Intra- and Extra-regional Effects of Plurilateral FTAs in Asia Hiro Lee (Osaka University) Robert F. Owen (University of Nantes) Dominique van der Mensbrugghe (World Bank) 1

Background and Objective In the past decade a growing number of free trade agreements (FTAs) involving Asian countries have been signed or ratified, and a large number of FTAs are currently being negotiated. Free trade among ASEAN, China, Japan and Korea (ASEAN+3 FTA) and free trade among ASEAN, China, Japan, Korea, India, Australia and New Zealand (ASEAN+6 FTA) have been proposed and are under study now. 2

Background and Objective A regional integration arrangement among either ASEAN+3 countries or ASEAN+6 countries is expected to have non-negligible effects on countries outside of the preferential zone as the reduction in barriers across partners leads to a re-orientation of trade. Using a dynamic global CGE model, we evaluate the effects of Asian integration on economic welfare, trade adjustments and sectoral output of the EU and North America. 3

Previous Studies Owen (2001): the lessons from the EU experience can be of general applicability for understanding the political economy of the integration process elsewhere. Plummer (2007): exclusions of individual products should be minimized on efficiency grounds. Kawai and Wignaraja (2007): consolidation of multiple and overlapping FTAs into a single Asian FTA would help alleviate the negative effects of different rules of origin associated with individual FTAs. 4

Advantages of using a CGE model Inter-industry linkage effects are fully captured. We can assess the impact on output, exports, imports, etc. in all industries and all countries simultaneously. When evaluating effects of FTAs, we can assess the effects on both member and non-member countries. Interactions between product markets and factor markets are also captured. We can evaluate the effects of a trade policy on intersectoral adjustments (i.e., movements of L and K across industries). 5

Overview of the Model The numerical simulations undertaken for this paper are derived from the World Bank’s LINKAGE model (van der Mensbrugghe, 2005). This model has been used for an assessment of various Doha Round proposals by Anderson et al. (2006) and the evaluation of the costs and benefits of different regional trade agreements presented by the World Bank (2005). In many respects, the structure of the LINKAGE model is similar to the GTAP model and the MIRAGE model, two other widely used global trade models. 6

ND: Aggregate intermediate demand VA: Value added plus energy XP: Output ND: Aggregate intermediate demand VA: Value added plus energy XAp: Intermediate demand XD: Demand for domestic goods XMT: Aggregate import demand WTF: Demand by region of origin Labor Unskilled Skilled HKTE bundle HKT bundle XEp: Energy bundle KT bundle Highly skilled By type of energy By region of origin…  p Sector-specific factor  v  e  h  ep  m  w  l  = 0  k Capital 7

Some features of our model 1. The model links trade openness to productivity. where i,t is the sector-specific productivity factor, Ei,t is exports of commodity i, Xi,t is output of commodity i, fi,t is a shift parameter, and hi is the elasticity of productivity with respect to openness. 8

Some features of our model (cont.) 2. The model allows for non-monetary trade and transport cost , which is represented by the efficiency parameter r,r',i. where WPMr,r',i is the CIF price of imports into region r' originating in region r, WPEr,r',i is the FOB price of commodity i, and r,r',i is the ad valorem trade and transport margin. 9

Some features of our model (cont.) This type of cost is referred to as ‘iceberg’ transport cost, developed by Samuelson (1952). In our paper, an increase in r,r',i represents a reduction in trade-related risk, lower administra-tive barriers to trade (e.g., streamlining customs procedures), and/or a fall in technical barrier (e.g., mutual recognition of product standards). 10

A caveat of the model Foreign capital flows (e.g., FDI) are exogenous in the current version. We acknowledge that endogenous treatment of FDI is very important when we discuss the implications of economic integration because trade and FDI are closely linked. 11

Regional Aggregation 1. China (including Hong Kong) 2. Japan 3. Korea 4. Taiwan 5. Singapore 6. Other ASEAN countries 7. India 8. Australia and New Zealand 9. North America 10. EU-15 11. New EU members since 2004 12. Rest of the world This seminar presents forward-looking scenarios for East Asian regional trade over the next two decades. 12

Sectoral Aggregation 1. Rice 2. Other crops 3. Livestock 4. Natural resources 5. Fossil fuel 6. Processed food 7. Textiles 8. Apparel 9. Wood and paper 10. Petroleum prod. 11. Chemicals 12. Iron and steel 13. Nonferrous metal 14. Metal products 15. Machinery 16. Electronic equipment 17. Motor vehicles 18. Other transport equip. 19. Other manufactures 20. Construction & utilities 21. Trade & transport 22. Services This seminar presents forward-looking scenarios for East Asian regional trade over the next two decades. 13

Policy Scenarios We consider: ASEAN+3: Free trade among the ASEAN members, China, Japan and Korea ASEAN+6: Free trade among the ASEAN members, China, Japan, Korea, India, Australia and New Zealand under the four scenarios. 14

Policy Scenarios Scenario 1: The FTA members remove bilateral tariffs and export taxes/subsidies (except rice) over the period 2008-2015. Note: Rice is excluded because it is extremely unlikely that Japan and Korea would concede to a region- wide FTA involving free trade in rice. Scenario 2: Scenario 1 plus a 2.5% reduction in frictional costs of trade (e.g., administrative and technical barriers) among the FTA members over the period 2008-2015. 15

Policy Scenarios Scenario 3: Same as scenario 2 except that the sector-specific productivity factors related to openness (i,t) are now endogenous and determined by equation Note: i,t are exogenous in scenarios 1 and 2. 16

Policy Scenarios Scenario 4: Scenario 3 plus a 10% reduction in the trade and transport margins over the period 2008-2015 for the FTA members compared with the baseline, resulting from an increase in competition. 17

Table 3. Effects on welfare resulting from the ASEAN+3 FTA (% deviations in equivalent variations from the baseline in 2015) Scenario 1 Scenario 2 Scenario 3 Scenario 4 China 0.10 0.77 2.61 4.53 Japan 0.14 0.33 0.36 0.76 Korea 0.75 1.41 1.65 2.99 Taiwan -0.24 -0.36 -0.27 -0.44 Singapore 0.29 2.96 3.10 6.45 Other ASEAN 0.07 1.21 1.23 3.97 India -0.05 -0.08 -0.07 -0.12 Australia/NZ -0.06 -0.15 North America -0.01 -0.02 EU-15 0.00 World 0.03 0.13 0.26 0.52 18

Table 4. Effects on welfare resulting from the ASEAN+6 FTA (% deviations in equivalent variations from the baseline in 2015) Scenario 1 Scenario 2 Scenario 3 Scenario 4 China 0.30 0.71 2.45 4.11 Japan 0.18 0.31 0.33 Korea 0.93 1.33 1.55 2.73 Taiwan -0.34 -0.42 -0.36 -0.53 Singapore 1.18 2.94 3.06 5.88 Other ASEAN 0.88 1.53 1.56 India 0.00 0.75 1.40 Australia/NZ 1.07 2.05 1.77 2.96 North America -0.02 -0.03 EU-15 -0.01 World 0.07 0.15 0.28 0.55 19

Table 5. Trade flow adjustments for selected products resulting from the ASEAN+6 FTA (Scenario 4, percent deviations from the baseline in 2015) Exporting region Crops other than rice Importing region ASEAN +6 EU-27 North America World ASEAN+6 125.8 -9.2 -7.0 69.0 -16.6 -0.1 1.1 -0.6 -18.6 0.3 1.5 -9.6 4.0 0.1 1.8 20

Table 5. Trade flow adjustments for selected products resulting from the ASEAN+6 FTA (Scenario 4, percent deviations from the baseline in 2015) Exporting region Processed food Importing region ASEAN +6 EU-27 North America World ASEAN+6 80.4 -8.6 -9.0 43.7 -9.1 0.2 0.9 -0.5 -11.0 0.4 1.1 -3.2 35.2 -0.2 -1.0 8.4 21

Table 5. Trade flow adjustments for selected products resulting from the ASEAN+6 FTA (Scenario 4, percent deviations from the baseline in 2015) Exporting region Apparel Importing region ASEAN +6 EU-27 North America World ASEAN+6 28.7 0.7 0.0 9.9 -13.3 -0.5 -0.3 -1.9 -11.2 -0.4 -0.1 -1.5 22.2 0.3 5.4 22

Table 5. Trade flow adjustments for selected products resulting from the ASEAN+6 FTA (Scenario 4, percent deviations from the baseline in 2015) Exporting region Iron and steel Importing region ASEAN +6 EU-27 North America World ASEAN+6 26.6 -7.0 -6.2 14.4 -6.1 0.2 0.7 -0.2 -2.7 0.1 13.1 -0.5 3.5 23

Table 5. Trade flow adjustments for selected products resulting from the ASEAN+6 FTA (Scenario 4, percent deviations from the baseline in 2015) Exporting region Electronic equipment Importing region ASEAN +6 EU-27 North America World ASEAN+6 5.5 -3.5 -2.8 1.4 -2.0 1.1 1.9 0.6 -1.8 0.8 1.6 0.3 3.1 -0.3 -0.7 0.9 24

Table 5. Trade flow adjustments for selected products resulting from the ASEAN+6 FTA (Scenario 4, percent deviations from the baseline in 2015) Exporting region Motor vehicles Importing region ASEAN +6 EU-27 North America World ASEAN+6 69.3 -5.4 -4.0 10.7 -4.6 0.2 0.7 0.0 -4.9 0.5 29.8 -0.1 -0.5 2.2 25

Conclusions Under the ASEAN+3 FTA, Singapore would realize relatively large welfare gains (in percent deviation from the baseline), followed by China, other ASEAN countries, Korea and Japan. Under the ASEAN+6 FTA, India would incur some welfare losses in scenario 1 largely because of a deterioration of its terms of trade after the removal of high tariff rates relative to the other members. In contrast, Australia & NZ are expected to realize relatively large welfare gains. 26

Conclusions (cont.) The welfare effects on the EU and North America resulting from Asian economic integration are very small. The results suggest that the reduction in frictional trade barriers (e.g., administrative and technical barriers) would be more important at the macro-level than tariffs themselves. 27

Conclusions (cont.) The incorporation of a linkage between openness and productivity leads to an increase in welfare gains for all member countries although the extent of welfare gains varies substantially across regions. China’s welfare gain increases more than three-fold when sectoral productivity becomes endogenous, suggesting that increases in export-output ratios are far greater for China than for the other members in many products. 28

Conclusions (cont.) The results indicate that the EU and North America will lose export revenues not only in the integrated Asia, but also globally, in a number of products — e.g., crops other than rice, processed food, textiles and apparel. For iron and steel, machinery, electronic equipment and motor vehicles, the reductions in EU and North American exports to East Asia are more moderate. 29

Future Extensions Inclusion of a scenario in which the ASEAN+6 FTA is extended to the EU. Inclusion of a scenario in which the ASEAN+6 FTA is extended to North America. Inclusion of services trade liberalization Incorporating endogenously determined FDI into the model. However, a major impediment is that the data on bilateral FDI flows by sector are not available for most countries. 30