Analysis of the proposed china asean free trade area a gravity model and RCAI approach

... Participating Countries AFTA ASEAN Free Trade Area Brunei Darussalam Cambodia Indonesia Laos Malaysia Myanmar Philippines Singapore Thailand Vietnam BAFTA CEFTA Baltic Free- Trade Area Central.. .ANALYSIS OF THE CHINA -ASEAN FREE TRADE AREA: A GRAVITY MODEL AND RCAI APPROACH BENJAMIN A ROBERTS (M Soc Sci., NUS) A THESIS SUBMITTED FOR THE DEGREE OF MASTER OF SOCIAL SCIENCE DEPARTMENT OF. .. Southern Common Market Bahrain Kuwait Oman Qatar Saudi Arabia United Arab Emirates Argentina Brazil Paraguay Uruguay MSG NAFTA SAPTA Melanesian Spearhead Group Fiji Papua New Guinea Solomon Islands

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ANALYSIS OF THE CHINA -ASEAN FREE TRADE AREA: A GRAVITY MODEL

AND RCAI APPROACH

BENJAMIN A ROBERTS

NATIONAL UNIVERSITY OF SINGAPORE

2003

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ANALYSIS OF THE CHINA -ASEAN FREE TRADE AREA: A GRAVITY MODEL

AND RCAI APPROACH

BENJAMIN A ROBERTS (M Soc Sci., NUS)

A THESIS SUBMITTED FOR THE DEGREE OF MASTER OF SOCIAL SCIENCE

DEPARTMENT OF ECONOMICS

NATIONAL UNIVERSITY OF SINGAPORE

2003

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Acknowledgement

I would like to thank Dr Shandre Thangavelu and Professor Thampapillai for all their support and encouragement during my not so fascinating candidature at the National University of Singapore Special regards goes to all my colleagues and friends who made my days at NUS enjoyable

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TABLE OF CONTENTS

1.1 Overview of GATT/WTO/RTAs &

4 Economic Overview of China & ASEAN 33

4.1 Overview of Macroeconomic Indicators 34-38

4.3 Summary of the Trading Partners of the CAFTA Economies 41-46 4.4 Trade Policy Summary of the CAFTA Economies 47-53

5.2 Articles Pertaining to Trade in Goods 59-63

6 Exposition of the Revealed Comparative Advantage Index 64-65

6.2 Complementarities in the Production Activities of

6.3 Necessary Steps to a Mutually Beneficial

7 A Gravity Model Approach to the Proposed FTA 97-98

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LIST of TABLES

Table 1: RTAs Notified to the GATT & in Force in the 1948-1989 Period 9-10

Table 2: Definitions & Abbreviations of Regional Trade Agreements 11

Table 3: RTAs Notified to the GATT/WTO & in Force in the

Post 1989 Perio d 12-17

Table 4: Definitions & Abbreviations of Regional Trade Agreements 18

Table 5: Macroeconomic Indicators of China & the ASEAN Economies 34

Table 6: Industries making up the Industrial Sector in China & ASEAN 39

Table 9: Tariff & Non-Tariff Highlight of the CAFTA Economies 47-49

Table 12: RCAI Indices for the Top Five Exports of the CAFTA Economies 67-68

Table 14: World Market Share of Commodities in which the CAFTA Economies Have a Revealed Comparative Advantage 76 Table 15: Sector Contribution to GDP & Employment 81

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Table 16: China's Revealed Comparative Disadvantage Index 83

Table 17: Geographical Distribution of Global FDI Flows to Selected Countries 91

Table 20: Explanatory Variables Descriptive Statistics 108-109

Table 21: F-Statistic and p-Values of Trade Flows 111

Table 22: OLS Regression Coefficients for Exports 112

Table 23: OLS Regression Coefficients for Imports 113

Table 24: Tobit Regression Coefficients for Exports & Imports 114

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LIST of FIGURES

Figure 1: Per Capita GDP of CAFTA Economies 35

Figure 2: GDP & Per Capita GDP of China 36

Figure 4: Sector Composition of GDP of CAFTA Economies 38

Figure 5: Import Origination of the CAFTA Economies (2000) 40

Figure 6: Export Destinations of the CAFTA Economies (2000) 40

Figure 7: Percentage Changes in ASEAN Exports

Figure 8: Percentage Changes in ASEAN Imports

Figure 9: Relative Importance of Explanatory Variables

in the Gravity Model Overtime 123

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SUMMARY

In this thesis, I have attempted to analyze the economic feasibility of the proposed China-ASEAN Free Trade Area by first evaluating the Framework of Agreement and objectives underlying both CAFTA and AFTA That the objectives of both regional trade arrangements were almost synonymous meant that the aspired integration is a possibility Other areas of concern pointed out include the liberalization of tax

regimes and the tarrification of non-tariff barriers among some of the ASEAN

members vis -à-vis China Under a still limiting three-digit SITC classification, I was able to show that only some of the CAFTA economies had similar RCAI An

examination of the Revealed Comparative Disadvantage Indices of China also showed that the ASEAN countries were in a position to tap on China's import market Whilst ASEAN economies like Singapore, Malaysia, and Thailand could easily do so, others like Cambodia, Laos, Malaysia, and Vietnam (CLMV) will have to realign their industrial strategies to take advantage of China's Revealed Comparative Disadvantage Indices Broadly taken, the inter member RCAI indices reveal some similarities but vast differences exist to allow for complementarities in their production activities Like most FTAs, the proposed China-ASEAN FTA will have its effect on the global trading system The underlying assumption of trade creation meant that members of the FTA had a potential to improve their welfare This welfare improvement is not automatic and requires conscious effort on the part of the less developed ASEAN economies The results of the model were convincing enough to label the proposed

FTA a 'natural' trading bloc The model also showed a potential for increased trade

flows, both for Imports and Exports, within the Regional Trade Agreement

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1 INTRODUCTION

The economic benefits realised from the formation of the European Union (EU) and that of NAFTA1 have led to an appreciation of the benefits inherent in economic integration Economic theory claims that the potential benefits from economic

integration are much more likely to be realised provided that integrating members were

trading amongst themselves ex ante This postulation is premised on the need for the

avoidance of trade diversion In this regard integration is beneficial if it is trade

creating and not trade diverting, that is, if it is dynamic

The recent proposed China-ASEAN Free Trade Area (FTA), like other regional trade agreements (RTA), has drawn some concerns Sceptics writing on the subject have downplayed its economic feasibility and prospects despite projections that the FTA will create an economic region of 1.7 billion people with a GDP of US$2 trillion and a trade value of US$1.23 trillion (2001) The China-ASEAN FTA, like all FTAs, must be evaluated from an economic as well as from a social and political dimension if one is to

make an informative finding Though acknowledging the de jure dimension of the proposed FTA, emphasis is placed on the de facto dimension with an assumption, albeit

a logical one, that the economic is synonymous to the social

The Thesis comprises of eight chapters Chapter one is the introductory chapter and it gives an overview of the GATT/WTO/RTAs and the Multilateral Trade System Chapter two surveys the existing literature on the static and dynamic models to regional trade agreements Chapter three outlines the research methodology of the thesis

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Chapter four gives an economic overview of the economies with which this thesis is concerned Chapter five provides a succinct overview of the agreement underlying the China -ASEAN Comprehensive Economic Co-operation Emphasis is given to the trade aspects of the Agreement Chapter six details the Revealed Comparative Advantage Indices of the production activities of the economies concerned Chapter seven deals with the dynamic aspects of the proposed FTA using the Gravity Model of Trade Chapter eight, the concluding chapter gives a synthesis of the static and dynamic analyses to trade and gives an overview of what the two approaches revea l for the proposed FTA

1.1 OVERVIEW of GATT/WTO/RTAs & the MULTILATERAL TRADE

SYSTEM

Since the adoption of GATT in 19472 (by way of the Geneva Round) and up until the end of 1994 there were 124 regional trade agreements notified to the GATT This number increases to 150 if trade in services is accounted for With the creation of the WTO in 1995, the international trade environment has seen an exponential growth in the formation of FTAs/RTAs Following its creation, the WTO has received over 100 notifications for the formation of FTAs/RTAs in both Goods and Services This works out at an average of 3.4 RTAs per year in the GATT period compared to over 12.5 RTAs per year in the WTO period for both Goods and Services The average number

of notifications between the two periods has therefore grown by over 260% This is an

1 Ment ion is only made of these two FTAs (RTAs) but there are currently 224 RTAs that have been notified to the WTO This is inclusive of the GATT years and includes RTAs in both Goods and Services

2 There were 8 Trade Rounds negotiated under the auspices of the GATT most of whose objective was to reduce tariff levels within the multilateral trading system Since the inception of the WTO there has been

4 Ministerials of which 3 went well with Seattle having failed The last of these was the Doha

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astronomical rate, especially if we consider the fact that not all FTAs/RTAs formed were notified to the GATT or notified to the WTO Given this exponential growth in notifications it is only logical to ask why this upsurge of interest among nations to form FTAs and why now? Answering this question requires an understanding of what an FTA/RTA is; what its creation does to the multilateral trade framework; and what purpose it serve s

In the broadest sense a regional trade area (RTA) refers to the geopolitical integration

of countries with the aim of promoting trade (either in goods or services) within the integrating area and among the integrating members Pursuant to this definition, a RTA

is all encompassing in that it is inclusive of a Free Trade Area, Customs Union,

Common Market, and Monetary Union, respectively The ordering is, however, not strict as is evidenced in the real world The European Union as we know it today, for example, started with the formation of the European Economic Community (Common Market)3 and not with a Free Trade Area Actually five of the founding fathers of the European Free Trade Agreement (EFTA) including pioneering Britain would later leave the EFTA to join the European Community4 Another example of a RTA that did not follow the prescribed economic path is the South African Customs Union (SACU) and the ECOWAS of West Africa, though these are less binding compared to its

Ministerial or better yet the Doha Declaration of 2001 The Cancun Ministerial will be held September

2003

3 The EEC was established in 1958 by a treaty among original members Belgium, France, Italy,

Luxembourg, The Netherlands, and West Germany It was, however, the European Coal and Steel Community of 1952 that laid the foundation to the EEC In 1958 Britain proposed for the expansion of the EEC into a transatlantic FTA but was turned down It however succeeded in forming the European Free Trade Area (EFTA) with signatories Austria, Denmark, Norway, Portugal, Sweden and Switzerland Iceland joined in 1970 with Finland joining in 1986 along with Liechlenstein in 1991 However, in 1973 Denmark and Great Britain will leave EFTA to join the European Community Portugal followed in

1986 and then Austria, Finland, and Sweden in 1995 As it stands today the EFTA is comprised of the original members of Iceland, Norway, Switzerland, and Liechlenstein However, the EFTA has forged trade relations with some of its East European counterparts These include the EFTA-Bulgaria FTA, the EFTA-Czech Republic FTA, the EFTA-Hungary FTA, the EFTA-Poland FTA and the EFTA-Israel FTA

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counterparts in Europe The logical path is, however, enhancing given the stepping stone guidance to forming a formidable RTA

The encompassing nature of the definition of a RTA has made it synonymous to its different levels and forms It is therefore very common to use the term RTA

interchangeably with either a Customs Union or a FTA Strictly speaking, the three are not synonymous especially if we consider the fact that an FTA and a Customs Union have a 'trade in goods' connotation whereas a RTA can be taken to mean either trade in goods or in services or both To this end, an RTA covers both the GATT and General Agreement on Trade in Services (GATS) whereas an FTA is primarily concerned with the GATT This distinction between an RTA and an FTA is conveyed further by the distinction made within the Committee on Regional Trade Agreements (CRTA) which was formed in February of 1996 by the WTO6 The CRTA is comprised of three bodies- the Council for Trade in Goods (CTG); the Council for Trade in Services (CTS) and the Commit tee on Trade and Development7 The objective of the CRTA is

to allow for transparency of RTAs and to enable its country members the opportunity to evaluate compliance of a RTA to the World Trade Organisation rules

The earlier question regarding the upsurge in the number of FTAs in the World Trade Organisation (1995-onward) compared to the GATT (1948-1994) is an important one

An examination of the depth and coverage of the RTAs in the two periods will help us

4 See EU Web-site ( www.eurunion.org ) for history of the Union

5 See subsequent pages for a list of the RTAs with or without notification to the WTO

6 See the WTO web -site ( www.wto.org/english/tratop_e/region_e/regcom_e.htm ) for further details

7 The CTG handles all notifications falling under Article XXIV of the GATT (trade in goods) whereas all notifications of RTAs falling under the Enabling Clause are made to the CTD The CTS tracks all notifications of RTAs covering GATS

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in answering the question - why an upsurge in the number of RTAs following the creation of the WTO

The growth rate in the average number of RTAs in the two period referred to earlier is alarming It is alarming not because of the inter-period comparison of the RTAs notified to the GATT/WTO but because of the potential consequences it might have on the multilateral trade framework which the WTO is responsible for promoting An evaluation of the RTAs formed after 1989 contrasts sharply with the RTAs formed in the 1948-89 period Perhaps the only exception that could be cited in terms of

complexity and degree of product coverage is the EC It should, however, be pointed out that the EU, which became effective in January 1993, is more encompassing than the EC was Other Customs Union or FTAs formed before 1989 (see table 1) were less comprehensive and less binding by way of legal framework In fact some, PTN and LAIA, were merely protocols to the facilitation of trade While others like the GSTP are mere non-binding preferential agreements It is no coincidence therefore that these RTAs fall under the classification of "other" in the "Type of Agreement" heading in table1 Looking at table1 it becomes evident that the RTAs formed from 1948-89 involved less of developing countries and even lesser RTAs among developing

countries In fact most of the RTAs involving developing countries were through plurilateral/bilateral agreements with the EC The RTAs that existed exclusively among developing countries were not RTAs in the strict sense of the word but had objectives of fostering trade amongst themselves without necessarily harmonising, reducing tariffs, or intending for a broader product coverage

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Besides the above differences in the RTAs of the two periods, another major distinction between the two concerns the Rules of Origin (ROO8) Regarding the ROO it is safe to say that all RTAs in the 1948-89 period were less conscientious of the ROO primarily because the GATT MFN principle (clause) did not come into play until 1994

However, there are other ROO besides the "MFN rules of origin." There is also the

"Preferential rules of origin" which as the name suggests allow for preferential access (of goods) to RTA member countries This is considered an integral part to the

formation of FTAs albeit the MFN principle of the GATT Reconciling this integral aspect to a FTA with the MFN principle of the GATT is not free of problems and has indeed resulted, in part, to the existence of two major models of the ROO - the "pan-European" and the NAFTA-model of ROO Wide differences exist between the two in terms of regional content requirements (%), rules of tolerance, and exceptions for sector specific goods Variations are lesser in the ROO within the "pan-European" model than it is in the NAFTA-model T his should not be surprising given that the EU

is, in terms of level, in the final stage of a RTA whereas the NAFTA is still in the first stage Despite these level differences, it is evident that RTAs with lesser exceptions, in terms of coverage, and lesser or harmonised standards (Sanitary and Photo-sanitary)

would tend not to hamper the multilateral trade framework (WT/REG/W/45, 2002)

RTAs formed in the post 1989 period are relatively more harmonising than those formed in the 1948-89 period The most noteworthy of mention been NAFTA, AFTA, and MERCUSOR (see table3&4) These RTAs provide for a wider product coverage, harmonisation of tariffs, harmonisation of standards, and some go as far as providing for some harmonisation in procurements along with addressing issues of IPRs and

8

Rules applied in FTAs to determine whether goods qualify for duty-free admission Normally such rules specify a minimum percentage of inputs which have to come from member countries

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competition policy The RTAs of this period also tend to be more aligning with WTO guidelines and are relatively more transparent Another important distinction between the RTAs of the two periods is the number of RTAs forme d exclusively among

developing countries in the post 1989 period that have remained effective in terms of objective Good examples are AFTA and MERCUSOR and to a lesser extent

CARICOM (see table3&4) Despite these differences in RTA type, transparency, product coverage, harmonisation, and safeguard provisions the pertinent question of their effect on the multilateral trade framework is still to be answered Do RTAs, in the words of Bhagwati (1992), act as "building-blocs" or "stumbling-blocs" to the

multilateral trade system?

The question of whether RTAs foster or hinder the multilateral trading system is argued

to be too early to answer Winters (1998) points out in his "Regionalism versus

Multilateralism" study that the verdict is still out on the question given the short history

of effective RTAs He argues that "one can build models that suggest either conclusion but to date these are sufficiently abstract that they should be viewed as parables rather than sources of testable predictions"(pg.1) Putting aside economic models and

invoking logic against a backdrop of RTA objectives would perhaps shed some light on the question To clarify the point, one can look at the different RTA forms along with their objectives and provisions and ask what their effect on the multilateral trading system is likely to be This possibility would perhaps allow us to not wait for time series data to make for an informed empirical analysis, albeit its importance This possibility was undertaken in Viner's (1950) pioneering work on the conventional analysis of RTAs along with Meade (1955) and Lipsey (1960) All three evaluated RTA implications (at different degrees) on the multilateral trading system by way of a

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Customs Union and the resulting concerns of trade diversion Obviously the partial equilibrium analysis, the underlying assumptions, and the focus on a CU meant that a thorough analysis would be shortcoming I will return to this issue in more details under the Literature Review section of the thesis For now the important point to note

is that an awareness has been created that RTAs have an effect on the multilateral trading system but how the different levels (forms) of RTA affect the RTA and whether

they do in different ways has yet to be conveyed by research A priori it is safe to posit

that an FTA, Customs Union, Common Market, and Economic Union will affect the multilateral trading system in different ways even if this reasoning is solely based on the differences in the encompassing nature and objectives of the different RTA forms

The objectives of RTAs are different and this difference is reflected in the policies and agreements underlying them An FTA, for example, provides an agreement for the harmonisation of tariffs, amongst others, among integrating members whereas a CU allows for this along with a common trade policy toward countries outside of the Union An economic Union, the EU for example, goes well beyond the provision of the two Against this framework we can then make a case for why there has been an explosion in the number of RTAs, especially in the post 1989 period RTAs have been and are currently in the rise because they facilitate trade and lend a sense of belonging

to the multilateral trade framework even if it may concomitantly hinder globally freer trade

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TABLE 1: RTAs Notified to the GATT and in Force in the 1948-1989 Period

By date of entry into force

Agreement entry into Date of

force Date provision Related agreement Type of

WT/

document

EC (Treaty of Rome) 1-Jan-58 10-Nov -95 GATS Art V Services

agreement REG39 Under factual examination …

EC (Treaty of Rome) 1-Jan-58 24-Apr-57 GATT Art

XXIV Customs union … Report adopted 6S/70 & 109 29.11.57

REG85 Report adopted 9S/70

04.06.60

XXIV Customs union REG93 Report adopted 23.11.61 10S/98

TRIPARTITE 1-Apr-68 23-Feb-68 Enabling

Clause Other … Report adopted 16S/83 14.11.68

EFTA accession of Iceland 1-Mar-70 30-Jan-70 GATT Art

XXIV Accession to free trade

agreement

… Report adopted 18S/174

29.09.70

EC — OCTs 1-Jan-71 14-Dec -70 GATT Art

XXIV agreement Free trade REG106 Report adopted 09.11.71 18S/143

EC — Malta 1-Apr-71 24-Mar-71 GATT Art

… Report adopted C/M/107

11.07.75

Clause Other … Examination not requested …

EC — Iceland 1-Apr-73 24-Nov -72 GATT Art

EC — Cyprus 1-Jun-73 13-Jun-73 GATT Art

XXIV

Customs union

21.06.74

EC — Norway 1-Jul-73 13-Jul-73 GATT Art

XXIV agreement Free trade … Report adopted 28.03.74 21S/83

Bangkok Agreement 17-Jun-76 2-Nov-76 Enabling

EC — Algeria 1-Jul-76 28-Jul-76 GATT Art

XXIV

Free trade agreement

11.11.77

EC — Egypt 1-Jul-77 15-Jul-77 GATT Art

EC — Jordan 1-Jul-77 15-Jul-77 GATT Art

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GATT/WTO notification Examination process Agreement entry into Date of

force Date provision Related agreement Type of

WT/

document

EC — Lebanon 1-Jul-77 15-Jul-77 GATT Art

EC — Syria 1-Jul-77 15-Jul-77 GATT Art

XXIV

17.05.78

EC accession of Greece 1-Jan-81 24-Oct-79 GATT Art

XXIV Accession to customs

union

09.03.83

XXIV

02.10.84

United States — Israel 19-Aug-85 13-Sep-85 GATT Art

XXIV agreement Free trade … Report adopted 14.05.87 34S/58

19.10.88

CER 1-Jan-89 22-Nov -95 GATS Art V Services

agreement REG40 Consultations on draft report …

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TABLE2: Definitions and abbreviations

ASEAN Association of South East Asian

Nations

Brunei Darussalam Cambodia Indonesia Laos Malaysia Myanmar Philippines Singapore Thailand Vietnam

BANGKOK Bangkok Agreement Bangladesh China India Republic of Korea Laos Sri Lanka

CAN Andean Community Bolivia Colombia Ecuador Peru Venezuela

CARICOM Caribbean Community and

Common Market Antigua & Barbuda Bahamas Barbados Belize Dominica Grenada Guyana Haiti Jamaica Monserrat Trinidad & Tobago St Kitts & Nevis St

Lucia St Vincent & the Grenadines Surinam CACM Central American Common Market Costa Rica El Salvador Guatemala Honduras Nicaragua

CER Closer Trade Relations Trade

Agreement

Australia New Zealand

EC European Communities Austria Belgium Denmark Finland France Germany Greece Ireland Italy

Luxembourg Netherlands Portugal Spain Sweden United Kingdom EEA European Economic Area EC Iceland Lichtenstein Norway

EFTA European Free Trade Association Iceland Liechtenstein Norway Switzerland

GSTP General System of Trade

Preferences Among Developing

Countries

Algeria Angola Argentina Bangladesh Benin Bolivia Brazil Cameroon Chile Colombia Cuba Democratic People's Republic of Korea Ecuador Egypt Ghana Guinea Guyana Haiti India Indonesia Islamic Republic of Iran Iraq Libya Malaysia Mexico Morocco Mozambique Nicaragua Nigeria Pakistan Peru Philippines Qatar Republic of Korea Romania Singapore Sri Lanka Sudan Thailand Trinidad and Tobago Tunisia United Republic of Tanzania Uruguay Venezuela Vietnam Yugoslavia Zaire Zimbabwe

LAIA Latin American Integration Association Argentina Bolivia Brazil Chile Colombia Cuba Ecuador Mexico Paraguay

Peru Uruguay Venezuela

OCT Overseas Countries and Territories Greenland New Caledonia French Polynesia French Southern and

Antarctic Territories Wallis and Futuna Islands Mayotte Saint Pierre and Miquelon Aruba Netherlands Antilles Anguilla Cayman Islands Falkland Islands South Georgia and South Sandwich Islands Montserrat Pitcairn Saint Helena Ascension Island Tristan da Cunha Turks and Caicos Islands British Antarctic Territory British Indian Ocean Territory British Virgin Islands

PTN Protocol relating to Trade Negotiations

among Developing Countries Bangladesh Brazil Chile Egypt Israel Mexico Pakistan Paraguay Peru Philippines Republic of Korea Romania Tunisia Turkey Uruguay

Yugoslavia SPARTECA South Pacific Regional Trade and

Economic Cooperation Agreement Australia New Zealand Cook Islands Fiji Kiribati Marshall Islands Micronesia Nauru Niue Papua New Guinea Solomon Islands Tonga

Tuvalu Vanuatu Western Samoa TRIPARTITE Tripartite Agreement Egypt India Yugoslavia

Source: Compiled from WTO CTRA

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TABLE 3: RTAs Notified to the GATT/WTO and in Force in the Post 1989 Period

By date of entry into force

Laos — Thailand 20-Jun-91 29-Nov -91 Enabling

Clause

Other … Examination not

requested

EC — Andorra 1-Jul-91 25-Feb-98 GATT Art

XXIV Customs union REG53 Factual examination concluded …

Clause Customs union COMTD/1 Under factual examination …

EC — Czech Republic 1-M ar-92 13-May -96 GATT Art

XXIV agreement Free trade REG18 Factual examination concluded …

EC — Slovak Republic 1-Mar-92 13-May -96 GATT Art

XXIV agreement Free trade REG18 Factual examination concluded

…

EC — Hungary 1-Mar-92 3-Apr-92 GATT Art

XXIV agreement Free trade REG18 Consultations on draft report …

EC — Poland 1-Mar-92 3-Apr-92 GATT Art

EFTA — Turkey 1-Apr-92 6-Mar-92 GATT Art

EFTA — Czech Republic 1-Jul-92 3-Jul-92 GATT Art

EFTA — Slovak Republic 1-Jul-92 3-Jul-92 GATT Art

XXIV

08.12.94

Czech Republic — Slovak

Republic 1-Jan-93 30-Apr-93 GATT Art XXIV Customs union REG89 Report adopted 04.10.94 41S/112

EFTA — Israel 1-Jan-93 1-Dec-92 GATT Art

Kyrgyz Republic —

Russian Federation 24-Apr-93 15-Jun-99 GATT Art XXIV agreement Free trade REG73 Under factual examination …

EC — Romania 1-May -93 23-Dec -94 GATT Art

XXIV

REG2 Factual examination

concluded

…

EFTA — Romania 1-May -93 24-May -93 GATT Art

Faroe Islands — Norway 1-Jul-93 13-Mar-96 GATT Art

Faroe Islands — Iceland 1-Jul-93 23-Jan-96 GATT Art

EFTA — Bulgaria 1-Jul-93 30-Jun-93 GATT Art

Clause

Other … Examination not

requested

… EFTA — Hungary 1-Oct-93 23-Dec -93 GATT Art

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EFTA — Poland 15-Nov -93 20-Oct-93 GATT Art

EC — Bulgaria 31-Dec -93 23-Dec -94 GATT Art

agreement … Factual examination not started …

XXIV agreement Free trade REG4 Consultations on draft report

EC — Poland 1-Feb-94 27-Aug-96 GATS Art V Services

agreement REG51 Factual examination concluded …

agreement REG4 Consultations on draft report …

Georgia — Russian

Federation 10-May -94 21-Feb-01 GATT Art XXIV

XXIV agreement Free trade REG82 Under factual examination …

Romania — Moldov a 1-Jan-95 24-Sep-97 GATT Art

EC — Lithuania 1-Jan-95 26-Sep-95 GATT Art

EC — Estonia 1-Jan-95 30-Jun-95 GATT Art

XXIV

Finland and Sweden

1-Jan-95 20-Jan-95 GATS Art V Accession to

services agreement

REG3 Consultations on

draft report

…

EC — Bulgaria 1-Feb-95 25-Apr-97 GATS Art V Services

agreement … Factual examination not started …

EC — Czech Republic 1-Feb-95 9-Oct-96 GATS Art V Services

EC — Slovak Republic 1-Feb-95 27-Aug-96 GATS Art V Services

agreement REG52 Factual examination concluded …

Faroe Islands —

Switzerland 1-Mar-95 8-Mar-96 GATT Art XXIV agreement Free trade REG24 Factual examination concluded …

EFTA — Slovenia 1-Jul-95 18-Oct-95 GATT Art

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Armenia 27-Oct-95 4-Jan-01 GATT Art XXIV agreement Free trade REG114 Factual examination not started …

Kazakhstan 11-Nov -95 29-Sep-99 GATT Art XXIV agreement Free trade REG81 Under factual examination …

EC — Turkey 1-Jan-96 22-Dec -95 GATT Art

XXIV Customs union REG22 Under factual examination …

Estonia — Ukraine 14-Mar-96 25-Jul-00 GATT Art

EFTA — Estonia 1-Jun-96 25-Jul-96 GATT Art

XXIV

concluded

…

EFTA — Latvia 1-Jun-96 25-Jul-96 GATT Art

Georgia — Ukraine 4-Jun-96 21-Feb-01 GATT Art

XXIV agreement Free trade REG121 Factual examination not started …

Georgia — Azerbaijan 10-Jul-96 21-Feb-01 GATT Art

Slovenia — Latvia 1-Aug-96 20-Feb-97 GATT Art

EFTA — Lithuania 1-Aug-96 25-Jul-96 GATT Art

XXIV

1-Sep-96 20-Feb-97 GATT Art

REG76 Under factual

examination

…

Slovak Republic — Israel 1-Jan-97 30-Mar-98 GATT Art

XXIV agreement Free trade REG57 Factual examination concluded

…

Poland — Lithuania 1-Jan-97 30-Dec -97 GATT Art

Slovenia — Estonia 1-Jan-97 20-Feb-97 GATT Art

EC — Faroe Islands 1-Jan-97 19-Feb-97 GATT Art

Canada — Israel 1-Jan-97 23-Jan-97 GATT Art

XXIV

concluded

…

Slovenia — Lithuania 1-Mar-97 20-Feb-97 GATT Art

Israel — Turkey 1-May -97 18-May -98 GATT Art

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Slovak Republic — Latvia 1-Jul-97 14-Nov -97 GATT Art

Slovak Republic —

Lithuania 1-Jul-97 14-Nov -97 GATT Art XXIV agreement Free trade REG48 Factual examination concluded …

Czech Republic — Latvia 1-Jul-97 13-Nov -97 GATT Art

Canada — Chile 5-Jul-97 26-Aug-97 GATT Art

Czech Republic —

Lithuania 1-Sep-97 13-Nov -97 GATT Art XXIV agreement Free trade REG46 Factual examination concluded …

XXIV Customs union REG71 Under fac tual examination …

Czech Republic — Israel 1-Dec -97 30-Mar-98 GATT Art

XXIV

concluded

…

Ukraine 19-Jan-98 15-Jun-99 GATT Art XXIV agreement Free trade REG74 Under factual examination …

Romania — Turkey 1-Feb-98 18-May -98 GATT Art

Hungary — Israel 1-Feb-98 24-Mar-98 GATT Art

Czech Republic — Estonia 12-Feb-98 3-Aug-98 GATT Art

XXIV

concluded

…

EC — Tunisia 1-Mar-98 23-Mar-99 GATT Art

Poland — Israel 1-Mar-98 25-Feb-99 GATT Art

XXIV agreement Free trade REG65 Factual ex amination concluded …

Lithuania — Turkey 1-Mar-98 8-Jun-98 GATT Art

REG75 Under factual

concluded

…

Czech Republic — Turkey 1-Sep-98 24-Apr-99 GATT Art

Slovak Republic — Turkey 1-Sep-98 24-Mar-99 GATT Art

Slovenia — Israel 1-Sep-98 8-Mar-99 GATT Art

XXIV

concluded

…

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Georgia — Armenia 11-Nov -98 21-Feb-01 GATT Art

Estonia — Faroe Islands 1-Dec -98 26-Jan-99 GATT Art

Bulgaria — Turkey 1-Jan-99 4-May -99 GATT Art

Poland — Latvia 1-Jun-99 29-Sep-99 GATT Art

Poland — Faroe Islands 1-Jun-99 18-Aug-99 GATT Art

Authority 1-Jul-99 21-Sep-99 GATT Art XXIV agreement Free trade REG79 Factual examination not started …

Georgia — Kazakhstan 16-Jul-99 21-Feb-01 GATT Art

Chile — Mexico 1-Aug-99 14-Mar-01 GATS Art V Services

agreement REG125 Factual examination not started …

Chile — Mexico 1-Aug-99 27-Feb-01 GATT Art

EFTA — Morocco 1-Dec -99 20-Feb-00 GATT Art

XXIV

concluded

…

Georgia — Turkmenistan 1-Jan-00 21-Feb-01 GATT Art

EC — South Africa 1-Jan-00 14-Nov -00 GATT Art

WAEMU/UEMOA 1-Jan-00 3-Feb-00 Enabling

1-Jan-00 21-Jan-00 GATT Art

Hungary — Latvia 1-Jan-00 20-Dec -99 GATT Art

EC — Morocco 1-Mar-00 8-Nov-00 GATT Art

Hungary — Lithuania 1-Mar-00 20-Dec -99 GATT Art

XXIV

concluded

…

EC — Israel 1-Jun-00 7-Nov-00 GATT Art

Mexico — Israel 1-Jul-00 27-Feb-01 GATT Art

Latvia — Turkey 1-Jul-00 22-Jan-01 GATT Art

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EC — Mexico 1-Jul-00 1-Aug-00 GATT Art

Turkey — Former

Yugoslav Republic of

Macedonia

1-Sep-00 22-Jan-01 GATT Art

New Zealand - Singapore 1-Jan-01 4-Sep-01 GATT Art

XXIV

REG127 Factual examinati on

not started

…

New Zealand - Singapore 1-Jan-01 4-Sep-01 GATS Art V Services

agreement REG127 Factual examination not started …

EFTA — Former Yugoslav

Republic of Macedonia 1-Jan-01 31-Jan-01 GATT Art XXIV agreement Free trade REG117 Under factual ex amination …

Hungary — Estonia 1-Mar-01 4-Oct-01 GATT Art

EC — FYROM 1-Jun-01 21-Nov -01 GATT Art

EFTA - Mexico 1-Jul-01 25-Jul-01 GATT Art

XXIV

EFTA — Jordan 1-Jan-02 22-Jan-02 GATT Art

XXIV agreement Free trade REG133 Examination not requested …

EFTA — Croatia 1-Jan-02 22-Jan-02 GATT Art

XXIV agreement Free trade REG132 Examination not requested …

Slovenia — Bosnia and

Herzegovina 1-Jan-02 21-Jan-02 GATT Art XXIV agreement Free trade REG131 Examination not requested …

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Table4: Definitions and abbreviations

AFTA ASEAN Free Trade Area Brunei Darussalam Cambodia Indonesia Laos Malaysia Myanmar

Philippines Singapore Thailand Vietnam BAFTA Baltic Free-Trade Area Estonia Latvia Lithuania

CEFTA Central European Free Trade

Agreement Bulgaria Czech Republic Hungary Poland Romania Slovak Republic Slovenia

CEMAC Economic and Monetary

Community of Central Africa

Cameroon Central African Republic Chad Congo Equatorial Guinea Gabon

CIS Commonwealth of Independent States Azerbaijan Armenia Belarus Georgia Moldova Kazakhstan Russian

Federation Ukraine Uzbekistan Tajikistan Kyrgyz Republic COMESA Common Market for Eastern and

Southern Africa Angola Burundi Comoros Democratic Republic of Conga Djibouti Egypt Eritrea Ethiopia Kenya Madagascar Malawi Mauritius Namibia Rwanda

Seychelles Sudan Swaziland Uganda Zambia Zimbabwe EAC East African Cooperation Kenya Tanzania Uganda

EAEC Eurasian Economic Community Belarus Kazakhstan Kyrgyz Republic Russian Federation Tajikistan

ECO Economic Cooperation Organization Afghanistan Azerbaijan Iran Kazakhstan Kyrgyz Republic Pakistan

Tajikistan Turkey Turkmenistan Uzbekistan GCC Gulf Cooperation Council Bahrain Kuwait Oman Qatar Saudi Arabia United Arab Emirates

MERCOSUR Southern Common Market Argentina Brazil Paraguay Uruguay

MSG Melanesian Spearhead Group Fiji Papua New Guinea Solomon Islands Vanuatu

NAFTA North American Free Trade Agreement Canada Mexico United States

SAPTA South Asian Preferential Trade

Arrangement Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka

UEMOA

WAEMU West African Economic and Monetary Union Benin Burkina Faso Côte d'Ivoire Guinea Bissau Mali Niger Senegal Togo

Source: Compiled from WTO CTRA

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2 LITERATURE REVIEW of REGIONAL TRADE AREAS

Every RTA formed, regardless of type, differs from each other Thus no two FTA, Customs Union, Common Market, or Economic Union is alike even though they may share some common characteristics This limited comparability among RTAs

necessarily mean that trade models employed to enhance our understanding of RTAs will differ not only in the type of RTA been examined but in terms of the program structure of the RTA An example will suffice to clarify on this point A model

employed, ex ante, to evaluate the potential net effect to forming NAFTA will produce findings that are very different from a model employed, ex ante, to evaluate the

potential net effect from AFTA This difference can be attributed to differences in product coverage, size of economic regions concerned, characteristic of the economic regions, trade level among the economic regions, program provisions, and level of protectionism, amongst others This variance in models is further enhanced by the underlying assumptions

In his survey of the literature on 'Regionalism versus Multilateralism' Winters (1996) points out that the models employed to evaluate RTAs often focus on political,

organizational, and hardly economic objectives This shortcoming to economic

objective is understandable given the de jure nature of RTAs Under the economic

objective, assumptions of a competitive framework with a homogeneous good model

or a monopolistic framework with differentiated goods model is often employed Within this dualistic approach four additional characteristics can be examined with each additional characteristic having sub-characteristics9 This classification scheme

9

For greater details see Alan L Winters Policy Research Working Paper "Regionalism versus

Multilateralism" published under the WB working paper series WPS1687, 1996

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provides some 64 different models through which our understanding of RTAs and their effect on the multilateral trade system has been enhanced

The different models can, however, be reduced to a bare minimum of two The two are the static & dynamic models The static models tend to be concerned with welfare implications resulting from a RTA The focus of the static models has tended to be a Customs Union, often between two countries, with an evaluation of its effect on a third

country or the ROW Viner's Customs Union Issue (1950) is the pioneering work of

this model type Others inc lude works of Meade (1956), Lipsey (1957), and Kemp & Wan (1976) It almost seems that the static RTA models have given exclusive

emphasis to Customs Unions as if they were the sole RTA-type This is

understandable to the extent that a CU has a single common external tariff to the ROW given its common external trade policy This CET advantage makes it easier to

analyze The static model, following from Viner's work, has come to face much criticism I must indeed go in the record to say that I have never come across any piece of work that has faced this much criticism, though on a positive note given its pioneering status

One of the major criticisms of the Vinerian perspective is that it assumes a constant return to scale (CRS) production function Michaely (1976) for example underlines this criticism by employing an increasing cost of production (a concave PPF) curve in which he shows that the net effect of trade creation and trade diversion, as treated in Viner, can be either welfare improving or worsening depending on the traded good's elasticity of demand and supply While not questioning Michaely's model of an increasing returns to scale (IRS) production function and the conclusions at which he

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arrives, I can only wonder if he actually read in toto Viner's The Customs Union Issue

I dare raise such a question because Viner pointed out in his work that "as output of any industry in a particular country increases over the long run relative to the national

economy as a whole, its money costs of production per unit (average costs) relative to the general level of money costs (General price level) also tended to rise (p 45)." It is

evident that Viner is implying an industry exhibiting IRS production techniques and assuming, like he does, a two-goods economy (imports and exports) one is bound to observe a concave production possibility frontier (convex marginal rate of

transformation curve) and not the flat marginal rate of transformation that Michaely argues Therefore this criticism on the Vinerian perspective is an assumed one In fact Michaely goes at length to quote Viner's analysis on the CU and would later point out

that "Nothing is said here EXPLICITLY about the nature of the cost curves

References to a high -cost or a low-cost country, here and elsewhere in Viner's

analysis, could CONCEIVABLY apply to the marginal costs at the point of production before the establishment of the union This does not NECESSARILY imply that

marginal costs are constant" (emphasis omitted, p 83)

Despite this assumed constancy in marginal costs critics got it right in pointing out that Viner's analysis could only have resulted in either trade creation or trade diversion and not both to the extent of having a net effect This criticism was, however, pointed out

by Viner himself albeit some qualifications needed for this either/or outcome to hold

In his CGE analysis of PTAs Yang (1998) shows how a partial equilibrium analysis (through an elimination of tariff in a RTA) results only in trade creation or diversion Trade creation occurs when the prices of imports (intermediate-inputs) from RTA members fall because of the elimination or reduction in tariffs This trade creation is

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only a 'potential' for it assumes that domestic production is efficient relative to the ROW and that transportation costs are zero On the other hand trade diversion only requires substitution of imports from the ROW to a RTA member following a fall in prices by way of tariff reduction (elimination) within the RTA This preferential tariff treatment (assuming homogeneous goods) is all it takes for trade diversion to occur Even though trade diversion takes place it is still possible for society to gain in welfare providing society's consumption pattern improves This improvement in the

consumption pattern (variety in the consumption basket) may more than compensate for the diversion from a 'least' to a 'high' cost producer as pointed out in Meade and Lipsey (op Cit.) Viner's focus on production costs therefore missed the welfare implication that could result from the dominance of the income effect following preferential tariff treatment

That Viner assumes a two-good three-country model with prohibitive tariff on the RTA member and that the focus country is the smallest of the three countries

non-necessarily means that trade diversion took place Trade creation does not occur because the focus country is a price taker; meaning that it is relatively inefficient in the production of its export commodity Given its high elasticity of demand for imports the focus country enjoys a higher welfare than would have been the case had it

operated under autarky Note however that a change in the underlying assumptions of smallness, high demand elasticity for imports, high income elasticity of import

demand and low substitution elasticity between the import sources (Armington

elasticities) can shift the outcome to one of trade creation

The exporting country (member RTA) can experience trade creation but for this to happen an implicit assumption is necessary That is, the substitution effect resulting

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from a reduction (elimination) in tariff must dominate the income effect and the import good must be an ordinary good This does not have to be the case and if the import good is a necessity, luxury, inferior, or normal good the income effect will dominate Therefore analyzing the effects of a CU on trade creation or diversion necessitates a closer examination of the characteristics of the goods involved Most research

interests on RTAs (CU issue) fall short of this analysis Despite this shortcoming the trade creation and trade diversion of Viner remains the cornerstone for evaluating RTAs effect on welfare However more dynamic and robust models, owing largely to the static nature of the Vinerian model, are now been used to analyze the effects of RTAs

Recent integration studies on trade have tended to employ models that are known for their dynamism and empirical robustness Among these are the Gravity model and the now dominant CGE models like the Global Trade Analysis Project or GTAP model and the Michigan Model of World Production and trade Whilst both model-types (Gravity and CGE) are noted for their respective robustness they both have their shortcomings and for that matter cannot be exclusively relied upon to arrive at a comprehensive study of RTAs

2.1 The Gravity Model

The Gravity model, pioneered by Tinbergen (1962) and Linneman (1966), is renowned

for its empirical robustness but has been used, in conjunction, to undertake ex ante

analysis of RTAs The works of Porogan (2000) and Carillo and Li (2002) are

examples of such complementary analysis The model is a bilateral trade model and in

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its most rudimentary form relates the trade between two countries to their national incomes and the geographical distance between them Mathematically, it is

represented as:

) , ,

where

TFij= Trade flow between country i and country j

GDij= Geographical distance between country i and country j

The model in its crudest form tells us that trade between two countries (regions) is directly related to the countries' national income and inversely related to their

geographical distance (Carillo and Li, 2002) Though the model was developed in the early 1960s, its application to the study of RTAs became popular following Krugman's (1991) study in which he posits that geography (proximity) plays a role in the decision

to forming RTAs He shows how proximity can lead to agglomeration of production

to a given region and in the process biasing trade to that region by promoting a

regional integrating area (RIA) Despite its simplicity and intuitive nature the Gravity model have come under heavy criticisms Baldwin (1994) and Leamer (1994)

criticized the model on grounds that it lacks a theoretical foundation This criticism did not hold its ground for long given some of the assumptions made by studies employing the model to show how proximity, amongst other explanatory variables, influence decisions on regional integration Perhaps Anderson (1979) best addressed the lack in 'theoretical foundation' criticism in a derivation of the model from trade theory Other works including Deardorff (1998), Eaton & Kortum (1997), and

Helpman & Krugman (1985) derived the Gravity model from a Heckscher-Ohlin,

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Ricardian, and the 'New International Trade Theory' framework, respectively Carillo and Li (2002) also showed how a classification into differentiated and homogeneous product category (intra regional and intra-sub regional trade) had different impacts on trade flows between and within the LAIA, Andean Community, and MERCUSOR, dispelling of the 'theoretical foundations' criticism

Other criticisms of the model are technical in nature and allude to issues of

mis-specification of the equation by way of the explanatory variables, the concerns of spatial dependence (caused by spatial aggregation and externalities) and

heteroskedasticity (Anselin, 1998) Despite the valid concerns of these criticisms it is evident that econometric tools exist for dealing with them Porogon (2000) points out that Spatial Econometrics technique deals with the spatial dependence problem Other criticisms relates to the argument by some, for example Evernett & Keller (1998) that the success of the model depended on its assumption of IRS production technique outside of which it becomes less successful The application of the model by Carillo and Li (2002) under a differentiated and homogeneous product classification has proved otherwise This is shown by level of significance on the exporter GDP

coefficient of the homogeneous product category

Despite the empirical robustness and intuitive attribute of the Gravity model other more dynamic models have come to be appreciated given their prediction power As mentioned earlier the GTAP in its variant forms is an example of such dynamic model

capable of making a case for or against RTAs, ex ante Perhaps this and its 'shocking'

capability made it so popular Other advantages of GTAP include the broad

familiarity with and transparency of its database It is also very much aligned with

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classical theory given its assumptions of CRS and perfect competition; although it

allows for imperfect competition by way of fragmentation in production (Y ang, 1998)

2.2 FEATURES of the GTAP Model

The GTAP, established in a comity effort in 1992, was motivated primarily by the

increasing level of global integration made possible by the 'Rounds' of trade

negotiations of the GATT/WTO10 The comity ef fort to the creation of the GTAP

database has made quantitative analyses and assessments of RTAs and

country-specific trade policies easier Adams (1998), for example, making use of the GTAP database through an Applied General Equilibrium (AGE) analysis was able to show how liberalization of APEC's trade would not only affect macro variables in the APEC region but on the ROW as well He showed that liberalization in the APEC region

would have a positive effect on intra- exports and imports along with impr ovement in the Real GDP (both at market prices and factor costs) but a negative effect on the same variables in the ROW The effects of liberalization on variables such as the rental

rates of capital, the terms of trade, and real exchange rates were less uniform within the region, with some members enjoying positive gains while others exhibited losses The ROW, however, exhibited losses on all counts, though to varying degrees11 From the above simulation findings it becomes evident why CGE models to trade analyses is robust Depending on the interests of the modeler, various macro variables and how they are affected by a reduction or elimination in tariffs can be captured A

comparison to the Gravity model, for example, will reveal that the Gravity model

10 See Hertel's 'Global Trade Analysis' (1997) for more details on the originality and inspiration for the GTAP model

11

The changes (effects) from liberalisation are often stated as 'equivalent variation' following the shocks

to the initial (base) values

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would be less encompassing given the potential econometric problem with increasing the number of explanatory variables in a multiple-regression model This is of no concern under a CGE model and it is beneficial in that it provides for a broader

overview

Despite the advantages of the CGE models, they are not free of problems The

Michigan model, for example, has been criticized for its understatement of the

importance of the terms of trade effects along with problems of unsatisfactory 'closure rules'12 of the model Both the GTAP and Michigan model can also be criticized on their sole focus on merchandise trade Winter (1987) pointe d out this criticism on the Michigan model arguing that it provides for possible abstraction from trade and

investment in services, and international assets transactions The assumption of low substitution elasticities between imports and domestic output can have an

overestimation effect on trade following tariff elimination or reduction In comparison

to the Gravity model it is also evident that the GTAP or Michigan model is excessively theory based with a single period of relevant empirical data In that regard, the Gravity model probably is a better policy-based model than both the GTAP and Michigan model

CGE modeling is arguably dynamic and as pointed out earlier it can be very telling given the number of macro variables one chooses to include in the model, that is, the number of variables and equations in the model However one should be cautious lest

12 The Closure Rules concerns the method that is chosen to determine aggregate expenditure in a CGE model For example a model with x variables and y equations, where x>y, can be 'closed' by specifying

x - y variables as exogenous That is declaring them as constants Note these x - y variables can be

subjected to shocking as well See Deardorff and Stern's book Computational Analysis of Global Trading Arrangements (1990) for more details on 'Closure' in the Michigan Model and Hertel's Global Trade Analysis (1997) for more details on 'Closure' in the GTAP Model

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be led into believing that because of its dynamic nature all is right This is not only limited to the CGE models but the static ones as well Given this caveat, care needs to exercised when analyzing effects of RTAs, be it a FTA, CU, Common Market, or an Economic Union Mayes (1997) provides a list of warnings in evaluating economic impacts resulting from economic integration These include:

(1) The avoidance of treating quotas and other Non-Tariff Barriers (NTBs) as tariffs

by quantifying them as tariff equivalents He points out that this is wrong given that the beneficiary to tariff revenue is the importing country whereas the

beneficiary to the revenue from imposing quotas and other NTBs is the exporting country, except where the quota is auctioned

(2) The practice of not accounting for the complex array of income and substitution effects resulting from price changes following tariff elimination or reduction (3) The need for awareness that changes in prices can result from efficiency in

production, thus real changes, whereas tariffs are transfers and therefore have no real effects Note, however, that changes in prices can also be inflationary in nature

(4) The limitation to a before and after approach can be misleading with biased

findings For example, in evaluating the effects to forming an RTA (CU) one might be tempted to attribute all 'equivalent variations' following the RTA

formation to the tariff elimination This may not be the case given that there are other factors that could also be causes to the price changes Prices can change (fall) because of economies of scale that result from an expanded market but prices can also change because of a more competitive transport industry, be it shipping, airfreight, or trucking services

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(5) The issue of constancy in parameters is also noteworthy He warns that even if economies of scale and efficiency effects take place following integration it will not only be the explanatory variables that will change but the parameters as well Therefore it is incorrect to use the results of a model estimated in a period with integration to suggest what would have happened in the counterfactual

He points out further that the best model is highly simplified with simple assumptions

He argues that "…one of the stages in the argument is usually left out and, instead of comparing what the model predicts with integration to what it predicts without

integration, authors tend to compare actual behavior with what would have happened without integration attributing all differences to the effects of integration (p 77) I assume that in the above quote 'actual behavior' is synonymous to 'with integration.' All the above caveats just go to point out that models in themselves alone are

necessary but not sufficient in effecting a complete analysis of potential RTA benefits and costs To that regard, the proposed China-ASEAN FTA (CAFTA) will employ a two-tier complementary approach

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3 RESEARCH METHODOLOGY

The preceding introductory and overview chapters of this study gives a clear indication

of what the underlying thesis question plans to answer There are different

possibilities of going about this task but regardless of methodolo gy adopted one would either end up employing static or dynamic analysis or a combination of both The strength and weaknesses of both analyses has already been alluded to in the preceding chapters Static analysis has the added advantage of been dependent on empirical data but lack the dynamism necessary to make forecasts Dynamic analysis on the other hand has a predictive power capability but may only make use of one periodic

historical data and in that regard does not reflect substantial empirical data This advantage and disadvantage of both analyses type made it necessary for me to employ both in evaluating the economic prospects of the proposed CAFTA

First I carry out a historical analys is of the trade statistics of the CAFTA members using Balass a's relative comparative advantage index (RCAI) This analysis is static and makes use of five years trade statistics, 1996-2000 The analysis is an attempt to point out the comparative advantage and level of competitiveness in the top 5 traded commodities of the CAFTA economies and in the process evaluate whether their comparative advantages and competitiveness in the goods traded, both within and outside the proposed RTA, are in direct competition or in complement to each other The trade statistic figures are derived from the UNCTAD/WTO database of the

International Trade Center13 (ITC) and all reported figures are in the Standard

13

The URL for this site is www.intracen.org/tradstat/welcome.htm

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International Trade Classification 3 scheme (SITC3) The details of this analysis are expounded upon in chapter 5

Second a dynamic analysis using the Gravity model is undertaken The Gravity model

to be estimated will make use of trade data for the periods 1996-2000 This is essential for analytical conformity Trade data from the International Trade Statistics and Direction of Trade Statistics will be used Estimation of the Gravity Model14 will be either through Ordinary Least Squares (OLS) or Censored/Truncated (Tobit)

estimation The details of the Gravity model are provided in chapter 6

The results of the static and dynamic analyses are used in a complementary framework

to make a case for the economic prospect of the proposed free trade area The static analysis will address the empirical aspect of the analyses The revelation of

complementarity or competition in production and trade from the RCAI analysis will

be of interest to making a case for or against CAFTA The dynamic analysis part will provide some grounds as to what the future holds for the proposed China ASEAN FTA That the proposed FTA is to take ef fect in 2010 makes this aspect of the

analyses very important Besides making projections, it will tell us the effect CAFTA can have on some of the members of the Multilateral Trade System This revelation will be paramount especially in the context of t he WTO The welfare implications on the integrating economies will also be evaluated and claims that the proposed area will lead to an economic region with trade value of US$1.23 trillion will be assessed

14 It is argued that OLS is the best estimation technique for the Gravity model but Tobit has been proved

to be more robust under missing or no trade flow data between countries

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Albeit it's ambitious nature, a regional integration area of this magnitude must first start with an overview of the macro economic variables of the proposed integrating

economies This economic overview is what the next chapter is concerned with

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