The impact of free trade agreement on trade flow of goods in vietnam

INSTITUTEOFSOCIALSTUDIESH O CHIMINHCITY THEHAGUE NETHERLANDSPROGRAMMEFORM.AINDEVELOPMENTE CONOMICS... CHAPTER1 INTRODUCTION...1 1.1 ProblemStatement...1 1.2 ResearchObjectives...4 1.3 R

INSTITUTEOFSOCIALSTUDIESH O CHIMINHCITY THEHAGUE

NETHERLANDSPROGRAMMEFORM.AINDEVELOPMENTE CONOMICS

IwouldliketoacknowledgeandsendheartfeltgratitudetoAssc.Prof.DrNguyenTrongHoaiwhoismyacademicsupervisor.Hisadviceandrecommendationhavehelpedmetoovercomemyinsufficientknowledgeintradetheoriesandeconometrictechniques.Therefore,Icancontinueourworkandfinishthisstudy

ThisthesiscannotbecompletedwithoutthefineguidancefromtheVNPScientificCommittee.IwouldliketothanksincerelytoDrTruongDangThuy

Iwouldliket o addressmydeepg r a t i t u d e t o D r PhamKhanhNam,D r N g u y e n MinhDuc,DrPhamThiThuTra,andDrDinhCongKhaifortheirsupportingcomments

IwouldliketogiveagreatthanktoMsXuanHong,MrTam,MrHuy,andMrQuyinsupportingandprovidinginformation,labroomformywritingandpreparation

Onm y writingprocess,I receivedgreatsupportf r o m MsYen,MrAnh,andMrChinh,myclassmatesatclass19.Withouttheirsupportandsharing,itisreallydifficulttoc o p e withthehugepressureinfinishingthesisontime

o u t thatFTA’sestimatedcoefficientsareconsistentlypositive

Relatingtothemethodology,twomainproblemsdiscussedingravitymodela r e endogeneityofFTAandzero-

valueintrade.Firstly, thethesispoints outthatF T A isexogenousvariableinthegravitymodel.Secondly,sample

selectionmodel,PoissonPseudoMaximumLikelihood,andFixed-effectmodelareusedtosolvethezeroproblemsi n model.T h e empiricalr e s u l t s f r o m a l l e s t i m a t i

o n modelsarec onsistentwitheachotherintermofsignofFTA’scoefficient

Forpolicyimplication,thethesisproposesthatFTAisagoodtradepolicyf

o r V iet na m becausei t ca nh e l p t o improvet h e t o t a l b il ate ra l t r a d e valueamon

gF T A members.However,FTAdoesnotimpactontradeflowonly,butitalsohasef fect on ot he r aspects of Vietnam economys u c h as wagestr uc tu ra l, investment.T

h o s e issuesarebeyondtheobjectiveofthisstudy

Keywords:FreeTradeAgreement,gravitymodel,totalbilateraltrade

CHAPTER1 INTRODUCTION 1

1.1 ProblemStatement 1

1.2 ResearchObjectives 4

1.3 Researchquestions 4

CHAPTER2 LITERATUREREVIEW 5

2.1 Theoretical literature 5

2.1.1 TradeTheories 5

2.1.2 FreeTradeAgreement 8

2.1.3 Theroleoffreetradeagreement 9

2.2 EMPIRICALLITERATURE 16

2.2.1 TradeFlow 16

2.2.2 FreeTradeAgreement 18

2.2.3 Controllingfactors 19

2.2.4 ConceptualFramework 21

2.2.5 Empiricalstudy onestimationmodel 24

CHAPTER3OVERVIEWOFVIETNAM’SFREETRADE AGREEMENT 26

3.1 ASEANFreeTradeAgreement(AFTA) 26

3.2 ASEAN-People’sRepublicofChinaComprehensiveEconomicC o o p e r a t i o n Partnership(A CFTA) 28 3.3 ASEAN-AustraliaandNewZealandFreeTradeAgreement(AANZFTA) 31

3.4 ASEAN-IndiaFreeTradeAgreement(AIFTA) 33

3.5 ASEAN-RepublicofKoreaComprehensiveEconomicCooperationAgreement(AKFTA) 34

3.6 Japan-VietnamEconomicPartnershipAgreement(VJEPA) 37

CHAPTER4 RESEARCHMETHODOLOGY 39

4.1 ModelSpecificationandEstimationMethod 39

4.1.1 Model forsolvingendogenousproblem 41

4.1.2 ModelforSolvingHeteroscedasticityandZero-TradeValue 44

4.1.3 Log-formgravitymodel: 45

4.1.4 Multiplicative-formgravitymodel 49

4.2 VariableDefinition 51

4.2.1 Dependent Variablein ModelSpecification 51

4.2.2 Independent variablesin theModelSpecification 51

4.3 DataCollection 56

4.3.1 Sourcesofdata 56

4.3.2 SampleSelection 56

CHAPTER5 EMPIRICALRESULT 60

5.1 TestingResults 60

5.1.1 EndogenoustestingforFTA 60

5.1.2 TestingforMulti-collinearity 60

5.2 EmpiricalResults 60

5.2.1 Log-formgravitymodel 60

5.2.2 Multiplicative-FormGravityModel 66

CHAPTER6 CONCLUSION 70

6.1 Conclusion 70

6.2 PolicyImplication 72

6.3 Limitation 72

REFERENCE 74

Table3-1:ACFTA'sTariffEliminationscheduleforVietnam 29

Table3-2:PreferentialTariffRatecommitmentbyVietnamforAKFTA 35

Table4-1:ModelSpecificationsSummary 50

Table4-2:VariableDefinition 58

Table4-3:VariablesDescriptiveStatistics 59

Table5-1:TestingendogeneityofFTA 60

Table5-2:RegressionResultforFixed-EffectModel 62

Table5-3:RegressionResultforSampleSelectionModel 65

Table5-4:TestingResultsforCollinearityProbleminsampleselectionmodel 66

Table5-5:TestingresultsforInteractionTermsinSampleSelectionModel 66

Table5-6:RegressionResultsforPPMLmodelDependentvariableTvjt 67

LISTOFFIGURES Figure1-1:TradeshareofFTAcountriesandnon-FTAcountries 1

Figure1-2:TradeshareamongVietnamFTAs 2

Figure1-3:TradeShareofFTAcountries,EU,andUSA 2

Figure2-1:TheRelationshipBetweenFTAandTradeFlow 13

Figure2-2:ConceptualFramework 23

Figure3-1:TradePatternbetweenVietnamandASEANMembers,1990-2012 26

Figure3-2:ChangeinTradeFlowVietnamandASEANCountries,ExcludingBrunei 27

Figure3-3:TradePatternbetweenVietnamandACFTAmembers,1990-2012 30

Figure3-4:ChangeinTradeFlowbetweenVietnamandACFTAMembers 31

Figure3-5:TradebetweenVietnamandAustralia-NewZealand,1990-2012 32

Figure3-6:ChangeInTradeFlowBetweenVietnamAndAANZFTAMembers 33

Figure3-7:TradebetweenVietnamandIndia,1990-2012 33

Figure3-8:ChangeinTradebetweenVietnamandIndia,1990-2012 34

Figure3-9:TradebetweenVietnam-Korea,1990-2012 36

Figure3-10:ChangeInTradeFlowBetweenVietnamAndAKFTAMembers 36

Figure3-11:TradeBetweenVietnamandJapan,1990-2012 37

Figure3-12:ChangeinTradeFlowBetweenVietnamandJapan 38

Figure4-1:TotalBilateralTradebetweenVietnamandUS 43

Figure4-2:ASEANTradeBalancewithChina 44

a m i s a l s o launchingnegotiationwitha numberofcountriesandeconomicgroupstoestablis

hf r e e t r a d e agreementsuch asTPP,ASEAN-EUFTA.In2012,tradebalancesbetweenVietnamandothermembersofASEANFreeTradeAgreement(AFTA),recordedat-U S $3.443billion,andVietnam–Chinatradebalance,membersofACFTA,is–US

$16.397billion(CustomsHandbookonInternationalMerchandiseTradeStatisticsofVietnam,2012).Instarkcontrast,thenetexportofVietnamtotheAustraliaandNewZ e a l a n d ,membersofASEAN-

ANZFTA,i s US$1.2258billionin2012(computedb ase onCustomsHandbookonInternationalMerchandiseTradeStatisticsofVietnam,2 0 1 2 Itc a n b e o b s e r v e d t h a t t r

a d e p a t t e r n s o f V i e t n a m a m o n g FTAp a r t n e r a r e d i f f e r e n t

Asc a n b e s e e n f r o m t h e Figure1

-1 , s h a r e o f F T A c o u n t r i e s w a s a r o u n d 5 0 percento f V i e t n a m to ta l t r a d e overt h e p e r i o d o f 1 9 9 0 - 2 0 1 2 , t h u s t h e F T A -

t r a d i n g partnersplayessentialroleinthetradeofVietnam.However,from2000afterwards,t h e shareofnon-FTAcountriesgraduallyrose;

a s e i n s h a r e o f AFTAp l u s F o r i n s t a n c e , t h e t r a d e b e t w e e n Vietnama n d China,memberof ASEAN-

C h i n a FTA,i n c r e as e d n ea r l y th ree ti mes from2000t o2 0 1 2 AnotherpositivechangeaftersigningFTAiswithKoreatoestablishASEAN-

KoreaFTA.Yet,thechangeintradeshareofotherAFTAplusarenotsignificantly.T h e

r e f o r e , aquestionposedisthatwhethertheimpactofFTAonVietnamtradeflowissignificantornot

Source:Author’sConstruction

Relatingt o academicp e r s p e c t i v e , thef r e e t r a d e ise s p o u s e d i n i m p r o v i n g t

i e t n a m i s aff ected byherfreetradeagreements

Therearemanypapersinvestigatedtherelationshipbetweenfreetrade agreementandbilateraltrade.Ontheonehand,Hur,Alba&Park(2009)conductedar e s e a r c

h toeva lua te the

Hub-and-Spokep r o b l e m inf re e t r a d e agreements by u s i n g p a n e l dataanalysisof96countriesfrom1960to2000;andconcludedthatinspiteoftheexistingofoverlappingfreetrad

alsoincreased.Otherrelevantp a p e r b y B a i e r & B e r s t r a n d ( 2 0 0 9 ) w h i c h givesc o

m p r e h e n s i v e c o n t r i b u t i o n t o t h e empiricalmodeltoinvestigatethe effectof free

tradef l o w a l s o f o u n d t h e p o s i t i v e linkage.O n theo t h e r h a n d , Aitken( 1 9

7 2 ) doesa n empiricalresearchontradecreatingandtradedivertingaftertheestablishmentofEECa n d EFTA.H e f o u n d t h a t E E C i n c r e a s e t r a d i n g valueo f memberc o u n t r

i e s significantlyb y t r a d e creatinga n d e x t e r n a l t r a d e diverting,w h e r e a s t h e

e f f e c t o f E F T A isn ot considerablybecause o f trade diverting.B e s i d e s , B

h a v i s h, J u g u r n a t h, Stewart& Brooks( 2 0 0 7 ) , evaluateASEANFTA,APEC,C E R ,

increasesignificantlyitsmembers’trade,whileMERCOSUR,NFTAandAPECcreatedthetradediversion.Asaresult,thedemandf o r studyforinternationaltradeeffectonspecificcontextneedsacriticalexploration.However,papersanalysesthelinkagebetweenfreetradeagreementandtradeflowinV i e t n a m islimited.Forinstance,Thai(2006)

usedgravitymodeltocalculatethe tradeb e t w e en V i e t n a m a n d t w e n t y

-t h r e e E u r o p e a n c o u n -t r i e s T h e p a p e r f o u n d -t h e de-terminan-tsin-tradingsuchaseconomiccharacteristics,exchangeratevolatilityandt h e demandof des ti na ti on However,F r e e t ra de Agreementi s n ot mentionedi n t he p a p e r becauseVietnamandthosecountrieshavenotsignedFreetradeAgreementyet.

Otherp a p e r investigatest h e i m p a c t o f ASEANF r e e T r a d e A g r e e m e n t ( A F T A )

o n V i e t n a m ’ s economyisbyFukase

&Martin(2001).Theauthorsconcludedthatimpacto f AFTAi s n o t significant.Agriculturals e c t o r getsb e n e f i t fromt h a t f r e e t r a d e b e c a u s e ofexporting opportunitytoASEANmarket,whilesomeotherindustriesi s h u r t andneedtobeprotectedduetoASEANcompetitors.Thepaperappliedsimulationmethodologytodr aw t h e c

o ncl us io n, a n d doe s n o t ana lyz e the dynamice f f e c t ofAFTA.Therefore,thisthesiswilldepicttheroleoffreetradeagreementonbi lat er al trade in goodso f Vie tn am

b yap pl yi ng gravitymodelapp ro ac h, a n d pa ne ldatawhichdevelopedbypreviouspapers

CHAPTER2 LITERATUREREVIEW

2.1 Theoreticalliterature

2.1.1 TradeTheories

ThefirsttheoreticaltheoryoninternationaltradecomefromtheideaofAdamSmi

thi n h i s booknamed“AnInquiryintotheNatureandCausesoft h e WealthofNations

”,p u b l i s h e d in17 76 AdamSmithdisagreedw it ht he ideas o f mercantilistsw h o beli

evedthattradeonlybenefittothehomecountryatthecostoftradingpartner.B y concedingthatcountriescangainfromtrade,AdamSmithpointedoutthatgainf r o m tradeisattributedtotheefficientlyreallocationresourcewithincountrythroughtheabsoluteadvantageofcountry.Eachcountrywillbe moreeffectivelyandefficientlyproduce

ofothercountries,thustheabsoluteproductioncostwillbelowerincountry.Therefore,countrywillreallocateitsresourcestospecializeinproducingcommoditieswhichhaveabsoluteadvantage,an d exchangeforproductwithabsolutedisadvantage(Salvatore,2012).Infinal,bothc o u n t r i e s canconsumethegreaternumberofcommoditiesthanthoseofbeforetrade.B e s i d e s t h e i n c r e a s e i n volumeo f c o n s u m p t i o n , Schumacher( 2 0 1 2 ) a s s e r t e d t h a t AdamSmitht h e o r y a l s o a t t r i b u t e d t h e g a i n f r o

m t r a d e t o t h e i n c r e a s i n g i n internationalcompetitiveness.Thisisnotequivalentlydiscussedinmanytextbooks.However,a b s o l u t e advantagei s c l a i m f o r itsexplanationw h y o n e c o u n t r y w h o s e absoluteadvantageiscompletelyunavailablecantradewithothercountries.Thatist h e problemsolvedbytheorycalledcomparativeadvantage,orRicardianmodel

Anotheri n f l u e n t i a l theoreticalfoundationdevelopedb a s e d o n a b s o l u t

e advantageiscomparativeadvantage,orRicardianmodelnamedafterRicardo,thefirsteconomistmentionedtheconcept.InRicardianmodel,thedifferenceinrelativelaborproductivityistheprimaryreasonforinternationaltradebetweencountries,becauset h e modelassumest h a t l a b o r i s on ly o ne f a c t o r o f p r o d u c t i o n ; a n d l ab or ca n movefr eely

b etween sectorswithin country.Althoughthemodelisclaimedasitssimplifiedassumption,itscontributionisconsiderableonexplainingtradepatternofcountries.F i r st l y , R i c a r d i a n modelp o i n t e d o u t t h a t c o u n t r y e x p o r t

s a g o o d t o o t h e r c o u n t r y becauseitsamountofothergoodgivenuptoproducedthatgood in exportingcountry

islo wer thant ha ti n pa rt ne rc ou nt ry ; t h i s c o n c e p t isca ll edc om pa rat iv ead va

n ta ge Comparativeadvantageh a s h e l p e d t o explainw h y a c o u n t r y havingn o a

b s o l u t e advantagecanalsogainfromtrade,inotherwords,thecentraldeterminantintradeisrelativeproductivityofgoodswithincountryincomparetothatofothercountry.Incomparativeadvantage,internationaltradecanbenefittradingcountriesbecauseimportactivitiesi n themodela r e c o n s i d e r e d s i m i l a r l y t o i n d i r e c t p r o d u c t i o n ( K r u

g m a n , O b s t f e l d , & M e l i t z , 2 0 1 2 ) Indirectp r o d u c t i o n meanst h a t c o u n t r

y c a n specializeinagood,andthenexportthatgoodinexchangeforimportingothergooda t lowerrelativecostthandomesticproducing.Secondly,thecomparativeadvantagei s a n i n

i t i a l c o n c e p t i n o r d e r t o developt h e c o s t advantageo f c o u n t r y ( K r u g m a n ,Obstf eld , &Melitz,2012).Indetails,therelativelowproductivitycountryhaslowerwage,andthenleadstolowercostrelativetocostinhighproductivitycountry.Thisco nceptistheexplanationfornotionthathighwagecountrycanexportgoodstolowwagecountrybecauseofhighproductivitycompensationinhighwage.Finally,R i c a r d i a n modelimpliesthatallcountriescanbenefitfromtradebasedonitsdisputing assumptions

AccordingtoRicardianmodel,countrieswillcertainlybenefitfromparticipatingi n i n t e r n a t i o n a l t r a d e ; however,t h e c o u n t e r argumenti s t h a t t h e “onef

a c t o r a s s u m p t i o n ”i s u n r e a l i s t i c T h e r e f o r e , t h e s p e c i f i c

-f a c t o r s modelbreakso n e -factorassumptiono-f Rica rd ia n modelbyex te nd in g specific f act or of p r o d u c t i o n in e a c h sectorwithinacountry.Togetherwithmobilelabor,eachsectorconsistsofoneproductionfactorwhichcannotmovetoothersector.Thesimplespecificfactormodelexploitscapitalandlandastwospecificfactors.Thespecific-

factormodelpresentst h a t thecountrycanbepotentiallybetteroffby trading.Indetails,therearewinner wh ogainandloserwholosefromtrade.Themodelstatedthatspecificfactorintheexportingsectorofeachcountrygainsfromtrade,whereasspecificfactorinimportingsecto r losesfromtrade;besides,mobilefactor,namelylabor,maygainorlosewhichisdependontheconsumptionoflaborongoodsineachsector(Krugman,Obstfeld,

&M e l i t z , 2 0 1 2 ) Ingeneral,K r u g m a n , O b s t f e l d , & M e l i t z ( 2 0 1 2 ) a s s e r t e

d thatinternationaltradebenefitsc o u n t r i e s a s a w h o l e b e c a u s e a n increaseint h e

w i d e r choicef o r consumptionc a n compensatet h e s e c t o r h u r t Inc o n c l u s i o n , t

h e income

distribution effecthelpsto explain thebenefitandcost ofinternationaltrade,andgiver e a so nwhymanycountriesmaintainthetradebarriertoprotecttheirdomesticsectorfromforeigncomer.

Jones& Neary( 1 9 8 2 ) a ss e r t e d t h a ts p e c i f i c

-f a c t o r modelex pl ai ned t h e internationaltradeinshortrun,andcouldtrans-formtoHeckscher-O h l i n modelb e c a u s e specificfactorsaremobileinthelongrun.TheHechscher-Ohlinmodelisthemodelinwhichallfactorsofproductionmovefreelybetweensectors.Inthemodel,thereasoncountrytradewith ea c h otherisd e t e r m i n e d byth e differenceinr a t i o ofn a t i o n ’ s resources,andintechnology,thecombinationoffactorstoproduceagood.H -

O modelexplaint h a t countrywill gainfromtradeifitexportsproduct i n whosef a

c t o r iswellendowedandrelativelyintensive.Wellendowedmeansthattherelativer a t i ooffactorproductionsincountryishigherthanthatofitspartnercountrieswhilerelativei n

t e n s i v e e x p l i c a t e s t h a t relativer a t i o o f t h a t f a c t o r t o o t h e r f a c t o r u s e d t o p r

o d u c e

thatgoodishigherthanthatofproducingothergood.H-Omodelprovidest h a t i n t e r n a t i o n a l t r a d e w i l l impacto n incomed i s t r i b u

t i o n a s a r e s u l t o f changerelativeprice o f goods,a n d t he relativefac to rp ri ce (Krugman,O bs t f e l d , & Melitz,2 0 1 2 )

Thetheoreticalmodelsdiscussedabovearebasedonthecompetitivemarket,yetthereareothertypesofmarketssuchasmonopoly,oligopoly,andmonopolisticcom

atrade-relatedtheorybasedoneconomiesofs c a l e inmonopolisticcompetitionmarket.Theeconomiesofscaleisinternaltofirm,t h a t meansfirmgetp r o f i t w h e n i n c r e a s e s itss c a l

e o f o u t p u t T r a d i n g w i t h o t h e r c o u n t r i e s leadstospecialization,andcreatedconcentratedlocationofproduction.Int h at case,countries

notb a s e d primarilyoncomparativeadvantage.Th e questionputhereisthathowc o u

n t r i e s decidewhichindustriestheywillproduceinlargescaleinordertocompetea n d exportinworldmarket.Krugman(1979)suggestedthatthemarketstructuremaybeacontributedfactor.F or instant,inoligopolymarket,therearefewsuppliersforwholem

arket,andthisisanappropriateconditionforeconomiesofscale.However,t h e questio

n arisingis that howdomesticsfirmscancompetetoforeignfirmsin world

market.Therefore,thereasonthatcountrytradeisnotonlythedifferencesinnation’sresourceandtechnologybutalso t h e economieso f scale, an dyett h e r e is arelationshipb

i t h i n countrybecausefreetradeprovidecertainruleandprincipleintradeagreedbybothcountries,andisdifficulttoviolate.Thei s s u e posedi s t h a t howt o a p p r o a c h a f r e

e t r a d e i n r e a l w o r l d Krugman( 1 9 9 1 ) mentionedincreasingtrendofbilateralfreetradeagreementassubstitutionforglobalfreetradeagreement.Thepaperindicatesthatfreetradeagreementcan

benefitparticipantsbyreducingtheconsumer’sdistortion,increasethep o w e r intradetoothercountries, andcreatingtheefficientinproduction.Krugman( 1 9 91 ) alsomentionedthenotionof‘naturaltrading bloc’whichexplainsfreetradeagreement

a s a n a t u r a l p r o c e s s o f co u n t r i e s l o c a t e d n e a r together.F r e e t r a d e agreementalsoestablishedbetweencountrieshavingsimilareconomiccharacteristicsi n ordertoincreaseitstradingvalue(Baier&B e r g s t r a n d , 2004).WorldTradeOrganizationdefinedfr

eetradeagreementisanaccordbetweensignedcountriesont h e significantreductionontradetariffandothertraderegulation.

to f B.AssumethatAsetsatariffonclothingimportfrombothBandC.Ifthetariffishighenough,A w i l l p r o d u c e c l o t h i n g h e r s e l f However,A i s a s s u m e d t o forma c u s t

o m unionwithB.Asaresultofthosepolicies,priceofclothingimportedfromBw i t h o u t tariffischeaperthanC’swithtariff;

and,AwillimportclothingfromB.Thisphenomenon iscalledtradediversionofAfromCtoB.Lipsey(1957)analyzedthatacustom su n i o n c a u s i n g t r a d e diversionbychangethet r a d i n g p a t t e r n i n favoro f c u s t o m unionsuppliers.Lipsey(1960)mentionedthatmorelikelytheoccurrenceoft r a d e creationisthegreaterdifferenceintheco

importinggoodsfroml o w e r costsuppliertohighercostoneiscalledtradediversion.WhileLipsey(1960)advocatethattrade-

divertingcustomsunioncouldnotdecreasethewelfareofi m p o r t i n g c o u n t r i

e s b e c a u s e o f t h e s u b s t i t u t i o n i n c o n s u m p t i o n , Bhagwati( 1 9 7 1 ) p o

i n t e d outsubstitutionisnotasufficientconditions;yet,tradediversioneffectca

nr e d u c e economicwelfareundertheassumptionoffixedimportedlevel.Indetails,thechangei n i m p o r t p a t t e r n d u e t o formationofc u s t o m s u n i o n s c r e a t e s t w o o p p o

welfare.Lipsey(1957)andBhagwati(1971)definedthetradediversionasthechangeinth

tradel i b e r a l i z a t i o n i m p a c t s o n t h e t r a d e p a t t e r n o f signingcou nt ri es i n t h r e e

w a y s First e f f e c t i s t h e i n c r e a s e i n n e w t r a d e flowb e t w e e n b l o c ’ s members.Secondly,r ed u ci n g tradebarrier can divertthe importfromnon-

membersuppliersto membersuppliers.Finally,thechangeintermoftradeisanattributabletoariseindemandofsubstitutecommodity

2.1.3.2Theintensive marginandextensivemargin effect

InKrugman(1980), the patternoftradeisexplainedbytworeasons Firstly,co n su me rs ineachcountry havedifferentpreferences o n commoditieswiththe l ow substitutionelasticityofforeigngoods,sotheydemandtheexportinggoods.Thes e c

d u c e d , aggregatet r a d e f l o w c a n i n c r e a s e b e c a u s e a l l firmsr a i s e theire x p

o r t i n g c ap a c it y ofgoods;so,everyfirmisequallyimpactedbytradepolicieschanges.Melitz( 2 0 0 3 ) s t a t e d t h a t firmsw a n t i n g t o e n t e r e x p o r t i n g markete n c o u n t e r n

o t o n l y t h e variablecostssuchastransportationcostbutalsofixedcostwhichisindependenttothenumberofgoodsexported.Asaresultofthat,Melitz(2003)builtupamodeltof i n d t h e s t a t i c e q u i l i b r i u m o f firms’e x p o r t i n g i n c o u n t r i e s w h i c h

e x p o s e t o internationalmarket,thepaperconcludedthattradeliberalizationeffectsonthetradep a t t e r n o f firma n d r e a l l o c a t i o n r e s o u r c e s w i t h i n e x p o r t i n g i n

d u s t r i e s t h r o u g h t h e increaseinnumberofimportingcountries,andthedecreaseintradecost,bothvariablec o s t a n d f i x e d c o s t F i r s t l y , ther i s e i n t r a d i n g c o u n t r i e

s i s a conditiont o increaseintheproductivityrequirementforexportingf i r m s T h e l e a s

t p r o d u c t i v e firmsc a n b e f o r c e d t o exito u t oft h e m a r k e t ; t h e survivalfirmsw

i l l i n c r e a s e itsvolumeofexporttocurrentandnewdestinations(Melitz,2003).Secondly,thedecreasei n t r a d e c o s t c a n impacto n t r a d e p a t t e r n throught h e e m e r g e

n c e o f newexp or ter s Newexporterandcurrentexportercapturethehigherdemandfromexport

Furthermore,C h a n e y (2008)s u p p o r t e d t h e argumento f M e l i t z (2003)b y i m p o s i n g t he intensivemarginsa n d e x t e n s i v e marginse f f e c t o f t r a d e c o s t

o n t r a d e flow.H e p o i n t e d o u t t h a t f i r m is d i f f e r e n t i n productivitya n d s u f f e r s

f i x e d c o s t i n tr ading besidesvariablecost.Byaddingnewassumptions,Chaney(2008)statedthatchangeintradeflowduetotradebarriershockcanbeexplainedthroughtwomechanisms.T h e f i r s t m e c h a n i s m i s t h e intensivemarginmentionedb y Krugman(

t h a n moreheterogeneousindustries.Extensivemargineffectcandominatetheintensivemargin

effectinindustrywithhighdifferentiatedproduct.Moreover,Helpman,Melitz,andRubinstein(2008)statedthattheprofitabilityoffirmexportishigheriftheimportingcountries’demandishigher,andlowertradecosts.Ontheotherhand,firmwillnote x p o r t

i f t h e p r o f i t o f firmi s n e g a t i v e T h a t c a n e x p l a i n t h e z e r o valuei n e x p o r tbet ween t w o c o u n t r i e s H e s h o w e d t h e p r i m a r y b i a s i n estimatingimpacto f

t r a d e bar rier on tradeflowis attributedtoignoringextensivemargineffect.Thereducingint r a d e f ri ct io n mayn o t on ly lea d t o t hee xpa nsi on o f tr ade be twee n e

x i s t e n t cou nt ry pairs,butalsotocreatenewtradingpartners

Fromtheabovetheoreticalfoundation,theimpactoffreetradeagreementont r

TRADE WITH MEMBER TRADING PARTNERTRADE BARRIERS

TOTAL TRADE FLOW

-NEWEXPORTING FIRMS

Source:ConstructedbytheAuthor

Figure2-1presentsthetheoreticalfoundationtoanswerresearchquestionsofthethesis.Thefirstoneisthatwhattheimpactoffreetradeagreementontotaltradeflowbetweensigningc o u n t r i e s is.Secondly,howthatimpacthappens,orwhatc h an n e l s freetradeagreementeffectthechangeintradeflow

FTA and Trade Barriers:

FTAbyitsobjectivesistoeliminatethetariffs,quotaan dothertariffequivalentbarriersamongmemberstates.Theotherpurposeistobuildanintegratedregionaleconomy,soFTAwillfacilitatethereductioninothernon-

tradebarriersucha s technicalbarrier,capitalflow,crossbordertransitandhumanmovement.Trade Barriers and Trade with Member Countriesand Non-member Countries:

According

totradecreationandtradediversiontheory,whenthetradebarriersgoesdown,thetradingcostalsodecreasesbothinvariablecostandfixedcost.Thed ecr ease intradecostisaconditionfortwotradingactivities.Thefirstoneisthetradediversion.Non-

Trade with Member Countriesand Exporting Firms:

Thereducingtradecostbetweenfreetradecountrieswillincreasedemandofcommoditiesexportfrommembercountriestoothermembercountries.Thisleadstot h eintensivemarginandextensivemargineffectintradepattern.Firstly,thecurrente x p o

r t e r willincreasetheirvolumeoftradeduetotheincreaseindemandandlowerco st Theintensivemargineffectwillinfluencepositivelyontradeflowbetweentwocountries.However,t h i s e f f e c t w i l l b e l o w e r i n moreh e t e r o g e n e o u s p r o d u c t i v i t

y industries.Secondly,therewillbenewfirmsenterexportingmarket.Thosenewfirmsw i l l a

f f e c t positivelyi n thet r a d e f l o w betweenc o u n t r i e s T h e moreh e t e r o g e n e o u s productivitybetweenfirmsthemorepositiveeffectofextensive marginontradeflow

Exporting Firms and Total Trade Flow:

Theintensivemarginwillimpactpositivelyon

thelevelofgoodsexistingfirmse x p o r t , whiletheextensivemarginwillattractmorefirmscomeintothenewe x p o r t i n g market.Althoughtheimpactsofintensiveandextensivemarginarenotast h e samelevel,i n s e c t o r w h o s e p r o d u c t s substitutionelasticitya r ehigh,extensivemarginimpactwilldominateintensivemargin’seffect.However,botheffectsaretoincreasethetradevolumewiththemembercountries

2.2 EMPIRICALLITERATURE

Fromthetheoreticalmechanismbuiltintheoreticalliterature,thissectionaimst o provideempiricalindicatorsusedbypreviousresearches.Aitken(1973)isthefirsta u t h o r

w h i c h a p p l ie d t h e t h e o r y o f gravitymodeli n o r d e r t o e s t i ma t e t h e e f f ec t o f European E c o n o m i c C o m m u n i t y (EEC)andE u r o p e a n F r e e T r a d e Association(EFTA)ontheimportandexportofmembercountries Inhismodel,heproposedanumber

inthetheoreticalmodel.Thedependentvariablew a s export value.T h e in de pen den t variableswere Freetrade agreement,Incomeofexpor ting countries,Incomeo f Importing

c o u n t r i e s , D i s t a n c e b e t w e e n t r a d i n g p a r t n e r s Thoseindicatorshavebeenusedbylatterresearcheson observingtheimpacto f FTAontradeflowofcountries

Therea r e t w o mainp a r t s i n t h i s s e c t i o n Thef i r s t p a r t i s i n d i c a t o r f o r t r a

d e flow, whichisthedependentvariableinthisthesis.ThesecondpartisindicatorsforindependentvariableswhichareFreeTradeAgreement( F T A ) , exporter’sincome,importer’sincome,anddistancebetweentradingcountries

2.2.1 TradeFlow

Inempirical papers,therearethreeindicatorsfor tradeflowbetweencountries.Firstly,McCallum(1995)usedtheshipmentvaluefromonecountrytoothercountryast h e r e p r e s e n t a t i v e fort r a d e f l o w Inh i s p a p e r , h e a n a l y z

e d t h e i m p a c t o f t r a d e b o r d e r effectinthetradebetweenTheUnitedStatesofAmerica(USA)andCanada.Theideaofresearchisthatwithin-

provincialtradeofCanadaisgreaterthanthetradew i t h USA’sstates,orforeigntrade.Byapplyingthegravitymodelasfollow:

x ij

aby icy jddist ij

eDUMMY iju ij

(2.2)Wherexijisthetotalexportfromregionitoregionj

AndersonandWincoop(2003)examinedtheresultsobtainingfromMcCallum( 1 9 9

5 ) T h e au th or s arguedt ha tt her esu lt is overestimatedb e c a u s e i t omittedt ra de r e s

i s t a n c e variableswhicharecalledmultilateralresistanceterms(MRTs).Andersona

n dWincoop(2003)proposedanewestimated modelasfollow:

fortradeflow.ThedifferenceswithMcCallum(1995)arethevariables,themultilateralresistance terms.T h e meaningofM R T s is thati tindicated th e average

priceofexportcountrytotherestoftheworld’sprice.ThedefinitionsofMRTsareasf o ll o w:

(2.4)

(2.5)Baiera n d B e r g s t r a n d ( 2 0 0 7 ) c o n d u c t e d a researcht o estimatet h e impacto

f F T A ontradeflow.Thepaperuseddataof96countriesaroundtheworldfrom1960to2000.Inhisestimationmodel,thetradeflowbetweeniand jistheexportvaluefromitojdividedbytheGDPdeflatortoobtainrealtradeflow.Hur,Alba,andPark(2010)applied thegravitymodelproposed byBaierandBergstrand(2007) to findoutt h e hub-spokeeffectofFTAusingdataon96countriesaroundtheworldthroughout4 0 y e a r s f

r o m 1 9 6 0 Int h e model,d e p e n d e n t variablei s r e a l e x p o r t i n g value,t h e nominale x p o r t i n g valued i v i d e d b y G D P d e f l a t o r However,Yanga n d Martinez-

Z a r z o s o ( 2 0 1 4 ) estimatedwhetherASEAN-China FreeTradeagreementistradec r e a t i o n ortradediversion.Inthepaper,currentexportlevelinUSdollarrepresentfort r

a d e flowconceptininternationaltrade

Ont he ot her h a n d, Jugurnath,Stewart,a n d Br oo k (2007)di dn o t ex pl oi t t h e

e x p o r t valueasanindicatorfortradeflow.Insteadofthat,currentimportvalueisusea s adependentvariableinthemodel.Thereasonisthatcountryoftenstrictlyreportsitsimportvalueforthetaxpurpose,sotheimportvalueismorecorrectthanexportvalue

2.2.2 FreeTradeAgreement

Theprimarye f f ec t o f FTAont r a de f l o w i s throughtheeliminationo f t r a d e tariffs,somanyresearchpapershasanalyzedt ra de costasatoolforevaluationthe impactofFTA.AndersonandWincoop(2003)usethefollowingmeasurement:

p

biji n d i c a t e sthebordereffectinhisanalysis.T he variablewilltakethevalueof1ift woregionsisinsamecountry,otherwise,itisequaltooneaddtradingtax.Althought h e paperdidnotmentionaboutFTA,thepaperhasbeenappliedbylaterresearcher.B a i er andBergstrand(2007)estimatedtheimpactofFTAontradeflowofcountriesb y u s i n g variableFTAasa d u m m y variable.T h e variableFTAtookvalueo f 1 o f e x p o r t e r andimporterareinthesamefreetradearea,unlessFTAwasequalto0.Thep a p e r usepaneldataandfixedeffectestimationtofindtheFTA’scoefficient,andther e s u l t showedthatthereispositiverelationshipbetweenFTAandtradeflow.Basingo n B a i e r a n d Bergstrand( 2 0 0 7 ) , Jugurnath,Stewart,a n d B r o o k s ( 2 0 0 7 ) a l s o u s e d F T A as dummyvariablei n t h e i r p

a p e r However,t h e p a p e r n o t o n l y estimatedt h e impacto f FTAo n t r a d e f l o w , b u t

a l s o intentt o f i n d t h e t r a d e diversiona n d t r a d e cr eationeffectofFTA.Therefore,theysetupmoredummiesvariabletoseparatethediversionandcreationeffectintrade.Themodelisasfollow:

logIMPORT ijaX RTA ik RTA kj

Z a r z o r o

(2014)estimatedtherelationshipbetweenASEAN-China(ACFTA)ontradef l o w o f memberc o u n t r i e s T h e m o d e l o f p a p e r s e t u p t

h r e e t y p e s o f FTAd u m m y variables.ThefirstFTAvariableisequaloneifbothexportandimportcountriesarei n sameFTA.Thisvariableshowedthetradeincreasebetweenmembercountriesas

theeffectofACFTA.TheseconddummyFTAisequal1ifexporterisintheACFTA,andimporterisnotinACFTA.ThefinaldummyFTAisequal1ifonlyimporterisinACFTA.FTAdummyvariableisapplied t omeasuref re et ra de agreementeffectin H u r , Alba,andPark(2010).Objectivesofthepaperaretoanswertwoquestions.Thef i rs t questionistheeffectofFTAontradebyusingdummyvariableFTAasinBaierandBergstrand(2007).The

secondquestionisthehub

andspokenatureofFTA.Datacovered9 6 co u n t r i e s i n t h e w or ld i n 4 0 yearsfrom1960

B y applyingfixede f f ec t p an el datainestimation,thepaperpointedoutthattheincreaseinexportofcountriesw hi chareinsamefreetradeagreement

Inc o n c l u s i o n , i n d i c a t o r f o r F r e e T r a d e Agreementi s t h e dummyvariabletakingvalueo f 1i f twoc o u n t r i e s is insameFTA,otherwise, FTAequalt

e e n f o u n d t o impactpositivelyonthetradeflow

Hypothesis2:Incomeofcountriesrelatespositivelytotrade flowofgoods

2.2.3.2 Distance

Thedevelopmento f i n f o r m a t i o n technologya n d t r a n s p o r t a t i o n i n f r a s t r u

c t u r e h a s leadedtoadecreaseintransportcostbetweencountries,yetthequestionaroseis