Regionalism: Impact on Multilateralism

In this section, we examine how regionalism a la AFTA is affecting multilateralism. Unlike the GMS program of subregional cooperation, AFTA clearly falls within the textbook definition of institutional as opposed to market integration. In essence, AFTA is a preferential trading arrangement based on a legal agreement that prescribes tariff reductions on a purely discriminatory basis. It therefore has all the ingredients necessary for trade diversion and the potential to produce a classic second-best outcome where the welfare of even its members is reduced as a result. Necessary? Yes. Sufficient? No. Although AFTA members must extend trade preferences on a reciprocal basis and in accordance with a predetermined time frame, there is nothing that prevents members from voluntarily extending the same preferences to nonmembers. This is largely what the original ASEAN members have been doing by embracing the concept of “open regionalism” and thereby largely avoiding the second-best outcome.

A. Multilateralism through Open Regionalism

To minimize trade diversion, the original ASEAN members have been reducing their external tariffs, or tariffs applicable to non-ASEAN members, in conjunction with reductions on intra-ASEAN trade. This has minimized the margin of preference, or the difference between intra- and extra-ASEAN tariff rates, and thus minimized the potential for trade diversion. When preferences are fully multilateralized, the margin of preference is zero as is the potential for trade diversion. This was the case for more than two-thirds of the tariff lines for the original ASEAN countries in 2002 (see Feridhanusetyawan, 2005) and this continues to increase year by year. Furthermore, because the preferential tariff reduction schedules have been ambitious and rapid, AFTA has accelerated the pace of multilateral trade liberalization in the original ASEAN member countries. Instead of jeopardizing multilateralism, it has hastened the speed at which these countries have moved towards their goal of free and open trade. In this way, AFTA’s greatest achievement may have less to do with what it prescribes or mandates and more to do with what it promotes indirectly through the long-standing commitment of its members to the concept of open regionalism.

Figure 1 [ PDF 71.4KB | 1 page ] compares, in stylized form, trade liberalization outcomes under various scenarios involving WTO and AFTA. WTO negotiations and outcomes reduce the amount of time required for countries to move towards their goal of free and open trade (defined here as 0-5% average tariff rates). How does AFTA affect this outcome? If AFTA is implemented on a purely minimalist basis, or without any multilateralization of tariff preferences, then the time taken to arrive at the aforementioned goal is unchanged. Average tariff rates do fall more rapidly however, particularly up to AFTA’s 2003 deadline for 0-5% internal tariff rates, but this gain could be offset by the trade diversion that it would also induce. If, however, members choose to fully multilateralize their preferences for all tariff lines soon after AFTA’s commencement, then the deadline for free and open trade is moved forward to coincide with AFTA’s deadline of 2003. In reality, we observe that preferences for a majority of tariff lines have been fully multilateralized and if the remaining one-third or so of tariff lines are dealt with in the same way relatively soon, then the deadline will fall somewhere between 2003 and the WTO-based deadline. If this happens, AFTA would have served as a building block that enables countries to pursue multilateral goals at a faster pace.

Emulation of the approach taken by the original members would be in the interest of the Mekong economies. Indeed they will need to emulate this approach if they are not to be left behind, and if they are to succeed in deepening regional integration. Regionalism through ASEAN membership could then provide the GMS economies with an opportunity to pursue multilateralism aggressively and thus allow regionalism through AFTA to be a building block rather than stumbling block toward free and open trade. However, whether the worldwide proliferation of RTAs will eventually integrate rather than fragment the world economy remains a separate and open question.

There are reasons apart from minimizing trade diversion why the new member countries should emulate their predecessors in concurrently bringing down external tariffs. The freedom of members of an FTA to set their own barriers against trade with nonmembers raises the possibility of trade, production, and investment deflection. Trade deflection occurs when imports enter the FTA via the member country with the lowest tariff on nonmember trade. Trade deflection distorts the region’s trading patterns with the rest of the world and deprives the member country that eventually consumes the import of tariff revenue. In the case of the GMS, revenue is likely to be lost to a member like Singapore, which is virtually a free-trade port.

Production deflection will occur if the manufacture of products containing imported inputs shifts to countries that have lower tariffs on the inputs because differences in tariffs outweigh differences in production costs. This is detrimental to economic efficiency and welfare since the pattern of productive activity will be based on differences in duties rather than on comparative advantage. The deflection of production may also affect the pattern of international investment. If differences in tariffs outweigh differences in production costs, tariffs will dictate investment decisions. Investment deflection will reinforce detrimental effects on welfare and efficiency associated with production deflection. Although the GMS economies may not currently be subject to much production or investment deflection because most are still not developed enough to compete with the other ASEAN members for the same types of investments, they could avoid it in the future by multilateralizing their AFTA tariff preferences.

To deal with potential trade, production, and investment deflection, AFTA imposes “domestic ASEAN content” requirements based on “rules of origin.” These rules limit regional trade preferences to commodities that incorporate a minimum of 40% domestic ASEAN content. At best, application of these rules can only limit, but not eliminate, trade, production, and investment deflection in AFTA. Krueger (1995) goes further to suggest that these rules can lead to the “export” of protection. This occurs when a member country deliberately purchases a higher-cost input from another member rather than the lower-cost alternative from a nonmember in order to satisfy rules of origin requirements and to gain duty-free access for its end-product exports.

Furthermore, rules of origin are notoriously difficult to police, and the administrative burden can be substantial. Not only is the origin of a product difficult to determine in this era of increasing internationalization of production, but the transaction costs resulting from the extensive documentation associated with this cumbersome process could nullify any benefits coming from freer intra-regional trade. In many of the GMS economies, the administrative costs associated with implementing rules of origin or measuring domestic content could be crippling.

Adoption of the nondiscriminatory approach to regionalism by the new member countries would maximize the extent and pace of their integration with the global economy. They could avoid trade diversion, as well as trade, production, and investment deflection. The new members could also do away with the tedious and costly tasks of implementing rules of origin and measuring domestic content of their imports. This would be the first-best option.

B. Multilateralism Even Without Open Regionalism?

A myriad of political economy considerations often stands in the way of first-best economic solutions. As Krugman (1993) puts it, preferential trading arrangements may have to be accepted, “…more or less grudgingly, as the best option in an age of diminished expectations.” This view may derive from the fact that the first-best option of nondiscriminatory trade liberalization may not always be politically feasible, or at least not immediately feasible, and that the second-best option is to liberalize trade within regional blocks. In some of the Mekong countries, concerns relating to the impact on government revenue and the competitiveness of domestic production appear to stand in the way of multilateral trade preferences (see Appendix 1).

In light of this, the question then is whether the pursuit of discriminatory regionalism necessarily implies that multilateralism will be impaired? This need not be so for the GMS economies in AFTA. Even if they chose not to multilateralize their preferences, regionalism can work in other ways as a vehicle to promote closer integration with the rest of the world. Even as a second-best option, regionalism through AFTA can help in the pursuit of multilateralism.

One avenue through which regionalism can promote multilateralism is through the strong links that the original ASEAN countries have with industrialized nations. Regional integration is bringing globalization to the doorstep of the Mekong through these links. Increasing integration with the original ASEAN countries will provide the GMS economies with a conduit to the outside world. Because the original ASEAN members conduct most of their trade extra-regionally and receive most of their FDI from non- ASEAN members, they have long-established links with the major industrialized countries. By integrating more closely with the original ASEAN members, the GMS economies will increase their opportunities for trade and investment with the rest of the world.

Indeed, the objective of establishing the ASEAN Economic Community (AEC) by 2020, a decision made at the 2003 Bali Summit, is to present this region of 530 million or so people to the global community as a single market and production base with a free flow of goods and services and relatively free flows of capital and labor. The AEC provides the GMS economies with a great opportunity to increase trade and investment with the outside world and to integrate more closely with the world economy.⁸

The strategic location of the GMS between the burgeoning economies of the PRC and India provides opportunities for integration beyond the region and presents a number of opportunities. The potential to boost trade, tourism, and investment is significant. Recognizing this potential, ASEAN leaders again confirmed their commitment to regionalism as a means to an end by signing framework agreements at the Bali Summit on comprehensive economic cooperation with both the PRC and India. These agreements will create free-trade areas between ASEAN and these countries.⁹

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