CGE Analysis of East Asian FTA Scenarios

A growing body of empirical literature has been developed on the impact of prospective FTAs on East Asian economies using computable general equilibrium (CGE) models. This interest can be traced to the rapid spread of FTAs in East Asia in recent years, concerns over costs of multiple and overlapping FTAs, active discussions on the formation of an ASEAN+3 or ASEAN+6 FTA, advances in CGE models and computing power, and improvements in modeling capacity especially in the region. A brief overview of recent CGE studies and a set of CGE estimates of the impact of various FTA scenarios involving ASEAN (e.g., ASEAN+1 FTAs, an ASEAN+3 and an ASEAN+6 FTA) are provided in this section.

4-1. Recent CGE Studies

CGE models are a powerful tool for analyzing the economic effects of FTAs. These models are based on a clear economy-wide theoretical structure embodying a general equilibrium condition. East Asian FTA studies commonly use the Global Trade Analysis Project (GTAP) database but vary in the underlying model and behavior of agents, the policy scenarios analyzed and the version of the database used. The most widely used model is the standard GTAP model (or some variant of GTAP) characterized by constant returns to scale in production, perfect competition, and the Armington assumption. ²⁷ More recently, a few studies have used more complex CGE models with firm-level imperfect competition such as the Paris-based Centre d'Etudes Prospectives et d'Informations Internationales (CEPII) Mirage Model or the Asian Development Bank's General Equilibrium Model for Asia's Trade (GEMAT).

The simulation approach embodied in CGE models sheds light on the effects of alternative FTA policy scenarios (e.g., an ASEAN+3 FTA scenario or a PRC-Japan-Korea FTA scenario). Such scenarios tend to focus on the removal of price distortions against imports that arise from existing trade barriers and other sources. The results of CGE studies provide insights into the numerical magnitude of gains and losses from trade liberalization and the distribution across regions, countries and sectors. Accordingly, CGE studies can help in framing negotiation positions with FTA partners, indicate implementation schedules for trade liberalization and suggest the need for appropriate structural reforms to mitigate adverse impacts.

Some interesting findings from recent CGE-based East Asian FTA studies can be mentioned. One strand of literature has exclusively focused on the formation of an ASEAN+3 FTA (or a variant like ASEAN+4). Influential examples include Urata and Kiyota (2003) and Zhang et al. (2006). Urata and Kiyota's (2003) GTAP simulations indicate that an ASEAN+3 FTA will generate welfare gains for all members from the highest of 12.5% of GDP for Thailand and 6.6% for Viet Nam to the lowest of 0.19% for Japan and 0.64% for the PRC. They also report modest welfare losses for non-members such as the EU (-0.02%) and the USA (-0.09%). GTAP simulations by Zhang et al. (2006) confirm these initial findings—an ASEAN+3 FTA is estimated to increase the overall GDP of East Asian countries by 1.2% and economic welfare by $105 billion and raise every member's GDP in excess of 1.7%, with the exception of Japan. In a similar vein and based on GTAP, Mohanty, Pohit and Roy (2004) find that an ASEAN+3 and India FTA will bring gains to members of between $147 billion (liberalization of trade barriers only scenario) to $210 billion (liberalization of barriers to trade, investment and labor).

Another strand of literature compares alternative FTA scenarios in East Asia and provide additional insights on the costs and benefits of possible FTAs. Using GTAP, Gilbert et al. (2004) find that an ASEAN+3 FTA will produce higher welfare gains for members than a narrower PRC-Japan-Korea FTA indicating that broadening FTAs in East Asia brings more benefits. Based on a GTAP model which includes capital accumulation, Cheong (2005) reports that all members reap larger gains from an ASEAN+3 FTA compared to a series of bilateral arrangements between East Asian economies and that ASEAN and Japan are expected to benefit the most. Bchir and Fouquin (2006) use the CEPII Mirage Model to create several scenarios of economic integration based on a hub and spoke approach (ASEAN+1) and an ASEAN+4 (including India) regional approach. They find that ASEAN would be better off with a series of bilateral agreements than with an ASEAN+4 approach as this would allow them better to exploit their comparative advantage in agriculture, which is characterized by much higher levels of protection in the region than manufactures. Drawing on GEMAT simulations for an FTA involving goods only, Plummer and Wignaraja (2006) report that the current wave of bilateral FTAs is inferior to any of the major FTA proposals in East Asia (including an ASEAN+3, an ASEAN+6, or an APEC FTA). They find that an ASEAN+6 FTA will bring larger global welfare gains than an ASEAN+3 FTA. Their study provides preliminary assessment of the economic effects of an ASEAN+3 and ASEAN+6 FTA even though services trade, trade facilitation, and other aspects of FTAs are excluded from the exercise.

While there has been some CGE work on an ASEAN+3 FTA and other alternatives, only limited work is available on the effects of an ASEAN+6 FTA or a comparison between an ASEAN+3 and an ASEAN+6 FTA. Furthermore, such work tends to narrowly focus on an FTA involving goods only while other aspects of the coverage of East Asian FTAs (e.g. services and trade costs) are excluded. There is a need for a more comprehensive set of CGE estimates on East Asian FTAs to fill these gaps in the literature and to respond to the widespread interest on alternative FTA scenarios among the regional policy circles.

4-2. FTA Scenarios and Results

Accordingly, a CGE exercise was undertaken by ADB using a variant of the GTAP model.²⁸ Some features of the model, dataset and coverage of FTA provisions should be noted. The model is characterized by an input-output structure (based on regional and national input-output tables) that explicitly links industries in a value added chain from primary goods, over continuously higher stages of intermediate processing, to the final assembling of goods and services for consumption. Inter-sectoral linkages are both direct, like the input of steel in the production of transport equipment, and indirect, via intermediate use in other sectors. The model captures these linkages by modeling firms' use of factors and intermediate inputs. The key aspects of the model are as follows: (i) it covers world trade and production; (ii) it includes intermediate linkages between sectors; (iii) and it allows for trade to affect capital stocks through investment activities. The final point means that medium- to long-run investment effects are captured in the model.

The main database used is the GTAP dataset version 6.3 which included detailed national input-output, trade and final demand structures. This database was projected through to 2017 trade and production patterns to represent a post-Uruguay Round world.²⁹ The coverage of FTA provisions is a stylized FTA that includes goods, services and some aspects of trade cost reduction. Hence, the analysis includes the impact of regional tariff elimination for goods, liberalization of services trade, and trade facilitation including improved trade-related infrastructure.³⁰ Projection of the database to take into account implementation schedules for trade agreements and extending the coverage of the stylized FTA beyond goods are relatively recent developments in the CGE literature on FTAs.

Based on the above CGE framework, five East Asian FTA scenarios are considered:

1. An ASEAN+PRC FTA: free trade among the 10 ASEAN members, and PRC.
2. An ASEAN+Korea FTA: free trade among the 10 ASEAN members, and Korea.
3. An ASEAN+Japan FTA: free trade among the 10 ASEAN members, and Japan.
4. An ASEAN+3 FTA scenario: free trade among the 10 ASEAN members, PRC, Japan and Korea;
5. An ASEAN+6 FTA scenario: free trade among the 10 ASEAN members, PRC, Japan, Korea, India, Australia and New Zealand.

The five scenarios selected represent an illustrative range of FTA possibilities in East Asia. Scenarios 1-3 are FTAs between ASEAN and each of Northeast Asian countries. Scenarios 1 and 2 have been concluded while Scenario 3 is under negotiation (see Appendix Table 2 [ PDF 11.3KB | 2 pages ]). Scenarios 4 and 5 represent on-going discussions among policymakers on region-wide FTAs. Based on bridging ASEAN and the region's Northeast Asian neighbors, scenario 4 was an early attempt at an East Asia-wide FTA. Scenario 5 has emerged with the realization that the synergies could be gained by linking Australia-New Zealand and India with ASEAN+3.

Table 11 [ PDF 15.4KB | 2 pages ] shows the estimated impacts on national income of the FTA scenarios. The two East Asia-wide FTA scenarios—ASEAN+3 FTA and ASEAN+6 FTA—offer larger gains to world income than any of the three ASEAN+1 FTA scenarios. The ASEAN+6 FTA scenario—which is broader in terms of country coverage—offers the larger gains to world income ($260 billion, measured in constant 2001 prices) than the ASEAN+3 FTA scenario ($214 billion). Looking separately at the ASEAN+1 scenarios, the ASEAN+PRC FTA scenario indicates larger gains ($82 billion) to world income than the other two ASEAN+1 scenarios.

A breakdown of the world income figure for the ASEAN+6 FTA scenario indicates that the gains to members of the FTAs are significant ($285 billion) while the losses to non-members are relatively small ($25 billion). Similarly, in the ASEAN+3 scenario, the gains for members are large at $228 billion while losses to non-members are only $14 billion. Hence, insiders gain and outsiders lose relatively little from the formation of an ASEAN+3 or an ASEAN+6 FTA.

The ASEAN+3 and ASEAN+6 FTA scenarios have different impacts on regions and countries. The three Northeast Asian economies (members of all proposed FTAs) are expected to see the largest gains under the ASEAN+3 FTA ($166 billion) and the ASEAN+6 FTA ($172 billion).³¹ The ASEAN economies (also members of the proposed FTAs) experience the largest gains from the ASEAN+PRC FTA ($44 billion) among the three ASEAN+1 FTAs and obtain further gains from the ASEAN+3 FTA ($62 billion) and the ASEAN+6 FTA ($67 billion). The projected gains for ASEAN members as a percent change from 2017 baseline income are substantial under the ASEAN+6 scenario—Thailand (12.8%), Viet Nam (7.6%), Malaysia (6.3%) and Singapore (5.4%). Among the Northeast Asian countries, Korea (6.4 %) experiences larger gains than Japan or PRC.

India, Australia and New Zealand either experience gains or losses depending on whether an ASEAN+3 FTA or an ASEAN+6 FTA is formed. They experience losses in the ASEAN+3 scenario and gains in the ASEAN+6 scenario. Under the ASEAN+6 scenario, the projected gains as a percent change from 2017 baseline income are 2.4% for India, 3.9% for Australia and 5.2% for New Zealand.

The impact of the ASEAN+3 or ASEAN+6 FTA on third parties is limited with a few exceptions (like Taipei,China). There are small losses (typically less than 1 % change from 2017 baseline income) for the rest of South Asia, the rest of Oceania, Central Asia as well as the US and Russia. Meanwhile, there are small gains for the EU, Canada, Mexico and Sub-Saharan Africa.

The estimated wage effects for unskilled workers (see Table 12 [ PDF 7.5KB | 1 pages ]) can be taken as a rough measure of the distributional impact of the ASEAN+3 and ASEAN+6 scenarios. These are somewhat related to the income gains for members under the alternative scenarios. In the ASEAN+6 scenario, Thailand, Korea, Viet Nam, Singapore and Malaysia—with relatively large income effects—experience relatively large unskilled wage increases (between 5 % to 12%). Several other countries (such as Japan, PRC, Indonesia, Philippines and India)—with relatively smaller income effects—witness unskilled wage increases of under 2%. Unexpectedly, however, Cambodia, Australia and New Zealand see small declines in unskilled wages. Third parties to the agreements such as the rest of South Asia; other Oceania; Hong Kong; and Taipei,China experience small declines in unskilled wages.

CGE simulation studies are useful in quantifying income effects of eliminating import tariffs on goods trade and liberalizing cross-border trade in services through the formation of an FTA. A shortcoming of such studies, however, is their inability to incorporate rules of origin and nontariff measures (e.g., SPS and TBT) which are likely to afford more protection for domestic industries than tariffs. Thus, CGE studies are best when used in conjunction with other empirical tools – notably analysis of the complex structure of FTAs and enterprise perception studies of the benefits of FTAs.³²

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