The ASEAN Preferential Trading Arrangements (PTA): An Analysis of Potential Effects of Intra-ASEAN Trade 9789814377539

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The Institute of Southeast Asian Studies

The Institute of Southeast Asian Studies was established as an autonomous organization in May 1968. It is a regional research centre for scholars and other specialists concerned with modem Southeast Asia. The Institute's research interest is focused on the many-faceted problems of development and modernization, and political and social change in Southeast Asia. The Institute is governed by a twenty-four member Board of Trustees on which are represented the National University of Singapore, appointees from the government, as well as representatives from a broad range of professional and civic organizations and groups. A ten-man Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute's chief academic and administrative officer. The responsibility for facts and opmwns expressed in this publication rests exclusively with the authors and their interpretations do not necessarily reflect the views or the policy of the Institute or its supporters.

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THE ASEAN PREFERENTIAL TRADING ARRANGEMENTS (PTA) An Analysis of Potential Effects on Intra-ASEAN Trade

by

Ooi Guat Tin

Research Notes and Discussions Paper No. 26 Institute of Southeast Asian Studies ASEAN Economic Research Unit 1981

CONTENTS

PREFACE

I

INTRODUCTION

1

II

POLICIES TOWARDS TRADE LIBERALIZATION

3

III

THE ASEAN PREFERENTIAL TRADING ARRANGEMENTS (PTA)

6

IV

V

VI

EVALUATION OF THE MAXIMUM POTENTIAL TRADE CREATION EFFECTS OF A 20% ACROSS-THE-BOARD TARIFF REDUCTION

12

AN ILLUSTRATIVE STUDY OF DATA OF MAXIMUM POTENTIAL TRADE DIVERSION EFFECTS

21

CONCLUSIONS

27

APPENDIX

29

REFERENCES

33

PREFACE

The success of the Preferential Trading Arrangements {PTA) scheme should not be judged by the number of trade preferences that have been exchanged and implemented but rather by its impact on trade expansion and more generally on economic welfare. Some preliminary studies on the effects of selective tariff reduction have indicated that the impact on intra-ASEAN trade has been insignificant. The purpose of this paper is to simulate the maximum potential impact of the new approach to tariff reduction on trade expansion. More specifically, we are interested in assessing the potential trade creation effects of the 20% across-the-board tariff reduction on all items with import value of less than US$50,000 each in 1978 trade statistics. In addition, the implications of the latest proposal by the ASEAN Economic Ministers {AEM) to consider raising the cutoff ceiling to US$500,000 are also analysed. This paper has benefited greatly from comments by H.W. Arndt. I am indebted also to Hans Christoph Rieger and Pradumna Rana who commented on an earlier draft of this paper. A condensed version of this paper was presented in a seminar at the Institute of Southeast Asian Studies. January 1981

Ooi Guat Tin

1:

INTRODUCfiON

The idea of ASEAN trade liberalization as a technique of cooperation m trade and industry was conceived as far back as 1970 when the ASEAN Governments commissioned a United Nations team to study the possibilities for closer cooperation among them in specific sectors of economic activity. In the area of trade and industry, complete removal of tariffs and non tariff barriers (NTBs) would have offered the quickest way of expanding the ASEAN market, but this met with objections from some member countries for fear of possible adverse effects on their domestic economies. Given the circumstances of ASEAN, the Robinson Report 1 recommended a gradual step-by-step and itemby-item approach, with a policy of progressive advance towards a long- term goal of a limited free trade area (1990 was suggested). Lack of political will delayed the process of implementation. It was only in 1976 when political developments in Indochina created a sense of urgency that we witnessed a concerted action by the five ASEAN countries to move towards this goal. At the Bali Summit, the five ASEAN Heads of Government firmly endorsed the "institutionalization" of ASEAN economic cooperation in the Declaration of ASEAN Concord. A working machinery headed by the ASEAN Economic Ministers (AEM) was established. Three important measures of economic cooperation were agreed upon: the ASEAN Preferential Trading Arrangements (PTA), ASEAN industrial projects based on the "package deal" approach, and ASEAN industrial complementation. This paper focuses on the PTA only. In the light of renewed emphasis on economic cooperation, the ASEAN Foreign Ministers concluded the Agreement on Preferential Trading Arrangements on 24 February 1977 in Manila. The expectations of the signatory governments were that preferential trading arrangements would act as a stimulus to the strengthening of national and ASEAN economic resilience and the development of the domestic economies of the member states by expanding investment and production opportunities, trade and foreign exchange earnings. The PTA provides the institutional framework for ASEAN trade expansion through the adoption of various instruments which will be spelt out later in the paper.

1 United Nations, Journal of Development Planning, No. 7 (1974).

- 2 -

Following the ratification of the PTA, there was a series of ad hoc officials' and ASEAN Economic Ministers' meetings which, at each round, considered 50 items from each country for tariff cuts. Subsequently, the frequency of the meetings has been regularized at quarterly intervals and the number of preferences considered increased from 100 to 150. At the time of writing, 5,825 trade preferences have been exchanged and implemented, with preferential rates varying from item to item, and ranging from 10% to 30% of existing rates. At the ninth ASEAN Economic Ministers' Meeting held in April 1980 m Singapore, the Ministers, in the hope of making more rapid progress, decided to lower tariffs on "lightly-traded" or smaller value items, and subsequently announced a 20% across-the-board tariff cut on all items with import value of less than US$50,000 each in 1978 trade statistics. Certainly, by avoiding the administrative delays of the selective approach, this new method substantially increased the number of commodities for which the member countries extended tariff preferences to each other. The success of the PTA scheme, however, should not be judged by the number of items that come under it, but rather by its effect on intra-ASEAN trade expansion. Theoretically, trade liberalization can exert a twofold stimulus on ASEAN trade. On the one hand, a reduction of intra-ASEAN tariffs can lead to increased imports from other ASEAN countries of commodities hitherto produced domestically behind protective tariff walls. This is the trade creation effect. On the other hand, the preferential treatment of imports within the ASEAN regwn can divert imports from non-ASEAN sources. This is the trade diversion effect.2 Since the tariff cuts, both item-by-item and across-the-board, have been carefully designed to ensure that they make no serious inroads into tariff protection for domestic producers, it must be assumed a priori that trade diversion effects greatly outweigh trade creation effects of intra-ASEAN trade liberalization. But this is not to deny that there may be some trade creation effects if the tariff cuts are carefully tailored to exert some competitive pressure from imports on domestic protected industries while avoiding serious injury.

2 For a theoretical treatment on Customs Union Theory, see Herbert G. Grubel, lnt11mational Economics, 1977 Irwin Series, USA.

- 3 -

In principle, therefore, it would be desirable to attempt to measure both trade creation and trade diversion effects. In practice, it is obviously too early to assess ex post what effects have actually occurred. Any such measurement must wait for some years. What this paper attempts to do is to estimate ex ante the maximum potential effects, both on trade creation and trade diversion, that can be expected from the new procedure of 20% across-the-board tariff reductions on small items. Section II outlines briefly the history of the moves towards intra-ASEAN trade liberalization by highlighting the policies of the five countries on the pace and method of liberalizing trade. Section III describes the Preferential Trading Arrangements agreed upon by the ASEAN Economic Ministers as the blueprint for cooperation in trade, and focuses on one of the techniques of trade cooperation, namely the item-by-item approach as the means to promote greater intra-ASEAN trade. Section IV attempts to estimate the possible trade creation effects by a simulation exercise using price elasticities of demand. Section V seeks to indicate the order of magnitude of maximum possible trade diversion effects by an illustrative study of data for the Philippines and Thailand. The latest proposal by the ASEAN Economic Ministers to study the implications of raising the cutoff ceiling to US$500,000 are also analysed. The conclusions of the study are presented in Section VI.

II:

POLICIES TOWARDS TRADE UBERAUZATION

Prior to the signing of the ASEAN PTA, in February 1977 the five countries held divergent views regarding the method and pace of liberalizing intraregional trade. The countries strongly in favour of an across-the-board trade liberalization were the Philippines and Singapore, while Indonesia and Malaysia favoured the cautious step-by-step approach to trade liberalization. Thailand was neutral, but tended to lean towards the former approach. Singapore is the foremost advocate of trade liberalization, largely for two reasons. First, its small domestic market for import substitution inhibits

-4 -

it from adopting a restnctive trade policy. Second, Singapore's role as the region's entrep6t centre means it is heavily dependent on international trade. In light of its dependence on international trade, Singapore has a very low tariff structure. In terms of tariff rates, it has the most rates falling within the 10% to zero range -- 93% of all such rates in the consolidated ASEAN schedule (The Philippines Tariff Commission, January 1979, preliminary). Based on a comparison of modes and weighted averages (weighted by country imports in 1976), its overall 'weighted average tariff rate of 3.7% ad valorem is 17.2% below the overall regional average of 20.9% {the weighted average for Indonesia IS 20.2%; Malaysia -- 6.6%; Philippines -- 23.0%; Thailand -- 30.4%). A similar stand is also adopted by the Philippines, although its average nominal and effective rates are considerably higher, 30% and 62% respectively. 3 As the Philippines is orientating towards ASEAN in its foreign and economic policies, the Philippine Government is willing to lower tariff levels to promote intraregional trade. This is also compatible with its recent export promotion programmes. Both Singapore and the Philippines thereby pressed for tariff reduction, export promotion and regional finance schemes. Indonesia and Malaysia opposed trade liberalization by tariff cuts across the board and advocated the more cautious item by item approach. Indonesia's stand is understandable in light of its less developed import substitution industries. In Indonesia, manufacturing {by industrial origin) accounts for only 12.3% of gross domestic product (GDP), compared with 21.3% for Thailand, 19.1% for Malaysia, 24.4% for the Philippines and 21.7% for Singapore (1978). 4 Indonesia fears that its market would be flooded by Filipino and Singaporean manufactures since its manufacturing sector is being sustained by very high levels of protection. The tariff rates in Indonesia, which are among the highest in the region, increase with the level of fabrication, probably including shelters for some industries with negative value added at world market prices.

3 R.M. Bautista, John H. Power & Associates, Industrial Promotion Policies in the Philippines (Manila: Philippine Institute for Development Studies, 1979). 4 Asian Development Bank, Key Indicators of Developing Member Countries of Asian Development Bank, Vol. X, No. 2 (October 1979).

- 5 -

Malaysia's attitude carnes with it certain inherent contradictions. Unlike Indonesia, Malaysia has a low rate of inflation, 6.4% (12 months to February 1980).5 Its modern manufacturing sector is generally efficient as evidenced by the quite spectacular expansion of its exports of manufactures. Its gross exports of manufactures grew by 36.8% in 1978 and 32.3% in 1979 and accounted for 20% of its total gross export earnings.6 Malaysia's tariff rates are rather moderate among the ASEAN countries. Malaysia's attitude can be partly explained in terms of domestic socio-political implications. It fears that trade liberalization would have an adverse effect on its growing bumiputra economy -- and partly by its sympathies for Indonesia, with which it shares common socio-cultural linkages. Thailand was neutral in principle, but tended to go along with the Philippines and Singapore. Despite Thailand's more severe modal tariff rates, it 1s willing to compromise by lowering tariff rates to promote intra-ASEAN trade. From the above analysis, it can be seen that the different priorities of each ASEAN country constitute obstacles to agreement on the pace and method of trade liberalization. While the preferential trading arrangements were going through a series of negotiations, Singapore, the Philippines and Thailand proceeded with preferential trading arrangements on a bilateral and trilateral basis. Singapore and the Philippines signed the first bilateral trade cooperation pact on 20 January 19 77, one week before the Third Economic Ministers' meeting in Manila. They agreed to implement mutual across-the-board preferential tariff reductions of 10% of existing tariffs on all products traded between them within the framework of ASEAN economic cooperation. Furthermore, on 1 February 1977, Singapore and Thailand agreed to a preferential tariff agreement on seven groups of products. Subsequently, these preferences were extended to the trilateral level providing for a tariff cut of 10% for about 1,700 items traded among these three countries. It was further agreed that the tariff preferences be extended to Indonesia and Malaysia on a unilateral basis. However, the trilateral

5 ABECOR, Country Report -- Malaysia, May 1980. 6 Bank Negara Malaysia, Annual Report & Statement of Accounts 1979.

- 6 -

agreement has not been implemented till now, and to all intents and purposes it has been superseded by the ASEAN Preferential Trading Arrangements.

III:

THE ASEAN PREFERENTIAL TRADING ARRANGEMENTS (PTA)

The signing of the Agreement on ASEAN PTA on 24 February 1977 carnes with it the objective of promoting greater economic cooperation and intraregional trade. This objective is to be effected by offering a range of trade concessions through the following provisions.

Instruments 1. Long-term quantity contracts. The ASEAN members are encouraged to undertake long-term, three to five years, supply contracts for basic commodities such as fuels and agricultural products, particularly rice. Commodities sold under these contracts enjoy preferential duties and priority supply in times of a worldwide shortage. An emergency sharing scheme for crude oil and/or oil products in situations of shortage or oversupply was drawn up in 1977. Similarly, Singapore, Malaysia, and Indonesia are given priority over non-ASEAN countries for Thailand's rice exports. Singapore and Thailand have concluded a bilateral long-term agreement for the preferential supply and purchase of maize m times of glut or shortage. 2. Purchase finance support. Trade financing at preferential interest rates could ultimately take the shape of a regional export-import bank extending credit to either exporters or importers of selected products that qualify for trade preferences. The government Committee on Finance and Banking (COF AB) and the private sector ASEAN Banking Council are discussing the possibility of setting up an ASEAN export-import bank. 3. Government procurement preferences. Each of the ASEAN members Issues pretender notices of government contracts to the other four. Moreover,

- 7 -

a preferential margin of 2.5% (not to exceed US$40,000) per bid is offered to ASEAN countries. A company operating in an ASEAN country was granted this concession recently, but the process involved was not automatic, indicating limitations of the scheme. 4. Tariff preferences. Initially, these are to be negotiated on a product by product basis, either multilaterally or bilaterally. Where bilateral concessions are agreed, they should be extended to the other ASEAN countries on an ASEAN most-favoured-nation basis. Now, tariff preferences are also negotiated for across-the-board reductions. Products of the ASEAN industrial projects and those included in ASEAN industrial complementation schemes will qualify for trade concessions, including but not limited to, tariff reductions. 5. Liberalization of nontariff trade barriers on a preferential basis.

Rules of Origin To be eligible for preferential treatment, products must meet certain rules of origin requirements. Three major groups can be identified: 1. Products wholly produced or obtained in ASEAN. These include mineral products extracted from ASEAN; agricultural products harvested there; animals born and raised there and products obtained from these animals; products obtained by hunting or fishing in ASEAN, marine products taken from the sea by ASEAN vessels (vessels at least 60% owned by ASEAN nationals); and waste and scrap resulting from ASEAN manufacturing operations. 2. Products partially produced or obtained in ASEAN. Products qualify for preferences if their final processing is carried out in an ASEAN country and if at least 50% of the f.o.b. value originates in that ASEAN country. Because Indonesia's manufacturing sector is so much less competitive than that of its trading partners, it has been given an additional measure of import protection. Products imported by Indonesia -- with a few exceptions -- must have 60% local content to qualify. 3. Products with components from more than one ASEAN country. For companies trying to rationalize production between various ASEAN countries, the origin requirements are somewhat different. Products made

- 8 -

from components originating in other countries of the association will be considered of ASEAN origin as long as the cumulative regional content is not less than 60% of its f.o.b. value. For example, if a product is assembled in the Philippines with components originating in Thailand, the product will have preferential access to the Malaysian market if the combined Philippine and Thai content is at least 60% of the f.o.b. value. The final processing must take place in an ASEAN country. Products included in ASEAN industrial complementation schemes and ASEAN industrial projects could have the origin requirements entirely waived, but this would be subject to negotiation. The ASEAN Automotive Federation is seeking the relaxation .of origin rules for products included in its complementation programme.

Escape Clauses The PTA agreement also provides an escape mechanism that allows the suspension of a country's tariff preferences in certain situations: 1. If the import of a product enjoying trade concessions is increasing at such a rate that it threatens "serious injury" to sectors producing similar products in the importing country.

2. If a country has overriding balance of payments problems and needs to protect its foreign exchange reserves by restricting imports. 3. If a country needs to limit exports of a certain product to ensure sufficient domestic supply; or 4. If a country feels one or more of the other member countries Is not fulfilling its obligations under the trade preference programme. Complaints can be made directly to the country or countries involved. If a satisfactory settlement is not reached within 60 days, the dispute is referred to the Committee on Trade and Tourism (COTT). COTT will then consult with the offending country. Where the situation is particularly serious, the aggrieved country can temporarily suspend the application of concessions by giving 30 days written notice.

- 9 -

In all the above situations except the last, tariff preferences must be suspended in a nondiscrimina tory manner within ASEAN.

Institutional Arrangements and Development of Procedures The ASEAN Committee on Trade and Tourism (COTT), established by the Third Meeting of Economic Ministers in January 1977, has been authorized and directed to conduct negotiations on products eligible for tariff concessions as well as to revie.w and supervise the implementatio n of the agreement. COTT ts assisted by a technical body, namely the Trade Preferences Negotiating Group. Under the agreement, there are two methods of liberalizing trade: 1.

Matrix approach

A country may make a specific request to and get a response from another country. The concessions initially negotiated bilaterally are subsequently "multilaterali zed" to include the other ASEAN countries.

2.

Voluntary approach

Each country volunteers a list of products for preferential treatment at each round of negotiations. Thus, prior to every meeting of the COTT, each of the five ASEAN Governments draws up a list of items on which it is willing to grant preferences to the other four. The list comprises products for which the other four countries have requested preferential treatment and on which the country will offer voluntarily to reduce tariffs. Once COTT has finalized the list, it passes it to the ASEAN Economic Ministers for final approval. At the Fourth Meeting of the COTT, the ASEAN countries identified 71 preferences of which 21 were negotiated, and 50 were based on voluntary offers of 10 products from each country. These preferences were considered relatively significant regional trade items, including textile products and garments, cement, rubber tyres, maize and palm oil. There were 38 manufactured products as against 28 primary commodities. These items according to 1976 trade values amounted to US$515 million in intra-ASEAN imports and US$501 million in intra-ASEAN exports; compared to their share of US$1.55 billion in the total ASEAN imports and US$2.26 billion in the total export. The list was implemented

- 10 -

effective 1 January 1978, with preferential rates varymg from item to item, and ranging from 10% to 30% of existing rates. At the same time, to accelerate the exchange of trade preferences and to accord preferences to ASEAN products vis-a-vis similar products from nonASEAN sources, the Economic Ministers agreed to focus future trade negotiations on products with good potential for import substitution in ASEAN. An inventory of products (in terms of the 6 digit Brussels Tariff Nomenclature [BTN] Code or equivalent Standard International Trade Classification [SITC] Code) from which member countries are prepared to negotiate would be drawn up based on the following guidelines: ( 1) The list would include products for which the value of retained imports exceed US$1 million; and (2) The list would exclude products for which there is surplus production m ASEAN and products considered sensitive by each member country. Further progress m the expansion of the PTA scheme was made at the Sixth Uune 1978, Jakarta) and Eighth ASEAN Economic Ministers' meeting held in September 1979 in Manila. Apart from the routine business of approving another 1,001 preferences for the PTA scheme, the Economic Ministers at the latter meeting were able to agree on some positive measures aimed at making the scheme more effective. First, they agreed to expand the number of preferences exchanged at each round of negotiations from 1 00 (previously 50) to 150. With negotiations held four times a year, the 50% increase in preferences would mean that ASEAN countries will be adding 3,000 new preferences annually instead of the previous figure of 2,000. Second, the Economic Ministers agreed to consider deeper tariff cuts under the PTA. Third, it was decided to do away with "lightly traded" items which were often offered under the voluntary offer system. Henceforth all items having import values of less than US$50,000 each, based on 1978 trade statistics, would automatically be inckded under the PTA. Fourth, the Economic Ministers also agreed that positive actions should be taken to reduce nontariff barriers that tend to inhibit trade· among the ASEAN countries. The above decisions laid the groundwork for the Ninth ASEAN Economic Ministers meeting held in April 1980 in Singapore to take concrete measures to develop the PTA scheme. As expected, the Ministers approved the addition of

- 11 -

1,498 preferences to be implemented with effect from 22 July 1980. Thus, within a period of 2¥2 years, the list of trade preferences grew from 71 to 4,325. A summary of items implemented and the respective dates of implementation are presented in Table 1

Table 1: Number of Items Implemented by Countries

Total Number of

Dates of Implementation

1 January 1978 1 September 1978 15 March 1979 10 December 1979 1 April 1980 22 july 1980 24 January 1981

Indonesia

Malaysia

Philppinca

Slnppon:

Thailand

15 152 100 200 100 300 300

15 148 100 201 100 279 296

14 149 100 200 100 266 248

13 156 100 200 100 293 294

14 150 100 200 100 188 297

755 500 1,001 500 1,326 1,435

1,167

1,139

1,077

1,156

1,049

5,588

Items Implemented

71

The highlight of the meeting, however, was the agreement to accord tariff cuts of 20% across-the-board on "lightly traded" items, defined as all items having import values of less than US$50,000 each in 1978. These tariff cuts on items totalling 6,188 in number came into effect on 22 July 1980. Malaysia headed the list with 1,717 items, followed by the Philippines (1,625}, Thailand (1,509), Indonesia (743) and Singapore (584). It was hoped that by avoiding the administrative delays of the selective approach, the new method · would facilitate the process of substantially increasing the number of commodities for which the member countries extend tariff preferences to each other.

- 12 -

IV:

EVALUATION OF THE MAXIMUM POTENTIAL TRADE CREATION EFFECI'S OF A 20% ACROSS-THE-BOARD TARIFF REDUCTION

Based on the number of items for which trade preferences have been implemented, ASEAN's performance in liberalizing intra-ASEAN trade has indeed been impressive. However, the success of the PTA scheme should not be judged by the number of trade preferences that are exchanged and implemented but rather by its impact on trade expansion. Seiji Naya {1980) computed the effects of tariff reduction on the first three batches of preference items and found the expansionary effects to be negligible. In this section, the impact of the 20% across-the-board tariff reduction on trade creation will be examined more closely. 7 Since the required data are not available for Indonesia and Malaysia, and tariff structures are already low in Singapore, the study considers the cases of only two countries, the Philippines and Thailand.

Analytical Framework Theoretically, trade liberalization can exert a twofold stimulus on ASEAN trade -- trade creation at the expense of domestic producers and trade diversion at the expense of non-ASEAN exporters. The first effect is usually estimated ex ante by using import demand elasticities. The import expansion effects due to a tariff cut can be derived from the comparative statics of an aggregate import demand function for commodity {SITC) group i which can be written as (1)

where M1 = quantity imported, plm = price of import in domestic currency, X = all other factors affecting import demand. To estimate the expansion effects of a tariff reduction, assume that (1) countries under discussion are small open economies and hence are price takers in world markets, and (2) tastes and technology remain unchanged.

1 For the convenience of the readers, the 20% across-the-board tariff reduction on all items with import value below US$50,000 is referred to as "the new tariff reduction".

- 13 -

Differentiating equation (1) with respect to tl (average rate on commodity group i) gives the change in import quantity of i due to a tariff cut as d Mi

=

dti

=

where ni d

=

af

d Pb

aPIm

dti

pi ni MI d m d pi dti m

oMI

pi m

oPIm

MI

(2)

IS the price elasticity of import demand.

Given by assumption the importing country IS a pnce taker m world markets we can write -I -i pi = Pm (1 + t 1), where P m = world price m d pi

so

that~=

dt 1 Then substituting m equation (2) we get

(3)

Also by definition import value of commodity group i, MVI and

d MVi=

-I equal to pm MI

-1

pm d MI

Substituting this value we get dMV1 =

IS

ni d

Ill

equation (3) dt1 (1 +

MVI t 1)

(4)

- 14 -

where MVI

=

the original import value of commodity group increase in import value of group i

=

reduction in average tariff rate on commodity group

=

the original average tariff level on commodity group i

=

the price elasticity of import demand of commodity group

Equation (4) indicates that the direct effect of tariff reduction on commodity group i depends on the level of original tariff ( ti) and the price elasticity of import demand. The equation however assumes that the tariff cut at a uniform rate applies to all commodities in group i. In order to use this formula in the case of a 20% cut for items less than US$50,000 in import value only, the following modification has to be made. The original average tariff rate on commodity I, (ti) 0 , can be written as =

m . 2: w! . 1 J J=

where subscriptsj ~d k m:e respectively and wj and in group i. Since the 20% values are less than 50,000,

wk

(tih

=

m 2: j=1

w!J

tl J

n

z:

+

{5)

k=m+1

items in group i with import values ~50,000 are the weights based on import shares of j and k tariff cut is applied only to items j w~ose import the new weighted average tariff rate (t1)} Is, m

tJ (1-.2) +

E

k=m+1

~k

tk

(6)

From equations (5) and (6), we get (tih

=

(t1)o - .2

m 2: j=1

wj

tl ]

=

Substituting this value m equation 4, we get

(7)

(8)

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llMV1

. -.2 rw! tl n ~ [ ___J__ J -1 (MV1)

=

(9)

Data on ti•s are not directly available. If we assume that tl's and tl 's J J k are equal for all j's and k's so that tj = tk = (ti) 0 we obtain

(10)

By definition f!MV 1

=

f!MVj + flMVk.

Since tariff cut applies only to j's,

flMVk_ = 0 f!MV

1

=

·8

f!MV}

The new tariff reduction applies only to imports from ASEAN, and so the parameters in equation (10) must relate only to ASEAN. Parameters relating only to ASEAN however, are difficult to obtain because of data limitations. Hence, we make a bold assumption that the values are the same from ASEAN as from the rest of the world. Such assumptions regarding tariff rates and elasticity estimates have been made in the studies of Naya, Bautista, and Akrasanee in a similar context.

8 Alternatively the average tarjff rate for commodity group i can be defined in tenns of simple average tariff rate (8 1) 0 if we assume that (SI) is the same for all j's and k's. 0

MV~ .I

Since in this fonnula we are assuming that the 20% cut is across-the-board for all j's and k's, the estimate derived by using it is an overestimate.

(11)

- 16 -

Results of Estimation In order to use equations (10) and (11), preliminary calculations have to be made:

(a) Items whose import value from the world is less than US$50,000 each in 1978 trade statistics have to be selected. For Thailand, the annual import data in baht had to be converted into U.S. dollars by using the average annual exchange rate based on the International Monetary Fund (IMF) data. The selection of items is based on the annual import trade data of the respective countries. In the case of the Philippines, the items were selected at the seven digit SITC level of disaggregation while for Thailand, the items were selected at the six digit BTN level. In the latter case, the selected items were matched with the equivalent SITC level of product disaggregation. The selected items (1,385 in the Philippines' total, and 969 in Thailand's)were then classified into SITC one digit commodity groups. The items we have selected are independent of the official list of items for all ASEAN countries which is not available as yet. It must be noted that this computed list could differ substantially from the official list because the items in the latter list have to meet the "rules of origin" and escape clauses requirements. (b) Elasticity estimates of items selected at the six and seven digit level of disaggregation used in this study are simply not available. Therefore, data on the price elasticities of import demand by one digit SITC groupmg were used. These estimates were obtained from available sources. They are presented in Table 2. (c) The simple and weighted average tariff rates for both the Philippines and Thailand computed by the Philippine Tariff Commission (using import values in 1976) are used as proxy estimates in our computational exercise. These are presented in Table 2. The results of our calculations are presented in Tables 3 and 4. In view of the number of qualifications and assumptions that had to be made m our computational exercise, the results for the Philippines and Thailand are only rough estimates and should be interpreted with caution. In Tables 3 and 4, the maximum potential trade creation effects of the 20% across-the-board tariff cuts for each SITC one digit level are presented. In addition to these calculations, the effects on total imports were also estimated as the weighted

Table 2: Available Estimates of Price Elasticities of Import Demand and Average Tariff Rates: The Philippines and Thailand

Price Elasticity of Import Demand

SITC

Philippines 1

-1.236 -0.462 -3.640 -1.206 -0.015 -0.383 -4.260 -0.703 -0.422 n.a.

0 1 2 3 4 5 6 7 8 9

Philippines3

n.a. -0.4886 -2.6947 n.a. n.a. n.a. -0.4061 -1.1188 -1.4841 -1.7914

67.2 62.5 27.4 14.9 43.9 41.1 52.0 23.0 68.9 62.5

42.6 62.4 18.4 14.2 24.7 28.1 32.0 18.0 37.8 20.8

22.5 99.8 13.8 19.7 30.0 20.3 28.1 22.8 28.3 82.0

34.3 68.9 7.2 1.2 23.0 19.3 20.1 32.5 30.3 29.5

44.2

29.4

23.0

30.4

Note:

1 Bautista and Annas (1978). 2 Akrasanee (1978). 3 ehilippine Tariff Commission (1979) n.a.

- not available.

Thailand3

Weighted Average Tariff Rate (in %)

Thailand2

Overall

Sources:

Simple Average Tariff Rate (in %)

Philippines3

Thailand3

1-' -...)

Table 3:

SITC*

0 1 2 3 4 5 6 7 8 * 0 1 2 3

The Philippines:

Total Number of Selected Items

228 16 78 9 18· 181 420 213 222 --

Total Import Value of Items Selected

Estimates of Maximum Potential Trade Creation Effects

Trade Creation Effec:ts

Total Import Value of all Items

Weighted Averages

~MV!=

Mv! J (US$) (a)

Mvi

J. ~MV 1

(US$) (b)

(US$) (d)

1,560,015 281,910 1,077,188 60,319 322,494 2,957,352 6,799,845 3,773,973 3,077,411

346,092,329 47,019,305 258,459,324 1,089,784,565 14,941,738 575,132,663 761,579,276 1,411,143,144 137,188,793

Food and live animals Beverages & tobacco Crude materials, inedible Mineral fuels, lubricants

4 5 6 7 8

-· -

70,831 13,011 95,095 2,394 223 38,226 1,270,854 98,519 57,291

Simple Averages

~Mvj_J

~MVi/

MV~

MVi

J

(%) (d/b) 4.54 4.62 8.83 3.97 0.07 1.29 18.69 2.61 1.86

Animal, vegetable oil & fats Chemicals Basic manufactures Machineries & transport equipment Miscellaneous manufactured goods

~Mv!= J.

~Mvl!

~MVi/ MVi

(%) (d/c)

(US$) (d)

Mv! J (%) (d/b)

0.02' 0.03 0.04 0.00 0.00 0.00 0.17 0.00 0.04

154,992 10,018 168,656 1,886 295 65,985 1,981,975 99,221 105,954

9.93 3.55 15.66 3.13 0.09 2.23 29.15 2.63 3.44

1

~MV

(%) (d/c) 0.04 0.02 0.07 0.00 0.00 0.01 0.26 0.00 0.08

00

Table 4:

SITC*

Thailand:

Total Number of Items Eligible for Tariff Cut

Estimates of Maximum Potential Trade Creation Effects

Total Import Value of Items Eligible for Tariff Cut

Total Import Value of all Items

J (US$) (a)

Weighted Averages

Simple Averages

,1MVj/

{iMVi I

IJ.MV

MV~

Mvi

(US$) (b)

(US$) (d)

(%) (d/b)

(%) (d/c)

MVi

MV~

Trade Creation Effects

.1Mv! =

J.

1

J

{iMV!= )

liMVj

I

IJ.MVi/ MVi

{iMV1

Mv!

(US$) (d)

(%) (d/b)

(%) (d/c)

J

1

12

149,874

72,301,120

5,627

3.8

0.01

5,975

4.0

0.01

2

105

1,457,364

1,496,141,735

122,060

8.4

0.01

52,753

3.6

0.00

6

423

5,772,356

46,814,147

133,656

2.0

0.24

78,464

1.4

0.17

7

133

2,385,101

716,874,583

81,410

3.4

0.01

130,905

5.5

0.02

8

259

4,264,384

1,660,016,095

347,210

8.1

0.02

294,339

6.9

0.01

9

37

394,986

297,990,256

24,367

6.2

0.01

32,237

8.2

0.00

*

1 - Beverages & tobacco 2 -- Crude materials, inedible 6 - Basic manufactures 7 - Machinerka & transport equipment 8 - Miscellaneous manufactured goods 9 - Goods not classified elsewhere

......

1.0

- 20 -

averages of the effects on each SITC one digit level. The weights used were the normalized share of each SITC group on total imports (SITC 0-9) of the country. This computation was also used to estimate the maximum overall creating effects for items < 50,000. Several findings emerge: (1) The maximum overall trade creation effects on total imports (SITC 0-9) are negligible for both the Philippines (0.06%) and Thailand {0.02%). (2) In the case of the Philippines, although the data in column (dfh) indicate that the estimated effect of the tariff cut is to increase imports of commodities less than 50,000 between 0.1% to 19% (with the highest for SITC 6), the contribution of such effects on total imports of each SITC group (column dfc) is insignificant (0% to 0.2%). (3) Similarly the trade creation effect for 1.4% to 8.2% (with the effects on total imports

Thai data in column (dfb) indicate a relatively high imports of commodities less than 50,000 ranging from highest for SITC 9), but the contribution of such of each SITC group is negligible (0% to 0.17%).

(4) The results based on simple averages are generally similar to those using weighted averages for both countries (Table 3, column d/b and dfc; Table 4, column dfh and d/c). The above analysis has clearly shown that the effects of a 20% acrossthe-board tariff reduction on the Philippines' and Thailand's total imports are negligible. If similar estimates were made for the other ASEAN countries, the results would almost certainly not differ substantially for Singapore and Malaysia, both of which have a relatively low tariff structure. The potential trade creation effect is larger in the case of Indonesia, because of its high tariff protection for domestic producers. But it is important to remember that it is the policy of the Indonesian Government to prevent serious adverse effects on domestic producers. If the present set of tariff cuts threatened such effects, Indonesia would almost certainly insist on adjustment. It is perhaps encouraging to note that at the Tenth ASEAN Economic Ministers' Meeting held in October 1980 in Bangkok, new approaches to intraASEAN trade expansion have been considered. Two major proposals were noted. First, all the items that have already been endorsed under the PTA should enjoy a deeper tariff cut of up to 25%. At present, most of them

- 21 -

enjoy only a 10% preferential margin. Second, the meeting decided to study the implications of raising the cutoff ceiling from US$50,000 to US$500,000 so that all items with an import value below this would enjoy a preferential margin of 20%. In light of this latter proposal, a sensitivity analysis for the Philippines

was incorporated to estimate the effects of raising the ceiling to US$100,000; US$300,000; and US$500,000 and increasing the tariff cut to 30%, 50% and 100%. Owing to data limitations such an attempt was not made for Thailand. The results for each SITC group are presented in the appendix. Table A.3 indicates that the proposal to raise the cutoff ceiling to US$500,000 and granting a 20% tariff cut is estimated to lead to a slightly greater creating effect on the imports of all items below this import value (see column dfh). Also, the relative trade creation effects on imports of each SITC group show a slightly greater increase (see column d/c in Table A.3) as compared to the data in column d/c in Table 4. Table 5 summarizes the major findings of the maximum potential trade creation effects on total imports (SITC 0-8) for levels of tariff cuts ranging from 10% to 100% and cutoff ceiling ranging from US$50,000 to US$500,000. Figure 1 presents the summary graphically. Two notable features can be observed. First, the proportion of cutoff items as a percentage of total imports is low. Items with import value of less than US$500,000 form only 5.17% of total imports. Second, the maximum possible trade creation effect is low even with a high tariff cut. A complete removal of tariffs for all items with import value of less than US$500,000 results only in a 2% increase.

V:

AN ILLUSTRATIVE STUDY OF DATA OF MAXIMUM POTENTIAL TRADE DIVERSION EFFECTS

Trade diversion which is a cross pnce effect is much more difficult to estimate as it requires estimates of substitution elasticities. Such estimates arc at present not available. Consequently, a method was rlcvised to indicate thl' order of magnitude of maximum possible trade diversion effects by an

Table 5:

s11mmary

oi Estimated Maximum Potential Trade Creation Effects on Total Imports for the Philippines

Cutoff Ceiling ('000 US$) 50

Number of items less than cutoff ceiling Total value of these items (US$)

% of total imports (0-8)

100

1,946

1,385 19,910,507

56,576,581 1.22

0.43

300

2,466 148,333,516 3.20

500

2,702 239,805,512 5.17

Absolute (relative in % in parenthesis) expansionary effect of a hypothetical tariff reduction of

1'.:1 1'.:1

10%

823,225 (0.02)

2,599,268 (0.06)

6,149,201 (0.13)

9,216,705 (0.20)

20%

1,646,444 (0.04)

5,198,191 (0.11)

12,298,401 (0.26)

18,433,411 {0.40)

30%

2,469,671 (0.05)

7,797,285 (0.17)

18,420,602 (0.40)

27,650,114 (0.60)

50%

4,119,117 (0.09)

12,995,480 (0.28)

30,746,005 (0.66)

47,486,078 {1.02)

100%

8,232,232 {0.18)

25,990,957 (0.56)

61,492,011 (1.32)

92,167,051 (1.99)

- 23 -

Figure 1:

Estimated Maximum Potential Trade Creation Effects of Varying Preferential Levels

Creation of total imports (%) 2.0 1.8 1.6 1.4

1.2 1.0 0.8 0.6

Preferential Tariff Cut (%)

- 24 -

illustrative study of data for the Philippines and Thailand. Both the Philippines and Thailand's imports of items less than US$50,000 are categorized into ASEAN and non-ASEAN imports. The share of non-ASEAN in total imports of these items indicates the maximum limit for possible trade diversion from non-ASEAN to ASEAN. Obviously, it is possible that ASEAN trade liberalization may not lead to any trade diversion at all for certain commodities in our static analysis. 9 This IS likely if there are no ASEAN producers of particular commodities. Again, the price of a commodity including tariff imported from a non-ASEAN source may be lower than the price of a similar commodity from ASEAN even after the tariff cut_ In other words, the 20% tariff reduction may not be a sufficient incentive to induce ASEAN producers to manufacture that product. Clearly, therefore, our estimate of the maximum possible trade diversion effect indicates only outer limits. Actual trade diversion effects will be much smaller and may be only a fraction of these maximum potential effects.

Results of Estimation The results of the maximum possible trade diversion effects for the Philippines and Thailand (Tables 6 and 7) are: (1) The maximum overall trade diversion effect on total imports (SITC 0-9) is less than one percent for both the Philippines (0.38%) and Thailand (0.65%). (2) In the case of both the Philippines. and Thailand, the data indicate a high maximum trade diversion potential (98.21 %) and (9 7.98%) respectively for items below US$50,000. (3) The share of items below US$50,000 in Thailand's total imports substantially higher than in the Philippines' case (0.67% as against 0.39%).

IS

One reason for the high trade diversion effects in the case of

9 It is obviously too early to assess ex post what ef£ects have actually occurred. measurement must wait for several years.

Any such

Table 6:

SITC

Estimates of Maximum Potential Trade Diversion Effects for Items < 50,000

Philippines:

Total Number of Items Selected

Imports from A SEAN US$

Imports from Non-ASEAN US$

Total Import Value of Items < 50,000 US$

Share of Non-ASEAN Imports %

0

228

34,600

1,525,415

1,560,015

97.78

1

16

469

281,441

281,910

99.83

2

78

28,683

1,048,505

1,077,188

97.34

3

9

--

60,319

60,319

100.00

4

18

758

321,736

322,494

99.76

5

181

32,940

2,924,412

2,957,352

98.87

6

420

173,640

6,626,205

6,799,845

97.45

7

213

47,052

3,726,921

3,773,973

98.75

8

222

40,135

3,037,276

3,077,411

98.70

9

17

566

115,372

115,938

99.51

0-9

1,402

358,843

19,667,602

20,026,445

98.21

Philippines' Total Imports

= 5,143,358,231

Share of Non-ASEAN Imports for Items

< 50,000 = 0.38%

N) (,J1

Table 7:

SITC

Thailand: _Y,slimates of Maximum Potential Trade Diversion Effects for Items < 50,000

Total Number of Items Selected*

Imports from ASEAN US$

Imports from Non-ASEAN US$

Total Import Value of Items timates of ~Ltxit,hl!l!_Potential Trade Creation Effects

Toble .\.):

____ ________ "

~o.

SITC*

Total Im1H)rt

of ltems

-------

-

~----------------

Creation Effects Based on Weighted Average of

Total Import

Eligible f0