found that the reduction of tariffs under the AFTA scheme had a significant effect in increasing the bilateral exports of ASEAN members. Similarly, Siah et al. (2009) adopted a gravity model to examine whether ASEAN integration promoted intra- ASEAN trade between Indonesia, Malaysia, the Philippines, Singapore, and Thailand. The results indicate that the effects of ASEAN are mixed and inconclusive. Trade creation and/or trade diversion can exist, depending on the specific country. The results show that ASEAN countries may not, as a whole, benefit from the formation of AFTA. Moreover, Sudsawasd and Mongsawad (2007) showed that the ASEAN-5 would benefit more if they fully liberalized trade among themselves. This is partly due to less trade diversion, better resource allocation, and an improvement in the terms-oftrade effect. The studies conducted by Ramasamy (1995) are able to fill in some of the gaps in Sudsawasd and Mongsawad s research by estimating the negative effect of trade diversion among ASEAN member countries. They also reveal that trade creation is greater than trade diversion for Indonesia, the Philippines, and Thailand, while the reverse is true for Malaysia and Singapore due to misallocated resources. 3 Frankel (1993) and Elliott and Ikemoto (2004), 2 Take Rose (2002) for WTO members and Krueger (1999) for NAFTA members, for example. 3 The Philippines has experienced the highest trade-diversion rate of all the ASEAN nations, which is estimated at around 10 per cent of its GDP in Singapore

5 54 Piriya Pholphirul who also used a gravity model to detect and quantify a possible gain in intraregional trade among ASEAN countries, found that trade volumes were not significantly affected in the years immediately following the signing of the AFTA agreement. The degree of trade creation should have been even smaller from 1988 to 1992, but increased a little after 1993 when the AFTA agreement was signed. A number of the studies mentioned above took a gravity-model or econometrics approach as their central methodology in quantifying and comparing the trade-creation and trade-diversion effects of AFTA. Using this type of methodology alone is bound to lead to certain technical problems, however, as it only measures the short-term impacts. In the long term, there is a possibility that the positive effects of trade integration due to agreements like AFTA will result in a positive gain for all the member countries due to greater competition, economies of scale, more product variety, and economies of scope from intra-industry trade, which will outweigh the short-term effects. This paper therefore aims at making simple ex-ante estimations of the effects of trade liberalization on Thailand and at determining the possible degree of its trade creation due to AFTA. It also analyzes the potential gains to Thailand as a member of AFTA. This may be determined by examining the similarity of its trade patterns with other ASEAN countries. The comparison of trade patterns between nations can be analyzed by using three fundamental trade indicators, namely the Export Similarity Index (ESI), the Intra-Industry Trade (IIT) index, and Revealed Comparative Advantage (RCA) rank correlation. The differences in trade patterns reflect the degree of competition between the countries and explain whether or not trade creation and trade diversion should exist. 2 Thailand s Trading with ASEAN and Other Trading Blocs A permanent member of ASEAN since it was formed in 1992, Thailand is one of the ASEAN-6, six nations that have all made significant progress in lowering intra-regional tariffs through the Common Effective Preferential Tariff (CEPT) Scheme for AFTA. There is no doubt that intra-asean trade has been increasing among ASEAN s economies. The United States, Japan, and the European Union are ASEAN s main trading partners. In addition, trade with China has been growing very quickly in recent years. follows with 8 per cent, Thailand with 6 per cent, Malaysia with 5 per cent, while in Indonesia s case, just 3 per cent of its trade was diverted.

6 Does AFTA Create More Trade for Thailand? 55 Even though intra-regional trade among ASEAN members has continually increased over time from 17.4 per cent in 1980 to 22.8 per cent in 2002 and 24.9 per cent in 2006, trade among ASEAN s members is relatively low compared to other trade blocs around the world, such as NAFTA, FTAA, 4 or the EU-25, all of which involve more than 50 per cent intra-group trade. 5 Thailand s trading with other ASEAN members fell to as little as 20 per cent in 2006 compared to extra-asean countries. Intra-ASEAN trade has been increasing, but trade with the rest of the world continues to be much more important for Thailand and the other ASEAN countries. 6 As just mentioned, the United States of America, Japan, and the European Union are ASEAN s main trading partners. Trade with China has also been growing very quickly in recent years, however. Singapore is the most active trader in the ASEAN bloc, despite its small size. If one compares AFTA with other trade blocs around the world, like NAFTA, FTAA, and the EU, the intra-regional trade of these groups is found to be continuously increasing as well. However, the intra-regional trade of AFTA s members is still considerably less than for other Preferential Trade Agreements; it was just 17.4 per cent in 1980 and had only increased to 22.8 per cent by Intragroup trade in NAFTA, on the other hand, accounted for 56 per cent in 2002, which was a large increase compared with the figure in 1980 (33.6 per cent). In the same year, trading within FTAA was also at a level of 60.7 per cent, increasing from 43.4 per cent in Intra-EU trade amounted to per cent of the member states overall trading from 2000 to In view of this, the amount of intra-regional trade conducted by the ASEAN countries cannot be considered to be very large compared to other trade liberalization areas there is still plenty of room for more business in the future when trading has been liberalized even further within the region. 7 4 The Free Trade Area of the Americas (FTAA) is an attempt to expand the North American Free Trade Area (NAFTA) to include every country in Central America, South America, and the Caribbean (with the exception of Cuba). Negotiations began right after the implementation of NAFTA in The Lao PDR and Myanmar prove the exception here, as their intra-asean trade volumes were as high as 79.8 per cent and 59 per cent of the total trade volume of the two countries in 2006 respectively. 6 After the Asian crisis, when economic growth in the region was slow, the low share of intra-asean trade relative to total trade proved advantageous; dynamic trade with the rest of the world contributed to a speedy recovery in the ASEAN region. 7 Ariff (2001) takes this point one step further. He states that there is no incompatibility whatsoever between AFTA s two goals of enhancing intra-asean trade and increasing ASEAN s competitiveness in the world. A high ratio of intra-regional trade may not be in ASEAN s interest, as this might take place at the expense of extra-regional trade.

7 56 Piriya Pholphirul Table 1: Percentage of Intra-regional Export Volume among Trade Blocs Year Partner AFTA APTA MERCOSUR Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world

8 Does AFTA Create More Trade for Thailand? 57 Year Partner NAFTA FTAA EU 25 Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Intra-group Rest of the region Rest of the world Source: UNCTAD 2007.

9 58 Piriya Pholphirul Table 2: Intra- and Extra-ASEAN Trade in 2006 Country Value (million USD) Intra-ASEAN Share of total trade (per cent) Total Trade Value (million USD) Extra-ASEAN Share of total trade (per cent) Brunei 2, , Cambodia 1, , Indonesia 37, , Lao PDR Malaysia 73, , Myanmar 3, , Philippines 18, , Singapore 146, , Thailand 50, , Vietnam 18, , ASEAN 352, ,052, Source: UNCTAD Even though intra-regional trade among ASEAN members was relatively low in 2006 (24.9 per cent), the trade volumes of ASEAN countries with other countries in the region were as high as 60.7 per cent. There is an implication here that ASEAN would benefit even more if it were to increase trade and investment with other countries. Of all the ASEAN members, Singapore traded the most in 2006 (USD146,102 million). Malaysia, Thailand, and Vietnam are other ASEAN countries that also have high trade volumes (USD73,270.2 million, USD50,484 million, and USD18,667.7 million respectively). However, relatively low and stable intra-asean trade shares (around per cent) within the ASEAN bloc and intra-trade volumes for Thailand indicate that opportunities exist for these prospective countries to benefit considerably if they decide to increase their opportunities by joining other Preferential Trading Agreements, especially

10 Does AFTA Create More Trade for Thailand? 59 one in the Asia-Pacific region like the Asia-Pacific Trade Agreement (APTA), which is the oldest PTA in that geographical area. 8 To be more specific, Thailand has been particularly active in four ASEAN markets to date: Indonesia, Malaysia, the Philippines, and Singapore. Between 1996 and 2001, its trading grew around 11.4 per cent annually. The high-growing items were HS-33: essential oils, perfumes, and cosmetics (30.5 per cent), HS-99: commodities not elsewhere specified (28.4 per cent), and HS-29: organic chemicals (26.7 per cent). The low-growing items exported to ASEAN-4 countries are, for example, HS-73: articles of iron or steel (0.4 per cent), HS-40: rubber and articles thereof (1.8 per cent), and HS-55: manmade staple fibers (2.5 per cent). On the import side, Thailand s imports from ASEAN-4 countries grew by about 3.7 per cent annually in the period from 1996 to The high-growing import items are HS-32: tanning, dyeing extracts, and tannins (17 per cent), HS- 76: aluminum and articles thereof (16.4 per cent), and HS-71: pearls and precious stones (10.2 per cent). The slow-growing imported items from ASEAN-4 countries are HS-85: electrical and electronic equipment (2 per cent), HS-48: paper and paper board (1.3 per cent), and HS-84: nuclear reactors, boilers, and machinery, etc. (0.5 per cent). On the import side, Thailand s imports from ASEAN member countries increased from 13 per cent in 1990 to 17 per cent in 2003, offsetting the reduction in import shares from European Union countries, Japan, and the United States. Thailand s import shares from European Union countries, Japan, and the United States decreased from 16 per cent, 30 per cent, and 11 per cent respectively in 1990 to 10 per cent, 24 per cent and 9 per cent respectively in Other major import markets are China (8 per cent in 2003), Taiwan (4 per cent), South Korea (4 per cent) and the United Arab Emirates (3 per cent). Market diversification is therefore an important argument showing Thailand s low dependence on exports and imports in a particular market. 8 The Asia-Pacific Trade Agreement (APYA) in 2005 in Beijing, China was finally established and ratified by five of the seven countries, excluding the Philippines and Thailand. However, the Lao PDR has not yet issued customs notification on the tariff concessions granted. Thus, it is not considered an effectively participating member. China joined the Bangkok Agreement in 2001, making APTA the only regional preferential trade agreement linking the two most populous countries of the world: China and India. Pholphirul (2009) analyzes the potential gains for Thailand on entering one of the oldest PTAs in the Asia-Pacific region, namely the Asia-Pacific Trade Agreement (APTA). He finds that joining the APTA membership should yield around USD1,841 million in export gains per year for Thailand due to tariff reductions, mainly from China, Korea, and India.

11 60 Piriya Pholphirul In addition to a multilateral trading system, Thailand has concluded a network of bilateral preferential trading arrangements with several trading partners such as Australia, Bahrain, India, Japan, Peru, New Zealand, and the United States. In this regard, the FTA negotiations can be used as a means of maintaining and strengthening its shares in traditional export markets such as Japan, Europe, and United States as well as broadening and deepening its trade and investment access in potential markets, particularly China, India, Australia, and New Zealand. It is hoped that a free trade agreement with a far-off country, like Peru or Bahrain, will be a major step forward in achieving further trade expansion and economic cooperation with Latin America and the Middle East. There is no doubt under these open foreign policies why the country s degree of openness in terms of trade-to-gdp ratio was as high as per cent in 2006, which significantly increased when the baht currency was devalued in Currently, exports make up 58.8 per cent of the Thai GDP. During 2006, there was a temporary appreciation of the baht coupled with intense competition in the world market; according to the calculation of trade data from PC-TAS, Thailand s exports grew by only 10.9 per cent in its merchandise trade, which was much lower than the average growth rate among other ASEAN economies (15.8 per cent). The lower growth of export volumes indicates that Thai exports are losing their competitive edge in the world market. Global competitiveness has become a major challenge among trade policymakers and exporters in the new era. 3 Analyzing Trade Creation by Means of Trade Indicators As Thailand has become more liberalized over the years, either in the form of multilateralism, regionalism, or bilateralism, the country has grown deeply concerned about the competitiveness of its own exports in foreign markets. This phenomenon has resulted in a proliferation of analytical studies on the country s potential gains and losses from liberalization. Negotiators can use these analyses as extra information to shape their stance during trade talks, and the public can be informed to prepare it for forthcoming opportunities and threats. This section analyzes the potential gains to Thailand as a member of AFTA. These can be determined by analyzing the similarities of its trade patterns to the patterns of other ASEAN countries. A difference in the trade pattern reflects the degree of competition among countries and explains whether or not trade creation and trade diversion should exist. The comparison of trade patterns among countries can be analyzed by using three fundamental trade indicators, namely the Export Similarity Index (ESI),

12 Does AFTA Create More Trade for Thailand? 61 the Intra-Industry Trade (IIT) index, and Revealed Comparative Advantage (RCA) rank correlation. The differences in trade patterns reflect the degree of competition among countries and explain whether trade creation or trade diversion should exist Export Similarity Index One of common analytical tools adopted in many of these research works is the Export Similarity Index, which measures the similarity of any two countries products exported to the third market. This is based on the reasonable assumption that if two countries produce and export similar products, then the level of competition will be intensified by opening up trade between the two. 10 The Export Similarity Index (ESI) has been calculated to investigate trade competition among countries. 11 Based on a six-digit harmonized system (HS), the index indicates the similarity of the export commodity structures of two selected countries. An ESI value of 100 indicates that two countries export structures are the same, while an ESI value of 0 reveals that two countries export structures are very different. The ESI values among the ASEAN countries and other East Asian nations show higherdegree pair-wise export similarities between the countries. The increases in the ESI value from 1996 to 2001 imply a higher degree of export similarity among those countries. Among ASEAN members, Singapore and Japan, as well as Singapore and Korea, had a very similar export pattern. Thailand had the highest index value compared with China and other East Asian countries. Also, the Philippines and Indonesia showed minor similarities in the structure of their exports with East Asian countries. The calculation table is shown below: 9 The Thailand Development Research Institute (1996), however, concludes there is a strong similarity in the trade structure of AFTA member countries, which results in a high degree of competition among these nations. 10 The Export Similarity Index was first introduced by MacDougall in 1952 with the aim of measuring the similarity of British and American exports. 11 The formula of the Trade Similarity Index is i S ab, c MinimumX ac, X bc 100 where ab c i Index between country A and country B in market C, ac i S, is the Trade Similarity X i is the weight of the commodity i in A s trade in market C, and bc X i is the weight of the commodity i in B s trade in C.

13 62 Piriya Pholphirul Table 3: Export Similarity Index (ESI) among AFTA Countries and East Asian Countries Thailand Indonesia Malaysia Year Thailand Indonesia Malaysia Philippines Singapore China Japan Korea AFTA Countries Philippines Singapore China Japan Korea Source: East Asian Countries Author s own calculation. Calculated from PC-TAS, UN. Within ASEAN, all the index values increase when the individual members are compared with ASEAN s export structure. In the case of Thailand, for example, the degree of export similarity is the highest between Thailand and Malaysia, followed by the similarity between Thailand and China. Among the AFTA member countries, only Indonesia has an export pattern that is less similar to other East Asia countries compared to other AFTA members. Malaysia s index was the highest, while that of Indonesia was the lowest. Singapore and Malaysia illustrated the strongest ties among ASEAN countries. Therefore, the ESI indicates that the East Asian countries seems to have more similar export structure to each ASEAN countries than intratrade structure among AFTA member countries. Competition within groups

14 Does AFTA Create More Trade for Thailand? 63 seems to be more evident than between groups. Japan and Korea exhibit more rivalry in terms of their export structure. Singapore s export structure is closer to Japan s and Korea s, while Thailand s structure is closer to China s. 3.2 Revealed Comparative Advantage (RCA) Rank Correlation The potential gains from a preferential agreement depend on whether the trade patterns between Thailand and the other ASEAN countries are complementary or substitutable. Spearman s rank correlation between the Revealed Comparative Advantage (RCA) is used to estimate gains/ losses from trade. This correlation index shows the trade patterns between Thailand and other ASEAN countries. Since Revealed Comparative Advantage (RCA) rank correlation is calculated from the RCA index, which measures the competitiveness of the countries industries in the global market, the positive values of RCA rank correlation coefficients indicate the similarities of the trade structure between nations so that trade items between the countries are substituted for each other. 12 Conversely, the negative values indicate a dissimilar trade structure. In other words, the traded items between countries are complementary. 13 Referring to Figure 1 below, the RCA rank correlation is shown on the vertical axis, while the horizontal axis reflects Thailand s export volume as a share of the country s imports. The size of the circle represents Thailand s export volume. As the result, based on the analysis of RCA rank correlation shown as a positive value, Thailand s trade structure is found to substitute those of other ASEAN countries. For example, the trade substitution between Thailand and the Philippines is about 45 per cent, it is about 33 per cent between Thailand and Indonesia, and it is 22 per cent between 12 The formula of RCA is X ik X k / X iw X w where X ik is the value of sector i export of country k, and X iw is the total value of the world exports of product i. A comparative advantage is revealed if the RCA > 1. If the RCA < 1, however, the country is said to have a comparative disadvantage in the commodity i. 13 RCA rank correlation reflects the comparative advantage in trade patterns. Regarding the standard trade model, the Heckscher-Ohlin theorem (H-O) states that for a country that has a comparative advantage in the production of goods that involve intensive but abundant labor, a relatively cheaper price should result. Inter-industry trade between two different countries (in terms of their resource abundance) results in more trade, which therefore increases a country s welfare. On the other hand, a decline in trade between countries with similar trade structures reduces both countries welfare.

15 64 Piriya Pholphirul Thailand and Malaysia. The trade substitution between Thailand and Singapore is only 2.3 per cent, however. Moreover, the negative value of RCA rank correlation implies a degree of complementary trade. There is a complementary pattern between Thailand and other non-asean countries such as the EU (20 per cent), with Australia (17 per cent), with Great Britain (30 per cent), and with the U.S. (9 per cent). The RCA rank correlation can be estimated in order to compare the export structure between Thailand and each ASEAN country in terms of its industry basis. The RCA rank correlation indices on an industry basis are estimated based on International Standard Industrial Classification (ISIC) product codes. These estimated coefficients can be used to interpret the complementarities/ substitute competitiveness structure. Using the concept of comparative advantage, the negative value of the estimated index explains trade complementarities (similarity) between two countries, which thus imply higher gains from trade. The positive value of the estimated index, on the other hand, explains substitute trade between these countries, which implies lower gains from trade between Thailand and other ASEAN member countries. The result shows that the trade structures between the prospective countries and other AFTA states are rather similar considering all of the positive values of the RCA rank correlation. For agricultural products (ISIC-1), the correlation between Thailand and other ASEAN countries such as Indonesia, the Philippines, and Malaysia was higher than for other nations, including China. The correlation with the EU and U.S. was low. Thailand had a high correlation with ASEAN, China, Japan, and Korea in the areas of food processing and textiles. There are therefore a number of potential product groups that have a significant negative coefficient value, which can be used to determine the dissimilarity of the trade structure between Thailand and other non-asean countries. These groups can be considered for potential trade with the U.S. in areas like ISIC-1 and ISIC-33 to 36, products from ISIC-35 could be traded with China, and products from ISIC-32 and ISIC-39 could be traded with Japan. Bilateral or regional trade agreements between Thailand and these non- ASEAN countries ought to help to create a higher trade volume with these countries.

16 Does AFTA Create More Trade for Thailand? 65 Figure 1: Revealed Comparative Advantage (RCA) Rank Correlation Share of Country Import from Thailand (per cent) Source: RCA rank correlation Author s own calculation. Calculated from PC-TAS, UN.

17 66 Piriya Pholphirul Table 4: RCA Rank Correlation Coefficient for Thailand and Other Selected Countries Countries ISIC1 ISIC2 ISIC31 ISIC32 ISIC33 ISIC34 EU Philippines Indonesia Malaysia Singapore USA China Japan Korea India Number of products Countries ISIC35 ISIC36 ISIC37 ISIC38 ISIC39 EU Philippines Indonesia Malaysia Singapore USA China Japan Korea India Number of products 1, , Note: ISIC-1 - Agriculture, hunting, forestry, and fishing; ISIC-2 - Mining and quarrying; ISIC-3 Manufacturing. ISIC-31 - Manufacture of Food, Beverages and Tobacco, ISIC-32 - Textile, Wearing Apparel and Leather Industries, ISIC-33 - Manufacture of Wood and Wood Products, Including Furniture, ISIC-34 - Manufacture of Paper and Paper Products, Printing and Publishing, ISIC-35 - Manufacture of Chemicals and Chemical, Petroleum, Coal, Rubber, and Plastic Products, ISIC-36 - Manufacture of Non-Metallic Mineral Products, except Products of Petroleum and Coal, ISIC-37 - Basic Metal Industries, ISIC-38 - Manufacture of Fabricated Metal Products, Machinery and Equipment, ISIC-39 - Other Manufacturing Industries. Source: Author s own calculation. Calculated from PC-TAS, UN.

18 Does AFTA Create More Trade for Thailand? Intra-Industry Trade Index Besides the degrees of similarity and intensity in countries trade with one another, another positive feature of this trade structure is the high degree of intra-industry trade between the prospective countries and the member states. Intra-industry trade refers to the exchange of products belonging to the same industry. The term is usually applied to international trade, where the same kinds of goods and services are both imported and exported. Intraindustry trade plays a particularly large role in the trade in manufactured goods among countries, which accounts for most of world trade. Over time, countries have become increasingly similar in their levels of technology and in the availability of capital and skilled labor. Thus, nowadays, there is often no clear comparative advantage within an industry due to different endowment and non-identical trade structure. Much of international trade therefore takes the form of two-way exchanges within industry, driven in large part by economies of scale rather than inter-industry specialization (Krugman 1995). Intra-industry trade not only increases growth in intra-regional trade blocs, but also generates benefits from trade by increasing product variety. 14 Intra-industry trade allows countries to benefit from larger markets. By engaging in intra-industry trade, a country can simultaneously reduce the number of products it produces and increase the variety of goods available to domestic consumers. 15 Therefore, intra-industry trade tends to be prevalent between countries that are similar in their factor endowment, such as capital-labor ratio, skill levels, and so on. Gains from trade will be large when economies of scale are strong and products are highly differentiated. To investigate this issue, the third indicator, Intra-Industry Trade (IIT), is calculated to reflect the pattern of intra-industry trading between countries. 16 This index captures trade between two countries (Thailand and an- 14 Intra-industry trade does not reflect comparative advantage. It is economies of scale that keep each country from producing the full range of products for itself. In this case, economies of scale can be an independent source for determining trade volumes. 15 To produce fewer varieties, a country can produce each variety of goods on a large scale, with higher productivity and lower costs. At the same time, consumers benefit from the increased range of goods on offer. 16 To be more precise, the standard formula for calculating the importance of intraindustry trade within a given industry is ITT= 1 where X ij is the value X ij M ij X M of country i s exports of product j to the market under investigation and M ij is the value of the country s imports of product j from the market being examined. If ij ij

19 68 Piriya Pholphirul other ASEAN country in this case) within the same product group. A high IIT index shows a high trade proportion in that particular product group, and a low IIT index implies less trading of that product group and a possibility to compete in the third country. Therefore, a high level of IIT between two countries suggests an advanced degree of economic integration and tends to be positively correlated with participation in a preferential trading area. For simplicity, the products shown within this calculation indicated as a two-digit ISIC level illustrate the intra-trade pattern between Thailand and ASEAN and East Asia countries. By observing the sectors that contained high proportions of export shares between 1997 and 2001, for example, the IIT indices are higher for the ASEAN countries than those of East Asia countries for items in ISIC-32 ( Textile, Wearing Apparel and Leather Industries ) (10.48 per cent), ISIC-35 ( Manufacture of Chemicals and Chemical, Petroleum, Coal, Rubber and Plastic Products ) (10.51 per cent), and ISIC-38 ( Manufacture of Fabricated Metal Products, Machinery and Equipment ) (46.91 per cent). As a previous study conducted by the Thailand Development Research Institute (1996) has also shown, we can see that the intra-trade patterns between Thailand and AFTA member countries indicate a high degree of intra-industry trade that is different from the trade pattern of Thailand and other non-afta countries, which seems to indicate inter-industry trade. Therefore, this implies that the gains that might come from trade creation from AFTA can be caused by an increase in the trade volumes in the same industries rather than from trade between different industries, which might be predicted from the original trade theory. there is no intra-trade within a given industry, we expect a country either to export a product or to import it, not both, in which case the IIT index would always equal zero. On the other hand, if a country s exports and imports within an industry are equal, we find IIT = 1.

20 Does AFTA Create More Trade for Thailand? 69 Table 5: Thailand s Intra-Industry Trade (IIT) Index, Averaged for 1997 to 2001 ISIC Indonesia Malaysia Philippines Singapore China Japan Korea Per cent of exports ISIC ISIC ISIC ISIC ISIC ISIC ISIC ISIC ISIC ISIC ISIC Source: Author s own calculation. Calculated from PC-TAS, UN. Besides comparing trade structures among countries, the three indicators referred to above ESI, IIT, and RCA rank correlation can also determine trade diversion. Because all three indicators determine a high degree of trade similarity among AFTA member countries, trade diversion might be created within the AFTA trade bloc, while trade creation within AFTA is also less likely to be created if there is a high degree of trade similarity. Therefore, if we want to analyze the possibility of trade diversion among AFTA member countries due to the impact of China, due to the sufficiently high values of ESI, IIT, and RCA rank correlation indicators, Thailand will not suffer from China s impact, but rather enjoy the benefits from trade diversion due to the Chinese economy. Nevertheless, China has a greater competitive impact on costs due to its relatively low labor costs. In addition, higher IIT values indicate a trend not only toward more economies of scale in production, but also toward product differentiation, long-term business relations, and quality upgrading among ASEAN member countries due to fiercer competition once free trade is fully implemented in the future. With regard to international trade, one can distinguish between market diversification and product diversification. Market diversification is explained by analyzing the diversification of the country s export and import markets. The risks from a given shock from a country s trading partner might be lower if market diversification existed. Market diversification also

21 70 Piriya Pholphirul helps to decrease the aggregate volatility due to such shocks. Thailand s potential market is composed of ASEAN members; Thailand s exports to ASEAN increased dramatically from 12 per cent in 1990 to 21 per cent in Nevertheless, the increase in Thailand s export share to ASEAN is a tradeoff for the reduction of its export share to other major export markets: European Union countries, Japan, and the United States, which amounted to 23 per cent, 17 per cent, and 23 per cent respectively in 1990 and to 15 per cent, 14 per cent and 17 per cent respectively in Product diversification of a country s export structure also indicates a low dependence on primary export groups, the prices of which are volatile. Based on the traditional theory of international trade, product diversification in exported items might imply a comparative advantage for domestic production. Thailand s major export items are computers and components (which make up around 10 per cent of its total exports), car assemblies and spare parts (6.9 per cent), electronics and circuits (4.7 per cent), petrochemical products (3.8 per cent), and para rubber (3.2 per cent) respectively. In comparison to other emerging countries, this evidence indicates that Thailand s export structure is diversified among different product groups. The Herfindahl-Hirschman Index (HHI) is computed to measure the extent of Thailand s export diversification. 17 The HHI is found to vary around 0.25 to 0.3, which implies a high degree of export diversification (or a low degree of export concentration). 18 A high degree of product diversification gives Thailand substantive opportunities for the use of market-penetration and market-development strategies on launching new and diversified products in the ASEAN market. 17 The Herfindahl-Hirschman Index is a quantitative measure of export concentration (or the inverse of diversification). The more diversified the composition of exports, the lower the value of this index. 18 Pholphirul and Vichyanond (2006) explain the importance of a high level of exports for Thailand s economy. They also point out why the external shocks that the country has suffered have failed to diminish its macroeconomic growth process.

22 Does AFTA Create More Trade for Thailand? 71 Figure 2: Herfindahl-Hirschman Index of Export Diversification Source: Author s own calculation. Data collected from PC-TAS, United Nations. Even though the above results reveal that AFTA creates a low degree of trade for Thailand, the trade-diversion effect can also be small. ASEAN members, including Thailand, have not transferred their import transactions

23 72 Piriya Pholphirul from non-member trading partners to member ones. This means that there has been no import trade diversion in the ten-year period since AFTA was established. One possible interpretation is that the dynamic network of domestic production together with foreign investment projects in ASEAN countries have caused these countries to prefer importing from non-members outside the region (Kien and Hazimoto 2005; Elliott and Ikemoto 2004). 4 Conclusion and Policy Recommendations The aim of this paper was to examine whether the ASEAN Free Trade Agreement (AFTA has created trade for and/or diverted it away from Thailand by referring to three trade indicators: the Export Similarity Index, Revealed Comparative Advantage (RCA) rank correlation, and the Intra-Industry Trade Index. Consistent with previous studies quantifying the effects of AFTA by using the gravity model, it shows a high degree of similarity between the trade structure of Thailand and AFTA, which indicates fewer benefits of trade creation from AFTA and a greater possibility of trade diversion when the AFTA scheme is fully implemented. This similarity pattern explains the reasons for future collaboration among member countries and supportive arguments for the future extension of ASEAN to become ASEAN+. In addition to gains from trade in different structures explained by RCA rank correlation, intra-industry trade implies gains from product varieties. The estimated results of product differentiation and intraindustry trade patterns show that trading with ASEAN countries should enhance the trade gains for Thailand, not only by widening product ranges, but also by expanding product varieties. This paper has focused on trade in manufacturing goods, one of the most dynamic export sectors of recent decades, provoking drastic changes in the composition of exports among ASEAN countries. As well as promoting intra-regional trade among the ASEAN members, a more investmentfriendly policy should be adopted throughout the region; the AIA should attract more foreign direct investment (FDI) inflows from both ASEAN and non-asean source countries. The goal of the AIA is to create a liberalized and transparent investment environment for ASEAN investors by 2010 and for any investor by Therefore, the AIA should directly benefit Thailand, which will then create more ways of attracting foreign direct investment. This greater attractiveness will stem from the economies of scale of the expanded ASEAN market as well as the free movement of goods between the ASEAN economies. Nevertheless, within the region, Thailand is competing against other ASEAN countries for FDI, especially in

24 Does AFTA Create More Trade for Thailand? 73 areas where it has a comparative advantage relative to other ASEAN economies. The greatest challenge that Thailand has faced so far within the ASEAN context was when China started to become a formidable competitor for foreign investment and began to grow more active in export markets. Labor-intensive manufacturing activities then started to get relocated to China. Theoretically, with a market covering 500 million people, ASEAN has no reason to feel discouraged. The new challenge is in finding out how Thailand and other ASEAN members can obtain market access to China by expanding the ASEAN-China framework as well as other ASEAN+ agreements. 19 A number of issues ought to be of concern to relevant policymakers in Thailand (as well as in other ASEAN countries). First, Thailand should make an effort to reduce its transaction costs and improve trade facilitation. Even though a number of studies such as those by Siah et al. (2009) and Hapsari and Mangunson (2006) found that distance has no significant effect on trade volume among ASEAN countries, improving trade facilitation helps reduce transaction costs not only in intra-asean trade, but also with respect to other trade blocs. Second, besides trade cooperation in an FTA context, Thailand should strengthen and deepen its cooperation in various ways, for example promoting trade in services (e.g. education, tourism, construction), cultural exchange and personal movement, and investment. The strengths and weaknesses of Thailand (as well as each member country) should be identified. Third, if there is some concern about trade diversion, then Thailand has to enforce AFTA s rules of origin requirement to make goods more difficult to import from non-asean nations. Theoretically, the way to mitigate the degree of trade diversion is to set the long-term goal of moving ASEAN into global free trade arrangements. However, in the short to medium term, the expansion of ASEAN to include other potential countries (ASEAN+) has to be emphasized, as this study makes clear. Nevertheless, ASEAN+ may possibly distract Thailand as well as other member countries due to the effect called the spaghetti bowl in which free trade agreements between Thailand and other countries may overlap with 19 Sudsawasd and Mongsawad (2007) support the idea of focusing on ASEAN+ by investigating the economic impact of bilateral free trade agreements (FTAs) between the ASEAN-5 member countries (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) and the seven FTA candidates (Australia, India, Japan, New Zealand, South Korea, and the United States). By using the gravity model and the Computable General Equilibrium (CGE) model, they suggest the strategy of expanding the ASEAN-5 s partners: ASEAN + 3 FTA, ASEAN-China FTA, ASEAN-US FTA, ASEAN-Japan FTA, and ASEAN-India FTA.

25 74 Piriya Pholphirul the ASEAN+ framework. These agreements (summarized in the table below) have already been signed and named as different agreements, such as the bilateral agreements between Thailand-India, Thailand-Japan (JTEPA), Thailand-Australia, Thailand-New Zealand, and BIMSTEC at a multilateral level. With limited resources, Thailand (as well as each member country) may have to prioritize all its potential agreements. This is both a political and an economic issue determining the order of PTA attractiveness. Table 6: Thailand s Bilateral and Regional Trading Initiatives Partner Type Title Japan Bilateral Japan-Thailand Economic Partnership Agreement (JTEPA) Regional ASEAN-Japan Comprehensive Economic Partnership United States Bilateral Thailand-US FTA Australia Bilateral Thailand-Australia FTA Regional ASEAN-Australia and NZ FTA New Zealand Bilateral Thailand-NZ Close Economic Partnership India Bilateral Thailand-India FTA Regional ASEAN-India CECA Korea Regional ASEAN-Korea FTA China Regional ASEAN-China CECA Framework EU Regional ASEAN-EU FTA Bahrain Bilateral Thailand-Bahrain FTA Peru Bilateral Thailand-Peru Closer Economic Partnership EFTA Bilateral Thailand-EFTA FTA BIMSTEC Regional The Bay of Bengal Initiative for Multi- Sectoral Technical and Economic Cooperation