Appendix 1

Concerns over Open Regionalism: Competitive and Revenue Effects

Some major concerns of the GMS economies about multilateralizing tariff preferences relate to perceived negative impacts on domestic production and government tariff revenue collection. The fear for domestic production is that if liberalization were to proceed multilaterally rather than regionally, a flood of imports might wipe out some industries. It is often argued that a number of industries in the transitional economies of the GMS are infant industries requiring protection for survival, but this issue relates to protectionism, not to whether liberalization should be preferential or multilateral once the decision has been made to liberalize. If grounds for protection based on the infant industry argument are valid, then such an industry should be quarantined from both preferential and multilateral liberalization until it has developed sufficiently to survive without protection. AFTA provides for a more gradual phasing in of tariff reductions for such industries by allowing them to be placed on the temporary exclusion and sensitive lists. For other industries, there is no reason to fear multilateral liberalization; on the contrary, it ensures that consumer welfare is maximized by enabling imports to be sourced internationally from the lowest-cost producer. So multilateralizing preferences should not jeopardize production of so-called sensitive industries in these economies because all that is being recommended is uniformity in provision of tariff reductions to all trading partners with no change in the time frame of liberalization schedules or in the range of products covered.

Another major concern about multilateral tariff reductions is that they might further erode revenue from trade taxes associated with AFTA-based trade liberalization. In other words, it is expected that a two-tier tariff rate—a CEPT rate for the intra-ASEAN producer and a higher MFN rate for extra-ASEAN producers—will mitigate total revenue loss somewhat. A significant difference between the two rates would, however, create a strong incentive for trade deflection. This would simply result in revenue being lost altogether to the member country with the lowest external tariff, which in this case is most likely Singapore. In short, if trade deflection occurs as a result of the dual tariff system, then tariff revenue collected by the importing country could actually be lower than if the tariff reductions were multilateral.

Apart from this, maintaining a system whereby two rates apply to each (if not most) tariff lines also increases the potential for rent-seeking behavior. It is an open secret that some portion of revenue associated with trade taxes is collected privately rather than publicly. This is reflected in the high estimates of the share of informal cross-border trade in the GMS. A higher MFN rate compared with the CEPT rate will provide a new avenue through which private rents are extracted with little or no change to public customs revenue collection. Indeed, reducing tariffs would remove some of the incentive for smuggling thereby increasing the share of total trade subject to tariffs. For these reasons, concerns about potential revenue loss should not stand in the way of these economies multilateralizing their CEPT tariffs and offering them to all trading partners on a nondiscriminatory MFN basis.

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