Impacts of afta on goverment revenue external trade and FDI of lao PDR (tt)

In addition, many studies on economic impacts, particularly government’s revenue, intra-trade, and FDI flows of the entire and individual member countries have been conducted.Chaiwootet

I INTRODUCTION

1 Background

Regional integration has become the main form of trade liberalization since the early 1990s.Progress of the integration has been very impressive in recent decades for a number of developing countries in Asia and, to a lesser extent, in Latin America These countries have become successful because they chose to participate in regional and global trade, helping them to attract the bulk of foreign direct investment in developing countries (IMF, 2001)

There are a number of arguments on free trade It can bring about several advantages and disadvantages The benefits can be indicated in trade creation, increased exports, economies of scale, increased competition, make use of surplus raw materials, increased production, production efficiencies, benefits to consumers, foreign exchange gain, employment opportunities, and economic growth

Although free trade has benefits, there are a number of disadvantages such as changes in structural unemployment in the short term, increased domestic economic instability from international trade cycles, as economies become dependent on global markets, developing or new industries may find it difficult to become established in a competitive environment with no short-term protection policies by governments, free trade can lead to pollution and other environmental problems, free trade may raise government revenue by import taxes, but this will only be a small amount of money

In Southeast Asian region, ASEAN Free Trade Area (AFTA) is a significant trade bloc Having established in 1992, it is considered in the second level of economic integration The primary goals of AFTA are to increase ASEAN’s competiveness through eliminating the tariffs and non-tariff barriers within member countries and to attract more foreign direct investment

to the region

The impacts of free trade in general and AFTA in particular can be

reviewed from different countries’ case studies Within ASEAN member, a number of research papers focus on the consequences of AFTA on economy as

a whole These can be found in the study case of Vietnam conducted by Fukase and Martin (1999), Loc (2001), Ba (2004), Harris et al (2007), and Thanh (2007) The main findings reveal that there is an increase in welfare and poverty reduction thanks to broader liberalization

In addition, many studies on economic impacts, particularly government’s revenue, intra-trade, and FDI flows of the entire and individual

member countries have been conducted.Chaiwootet al (2006) analyze the

economic impacts of AFTA on Thailand’s economy, whereas Piriya (2010) examines whether the AFTA creates trade for Thailand or actually diverts it away from the country by analyzing various trade indicators and Pupongsak (2009) investigates the impact of trade liberalization on taxation and government revenue of Thailand Fukase and Martin (2001) explore implications for Cambodia of its entry into the AFTA through considering the trade regime, including the reliance on customs duties as a revenue source

Hartono et al (2007) investigate the impacts of AFTA on the Indonesian

economy, namely economic growth, poverty, and income distribution

Participating in AFTA is challenging for newer ASEAN members (Cambodia, Lao PDR, Myanmar, and Vietnam) in terms of social and economic development Therefore, there have been some studies related to the consequences of AFTA commitment execution on CLMV The empirical evidence can be found in the work done by Tongzon, Khan, and Doanh (2004 and 2005) and Araya (2002) which focus on analyzing how CLMV deal with revenue lost and options for revenue management after participating in AFTA tariff reductions, as well as the challenges of economic integration for CLMV

Elsie (2005) examines whether the formation of AFTA leads to an increase in ASEAN intra-trade and how it brings trade benefits to economies with different stages of development from 1988 to 2003 Adams and Park (1995) evaluate the impact of AFTA with a link to Computable General

Equilibrium (CGE) model to quantify the macroeconomic effects of external shock, domestic policy, and regional-grouping and market-opening efforts through tariff reduction policies among ASEAN nations Hapsari and Mangunsong (2006) analyze the determinants of AFTA members’ trade flows and potential for trade diversion, including the impacts of creation of AFTA on its intra- and extra-regional trade flow by comparing trade patterns of AFTA countries with AFTA members and non-members David Cheong (2008) studies the effects of AFTA, using a gravity model to address changes in trade patterns of ASEAN during 2001-2003 Adams and Horridge (2000) estimate the AFTA trade liberalization on ASEAN member countries, with special reference to Thai economy in long term Ho Sze Yin (2010) investigates the effects of AFTA whether it leads to trade creation or diversion among member countries during 1988-2004 Gumilang (2011) studies the trade agreements

with Japan (IJEPA) and AFTA with reference to Indonesia Hector et al (2009)

examine the impacts of AFTA on trade flows and external trade barriers during 1992-2007

In case of Lao PDR, one of the most directly related to the consequences

of implementing AFTA can be found in the study conducted by Menon (1999), AusAid and UNDP (1996), and Phouphet (2004) In these papers, the main objective is to examine the impacts of AFTA on Lao economy by addressing the trade, government revenue and foreign investment flows The key findings show that (i) trade diversion is likely to be low; (ii) the reduction in government revenue from trade taxes is likely to be low; and (iii) foreign direct investment (FDI) flows are likely to grow sharply in the future However, Phouphet argues that AFTA will lower the general price, causing an increase in real consumption, investment, and macroeconomic variables, and therefore the GDP will also increase Besides, Phongsavanh (2003) studies the Lao PDR’s integration in ASEAN The main objective is to initially assess the potential impacts of joining ASEAN of the Lao PDR By employing descriptive approach, the results reveal that through accessing to ASEAN and following the commitments of AFTA, the trade regime of the Lao PDR is negatively

affected However, the risk of trade diversion is considered to be minimal, it may occur in some imported products, namely automobiles Simultaneously, the welfare of people will be improved through AFTA’s scheme as they can buy commodities at lower prices with more choices in a larger ASEAN market

From the above-revised researches, the discrepancies between this study and the previous ones, particularly the one conducted by Phouphet (2004), can

be distinguished in terms of analytical methodology, independent variables used in the models, and time periods In building Lao macroeconomic model, Phouphet focuses on the effects of AFTA on the whole economy through changing general price He also focuses on demand and supply sides which are adjusted by general price mechanism Since Lao PDR is an agricultural country, he thus divides the supply side (GDP) into agricultural and non-agricultural GDP to analyze the agricultural structure change To analyze the trade structure change, trade with Thailand and trade with non-Thailand are also divided.The model consists of 15 structural equations The main policy variable is government investment, foreign direct investment, money supply, and exchange rate The main target variables are GDP, general price, private consumption, domestic investment, export, and import He uses ordinary least square method to estimate structural equations and Newton method to simulate the model.In the export and import equations, there is no tariff rate Therefore,

he assumes that the effects of AFTA by deduced tariff have the same effect by decreasing import price by 5 per cent The data used covers during 1988-2000, which is a short-time period and the data per se is not well organized and less reliable since the economic structure had changed from centrally planned to market-oriented economy in 1986

In this paper, rather than using only the OLS method of econometric approach to estimate the impacts of AFTA on government revenue, external trade, and FDI, but descriptive approach is utilized to analyze the tendency and relationship among the specified variables In the export and import equations, the tariff rate of both ASEAN member countries and Lao PDR are included

Concerned with the time period, it covers from 1990 to 2012 which is longer and more accurate

2 Objective

The main objectives of this dissertation are twofold as follows:

 To review the economic performance of Lao PDR before and after participating AFTA;

 To estimate the impacts in implementing the Common Effective Preferential Tariff (CEPT) scheme under AFTA on the Lao PDR’s government revenue, external trade (exports and imports), and Foreign Direct Investment (FDI) flows

The findings of this paper are considered significant for the author since

it deepens more understandings on economic development policies, strategies and growth in Lao PDR in the past and shades light on the future development directions

Moreover, the results will provide better knowledge on the repercussions of regional economic integration, particularly with ASEAN on the Lao government revenue, external trade directions, influx of FDI, and smuggling activities

In addition, this paper will be a useful reference for the scholars, researchers, and general interested groups who desire to analyze the similar issues in the different case studies, approaches, and time periods

5 Scope of Study

The scope of this study is to focus on the impacts of regional economic integration, namely AFTA on the Lao government revenue, external trade, and FDI These indicators are selected as dependent variables to indicate the impacts during 1990-2012 These time periods cover several internal, regional, and international economic shocks, namely the implementation of NSEDP, membership of ASEAN and AFTA implementation of Lao PDR, Asian Financial Crisis in 1997, and global economic crisis in 2008

To clearly present the results or the relationship between the tariff reduction under AFTA’s CEPT scheme, tables and charts will be used Also, to distinguish differences of economic development, changes in government revenue, FDI, and external trade, the duration of time will be divided into a five-year period: 1990-1995, 1996-2000, 2001-2005, and 2006-2012, which are

in accordance with the five-year NSEDP of the GOL

Table 1: Framework on Analyzing the Impacts of AFTA on Economic

Performance, Government Revenue, Trade, FDI

Economic — Economic development measured by GDP growth rate

Issues Indicators

Performance during 1990-2012;

— GDP per capita during 1990-2012;

— Structure of Lao Economy;

— Economic growth rate by sectors: Agriculture, Industry, and service, covering from the 3rd to the 6th five-year NSEDP

— Growth rate and percent share of trade balance to GDP;

— Trade directions (main exporting and importing markets);

— Compositions of exports and imports;

— Percent share of total trade to intra-trade of ASEAN;

— Degree of trade openness (terms of trade);

FDI

— FDI flows from ASEAN members (intra-FDI) and ASEAN countries (Extra-FDI);

non-— Percent share of total FDI to intra-FDI of ASEAN;

— FDI by home/original countries;

— FDI by economic sectors

3.2 Econometric Approach

To obtain the empirical evidences of the consequences of the AFTA on

government revenue, FDI, and external trade (dependent variables), the Ordinary Least Squares (OLS) method is applied The functions of the above-mentioned dependent variables can be expressed as follows:

1 Export Function

EXP: f 1 (GDPF, TAXA, INFR, EXR, LIB) ……… (1)

2 Import Function

IMP: f 2 (GDP, TAXL, INFR, EXR, LIB) ……… (2)

3 Government Revenue Function

GOVR: f 3 (GDP, TAXL, INFR, EXR, IM, LIB) ……… ………… (3)

4 Function of Foreign Direct Investment

FDI: f 4 (GDP, TAXL, INFR, EXR, LIB) (4)

Where,

f i : Shows functional forms of the model/equation ith;

GDPF : National income of ASEAN member countries, proxied by the

income of major trading partner, namely Vietnam, Thailand, and China;

commencing in 1998; Dummy Variable, LIB = 0 (1990-1998), LIB

= 1 (otherwise);

In the import function (IMP), GDP is related positively to IMP which implies that when income increases, demand for imports will also rise As a result, the expected sign of GDP is positive (+) With regard to TAXL, the expected sign is positive (+) because decreased tariff rate will also encourage more demand on imports With respect to INF, when domestic price rises the

commodities become more expensive It is better to import rather than consume domestically produced goods and services Therefore, the expected sign of INF is positive (+) On contrary, depreciation of exchange rate will lower the imports Thus, the expected sign of EXR is negative (-) It is expected that AFTA bring about better quality commodities and cheaper price

to Lao market Consequently, the expected sign of LIB is also positive (+)

With regard to the FDI function, it is important to observe that economic growth of host country is one of attracting factors for FDI So, the expected sign of GDP is positive (+) Also, the expected sign of TAXL is positive (+) more invest capital will flow to Lao PDR when the tariff rate is gradually eliminated

In respect of the function of government revenue, there is not only tax that affects government revenue, but also other factors, namely macroeconomic stability and external environment (economic growth, price stability, and exchange rate) In the Lao context as an importing country, the tax revenue derived from imports is the major income source of the GOL Therefore, it is determined as an independent variable in the function, which is associated positively with GOVR In this connection, it is expected that GOVR will reduce after joining AFTA (both TAXL and LIB are expected to have negative signs)

From functions (1), (2), (3), and (4), the econometric models of imports, exports, government revenue, and FDI in the logarithm forms can be written as follows:

……… ………… … (5)

……… ……….………… (6)

(7)

…… … (8)

To obtain the empirical evidences, Equations (5), (6), (7), and (8) will

be estimated by applying the OLS method In the computing process, both Lao and weighted-average data (WAD) will be used to find the most appropriate results to better describe the issues in the Lao context.There are two main reasons why the WAD is also used in estimating the equations First, the structure of economy has been changed since the New Economic Mechanism initiated in 1986, causing the data collection has been haphazard until in 2000 onward Second, the WAD is acquired by calculating the weight of a particular item or variable to the total number of major trading partners, namely Vietnam, Thailand, and China These three neighboring countries are the top three export and import markets, as well as the home countries for FDI in Lao DPR Therefore, any internal policy changes or unexpected shocks occurred in these countries will also bring about the impacts on the Lao economy The formula

of the WAD can be expressed as follows:

Where,

: are the weighted-average and total foreign income (Vietnam, Thailand, and China);

and China, respectively;

: is a sum of foreign income (Vietnam, Thailand, and Vietnam);

: are the weighted-average and the sum

of imports of foreign countries;

: Are total imports of Vietnam, Thailand, and China, respectively;

: are the weighted-average inflation and exchange rates;

respectively; and : are the exchange rate of Lao PDR,