In Regional Trading Arrangements among Developing Countries: The ASEAN Example, Research Report 103, Dean A. DeRosa examines the experiences of the Association of Southeast Asian Nations (ASEAN) with regional investment and trade arrangements and presents a quantitative analysis of the economic implications of the new ASEAN Free Trade Area (AFTA). The report focuses on the new trading area's potential for significantly reducing trade and macroeconomic policy-related disincentives to greater agricultural production and trade by the ASEAN countries, compared with an alternative policy of broader trade liberalization.

With the exception of Singapore, the ASEAN countries are mainly low- and middle-income developing countries whose economies share many similarities related to their geographic location as well as common aspects of their culture, history, and economic and social development. Given their high population levels, compared with not only the major industrial countries but also most countries in Africa, Latin America, and the Middle East, the ASEAN countries have a comparative advantage in the production and international trade of many labor- intensive manufactured goods. Despite the steady pace of their industrialization and some significant reserves of mineral fuels and ores, however, Indonesia, Malaysia, the Philippines, and Thailand (the so-called ASEAN-4) are still heavily agrarian-based economies, with cultivation and exports devoted in large measure to tropical agricultural commodities and related products.

In addition to the pursuit of relatively stable monetary and fiscal policies, the prime reason for the economic success of the ASEAN countries lies in their steadily increasing openness compared with other developing countries--a policy that has been termed "open regionalism." But political factors have kept the trade relations of the ASEAN countries from being as open as they could be. Using quotas and other nontariff barriers to imports, these countries have in many instances hindered trade in manufactures to protect favored domestic industries. They have also restricted imports of many cereal grains and other food commodities.

ASEAN was founded in 1967, primarily out of concern for political security in Southeast Asia, but over time ASEAN's economic arrangements have arguably become more important than its original political goals. In 1976 ASEAN members agreed to pursue coordinated investment projects, mainly in an attempt to make economic structures in the various ASEAN countries more complementary. Because of the opposition of national interests concerned for the profitability of their local investments, however, the investment schemes have been largely unsuccessful, and only a small number of cooperative investment projects have been completed and are economically viable to date.

The ASEAN preferential trading arrangements, established in 1977, sought to expand intra-ASEAN trade by reducing tariff and nontariff barriers to goods produced in member countries. Only negligible increases in trade within the region were achieved, however, because of persistent, though generally declining, reliance on nontariff barriers in many ASEAN countries and, more fundamentally, because of the opposition of many of the same vested interests that have prevented the success of the coordinated ASEAN investment programs. In January 1992, the ASEAN heads of state, concerned about the increasing bilateralism of the major industrial countries, agreed to establish the ASEAN Free Trade Area. Beginning in 1995, each ASEAN country will reduce the level of its tariffs on imports of manufactures and highly protected categories of agricultural and other natural resource--based commodities from within the region to a range of 0 to 5 percent by the year 2003. The AFTA agreement also calls for the simultaneous elimination of nontariff barriers to trade within ASEAN.

The report therefore quantitatively analyzes the medium- to long-term economic effects of the AFTA plan compared with those of a policy of complete liberalization of trade in Southeast Asia on a nondiscriminatory or MFN basis. The analysis is based on a multisector, computable general equilibrium model of the trade relations of the ASEAN countries both within ASEAN and with the rest of the world. The simulation model accounts for both tariff and nontariff barriers in the ASEAN countries and their principal trading partners. It measures how simultaneously reducing tariffs and nontariff barriers on either a preferential or a nondiscriminatory basis affects economywide variables, such as gross national expenditures and the exchange rate, and the prices and quantities of primary commodities and industrial goods produced, consumed, and traded.

Simulations of the model find that the AFTA does create trade. Indeed, the new free trade area is estimated to expand total trade within ASEAN by as much as US$2.9 billion, or 19 percent (Figure 2). In addition, the simulation results reveal that the ASEAN countries' expansion of production and exports in various economic sectors under the AFTA plan bears close similarity to that expected under MFN liberalization. Finally, agricultural production under AFTA is found to rise slightly in the ASEAN-4, indicating that the bias against agriculture resulting from industrial and other protection in the ASEAN countries is reduced, albeit by margins that are substantially narrower than under MFN liberalization (Figure 3). In Singapore, however, agricultural production declines under AFTA because the new preferential trade area causes the city-state to become a still larger source, within ASEAN, of manufactured goods, previously imported chiefly from the major industrial countries.

Overall these results, though positive, fall short of the results expected under MFN liberalization. In particular, the ASEAN countries' consumption and imports in various economic sectors under AFTA are quite different from those under MFN liberalization, reflecting the discriminatory nature of the AFTA plan and the limitations that discrimination ultimately places on possibilities for greater economic welfare and trade. The AFTA plan is found to yield much smaller improvements to economic welfare (that is, real expenditures on final demand, or real absorption) for most of the ASEAN countries than does MFN liberalization. Indeed, only Singapore and to a lesser extent Malaysia show significant improvement in economic welfare under AFTA, for these two countries, by virtue of their initially relatively open economies, stand to gain substantially from both creation of new trade and ASEAN-wide diversion of trade away from the rest of the world. And compared with AFTA, MFN liberalization results in a smaller gain in intra-ASEAN trade (US$1.7 billion), but it raises the estimated gain in total ASEAN trade with the world (US$9.1 billion) by over three times more than AFTA does (US$2.4 billion). It achieves this enormous gain by exploiting wider differences in the sources of international comparative advantage between the ASEAN countries and their international trading partners, especially the major industrial countries.

Ironically, the present resurgence of interest in regional schemes to expand trade has its origins in the dissatisfaction with multilateral efforts under the GATT to achieve continued, and more timely, progress in liberalizing global trade relations. Moreover, regional trading arrangements among developing countries have come to be viewed as providing an economic defense against shifting patterns of trade and investment likely to follow in the wake of the initiatives in North America and Western Europe to establish new and wider free trading areas. In this vein, policymakers in developing areas also see regional trading arrangements as appropriate instruments for bargaining more effectively within the World Trade Organization and in bilateral negotiations with officials from larger and more-developed countries. ASEAN policymakers, for instance, believe that bargaining on a united basis, bolstered by AFTA, will provide them with more economic leverage to demand reciprocal trade concessions giving them increased access to markets in the European Union, Japan, and the United States.

The last view, however, confuses the gains from trade with the interests of local producers in increasing their output, destined for either sheltered regional markets or more open markets abroad. The gains from trade ultimately concern the possibilities for increased consumption of goods and services at the lowest possible resource cost. From this perspective, the largest gains from trade, as illustrated here, are actually within the grasp of most countries if they act unilaterally or in concert to reduce their own levels of protection on an MFN basis and pursue their comparative advantage in available, albeit frequently protection-ridden, world markets. From an international political economy perspective, on the other hand, a question for future research is whether the emerging competition between multilateral and regional approaches to trade liberalization might ultimately lead to a desirable outcome for the world economy reflecting the objectives of multilateralism and improving the circumstances of agriculture in low-income and other developing countries.