The effect of regional trade agreements on members competitiveness: The case of AFTA

Transcription

1 NATIONALEKONOMISKA INSTITUTIONEN Uppsala Universitet Kandidatuppsats Författare: Simon Ekberg och Hanna Seiz Termin: HT11 The effect of regional trade agreements on members competitiveness: The case of AFTA 1

2 Abstract This paper studies whether the increased intra- regional trade, created by the ASEAN free trade agreement, has lead to an increased competitiveness of the member countries in a third (non- member) market. We focus on the computer equipment sector and the ASEAN countries that are examined are: Singapore, Malaysia, Thailand, and the Philippines (ASEAN4). The regions competitiveness is measured by employing the Balassa index of revealed comparative advantage (RCA) on the imports of a third country during the time- period The third country whose imports will be used in the study is Australia. Reasons being that Australia is one of the larger trading partners with the ASEAN4 and that no multilateral, nor bilateral, trade agreement was in place between Australia and any of the ASEAN4 countries during the period of interest. The main finding of the study shows that there exists a significant positive relationship between intra- regional trade in the computer equipments sector among the ASEAN4, and the regions level of competitiveness in the Australian market. Keywords: AFTA, comparative advantage, intra- regional trade 2

3 Table of Contents 1. Introduction Literature Review 7 2. Background ASEAN Background ASEAN and the electronics industry Identifying our third country; Australia Theoretical framework International Trade Theory New trade theory Empirical method and data Gruber-Lloyd index Trade in computer equipment Revealed comparative advantage The pooled OLS regression model Data Empirical findings Discussion of findings Reference list Appendix 29 3

4 List of acronyms AEC ASEAN ASEAN4 AFTA CEPT EMU EFTA FTA FDI GL IAI IL MERCOSUR NAFTA RCA RTA SITC ASEAN Economic Community Association of South East Asian Nations Malaysia, Singapore, Thailand, Philippines ASEAN Free trade Area Common Effective Preferential Tariff European Monetary Union The European Trade Association Free trade Agreement Foreign Direct Investment Gruber- Lloyd index Initiative for ASEAN Integration Inclusion List The Southern Common Market The North American Free Trade Agreement Revealed comparative advantage Regional Trade Areas Standard International Trade Classification 4

5 1. Introduction In the past few decades, there has been a movement towards open regionalism and economic integration across the world, with an expanding network of Regional Trade Agreements (RTAs) and Free trade Areas (FTA). Between the years of 1958 and 1979, there were a total of 16 notified Free Trade Agreements whereas between 1980 and 2005, that number rose to more than one hundred (Crawford & Fiorentino, 2005). A free trade area is an agreement to reduce or eliminate trade barriers between countries, while maintaining separate national tariff schedules (Krugman & Obsfeld, 2006), and it is the most commonly used type of RTA. The World Trade Organization (WTO) more broadly defines a Regional Trade Agreement as actions by governments to liberalize or facilitate trade on a regional basis, sometimes through free- trade areas or customs unions. The European Free Trade Association (EFTA), The North American Free Trade Agreement (NAFTA) and The Southern Common Market (MERCOSUR) are well- known regional trade agreements, each promoting free trade and economic integration to various degrees among member countries (WTO, 2011). Economic integration is thought to result in trade creation and stimulate investment and economic growth (Krugman & Obsfeld, 2006). However, FTAs are sometimes criticized for creating efficiency losses by favouring member countries in a way that diverts trade from the most efficient countries to the less efficient member countries. In 1967, the Association of Southeast Asian Nations (ASEAN) was established by Indonesia, Malaysia, Philippines, Singapore and Thailand. Since then, the association has expanded with Brunei, Vietnam, Laos, Cambodia and Myanmar and now consists of 10 member countries. One of the most important steps towards economic integration in the region was the creation of the association s free trade agreement; AFTA, which involved reduction of tariffs and non- tariff barriers between member countries. The effects of AFTA and whether it lead to economic growth and competitiveness is important for future decision making in ASEAN, as well as for other regions struggle towards growth and prosperity, and has therefore been heavily studied and evaluated. Previous studies made by Hapsari and Mangunsong 5

6 (2006), and Amin, Hamid and Saad (2009) among others, have mostly proven AFTA being successful in increasing intra- regional trade between its member countries. This paper aims to develop this idea further and study whether the increased intra- regional trade also resulted in increased competitiveness for the region in a third (non- member) market. Existing theory give reasons to predict that increased intra- regional trade would benefit the countries involved in a way that enhance their competitiveness on the world export market. The foundation of international trade theory focuses on specialization due to absolute and comparative advantage when explaining reasons for trade. Since Krugman introduced his model of monopolistic competition there has been an increased focus on explaining intra- industry trade and why countries trade similar goods with each other. Whether the benefits of increased trade between the AFTA member countries can be explained through traditional trade theory or new trade theory depends on which trade patterns we observe. However, in either case, we wish to examine whether an increase in trade between the AFTA members has resulted in a change in their competitiveness in a third market. Therefore, trade flows to a third country outside the agreement are observed and used to measure the regions competitiveness. For reasons discussed later on, the chosen third country is Australia. The studied time- period is , which covers three years before the implementation of AFTA, and a twelve- year period during which the tariffs were phased out and no external trade agreement was in force between the member countries and Australia. Since the time- line of tariff reductions was different for countries joining ASEAN at different stages, we will focus on the original member nations; Singapore, Philippines, Malaysia and Thailand (ASEAN4), with the exception of Indonesia, where the data provided were insufficient. We have further focused on the sector or computer equipment because of its economic importance to the ASEAN nations, and the fact that it was relatively more affected by AFTA than other sectors. 6

7 1.2 Literature Review The empirical literature covering AFTA s proposed effect on intra- ASEAN trade is substantial and most studies conclude that AFTA has indeed been successful in promoting intra- regional trade among its members. During the period of interest for this study, intra- ASEAN trade increased its share of total ASEAN trade from 19% in 1993, to 25% in 2003 (United States International Trade Commission, 2010). Whether this increase can be solely attributed to the establishment of AFTA is however still up for debate. When evaluating the effects of a FTA, the question whether an increase in intra- regional trade is net trade creating (increased trade with efficient members) or net trade diverting (increased trade with inefficient members due to lower trade barriers) is of great importance to conclude whether the reduction of trade barriers promotes trade in a way that improves welfare. Wha- Lee and Park (2005), Elliot and Ikemoto (2003), and Gosh and Yamarik (2004) found, using the Gravity Model, that the majority of FTAs (including AFTA) increased trade among member countries, and that they are net trade creating. Findings by Dee and Gali (2003) on the other hand, showed that FTAs weren t as successful as suggested. Amin, Hamid and Saad (2009) investigates this issue in the case of AFTA and find that intra- ASEAN trade is indeed trade creating, both on the aggregated total level and on four different disaggregated one- digit SITC levels. Among the disaggregated sectors that exhibit an effective increase in intra- ASEAN trade is SITC 7, where our product group of interest is found. Thereby, AFTA seems to have been able to increase intra- ASEAN trade in computer equipment in an effective manner. Our focus in this paper is on how the increased intra- regional trade as a result of AFTA, has affected the regions competitiveness on the world export market, rather than the more commonly adopted narrow focus of changes in trade within the region. The most widely adopted model when evaluating FTAs is the previously mentioned Gravity Model. It explains how trade patterns between two countries can be estimated by geographical distance and the size of their economies. Later on, the Gravity Model has also been used to study not only individual countries but also trade flows between trade blocs or regions. However, we adopt a simpler method that may be more suitable for our question of interest. These models and measurements will be further explained and discussed in section 3: Empirical method and data. 7

8 The next section of this paper provides a more thorough background of the formation of ASEAN and AFTA, and what the association looks like today. We will further discuss and justify our focus on the electronics industry and the choice of the third country; Australia. Section 3 outlines our theoretical framework necessary to analyse our issue Firstly, the basics of traditional trade theory, secondly, the domestic effects of a tariff, while finally proceeding with the more recent new trade theories. Section 4 explains how we have chosen to design our empirical method and gathered our data. Section 5 presents our findings, whereas section 6 concludes with a discussion of our findings in the light of the theoretical framework. 2. Background 2.1 ASEAN Background The Association of Southeast Asian Nations was established in Bangkok, Thailand in 1967 by Indonesia, Malaysia, Philippines, Singapore and Thailand. The main purpose was to accelerate economic growth, social progress, and economic and cultural development among the member countries (ASEAN Secretariat, 2011). ASEAN expanded with Brunei in 1984, Vietnam in 1995, Laos in 1997, and Cambodia in One of the most important steps towards increased economic integration and trade in the region was the creation of the ASEAN Free Trade Area (AFTA) in AFTA involved the reduction of tariffs and other trade barriers between member countries in order to facilitate intra- regional trade within ASEAN, and thereby increase the areas competitiveness on the world market through economies of scale, greater specialization, and inflow of foreign direct investment (ASEAN Secretariat, 2011). The Common Effective Preferential Tariff (CEPT) scheme was the realization plan of AFTA, establishing the rules and deadlines for the phasing- out of tariffs on manufacturing and agricultural products. Those goods that were to be directly affected by AFTA from the start and thereby experience immediate reductions of tariff rates were listed on the Inclusion List (IL). By 2001, as many as 98,26 % of all tariff lines were listed on the IL, which shows the extensiveness of AFTA (ASEAN 8

9 Secretariat). Examples of exceptions from the inclusion list are products defined as being extra sensitive or crucial for reasons such as national security, animal and plant life, and health. The overall goal for goods on the IL was to reduce their respective tariff rates to 0-5% by The IL was further divided into a Fast Track and a Normal Track. Machinery and electrical appliances, which includes computer equipment, was one of the twelve sectors that were listed on the Fast Track and therefore experienced the largest drop in tariff rates in the least amount of time. Different deadlines were set for Vietnam, Laos, Myanmar and Cambodia that joined the agreement at a later stage. ASEAN has, with a few exceptions, managed to meet the CEPT scheme and the desired tariff reductions. Between 1993 and 1997, intra- ASEAN exports increased with an average of 29,6 % per year, which is substantially higher than the 18,8 % average annual increase of total ASEAN exports during the same period (ASEAN Secretariat, 2001). Since, as previously mentioned, AFTA was one of the most important steps towards achieving ASEAN s long- term goal of deep economic integration, evaluating the effects of AFTA and how successful it was in increasing ASEAN s competitiveness is vital for the future of ASEAN, and also of interest to other communities and regions when building their future and economic growth. 2.2 ASEAN and the electronics industry Since the trade in computer equipment was significantly affected by AFTA and the fact that it is an important industry for ASEAN as a whole, it became a natural focus for this paper. Within ASEAN, electronics is by far the largest sector in terms of trade value. The industry of electronics commonly refers to all electrical components and appliances. Moreover, ASEAN is the worlds second largest exporter of computer equipment and accounted for 21 % of global production in 2008 (U.S International Trade Commission, 2010). Machinery and electrical appliances (HS product group 84-85) was one of the broadly defined sectors undergoing the Fast Track CEPT- scheme, meaning that tariff lines on such goods were immediately affected by AFTA with the aim to undergo the 9

10 most rapid changes. It is also within machinery and electrical appliances we find our more narrowly defined product group of interest; computer equipment (product group 752 SITC rev. 3). The tariff reductions for goods characterized as machinery and electrical appliances are presented in the table below. Table 1 CEPT TARIFFS (in %) FOR MACHINERY AND ELECTRICAL APPLIANCES (HS: 84-85) Year Malaysia 5,2 4,7 4,1 3,68 3,27 3,05 2,8 2,27 Philippines 6,19 5,94 5,37 4,94 4,21 4,01 3,67 3,45 Singapore Thailand 8,51 8,45 7,28 7,2 5,8 5,8 4,93 4,1 ASEAN 5,88 5,52 4,64 4,28 3,47 3,4 3,06 2,69 Source: ASEAN Secretariat The table identifies the average tariff rates and highlights the countries that underwent the largest changes. Singapore was already characterized as a very open economy with tariff rates close to zero before the implementation of AFTA. Singapore could however still have benefited from lower tariffs in other ASEAN countries when exporting. Still, Thailand and Philippines, whose tariff rates on machinery and electrical appliances in 1996 were quite high compared to the other ASEAN countries at the time, should be more affected by the tariff reductions than Singapore. By 2003 which is the end of our studied time period, the tariffs were between 0-5 % for each country of interest. 2.3 Identifying our third country; Australia Australia is currently the seventh largest trading partner of ASEAN, accounting for 3.6 % of ASEAN exports and 2% of ASEAN imports. Australia currently has six FTAs in force with New Zealand, Singapore (since 2003), Thailand (since 2005), the US, Chile, and ASEAN (since 2009). Thus, up until 2003 there were no trade agreements in force between Australia and ASEAN, nor between Australia and any of the individual ASEAN original member countries. This is important when trying to isolate the 10

11 effects of intra- regional trade on ASEAN4 s competitiveness on Australia, thus ensuring that no other trade agreement distorts our observed trade flows. Since 1970, Australia s international trade has shifted from Europe and the US towards Asian countries. Evidently, Australia has also been of increased importance for ASEAN and has been one of ASEAN s main export partners for the past thirty years. To make sure that ASEAN didn t already possess a dominant position in the Australian import market for computer equipment, we observed trade flows in computer equipment going from ASEAN4 to Australia, both prior to, as well as after, AFTA was implemented. As illustrated by figure 1, the ASEAN4 countries held only a small market share of Australia s computer equipment imports in the period prior to AFTA. Therefore, there is no reason to believe that an increased advantage for the ASEAN4 countries on the Australian market could be a result of ASEAN4 having a monopoly position in Australia prior to AFTA. An increased market share in Australia should therefore be an effect of increased ASEAN4 competitiveness. Figure 1 Source: Authors calculation based on UN COMTRADE data 11

12 3. Theoretical framework Economic integration is defined as the institutional combination of different national economies into larger economic blocs or communities and can exist in various degrees. A free trade agreement is considered a lighter form of economic integration since it only involves reduction of intra- group tariffs and trade barriers. A FTA seldom involves reduction of all tariff lines, thereby only partially living up to its name as a completely free trade area. In other words, FTAs can vary in magnitude and differ with respect to degree of economic integration among its members (Robson, 1998). The following section will from existing theory explain the implications of international trade. The first few paragraphs outline the basics of why individuals or countries specialize and gain from trading with each other. Secondly, a diagram will help illustrating the domestic efficiency losses created by a tariff. Lastly, there will be a discussion of why countries chose to engage in intra- industry trade. 3.2 International Trade Theory The foundations of international trade theory dates back as long as to 1776 and Adam Smith s work in his famous An Inquiry into the nature and causes of the wealth of nations, where he develops the idea of absolute advantage. British economist David Ricardo further developed Smith s idea into the concept of comparative advantage. According to Ricardo, a comparative advantage appears as soon as countries differ in their opportunity cost of production, thereby coming up with an explanation to why a country can gain from trade with other countries, in spite of having an absolute advantage in all goods (WTO, 2008). By specializing in the manufacturing of products that a country has a lower opportunity cost of production, gains from trade will appear as world output increase when countries specialize and are allowed to trade freely with each other. The concepts of absolute and comparative advantage provide a basic understanding of how opening up an economy from autarky to free trade can lead to welfare- gains (Sawyer & Sprinkle, 2006). Outside of the theoretical world, virtually no country operates in absolute autarky. However, the degree of openness towards trade and the prevalence of tariffs and 12

13 other trade barriers have varied significantly, both over time and between countries. The figure below illustrates more specifically, how tariffs are thought to affect a domestic market. Figure 1 Source: Krugman & Obstfeld, 2006 The figure illustrates demand and supply of a certain good in the domestic market. If the country would be completely isolated and not trade with the rest of the world, the good would be consumed at Q and the price would be P, which is the equilibrium illustrated by the intersection of the demand and supply curve. When opening up to trade with the world, the good can be purchased at P(w), which represents the world market price of the good, and Q2 would be demanded. P(t) is the price of the good after imposing a tariff on imports. At the higher price, P(t), consumers demand a lower quantity than when they are faced with the world price P(w) and imports decrease from the difference between Q2 and Q1, to the difference between Q4 and Q3. The areas a, b, c and d, collectively represents the loss for consumers when the tariff is imposed. Area c is government revenue, and area a represents the gains made by the domestic producers who now get a chance to sell more goods. Area b 13

14 and d represent efficiency losses that the imposed tariff creates, and is highlighted by the opponents of protectionism since free trade and reduction of tariffs would eliminate these efficiency losses. 3.3 New trade theory While traditional trade theory effectively explains trade occurring between countries with different technology and/or factor endowments, it has been less useful in explaining the growing importance of intra- industry trade, and trade between countries with similar industrial structure (Krugman & Obsfeld 2006). Intra- industry trade is typically defined as the trade that occurs when a country exports and imports goods within the same industry or product group. When observing trade flows today it becomes evident that countries often trade similar goods with each other, and that countries are not only an exporter or an importer in a specific industry, which is what to be expected according to traditional trade theory and specialization based on comparative advantage. These shortcomings have given birth to a more recent theoretical framework that introduces economies of scale and product variety as causes of trade between nations. (WTO, 2008) Most intra- industry trade is trade in differentiated goods where different features distinguish one good from its competitors in the same market or industry. Furthermore, the market is often characterized by the existence of many firms providing these slightly differentiated products. Thus, the market is characterized by monopolistic competition; where each firm maintain some control over its own pricing, rather than the commonly used theoretical scenario of perfect competition (Krugman & Obsfeld, 2006). Krugman s model of monopolistic competition is one of the best- known ways of explaining the causes of intra- industry trade and trade between similar countries. The model is based on the concepts of economies of scale and consumers love of variety and explains how an imperfect market can benefit consumers in terms of lower prices and a wider variety of products (WTO, 2008). 14

15 Economies of scale refer to the fact that a larger scale of production allows for lower per- unit costs, i.e. the average cost of production falls with an increasing scale of production. Thus, the model assumes that it is economically efficient to produce at larger quantities, and that larger firms have a cost advantage over smaller firms. This holds true especially for industries characterized by high fixed costs where investment in machinery and equipment is necessary for production, like in the automotive industry and the manufacturing of electronics. Further, the model assumes that consumers value variety and reach a higher utility when provided with choice and freedom in consumption. The existence of scale- effects and the fact that consumers value variety have opposite effects on the number of firms. Scale- effects make it more efficient to produce at large quantities and prohibit the existence of many small firms. Consumers love of variety, on the other hand, will promote the existence of many firms providing differentiated goods. (WTO, 2008) Given the assumptions and market structure discussed above, the causes and gains from intra- industry trade become easier to understand. Opening up to trade with other countries give producers access to a larger market, which allows them to expand production and benefit from economies of scale. Furthermore, consumers experience an increased variety of goods when foreign products are introduced to their domestic market. With a wider choice of products, consumers become more price- sensitive as a result of the increased availability of substitutes, leading to increased competition among firms. As a result, the least competitive firms are forced to exit the market leaving only the most competitive ones to survive. In market equilibrium, price equals average costs, and the total number of firms is determined. The more firms there are, the less control a firm has over its own pricing. Similarly, the more firms there are, the smaller the market share for each individual firm and the higher the average cost (smaller benefit from economies of scale). Thus, opening up to trade with other nations leads to fiercer competition. In the perspective of a consumer, there will be more similar products to choose from. However, the total number of firms providing the goods will likely decrease, since the least efficient are forced out of business. The increased competition facilitated by trade is referred to as pro- competitive effects. (WTO, 2008) Worth notifying is 15

16 how increased competition coupled with lower trade barriers increase the incentives for companies to invest in R&D and new technology in order to reduce production costs and stay competitive. Melitz model (2003) is part of a new strand of theory addressing firm- specific differences and it elaborates on Krugman s model of monopolistic competition by allowing for differences between firms. It assumes that there is a fixed cost associated with producing on the domestic market and similarly, a separate fixed cost associated with exporting and serving the international market. Only the most efficient producers will both serve the domestic market and the international market, the medium- efficient firms will stay in the domestic market and the least efficient will not produce at all. In the short run, falling trade costs, such as the reduction of tariffs, reduce the barrier to export, creating incentives for the most competitive non- exporting firms to start exporting. When more firms start exporting, the competition and the required minimum level of productivity needed for covering the fixed costs, will increase. Thus, in the long run, the intensified competition created by lower trade barriers will increases the average industry productivity level. (WTO, 2008) In summary, new trade theories together with the firm- specific theories, such as the Melitz model, shows how the reduction of a tariff will affect the price of a produced good both because of the removal of the actual cost associated with the tariff, and perhaps more interestingly, because of its effect on firms productivity and decreased production costs. All together it results in an overall increased competitiveness of the industry in the affected region, leading us to expect a positive effect on the ASEAN4 countries competitiveness in the third market due to AFTA. 4. Empirical method and data Since we are investigating how intra- regional trade in computer equipment within ASEAN4 has affected the regions competitiveness in a third market, we will firstly have to look at the characteristics of the trade conducted among the ASEAN4 economies. I.e. is it characterized as intra- industry or inter- industry trade? Secondly, 16

17 we will measure the size of computer equipment trade within ASEAN4, in both absolute and relative terms, to conclude if trade in our sector of interest has increased following the implementation of AFTA. Thirdly, we will employ the index of revealed comparative advantage (RCA) on Australian import flows, originating in ASEAN4 and the rest of the world, in order to measure changes in the ASEAN4 regions level of competitiveness. Then, based on the results from these first stages, we will use a pooled OLS regression to test the relationship between changes in intra- regional trade and level of competitiveness. According to the previously explained theory, we expect to find a positive relationship between intra- regional trade within ASEAN4 and the regions level of competitiveness in Australia. 4.1 Gruber- Lloyd index The Gruber- Lloyd index will be used to investigate the nature of the intra- regional trade and measure the level of ASEAN4 intra- industry trade in computer equipment prior to, and following AFTAs implementation. It illustrates to what extent a country is solely an exporter or importer, or both, of a specific type of product, and can help us study whether changes in intra- industry trade patterns have occurred during the studied time- period. For example, if one country specialized entirely in the production and exports of computer equipment, the observed GL- index would be close to zero, and that country s trade would best be analyzed using traditional trade theory. Similarly, if a country is involved in extensive intra- industry trade, the analysis is best performed using new trade theory. Since the ASEAN region as a whole is the second largest exporter of electronics, it is highly likely that all countries are producing computer equipment. The question is to what extent they are trading with each other in this product- type and whether the pattern changed with the implementation of AFTA. The GL- index will take a value between 0 and 1, where 0 indicates no intra- industry trade in the considered product category, and 1 indicates complete intra- industry trade in the category of interest. In other words, if a country export and import equal amounts of a specific type of good, its GL- index will be 1. Consequently, if a 17

18 country is solely an exporter or an importer of the good, the GL- index will be 0. The index was first introduced in 1971 by Herb Grubel and Peter Lloyd and is defined as follows: GL- index = 1 - ( X- M )/(X+M) (Gruber & Lloyd, 1975) In our study, X represents export of computer equipment going to rest of ASEAN4, and M represents import of computer equipment coming from the rest of ASEAN Trade in computer equipment The reduced tariff lines for computer equipment within ASEAN are thought to facilitate trade between the member countries. Therefore, an absolute increase in intra- industry trade between ASEAN4 is expected after the removal of tariffs. Further, the increase is thought to be relatively larger than the increase in other sectors on average, since computer equipment was listed on the fast track and experienced quicker tariff reductions in comparison to goods not listed on the fast track. In order to measure the relative importance of trade in computer equipment within ASEAN4, we will calculate the intra- ASEAN4 trade in computer equipment as a relative share of total intra- ASEAN4 trade. This measure will show if trade in the sector of interest has increased its importance among the ASEAN4 members during the studied period. It is simply calculated as: (Country X s intra- ASEAN4 trade in computer equipment) (Country X s intra- ASEAN4 trade in all product categories) 4.3 Revealed comparative advantage The level of each ASEAN4 country s competitiveness in the Australian market for computer equipment will be measured by the Balassa index of revealed comparative 18

19 advantage (RCA). The index use trade flows to calculate a country s relative advantage in the production of a specific type of good, compared to the rest of the world. It is originally defined as: (X ij /Σ i X ij ) RCA = ( j X ij / i j X ij ) Where X ij represents country i s export in product category j. If RCA ij > 1 country i has a comparative advantage in the production of j, the higher the index, the greater the advantage. If RCA ij < 1 country i has a comparative disadvantage in the production of j (Balassa, 1965). Since our study seeks to examine ASEAN4 s level of competitiveness in the Australian market, a slightly modified RCA- index will be employed where calculations are based on Australian import flows. The RCA index employed in the study is defined as follows: (M ij /Σ i M ij ) RCA = ( j M ij / i j M ij ) Where M ij represents Australian imports in product category j originating from country i. Since the RCA- index accounts for all of Australia s imports, originating in all countries, the only way for the ASEAN4 countries to increase their comparative advantage is to become more competitive compared with the rest of the world. Therefore, the RCA proves to be a suitable measure for investigating whether trade liberalization within ASEAN has contributed to their international competitiveness. 19

20 4.4 The pooled OLS regression model A pooled OLS regression model will finally be used to test the relationship between RCA and intra- regional trade within ASEAN4, in both absolute and relative terms. Through the model we will be allowed to investigate to what extent variations in intra- regional trade explains the level of competitiveness in the Australian market for computer equipment. Our regression model is defined as follows: Y it = α 1 + α 2 D 2it + α 3 D 3it + α 4 D 4it + βx it + ε it Where, Y = RCA in the Australian market for computer equipment X = Absolute size of intra- ASEAN4 trade in computer equipment in our first regression, and relative share of computer equipment in intra- ASEAN4 trade in our second regression D 2 = 1, if country is Malaysia D 2 = 0, if otherwise D 3 = 1, if country is Thailand D 3 = 0, if otherwise D 4 = 1, if country is Philippines D 4 = 0, if otherwise ε = Error term The dummy- variables D x are used to capture the country effect of Malaysia, Thailand, and the Philippines respectively. I.e. using Singapore as reference country, α 2, α 3, and α 4 will tell us by how much the average expected RCA differs for Malaysia, Thailand, and the Philippines in relation to Singapore. 20

21 4.5 Data The data used in this study covers aggregated total trade flows and disaggregated (SITC 3- digit level) trade flows for each ASEAN4 member, as well as aggregated and disaggregated Australian import flows originating from the ASEAN4 countries and the rest of the world. The studied time period is chosen because it provides reference data for years prior to when AFTA was implemented in 1992, and because of the fact that there were no trade agreements in force between Australia and ASEAN, or between Australia and any of the individual ASEAN4 countries up until The data is retrieved through WITS (World Integrated Trade Solution), which uses the UN COMTRADE database. Since a pooled OLS model will be employed, all observations in all periods will be regarded as a single sample in our regressions. Worth noting is that the UN COMTRADE database relies on each country to report accurate and reliable data for each individual year. In this study, no further precautions have been taken in order to guarantee the reliability and accuracy of the data. 5. Empirical findings When testing for intra- industry trade in computer equipment among ASEAN4, using the GL- index (view figure 3 in appendix), we conclude that all countries except Thailand 1 have maintained a relatively high level of intra- industry trade during the studied time period. The high level of intra- industry trade prior to AFTA shows that the computer equipment industry was already an active and integrated sector before the implementation of AFTA. Further, there is no clear change in pattern or trend after 1992 and the GL- index is rather quite irregular. From this result it can be concluded that we are dealing with intra- industry trade, meaning that benefits from increased trade among the members will have to be explained and discussed through channels of new trade theory. As shown in figure 4 (view appendix), intra- ASEAN4 trade in computer equipment has increased in absolute terms for all member countries, but to various degrees. 1 The reason for Thailand s GL- index dropping during is the fact that they switched to being almost solely an exporter of computer equipment during that period. 21

22 Singapore is the country that has experienced the largest absolute trade growth in computer equipment during our studied time- period. Thailand exhibits a similar pattern to Singapore, with a drop in trade of computer equipment following 1996, most likely due to the Asian financial crisis. Malaysia and the Philippines have experienced a steadier positive trend during the studied period, and trade in computer equipment seems to be less affected by the crisis in From our calculations we can also conclude that computer equipment has indeed increased its share of intra- ASEAN4 trade during the studied time period (view figure 5). Implying that AFTA affected the sector of computer equipment relatively more than other sectors on average. Once again, as can be seen in figure 5, Thailand exhibits the most eye- catching changes with a five- fold increase between before dropping in 1997, again, most likely due to the Asian financial crisis. Figure 6 illustrates the RCA in computer equipment for each ASEAN4 country in the Australian market. Malaysia and the Philippines both display a steady increase in its respective RCA following AFTAs implementation. Thailand also displays an increasing RCA in the beginning of the post- AFTA period, although the increase is not as strong as for Malaysia and the Philippines. Singapore already possessed a comparative advantage at the beginning of our studied period, indicating that Singapore was already competitive in the Australian market for computer equipment prior to AFTA. Overall, each country has experienced an increased RCA during the studied time period, i.e. each country has increased its competitiveness in computer products on the Australian market. From the initial findings discusses above, we can conclude that we are dealing with intra- industry trade, meaning that changes in levels of competitiveness will have to be explained through new trade theory. Furthermore, intra- regional trade in computer equipment within ASEAN4 has increased in both absolute and relative terms following the implementation of AFTA, and the regions level of competitiveness has increased in our third market. The question is how well the changes in intra- regional trade and competitiveness correlates with each other. 22

23 Two regressions were performed with ASEAN4 RCA as dependent variable in both scenarios. Our first regression uses the absolute size of intra- ASEAN4 trade in computer equipment as independent variable, while the second uses the relative share of computer equipment in total intra- ASEAN4 trade. To isolate the country effect, Singapore is used as the reference country while dummy variables for Malaysia, Thailand, and the Philippines are employed. The results of the regressions are presented in the table below. Table 2 Regression Analysis: ASEAN4 RCA vs Intra- ASEAN4 trade Coefficient Coefficient Constant 2,5789** 3,2362** Intra- ASEAN4 trade (Absolute size) 0, ** (0,7874) (0,6352) (0, ) Intra- ASEAN4 trade (Relative share) 40,29** (10,42) Country effect: Malaysia - 0,6001-1,4033** (0,8024) (0,6743) Country effect: Thailand - 2,3250** - 3,8893** (0,7831) (0,6077) Country effect: Philippines 0,1378-1,1154* (0,8688) (0,6646) R 2 53,2% 53,7% No. observations * P<0,1 ** P<0,05 Source: Authors calculation based on UN COMTRADE data 23

24 The regressions show that it exists a positive relationship between the regions competitiveness in Australia and the absolute size of intra- ASEAN4 trade in computer equipment, as well as its relative share of total intra- ASEAN4 trade. The coefficient 0, for intra- ASEAN4 trade in absolute size tells us that an increase in intra- ASEAN4 trade of 1 million USD expects to increase RCA with approx 0,001. To put this into context, intra- ASEAN4 trade in computer equipment amounted to 4,4 billion in The coefficients for country effects indicate how the average expected RCA differs for Malaysia, Thailand, and the Philippines in relation to the reference country Singapore. The coefficients for the Malaysia- and Philippines- dummy proved to be statistically insignificant in our analysis. When examining the regression results using the relative share of computer equipment in total intra- ASEAN4 trade as independent variable, all results prove to be statistically significant at the 90% level. The coefficient of 40,29 indicates that a one percent increase in computer equipment s share of total intra- regional trade expects to increase RCA in Australia with approx 0,4. All coefficients for country effects are negative, implying that on average, Singapore has the highest expected RCA in the model. The explanatory level of the second regression is similar to the first one with R 2 equating to 53,7%. 6. Discussion of findings The aim of our study was to observe whether increased intra- regional trade among the ASEAN4 countries resulted in increased competitiveness for the region in a third market. In order to explain through which channels a possible increase of competitiveness occurred, we wanted to investigate the nature of the increased intra- regional trade and see whether changes in trade patterns were moving towards individual specialization of each country or an increased intra- industry trade. Our finding of an absolute increase of intra- regional trade in computer equipment is in line with previous research that through the gravity model has shown AFTAs positive effect on intra- ASEAN trade. Similarly, as predicted, the intra- ASEAN4 trade in computer equipment has grown more than intra- ASEAN4 trade on average, i.e. 24

25 the importance of this industry has increased for each country during our studied time- period. Moreover, each country shows an increased competitiveness in the production of computer equipment during our studied time period, exemplified by an increased revealed comparative advantage in the Australian market. Further, each country s separate Gruber- Lloyd index shows that the computer equipment industry was already well integrated among the ASEAN4 prior to AFTA. In other words, countries were both exporting and importing computer equipment. Additionally, there is no clear trend or direction in which the GL- index changed after the implementation of AFTA. The GL- indices shows that we are dealing with not only intra- regional trade but also intra- industry trade. This is an important insight for the discussion of possible reasons behind our observed relationship and how increased trade among countries in a specific sector can lead to increased competitiveness for a region as a whole. Through the perspective of new trade theory, the removal of tariffs between the ASEAN4 countries give firms in each market incentives to export to other member countries in order to gain access to a larger market and benefit from economies of scale. Moreover, consumers in each market experience utility from having a wider choice of products to choose from, thus demanding a broader variety of computer equipment, which in turn leads to imports from other producing countries. With a larger variety of products, consumers become more price- sensitive. This way, each company face greater competition as a consequence of a more integrated market, with the effect that the least efficient firms go out of business. Through survival of the most competitive firms and investment in R&D to increase productiveness, the region as a whole become more competitive, which is evident on the Australian market where an increased competitiveness, measured by RCA, is found. However, our analysis, which is based on new trade theory, assumes that it is existing firms that become more competitive. But, as mentioned when discussing the aims and objectives of AFTA, the removal of tariffs was not solely based on the desire to promote intra- regional trade; it was also a way for ASEAN to attract foreign direct investment (FDI). Thus, our observed increase in ASEAN s competitiveness 25

26 could possibly be a result of new, more competitive firms entering the ASEAN region, replacing the old firms rather than existing firms becoming more competitive. In order to rule out the possibility that it was mainly new firms that entered each market, and thereby increased the overall competitiveness of the region, the FDI flows into the sector of computer equipment should be studied. However, our data and findings serve as a starting point and provide some relevant support for the new trade theories. Further, it is an attempt to give the evaluation of free trade areas a broader perspective and to focus on the effects for the region on the world market rather than just looking at the intra- regional effects of the agreement. 26

27 7. Reference list Amin, Hamid & Saad (2009) Economic Integration Among ASEAN Countries: Evidence from Gravity Model, EADN Working Paper No. 40. ASEAN Secretariat (2001) ASEAN Free Trade Area (AFTA): an update, available at: (Accessed: ). ASEAN Secretariat (2011), available at: (Accessed: ). Balassa (1965) Trade Liberalisation and Revealed Comparative Advantage, The Manchester School, Volume 33. Crawford & Fiorentino (2005) The changing landscape of regional trade agreements, WTO Publications, discussion paper no.8, Geneva. Dee & Gali (2003) The trade and investment effects of preferential trading arrangements, working paper 10160, National Bureau of Economic Research. Elliott & Ikemoto (2003) AFTA and the Asian crisis: Help or hindrance to ASEAN intra- regional trade? School of Economics Discussion Paper Series 0311, School of Economics, University of Manchester. Gosh & Yamarik (2004) Are regional trading arrangements trade creating? An application of extreme bounds analysis, Journal of International Economics, Vol. 63, No. 2. Grubel & Lloyd (1975) Intra- Industry Trade: The Theory and Measurement of International Trade in Differentiated Products, MacMillan. 27

28 Hapsari & Mangunsong (2006) Determinants of AFTA Members Trade Flows and Potential for Trade Diversion, Asia- Pacific Research and Training Network on Trade, Working Paper Series, No. 21. Krugman & Obsfeld (2006) International Economics: Theory and Policy Seventh Edition, Pearson. Robson (1998) The economics of international integration Fourth edition, Routledge. Smith (1904) An Inquiry into the Nature and Causes of the Wealth of Nations, Edwin Cannan, ed Library of Economics and Liberty, available at: (Accessed: ). Sawyer & Sprinkle (2006) International economics second edition, New Jersey: Pearson Prentice Hall. The World Trade Organization (2008) World Trade Report 2008 Trade in a globalizing world. The World Trade Organization (2011) Regional trade agreements, available at: (Accessed: ). U.S. Department of State, Association of South East Asian Nations (ASEAN), available at: (Accessed: ). United States International Trade Commission (2010) ASEAN: regional trends in Economic Integration, Export, Competitiveness and Inbound Investment for Selected Industries. 28

29 8. Appendix Figure 3 Source: Authors calculation based on UN COMTRADE data Figure 4 Source: Authors calculation based on UN COMTRADE data 29

30 Figure 5 Source: Authors calculation based on UN COMTRADE data Figure 6 Source: Authors calculation based on UN COMTRADE data 30