The future of asean economic integration

In Asia, one of the regions with a potential bright future for strong regional economic integration is ASEAN with its ASEAN Free Trade Area AFTA, which completed its 0 percent tariff rate

THE FUTURE

OF THE ASEAN

ECONOMIC INTEGRATION

Kiki Verico

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The Future of the ASEAN Economic Integration

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The Future of the ASEAN Economic

Integration

ISBN 978-1-137-59612-3 ISBN 978-1-137-59613-0 (eBook)

DOI 10.1057/978-1-137-59613-0

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Kiki Verico

Th e Institute for Economic and Social Research (LPEM),

Faculty of Economics and Business ,

University of Indonesia ,

Jakarta , Indonesia

In memory of my late father, Ma’as Sary (1943–1988) You have always been my inspiration

To my mother, Nahdiar Ma’as,

Without you none of this would be possible

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Empirical experiences from the European Union’s (EU) economic integration, which has been adopted as theory in regional economic integration studies, show that neighboring countries within a region can achieve economic integration having undergone phases from trade (Free Trade Area/FTA) to investment ( Custom Union and Common Market ) before fi nally achieving fi nancial integration (Single Monetary Union and a Single Currency) Th is theory was fi rst proposed by Jacob Viner in

1950 and continued by Bela Balassa in 1961 who argues that this process requires formal institutionalization at the regional level

Southeast Asian countries have a similar formal institution at regional level, ASEAN (Association of Southeast Asian Nations) , established in

1967 Currently ASEAN’s commitment is to transform Southeast Asia ’s economic integration from free fl ows of goods (FTA) to that of invest-ment, services, and capital at the end of 2015 and afterwards named the ASEAN Economic Community (AEC) Th e center point of this regional economic integration process is intra-regional trade, which connects both trade and investment at the regional level Intra-regional trade is created

by ASEAN Free Trade Area (AFTA) and in turn aff ects long-term ment and free fl ows of people Th e latter is part of the AEC It is, there-fore, essential to observe the impact of AFTA on intra-regional trade and further the impact of intra-regional trade on the long-term investment infl ows ( Foreign Direct Investments/FDI )

Pref ace

Historical perspectives prove that ASEAN’s economic integration process has been largely infl uenced by the international dynamic situ-ation, which includes, for example, the end of the Vietnam War, which led to the fi rst ASEAN summit taking place in 1976, almost ten years after ASEAN’s establishment in 1967 ASEAN commitments on AFTA

in 1992 had been decided just after the end of the Cold War in 1989

Th e ASEAN enlargement to the APT was also aff ected by the dynamic changes aff ecting the ‘Greater East Asian’ ( Bowles and MacLean 1996) region after China adopted a market economy, joined the WTO, and became one of the largest economic entities, in terms of nominal GDP,

in the world To some extent, ASEAN needs external factors to stimulate its internal reform and cooperation

Given its open regionalism, which contrasts with that of the EU’s closed regionalism, ASEAN has several other economic cooperations that involve its members, such as direct bilateral trade agreements between members and non-members of ASEAN; sub-regional economic cooperation which involves limited member states of ASEAN; then regional cooperation involving ASEAN members as well as regional-plus which incorporates all ASEAN members with non-members under the so called “ ASEAN umbrella ” Th is study attempts to analyze the impacts of bilateral, sub-regional, and regional economic cooperation to investment (FDI infl ows)

Th is objective is essential for ASEAN if it is to shift its economic tion from trade to investment As for the regional- plus framework, this study will analyze the impact on not only shifting ASEAN’s economic inte-gration from trade to investment but also the impact from investment to

fi nancial integration afterwards In sum, this study will discuss all relevant arrangements of economic cooperation that could integrate trade, invest-ment, and fi nancial aspects in Southeast Asia from various level of coop-erations of bilateral, sub-regional, regional, and regional plus frameworks

ASEAN in Descriptive Data View

Data of the World Trade Organization (WTO) in 2006 show that Asian regional trade depends more on the Asian region itself than from any other region Th is can be seen through Asia’s intra export in which 50 percent

of their export in 2006 went to Europe, while Latin America depends more on North America with 31.4 percent of their export going to North America Meanwhile the Middle East depends more on the Asian mar-ket with 52.6 percent of their exports in 2006 going to Asia Naturally, most of the region’s countries rely on their trade activities to their own region given the closer distance, lower cost in trade-related services such

as export import insurance and transportation cost, as well as similarities

in demand factors within countries in the region

In Asia, one of the regions with a potential bright future for strong regional economic integration is ASEAN with its ASEAN Free Trade Area (AFTA), which completed its 0 percent tariff rates among members

in 2015 and will enter the economic community afterwards Given this,

it is essential to understand the potential capacity of AFTA in terms of enhancing trade liberalization and its connection to investment creation According to Table P.1 in terms of trade Asia depends more on its region Historically in Asia, Southeast Asian countries have good trade relations with East Asian countries Th ey both are very close to each other and have had a long history of interdependent relations

Regional economic integration can promote FDI infl ows and nomic development in individual countries of the region ( Aggarwal , 2008) Th erefore, the role of FDI infl ows becomes important to see the connectivity between ASEAN and East Asian countries Th is is useful

eco-to assess potential interconnection between Southeast and East Asian countries From a historical perspective, Japan, China, and South Korea have played an important role in promoting Southeast Asia economic networks Japan established a Regional Production Network (RPN) in Southeast Asia to produce automotive and electronic products in several ASEAN countries in the 1930s ( Akamatsu 1944; Kojima 1978; Urata 1993) China had Guanxi , a traditional business network within ethnic

Chinese in Southeast Asia ( Wang 2001) Th is network is also known as

ECBN ( Ethnic Chinese Business Network ) and works based on trust and usually avoids formal agreements between them China holds a non- formal yet solid business network in Southeast Asia ( Peng 2002) A regional production network producing fi nal goods has been established between South Korea and Southeast Asian countries South Korea estab-lished production networks in Southeast Asia originally in Cambodia, Laos, Myanmar, Vietnam (also referred to as CLMV), and Th ailand, then to other Southeast Asian countries (Cheong 2011) Korea’s largest trading partners in Southeast Asia are the ASEAN-6, ASEAN’s found-ing members with the largest share starting from Singapore, Indonesia, Malaysia, Th ailand, and Philippines; while among the ASEAN-4, which are its CLMV members, the largest Korean trading partner is Vietnam Korea’s exports to ASEAN are mostly of heavy industry, chemical prod-ucts, and light industries while Korean’s dominant imports from ASEAN are primary products, raw materials, and energy sources

China, Japan, and South Korea play important roles in promoting and enhancing production networks between East Asia and other Asian coun-tries especially Southeast Asian countries Global production networks (GPN) in Asia have promoted more intermediate goods transaction than that of consumption and capital goods China, Japan, and South Korea are among the largest FDI investors in Southeast Asia Th is economic cooperation has been stimulated by market-driven factors that are crucial

in helping ASEAN to move from intra-regional trade to investment gration and fi nally to fi nancial integration

Bowles and MacLean (1996) argue that East Asia shows increasing interest in Southeast Asia in particular on regional trade and invest-ment Th is makes the ASEAN+3 (APT of ASEAN and China, Japan,

& South Korea) compose economic integration of advanced ogy products from Japan and South Korea, skilled-labor intensive from China, and labor-intensive products from ASEAN Enhanced relations between intra-regional trade and direct long-term investment infl ows are the key success factor for the establishment of further compact economic integration

ASEAN needs external countries that have the potential to become member states starting from its FTA such as the ASEAN+1 FTA then to become part of the economic community , common market, and fi nally,

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Preface xi

fi nancial integration Why? Take for instance the indicator of the annual GNI/capita (US$) the convergence of which is one of the most important long-term issues in ASEAN Unlike the EU, which has high-income coun-tries in terms of GNP per capita, with a large size in terms of proportion

of population and value added, ASEAN’s high-income country members such as Singapore and Brunei are small in terms of size (GDP and popula-tion) yet a large-population-sized country, Indonesia, is not a high-income country Th erefore, ASEAN’s power is not at the center, but appears more like a “doughnut-shape” without a single country playing as the center of power Details in GNI per capita of ASEAN members are described in Fig P.1 (Appendix) Open and soft regionalism principles help ASEAN

to enlarge its economic cooperation to other countries Th is will be a very important factor for achieving economic convergence in Southeast Asia ASEAN has member states with varying economic levels Th ey come from diff erent GNI per capita levels For instance, Singapore and Brunei are classifi ed as high income countries (above US$ 12,736 per capita per year), while Malaysia and Th ailand are upper-middle-income countries (between US$ 4,125 and US$ 12,736 per capita per year) and Indonesia, Philippines, Vietnam, Laos, and Myanmar are lower-middle-income countries (between US$ 1,045 and US$ 4,125) while Cambodia is clas-sifi ed as a low-income country ASEAN’s economic divergence is, there-fore, higher than the EU-27, which consists of only two income groups with the majority in high income and only one country with upper-middle- income status Th is high economic convergence explains why the EU has strong economic integration and fi t with legally binding and closed regional integration choice Th e EU has a level playing fi eld within its members and this helps the EU to attain a high level of intra-regional trade share compared with other regions

Economic divergence in ASEAN is not only seen in the GNI per capita per year gap but also in the proportion of each member state’s economic size both in terms of value (GDP) and population to ASEAN’s total of these factors Th is indicator shows that high income countries such as Singapore and Brunei are actually small in terms of size while a lower-middle-income country such as Indonesia is big in terms of size Illustration of the size of GDP and population of ASEAN members can

be seen in Fig P.2 (Appendix)

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Th is fi gure shows that Indonesia is the biggest country in ASEAN in terms of size (GDP and population) It contributes up to 36 percent

of ASEAN’s GDP and its population proportion of the total ASEAN population is also large at 41 percent Th erefore, if we compare Indonesia’s contribution in the ASEAN economy to Indonesia’s contribution on ASEAN population, we can notice that Indonesia’s productivity is smaller (0.88) compared to Singapore (14.16)

Each member state’s productivity rank is similar to that in the Human Development Index (HDI) rank Take, for instance, 2014 where Singapore (world rank 9) and Brunei (rank 30) have very high HDI while Malaysia (rank 62) and Th ailand (rank 89) have high HDI Indonesia (rank 108), Philippines (rank 117), Vietnam (rank 121) and Laos (rank 139) have medium HDI classifi cations In terms of GNI per capita, interestingly Myanmar (lower- middle) is better than Cambodia (low) but in terms of HDI, Cambodia (medium level at rank 136) is ranked higher than Myanmar (low level at rank 150) For the case of Myanmar and Cambodia, a better HDI does not mean a better GNI per capita But the improvement of HDI will improve the level of GNI per capita since

it is connected to productivity and the increasing of value added

Figures P.1 and P.2 (Appendix) show that high and upper-middle income member states of ASEAN have a higher contribution proportion for GDP to total GDP than that of their population contribution For example, in 2014, Singapore’s GDP to total ASEAN GDP was 12 percent while her population to total ASEAN population was only 1 percent Brunei’s GDP to total ASEAN GDP was 1 percent while her popula-tion only contributes 0.5 percent Upper-middle-income countries such

as Malaysia and Th ailand also contribute higher percentage of GDP to total ASEAN GDP than their population percentage to total ASEAN population, while for lower-middle-income countries such as Indonesia, Philippines, Vietnam, Laos, Myanmar, and Cambodia contribute a higher proportion in population than in GDP

If ASEAN’s GDP and population data are compared to that of global level data, we can see that in 2014, ASEAN’s population and GDP share

to the world are 9 percent and 3 percent respectively If we were to take ASEAN+3 (ASEAN plus China, Japan, and South Korea) instead, these proportions (compared to total global fi gures) would be 30 percent and

Preface xiii

24 percent respectively While ASEAN+6 (ASEAN+3 plus Australia, New Zealand, and India) would represent 48 percent and 29 percent of the global GDP and population Th is means that with the ASEAN+6 framework, the contribution towards population increases from 30 per-cent to 48 percent which is more than the increasing in its GDP share from 24 percent to 29 percent Th is is indicating that ASEAN+3 is a

‘more productive’ framework than the ASEAN+6

In term of ASEAN+3, ASEAN’s integration index, based on author’s calculation, is signifi cantly aff ected by Japan then South Korea and recently by China Japan established a regional production network that offi cially integrates the Southeast Asian market both in the produc-tion and trade as South Korea has with Th ailand and Cambodia, Laos, Myanmar, and Vietnam, and Chinese which are known as non-formal trading networks and recently are formal investment networks

Due to such gaps in macroeconomic performance and the mismatch between economic value and size, ASEAN’s economic cooperation is fragile Unlike the EU, the macroeconomic gaps among the ASEAN member economies unfortunately create a ‘non-single dominant power’ within the region Member states with strong economic performance are not large countries in terms of population size or area Th e EU has Germany which is classifi ed as a rich country with a large population and geographic space Th e richest ASEAN member state on the other hand is not its largest country whereas its largest country is not the richest mem-ber state, making some scholars, as mentioned earlier, liken ASEAN’s economic power to a doughnut, which has a hollow middle, as ASEAN has no single central power

In terms of GNI per capita (current US$), in ASEAN, only Singapore and Brunei have been classifi ed as high income countries while in term of GDP size (current US$) only Indonesia has become a member of the G20

In terms of economic growth, the author’s calculation using World Bank data, shows that the recent (2013–2014) economic growth of ASEAN was

at 4.3 percent, with ASEAN+3 at 3.7 percent and ASEAN+6 at 4 percent, all of which are higher than the global economic growth at 2.5 percent Data show that in terms of contribution to the world’s economic growth, the more countries involved in a grouping the greater their con-tribution regardless of whether positive (pulling up the world’s economic

growth) or negative (pulling down the world’s economic growth) Th e highest contribution to the world economic growth is from the framework

of the ASEAN+6 at 42 percent, the ASEAN+3 at 32 percent and ASEAN

at 4 percent Th is proportion order is similar to their contribution to the World’s GDP of which ASEAN+6 was 29 percent, ASEAN+3 was 24 percent and ASEAN was 3 percent respectively

Germany is the largest country in the EU in terms of economic size (GDP) and population and has a high income level while ASEAN does not have member states that are both large and rich ASEAN still has the potential to achieve what the EU has completed in its comprehen-sive regional economic integration process Following this enthusiasm,

in the future ASEAN may achieve both real sector and monetary tor integration Th e fi rst option is for Indonesia, with the highest size of GDP and population in ASEAN, to achieve high-income level, given that rich countries cannot increase their size to be big but it is possible for a big country to become rich in the future Fulfi lling this condition could assist ASEAN to have strong leadership Th e second option would be for ASEAN to utilize the ASEAN-PLUS frameworks such as the ASEAN+ FTA, ASEAN+3, ASEAN+6, and so on, as well as optimizing its sub- regional economic role

In line with the ASEAN-PLUS frameworks, ASEAN promotes an

‘open-regionalism’ principle to attract investment creation (FDI infl ows)

in Southeast Asia from non ASEAN member states Th is involves at least two stages: fi rst, to have trade liberalization among member states in order to increase intra-regional trade then to use it to attract FDI infl ows from non-member states to Southeast Asia Horizontal FDI infl ows from non- member states will increase when trade costs of being excluded are high which then motivates the non-member state to change its trade preference into investing into a member state Other reasons include the fact that the non-member state gains trade benefi ts from the region such

as collecting trade account surplus and enlarging market access, which also motivates it to invest FDI and produce its products locally Th is strategy will also reduce transportation costs Th ese non-member state investors invest their surplus current account back into the region in order to fulfi ll the region’s domestic demand, to reduce service-link costs (shipping, insurance, custom clearance, other administrative and local

Preface xv

transportation cost), to avoid currency volatility costs, transaction costs

of trade, and to increase benefi ts from the investment (FDI) itself

Th e enlargement of ASEAN’s economic integration to include East Asian countries such as Japan and China is important for at least two main reasons: (1) ASEAN had started enhancing her tight economic cooperation with East Asian countries (China, Japan, and South Korea) via trade, investment, and fi nance due to the Asian Financial Crises in late 1990s (2) ASEAN has a very long history and strong trade relations with East Asian countries over centuries (3) ASEAN depends on invest-ments fl owing in (FDI) from Asian countries in particular the East Asian region Th is is because some potential FDI source countries worry about

“hollowing out” risks Th is hollowing-out at fi rst comes from the cern of the EU that related to her plan on “the enlargement of EU from Western to the Eastern part of Europe.” Th e hollowing-out assumption made the EU concerned about the risk of investing outside the European region, therefore, the EU prefers to invest in Europe especially given the recent enlargement to Eastern Europe

Western European FDI investors believe if they invest (FDI) outside the region, for example, in Asia, that direct investment will remove their production network from Europe to Asia, which will generate unem-ployment in Europe Regarding the EU’s plan to enlarge its membership towards the eastern part of Europe, which are basically countries that need FDI infl ows and off er low cost production process compared to producing in West Europe, the EU prefers to invest in Eastern Europe rather than in countries outside Europe, such as Asia including Southeast Asia , Africa, South or Latin America Th is explains why Asia depends

on its long-term investment (FDI) infl ows from advanced economic countries such as Japan, China, and South Korea Last, but not least, the enlargement of ASEAN economic cooperation to East Asia countries was more reasonable because regional economic integration in East Asia

is much better than that in Central Asia, South Asia and Pacifi c (ADB, 2010) Since both Japan and China invest in Southeast Asia in the manu-facturing sector and considering that AFTA is applied in that sector, this chapter will focus on the manufacturing sector

Verico’s (2013a) study shows that, prior to Southeast Asia ’s economic crises that started at the end of 1997, average FDI infl ows in ASEAN was

7.7 percent of the World’s total FDI infl ows (1995–1997) yet this share dropped to 3.14 percent in 1998 and constantly decreased until 2000

Th e average FDI infl ows decreased to 2.5 percent (1998–2000) FDI infl ows in ASEAN started to increase in 2001 and constantly increased

up to 2005 Average FDI infl ows in ASEAN reached 3.79 percent of the total World’s FDI infl ows Even now average FDI infl ows in ASEAN are lower than that before the 1997 Asian economic crises, but the level has been increasing Decreasing FDI infl ows due to Asian fi nancial crises in 1997–1998 not only reduced FDI infl ows in Southeast Asia but also in East Asia Th is proves that both regions are interconnected Detailed fi g-ures are shown in Table P.2 (Appendix)

Since 2000, FDI infl ows in the developed countries of North America and the EU decreased while FDI infl ows in developing countries such as Southeast Asia and Latin America increased (see Table P.2) Th is refl ects the movement of production- based networks from developed to devel-oping countries, including in Southeast Asia Increasing FDI infl ows supports ASEAN’s objective of having an economic community since it needs long-term investment and the fi gures above shows that integration

of East Asia and Southeast Asia gives signifi cant impact to both regions

Th ese regions receive around 22 percent of total world’s FDI infl ows Data on FDI infl ows to ASEAN countries (from 1995 to 2014) shows that Singapore has been the largest host country of FDI infl ows

in Southeast Asia followed by Indonesia In addition to huge diff erences

in terms of percentage of FDI infl ows to total FDI infl ows in ASEAN, the FDI infl ows trend has never become negative while FDI infl ows in Indonesia experienced a negative value due to capital outfl owing from non-residents between 1998 and 2002 Th ailand follows as the third largest receiver of FDI infl ows after Singapore and Indonesia In 2014 the biggest FDI infl ows recipients in ASEAN are Singapore, Indonesia,

Th ailand, Malaysia, Vietnam, and Philippines Th e proportion of FDI infl ows between Singapore and other ASEAN members are enormous as Singapore for instance in 2014 received 51 percent of Total FDI infl ows while other 49 percent went to other member states Detailed fi gures are presented in Table P.3 (Appendix)

Verico’s (2013a) study found that the majority of FDI infl ows by source (home) country to ASEAN come from the EU, Japan, USA, and

fi gure represents a long-term economic connection between ASEAN members and their long-term investors

In terms of proportion, ASEAN intra-investment is around a half of ASEAN intra-regional trade In 2014 intra-ASEAN trade is estimated

at around 24 percent with intra-ASEAN investment around 17.9 cent On the other hand, ASEAN in terms of trade and investment still depends on external non-members or on inter-regional trade and inter- regional investment at around 76 percent and 82.1 percent A detailed description is in Table P.4 (Appendix)

per-Both intra-ASEAN investment and extra-ASEAN investment are still dominantly held by the ASEAN-6 (Brunei, Indonesia, Malaysia, Philippines, Singapore, and Th ailand) at around 88.8 percent of intra- investment and 91 percent of extra-investment than those obtained by ASEAN-4 (Cambodia, Laos, Myanmar, and Vietnam) at around 11.2 per-cent for intra-ASEAN investment and 9 percent for extra-ASEAN invest-ment At the country level, the largest proportion of intra- investment

is obtained by Indonesia at around 55.2 percent while the largest portion of extra-investment is received by Singapore at 60.4 percent At the country level, in 2014, intra-ASEAN investment was dominated by Myanmar at 72.2 percent of total FDI infl ows and Indonesia at 60.4 percent As for the extra-ASEAN investment, Philippines, Th ailand, and Singapore, all gain more than 93 percent of their FDI infl ows from ASEAN’s non-member states

As for disaggregation of FDI infl ows at sectoral level, Plummer and Cheong (2008) use specifi c data on FDI infl ows by sector based on source country Th ese data show a diff erent pattern for each ASEAN and selected countries Th e majority of FDI infl ows from Japan to ASEAN countries were in the manufacturing sector Th e majority of FDI infl ows from USA to ASEAN were in the fi nancial sector (28.5 percent), fol-lowed by the manufacturing sector (23.11 percent) and commerce (10.24 percent) Th e majority of FDI infl ows from the EU to ASEAN were in

the manufacturing sector (33.13 percent), followed by the fi nancial tor (26.28 percent) and mining/quarrying (13.01 percent) For ASEAN member states, such as Indonesia, its majority FDI infl ows in ASEAN were placed in the real estate sector (71 percent), while for Singapore the majority is in the manufacturing sector (52.97 percent), for Th ailand in the fi nancial sector (39.29 percent) and Malaysia in the real estate sector (41.14 percent)

At the regional level with its ASEAN FTA, ASEAN has two tives, one is to increase intra-regional trade Th is is a direct objective of AFTA Another is to attract FDI infl ows Th is is seen as an indirect objec-tive of AFTA ASEAN has several agreements to attract FDI infl ows and these hold the direct objective of increasing FDI infl ows in Southeast Asia Aside from the expected positive impact of intra-regional trade to FDI infl ows, there is a fi nding showing that intra-regional trade can have

objec-a negobjec-ative impobjec-act on FDI infl ows due to the disincentive to hobjec-ave term investment to ASEAN by non-member states Th e higher propor-tion of FDI infl ows from non-member states than from member states can generate signifi cant impact on ASEAN’s FDI infl ows One of the factors is the existence of trade defl ection in typical FTA as it does not harmonize the external tariff rate from members to non-members Th is weakens discriminative trade arrangements and provides less incentive for non-member FDI investors to change their strategy from doing trade to putting long-term investment in the member countries ( Verico , 2013a)

Th e positive impact of AFTA on intra-regional trade indicates high trade creation while negative impact of intra-regional trade on FDI infl ows in the manufacturing sector indicates low trade diversion impact and the existence of trade defl ection in Southeast Asia Th is circumstance will stimulate more FDI infl ows from ASEAN member states than non- ASEAN member states starting from comprehensive implementation of AFTA by the founding members in 1999

Th e share of ASEAN intra-regional trade by the observed countries of Indonesia, Malaysia, Philippines, and Th ailand can be seen in Fig P.3 (Appendix) Th is fi gure shows that Indonesia has the highest proportion followed by Malaysia, Th ailand, and Philippines Th is is the proportion of each observed member’s intra-ASEAN trade to total intra- ASEAN trade

Th e trend of intra-regional trade is increasing, but even at the current

Th e crises signifi cantly aff ected FDI infl ows in Indonesia, the FDI infl ows had been negative due to capital outfl owing from non-residents during the crises Verico’s (2013a) study found that average FDI infl ows

in Southeast Asia from non-member states is higher than that from ber states except in 1991 and 2002 Th is can be related to the regional economic progress by which 1991 was only one year before formal sign-ing of AFTA while 2002 was offi cial implementation of 5 percent tariff of CEPT ( Common Eff ective Preferential Tariff ) for ASEAN-6 (Indonesia, Malaysia, Th ailand, Singapore, Philippines, and Brunei Darussalam)

mem-Th e percentage of FDI infl ows from ASEAN to ASEAN to total FDI infl ows in ASEAN has increased since year 2002 In general FDI infl ows

in Southeast Asia were decreasing in the period 1998 to 2002 due to negative FDI infl ows (capital out fl ows from non-residents) due to the economic crises Th is fi gure confi rmed the existence of the J-curve—it took about a 5-year period for the negative impact of the economic crises

to change to a positive result in Southeast Asia

Figure P.4 (Appendix) describes the FDI infl ows (million US$) in Indonesia, Malaysia, Philippines, and Th ailand Based on the latest data (2014), FDI infl ows to Indonesia hold the highest value followed

by Th ailand, Malaysia, and Philippines Th ailand experienced a slowing down of FDI infl ows due to a fl ooding natural disaster in the period

2010 to 2011 In the last fi ve years, Malaysia has shown relatively stable FDI infl ows and Philippines shows a persistent positive trend Th is indi-cates Philippines is getting more attractive for FDI infl ows and this helps ASEAN to attain economic convergence in the region through the estab-lishment of a solid network of investment

Th is book has benefi ted from academic wisdom, guidance, and support received throughout my early academic career in the fi eld of regional economic integration which I started more than ten years ago at the Asia- Europe Institute University of Malaya in collaboration with Universidad Autonoma de Madrid Later I continued my academic journey in this same fi eld at the Graduate School of Asia-Pacifi c Studies at Waseda University Th erefore, I am indebted to the late Professor D Fernando Rodrigo Rodriguez and Professor Shujiro Urata for their priceless insights and also Professor Nobuhiko Fuwa for his valuable views

I would also like to thank the excellent editors, Amber Husain and Laura Pacey at Palgrave Macmillan, for their tireless work in seeing this book to publication

Finally, I owe a special thank you to my mother and in-laws, Ama, Bunda, and Abah, who have been a constant source of support and com-fort In particular, I am eternally grateful to my beloved wife, Liza, for her unconditional love, great patience, and relentless support, in particular the extensive feedback she provided on an earlier draft of this book Last but not least, to my son, Omar, who was enlisted without consent, to my academic journey I couldn’t have asked for better company

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Contents

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2.3.4 ASEAN Free Trade Area (AFTA):

Historical Approach 52 2.3.5 ASEAN Free Trade Area (AFTA):

Political-Economy Approach 58 2.3.6 Th eory of Comprehensive Regional Integration 62 2.3.7 Overview: Comprehensive Regional Economic

of Seemingly Unrelated Regressions Estimator

2.5.3 Econometric Analysis: System Analysis

of Simultaneous Equation Models Estimator (SEME) for AFTA 97

2.6.1 Th e Impact of AFTA and Intra-regional Trade

on Aggregate FDI Infl ows (Investment Creation): Non-system Equations of Panel Data 97 2.6.2 Th e Impact of AFTA and Intra-regional Trade

to Aggregate FDI Infl ows (Investment Creation): System Equations of SURE and 3SLS (SEME)

Contents xxv

4 Th e Impact of the International Tripartite Rubber

Organization (ITRO): Sub-Regional Level Analysis 145

4.3 Literature Review 149 4.3.1 Overview: ASEAN’s Sub-Regional Economic

4.3.2 History of Natural Rubber and the

International Tripartite Rubber Organization (ITRO) 151 4.3.3 Learning from European Economic Integration:

From the ECSC to Now 153 4.3.4 Oligopoly (Duopoly) Market Power

5.5.1 Regional Production Network of ASEAN:

Literature and Desk-Research 189 5.5.2 Th e Role of ASEAN+1 192 5.5.3 Unilateralism and Service-Sector Liberalization 194 5.5.4 Featuring: Indonesia’s 2015 Field

Survey of the AEC 199

7.1 Executive Summary for the Future

of ASEAN Economic Integration 229

1988–2014 247 Fig 1.1 Prisoner’s dilemma of developed and developing

Fig 1.2 Open regionalism in ASEAN in comparison to

Fig 4.4 Total quantity of trade between IMT and Non-IMT

compared to its Cournot-Nash equilibrium line 1988–2008 250 Fig 4.5 Rubber impact on Indonesia economy Input Output

List of Figures

Fig 4.6 Indonesia’s rubber market orientation 1988–2008 251 Fig 4.7 Illustration for the connection between CNE

(microeconomic analysis) and Indonesia’s I-O analysis

Table 1.1 Weighted average MFN and CEPT

manufactured goods in ASEAN (%) 2003 and 2007 235 Table 2.1 Selected variables, hypothesis, and

Table 3.1 BFTAs of fi ve ASEAN founding members

Table 3.2 Selected variables, hypothesis, and sources

Table 3.4 Quality rank of overall, infrastructure, and

customs Global Competitiveness Report

(2009–2010) logistics performance index and

Table 4.1 Selected variables, hypothesis, and sources of data

List of Tables

Table 4.2 Market proportion founding members

of ITRO (Indonesia, Malaysia, and Th ailand/IMT)

and the rest of exporters (Non-IMT) in tonnes 1988–2008 242 Table 4.3 Rubber impact on Indonesia economy input

Table 6.1 Stationarity test on pair infl ation rate

(CPI) of ASEAN-5 founding members and

East Asian countries (China, Japan, and Korea) 1988–2008 243 Table 6.2 Error correction mechanism pair infl ation

rate (CPI) of ASEAN-5 founding members and

East Asian countries (China, Japan, and Korea) 1988–2008 244 Table 6.3 Cointegration test on infl ation rate (CPI) of ASEAN-5

founding members and East Asian countries (China, Japan,

Table 6.4 Exchange rate and infl ation rate diff erence Yuan

China and all observed countries 1988–2008 245 Table 6.5 Relationship characters on exchange rate and

infl ation rate diff erence to trade relations 1988–2008 245

Model 2.1 Indirect impact of intra-regional trade

(trade creation) on FDI infl ows (investment creation)

and direct impact of AFTA on FDI infl ows 252 Model 2.2 Th e impact of intra-regional trade and FDI infl ows

in system equation models of Seemingly

Unrelated Regression Estimator (SURE) and Simultaneous

Model 3.1 AFTA, BFTA, and macroeconomic factors on FDI infl ows at

Model 3.2 Reduced form estimation on BFTA and

macroeconomic factors on FDI infl ows at country level 254 Model 4.1 Panel data (PLS) of the impact of ITRO

on FDI infl ows in natural rubber: sub-regional

economic agreement, case of IMT’s natural rubber (ITRO) 255

List of Models

ACFTA ASEAN China Free Trade Area

ADB Asian Development Bank

AEC ASEAN Economic Community

AETS Agreed Export Tonnage Scheme

AFAS ASEAN Framework Agreement on Services

AFTA ASEAN Free Trade Area

AIA ASEAN Investment Area

AIC ASEAN Industrial Complementary

AICO ASEAN Industrial Cooperation

AIJV ASEAN Industrial Joint Ventures

AIP ASEAN Industrial Project

ANRPC Asian Natural Rubber Producer Country

APEC Asia-Pacifi c Economic Cooperation

APT ASEAN Plus Th ree

APTA Asia-Pacifi c Trade Agreement

ARBC ASEAN Rubber Business Council

ARF ASEAN Regional Forum

ASC ASEAN Security Community

ASCC ASEAN Sociocultural Community

ASEAN Association of South East Asian Nations

ASEAN-4 ASEAN’s new members, Cambodia, Laos, Myanmar, and

Vietnam

xxxiv List of Abbreviations

ASEAN-6 ASEAN’s original members, Indonesia, Malaysia, Th ailand,

Philippines, Singapore, and Brunei ASP ASEAN Surveillance Process

BFTA Bilateral Free Trade Agreements

BIMP-AEGA Brunei, Indonesia, Malaysia and Philippines—East ASEAN

Growth Area CEPT Common Eff ective Preferential Tariff

CLMV Cambodia, Laos, Myanmar and Vietnam

CMSA Constant Market Share Analysis

CNE Cournot-Nash Equilibrium

COO Country of Origin

CU Custom Union

EC Economic Community

ECBN Ethnic Chinese Business Network

ECSC European Coal and Steel Community

EEC European Economic Community

EU European Union

FAO Food and Agriculture Organization

FDI Foreign Direct Investment

GDF Global Development Finance

IMF International Monetary Fund

IMT-GT Indonesia, Malaysia, and Th ailand – Growth Triangle INRA International Natural Rubber Agreements

IRCO International Rubber Cooperation

IRSG International Rubber Study Group

ITRO International Tripartite Rubber Organization

JAFTA Japan ASEAN FTA

KAFTA Korea ASEAN FTA

LAIA Latin American Integration Association

MFN Most Favored Nations

NAFTA North American Free Trade Agreement

PTA Preferential Trade Arrangement

RCA Revealed Comparative Advantage

ROO Rule of Origin

RPN Regional Production Network

RTA Rubber Trade Association

SC Single Currency

SGP Stability and Growth Pact

SIJORI Singapore – Johor, Malaysia – Riau, Indonesia

SM Single Market

SMS Supply Management Scheme

SMU/PU Single Monetary Union or Political Union

TAC Treaty of Amity and Cooperation

WDI World Development Indicator

WTO World Trade Organization

is beyond the scope of this study that has a regional-level focus.

These three levels of analysis will focus on the impact of various levels

of economic cooperation on Foreign Direct Investment (FDI) inflows The first analysis reviews the impact of ASEAN Free Trade Area’s (AFTA) regional economic cooperation The second analysis analyses the impact

of direct Bilateral Free Trade Agreements (BFTA) on FDI inflows This study will analyse BFTA at country level The third analysis discusses the Association of South East Asian Nations’ (ASEAN) sub-regional cooperation It adopts limited ASEAN member states’ cooperation on natural rubber products This study chooses natural rubber because

some Southeast Asian countries, in particular Thailand, Indonesia, and Malaysia, are the world’s main producers of natural rubber, which explains why natural rubber has been included among the top 11 priority products for the ASEAN Economic Community (AEC) 2015 to enhance trade and investment integration in Southeast Asia In order to conduct this analysis, this study will focus on the International Tripartite Rubber Organization (ITRO), which has control over 65 percent of production

on the world natural rubber market

All of these analyses at the regional, bilateral, and sub-regional level attempt to assess the impact of ASEAN’s trade arrangements towards its investment inflows This is both by theory and empirical evidence within the European Union (EU) context, the key success factor in achieving an economic community Since, from the end of 2015, ASEAN has been preparing its economic community, this study will also discuss the AEC.This study discusses the potential success factors for the AEC 2015 based on the implementation of ASEAN-PLUS Frameworks such as ASEAN China Free Trade Area (ACFTA), ASEAN Japan FTA, ASEAN South Korea FTA, ASEAN Australia New Zealand FTA and ASEAN India FTA Given the EU’s experience and regional economic integra-tion theories that have been derived from this empirical evidence, the Economic Community (EC) phase will be the longest period in the AEC’s regional economic integration, which starts from FTA to Single Currency Empirical evidence from the EU and other theories show that

EC is the key success factor for a region to move forward from intra-trade cooperation to investment cooperation both of which are the necessary conditions for monetary union and a single currrency Monetary union is also known as a political union that requires fiscal policy harmonization such as the Stability and Growth Pact (SGP) in the EU Therefore, it is essential to discuss the future of ASEAN monetary integration after the discussion about the AEC 2015 Discussion of the AEC is very impor-tant in order to assess ASEAN’s future financial integration This will be discussed in Chap 6

This study considers Indonesia, the largest economy and population group in Southeast Asia with stable positive economic growth during the global financial crises in 2008 and the recent global economic tur-moil that arose because of economic instability in the USA, Europe, and,

recently, in China It is essential to place Indonesia as the centre of this study’s story both in discussing ASEAN’s current economy and its poten-tial future.

1.2 ASEAN Economic Cooperation’s

Overview

In addition to the ASEAN FTA there are several other sub-regional nomic cooperation agreements that involve a selected number of ASEAN member states The first sub-regional economic cooperation was estab-lished in 1993 just a year after AFTA was officially signed It is known as the IMT-GT (Indonesia, Malaysia, and Thailand-Growth Triangle) One

eco-of the major objectives eco-of this organization is to enhance export tiveness and investment (www.imtgt.org) A year later, in 1994, Indonesia and Malaysia invited Brunei and Philippines to establish another sub-regional economic cooperation called the BIMP-EAGA (Brunei, Indonesia, Malaysia, and Philippines—East ASEAN Growth Area) This organization focuses on infrastructure and investment at the sub-regional level (https://www.adb.org/countries/subregional-programs/bimp-eaga)

competi-In 2001, Thailand, competi-Indonesia, and Malaysia established the competi-International Tripartite Rubber Organization (ITRO), another sub-regional economic cooperation This organization controls a particular product, natural rubber, with a specific supply management scheme (SMS)—a supply- side policy to control production quantity—and an agreed export ton-nage scheme (AETS) to control the quantity of trade Both policies are designed to maintain oligopoly market power The higher the oligopoly market powers of a certain primary product, the higher are the incen-tives for investors to invest FDI in that product (Pindyck and Rubinfeld 2005) ITRO is expected to attract FDI inflows for natural rubber as its production and trade quota have been predicted to increase its oligopoly market power

At the bilateral level, BFTAs are expected to attract investment from advanced countries and non-member states Yet a BFTA itself creates a dilemma for its regional FTA On one side, member states receive benefit from establishing BFTAs, though, given the difference in economic levels

1 General Introduction 3

among member states, such benefits will differ between more advanced and less advanced member states, which will increase the economic gaps within the member states However, since no member state of a regional FTA wants to be left behind when its fellow members establish a direct BFTA with non-member states from advanced economies, other member states will also make BFTAs, regardless of the risks.

BFTAs make trade arrangements very complicated as a result of their substitution effect on regional trade arrangements, which increases the economic gap between regional member states thus opposing the main objective of the regional trade agreements (Panagariya 2000; Tumbarello 2007) In 2003, a year after ASEAN-6 (ASEAN’s original members which consist of Indonesia, Malaysia, Thailand, Philippines, Singapore, and Brunei) agreed a maximum 5 percent regional tariff rate—the Common Effective Preferential Tariff (CEPT)—ASEAN member states formed BFTAs The first BFTA was established by Singapore, with other member states following suit BFTAs are directly established by regional member states with non- regional states that are advanced economies, as the main objective

of having a direct BFTA is to attract FDI inflows from advanced economic countries (Manger 2005)

At the regional level, ASEAN, which was established in 1967, signed its first preferential trade arrangement (PTA) in 1977 yet only achieved its common free trade area—the ASEAN Free Trade Area (AFTA)—in

1992 which took effect in 1999 AFTA had three stages of negotiations (Nesadurai 2003): identification (1992–1995), expansion (1996–1998), and implementation which began in 1999 Yet due to the financial crises that hit Southeast Asia in mid-1997, the expansion changed into the con-solidation stage AFTA is expected to generate impact on intra-regional trade (trade creation) and on FDI (investment creation) “Foreign inves-tors favor liberalization and welcome the prospect of producing for a region-wide market” (Ravenhill 1995, p 856) Therefore, trade and investment liberalization is important, not only for its regional member states but also for non-member states

The AFTA imposes trade discrimination policies at the regional level between Southeast Asian countries as member states and non-Southeast Asian countries The AFTA also implements the CEPT as the internal

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tariff for member states with a maximum 5 percent for inclusion list products (liberalized product) of ASEAN-6 by 2002 and 2010 for ASEAN-4 (ASEAN’s newer members, Cambodia, Laos, Myanmar, and Vietnam) ASEAN is currently attempting to enhance its regional trade liberalization in the AFTA by increasing its attractiveness for long-term investment creation of FDI In order to advance trade liberalization at the regional level, ASEAN decided to deepen its CEPT’s implementa-tion tariff down to 0 (zero) percent in 2010 for ASEAN-6 and 2015 for ASEAN-4 This combination of full-trade liberalization at regional level (CEPT of 0 percent) and FDI inflows increase is believed to be a good start for ASEAN towards achieving the AEC of 2015.1

A free trade area is a form of economic integration wherein all trade barriers among members are removed, but each nation retains its own barriers to trade with non-member states (Salvatore 2004) This has been adopted by the AFTA, and according to its soft and open regionalism principles ASEAN allows its member states to have direct bilateral free trade agreement (BFTA) with states outside AFTA A BFTA is the best alternative for non-member states to avoid a discriminative regional trade policy For non-member states that are developed countries, BFTAs cre-ate mutual benefits with developing country member states within the region Take the example of Japan and Mexico, the latter a member state of the North American Free Trade Agreement (NAFTA) A BFTA between these two countries provides mutual benefit, where Japan receives market access through Mexico even though Japan is not a member of NAFTA while Mexico receives FDI from Japan

This study also observes the impact of BFTAs on intra-regional trade, which indirectly shows the “spaghetti bowl phenomenon” in Southeast Asia This phenomenon explains the negative impacts of BFTAs towards the regional economic arrangement There are at least two negative impacts: (1) BFTAs can substitute regional economic arrangements, which will weaken the function of the regional economic arrangements; and (2) A BFTA can increase the economic gap between developed and developing countries of the member states A BFTA gives more bene-fit to developed countries than to developing ones Member states in regional economic organizations, having different levels of development, may see increased economic gaps between them This will jeopardize

1 General Introduction 5

the main objective of regional economic integration, which is to reduce the economic gaps within member states in order to establish economic convergence.

1.3 Purpose

The purpose of this study is:

1 To analyze the impacts of free trade agreements between member states (at the regional level, AFTA) on intra-regional trade (trade cre-ation) and FDI inflows (investment creation) in the observed coun-tries At this stage, this study will also observe the impact of BFTAs on intra-regional trade as a proxy to indicate the “spaghetti bowl phe-nomenon” which in the Asian context is known as the “Asian noodle-bowl phenomenon.”

2 To analyze the impact of free trade agreements between member and non-member states (at the bilateral level, BFTA) on FDI inflows at country level (investment creation)

3 To analyze the impacts of sub-regional economic cooperation on FDI inflows of a particular primary product (investment creation), in this case natural rubber

4 To discuss the AEC 2015, a very important stage in regional economic integration since this is the critical stage to shift ASEAN from intra- trade of free flows of goods to investment free flows The latter is the essential key for the free flows of people, given movement of people depends on the free flows of long-term investment

5 To review the future of ASEAN’s economic integration, this study features financial integration in ASEAN This part follows the discus-sion on the AEC as the necessary condition for ASEAN to complete its economic integration from real sector of intra-trade and invest-ment to monetary sector integration of single monetary union and the potential establishment of a single currency This study discusses ASEAN regional economic integration from start to finish, from FTA, EC, and single market (SM) to the monetary integration of the single monetary union or political union (SMU/PU) to single cur-rency (SC)

1.4 Proposition

The following hypotheses have been derived from these purposes:

1 A positive impact of the AFTA on intra-regional trade (trade creation) and on aggregate foreign direct investment (investment creation) In addition, this study proposes the hypothesis that BFTAs have negative impacts on ASEAN’s intra-regional trade

2 A positive impact of direct BFTAs on individual country’s FDI ment creation)

3 A positive impact of sub-regional economic cooperation on a lar product’s FDI (investment creation) This study takes the role of ITRO in attracting FDI inflows as a proxy to assess its effectiveness as

particu-a sub-regionparticu-al orgparticu-anizparticu-ation with pparticu-articulparticu-ar product mparticu-anparticu-agement

4 A positive impact of AEC on crafting the bright future of ASEAN’s economic integration development ASEAN has a large potential to complete its economic integration phases from trade to investment and finance Given this, ASEAN’s success story will complement the existing empirical evidence and theories of the EU’s success story

5 Regarding variances of difference between the EU and ASEAN, the two will enrich the empirical evidence and theories of regional eco-nomic integration ASEAN may complement the EU as a role model for regional economic integration pathways

6 A positive impact of the opening and enlargement of ASEAN economic integration under ASEAN-+ Frameworks to shift ASEAN economic cooperation from intra-trade to investment and monetary union This proposition is based on the ASEAN’s open regionalism and given the time-line it limits to ASEAN-+3 which covers China, Japan, and South Korea

2 Does AFTA generate intra-regional trade?

3 Does this intra-regional trade generate investment creation (FDI inflows) at regional level?

4 Does FDI inflow affect intra-regional trade?

5 Do direct BFTAs generate investment creation (FDI inflows) at vidual country level?

6 Do direct BFTAs affect intra-regional trade?

7 Does the existing sub-regional economic cooperation in particular products (e.g., natural rubber by ITRO) generate investment cre-ation (FDI inflows) in particular countries (Indonesia, Malaysia, and Thailand)?

8 Does ITRO increase the oligopoly market power of its natural ber main producers?

9 Can ASEAN complete its regional economic integration stage from trade to investment (economic community) to support its financial integration?

10 Do ASEAN-+ Frameworks support ASEAN to achieve its financial integration?

1.6 Theoretical Framework

At the regional level this study analyzes how PTAs affect FDI inflows This study uses the basic concept of trade creation and trade diversion and adopts investment creation as the proxy for them Trade diversion occurs from most-efficient non-member states to efficient member states while trade creation occurs from local producers in less efficient member states to local producers in efficient member states

Theoretically, trade creation and trade diversion (leading to FDI ation) is based on the trade and investment relations among member states and also between member and non-member states Assume that there are three countries which produce the same product (x): countries

cre-a cre-and b, which cre-are member stcre-ates, cre-and country c cre-a non-member stcre-ate Country c produces product x more efficiently than countries a and b, while country b produces x more efficiently than country a Therefore, the transitivity function of price, wage, and productivity ‘pre- establishment

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of AFTA “is P cx < P bx < P ax and MPL W cx MPL W MPL W

cx bx bx ax ax

W MPL

Output function (Q), which connects countries in the economy, can be divided into three orientations: domestic market, foreign market (export) and investment function (FDI) The first two orientations belong to the trade function Profit function for each output function is defined as: