Roadmap to an ASEAN Economic Community 9789812306388

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Roadmap AEC Titlepgs.fh11 9/8/05 10:34 PM Page 2

Roadmap

to an

ASEAN

Economic Community

The Institute of Southeast Asian Studies (ISEAS) was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the many-faceted problems of stability and security, economic development, and political and social change. The Institute’s research programmes are the Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), and Regional Social and Cultural Studies (RSCS). ISEAS Publications, an established academic press, has issued more than 1,000 books and journals. It is the largest scholarly publisher of research about Southeast Asia from within the region. ISEAS Publications works with many other academic and trade publishers and distributors to disseminate important research and analyses from and about Southeast Asia to the rest of the world. ii

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Roadmap AEC Titlepgs.fh11 9/8/05 10:34 PM Page 1

Roadmap to an ASEAN

Economic Community Edited by Denis Hew

I5ER5 Singapore

INSTITUTE OF SOUTHEAST ASIAN STUDIES

First published in Singapore in 2005 by ISEAS Publications Institute of Southeast Asian Studies 30 Heng Mui Keng Terrace Pasir Panjang Singapore 119614 E-mail: [email protected] Website: http://bookshop.iseas.edu.sg All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies. © 2005 Institute of Southeast Asian Studies, Singapore The responsibility for facts and opinions in this publication rests exclusively with the editor and contributors and their interpretations do not necessarily reflect the views or the policy of the Institute or its supporters. ISEAS Library Cataloguing-in-Publication Data Roadmap to an ASEAN Economic Community / edited by Denis Hew. A collection of papers originally presented at the ASEAN Roundtable 2003 on Roadmap to an ASEAN Economic Community, organized by ISEAS, 20–21 August 2003, Singapore. 1. Southeast Asia—Economic integration—Congresses. 2. Southeast Asia—Foreign economic relations—Congresses. I. Title: ASEAN Economic Community II. Hew, Denis. III. Institute of Southeast Asian Studies. IV. ASEAN Roundtable (2003 : Singapore) HC441 A843 2003 2005 ISBN 981-230-347-2 Typeset by Superskill Graphics Pte. Ltd. Printed in Singapore by Oxford Graphic Printers Pte Ltd iv

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Contents Acknowledgements

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Contributors

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Foreword by K. Kesavapany

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Introduction: Roadmap to an ASEAN Economic Community Denis Hew

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ASEAN Economic Community: Concept, Costs, and Benefits Hadi Soesastro

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Creating an ASEAN Economic Community: Lessons from the EU and Reflections on the Roadmap Michael G. Plummer

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Institutional Reforms to Achieve ASEAN Economic Integration Narongchai Akrasanee and Jutamas Arunanondchai

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ASEAN Economic Community: Political and Security Implications Mely Caballero-Anthony

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ASEAN Economic Community: Perspective from ASEAN’s Transitional Economies Vo Tri Thanh

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Role of AFTA in an ASEAN Economic Community Jose L. Tongzon

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Contents

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FDI and the Free Movement of Investments in ASEAN Tham Siew-Yean

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Services Trade Liberalization in ASEAN Christopher Findlay

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Labour Mobility within ASEAN: Issues and Policy Implications for the ASEAN Economic Community Carunia Mulya Firdausy

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ASEAN Economic Community: Implications for Poverty Reduction in Southeast Asia Abuzar Asra, Gemma Esther Estrada, and Ernesto M. Pernia

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Financial Integration in ASEAN and Beyond: Implications for Regional Monetary Integration Ramkishen S. Rajan

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Appendix: ISEAS Concept Paper on the ASEAN Economic Community

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Index

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Acknowledgements I would like to thank the chapter writers for their valuable contributions. Their papers were first presented at the ASEAN Roundtable 2003 in Singapore on 21–22 August 2003. The Roundtable — from which this book emanates — brought together academics and experts on economic integration to discuss pertinent issues as well as identify new strategies and policies that would contribute towards realizing the ASEAN Economic Community by 2020. My thanks also to the Roundtable discussants for their valuable comments on the papers presented. I am grateful to the administrative staff of ISEAS, especially Karthi Nair, who worked tirelessly to ensure that the Roundtable ran smoothly. I would like to thank Mely Caballero-Anthony for her editorial assistance and advice. My sincere thanks also go to the staff in the ISEAS Publications Unit for their valuable support in getting this book published. Finally, this project would not have been possible without the generous support of Konrad Adenauer Stiftung. I would like to express my appreciation for their continued support.

Denis Hew Editor

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Contributors Narongchai Akrasanee is Chairman, Seranee Holdings Co. Ltd. and MFC Asset Management Plc, Bangkok. Jutamas Arunanondchai is Senior Researcher, Fiscal Policy Research Institute Foundation, Bangkok. Abuzar Asra is Senior Statistician, Economics and Research Department, Asian Development Bank, Manila. Mely Caballero-Anthony is Assistant Professor, Institute of Defence and Strategic Studies, Singapore. Gemma Esther Estrada is Staff Consultant, Economics and Research Department, Asian Development Bank, Manila. Christopher Findlay is Professor of Economics, Asia Pacific School of Economics and Government, Australian National University, Canberra. Carunia Mulya Firdausy is Lecturer at the Faculty of Economics, University of Indonesia and the University of Tarumanagara and Research Professor in Economics, Indonesian Institute of Sciences, Jakarta. Denis Hew is Fellow and Co-ordinator, Regional Economic Studies, Institute of Southeast Asian Studies (ISEAS), Singapore. Ernesto M. Pernia is Professor of Economics, University of the Philippines. viii

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Contributors

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Michael G. Plummer is Professor of International Economics, Johns Hopkins University SAIS, Bologna. Ramkishen S. Rajan is a Visiting Associate Professor at the Lee Kuan Yew School of Public Policy, National University of Singapore. Hadi Soesastro is Executive Director, Centre for Strategic and International Studies (CSIS), Jakarta. Tham Siew-Yean is Professor and Senior Research Fellow, Institute of Malaysian and International Studies (IKMAS), Bangi. Jose L. Tongzon is Associate Professor, Department of Economics, National University of Singapore. Vo Tri Thanh is Director, Department for Trade Policy and International Integration Studies, Central Institute for Economic Management (CIEM), Hanoi.

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Foreword At the Ninth ASEAN Summit in October 2003, ASEAN leaders agreed to establish an ASEAN Community (AC) by 2020 (Bali Concord II). This community encompasses three major components or “pillars”, namely: 1. The ASEAN Security Community (focusing on regional political and security co-operation) 2. The ASEAN Economic Community (focusing on regional economic integration) 3. The ASEAN Social-Cultural Community (focusing on regional sociocultural co-operation) In line with the ASEAN Vision 2020 statement, the creation of an AC would ensure closer, more comprehensive, and mutually beneficial integration among ASEAN member states and their peoples. It would strengthen the basis for peace, stability, security, development, and prosperity within the region as well as enhance the regional coherence and competitiveness in the face of new challenges unleashed by globalization and the rise of new economic powerhouses in Asia. However, achieving the end goal of the ASEAN Community will be challenging, given the region’s cultural diversity, different levels of economic development, and variations in strategic outlooks and external affiliations. Translating such diversities into “equitable development opportunity and prosperity” (to which the Bali Concord II also aspires) will not be an easy task. The High-Level Task Force on ASEAN Economic Integration has produced a plan of action to kick-start the ASEAN Economic Community (AEC) project. The plan of action provides numerous policy recommendations x

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to be implemented over the next few years. At the track-two level the Institute of Southeast Asian Studies (ISEAS) and ASEAN–Institute of Strategic and International Studies (ISIS) have contributed concept papers on the AEC. Against this backdrop, ISEAS organized the ASEAN Roundtable in Singapore on 21–22 August 2003. The objective of the annual ASEAN Roundtable, which was first initiated by ISEAS in 1988, is to review major developments in ASEAN and to explore new directions for ASEAN economic co-operation in the light of the rapidly changing global environment as well as in terms of the emerging domestic economic situation and needs. The theme chosen for the ASEAN Roundtable 2003 was “Roadmap to an ASEAN Economic Community”. Dr Vivian Balakrishnan, Minister of State for National Development and Trade and Industry, delivered the keynote address. This book reflects the main findings that emerged from the ASEAN Roundtable 2003. I hope it is of interest to policy-makers and all those who have an interest in the future of ASEAN.

K. Kesavapany Director ISEAS

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Introduction: Roadmap to an ASEAN Economic Community Denis Hew

1. Introduction At the Ninth ASEAN Summit in Bali on 7 October 2003, the ASEAN leaders had agreed to establish an ASEAN Economic Community (AEC) by 2020. The AEC is one of three pillars — the other two being the ASEAN Security Community and the ASEAN Socio-cultural Community — that make up the ASEAN Community (Bali Concord II). In line with the economic aspect of the ASEAN Vision 2020, it is envisaged that the AEC would be a single market and production base with a free flow of goods, services, investments, capital, and skilled labour by 2020.1 The ASEAN Economic Ministers’ High-Level Task Force (HLTF) on Economic Integration had unveiled bold and ambitious economic initiatives with clear deadlines (many within the following two years) to expedite the economic integration process to realize the AEC. These initiatives (annexed to the Bali Concord II) include: • • •

Fast-track integration of eleven priority sectors Faster customs clearance and simplified customs procedures Elimination of barriers to trade

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Accelerated implementation of the Mutual Recognition Arrangements (MRAs) for key sectors (for example, electrical and electronic equipment and telecommunications equipment) Harmonization of standards and technical regulations

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The eleven priority sectors earmarked for fast-track integration are: woodbased products, automotives, rubber-based products, textiles and apparels, agro-based products, fisheries, electronics, e-ASEAN, health care, air travel, and tourism. In 2003 these eleven sectors accounted for more than 50 per cent of intra-ASEAN trade. At the Tenth ASEAN Summit in Vientiane on 29 September 2004, the framework agreement for the integration of these priority sectors was signed. Under this agreement, tariffs under the Common Effective Preferential Tariffs (CEPT) Scheme for products in these sectors would be eliminated by the ASEAN-Six (that is, Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand) by 2007 and by 2012 for the newer members of ASEAN (that is, Cambodia, Laos, Myanmar, and Vietnam).2 These deadlines are three years earlier than the original target under the ASEAN Free Trade Area (AFTA) and the agreement covers about 4,000 tariff lines, or about 40 per cent of the total tariff lines in ASEAN. In the area of trade in goods, improvements in the CEPT Scheme Rules of Origin (ROO) would be finalized by 2004. This would include making the ROO more transparent, predictable, and standardized and taking into account the best practices of other regional trading arrangements (RTAs), including the World Trade Organization’s (WTO) ROO. To ensure transparency on non-tariff measures (NTMs) and eliminate those that are barriers to trade, the following measures would be undertaken over the next two years: • • • •

Establish an ASEAN database on NTMs Set clear criteria to identify measures that are barriers to trade Set a clear and definitive work programme for the removal of such barriers Adopt the WTO agreements on Technical Barriers to Trade, Sanitary and Phyto-Sanitary and Import Licensing Procedures, and develop implementation guidelines appropriate for ASEAN

One of the most important recommendations by the HLTF was the creation of a more effective dispute settlement mechanism (DSM) with powers to make legally binding decisions in resolving trade disputes among member states. The number of trade disputes would likely rise significantly as the region moves towards a higher level of economic integration. Hence, a

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credible DSM would be absolutely critical for the AEC to succeed. The following measures would be undertaken to enhance the DSM:3 • •

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Establish a legal unit within the ASEAN Secretariat to provide legal advice on trade disputes Establish the ASEAN Consultation to Solve Trade and Investment Issues in order to provide quick resolution to operations problems (this would be similar to the European Union [EU] mechanism) Establish the ASEAN Compliance Body

The complete depoliticization of the DSM process — one of the main aims of the new enhanced DSM — would be a difficult task.4 Even in the WTO, where proceedings are more legalistic, disputes among member countries continue to be politically charged (Hsu 2003). The other concern is whether there would be sufficient funding to implement the new DSM system. Hsu (2004) argues that although the enhanced DSM is an important development, it deals with the final stage of the dispute process where obligations are asserted and challenged. But what needs serious attention is the establishment of these obligations in clearly enforceable forms — otherwise there would be nothing to enforce despite the existence of a strong depoliticized DSM. Besides the ASEAN minus X formula, ASEAN may also use the “Two plus X” approach where two member countries that are ready to integrate certain sectors can go ahead first. In fact, the latter approach would particularly benefit Thailand and Singapore as both countries are keen to expedite economic integration and realize the AEC before 2020. However, this approach could be problematic as it does not require a consensus among all member countries (unlike the ASEAN minus X principle). The other concern is that the bilateral nature of this process could lead to a fait accompli where the third “plus X” country may be bound by whatever has already been agreed by the first two countries (Hew and Sen 2004). Notwithstanding the concerns raised above, the economic initiatives recommended by the HLTF were formulated with the business community in mind. For example, faster customs clearance and the harmonization of product standards and technical regulations are clearly aimed at reducing the transactions cost of doing business in the region to make it attractive to multinational corporations (MNCs) as well as domestic enterprises that want to become regional players. Aside from tariff elimination, the ASEAN framework agreement to integrate the eleven priority sectors would focus on trade and facilitation measures that would reduce business costs in ASEAN.

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Why form such an economic community? In this increasingly competitive environment, there are deep concerns that Southeast Asia would be overtaken by the emerging market economies of China and India. In particular, there is a growing perception that foreign direct investment (FDI) inflows are being diverted away from ASEAN towards China. According to UNCTAD (2004), China is now the world’s largest recipient of FDI — the country received US$53.5 billion in FDI inflows in 2003 compared to ASEAN’s US$19 billion. Against this backdrop, the AEC comes at an opportune time. It could provide the means for ASEAN economies to revitalize and remain competitive in the face of growing economic challenges. An integrated ASEAN with a sizeable market of over 500 million people should retain the region’s attractiveness as an FDI destination and revitalize production networks in the region. An integrated ASEAN could become an alternative to China as a regional production base for MNCs. Some have referred to this as the “China plus One” formula as MNCs would prefer to diversify their risk by investing in an alternative regional site rather than “put all their eggs” in one basket and invest solely in China. Achieving a higher level of economic integration may seem daunting at first glance but ASEAN is not starting from scratch. This is because ASEAN has already put in place potential building blocks towards achieving the AEC. These potential building blocks would include economic integration initiatives such as the ASEAN Free Trade Area (AFTA), ASEAN Framework Agreement on Services (AFAS), and the ASEAN Investment Area (AIA). Looked at holistically, the formation of an AEC could be seen as a logical step up the economic integration ladder. 2. ISEAS Concept Paper In February 2003 the Institute of Southeast Asian Studies (ISEAS) prepared a concept paper on the AEC. The main objective of this paper was to flesh out the idea of the AEC. The ISEAS Concept Paper argued that the end goal of an AEC by 2020 would not be a customs union like the European Economic Community of the 1950s. Basically, a customs union is a group of countries where trade barriers among member countries are removed and a common external tariff policy is established with non-member countries. It is one integration level above a free trade area (FTA) where tariffs are harmonized among member countries, but they are allowed to have different tariffs with non-members.

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Given the different degrees of openness and stages of economic development among ASEAN countries, forming a customs union would be extremely difficult to achieve by the given deadline. Instead, it would be more realistic to envisage the AEC as an “FTA plus” arrangement that covers a zero-tariff ASEAN FTA and some elements of a common market (namely free movement of capital and skilled labour). The ISEAS Concept Paper, which was taken into account by the HLTF, envisaged the AEC to have the following characteristics: 1. Free movement of goods, services, investments, and capital. This would include achieving a zero-tariff FTA and the elimination of all non-tariff barriers (NTBs); 2. An attractive regional production platform that would be a magnet for FDI; 3. Free movement of skilled labour and creative talent; 4. Free movement of tourists from all ASEAN countries; 5. Harmonization of customs procedures and minimization of customs requirements; 6. Harmonization of standards that are consistent with international standards; and 7. A well-developed institutional and legal infrastructure to facilitate the economic integration of ASEAN. The ASEAN Roundtable 2003 — from which this book emanates — brought together academics and experts on economic integration to discuss pertinent issues as well as identify new strategies and policies that would contribute towards realizing the AEC by 2020. The ISEAS Concept Paper essentially became the background point of reference to the ASEAN Roundtable 2003 (and can be found in the Appendix of this book). 3. ISEAS ASEAN Community Roundtable In June 2004 ISEAS organized a Roundtable to examine the broader concept of an ASEAN Community, which would cover not only the AEC but also the ASEAN Security Community and the ASEAN Socio-cultural Community. This Roundtable provided the opportunity for scholars and experts on ASEAN to “brain-storm” in a more comprehensive and integrated manner, the different ideas and proposals underpinning the process of community building that ASEAN is embarking upon. From the Roundtable discussions, the salient issues related to ASEAN economic integration were as follows (ISEAS 2004):

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From the Bali Concord II, it was clearly evident that the ASEAN leaders were not prepared to establish supranational institutions to co-ordinate economic activities in the region. In this light, ASEAN could consider using legally binding agreements to ensure the successful implementation of economic programmes. ASEAN should not be using economic terms like a “single market” (Bali Concord II, paragraph B.3) without understanding its full economic implications. A single market, in the European context, would imply a common market plus harmonization of all laws, regulations, and taxes. Given the different levels of economic development and income within ASEAN, even the end goal of a customs union (one integration level below a common market) would be difficult to realize by 2020. ASEAN countries were not prepared to harmonize tariffs and have a common external tariff policy (as required of a customs union). Consequently, this has led to difficulties in ASEAN’s FTA negotiations with countries outside the region. To create an integrated ASEAN market, hindrances to the movement of goods must be removed. This would, inter-alia, involve improved customs co-ordination and the harmonization of standards and technical regulations. More participation should be given to professionals (particularly ASEANbased professionals) in the implementation of the AEC. In the ASEAN– Institute of Strategic and International Studies (ISIS) study on the AEC, it was proposed that “regional units”, staffed by independent professionals, be established to manage economic activities in the region (see also Soesastro, chapter 2). Despite the promising start, there are some concerns that the AEC project might be losing momentum. Hence, a champion is needed to drive the economic integration process. The ASEAN HLTF on Economic Integration could be this champion.

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4. About This Book The next five chapters address broad issues pertaining to the AEC, including alternative approaches towards achieving this end goal. Drawing on the ASEAN–ISIS report on the AEC, Soesastro (chapter 2) argues that the ultimate form of integration for the AEC is the creation of a fully integrated market — a common market — by 2020. (A common market is understood to be an arrangement in which there are complete free flows of trade as well as free mobility of labour and capital.) This would mean

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that by 2020 the AEC would be declared a common market but it would take into account areas where member countries could reserve deeper integration for a later stage (beyond 2020). He argues that this approach can be more liberalizing than the alternative approach suggested by ISEAS (that is, an “FTA plus” arrangement). Its additional advantage is in the explicit formulation of some kind of a “negative list” that can be brought under the umbrella of the integration project. Soesastro also suggests that ASEAN policy-makers should support the creation of “regional units” as a first step towards institutional integration. Regional units are staffed by nationals who are formally independent of governments. These regional units should also be given charge of areas where common policy approaches have been adopted by ASEAN. This would include the management of development collaboration (for example, the Initiative for ASEAN Integration) and the monitoring of progress of various economic initiatives. Plummer (chapter 3) considers what lessons can be learnt by ASEAN from the experience of the EU — the world’s most successful example of regional economic integration. In order to create a fully integrated market, he suggests that the AEC needs to be governed by the need to: (1) always maintain a clear outward orientation; and (2) reduce transactions costs to a minimum in the region. As an end goal for the AEC, Plummer proposes that ASEAN leaders should seriously consider the creation of a “Customs Union plus” arrangement based on open regionalism, that is, a zero or very low common external tariff (with the possibility of temporarily excluding sensitive sectors and allowing for the possibility of a longer transition period). He also highlights the negative aspects of European integration which the region should clearly avoid (for example, the huge and cumbersome bureaucracy that has emerged in Europe). Plummer also suggests that financial and monetary co-operation should be included as part of the AEC process, including institutional initiatives such as the possibility of establishing a regional bond market. Akrasanee and Arunanondchai (chapter 4) examine what is lacking in the current ASEAN institutions and highlights the institutional reforms needed to achieve economic integration in the region. They focus on two ASEAN institutions that play a key role in the implementation and co-ordination of ASEAN agreements, namely the ASEAN DSM and the ASEAN Secretariat. Akrasanee and Arunanondchai find that both institutions lack the mechanism to enforce regional economic agreements. They propose that ASEAN adopt a more centralized institutional structure and suggest that two

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supranational institutions be established to realize the AEC: (1) an ASEAN Court (to be responsible for dispute settlements; and (2) an ASEAN Economic Secretariat to manage regional economic integration. Caballero-Anthony (chapter 5) discusses the security and political implications of the move towards an AEC. In assessing the prospects of a bolder economic agenda, Caballero-Anthony revisits the dynamics of the nexus between politics/security and economics in ASEAN to show that a major challenge to be overcome is how to maintain the delicate balance between economics and security. She points out that while progress in economic and political/security co-operation should ideally move in tandem, the ASEAN experience has shown that often it is the latter concern that must take precedence over the other. Since its establishment, ASEAN has also shown how important it is to provide the right political and security environment to move ahead with economic co-operation and integration. This only serves to reinforce the idea that for ASEAN to progress, the pillars of political and security co-operation must also be secured. Caballero-Anthony also provides a good overview of the extent to which ASEAN co-operation has evolved in all three areas — economic, politics, and security. She describes ASEAN’s process of evolution as one of “patchwork institutionalization”, given the development of new mechanisms over the years. Caballero-Anthony reminds us that any assessment of ASEAN’s capabilities must take into account the extent to which the organization has moved towards more institutionalization, specifically in the direction of adopting a more rule-based approach to managing crises. These, she argues, are positive indications of an active, rather than a sunset, organization. Although the challenge of reconciling state-centric interests would remain crucial to the future of regional stability, the ASEAN story has proven that there has been scope for accommodation and improvement. Vo (chapter 6) examines the economic challenges arising from the AEC and its impact on the newer but less-developed members of ASEAN, namely the transitional economies of Cambodia, Laos, Myanmar, and Vietnam (CLMV). Given CLMV’s weak institutional capacity and resource limitations, he argues that these countries could run the risk of being marginalized during the process of regional economic integration. The challenges facing CLMV include the widening development gap between the older and newer members of ASEAN; rising competition from China and its impact on CLMV’s exports; social costs arising from structural reforms; and the possibility of falling into a “low labour cost trap” (which would impede efforts to move up the production value-added chain).

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Chapters 7 to 9 examine three existing ASEAN economic integration initiatives (that is, AFTA, AIA, and AFAS) which could potentially be building blocks to realize the AEC. Tongzon (chapter 7) assesses the progress made in the implementation of AFTA. Although significant progress has been made in tariff reduction under AFTA, there has been little progress in eliminating or harmonizing NTBs. He finds that the root cause of the slow implementation of trade liberalization in the area of NTBs is the fear by interest groups that less efficient protected sectors would not be able to compete in a liberalized trading environment. Tongzon also finds that the utilization of the CEPT concessions under AFTA has been low. One of the major reasons for this was the low margin of tariff preferences — between most-favoured nation (MFN) tariff rates and CEPT rates — which makes the benefits of the CEPT scheme unattractive. He notes that it is important to promote awareness and understanding of the long-term economic benefits of AFTA to the private sector — one of the major drivers of economic integration. Tham (chapter 8) assesses the progress made in the AIA and its contribution to FDI in the region. She finds the progress made in the AIA distinctly slow due to the nationalistic approach towards implementing the liberalization of investments, that is, it depends on the individual country’s plan of action. In turn, this slow progress has led some ASEAN members to engage in bilateral FTAs, which could add to the cost of doing business in the region (as firms would now have to deal with both bilateral and regional trade arrangements). Tham suggests that ASEAN should review the implementation mechanism for both trade and investment liberalization and to consider using a more rule-based approach. Findlay (chapter 9) assesses the progress made in services trade liberalization under AFAS. He finds that AFAS has made little progress and argues that the framework suffers from various constraints. In particular, Findlay identifies the inability of AFAS to mobilize sufficient political resources to support wide-ranging reforms as an important constraint. He suggests two alternative paths to expedite the liberalization of the services sector: one focuses on the categorization of the services segments while the other concentrates on the modes of supply. Chapters 10 and 11 examine the impact the AEC would have on labour mobility, poverty, and income inequality in the region. Firdausy (chapter 10) examines the key issue regarding labour mobility within ASEAN as the region moves towards an AEC. He suggests that two sets of policy measures be introduced under the AEC with regards to labour

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mobility. The first set of policy measures aims to optimize labour mobility to ensure better future economic, political, and social conditions within the region. Meanwhile, the second set aims to mitigate or minimize the adverse impacts of labour mobility. Given the different levels of economic development in ASEAN countries, labour mobility is an unavoidable phenomenon. In this light, Firdausy suggests that regulations to restrict or limit the future flows of migrant workers (especially unskilled and illegal workers) should be established within the AEC. Asra, Estrada, and Pernia (chapter 11) argue that fostering wider trade openness through the AEC could contribute to further economic growth and poverty reduction, but it could also result in unintended negative effects on poverty and income inequality. In particular, it may widen economic disparities in ASEAN, where the more-developed countries would benefit more than the less-developed countries. They also point out that the AEC may lead to poverty reduction reversals through its effects on prices of tradable goods, employment and wages of the poor, government revenue, and investments. To avoid these negative effects, Asra, Estrada, and Pernia recommend the judicious selection and sequencing of sectors to be liberalized, along with appropriate policy reforms. They also propose the creation of a ministerial-level ASEAN Committee on the Poverty Implications of Integration (ACPII). The final chapter by Rajan (chapter 12) focuses on the financial dimension of regional integration — in both ASEAN and the greater East Asia region — and its implications for regional monetary integration. Although he finds that the successful implementation of financial market initiatives (namely the Asian Bond Fund and Asian Bond Corporation) ought to bolster regional financial integration, it is critical that these initiatives do not detract from domestic structural reforms to broaden and deepen individual capital markets. Rajan also argues that given the divergence in economic and institutional structures in the region, any attempt to create a common currency without macroeconomic policy co-ordination and a mechanism for automatic intraregional fiscal transfers is far too risky and premature. 5. Concluding Remarks At the recent ASEAN Summit in Vientiane, the Vientiane Action Programme (VAP), a six-year plan (2004–10), was launched to realize the goals of the ASEAN Vision 2020 and the Bali Concord II. With regards to the AEC, the VAP aims to:

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1. intensify economic initiatives and measures targeted for completion on or before 2010 and accelerate the integration of the eleven priority sectors; 2. remove barriers to the free flow of goods, services, and skilled labour as well as facilitate the freer flow of capital by 2010; and 3. put in place all the essential elements and conditions for ASEAN to function as a single market and production base, initially for the eleven priority sectors, by 2010 (VAP, section 2, p. 9). Although there are roadmaps for the eleven priority sectors, an overall longer-term roadmap needs to be formulated to realize the AEC. This roadmap has to be comprehensive and carefully thought out — with clear timetables and milestones to be achieved — leading up to 2020. It is hoped that this book would provide some useful policy inputs into the development of this roadmap. Does ASEAN have the political will to integrate? This is perhaps the greatest challenge for ASEAN. Certainly one of the most valuable lessons to be learnt from the European experience was a strong political desire and a common vision to integrate their economies to form today’s EU. ASEAN appears to be making the right strategic steps by forging closer economic linkages through FTAs with its dialogue partners (such as China, Japan, South Korea, India, Australia, and New Zealand). But, at the same time, it should not get side-tracked from its efforts to integrate within ASEAN to realize the AEC. If the AEC fails, the region would undoubtedly be left behind by China, India, and more integrated groupings, and ASEAN’s role in the world would diminish.5 The big question would, therefore, be whether ASEAN is ready to make the crucial decisions in the long march ahead. NOTES 1.

2. 3.

The ASEAN Vision 2020 envisaged “a stable, prosperous and highly competitive ASEAN Economic Region in which there is a free flow of goods, services and investments, a freer flow of capital, equitable economic development and reduced poverty and socio-economic disparities” (ASEAN Secretariat 1999, p. 12). “ASEAN Accelerates Integration of Priority Sectors”, . For more details regarding the enhanced DSM, please see Recommendations of the High-Level Task Force on ASEAN Economic Integration (Annex 1: Mechanism of the Dispute Settlement Mechanism).

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Denis Hew

4.

To ensure depoliticization of the DSM process, an appellate body comprising well-qualified, independent, and experienced professionals would be established as the appeal body for the panels’ decisions. It would also adopt the existing WTO DSM panel-selection procedures, including the listing of qualified individuals who can serve as panelists and members of the appellate body. Rodolfo C. Severino, “Is ASEAN serious about economic integration?”, Straits Times, 9 December 2004.

5.

REFERENCES ASEAN. “Declaration of the ASEAN Concord II (Bali Concord II)”. 7 October 2003a. . ———. “Recommendations of the High-Level Task Force on ASEAN Economic Integration”. 7 October 2003b. . ———. “Vientiane Action Programme”. 29 November 2004. ———. “Framework Agreement for the Integration of Priority Sectors”. 29 November 2004. ASEAN–Institute of Strategic and International Studies (ISIS). Towards an ASEAN Economic Community — A Track-Two Report to ASEAN Policy Makers. Jakarta, April 2003. ASEAN Secretariat. “ASEAN into the Next Millennium: ASEAN Vision 2020, Hanoi Plan of Action”. Jakarta: ASEAN Secretariat, 1999. Hew, D. and H. Soesastro. “Realizing the ASEAN Economic Community by 2020: ISEAS and ASEAN–ISIS Approaches”. ASEAN Economic Bulletin 20, no. 3 (December 2003). Hew D. and R. Sen. “Towards an ASEAN Economic Community: Challenges and Prospects”. ISEAS Working Paper, December 2004. Hsu, L. “ASEAN Economic Integration — A Fillip for the Future”. In Trading Arrangements in the Pacific Rim. New York: Oceana Publications Inc., December 2003. ———. “The ASEAN Community: Institutional Implications”. In Towards Realising an ASEAN Community: A Brief Report on the ASEAN Community Roundtable. Singapore: Institute of Southeast Asian Studies (ISEAS), 2004. Institute of Southeast Asian Studies (ISEAS). Concept Paper on the ASEAN Economic Community. Singapore: Institute of Southeast Asian Studies (ISEAS), 26 February 2003. ———. Towards Realising an ASEAN Community: A Brief Report on the ASEAN Community Roundtable. Singapore: Institute of Southeast Asian Studies (ISEAS), 2004. UNCTAD. World Investment Report 2004: The Shift Towards Services. New York and Geneva: United Nations Conference on Trade and Development (UNCTAD), 2004.

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2

ASEAN Economic Community: Concept, Costs, and Benefits Hadi Soesastro

1. Introduction At the 2003 ASEAN Summit in Bali, the ASEAN leaders agreed to establish an ASEAN Economic Community (AEC) by 2020. The idea of an AEC was first proposed by Singapore’s Prime Minister Goh Chok Tong a year earlier at the 2002 ASEAN Summit. As with any other idea, its acceptability depends on how each ASEAN member assesses the benefits and costs, or the gains and pains, of a much deeper regional economic integration. The essence of the idea is about deepening ASEAN economic integration. In that sense it can be seen as a logical extension of the regional economic integration project that ASEAN has embarked upon with the historic decision in 1992 to form an ASEAN Free Trade Area (AFTA). However, the idea of establishing an AEC by 2020 also requires the drafting and crafting of an overall economic blueprint. The end goal will definitely be much broader and deeper than the removal of barriers to trade and investment through the AFTA and the ASEAN Investment Area (AIA) projects. And this end goal must be clearly spelled out. The process to achieving it will need to be clearly defined as well. In this sense, ASEAN may see a break with the past in terms of how it manages the process of regional economic integration.

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In the recent past, ASEAN economic integration has been driven by the process itself. When the ASEAN leaders decided in 1992 to form AFTA, they initially agreed to complete the integration project within fifteen years, from 1993 to 2008. Not long thereafter they agreed to accelerate the implementation and set 2003 as the completion date. In response to the 1997/98 financial crisis, the ASEAN leaders agreed to bring the completion date forward to 1 January 2002. ASEAN’s new members must also take part in the AFTA integration project, but they have been given ten years to fulfil their commitment to bring down most of their tariffs to 0–5 per cent. Now, a zerotariff AFTA has been adopted by ASEAN, to be achieved in 2010 by the older members and in 2018 (2015 for most products) by the newer members. The above developments show that ASEAN has progressively advanced AFTA’s completion date. It has also moved to a zero-tariff AFTA. A number of factors account for this progressive development. Perhaps some comfort level with the process has been achieved over time, leading to a greater willingness by the participants to move faster. The need to enhance the region’s economic competitiveness as a way to overcome the financial crisis and to face increased competition from China was another major factor. It should be noted, however, that the implementation of this integration project has been less impressive. Moreover, only a very small percentage of intra-ASEAN trade is in fact utilizing the lower AFTA preferential rates. While this may have been caused by the declining margin of preference as MFN (most-favoured nation) rates have also come down, such factors as lack of private sector awareness, lack of clarity in the application of the Rules of Origin (RoO), problems with customs authorities, and lack of dispute settlement mechanisms may be equally important. Most worrying, however, has been the backtracking from the original commitment by some members, for example, Indonesia on agricultural products and Malaysia in the automotive sector. The costs and benefits of an AEC can only be properly assessed when there is a blueprint. In fact, the blueprint itself will be the result of a process of negotiations that will have to incorporate the interests and concerns of the members along the way. This chapter therefore suggests that ASEAN should adopt a process to come to an agreement on the AEC that is different from the one that produced AFTA. AFTA is a narrowly focused project: the removal of trade barriers, specifically tariffs. It is also supposed to remove non-tariff barriers (NTBs), but this is not happening because there was no clear understanding about what this entails and how to do it. Some have correctly (and sarcastically) described AFTA as “Agree First, Talk After”. This

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approach should not be adopted in agreeing on building the AEC, which involves much broader and deeper integration. The North American Free Trade Agreement (NAFTA), the free trade agreement involving Canada, Mexico, and the United States, was negotiated through a lengthy process. What the agreement entails was made very clear from the outset. It is a contract with clearly stated commitments upfront. The text of the agreement and its annexes is said to be about 1,000 pages long. In the case of AFTA, the agreement was stated in less than ten pages. The European experience provides another model. European integration is based on a broad vision and is mainly driven by a strong supranational institution. ASEAN may need to develop its own process. It is unlikely that its members are willing to make detailed commitments upfront on the many aspects of the integration project. It is also unlikely to agree on establishing a strong supranational institution. What ASEAN can and needs to do is to come up with a clear definition of the end goal — or the ultimate form — of economic integration. It should also agree on the appropriate path to achieving it as well as on the institutional arrangements to implement the agreement. A process is already underway in ASEAN. This process is undertaken by a High-Level Task Force (HLTF) that was established by the ASEAN Economic Ministers (AEM). The HLTF is a follow-up of the ASEAN Competitiveness Study by McKinsey and Company, which was commissioned by the AEM. The HLTF was not explicitly charged with the task of fleshing out the idea of an AEC but it is working on a set of recommendations on how to deepen regional economic integration. In fact, the HLTF has recommended that the idea of an AEC be formalized as the end goal of ASEAN economic integration. This recommendation was approved by the AEM at the Thirty-fifth Meeting in Phnom Penh on 2 September 2003, and was to be submitted to the ASEAN leaders at the Summit in Bali in October 2003. The HLTF has received other inputs from ASEAN scholars, namely the Concept Paper on the ASEAN Economic Community by the Institute of Southeast Asian Studies (Singapore), and Towards an ASEAN Economic Community, a Track-Two Report by ASEAN–ISIS (Institute of Strategic and International Studies). This chapter suggests that the cycle of activities leading to the Bali Summit be seen as a first step towards the drafting and crafting of a blueprint for an AEC. The HLTF should continue to work on this. It should be given another year of intensive consultations and negotiations to produce the blueprint for the AEC to be achieved by 2020 or earlier.

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The next section of this chapter is a discussion about trade trends in the ASEAN region. Trade is the main vehicle for economic integration. The trade trends in ASEAN have been greatly influenced and facilitated by the large flows of investments into the region. AFTA was designed to capture and to reinforce this trend. This chapter proposes that the costs and benefits of ASEAN economic integration, including the AEC, be assessed in the context of this trend. The subsequent section discusses the concept of an AEC. This discussion draws heavily on the Report by ASEAN–ISIS. It examines the main elements of a broader and deeper economic integration scheme for ASEAN. This includes a discussion of the ultimate form of integration, the appropriate path to achieve it, as well as the need for institutional development to carry it out. The concluding section summarizes the main ideas that deserve further examination by academics and bureaucrats alike. 2. Economic Trends and Challenges in ASEAN ASEAN’s share of world exports has significantly increased: it amounted to 2.7 per cent in 1975 and 3.6 per cent in 1985, and experienced a big jump over the next ten years to reach 6 per cent of world trade in 1995 and 6.3 per cent in 2001. The same trend could be discerned for the whole of East Asia, including Japan. As can be seen in Table 2.1, East Asia’s share of world exports increased from about 11 per cent in 1975 to 26 per cent in 1995 and 2001. In comparison, the share of the European Union (EU-15) declined from 39 per cent in 1975 to 34 per cent in 2001, while NAFTA’s share remained stagnant at about 18 to 19 per cent throughout that period. Intra-ASEAN trade increased at higher rates of growth (19 per cent per annum) compared with ASEAN’s overall trade growth (15.6 per cent) during the period 1985–95. There was some decline during 1997–2000 due to the financial crisis, but growth has resumed since 2000. In 2001 intra-ASEAN exports reached US$74.2 billion, which is about one-fifth of total ASEAN exports. In comparison, intra-East Asia trade is about one-third of the region’s total trade. The shares of intra-EU trade and intra-NAFTA trade are about two-thirds and half, respectively. This suggests that ASEAN and East Asia rely much more on the rest of the world than is the case with the EU and NAFTA. However, East Asia as a whole is an important market for most ASEAN countries, accounting for about 50 per cent of their total trade. For many ASEAN countries China has become an important market. Table 2.2 shows the major changes in trade dependence on East Asia for each ASEAN country over the period 1985–2001.

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Table 2.1 Relative Importance of ASEAN in World Trade (In percentages) Country Group

1975

1985

1995

2001

ASEAN East Asia* EU (15) NAFTA

2.7 11.3 39.2 18.0

3.6 19.0 36.0 17.8

6.0 25.6 36.9 18.0

6.3 25.7 34.3 19.0

Intra-trade ASEAN East Asia EU (15) NAFTA

0.3 2.4 24.1 6.7

0.6 4.0 21.1 8.1

1.3 8.4 22.7 7.7

1.2 8.8 20.2 10.1

Value (US$ billion) Total ASEAN exports Intra-ASEAN trade

22.0 2.5

72.0 11.3

307.8 64.6

404.1 74.2

Note: *Includes ASEAN-Ten (excluding Myanmar), China, Japan, South Korea, Hong Kong, Taiwan, and Mongolia. Source: International Monetary Fund (IMF), Direction of Trade Statistics (various years). Table 2.2 Major Changes in ASEAN’s Trade Dependence on East Asia, 1985–2001 Export Markets Increasing in Relative Importance

Brunei Cambodia Indonesia Malaysia Lao PDR Philippines Singapore Thailand Vietnam

Largest

Second Largest

South Korea Thailand Malaysia China Thailand Taiwan China China China

China Hong Kong China Hong Kong Vietnam China Vietnam Indonesia Taiwan

Largest Declining Market Share Singapore Vietnam South Korea Singapore China Malaysia Malaysia Malaysia Hong Kong

Source: Ng and Yeats (2003).

For a number of ASEAN countries the market shares of Singapore and Malaysia have been declining most rapidly. This does not necessarily mean that their important positions in various ASEAN markets have been overtaken by China or other countries. Intra-ASEAN trade has traditionally been

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dominated by Malaysia and Singapore and by the bilateral trade between these two countries. Malaysia and Singapore are also the two largest exporters in ASEAN. Their combined exports accounted for about 51 per cent of total ASEAN exports in 2001. The exports of the older ASEAN members (ASEAN-Six) amounted to about 96 per cent of total ASEAN exports. Exports from the newer ASEAN members — Cambodia, Laos, Myanmar, and Vietnam (CLMV) — amounted to less than 5 per cent of total ASEAN exports in 2001. However, the growth of exports from CLMV has been very dramatic. This is in large part due to their low base, but nonetheless has been impressive. Vietnam’s exports, for instance, increased from a mere US$407 million in 1985 to close to US$15 billion in 2001. Bilateral trade intensities between pairs of ASEAN countries have continued to increase. As seen in Table 2.3, the trade intensity indices are high, especially amongst the ASEAN-Six. They have also increased in the trade with the Northeast Asian countries, including China, for some ASEAN countries. The increased intensity of trade within ASEAN between each ASEAN country and the whole ASEAN region has been due to increased complementarity within ASEAN trade. Intra-regional trade intensities are high in many sectors where complementarity indices are also high. These sectors include textiles, chemicals, metal and basic manufacturing, nonelectric machinery, transport equipment, and miscellaneous manufacturing. Table 2.4 lists the largest intra-ASEAN export products and their growth rates for the period 1985–2001. Seventeen out of the top thirty products of intra-ASEAN trade (at SITC four digit) come from office machinery, telecommunications equipment, and electrical machinery. They account for 45 per cent of intra-ASEAN trade. A more disaggregated analysis of the data further indicates that most of the trade is in parts and components. It can clearly be stated that the increase in both intra-ASEAN and extraASEAN trade since the late 1980s has been due to the increased competitiveness of ASEAN countries, including as supplier for the regional markets. It also suggests that ASEAN has been able to take advantage of the emerging regional production networks to export to global markets. AFTA may not have contributed directly to these developments. It may well be that the general opening up of the economies has facilitated these developments. In so far as AFTA, being seen as a training ground, has helped raised the level of confidence in the region to liberalize trade unilaterally, it can be argued that AFTA has been an important factor in raising the region’s competitiveness as well as in further facilitating the growth of production

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– 0.8 0.8 7.2 1.2 0.0 0.1

Indonesia

– 5.9 1.3 15.5 7.9 0.1 7.8

Indonesia

Source: Ng and Yeats (2003).

Indonesia Malaysia Philippines Singapore Thailand Cambodia Vietnam

Exporter

1985

Indonesia Malaysia Philippines Singapore Thailand Cambodia Vietnam

Exporter

2001

0.7 – 6.2 25.4 8.2 16.4 0.0

Malaysia

7.6 – 9.2 21.3 8.6 2.4 4.6

Malaysia

4.0 8.9 – 3.5 2.8 0.0 0.0

Philippines

7.4 5.1 – 11.8 7.6 1.1 11.6

Philippines

6.7 14.9 4.2 – 6.1 19.2 4.2

Singapore

3.1 24.2 8.0 – 9.6 4.3 7.7

Singapore

1.0 7.5 3.9 9.1 – 0.0 0.1

Thailand

7.5 9.6 9.1 10.6 – 2.5 7.6

Thailand

Table 2.3 Trade Intensity Indices in 2001 and 1985

7.2 3.8 3.0 1.5 2.1 0.8 0.7

Japan

6.1 5.8 12.5 4.9 10.2 0.6 2.6

Japan

2.3 3.8 1.1 0.8 1.2 0.0 1.5

South Korea

13.1 6.8 7.8 6.0 4.0 0.8 4.8

South Korea

0.3 0.7 1.2 1.0 2.5 8.2 0.0

China

0.1 4.3 0.1 4.2 5.0 1.6 5.2

China

ASEAN Economic Community: Concept, Costs, and Benefits 19

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Electronic microcircuits Parts of office machinery Parts of telecommunications equipment Other electrical machinery and equipment Piezo-electric crystals Diodes and transistors Petroleum oils Electrical switches and relays Printed circuits and parts thereof Electric motors and generators Cigarettes Motor spirit and other light oils Radiotelegraphic and telephonic equipment Digital central storage units Television picture tubes, cathode ray Machinery and appliances for specialized industries Other parts and accessories of motor vehicles Other electric power machinery

Commodity

283.8 54.3 124.1 120.7 256.2 151.6 2,513.0 170.6 32.7 16.5 25.9 419.6 2.0 0.2 21.4 87.1 39.2 20.0

7649 7788 7768 7763 3330 7721 7722 7162 1222 3341 7643 7524 7761 7284 7849 7712

1985 7764 7599

SITC No.

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620.8 610.3

638.1

735.6 730.4 675.4

2,034.4 1,963.8 1,757.3 1,719.0 1,294.5 1,171.4 941.2 787.5 758.1

2,530.3

12,693.6 8,489.1

2001

Intra-ASEAN Exports (US$ million)

0.3 0.2

0.7

0.0 0.0 0.2

0.9 2.0 1.2 19.6 1.3 0.3 0.1 0.2 3.3

1.0

2.2 0.4

1985

0.8 0.7

0.8

0.9 0.9 0.8

2.5 2.4 2.1 2.1 1.6 1.4 1.1 1.0 0.9

3.1

15.5 10.3

2001

Share of Total Intra-ASEAN Exports (%)

Table 2.4 Largest Intra-ASEAN Export Products, 1985–2001

26.5 27.8

18.4

60.4 454.2 29.5

24.2 16.1 22.0 1.1 20.3 29.2 38.1 27.5 31.5

25.9

31.5 45.1

1985–2001

Average Annual Growth Rate (%)

20

Hadi Soesastro

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7.4 20.1 19.8 8.7

7522 9710 7611 7523 5,990.5

35.4

8983

20.5 495.9 44.3

7731 3344 7491 129.5

20.0 36.9

7525 8939

7239

812.9

3343

Source: Computations based on United Nations COMTRADE data.

All above products

Gas oils Peripheral units for automatic data processing machines Miscellaneous articles of materials Insulated electric wire, cable, bars, and strips Fuel oils, n.e.s. Ball, roller, or needle roller bearings Parts of bulldozers, angledozers, and leveller machinery Gramophone and similar sound recorders Complete digital data processing machines Gold, non-monetary Television receivers, colour Complete digital central processing units 45,369.0

370.3

376.4 374.7 372.2

386.6

419.2

478.6 454.6 421.4

521.4 519.1

523.9

46.6

0.1

0.1 0.2 0.2

0.3

1.0

0.2 3.9 0.3

0.2 0.3

6.3

55.3

0.5

0.5 0.5 0.5

0.5

0.5

0.6 0.6 0.5

0.6 0.6

0.6

15.3

52.1

47.7 48.7 31.1

23.5

10.5

25.6 285.8 17.5

29.5 28.0

22.6

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networks. Multinational corporations operating in ASEAN have long prepared for the completion of AFTA as a way to rationalize their production in the region. AFTA was indeed meant to increase the attractiveness of the whole region for global investors. It is from this perspective that regional economic integration can be seen as a win-win proposition. It is also within this context that the idea of an AEC should be pursued. If the region as a whole can benefit from the undertaking, it will be easier for the group to provide assistance to members that are not (yet) in the position to fully exploit the opportunities created by a more integrated market. 3. Towards an ASEAN Economic Community The significance for ASEAN to make a timely move towards deeper economic integration is without any doubt. ASEAN members have realized that they have a much greater chance to maintain their international competitiveness if they work together towards the creation of an integrated market. This led to the historic decision in 1992 to form AFTA. More than a decade later, with the AFTA project already implemented by the older ASEAN members, it has become all the more important for the group to deepen and accelerate regional economic integration. ASEAN’s position in the regional and global stage had been adversely affected by internal and external developments during the past few years. The challenge faced by ASEAN is not simply to restore its position or to catch up with the rapid progress in the region and the world. It needs to stay ahead of the curve. Deepening and accelerating regional economic integration will significantly elevate ASEAN’s attractiveness as a global production base. Economic integration will also contribute to regional cohesion. This will strengthen ASEAN’s bargaining power and geopolitical influence. Deeper economic integration has been a key element in the grouping’s growing trade and economic ties with extra-regional countries. These ties will be further strengthened by the development of closer economic partnerships, including free trade agreements (FTAs), between ASEAN and a number of its trade partners. The ASEAN–China Comprehensive Economic Co-operation Framework Agreement is the first such initiative that will be followed by similar ones with Japan and other countries or groups of countries. In East Asia, ASEAN may even be placed in the position of becoming a “hub”. This is a very strategic and potentially powerful position. It will gain this position perhaps by default as none of the other East Asian economies can take such

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a leadership position. The study by the ASEAN Secretariat, Towards a Single Economic Space, made the point that ASEAN’s closer economic partnerships and free trade arrangements with key trade partners are expected to accelerate ASEAN’s own economic integration towards a single economic space in the global economy. The creation of an AEC by 2020 is a feasible proposition. As stated before, the AEC should be seen as a logical extension of the various initiatives taken and implemented by ASEAN thus far towards greater economic integration. It is the next logical step for ASEAN to take. However, this next step requires strong and firm commitments by ASEAN members to move forward in a credible and timely manner. This can be aided by a clear articulation of the ultimate form of integration as well as the appropriate path to achieve it. Equally important is a commitment by ASEAN members to embark on greater institutional integration. The following discussion on those main elements in the development of an AEC is based on the ASEAN–ISIS Report referred to earlier. This Report has also benefited from the ISEAS study. The Report began with a discussion of the ultimate form of integration. It then examined the path towards deeper integration and the institutional design to successfully carry it out, taking into consideration the political factors that are likely to be at play. The Report noted that in a sense ASEAN members have already committed themselves to deeper economic integration. The ASEAN Vision 2020, adopted by the ASEAN leaders in 1997, envisaged the creation of “a stable, prosperous and highly competitive ASEAN Economic Region in which there is a free flow of goods, services and investment, [and] a freer flow of capital …” (ASEAN Secretariat 1999, p. 12). The ultimate form of integration as proposed in the ASEAN–ISIS Report is the creation of a fully integrated market (a common market) by 2020 but takes into account areas where members reserve deeper integration for a later stage (beyond 2020). It suggests that ASEAN adopt a “common market minus” approach. An alternative approach, as proposed in the ISEAS study, is to adopt the “FTA plus” arrangement, namely an FTA that includes some elements of a common market (ISEAS 2003). The former approach can be more liberalizing. Its additional advantage is in the explicit formulation of some kind of a “negative list” that can be brought under the umbrella of the integration project. A common market is understood to be an arrangement in which there are complete free flows of trade, including internal trade — as in a customs union — as well as free mobility of labour and capital. Full mobility of labour

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involves the right to reside and seek employment in all member countries, and mutual recognition of professional and technical qualifications. Full capital mobility requires an absence of exchange controls and full rights of establishment for firms in all countries. It has been suggested that credible removal of tariffs may require policy harmonization or common policies on taxes, wages, prices, etc. It may even require common rules governing competition and monopoly, as well as in environmental regulations. However, it is still a matter of controversy whether a full common market requires a single currency and a common system of prudential regulations of banks and other financial institutions. ASEAN has no problems in achieving completely free flows of trade and investment by 2020. Under the AFTA programme the region will already achieve complete free flows of goods by 2020. The older ASEAN members (ASEAN-Six) have adopted a target of zero-tariff AFTA by 2010. The newer ASEAN members have also adopted zero-tariff AFTA, initially by 2018, but subsequently they have advanced the deadline to 2015 for most products. Under the AIA agreement, by 2020 there will already be free flows of investments, not only amongst ASEAN members but globally. In fact, by 2020 most intra-ASEAN liberalization in trade and investment will be multilateralized. ASEAN members of Asia-Pacific Economic Cooperation (APEC) may have introduced zero MFN tariffs by 2020. Other ASEAN members may have already brought down many of their MFN tariffs to zero. In view of this, ASEAN has the potential to embark on a programme to harmonize its external tariffs. This can be undertaken through progressive reduction of MFN tariffs by subsets of ASEAN members, especially those with higher tariffs. In the context of the World Trade Organization (WTO) round, ASEAN members can develop common strategies to reduce their MFN tariffs. These efforts help accelerate the free flow of internal trade (as in a customs union) and will significantly reduce transactions costs due to the progressive elimination of RoO requirements. The liberalization of trade in services in ASEAN is pursued under the ASEAN Framework Agreement on Services (AFAS). The intention is to move more progressively than under the GATS (General Agreement on Trade in Services) of the WTO. Hence GATS Plus. This has yet to be demonstrated by the ASEAN members. In the area of services liberalization ASEAN members need to examine two questions of policy importance. First, ASEAN should give serious attention to the sequencing of its services liberalization, giving priority to co-operation in strengthening the regulatory environment and institutional capacity. This

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is a priority area for ASEAN co-operation. Second, ASEAN should seriously examine whether in the liberalization of services it is more beneficial for ASEAN to adopt a policy of global opening. The ASEAN Vision 2020 proposes to accelerate the free flow of professional services. At the meeting of ASEAN Ministers of Labour (or Manpower) held in Indonesia in May 2003, some ASEAN members raised the possibility of a free flow of labour in the region. It should be noted that significant flows of unskilled labour are already happening in the region. Regularized flows can be a means to creating a progressively liberal environment in this area. A common policy approach to regularize these flows should be brought under the umbrella of the integration project. The agreement reached at that meeting was to give priority to the free flow of skilled professionals. ASEAN members agreed to begin to develop standards of quality for professionals. Rather than developing a common standard, it seems that ASEAN members will develop national standards and later adopt some kind of a mutual recognition agreement (MRA). The free flow of professionals and skilled labour is an important element of investment liberalization in the region. The ISEAS Study recommends the removal of work permits for ASEAN skilled and creative workers who are employed in another ASEAN country. The McKinsey Study proposes the introduction of special visas for skilled labour to ensure a balance between demand and supply. Free mobility of capital in ASEAN is another important element of investment liberalization in the region. Financial sector liberalization in the region should be focused on its appropriate sequencing. Accordingly, priority should also be given to strengthening the regulatory environment and institutional capacity. With a few exceptions the region already has liberal exchange regimes. Concerns over the volatility of short-term capital flows are legitimate and can be addressed through the development of a common policy approach amongst ASEAN members. In determining the appropriate path towards deeper integration, it is important to assess the region’s “initial conditions” for integration. In the case of ASEAN it is obvious that simultaneous trade and investment liberalization should be its main vehicle for integration. ASEAN has appropriately embarked on trade and investment liberalization through AFTA and the AIA. In view of the gaps that exist among ASEAN members, particularly between the ASEAN-Six and newer members, it appears that intra-regional investments can play an important role in building regional cohesion. Therefore, the AIA needs to move more progressively. ASEAN should also take measures to seriously eliminate all NTBs.

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Fast-tracking of trade and investment liberalization in specific sectors or areas may help build capacity and constituency for further liberalization. The main recommendation of the McKinsey Study is the fast-tracking of liberalization of selected sectors, namely consumer goods and electronics, and possibly adding on other high-potential sectors such as tourism, agrobiotechnology, and automotive industry at a later stage. The AEM has identified additional sectors in which ASEAN as a whole enjoys competitive advantages and agreed to accelerate the integration in a total of eleven priority sectors. The sectors and their country co-ordinators are as follows: 1. 2. 3. 4. 5. 6.

Indonesia: Wood-Based Products and Automotives Malaysia: Rubber-Based Products; Textiles and Apparels Myanmar: Agro-Based Products and Fisheries Philippines: Electronics Singapore: e-ASEAN and Health Care Thailand: Air Travel and Tourism

ASEAN’s economic integration project, which is driven by a deepening and acceleration of trade and investment liberalization, might have to introduce safeguard (or recourse) mechanisms that are based on clear principles. It is important to ensure that such safeguard mechanisms do not become obstacles to longer-term liberalization efforts. In view of ASEAN’s diverse membership, attempts must be made to achieve some overall balance of gains for members. This is the first principle. Experience elsewhere has shown that trade-offs can be made between net economic costs and political benefits for members. If this cannot be achieved, some flexibility should be adopted. This principle is known as ASEAN minus X (or Ten-X). Perhaps it is more appropriate to formalize a two-speed ASEAN, which can involve different subsets of ASEAN members for different areas of co-operation. As the consensus-based approach becomes more difficult to utilize in ASEAN, there have been proposals to introduce “qualified majority voting” for technical policy matters (the McKinsey Study) or even “coalitions of the willing”. ASEAN should also consider introducing the principle of redistribution of income or resources, which can be formalized in the form of either compensation schemes or joint efforts to provide regional public goods that would be mostly beneficial to the less-developed members of ASEAN. The above helps ensure the political feasibility of the integration project. In addition to the above, there may be a need to exclude, temporarily or even

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permanently, some sensitive sectors from the liberalization objective. However, ASEAN members must come to an agreement to bring these sectors under the umbrella of the integration project through a common policy approach. Such common policies can focus on managing production and trade. The use of domestic policy instruments (for example, subsidies) as a substitute for trade policy should also come under some common discipline. Another important element of the integration project is the adoption of a common external trade policy. ASEAN as a group and individual ASEAN countries have embarked on a series of preferential, discriminatory FTAs. ASEAN needs to develop a common framework so as to ensure that each of these initiatives can become a building block (and not a stumbling block) for wider regional agreements. It also should ensure that ASEAN as a group can drive the process. Otherwise ASEAN will become a spoke to arrangements that are determined by the trade partners. This will make it difficult to later amalgamate the different initiatives towards a wider regional arrangement. It should also be noted that unco-ordinated proliferation can lead to increased tensions between ASEAN members. Some ASEAN countries that are not in the position to participate in the game of forming FTAs may be left out. It is important to keep in mind that the production networks in ASEAN have become more complex. A common framework helps ensure that business transactions costs are minimized. RoO that are restrictive constrain sourcing of inputs. RoO that vary across products and agreements add to the complexity and costs. ASEAN members should also promote the concept of an ASEAN cumulative RoO. Singapore has entered into different bilateral agreements with different RoO. This may not matter for Singapore because it has no sectors (textile, automobile) where restrictive RoO apply. In the area of electronics (IT) its bilateral agreement with the United States has introduced a new rule, the socalled Integrated Sourcing Initiative (ISI), which is potentially beneficial for the region. In fact, a common policy approach can help define the role for the first mover(s) such as Singapore to strategically engage major partners in the Southeast Asian region as a whole. The common policy framework for ASEAN may also involve harmonization of external tariffs. Subsets of ASEAN can do this by forming separate customs unions that will help accelerate the reduction of MFN tariffs. Finally, a critical element of the integration project is the establishment of a credible dispute settlement mechanism (DSM). With the adoption of the Protocol on Dispute Settlement Mechanism in 1996, ASEAN has begun to

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move to a more formalized DSM. However, dispute settlement within ASEAN should be taken off the political realm (involving ministers or senior officials) and be brought into the legal realm. The ISEAS Study recommends the establishment of a high-level judicial body to enforce the DSM. This proposed court should be staffed by judges from every ASEAN member country. In the McKinsey Study a Dispute Settlement Bureau is to be established within the ASEAN Secretariat to process claims and to manage a roster of panelists. Ruling of disputes would be made by independent panelists who are nominated by ASEAN member countries. The study also recommends that private firms be given access to the DSM for limited types of dispute. Under the existing 1996 DSM Protocol, only member governments can bring a dispute before the DSM. It is important to note that at the Thirty-fifth AEM in Phnom Penh in early September 2003, the ASEAN ministers agreed to revise the existing DSM, “to ensure that binding decisions can be made expeditiously and based solely on legal considerations for intra-ASEAN trade disputes”. In addressing the important issue of institutional design, the ASEAN– ISIS Report believes that for ASEAN to be able to move ahead it must be transformed from being an inter-governmental co-operation structure into a regional institution. This process can only be gradual. The Report proposes the “strategic introduction” of “regional units” into the existing structure. The creation of regional units is a first step towards regional institutional development. Regional units, or independent regional bodies, are staffed by nationals who are formally independent of governments. The regional units should initially be given charge of areas where common policy approaches have been adopted. This would include, for instance, the management of development collaboration (for example, implementing the IAI — Initiative for ASEAN Integration) and the monitoring of progress of various other initiatives. A stronger ASEAN Secretariat, working together with the regional units, can function as the driver and guardian of the integration objective. The institutional design, consisting of the ASEAN Secretariat and the regional units, may eventually be amalgamated into a kind of ASEAN Commission. However, this need not be the case. The Secretariat and the regional units can continue to co-exist in a decentralized but synergistic fashion, with the regional units given the responsibility of managing various functional cooperation projects as well as overseeing specific tasks entrusted upon them, as described above. National-level political oversight will continue to be provided by the AMM (ASEAN Ministerial Meeting), aided by the SOM (Senior Officials Meeting) and the AEM (ASEAN Economic Ministers Meeting),

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and supported by the SEOM (Senior Economic Officials Meeting) or eventually by an ASEAN Council of Ministers. 4. Conclusion It is possible for ASEAN to move towards an economic community that is defined as a “common market minus”. One main element of this idea is to bring the areas or sectors that are excluded from liberalization under the umbrella of the integration project and be managed through a commonpolicy approach by newly created regional units. This will be a major institutional innovation for ASEAN. Short of transforming itself into a supranational arrangement, this new institutional design may be the optimal one for ASEAN. However, this should be carefully crafted and be based on clear principles. Indonesia, which hosted the 2003 ASEAN Summit, should provide leadership in developing these new concepts and mobilizing political support for moving towards an AEC. In her Inaugural ASEAN Lecture, then President Megawati Soekarnoputri began to outline a new architecture for ASEAN economic integration that rests on twin pillars, an AEC and an ASEAN Security Community (Megawati 2003). She also stated that Indonesia had chosen for the 2003 ASEAN Summit the theme: Towards an ASEAN Economic and Security Community. The AEC project, pursued in tandem with serious efforts to create an ASEAN Security Community, will transform the region into a zone of peace and prosperity, a force of stability in the wider region, and a constructive player in the global stage. REFERENCES ASEAN Economic Forum. “Towards a Common Framework for ASEAN ExtraRegional Cooperation”. Presentation to the ASEAN SEOM 3/34, 11 June 2003, in Yangon. ASEAN–ISIS. Towards an ASEAN Economic Community. A Track-Two Report to ASEAN Policy-Makers. Jakarta, April 2003. ASEAN Secretariat. “ASEAN into the Next Millennium: ASEAN Vision 2020, Hanoi Plan of Action”. Jakarta: ASEAN Secretariat, 1999. ———. Towards a Single Economic Space. Jakarta, 2003. Centre for Strategic and International Studies (CSIS). “Memorandum to ASEAN Policy Makers on ASEAN and Free Trade Areas in East Asia”. Jakarta, September 2002. Institute of Southeast Asian Studies (ISEAS). “Concept Paper on the ASEAN Economic Community”. Singapore, 26 February 2003.

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McKinsey & Co. ASEAN Competitiveness Study. 2003. Megawati Soekarnoputri. “ASEAN Today: Challenges and Responses”. Presented at the Inaugural ASEAN Lecture on the Occasion of the Thirty-sixth Anniversary of ASEAN. Jakarta, 8 August 2003. Ng, Francis and Alexander Yeats. Major Trade Trends in East Asia: What Are Their Implications for Regional Cooperation and Growth? World Bank Policy Research Working Paper no. 3084, June 2003. Soesastro, Hadi. “Trends and Issues of RTAs/FTAs in East Asia”. Presentation at the APEC SOM Policy Dialogue on RTAs/FTAs, 27 May 2003, in Khon Kaen, Thailand.

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3

Creating an ASEAN Economic Community: Lessons from the EU and Reflections on the Roadmap Michael G. Plummer

1. Introduction Southeast Asian economic co-operation through the institutional mechanism of the Association of Southeast Asian Nations (ASEAN) has been quite exciting of late. This is particularly noteworthy because the organization took almost a decade from its creation in 1967 to develop even the most superficial forms of economic co-operation, and then another fifteen years before the ASEAN Free Trade Area (AFTA) was launched in 1992. Since then, ASEAN has embraced other forms of co-operation, for example, the ASEAN Investment Area (AIA) in 1998, and is discussing other options pertinent to real and financial aspects of formal economic integration, as articulated, for example, in the Hanoi Plan of Action (ASEAN Vision 2020). Moreover, the group has been ambitious in terms of horizontal integration: it has expanded from five countries (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) in

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1967 to include Brunei Darussalam in 1985, Vietnam in 1995, Laos and Myanmar in 1997, and finally Cambodia in 1999. Hence, it now encompasses all of Southeast Asia. At the Ninth ASEAN Summit in October 2003, the ASEAN Heads of Government agreed to create an ASEAN Economic Community (AEC) by 2020. The name is evocative, for an economic community immediately brings to mind the European experience. In fact, when APEC was reinventing itself, it was proposed that the name be changed from Asia-Pacific Economic Co-operation to Asia-Pacific Economic Community. This idea was rejected explicitly because it would give the impression that APEC was intending to move in the direction of the European Community (EC) model, which was thought to be too controversial. That the ASEAN Heads of Government should consider establishing an AEC, even with the baggage the term brings, is in some sense nothing new. ASEAN has always studied carefully European economic integration and has seen it as a sort of role model, though certainly to be adapted to the Southeast Asian development context. In this chapter, we will consider what lessons the European experience might hold for ASEAN, as well as extending some suggestions — based in part on the European Union (EU) experience — as to how ASEAN might evolve into an AEC, that is, a “roadmap”. In this process, we will divide, somewhat artificially, real-side economic issues (trade and direct foreign investment, or DFI) from financial aspects of co-operation (for example, regional capital market development). We consider real-side issues in section 2, first reviewing briefly the European integration experience, including statistical analysis of the importance of the EU in the determination of European intra-regional and extra-regional trade and DFI. This is followed by a summary of lessons in the European context and some thoughts as to what might be adopted (and eschewed) in the ASEAN context as part of the AEC. Next, in section 3 we consider capital market development, with a strong emphasis on the role of the bond market and how a regional market might be devised, as well as other ancillary issues of monetary and financial co-operation. Section 4 gives some brief concluding remarks. 2. Real-Side Considerations

2.1. A Brief Review of the European Experience The progression of real-side economic integration in Europe is fairly well known. We content ourselves here with a brief review. An excellent, detailed review of its progression is found in Messerlin (2001).

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Substantive, multi-sector European economic integration began with the Treaty of Rome (1957), but other initiatives had been launched previously, for example, the European Coal and Steel Community, which in 1950 was the first initiative to bring resources under a common European authority (Story and Walter 1997). The European Payments Union (EPU), also established in 1950, was created as a multilateral clearing system for European balance of payments transactions serving to economize on scarce dollars at the time. The EPU had a strong effect in stimulating intra-European trade, mainly by discriminating against trade with the United States (Pomfret 1997). But the Treaty of Rome, which established the European Economic Community (EEC), constituted the most ambitious effort to create an integrated market in Europe. What it produced was essentially a “customs union plus” with a ten-year transition period, providing for free trade among the six original member states (Italy, Belgium, Luxembourg, West Germany, France, and Holland) and a common external tariff. The “plus” came with a few additional initiatives, most importantly the Common Agricultural Policy (CAP). The EEC was essentially fully functional in the late 1960s. Over the next fifteen years, the EEC concentrated more on horizontal expansion, negotiating free trade areas (for example, in manufactures with the European Free Trade Area, or EFTA) and two enlargements, to include its first new members in 1973 (the United Kingdom, Ireland, and Denmark), and second in the early and mid-1980s, Greece (1981) and Spain and Portugal (1985). Thus, by the launch of the Uruguay Round in 1986, the EEC — now called the integrated European Community (EC) — featured a customs union and a pyramid of preferences, under which it carried out — and continues to carry out — approximately 80 per cent of its trade. The economic effects of European integration were, of course, many, and the literature is replete with accounts of various policy innovations in Europe, for example, the creation of the EEC, the first and second enlargements, and its free trade area with EFTA. Many surveys of these studies exist, including Pomfret (1997), De Grauwe (2000), Sapir (1996), and Kreinin and Plummer (2002). In general, the literature would suggest that, while there can be no doubt that trade diversion resulted in many sectors, trade creation on the whole prevailed, with the possible exception of the second enlargement, where trade diversion in agriculture was estimated by some studies to be have been particularly large.1 In fact, up to this point, one might generalize in saying that European integration was on the whole liberal, with certain salient failures, including steel, textiles and clothing, and, especially, agriculture.

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Judging from the history of protection in other developed countries, for example, the United States, trade policies in the former two sectors would have been protectionist even without European integration, though, of course, the counterfactual is hard to predict. Still, even the greatest EU optimist would be compelled to concede that protection in agriculture became higher than it would have been. Messerlin (2001) and others maintain that this was the price that had to be paid in order to launch liberal initiatives in other sectors. This price has proven to be very high: in addition to the effects of trade diversion, the associated impediments to negotiating more comprehensive initiatives in other forums (for example, the General Agreement on Tariffs and Trade/World Trade Organization [GATT/WTO]); provocation of continuous bilateral disputes with key economic and strategic partners such as the United States; and creation of policy coherence problems in dealing with the developing world, the CAP sapped the EC budget of much of its resources, constituting from over three-fourths of the budget in the early 1980s to about half today. The recent (September 2003) failure at the WTO Ministerial in Cancun to move forward in the Doha Round was blamed on the EU insistence on an investment agreement that went too far for many developing countries, but agricultural-negotiation deadlocks, especially the U.S.–EU compromise which did not go far enough for the developing world, were probably equally at fault. It is important to note that, in the mid-1980s, while the customs union was definitely functioning, no truly integrated market existed, due in part to the fact that, while the EC had a common external tariff, it had no common external commercial policy. That is, non-tariff barriers (NTBs) were applied at the country level. Since the 1980s saw a steady increase in the use of various NTBs, for example, administrative actions and “voluntary” export restraints, this became an increasing problem in the EC context, as markets were not merely failing to integrate but were ostensibly diverging in some sectors.2 Thus, the decision to create a common market through the Single European Act (SEA, which amended the Treaty of Rome) in 1986 signalled a desire by European leaders not only to prevent this divergence but actually to move forward and create a common market in which goods, services, labour, and capital would flow freely. The SEA, or EC-1992, was a remarkable piece of legislation, especially since it involved not only trade matters but also hitherto-untouched domestic policies. The EC always appeared to be consistently more prepared to give up national authority to EC supranational institutions than other countries in regional organizations, but the SEA represented a major step forward, for it required significant change in domestic policies at almost all levels. In its

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284 directives, the SEA set out to create a region in which there would be no policy impediments to economic interchange, rendering, for example, border controls irrelevant. The economic effects were estimated to be large. The most influential study regarding the possible (ex ante) effects of the EC-1992 programme was the Cecchini Report (1988), which calculated a one-time potential increase in EC GDP of 2.5–6.5 per cent to result from the unified market. Other economists, using endogenous growth models, suggested that this might actually be a permanent effect. The Cecchini Report implied that, even though a price-competitiveness effect would tend to decrease imports from non-partners due to the EC’s greater efficiency, the internal growth effect of the EC-1992 programme might be so strong as to swamp static diversionary effects on non-member countries. But a number of studies have postulated what negative effects might arise for non-partner countries (for example, Bleaney, Greenaway, and Hine 1995; and Kreinin and Plummer 1998). Nevertheless, most would argue that the great policy shift generated by the SEA was, on the whole, liberal. At first many countries, especially in the Asia-Pacific region, were concerned about the programme and the possibility of a Fortress Europe. But as the SEA progressed, even the United States became convinced that it was generally an open initiative. Building on the success of the SEA, European leaders decided to take the additional step in the direction of an economic union by creating a monetary union. The Maastricht Treaty was initially signed in December 1991 but had to be revised to include the possibility of opt-outs when Denmark voted against it in 1992. With the crisis in the European Monetary System (EMS) in September 1992, the practical aspects of implementing the monetary union got off to a poor start and created many sceptics, though they were eventually proven wrong. In the meantime, the EU experienced a third enlargement in 1994, when Austria, Sweden, and Finland joined. A few important considerations need to be emphasized here. First, while the European experience is by just about any measure a success story, it has always had problems. The process of horizontal and vertical integration has not be linear; the EEC, EC, and Economic and Monetary Union (EMU) had been put in doubt at various times. However, the political will of the EU to move forward saved the integration process from stagnation or decline. Second, economic integration was able to progress also because of EC/EU institutional development. A large — many would argue far too large — bureaucracy has been built in Brussels and elsewhere. The European Commission has been instrumental in giving vision to European integration, as well as in implementing its policies, along with the European Court of

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Justice. The European Parliament has been an important democratic forum — the EC has been criticized at times for its alleged “democratic deficit” — and the frequent meetings of government officials at all levels have been essential in not only the creation and implementation of economic-integration programmes but also developing trust among member states. Third, EU integration has always been between industrialized countries. This changed when the first transitional economies of Central and Eastern Europe joined the EU in May 2004.

2.2. A Statistical Analysis of EU Integration It might be useful at this point to analyse empirically what effects these policy initiatives, inter alia, have had on integrating European markets. We referred above to a number of studies and/or surveys that have estimated the effects of various policy innovations in the EU. Here, we try to gauge the effects of economic integration policies on intra-regional trade and investment flows, as well as identify the trade–investment nexus that is so commonly referred to in the EU (and ASEAN) context but less frequently captured empirically. In doing this we use a gravity model, which posits bilateral trade or DFI flows as a function of various explanatory variables which flow from neoclassical trade and investment theory, including size (measured by the product of the reporting and partner country GDPs), wealth (proxied by the product of the two countries’ per capita incomes), and distance (estimated as the kilometres between the capital cities).3 Importantly, in our trade and DFI equations, we include a regional EU dummy variable, which is intended to capture the additional explanatory power that being a member of the EU might have.4 This should be the EU policy effect. Somewhat less conventionally, we include bilateral DFI flows as an explanatory variable in the case of bilateral trade determination, and trade as an explanatory variable in the case of the DFI regressions. Such an approach will allow us to get a better idea of the trade–investment nexus. Finally, we “nest” these binary variables by showing the results of the regressions with the EU binary variable alone, followed by DFI (in the case of the DFI regressions, trade), and then finally both together. We run these regressions for the major DFI importing/exporting countries in the EU (France, Germany, and the United Kingdom), as well as two key non-partner countries, the United States and Japan. The former countries will allow us to gauge what the effect of policy change in Europe has been for intra-regional trade and investment, and analysis of bilateral U.S. and Japanese trade and investment will give insight into how the EU integration process has affected these key non-partner countries.

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The results are presented in Table 3.1. Taking the trade regressions first, we see that, overall, the adjusted R2s are quite high for the European countries and Japan, ranging from 0.44 to 0.87, and somewhat lower for the United States.5 The estimated coefficients on the size, wealth, and distance variables are almost always statistically significant and of the expected sign (that is, positive for size and wealth and negative for distance) in the EU regressions. The size and distance variables are always statistically significant and of the correct (that is, anticipated) sign for the U.S. and Japanese regressions, though the wealth variables tend to be insignificant. The EU binary variable is always positive and statistically significant at the 99 per cent level in all EU regressions. This effect is seen for both trade creation and trade diversion combined and suggests a strong intra-European bias towards trade, even controlling for other key variables (that is, size, wealth, and distance). However, it is also true that the DFI variable is always highly statistically significant in these EU trade regressions, showing that DFI is an important determinant of intra-regional trade. Moreover, in each case, adding DFI actually reduces the EU binary-variable effect. For the non-partner countries, the EU effect is almost always statistically significant — but negative. This implies that, controlling for other variables, these countries trade less with the EU than one would have predicted otherwise. In short, it is the trade diversion effect. The DFI effect in the non-partner regressions is all positive and highly statistically significant, and of a magnitude even greater than in the EU regressions. The investment regressions tend to have lower R2s, which is a typical result in the literature as the determinants of DFI are thought to be far more complicated than on the trade side. Size is clearly an important determinant of DFI in all regressions, but the estimated wealth coefficients tend to be negative (except in the case of the United States), while distance is often statistically insignificant and, in the case of Japan, sometimes positive. While such results would be strange in the context of trade, they are easy to interpret in the context of DFI: if a company engages in foreign investment in order to take advantage of a cheap workforce abroad, the estimated wealth coefficient may be negative (and, since companies also engage in DFI to take advantage of high-skilled labour abroad — that is, in high-income countries — it is no wonder that many of the estimated coefficients are statistically insignificant, as there are contradictory motivations, which depend on the sector). A positive coefficient on the distance variable might be explained by transactions costs: for example, the further away a country, the cheaper it will be to produce there rather than export, ceteris paribus.

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2.64** 3.76** 2.79** –1.10** –1.32** –1.29** –0.17** –0.44** –0.16** –0.01 –0.01 –0.0003**

0.003** 0.003** 0.003** 0.002** 0.002** 0.002**

Trade Trade Trade DFI DFI DFI

1711** 4831** 1721** ––72 ** –315 ** –199.8**

Distance

3. U.K. Regressions, 1982–99 (observations: 594) Dep. Var C GDPs GDP PCs

6.96** 9.51** 7.19** –1.48** –0.46** –1.47** –0.48** –0.09** –0.45** –0.01 –0.06 –0.01

0.002** 0.001** 0.002** 0.001** 0.001** 0.001**

Trade Trade Trade DFI DFI DFI

4611** 9286** 4449** –404 ** –327 ** –339 **

Distance

2. German Regressions, 1982–99 (observations: 665) Dep. Var C GDPs GDP PCs

1** 1.04** 1.49** –1.71** –2.57** –2.41** –0.18** –0.52** –0.15** –0.14 –0.006 –0.03

0.002** 0.001** 0.001** 0.004** 0.003** 0.003**

Trade Trade Trade DFI DFI DFI

1624** 5142** 1464** 821 –418 ** –159 **

Distance

1. French Regressions, 1982–99 (observations: 697) Dep. Var C GDPs GDP PCs

EU Partner Countries

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–166.6**

3908.7** 126.8**

3926.6**

EU

1341.1** –208.6**

10055.9**

10719.7**

EU

–760.9**

7709.1** 4409.6**

8566.0**

EU

0.07** 0.07**

Trade

0.14**

0.14**

Trade

0.58** 0.60**

Trade

0.15** 0.14**

DFI

0.59** 0.49**

DFI

0.24** 0.19**

DFI

Table 3.1 Trade and Investment Determinants and Links in EU Integration

0.63 0.59 0.63 0.41 0.42 0.41

Adj. R2

0.55 0.49 0.58 0.33 0.27 0.32

Adj. R2

0.5 0.44 0.55 0.27 0.35 0.35

Adj. R2

249** 218** 202** 104** 106** 85**

F-Stat

206** 159** 187** 81** 64** 66**

F-Stat

173** 138** 175** 65** 96** 77**

F-Stat

38

Michael G. Plummer

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14726** 28661** 24953** 1704** 998** –225** 0.001** 0.002** 0.002** 0.0001** 0.0001** 0.0001** –1.21** –0.04** –0.73** 0.32** 0.37** 0.32** –1.15** –2.14** –1.87** –0.12** –0.07** 0.02**

Distance

8845** 7162** 7535** 544** –836** –874** 0.004** 0.002** 0.002** 0.0007** 0.0007** 0.0006** –3.17** –1.91** –1.03** –0.90** –0.35** –0.38** –0.56** –4182.1** –0.56** –0.51** –2933.8** –0.02** –519.7** 0.07** 0.07** 151.4**

EU

1288.6**

–12714** –13656** 432.9**

EU

0.16** 0.16**

Trade

0.06** 0.07**

Trade

Notes: 1. *,**denote statistical significance at the 90 and 99 per cent level, respectively. 2. GDPs=product of source and partner GDPs 3. GDP PCs=product of source and partner per capita income 4. Trade values are in US$’000; values of other continuous variables are in US$ million.

Trade Trade Trade DFI DFI DFI

5. Japanese Regressions, 1982–95 (observations: 448) Dep. Var C GDPs GDP PCs Distance

Trade Trade Trade DFI DFI DFI

4. U.S. Regressions, 1982–99 (observations: 702) Dep. Var C GDPs GDP PCs

Non-Partner Countries

2.51** 2.41**

DFI

2.18**

2.02**

DFI

452** 748** 201** 396** 317**

0.64 0.78 0.78

F-Stat

106** 108** 125** 26** 50** 49**

F-Stat

0.8 0.87

Adj. R2

0.37 0.38 0.47 0.13 0.22 0.25

Adj. R2

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Regarding the binary variables in the DFI regressions, we obtain some interesting results. First, the EU binary variables in the partner-country regressions are positive and statistically significant when trade is excluded (except for Germany) but insignificant when trade is included. This would imply that, controlling for the other variables, bilateral trade explains more than being part of the EU when it comes to foreign investment.6 The same is true for the Japanese regressions. On the other hand, for the United States, both being part of the EU and trade are important in determining U.S. outward DFI. This result might be explained by the theoretical model posited by Dunning and Robson (1988), in which the SEA was theorized to have an ambiguous effect on bilateral DFI flows in the case of partner countries but would have an unambiguous positive effect on non-partner outflows.7 To conclude, this statistical analysis would suggest that: (1) policies associated with the EU are, indeed, an important determinant of trade flows across the board; (2) there is clear evidence of both trade creation and diversion in partner- and non-partner countries; and (3) DFI is an important determinant of trade, and trade is an important determinant of DFI, thereby confirming the trade–investment nexus.8

2.3. Lessons for ASEAN In trying to glean EU lessons for the AEC, we have to begin with several caveats regarding the differences in the subjective environments facing the EEC in the 1950s and ASEAN today: 1. The institutional environment facing ASEAN in the first decade of the twentyfirst century is much different from that of the EEC of the 1950s. European integration was clearly pushed by both memories of a devastating war and emerging Cold War concerns. Political and social motivations for economic integration were, thus, far different from that of ASEAN today, though, it should be added, ASEAN has been instrumental in keeping Southeast Asia a peaceful region, an important contribution that is often underestimated. The “European Good” is interpreted much differently in Europe than the “ASEAN Good” in ASEAN; this puts considerable limitations on institutional development at many levels. Importantly, it reduces the possibility of relinquishing power to supranational organizations. Besides, such institutional development is difficult in the ASEAN context anyway, given that: (1) nation-state formation is much younger than was the case in the European context, and in some countries still maintains a strong priority; (2) divergence in socio-political institutions is far greater than it was in the European

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context, especially since in some European countries these institutions were being created anew after the war; (3) it is not clear that European institutionbuilding has been particularly successful in all areas, though it would receive high marks for economic-related matters (though this, too, is a testable hypothesis); and (4) these European institutions are quite expensive and ASEAN government budgets are much smaller (fortunately, ASEAN would not have to employ an army of translaters, as the EU does). That said, it is important to note that the notion of the “ASEAN Good”, though viewed differently in the ASEAN context, has been changing over the past ten years. In fact, ten years ago few people in the region (or the rest of the world) knew what ASEAN was; today, it is well known. 2. The international economic environment is far different today than it was in the 1950s. First, it is important to note that, today, the global marketplace is extremely open relative to the past. This is true because of extensive reductions in trade barriers internationally, due to the GATT/WTO rounds as well as unilateral liberalization, and huge increases in international capital flows (including DFI), which have increasingly been knitting an integrated global marketplace. The costs of using regional integration as a form of fortress, that is, to maximize trade diversion, are consequently much higher than they were in the past. Second, regionalism has grown by leaps and bounds recently; trade groupings reported to the WTO come to well over 200, with a majority being established after 1995. Some of these groupings include ASEAN’s most important trading partners and could potentially isolate ASEAN, as well as forcing it to pay costs of trade diversion. These trends further underscore the need for the AEC to be open as well as for the organization to be engaged in the regionalism movement.9 The more integrated the ASEAN marketplace is, the easier this will be. These considerations were far less important in the EEC context. 3. ASEAN features far greater diversity in terms of economic development. While the expansion of the EU to include the ten Central and Eastern European countries beginning in 2004 will change things, to date all fifteen EU countries are technically developed countries. ASEAN, on the other hand, features developed; “dynamic Asian economies”; middle-income developing countries; and least-developed countries. The Asian Development Bank in its Asian Development Outlook 2002 notes that the coefficient of variation (standard deviation divided by the mean) on income levels within ASEAN is 1.6 with a mean per capita income of US$1,975 in 2000,

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whereas the corresponding numbers for the EU were 0.6 and US$20,747. Hence, the divergence within ASEAN is far greater than that of the EU, and the countries are far poorer. This suggests that matters related to the speed of implementation of the AEC, and even the ability of ASEAN to be completely inclusive of all member states, will be complicated and difficult. Phased “Ten minus X” strategies, which is what AFTA in effect embraces, may not only be desirable but necessary. 4. ASEAN countries are far more open than was the case of Europe in the 1950s. ASEAN countries are (economically) small and very open relative to the EEC of the 1950s (and even with respect to most EU countries today), with the exception of a few of the transitional CMLV (Cambodia, Myanmar, Laos, Vietnam). ASEAN countries are closely integrated with international markets through international trade as well as multinational networks. Not only is this a reality but also a policy focus for ASEAN governments. This is another reason why one would expect the AEC to embrace openness much more than the EEC/EC might have. Having noted these caveats, we can delineate at least three major lessons that can be drawn from the real-side integration experience of the EU. First, we might begin with a negative lesson: ASEAN should avoid some of the pitfalls of inward-looking discrimination from which the EU continues to suffer (especially in agriculture), but which would be potentially catastrophic in the context of the ASEAN countries. As can be seen in Table 3.2, intraregional trade in ASEAN is only about one-fourth of total global trade (compared to two-thirds in the case of the EU) and ASEAN member states are highly integrated in terms of DFI-driven production networks. Hence, any real-side economic co-operation needs to be outward-looking. In fact, this approach is exactly what the ASEAN leaders ostensibly have in mind, that is, using ASEAN as a means of “going global”. Some scholars have noted that AFTA is actually more of an investment agreement than a trade agreement; free trade reduces intra-regional transactions costs and presents to multinational corporations a vertically integrated market. The AEC should never lose this vision, even when, as in the European case, compromises may have to be made. The EU countries are developed, high-income countries that together form a large economic space. They were able to push economic integration behind relatively protected markets, in the context of an international economy that was still fairly closed. Arguably, such a protected approach was not necessary to begin with and should have been avoided (the CAP has been, by many measures, a disaster); however, the

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Table 3.2 Intra-ASEAN Merchandise Trade, 1990 and 2001 Exports

ASEAN-Ten

1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001

Indonesia Malaysia Philippines Singapore Thailand

Total (US$ billion)

To ASEAN1 (% share)

144.2 385.0 25.7 56.3 29.5 87.9 8.2 32.1 52.7 121.8 23.1 65.1

20.1 23.5 1.8 2.5 6.0 5.7 0.4 1.3 9.4 9.3 1.9 3.3

Total (US$ billion)

From ASEAN1 (% share)

162.3 336.2 21.8 31.0 29.3 74.1 13.0 31.4 60.8 116.0 33.1 62.1

16.2 22.8 1.2 1.6 3.5 5.0 0.8 1.5 7.7 10.2 2.7 3.0

Imports

ASEAN-Ten

1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001

Indonesia Malaysia Philippines Singapore Thailand

Note: 1 Percentage share of ASEAN exports (imports) relative to total ASEAN exports (imports). Hence, for example, in 1990 total ASEAN imports amounted to US$162.3 billion, and 1.2 per cent of this figure (US$1.88 billion) originated from Indonesia. Source: WTO, “International Financial Statistics 2002”, .

cost of an inward-looking approach has increased exponentially. In any event it is not a viable option for the AEC. Second, and partly related to the first, the European experience teaches us that trade–investment links matter — as noted extensively in the statistical analysis above — and these relationships are shaping in large part the economic structure of the ASEAN economies. While the transitional ASEAN countries

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are still at the early stages of the economic development process, the original ASEAN countries have experienced tremendous changes in their economic productive structures in general and trade in particular. Primary-based exports (roughly estimated as SITC 0-4) have fallen in all the original ASEAN economies.10 Only Thailand continues to have a large agricultural-export base (it is, for example, the largest exporter of rice in the world) but it, too, is falling in importance. Energy (SITC 3) continues to be a significant export for Indonesia, but its share in total exports has been falling over time, coming to only a fraction of the three-fourths share two decades ago. The same basic story applies to the Malaysian experience. The big change throughout the region has been the impressive — in some cases, spectacular — increases in the share of SITC 7, that is, electronics and transport equipment, in the export structure of East Asia. Over the 1990s, the share of SITC 7 increased in all the ASEAN countries. Indeed, in most countries it is the largest export sector; it constituted 58 per cent, 41 per cent, 72 per cent, and 68 per cent of total exports in Malaysia, Thailand, the Philippines, and Singapore, respectively.11 Table 3.3 gives an idea of how much exports (and imports) in the ASEAN countries have changed over time, as seen in their exports (imports) to (from) the U.S. and EU markets, by correlating the export structure in 1990 (1995 for the EU, to include the third enlargement countries) and 1999 at the three-digit level using the Spearman Rank Correlation Coefficient (SRCC) technique.12 The SRCC is a non-parametric statistic that ranges from +1 (in the case of perfect correlation) to –1 (in the case of perfect negative correlation). Table 3.3 shows that ASEAN exports to the United States in 1990 were very different than in 1999, with the correlation coefficient ranging from 0.097 (Vietnam) to 0.547 (Thailand) and an unweighted mean of 0.323 for the 1990–99 period. Exports to Europe changed less dramatically but still considerably (and the EU is a much less important trading partner of ASEAN). While economic reform has played an important role in this process of structural adjustment, so has foreign investment. For example, Tamamura (2002) uses input–output analysis to capture the DFI-export link in East Asia, as well as decompose the effect of external demand (by country) on production, using electric/electronics as a case study. He finds that, for 1995 (his latest year), in every (original) ASEAN country, external demand induced more production than domestic demand except (marginally) Indonesia, where, however, domestic demand fell in relative importance from 87 per cent to 52 per cent. Most countries followed a similar pattern of internationalization of electronics production. The most extreme case of the ASEAN countries was Malaysia, where domestic demand induced only 6 per cent production. The

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Table 3.3 Spearman Rank Correlation Coefficients U.S. and EU Trade with Selected ASEAN Countries (At SITC Three-Digit Level) United States Imports

European Union

Exports

Imports Exports

1990–95 1990–99 1990–95 1990–99 Indonesia Malaysia Philippines Singapore Thailand Vietnam*

0.476 0.542 0.474 0.620 0.701 n.a.

0.307 0.382 0.301 0.400 0.547 0.097

0.692 0.774 0.751 0.857 0.766 n.a.

0.524 0.614 0.592 0.741 0.638 0.366

1995–99 1995–99 0.758 0.801 0.672 0.829 0.861 0.503

0.804 0.798 0.799 0.911 0.875 0.770

Note: *For U.S. trade with Vietnam, 1995–99. Source: Plummer (2003), p. 266.

United States was the most important external source of induced demand in electronics in 1995 (often by a considerable margin), with a simple average share of approximately 25 per cent for the sample. In the key cases of Malaysia and the Philippines, U.S. demand was even more important than domestic demand, and in the case of Thailand, they are about the same. The EU statistical analysis above showed that DFI was instrumental in effecting the impressive changes in EU trade over time as well. DFI has been a key protagonist in the EU integration process, and the ASEAN leaders have correctly emphasized the need to boost DFI inflows to the region. The difference lies in that, while the U.S.’s DFI in Europe was critical during the reconstruction period, intra-European DFI flows increased during the period of economic integration (and as the European economies rebuilt) and today are far more important. This is not the case in ASEAN. The vast majority of DFI will continue to come from outside the region and, given the critical benefits that DFI from developed countries brings with it (for example, in terms of long-term, non-debt-creating capital flows, new technologies, readymade access to foreign markets, and greater links to the international production chain), this should be encouraged. But it also underscores the point that the AEC needs to present itself to the world as an integrated marketplace with minimum intra-regional and extra-regional transactions costs. Again, the AEC needs to be open. As a final point here, it is noteworthy that most of the directives that led to the creation of a tightly integrated market for DFI in Europe came with the SEA. The European experience teaches us that accomplishing such a feat

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goes well beyond mere national treatment/most-favoured-nation treatment in the regional marketplace: economic co-operation needs to reduce myriad transactions costs associated with DFI, including those related to the labour market, as well as mutual recognition of product standards, and the like. The AEC will have to focus per force on many of these areas. A third lesson relates to how the EU has been able to gain from intraregional trade liberalization, though, as noted above, this could have been better organized to minimize trade diversion (rather than maximize it in some sectors, as in the case of agriculture). The customs union was important in building a regional market; the SEA, by creating a common external commercial policy, was able to do much more by keeping real-side transactions costs within the EU to a minimum, and producing a truly regional marketplace, resulting in a more efficient division of labour in most markets. It should be stressed, however, that the AEC should be concerned not merely with increasing intra-regional but rather global economic interaction more generally, of which the ASEAN market is only one part — in fact, a part that can be used as an international springboard. Trade and investment integration policies in ASEAN should be expected to achieve the same general results as they did in the EU case (as suggested in the above statistical analysis), but this increased interaction might actually manifest itself in a different way, given the fact that ASEAN countries are so diverse and most are still developing countries. To reiterate: the AEC should be a means of increasing economic prosperity for the social good rather than focusing on, say, increases in shares of intra-regional trade and investment. A successful integration programme could theoretically lead to a decrease in regional integration, as measured by trade and investment shares, for example.13

2.4. On the AEC Real-Side Roadmap But how will ASEAN be able to create its own “customs union plus”, even by 2020? Tariff dispersion rates across the ASEAN countries are, indeed, impressive: while ASEAN members tend to have fairly low tariffs and NTBs relative to other developing countries (except for the transitional ASEAN economies), they still vary considerably across the region. Moreover, Singapore is unique: it essentially has no tariffs. The EEC did not face this problem. Given the openness of its economy (over 300 per cent of GDP), Singapore cannot raise tariff rates to accept a ASEAN common external tariff that is not equal to zero. Likely options here would include a complete free trade zone in ASEAN, perhaps with some external tariff harmonization, or a “Ten minus X” customs union, in which the common external tariff

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would be determined through negotiations similar to those of the EEC but not all ASEAN countries would join. However, it would be hoped that, rather than merely adhering to the WTO Article XXIV requirement that tariff rates in a customs union should be no higher on average after the union, the rule should be that no tariffs should be higher, with specific exceptions in the case of sensitive industries. The political difficulty in achieving such an open regionalism solution leads the ISEAS Concept Paper to recommend the less-ambitious approach: it suggests an “FTA plus” arrangement, which would include certain elements of a common market, for example, free flow of capital, free flow of skilled labour, zero tariffs on intra-regional trade, but would not have a common external tariff. This is, perhaps, a practical solution. But it is important to recognize, as the EEC example teaches us, that without integrated external tariffs, markets will continue to be segmented. The European experience shows that not even a common external tariff is sufficient to integrate markets (rather, a common commercial policy was required). Continued market segmentation will reduce the attractiveness of the region to DFI and will keep certain transactions costs relatively high. In our view, one should not throw out the customs union possibility, perhaps with some excluded sectors, at least in the long run, and 2020 is the long run. In fact, we believe that the option of a 0–5 per cent common external tariff in an AEC should at least be explored for the more developed ASEAN countries. ASEAN might agree to make exceptions in a few industries that might be integrated later on (this was done in MERCOSUR with automobiles, with mixed results). While perhaps more difficult to implement, this option would have the effect of reducing transactions costs in the region substantially; mitigating any trade diversion potential of regional integration; increasing the ability of ASEAN to negotiate integration accords with other trading partners; and augmenting its clout in international organizations. It could be a critical step in turning ASEAN into a truly open marketplace. This approach is not really foreign to ideas that the ASEAN leaders have proposed in the past, for example, the Philippines-tabled proposal to multilateralize AFTA cuts. Moreover, many ASEAN countries have committed themselves to “open trade and investment” by the year 2020 as part of the Bogor Vision of APEC. True, it is unclear exactly how the Bogor Vision will be achieved, or even what it means: APEC has not completely spelled out the details, and many ambiguities persist. However, tariffs and NTBs in ASEAN have been falling over time anyway and will continue to do so, as part of the

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Uruguay Round commitments, likely commitments under Doha, and the liberal posture of the ASEAN leaders. In this sense, the AEC could be recognized as a purely outward-oriented endeavour. Fortress ASEAN was never an option, for the many reasons given above. And why not create an essentially open region? The economic argument for protectionism is extremely weak, as the ASEAN leaders have recognized. Some might continue to hold onto the infant-industry argument. But this argument has been more of an excuse for protection than a true means of efficient industrialization in ASEAN and elsewhere. We have fifteen years between now and an AEC in 2020: this is plenty of time for any industry to go through its transition. Besides, in order to make the infant-industry argument convincing, one must identify financial bottlenecks that prevent firms from setting up comparative advantage industries. Given the state of financial markets in at least the original ASEAN countries, this is not a problem. Moreover, this open-market solution does not mean that governments would have to throw away their ability to foster industrialization directly, should they desire to do so. Regardless of the merits of an active industrial policy, it is still possible even in an open customs union. This is something that the European experience clearly shows. Even today, a decade after the completion of the SEA and six years after monetary union, governments tend to have active industrial policies, for example, through direct subsidies, special financial and tax credits, and even de facto administrative rules (for example, the EU market in financial services is far from being completely integrated). Tariffs have always been a clumsy way to foster industrialization, and NTBs tend to be even worse. Of course, the transitional economies pose an important problem here. Cambodia, for example, received about 70 per cent of its government income from import-related taxes as recently as the late 1990s. However, it has reduced reliance on international trade-based taxes as part of its reform programme (and its accession to the WTO), as this has also been the case in the other CMLV. In fact, Vietnam has made tremendous progress in its transition programme and should be online with AFTA in 2006. Allowing the logical progression of this reform programme to continue to 2020 would not be easy but would be quite desirable from an economic development perspective. Again, 2020 is a long way off and much can happen; Vietnam has reinvented itself from a non-market, closed, and state-directed economy into an increasingly outward-looking, marketoriented economy in less time than it would have for the AEC. Laos has recently followed in the footsteps of Vietnam by signing a bilateral trade agreement (BTA) with the United States, similar to the 2001 Vietnam–U.S.

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BTA, in September 2003 (ratified in 2005). It may even be possible for ASEAN to allow for a longer-term transition period for Cambodia, Myanmar, and Laos, especially since there remain political uncertainties, especially in the first two. Thus, the FTA plus approach might be the more politically practical but a customs union “plus”, at least from an economic perspective, is, perhaps, a better option. But what about the “plus” part? Here, we concur with a number of the elements outlined in the ISEAS Concept Paper. Regarding labour flows, it would be politically difficult to adopt the SEA approach of (technically) free labour mobility. Moreover, this would not be necessary in the ASEAN context, at least from the point of view of multinationals and integrating the region with the global marketplace. Yet, the free flow of skilled labour would be important, as would be the facilitation of visas for non-ASEAN nationals in the context of a regional framework. Hence, the Concept Paper’s suggestion that the AEC include free movement of skilled labour is a good one. However, the process will be difficult, as it was in the European case. Mutual recognition of professional qualifications, university and technical eduation preparation, and the like will require a great deal of effort and political support. Yet, this process actually presents a good opportunity for the region, and especially for CMLV, to embrace “best practices”. It may well be that the process will be easier for ASEAN than it was for the EU, as fewer entrenched special interests and general resistance to reform in this area are present. Many would welcome this approach. The idea of adopting “best practices” also extends to other areas that were important in the SEA, for example, product testing, technical standards, food/health-related standards, and the like. Mutual recognition will be necessary in these areas and, hence, harmonization of at least minimum acceptable standards will have to be developed. Codes should borrow from internationally accepted standards wherever possible. We have already noted that attracting DFI is an important priority of the ASEAN leaders. The usefulness of a regional approach has been recognized from the beginning, with the (generally, failed) attempts at industrial cooperation in the mid-1970s to the (marginally more successful) initiatives of the late 1980s and, finally, the AIA in 1998. The AIA is surprisingly comprehensive; once the exclusion lists are incorporated into the mainstream, it will have gone a long way in creating an integrated ASEAN market, though national policies will have to be increasingly harmonized in order to create a truly regional economic space. We concur with the ISEAS Concept Paper that this will have to be a high priority in the AEC, and that this vision of an

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integrated market for DFI will not be attainable without the transactionscosts-reducing liberalization and facilitation initiatives under other aspects of the AEC. Our statistical results above in the case of the EU, which dovetail with the rest of the literature in the area, suggest that trade–investment links are extremely important and economic integration can be one of the potentially greatest fruits of the integration process. Ultimately, it could very well be that the success of the AEC would be determined by how well it is able to bring in DFI flows, especially from outside ASEAN. As is also emphasized in the ISEAS Concept Paper and in Findlay’s contribution to this volume, the free flow of services will be important, especially since services are becoming increasingly significant in the ASEAN countries, a process that will continue as ASEAN countries develop. The ASEAN Framework Agreement on Services (AFAS), which takes a “General Agreement on Trade in Services (GATS) plus” approach, is an important step forward in creating an integrated market. However, for the AEC ASEAN has a long way to go, even though services in the AEC will not require a radical change in policy; the third round of AFAS negotiations, which began in 2001, should at least in theory cover all sectors and modes of service provisions defined by the Organization for Economic Co-operation and Development (OECD), that is, (1) cross-border supply, in which a company exports the service from home; (2) consumption abroad, in which the user of the service consumes it outside his/her home country, for example, tourism; (3) commercial presence, in which a company directly supplies the service to foreign customers (this involves the establishment of an affiliate abroad and constitutes over three-fourths of all trade in services); and (4) presence of natural persons, in which the service-exporting country sends personnel abroad to supply services. The AEC will ultimately have to ensure a generally open market in services, including no policy-induced discriminatory restrictions (including trade taxes), national treatment, mutual recognition, and the like. This was a difficult process in the EU, as some of these sectors remain quite sensitive. For example, in the financial services area the SEA spelled out three principles for integration: (1) specific minimum requirements; (2) mutual recognition of member states’ legislation; and (3) the “home country principle” prevails, in which the regulations of the country in which the business was taking place would take precedence (Story and Walter 1997). However, not even the SEA has succceded in fully integrating the financial services sector. For instance, for the eurozone countries the former national central banks, which along with the European Central Bank (ECB) form the European System of Central Banks, continue to regulate their national banking systems, rather than the ECB. Moreover,

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the “Bolkestein Directive”, which was designed to enhance further integration of services in the SEA, was significantly watered down in March 2005 in order to preserve the “European social model”.14 Hence, as AFAS is expanded as part of the AEC process, it will be necessary to integrate the services sector carefully, for it is by its very nature more complicated than the goods sector. Moreover, as noted in the ISEAS Concept Paper, the AFAS progress to date has been weak, and there is a reason for this: certain services are sensitive politically. Most likely it will be necessary to exclude certain services from complete liberalization, but these should be kept to a minimum. As is also emphasized in the ISEAS Concept Paper, developing appropriate institutions under which the AEC can evolve will be necessary. In the early 1990s a number of us were involved in a project directed by Amnuay Viravan, Cesar Virata, and Seiji Naya, which proposed that the ASEAN Secretariat enhance its technical abilities. Many of our proposals were adopted; the Secretariat has been strengthened considerably from the days when it was mostly a “post office”. However, it will have to be enhanced drastically in order to facilitate the creation of the AEC. Many of the directorates of the EU could be emulated in the ASEAN context. But it is our view that the bureaucracy should be kept, to paraphrase Albert Einstein, “to the minimum possible but no less than that”. The first reason for this is that the EU bureaucracy is simply too big and expensive. Second, the drain on human capital in the ASEAN context would be detrimental to other domestic policy priorities, an important consideration especially for CMLV. Third, at least in the first stages of creating the AEC, ASEAN could keep the “social bureaucracies”, which are fairly substantial in the EU, somewhat as a separate project. While these institutions were important in making the EU what it is today, ASEAN, as noted above, has a different socio-political context. A fourth and related point relates to the creation of a “mini-state” in ASEAN, as has been done in the case of the EU, for example, in developing an integrated executive, legislative, and judicial system. As was noted above, the willingness in the EU to develop supranational institutions is more the exception than the rule; in our view ASEAN should try to minimize the supranational character of AEC, taking the idea of “subsidiarity” to the greatest extent possible. The executive component of ASEAN integration would have to be enhanced considerably, but this could arguably be done by adapting and expanding current institutions. Certainly, all ASEAN Secretariat staff will have to be recruited on a competitive basis, rather than being on secondment from a member-state government, in order to ensure a technically strong unit with a regional vision. This approach has been essential in the EU

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context. On the other hand, the creation of some sort of judicial authority to “enforce” (hitherto a bad word in ASEAN) AEC rules will be necessary. No doubt this will be difficult; the EU continues to have its own problems (the Alstom case in France is a good example but there are many more). As in the case of the EU, it would have to be an evolutionary process. 3. Financial-Side Considerations Section 2 highlighted real-side co-operation issues, including some institutional considerations. These will no doubt be the most important in the creation of the AEC. However, as the Asian financial crisis clearly demonstrated, ASEAN should not ignore financial (and monetary) aspects of co-operation, for they arguably will need to be developed alongside real-sector initiatives. We consider some of these areas here, based once again on the European experience. In the past just about every regional economic integration programme has focused in the first stage almost exclusively on the real-side of the economy. Financial integration has always been treated as something separate, to be taken up at a later date. In many ways, this is less true for European integration, though the point is debatable. While the EPU was a financial arrangement, it was only ad hoc, and was quickly phased out, as soon as European currencies became convertible. This was just as the Treaty of Rome actually began implementation. The EC did publish the Werner Report, which mapped out a plan for monetary union at a time of great turbulence in the Bretton Woods System (1968), and after the Bretton Woods System collapsed, it tried to create the (short-lived) European Snake and eventually the EMS, which expanded the Snake in March 1979. These attempts at exchange-rate co-operation were important because the “customs union plus” needed stable exchange rates in order to run well. Such cooperation was especially necessary for the CAP: the main goal of the CAP was to stabilize farmer incomes and flexible exchange rates put this at risk, for the country with a depreciating currency had an advantage over an appreciating-currency country, which was incompatible with the acquis communautaire. Hence, the EC had to develop a “green” exchange rate system, called “monetary compensation amounts” (MCAs), which prevented this “adverse” structural change from happening. However, this system was very expensive: Pomfret (1997) suggests that the MCAs constituted over 15 per cent of the CAP’s huge budget. Nevertheless, European capital markets tended to be substantially segmented until the implementation of the SEA was fairly advanced. There had been early attempts to create a single banking market as far back as 1972

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(it was still-born), still fifteen years after the Treaty of Rome, and in 1977 the European Council established the First Banking Directive (it did little to integrate the markets),15 but these and other attempts only marginally integrated the regional markets until the SEA initiatives. Today, the European banking system is far more integrated but some aspects of finance continue to be among the few areas in which the single market is still incomplete. Capital controls were removed as part of the SEA programme. In sum, even in the case of the EU, financial integration did not keep pace with integration in the real sector. But it is important to note that the EU experience teaches that real and financial links are important and need to be addressed. Moreover, this was not done, for example, in the case of MERCOSUR, a customs union which entered a crisis period with the Brazilian devaluation in January 1999 and from which it has not been able to emerge (the Argentine crisis has made things worse). The financial markets in MERCOSUR continue to be segmented. The Mexican peso crisis in December 1994 also created a great problem for the North American Free Trade Agreement (NAFTA); the United States and Mexico had only previously negotiated a marginal exchange stabilization fund that proved entirely insufficient given the magnitude of the shock. Hence, the tendency seems to be to let financial issues wait, but experience shows that this is an unwise policy. The Asian crisis might also be seen in this light. Prior to the crisis, APEC, for example, all but ignored financial and monetary co-operation, and ASEAN itself did little. In creating the AEC, therefore, ASEAN leaders would do well to focus on financial issues in tandem with real-sector integration. In this section we will make the case for closer co-operation in the financial area, focusing on capital markets and using some experiences from the EU.16 We will refrain from addressing monetary union considerations except tangentially, as our focus here is on the AEC institution-building process. To date ASEAN has mostly financed its private investments through bank lending. Equity markets tend to be thin, highly volatile, and illiquid; fixed-income markets are even less developed in most countries. While a strong reliance on bank lending is not necessarily an impediment to longerterm economic development — the German financial model, for example, is based on bank intermediation — it strongly limits the options available to firms and places a greater strain on the banking system (which can, inter alia, cause moral hazard problems in itself ). The lack of a reliable yield curve, which can only be established through a liquid bond market, has been a perennial problem for corporate issues. It also develops a tendency

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towards maturity mismatches. The Asian financial crisis underscored many of these weaknesses. The key advantage of stock market integration is that an integrated regional stock market is more efficient than segmented national capital markets. With an integrated regional stock market, investors from all the member countries are able to allocate capital to the locations in the region where it is the most productive. With more cross-border flows of funds, additional trading in individual securities will improve the liquidity of the stock markets, which will in turn lower the cost of capital for firms seeking capital and lower the transactions costs investors incur. These suggest a more efficient allocation of capital within the region. In many ways bond markets are more interesting than equity markets for ASEAN. First, the emergence of large fiscal deficits in the ASEAN countries since the crisis will be important sources of growth in the market. In the early mid-1990s many ASEAN governments had fiscal surpluses; the Asian crisis, with its severe effects on both sides of the government balance sheets (lower tax revenues on the one hand; higher spending on the financial clean-up, social spending, and higher interest payments on the other) has led to large budget deficits. A second — and related — point is that governments are increasingly using the bond market to clean up non-performing loans (NPLs) that continue to plague some ASEAN financial markets. Third, as ASEAN countries deepen their respective capital markets, the need to price risk efficiently becomes even more important. A deep, liquid bond market from which a reliable yield curve can emerge is of the essence in accomplishing this. Realizing the importance of developing capital markets, the ASEAN Finance Ministers endorsed a finance work programme designed to deepen capital markets in the region, as is evident in recent declarations.17 Regarding EU lessons in monetary co-operation, we must again underscore that comparisons are difficult, as relative economic-divergence problems continue to be critical. Nevertheless, even the EU is a diverse group, especially if one considers regions rather than countries (and will be much more so, once Central and Eastern European countries join). Moreover, ASEAN’s needs in economic co-operation are obviously quite different from those of the EU. As noted above, while ASEAN integration may be popular in the region, it is less than that in Europe, particularly among government leaders. In addition, various EU states had perennial macroeconomic (especially fiscal) problems; EMU allowed these member states to implement necessary austerity measures in the name of European integration. Yet, the credibility of most of the original ASEAN countries in terms of monetary and fiscal policies is actually quite high, especially for developing countries: inflation

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tends to be quite low in the original ASEAN countries and most countries had either budget surpluses or essentially balanced budgets prior to the crisis. Hence, neither the political nor political-economy dynamics, which were favourable in the case of most eurozone countries, could be considered as important in the case of ASEAN.18 Nevertheless, in the aftermath of the Asian crisis, things are changing. It has been clear to the ASEAN leaders that there exist “policy externalities”; some sort of restrictions on the conduct of monetary and fiscal policy could not only improve the macroeconomic environment in the ASEAN countries but also promote regional economic stability. Moreover, the possibility of competitive exchange-rate devaluations could be damaging to the implementation of the AEC. Political arguments for wanting to be part of Europe for European countries would be replaced in the ASEAN context by a fear to repeat the economic disaster of the crisis. Such co-operation could be formally arranged within or outside the AEC framework, without any pretention to initiatives leading to monetary union. In sum, it would appear that there are some useful lessons for ASEAN from the EU experience, though obviously the differing contexts suggest that there can be no “cookie-cutter” approach to economic integration in which ASEAN would merely import the EU model. But as the ASEAN leaders implement the AEC, they would do well to study carefully the EU experience.

3.1. A Regional Fixed-Income Market for the AEC In addition to the financial and monetary co-operation efforts noted above that would complement the AEC, we propose below a roadmap for the creation of an ASEAN regional bond market (ARBM), that is, an integrated system within which cross-issuances of fixed-income securities would be possible, consistent with the Hanoi Plan of Action. We use the experience of European integration, as well as that of other developed countries, as our primary model. In a nutshell, we believe that the creation of a bond market with integrated regional features, with its salutary effects on local markets, will help the AEC process by strengthening ASEAN financial development in general by reducing the need for extra-regional intermediation; increasing the participation in the regional market on both the demand and supply sides of the market, including higher participation by international players; creating greater diversity in the financial system with more efficient portfolio diversification/debt management for the private sector, quasi-governmental institutions, and governments; reducing to a minimum the currency and maturity mismatches that were part of the crisis; and developing a far more efficient capital-market environment in ASEAN, which will allow ASEAN

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not only to increase regional financial intermediation but also to boost its attractiveness internationally. Importantly, the development of any roadmap needs to keep in mind the difficulty of deepening financial markets in such a diverse region. ASEAN includes a country that is a global financial centre boasting a per capita income even higher than the OECD median (Singapore); a small, rich country that is only now creating a fledgling bond market (Brunei Darussalam); several middle-income countries that have been listed among the “dynamic Asian economies” at one time or another and have at least primary bond markets at various degrees of sophistication (Thailand, Malaysia, the Philippines, and Indonesia); and four transitional economies counted among the least-developed countries (LDCs) with an embryonic bond market (Vietnam) and without one (Cambodia, Laos, and Myanmar). We might summarize the “guiding principles” of the ARBM to be: 1. Complementarity: The regional bond market should be created simultaneously with domestic initiatives to develop local markets, especially in terms of the clearing and settlements system. 2. Efficiency and universality: As was clear in the European experience, ASEAN countries at a minimum will have to remove restrictions on intra-regional capital flows — save, perhaps, in certain strategic sectors — as well as lift any exchange controls. (Otherwise, the continuation of segmented markets would ensure that the ARBM would be weak, illiquid, and probably unpopular. The European experience suggests that free intra-regional movement of capital is a quid pro quo for integrating financial markets.) 3. Subsidiarity and harmonization: In order to ensure complementarity and compatibility, the development of a regional bond market should recognize the principles of subsidiarity, that is, regional requirements should be established only when they are absolutely necessary. The EU experience also teaches us that national treatment and mutual recognition (for example, of credit agencies), as well as development of best-practice accounting standards, codes of conduct, and conventions in bond issuance will eventually be necessary. 4. Flexibility and diversity: As ASEAN countries are extremely diverse in terms of financial development, regional integration will need to proceed on an “Ten minus X” basis, that is, allow the launching of the regional market by countries that meet the minimal requirements, while planning for the accession of other members as soon as they are ready. This is an approach that the EU has used with success in various spheres.

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5. Co-operation on currency denomination and economic policy: Again, the EU experience would suggest that the ARBM would do best to consider the option of developing a common denomination for bond issuances. This could either be in the form of, for example, an ASEAN Currency Unit or an “ASEAN plus Three” basket. The important thing is that a common denomination may prove necessary in order to ensure sufficient liquidity in the system. There would be many details that would have to be worked out in developing an ARBM in which cross-issuances would be easy and popular, but in our view it is feasible to have it up and running within eight years for the original ASEAN countries and within the 2020 deadline for all of ASEAN. Ultimately, the regional market would have the following characteristics: First, the vast majority of bond transactions, of course, would still be local, that is, residents would continue to be the largest investors and issuers in national markets. The regional market would merely complement the national markets. Second, the ARBM would allow ASEAN-resident private and semiprivate corporations, investment banks, other financial companies, as well as sovereign actors, to issue bonds freely in any participating ASEAN market. Third, ASEAN-based investors would receive national treatment, including with respect to their freedom in purchasing bonds, taxation, and the like. Fourth, the clearing and settlements system would be based on a deliveryversus-payment system, for example, the Real Time Gross Settlements (RTGS) system. (The RTGS system linkages could be carried out under the auspices of the participating ASEAN central banks and could function under the same rules, regulations, and procedures as the TARGET system in the EU, which is an excellent technical model.) And fifth, the ASEAN financial authorities would keep close tabs on the development of the regional and local markets and consider measures for improvement at all levels. 4. Concluding Remarks In this chapter, we have tried to consider what the objectives and substance of the AEC should be, using wherever possible appropriate lessons from the world’s most successful example of regional economic integration, that is, the EU. We note that while there is much that the EU can teach ASEAN, the ASEAN leaders should not underestimate the differences between the regions and the differing historical contexts. The EU integration experience is remarkable. It took a great deal of time before it became a truly integrated market, that is, about thirty-seven years,

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from the Treaty of Rome in 1957 until the implementation of the SEA, which was essentially complete in 1994. Once the process was given a big push in the mid-1980s, however, integration initiatives picked up steam, culminating in monetary union only five years later in 1999. At times, some leaders and experts gave up on the EU; the process was certainly not linear. In the mid-1970s, for example, France (temporarily) slapped import tariffs on Italian wine. In the early 1980s market segmentation increased with the use of NTBs outside the purview of the EC, leading some to suggest that the EC was doomed to retreat. After the September 1992 crisis in the EMS, it was very easy to be pessimistic about the future of monetary union. There were even sceptics up to the end. But the EU was able to persevere due to the commitment of its leaders and critical social elements. This is a very basic lesson: given the fact that the AEC will have to be far more comprehensive and “intrusive” in national markets than has ever been the case before, it will take strong commitment indeed in order to move the process forward. No doubt this is why there is much scepticism regarding the AEC. It was no different in the case of AFTA: in the late 1980s many pundits were speculating that since the region’s political exigencies had changed, ASEAN had no future as a regional organization. Instead, the ASEAN leaders responded by pushing forward impressively on the economic front, and AFTA became the first major initiative in this process. Since then, AFTA has expanded and deepened; co-operation has advanced significantly in the area of investment (AIA); liberalization of services are being actively pursued in the AFAS; other “deepening” measures are being spearheaded; and horizontal integration has expanded about as far as it can go, as ASEAN is now composed of all ten Southeast Asian nations. While the AEC will take a much more extensive commitment, it certainly is possible if the ASEAN leaders have the political will to see it through. We have argued that the AEC needs to be governed by the need to (1) always maintain a clear outward orientation; and (2) reduce transactions costs to a minimum in the region, in order to create a fully integrated market. The EU is a good guide for (2) and gives some important lessons (some negative) for (1). Our main recommendations regarding the substance of the AEC roadmap may be summarized as follows: 1. The ASEAN leaders should seriously consider the creation of a “customs union plus” arrangement based on open regionalism, that is, a zero or very low common external tariff (with the possibility of temporarily excluding sensitive sectors and allowing for the possibility of a longer transition period);

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2. In order to create an integrated ASEAN market, the AEC will also have to focus on creating a common investment region, building on the AIA; free flow of services (though it is likely that certain sensitive sectors could be excluded or allowed a longer transition process), building on the AFAS; and free flow of skilled labour. In this sense, our recommendations follow closely those of the ISEAS Concept Paper; 3. Expanding existing institutions will be necessary and additional ones will have to be created, especially in the area of monitoring and legal issues. In this sense, there is much that ASEAN can learn from the EU, but we noted that the EU is a special case and the nature of supranational ASEAN authority should be kept to a minimum, and that the region would do well to avoid the huge bureaucracy that has emerged in Europe; and 4. We also recommended that financial and monetary co-operation should be included as part of the AEC process, including institutional initiatives, such as the possibility of a regional bond market. True, these recommendations were based more on economic arguments than political considerations, though it is hoped that some pragmatism has been sprinkled in. But at this point in the planning process, the AEC roadmap should be developed for a smooth, well-paved road. There will be plenty of time to identify — and deal with — the potholes. NOTES 1. See, for example, Plummer (1991). 2. For example, Italy had very restrictive voluntary export restrictions placed on Japanese automobile exports, whereas Germany effectively had none. 3. For an in-depth analysis of the theoretical foundations of the gravity model, as well as critiques of its use, see Frankel (1997). 4. As we use data from 1982 to 1999, we include as EU members Spain and Portugal in 1986 and Austria, Sweden, and Finland in 1995. 5. An adjusted R2 tells us how much of the variance in the dependent variable is explained by the independent variables, adjusting for the number of independent variables. In the case of our regressions, they generally explain better than half of it, on par with the rest of the gravity literature. 6. Of course, as was calculated in the earlier regressions, trade is a function of being part of the EU. What is intended here is that being part of the EU does not explain much beyond its effect on trade. 7. Perhaps an example would clarify their argument. With the reduction in intraregional transactions costs created by the SEA, companies from partner countries will have an incentive to invest in the most efficient EU country. In some cases,

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8.

9.

10. 11.

12. 13.

this will mean opening up a factory elsewhere in the EU; to others, however, the preferred place to produce might be at home, meaning that it actually might close up factories elsewhere in the EU. Hence, it is not clear if intra-regional flows would increase or decrease. On the other hand, a country like the United States would not see any reduction in transactions costs (the common external tariff remains the same), so it would not have any incentive to move factories out of Europe. But greater efficiencies associated with the SEA in the internal market would create an incentive to invest more in Europe. Hence, somewhat paradoxically, one would predict an increase in U.S. DFI but it is unclear what effect there would be on EU intra-regional DFI. It should be noted that, theoretically, there is a simultaneity problem here: it is not clear if trade determines DFI, or if DFI determines trade. For example, it may be that a company decides to invest in a country and then services this investment with exports from home, in which case the numbers would show investment “causing” trade. However, it may equally be true that a company begins to penetrate a market through exports and then, once the market becomes more familiar, the “brand” is established, etc., the company begins to invest. In this case trade would “cause” investment. These regressions just show that they are related without assigning causality. In fact, Granger Causality tests (not reported) that the simultaneity problem does, indeed, exist: they are both causing each other. ASEAN is already doing this, including negotiations with China, the Closer Economic Relations (CER) group, and most recently, the “Enterprise for ASEAN Initiative” with the United States. Data for this structural-change analysis come from Plummer (2003). The Philippines case is the most dramatic and surprising. The value of SITC 7 exports increased over this period by over 100 per cent, with the largest changes in SITC 723 (civil engineering and contractors’ plants and parts), SITC 728 (machine and specialized equipment), 736 (machine tools), 751 (office machines), and 752 (automatic data processing machines). Laos, Cambodia, and Myanmar are excluded from the analysis due to data problems. This is because, for example, a successful AEC that brings in higher DFI flows from abroad — a key aim of the AIA — might not only reduce intra-regional DFI but also could reduce intra-regional trade, if multinationals take advantage of the attractive regional division of labour offered by ASEAN. For example, suppose that, as a result of the AIA, a Japanese automobile multinational sets up production plants in Indonesia and Singapore, whereby it exports US$1 billion in car components to Indonesia; adds US$100 million in labourintensive value added to production in Indonesia before exporting the semiprocessed products to Singapore for a further US$1 billion in processing and then finally exports back to Japan. This means that ASEAN intra-regional trade would have changed at the margin by: exports to Singapore from

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16. 17. 18.

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Indonesia (US$1.1 billion) divided by exports of Japan to Indonesia (US$1 billion) plus exports to Singapore from Indonesia (US$1.1 billion) plus imports of Japan from Singapore (US$2.1 billion), or 26 per cent, whereas extraregional trade would have increased by 74 per cent. The point is that this could be a successful economic activity for all parties involved, but intraregional trade shares might fall anyway. , published on 23 March 2005. Story and Walter (1997, p. 14) note that of the EU’s 9,434 credit institutions at that time, 429 were classified as foreign banks, and only 107 had a parent company based in a member state. Governments were reluctant to grant licences. Some of these arguments are also made in Plummer (2002), from which this section draws in part. See, for example, the Joint Ministerial Statement of the Fourth Finance Ministers Meeting, 25–26 March 2000, and the Hanoi Plan of Action (2001). This discussion draws from Kreinin and Plummer (2002).

REFERENCES Asian Development Bank (ADB). Asian Development Outlook 2002. Manila: ADB, 2002. Bleaney, M.F., D. Greenaway, and R.C. Hine. “The Impact of the 1992 Programme on Non-EC European Countries: An Overview”. In Economic Integration in Europe and North America, edited by M. Panic and A. Vacic. New York: United Nations, 1995. Cecchini, Paolo. The Costs of Non-Europe. Brussels: European Commission, 1988. Click, Reid W. and Michael G. Plummer. “Stock Market Integration in ASEAN after the Asian Financial Crisis”. International Center for the Study of East Asian Development (ICSEAD) Working Paper, May 2003. De Grauwe, P. Economics of Monetary Union. Oxford: Oxford University Press, 2000. Dunning, John and Peter Robson. Multinationals and the European Community. Oxford: Blackwell, 1988. Frankel, Jeffrey. Regional Trading Blocs in the World Trading System. Washington, D.C.: Institute for International Economics, 1997. Freeman, Nick J. “A Regional Platform for Trading Southeast Asian Equities: Viable Option or Lofty ‘Red Herring’?” Institute of Southeast Asian Studies Working Paper no. 4, 2000. Available at . Institute of Southeast Asian Studies (ISEAS). “Concept Paper on the ASEAN Economic Community”. Mimeographed. ISEAS, February 2003. Kreinin, Mordechai E. and Michael G. Plummer. “Ex Post Estimates of the Effects of the European Single Market Programme on the Exports of Developing Countries”. ASEAN Economic Bulletin 15, no. 2 (August 1998): 206–14. ———. Economic Integration and Development: Has Regionalism Delivered for Developing Countries? London: Edward Elgar, 2002.

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Messerlin, Patrick. Measuring the Costs of Protection in Europe. Washington, D.C.: Institute for International Economics, 2001. Plummer, Michael G. “Efficiency Effects of the Accessions of Spain and Portugal to the EC”. Journal of Common Market Studies 29, no. 3 (March 1991): 317–25. ———. “EU and ASEAN: Real Integration and Lessons in Financial Cooperation”. World Economy 25, no. 10 (November 2002). ———. “Structural Change in a Globalized Asia: Macro Trends and U.S. Policy Challenges”. Journal of Asian Economics 14, no. 2 (April 2003): 243–81. Pomfret, Richard. The Economics of Regional Trading Arrangements. Oxford: Oxford University Press, 1997. Sapir, Andre. “The Effects of Europe’s Internal Market Program on Production and Trade: A First Assessment”. Weltwirtschaftliches Archiv 132 (1996): 457–75. Story, Jonathan and Ingo Walter. Political Economy of Financial Integration in Europe: The Battle of the Systems. Cambridge, Mass.: MIT Press, 1997. Tamamura, C. “Structural Changes in International Industrial Linkages and Export Competitiveness in the Asia-Pacific Region”. ASEAN Economic Bulletin 19, no. 1 (December 2002): 52–82. Wellons, Philip. “Integration of Stock Exchanges in Regions in Europe, Asia, Canada, and the U.S.”. HIID. , undated.

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4

Institutional Reforms to Achieve ASEAN Economic Integration Narongchai Akrasanee and Jutamas Arunanondchai

1. Introduction We define “economic integration” as the pooling of resources and markets with the objective of bringing about greater efficiency in resource allocation. There is a consensus amongst the ASEAN leaders that economic integration is necessary for ASEAN to continue to be an effective player in the global production process. It follows that the long-term prosperity of ASEAN rests on the successful implementation of this mechanism. Where is ASEAN in the economic integration process? The first major economic agreement for the grouping is the ASEAN Free Trade Area (AFTA) which was launched in 1992. By the end of 2003, all tariff lines in the Inclusion List (IL) of the ASEAN-Six would be 5 per cent and below; while CLMV have been given more time until 2010.1 The ASEAN leaders have agreed to eliminate all import duties by 2010 for the ASEAN-Six and by 2015 for the new members.2 In the pipeline is the agreement on the ASEAN Investment Area (AIA) that would open up all ASEAN industries for investment (with the exception of industries in the General Exclusion List). Under the AIA, free flow of investments amongst ASEAN members is set for 2010; while for non-member countries, it is set for 2020. On top of this, there is the ASEAN Framework Agreement for Services (AFAS). Although

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the agreement is yet to be ratified by the ASEAN members, much of the details have already been fleshed out — where more progress has been made in the priority sectors, for example, financial services, telecommunications. It is useful to think of economic agreements, such as AFTA, AIA, and AFAS, as mechanisms to achieve economic integration. Whether these agreements will bring about more efficient resource allocation, however, depends upon the actions of the players within the economic system (that is, domestic and foreign producers, consumers, and ASEAN governments). The actions of the players are directly linked to their incentives, which are shaped by the “institution”. This chapter provides an analysis of what is lacking in the current ASEAN institutions or what may derail a successful economic integration process. Policy recommendations on the minimum institutional reforms required to achieve ASEAN economic integration are also provided. 2. Experiences of ASEAN Economic Integration The social norm or the informal institution3 in ASEAN is one where national sovereignty is highly valued; non-intervention in domestic affairs is stressed and decisions are reached by consensus.4 Evidently, this provides a weak framework for any agreement to be made. Since domestic interest and ASEAN community interest often conflict, the scope of (self-enforcing) co-operation is likely to be limited. Moreover, a consensus-based decision-making process is extremely time consuming, and the expansion of ASEAN to include four more members has further added to the complexity of an already very diverse economic and cultural group. With different stages of political and economic development, ASEAN members have different needs and wants. The formal institution in ASEAN can be characterized by the agreements that the grouping has achieved so far. As mentioned earlier, the most significant economic agreement thus far is AFTA. AFTA stipulates a reduction in tariff barriers amongst ASEAN members with different time frames for the ASEAN-Six and CLMV. The ASEAN leaders have agreed to meet for an ASEAN Summit every year to exchange views on regional security and seek out greater economic co-operation. Given that decisions are reached by consensus, it may be surprising that so many agreements and protocols have been signed among the ASEAN governments (for example, AFTA; the Framework Agreement on the AIA; and the Initiative for ASEAN Integration Work Plan). Apart from AFTA, the signed documents are either in the form of agreed plans on the direction of ASEAN interaction or they are initiatives to be implemented far into the future (for example, the AIA will be fully operational

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only in 2020 for non-ASEAN countries). Economic initiatives that are only realized far in the future creates uncertainty and implies that the ASEAN governments are not held answerable to any decisions made now. Agreements on work plans are more easily reached than treaties since they are less committal. Even the most concrete ASEAN economic agreements and protocols, such as AFTA and the ASEAN Dispute Settlement Mechanism (DSM), have failed time and time again to resolve trade disputes. Not only does the ASEAN DSM lack effective penalties but the Common Effective Preferential Tariff (CEPT) Scheme under AFTA also provides several loopholes for countries to withdraw from their tariff concession obligations. For example, the Protocol on the implementation of the CEPT Scheme Temporary Exclusion List (TEL) was endorsed at the ASEAN Economic Ministers Meeting (AEMM) in October 2000 to meet Malaysia’s demand for a delay in the tariff liberalization of its national automotive industry. Reyes commented: ASEAN’s decision to allow Malaysia to delay including autos in the AFTA free-trade scheme is the latest disappointment. Other members are now poised to postpone the lifting of tariff protection for their pet sectors. AFTA could collapse. … there is no guarantee that by the time the various sensitive products are scheduled for liberalization, individual governments will not actually backtrack from their commitments. … Currently it seems that inconvenient regulations can be circumvented by respective decrees (or protocols) as negotiated by the AEM.5

Malaysia’s decision to maintain tariffs on the import of cars has antagonized Thailand most as the latter sees itself as the automobile production centre for the region. This led to a lengthy trade dispute between the governments of Thailand and Malaysia. Both sides described each other’s claims as not being justified. In January 2003 the Philippines used the same CEPT Protocol to suspend its tariff reduction to 5 per cent for several petrochemical resins. In this case Singapore has demanded compensation and the two governments are negotiating a form of compensation, which is likely to be selective preferential duties on certain chemicals.6 The current ASEAN DSM, which uses bilateral negotiation as the main mechanism, brings about selective preferential duties, which in turn make market distortions pervasive in the system. This is illustrated in the case of the Philippines and Thailand whereby the former agreed to raise its rice import quota from Thailand in 2003 in return for allowing it to maintain high tariff rates on imported sugar. The reduction in the Philippines’ sugar tariffs is expected to be delayed until 2010.7

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Thus, it is unlikely that AFTA, AIA, and AFAS will deliver the goal of efficient resource allocation for ASEAN. This is because of the loopholes granted by the ASEAN Heads of Government. As a result, non-tariff barriers and other anti-competitive practices would continue to exist despite the market and investment liberalization. In ASEAN countries powerful domestic lobbies are present in a number of sectors and are resisting change. Confronted with these powerful lobbies, governments often back down (for example, the case of the upstream section of the petrochemical industry in the Philippines and the Malaysian national car industry). Hence, this has slowed down the economic integration process. 3. Institutional Reforms to Achieve ASEAN Market Integration So far, the ASEAN DSM has failed to resolve trade disputes due to its inability to enforce agreements. Currently, the ASEAN institution also lacks well-defined regulations to safeguard the interests of producers, investors, and consumers. This is likely to become more problematic as economic integration deepens. ASEAN needs an effective jurisdiction process. Moreover, it needs investment regulations and competition and consumer-protection rules to provide a transparent framework for conflict resolutions. While trade disputes should be resolved through a jurisdiction process, with the help of the AFTA Council, non-dispute-related cases should be left to the ASEAN Secretariat. Thus in addition to its role as a facilitator and coordinator for the implementation of ASEAN agreements and plans, the ASEAN Secretariat should be given the power to caution members who fail to implement the necessary reforms. This section focuses on two ASEAN institutions that play a key role in the implementation and co-ordination of ASEAN agreements, namely the ASEAN DSM and the ASEAN Secretariat. There are several reasons why the European Union’s (EU) institutional arrangement provides a particularly useful reference for ASEAN in its quest for a successful economic integration. Firstly, the EU has achieved the highest level of an economic integration — to date no other region has achieved this level of integration. Secondly, unlike the Australia–New Zealand Closer Economic Relations Trade Agreement (ANCERTA) and the North American Free Trade Agreement (NAFTA), where there are obvious economically dominant members in the agreement, several countries in ASEAN are of similar sizes and stages of development, for example, Malaysia, Thailand, the Philippines, and Indonesia. This characteristic also applies to the EU with Britain, France, and Germany being in this league of dominant economies.

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While embracing all aspects of the EU institution is politically unfeasible and unnecessary for ASEAN, the establishment of a supranational ASEAN Court — fashioned on the European Court of Justice — would be critical to the economic integration process.

3.1. ASEAN Dispute Settlement Mechanism It is well known that the World Trade Organization (WTO) DSM is extremely weak as an enforcement mechanism. The WTO DSM as modelled in NAFTA and used by ANCERTA is more suitable for a smaller trading bloc. This is because sanctioned retaliation, the ultimate penalty in these agreements, hurts most when the trade bloc is small and trade is concentrated among a few members. (Appendix 4.1 provides a summary of the dispute settlement process of ANCERTA, NAFTA, AFTA, and the EU.) As mentioned earlier, the ASEAN DSM has not been able to uphold formerly ratified agreements. This is partly due to the tendency of the ASEAN Economic Ministers (AEM), which has the highest authority on economic matters, to accommodate political interests of member states. This points to the need for a supranational body which is prepared to exercise jurisprudence over ASEAN and to uphold agreements signed by ASEAN members. In addition, a centralized judicial body has the ability to organize a concerted effort to impose a more severe penalty on the country that is found guilty of failing to fulfil its commitment. For example, it could enlist other ASEAN countries to suspend preferential trade arrangement for the nonconformist member. However, this would not be credible if the cost on the enforcers of imposing such a penalty is too high. The supranational ASEAN Court could thus learn from the Court of Justice of the EU. The latter has the authority to ensure that community law is effectively applied, that is, it solves disputes involving member states, EU institutions, businesses, and individuals. There are several categories of proceedings under the European Court of Justice, namely: (1) the preliminary ruling procedure; (2) the proceedings for the failure to fulfil an obligation; (3) the proceedings for annulment; and (4) the proceedings for the failure to act. The preliminary ruling is a co-operation between the national courts and the Court of Justice. If a member state fails to fulfil its obligation under the community law or if a dispute should arise, the proceedings for the failure to fulfil an obligation and the proceedings for the failure to act are followed respectively. Any request for the annulment of community provision and legal acts follows the proceedings for annulment. This type of process should ensure consistency in AEM’s actions and reduce the influence of politics on economic matters.

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Currently the AFTA Council plays an important role in monitoring the implementation of the CEPT Scheme for AFTA. In this way, the AFTA Council could play a useful and complementary role to the ASEAN Court. In particular, it could use its expertise to aid in resolving disputes arising from the interpretation of ASEAN agreements. As ASEAN progresses towards integration in other areas, for example, investments and services, the role of the AFTA Council should also be enhanced to cover these other areas. To ensure that investment and service sector liberalization brings about the greatest improvements in resource allocation, rules on investment, competition, and consumer protection should be agreed upon by ASEAN members prior to the liberalization. The complexity of the task in drawing a regulatory framework for ASEAN members should not be understated. This is because ASEAN members have different levels of development, in terms of market development and trade negotiation capacity. The latter implies that the negotiators from member states frequently have insufficient and different understanding of the negotiating approach and its objective. To accommodate the different stages of market development among ASEAN members, “core principles” for competition policy may be implemented in the short to medium run instead of competition rules. This is the stance of the Organization for Economic Co-operation and Development (OECD) Development Committee on Competition Law Policy and the Competition Policy Group of the Pacific Economic Co-operation Council (PECC) trade forum. The competition principles give a domestic government the choice of competition measures that would best solve the market distortions in its country.8 Even if an agreement can be reached on the regulatory framework, the failure to fulfil an obligation (for example, on investment facilitation) may stem from human and financial resource constraints. In this way, contributions and technical assistance for capacity building in training, human resources, and institutional development from the more advanced members of ASEAN, and where possible international organizations, would be necessary for the economic integration process to move ahead. Once the investment and competition regulations are in place, supported by an effective enforcement mechanism, foreign producers would benefit from the certainty of ASEAN government policies and actions. This would in turn reduce the risk and cost of entry into ASEAN, making the region more attractive for foreign investments.

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3.2. ASEAN Secretariat Although the reforms on the ASEAN Secretariat in the past decade — such as the introduction of an open recruitment process and the upgrading of the Secretary General of the ASEAN Secretariat to the Secretary General of ASEAN — have succeeded in bringing a more corporate feel, greater work continuity, and more respectability, the functions of the ASEAN Secretariat remain subservient to politics. This is because the ASEAN Secretariat continues to lack the power to enforce the implementation of regional agreements. Thus, while it has the task of initiating plans and co-operation programmes, co-ordinating, facilitating, and monitoring the approved projects and activities, it cannot penalize contracting parties who fail to uphold their commitments. Currently, the best that the ASEAN Secretariat can do under these constraints is to alert the contracting parties who fail to uphold their commitments and report to the Heads of Government. Given the non-interventionist stance of the ASEAN governments, typically nothing is done to discipline such members.9 The list of tasks that the ASEAN Secretariat is currently responsible for is rather similar to that of the European Commission (which is the driving force in the EU’s institutional system). However, the European Commission has the right to implement the European legislation, budget, and programmes adopted by the European Parliament and Council. The ASEAN Secretariat could usefully function in this way, particularly on economic affairs or matters pertaining to ASEAN economic integration. It may be that an ASEAN Economic Secretariat (AES) — separate from the ASEAN Secretariat — could be entrusted with the responsibility to enforce the implementation of agreements under the ASEAN economic integration framework. This reform would overcome the non-interventionist stance of ASEAN Heads of Government by assigning a formal institution to enforce members’ obligation towards economic integration. It is important to note, however, that the AES would only be able to fulfil its role properly if an effective judicial institution exists to support it. Only when ASEAN is able to keep its house in order can it conduct international dialogues with more weight. This is likely to become an important issue as regional economic integration progresses and more demands are made upon ASEAN countries (for example, customs reform and modernization; customs harmonization; the implementation of the ASEAN Sectoral Mutual Recognition Arrangement; the finance work programme; and other reforms).10

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In a similar way, Simon Tay11 acknowledges the problem of ASEAN’s preference for non-interference, non-binding plans, and the lack of compliance. However, he falls short of suggesting supranational institutions for ASEAN. Instead, he suggests that ASEAN should encourage the use of the ASEAN-X principle, whereby members which are ready to implement certain reforms earlier are able to do so. This principle is likely to help hasten the process of ASEAN economic integration through two channels: firstly it has a “demonstration effect” that can help to assure members which are uncertain of the impact of the liberalization measures; secondly it creates peer pressure. Nonetheless, it does not address the problem of non-compliance that is pervasive in the current institutional set-up. 4. Time for a More Centralized ASEAN Structure If AFTA is not a binding agreement, how can the AIA and AFAS be taken seriously by those outside ASEAN? Although reforming the ASEAN DSM to enforce economic agreements goes against the ASEAN social norm of nonintervention and the practice of “brushing things under the carpet”, such reforms are of paramount importance for the credibility of ASEAN. As new agreements come into force, the number of conflict cases will increase. If nothing is done to remedy the DSM, the number of dispute cases that are left unresolved is also expected to rise. Each additional unresolved case will undermine the credibility of ASEAN economic integration (and even ASEAN as an institution). At some critical point, the opportunity cost of allowing another unresolved trade dispute would be so great that the ASEAN governments would have no choice but to establish a supranational judicial system with the authority to enforce penalties.12 Past major economic agreements, such as AFTA, have been achieved as a reactive response from ASEAN to external changes. During the 1990s the rise in regionalism created an impetus for ASEAN to form a free trade area. In this way it would not be surprising if a major reform on the ASEAN judicial system could occur in response to changes in the perception of non-ASEAN economies. If this were true, then the opening up of China, which has the potential effect of sidelining ASEAN economies in global trade, would be an important factor that could hasten a major reform in the way ASEAN makes decisions, that is, the so-called “ASEAN Way”. How to move ahead with the consensus-based decision-making? There is a need to realign the conflicting objectives of ASEAN members. One possibility is to use transfer payment, particularly to narrow the development gap between CLMV and the original members. Up until now, ASEAN has relied

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heavily on funding from partner countries, for example, Japan, Australia, and China. Thus the major source of development assistance to CLMV does not come from ASEAN but from outsiders. By raising the level of development assistance from ASEAN to CLMV, this helps to strengthen the ties among ASEAN members, which can bring about greater compliance.13 It is obvious that ASEAN needs a more centralized structure, after having made several agreements, all of which need effective and efficient implementation. ASEAN thus needs to make the decision to become more centralized as soon as possible. To realize the ASEAN Economic Community (AEC), ASEAN should therefore consider setting up two supranational bodies, which are: 1. An ASEAN Court, to be responsible for dispute settlements; and 2. An ASEAN Economic Secretariat, to be responsible for economic affairs pertaining to ASEAN economic integration. 5. High-Level Task Force on ASEAN Economic Integration Early in September 2003, the AEM endorsed an additional DSM vehicle, namely the “advisory mechanism”, which is anticipated to take place before the consultation and the enforcement mechanism already in place in the general DSM procedure of AFTA.14 In the proposal, two newly appointed units would be involved in the advisory process. These are: (1) ASEAN Consultation to Solve Trade and Investment Issues or ACT and (2) ASEAN Legal Unit. These units perform differing roles and issues may be first referred to either unit. A brief description of each unit is given below: 1. ACT is a network of government agencies (one from each country) and is the first recourse for private individuals and businesses to lodge complaints that have resulted from failures to uphold agreements. Private individuals and businesses may contact an ACT unit in the home or host country and the appropriate government agency must come up with a proposed solution within thirty days. If the dispute is not resolved, then the issue can be raised with other DSMs. 2. ASEAN Legal Unit is to be staffed by qualified lawyers employed by the ASEAN Secretariat to offer legal interpretation/advice on potential trade dispute issues upon request from countries, ASEAN Compliance Monitoring Body, and ASEAN DSM. The advisory mechanism should facilitate the dialogue between the victim and the transgressor. Ultimately the High-Level Task Force hopes that this mechanism would lead to more disputes being resolved bilaterally.

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If a bilateral resolution cannot be reached at this stage, there is an additional non-legal avenue that can be pursued. This is through a newly established ASEAN Compliance Monitoring Body (ACMB). ASEAN citizens who are not from countries involved in the dispute would be selected to sit in the ACMB to review the problem and come up with a finding in a given time frame. Although the finding of the ACMB is not legally binding, it is recognized in the DSM should the case advance to this stage. Finally, the proposal mentions an “enhanced” DSM, whereby the original DSM is to be depoliticized by replacing the AEM, which is the current appellate body, with a group of qualified and independent professionals. Clearly the proposed set-up facilitates and opens more doors for the bilateral resolution of trade disputes. In addition, the replacement of the AEM by a group of experienced professionals as the appeal body should increase transparency in the DSM. While these measures are clearly welcomed, they fall short of solving the core problem with the current ASEAN DSM, which is the lack of an enforcement mechanism. Without a supranational Court, the appellate body remains lacking in the power to enforce its rulings. Thus the need for a centralized ASEAN Court remains relevant. How does the proposal by the High-Level Task Force fit with the institutions proposed in this chapter? The proposed functions of the advisory mechanism and the ACMB would complement the functions of the ASEAN Economic Secretariat and the ASEAN Court well. This is because, despite recent institutional improvements, there is still a need for ASEAN to have supranational institutions in order to ensure the successful implementation of economic agreements. 6. Conclusion Since its establishment in 1967, ASEAN has come a long way as an organization to promote regional co-operation. At this time, progress made in ASEAN economic projects is being hampered by the lack of an effective institutional mechanism to enforce regional agreements. Two important issues of economic integration have been identified in this chapter, namely dispute settlements and developing and monitoring cooperation schemes. For this purpose, it is proposed that ASEAN sets up an ASEAN Court, modelling after the EU, to deal with dispute settlements and establish an ASEAN Economic Secretariat to manage regional economic integration. It is also proposed that ASEAN makes the decision to adopt a more centralized institutional structure for economic co-operation in order to successfully realize the AEC.

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The WTO Dispute Settlement Body in case the government chooses to take the dispute to the WTO procedure.

The Senior Economic Officials Meeting (SEOM) is central in the process and occurs at least four times a year. The meeting reports directly to the AEM.

• The ASEAN Economic Ministers (AEM) is the highest authority on economic matters.

• The NAFTA Trade Commission, comprising Cabinet-level members, plays a significant role in the general Dispute Settlement Mechanism proceeding.

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continued on next page

• The Court of Justice: • The court comprises one judge per member state. • The court is aided by eight advocates general. • Appointed by joint agreement of the governments of the member states. • Renewable term of six years.

• The ministers of the member states (Australia and New Zealand) meet annually or otherwise as appropriate to review the operation of the agreement.

The European Union (EU), 1950 The judicial institution of the European Union: The Court of Justice, 1989

EU4

Organization

NAFTA3

• Trade in Goods: • ASEAN Free Trade Area • The North American Free • Australia–New Zealand Closer (AFTA): The Agreement on Trade Agreement (NAFTA), Economic Relations Trade the Common Effective 1994 • Agreement (ANCERTA), 1983 Preferential Tariff (CEPT), • Several specialized Dispute • 26 articles and 5 annexes 1992 Settlement Mechanism in this • Article 22: Consultation • The Protocol on Dispute agreement: and Review Settlement Mechanism, 1996 • Chapter 11: Investor–State • Article 3: Rule of Origin • 12 articles and 2 appendixes: Disputes • Trade in Services: General Dispute Settlement • Chapter 14: Financial Services The Protocol on Trade in Mechanism Process Disputes Services to the Australia–New • Chapter 19: Subsidies and Zealand Closer Economic Dumping Disputes Relations Trade Agreement, • Chapter 20: General Dispute 1989 Settlement Mechanism • 23 articles • Article 16: Notification • Article 19: Consultation

AFTA2

Agreement

ANCERTA1

Appendix 4.1 The Dispute Settlement Mechanism Institutional Reforms to Achieve ASEAN Economic Integration 73

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▼ Retaliation

▼ Compensation

▼ Voluntary implementation

▼ DSB adopts panel report

▼ Panel report issued to parties

▼ Interim review stage

▼ Panel examination

▼ Panel established by Dispute Settlement Body (DSB) ▼ Violation of the agreement

▼ Compensation and retaliation ▼ Appeal to AFTA Council within • Maximum time frame: 15 days 195 days ▼ AEM examination: 15 days

• Maximum time frame: 290 days

▼ Compensation and retaliation: 30 days

▼ ▼ Voluntary implementation: 30 days

▼ AEM examination: 30 days

▼ Appeal to AEM within 30 days

▼ SEOM (Treatment of panel result): 30 days

▼ Issuing a final report to the Commission within 30 days after the initial report

▼ Presenting initial report to the Commission within 90 days

▼ Establishment of panel

Court of Justice

▼ Court of Justice

▼ Requesting the annulment of community provision and legal acts

Member states, Council, etc.

3. Proceedings for annulment

▼ Monitoring member states’ fulfilment of the obligations under community law

Court of Justice

2. Proceedings for failure to fulfil an obligation

National courts

1. The preliminary ruling procedure • No hierarchy system but institutional co-operation

• The various categories of proceedings

EU

▼

▼ Panel examination: 60 days

▼ Establishment of panel

▼ AFTA Council (in cases under CEPT)

▼ Good offices, conciliation, mediation: 30 days

▼ Good offices, conciliation, mediation: 60 days ▼ SEOM: 30 days

Consultations: 45 days

NAFTA Consultations: 30 days

AFTA

▼

Consultations: 60 days

2. The government chooses to take the dispute to the WTO process.

▼ Ministers Meeting

Consultations

General Dispute 1. The ministers meet annually Settlement to review operation of the agreement. Mechanism Procedure

ANCERTA

Appendix 4.1 – continued 74

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▼

▼

▼

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continued on next page

* An exchange of statements between the parties and the establishment of the report by the judge-rapporteur/The public hearing/The advocate general gives his/her conclusions.

Court of Justice

▼

Written and oral phase*

Drawing up a ruling draft submitted to the other members of the Court for examination

▼

▼

Appointed as judgerapporteur

Advocate General

Drawing up the report for the hearing (the legal background/ observation of the parties)

▼

Appointed as judgerapporteur

▼

Specific judge

The Registry

▼

Problem cases

• Organization of work

Court of Justice

▼

Member states, community institutions, etc. can make complaints

▼

Contrary to the Treaty

4. Proceedings for failure to act

Institutional Reforms to Achieve ASEAN Economic Integration 75

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• The mechanism for the settlement of financial services disputes by applying and modifying the settlement from the general dispute settlement mechanism process. • The financial services roster is to be established whose members have expertise or experience in financial services law or practice.

Financial Services Disputes

NAFTA The NAFTA investors could bypass the local courts of a host government through access to binding international settlements under ICSID or UNCITRAL rules. • ICSID is the World Bank’s International Center for the Settlement of Investment Disputes. • UNCITRAL is the United Nations Commission for International Trade Law.

AFTA

Investor–State Disputes

ANCERTA

Appendix 4.1 – continued EU

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The United States plays a lead role; the United States also subsidizes many regional development programmes, creating additional linkages and incentives for compliance.

No clear economic leader; several ASEAN-Six countries are at similar stages of development, that is, Malaysia, Thailand, Indonesia, and the Philippines.

Comments

77

No clear economic leader: several large economic powers of similar sizes, that is, the United Kingdom, France, and Germany.

Sources: 1Fitzhenry and Robertson (2001). 2 “Protocol on Dispute Settlement Mechanism”, Dispute Settlement Mechanism, ASEAN Secretariat, 1996 (). 3 “General Information”, Dispute Settlement Mechanism, NAFTA Secretariat, 2003 (). 4 “Institutions of the European Union” ().

This is an agreement between two countries; therefore, the agreement is easier to sustain since issue linkages are more direct.

• The system is formally an inter-state dispute settlement mechanism. • Litigants: Importers, exporters, and competent authorities of each country. • Panel decisions are binding and enforceable through sanctioned retaliation. • The final panel decisions within 315 days after the request made.

Subsidies and Dumping Disputes

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NOTES 1. The ASEAN-Six are Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand. CLMV consists of Cambodia, Laos, Myanmar, and Vietnam. 2. For a discussion on the achievements of AFTA, see Ariff (2001). 3. North (1990) defines institutions as the rules of the game in a society. There are two types of game rules: informal rules (norms and customs); and formal rules (constitutional, property-rights rules, and contracts). 4. See Soesastro (2001) for a historical perspective of ASEAN informal institutions. 5. Reyes (2000). 6. “Petrochemical imports belie Singapore damage claim”, Manila Times, 24 June 2003. 7. “Manila gets sweet on Thai rice this year”, The Nation, 4 January 2003. 8. See Vautier, Lloyd, and Tsai (1999). 9. Although the surveillance process has been stepped up in various areas of cooperation (for example, measures to increase transparency and improve information flows), which should increase the incentive towards compliance through peer pressure, the process is still in its infancy. 10. Some of these reforms are currently being addressed — see the recommendations of the High-Level Task Force on ASEAN Economic Integration (which is annexed to the ASEAN Concord II). 11. See Tay (2001). 12. Although stopping short of setting up a supranational entity, ASEAN plans to enhance the DSM to make it more workable — see the recommendations of the High-Level Task Force on ASEAN Economic Integration (which is annexed to the ASEAN Concord II). 13. EU social assistance is the main source of funding in this area for many less advanced members. This is one of the attractions of joining the EU for many less advanced countries in the region, despite the need to observe the community law. 14. “Mechanisms of the Dispute Settlement System”, Annex 5 of the document produced by the High-Level Task Force on ASEAN Economic Integration for the Thirty-fifth ASEAN Economic Ministers Meeting, 2 September 2003, in Phnom Penh, Cambodia. REFERENCES Ariff, M. “Trade, Investment, and Interdependence”. In Reinventing ASEAN, edited by Simon S.C. Tay, Jesus P. Estanislao, and Hadi Soesastro. Singapore: Institute of Southeast Asian Studies, 2001. Declaration of ASEAN Concord II (Bali Concord II), 7 October 2003. . Fitzhenry, J. and D. Robertson. Australia New Zealand Closer Economic Relations Trade Agreement. Sydney: Baker & McKenzie, 2001.

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Manila Times, 24 June 2003. North, D. Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press, 1990. Reyes, A. “Keeping up with the Singaporeans — Rather than attack the Lion City, neighbors should learn from it”. Asiaweek 26, no. 48 (8 December 2000). Soesastro, H. “ASEAN in 2030: The Long View”. In Reinventing ASEAN, edited by Simon S.C. Tay, Jesus P. Estanislao, and Hadi Soesastro. Singapore: Institute of Southeast Asian Studies, 2001. Tay S.C. “Institutions and Process Dilemmas and Possibilities”. In Reinventing ASEAN, edited by Simon S.C. Tay, Jesus P. Estanislao, and Hadi Soesastro. Singapore: Institute of Southeast Asian Studies, 2001. The Nation, 4 January 2003. Vautier, K.M., P.J. Lloyd, and Tsai I.W. Competition Policy, Developing Countries and the WTO. Washington, D.C.: World Bank, 1999.

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5

ASEAN Economic Community: Political and Security Implications Mely Caballero-Anthony

1. Introduction In a region that has been beset by a series of crises, the vision of an ASEAN Economic Community (AEC) — first introduced at the Eighth ASEAN Summit in Phnom Penh in November 2002 — could not have come at a better time. The AEC envisages an economically integrated Southeast Asian region, displaying elements akin to the ultimate form of economic integration — that is, a single regional market, but yet to be tailored according to the current political, economic, and strategic conditions and realities of the region. While the modalities and final form of the AEC are yet to be unveiled,1 the ideas that have been floating around nonetheless signal encouraging trends about the revival of the economic dynamism that had characterized the region in the late 1980s until the onset of the Asian financial crisis in 1997. Indeed, since the start of the financial crisis, ASEAN has been at the receiving end from critics who have painted a gloomy picture of a “sunset” organization that has seen the light of day. ASEAN has been cast as “irrelevant”

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and “ineffective” in addressing many of the economic and security challenges that had hit the region. Several writings on ASEAN have also cast aspersions at the prevalence of regional norms that are seen to be obstructive to effective regional action.2 Against the many reservations on the prospects of ASEAN, the introduction of the AEC vision is by far the most convincing indicator that member states of this thirty-seven-year-old group have taken a definitive step that could significantly alter the very nature of ASEAN as an intergovernmental, co-operative association — to perhaps one that is similar to a supranational organization like the European Union. Several questions have emerged since the announcement of the AEC. Among these are: What are the implications of the AEC on the geopolitical and strategic environment of the region? How do political and security challenges of the region affect the prospects of an AEC? What are the implications of the AEC on the processes of institutionalization and capacity building in ASEAN? And, how does the idea of an ASEAN Security Community (ASC) relate with the AEC? The above questions are certainly not exhaustive and may require comprehensive analyses that are beyond the scope of a single chapter. However, for the purpose of a more focused discussion, I shall examine two salient points that are discussed in the major sections of this chapter. First, following the introduction, the chapter will assess the nature of political and security co-operation in ASEAN as it impacts on economic co-operation in the region. This is discussed in section 2. In doing so, a brief history of ASEAN’s evolution as a regional grouping will be provided to highlight, among others, the close nexus between politics/security and economics in the region. Second, the chapter will look at some of the political and security challenges that could affect the realization of the AEC and examine how ASEAN has responded to these challenges. This is discussed in section 3. Section 4 attempts to offer some thoughts on the road ahead for the AEC and concludes by going back to the seamless linkages between the AEC and the idea of an ASC.3 2. ASEAN’s Political and Security Co-operation: Paving the Way for Regional Economic Integration

2.1. Revisiting the Economics and Politics/Security Nexus Any analysis of economic co-operation in ASEAN, particularly within the context of deepening and widening economic integration, would inevitably touch on the nature of political and security co-operation of the organization.

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To be sure, the inextricable linkages between politics and economics, and/or security and economics have defined the very nature of ASEAN and would have consequently informed any assessment of its capacity to respond to regional challenges. Hence, it is useful at the outset to go back to the basics of ASEAN before proceeding to discuss the prospects and problems of realizing the AEC. Many writings on ASEAN have highlighted the very raison d’être of establishing an association for Southeast Asia — that is, regional reconciliation, in a regional milieu which was once characterized by intramural disputes.4 By establishing ASEAN in 1967, member states provided themselves with a framework for building a stable structure of relations to contain and manage intramural tensions, like the conflict between Malaysia and Indonesia (which were embroiled in the Confrontation in 1963 over the formation of the Federation of Malaysia), and Malaysia and the Philippines that disputed the territory of Sabah.5 To ASEAN’s founding members, regional reconciliation was essential to attain regional security order. But more importantly, a sustainable regional order could only be achieved if the national security of respective member states was also guaranteed. In this regard, notions of national security were comprehensively defined to include not just state and military security but also political, economic, socio-cultural, and so on, with particular attention given to economic development.6 To put it simply, national security — comprehensively viewed — was a prerequisite for national resilience and in the aggregate would result in building regional resilience and ensure regional security. The emphasis on economic development for national security and as a crucial element for national/regional resilience cannot be understated. The importance of economic development was in fact underscored in the first ASEAN document, that is, “ASEAN Declaration of 8 August 1967” (often referred to as the “Bangkok Declaration”), which said in part: [Considering that] the countries of Southeast Asia share a primary responsibility for strengthening the economic and social stability of the region and ensuring their peaceful and progressive national development…the aims and purposes of the Association shall be: (1) To accelerate the economic growth, social progress and cultural development in the region through joint endeavours in the spirit of equality and partnership in order to strengthen the foundation for a prosperous and peaceful community of Southeast Asian nations;…7

From the above, it is not altogether surprising that many security analysts working on ASEAN have consistently cited economic development as an essential approach to maintaining regional security. In fact, the evolving

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notions of regional security defined within the rubrics of comprehensive security, co-operative security, and human security have always included economic development as a critical element in the way security is conceptualized in Asia.8

2.2. Economic Development, Political Stability, and Regional Security: Many Sides of the Same Coin Economic development, political stability, and regional security (regardless of the order in which they are presented) are essential components of the ASEAN story of regional co-operation. The relationships of these three elements are often complex and profound. However, in fleshing out how one feeds into another, one could argue that economic development and economic co-operation in ASEAN are predicated on political stability and security in the region. In other words, political stability is a prerequisite in engendering the right environment for promoting economic development and fostering economic co-operation in Southeast Asia. In the experience of ASEAN, it could also be argued that it would not have been possible for ASEAN to advance its agenda of economic co-operation were it not for the benign political and security environment in the region. This peaceful environment was made possible first and foremost by the story of regional reconciliation among its founding members. As reflected in the thirty-seven-year history of ASEAN, this process of regional reconciliation was extended beyond the original, non-communist member states in the region to include other states regardless of their political and ideological orientations. Thus, ASEAN was, for all intents and purposes, a diplomatic device for regional reconciliation — which for a long time became the defining process underpinning the region’s approach to peace and security. The ultimate objective of the process was to build a security community founded on the assumption and towards the goal that no member states would ever go to war with one another. The process of engendering regional reconciliation was also underpinned by the assiduous cultivation of political and security co-operation among ASEAN members. In this regard, certain modalities had to be put in place and internalized by members to ensure that the co-operative environment is sustained. These modalities are found in ASEAN’s Treaty of Amity and Cooperation (TAC) adopted in 1976. The TAC basically outlined a set of principles and norms of interstate conduct, as well as modes of co-operation and decision-making. This set of principles included, among others: the respect for the principle of non-interference in the internal affairs of other states, the non-use of force, peaceful settlement of disputes, and so on.

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These norms and modalities have often been referred to as the “ASEAN Way”, which, as succinctly described by one scholar, is a feature anchored on, “the belief in the wisdom of minimal institutionalization and on the belief that parties in a dispute are less likely to go to war as long as dialogue continues, as well as promoting reassurance that states would not be coerced into supporting a decision to which they have not consented…”9 The “ASEAN Way” essentially portrays the nature of regional co-operation that has taken place and has led many scholars over the years to write about this seemingly unique characteristic. It is important to note, however, that beyond the informal ASEAN Way are the formal processes that have taken place, reflected in the numerous institutionalized meetings that have taken and continue to take place in the region. These include the ASEAN Summits, the annual and ad hoc meetings of ASEAN Foreign Ministers (AMM), meetings among Economic Ministers, and meetings of other ministers and senior officials (SOMs) which fall within the broad ambit of ASEAN’s political, economic, and security co-operation. These in turn can be considered as formal mechanisms since they provide the venues and opportunities for bilateral and regional issues to be addressed. As a result, over time ASEAN has generated a number of formal instruments that are indicative of the multifaceted nature of this organization and the many areas of co-operation that have defined ASEAN. These would include the major agreements grouped under the following areas: •

•

Economic and Political Co-operation 1. ASEAN Declaration, Bangkok, 9 August 1967 2. Declaration of ASEAN Concord, 24 February 1976 3. ASEAN Vision 2020, Kuala Lumpur, 15 December 1997 whose first six-year implementation is found in the Hanoi Plan of Action (HPA) of 1998 4. ASEAN–China Framework Agreement on Closer Economic Cooperation, November 2002 Security/Strategic Co-operation 1. Zone of Peace, Freedom, and Neutrality, Kuala Lumpur, 27 November 1971 2. Treaty of Amity and Co-operation in Southeast Asia, Bali, 24 February 1976 3. ASEAN Declaration on the South China Sea, Manila, 22 July 1992 4. Treaty on the Southeast Asia Nuclear Weapons-Free Zone, Bangkok, 15 December 1995 5. The ARF Concept Paper, 1995

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6. The ASEAN Troika, 2000 7. Rules and Procedures of the High Council on the Treaty of Amity and Co-operation in Southeast Asia, 2001 8. Declaration on the Conduct of Parties in the South China Sea, 2002 All these agreements and treaties outlined above have a role to play in the various elements of a comprehensive framework of managing conflicts and crises in ASEAN. It can be argued that these formal and informal modalities were critical in that these enabled ASEAN to push ahead with its agenda on economic co-operation in spite of the many crises that had confronted the region, especially in recent times. The next section will now discuss the growing list of political and security issues that have challenged the limits of existing regional mechanisms and may threaten the economic agenda of ASEAN. 3. Political and Security Challenges in ASEAN: Old and New While most observers agree that ASEAN has played a critical role in defusing tensions in the region and has decreased the probability of war among its members, the picture has been challenged in recent years. As the region found itself beset with a number of crises, the capabilities of ASEAN have come into question. These challenges became more pronounced during the 1997 Asian financial crisis and resurfaced in the aftermath of the 11 September 2001 terrorist attacks in the United States. However, against these “new” challenges also remain the old tensions of bilateral disputes among ASEAN states over territorial claims, the periodic disagreements between neighbours Malaysia and Singapore, and the constant concerns over the future of the South China disputed claims. There have also been the constant features of conflicts which were the products of the Cold War — such as the divide in the Korean Peninsula and the territorial disputes between Japan and China, Japan and South Korea, and so on. For the purpose of a more manageable discussion, this section will only highlight some of the current and more pressing regional challenges confronting ASEAN.

3.1. The 1997 Crisis and Its Repercussions The celebration of ASEAN’s thirty-year anniversary in 1997 was marred by several unfortunate events. That was the year ASEAN was to have enlarged its membership to include Cambodia, Laos, and Myanmar, thereby completing the dream of ASEAN’s founding fathers to have one Southeast Asia. One of

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these events was the power struggle in Cambodia in July 1997 which ended in a coup staged by the then Second Prime Minister, Hun Sen, to oust Prince Ranariddh as First Prime Minister. Soon after the Cambodian crisis, the region was hit by a devastating financial crisis. As states were coming to grips with the damages that followed, the onset of the haze problem from the forest fires in Indonesia only compounded the situation. As though the region had not had enough problems, a year later the region witnessed the alarming instability that unfolded in Indonesia, triggered by the unexpected downfall of the country’s long-serving President Soeharto. Since the founding of ASEAN, Indonesia and its leader Soeharto had been regarded as the beacon of stability in the region. In the same year Malaysia experienced its first major political crisis in thirty years with the dismissal and subsequent trial and imprisonment of its Deputy Prime Minister, Anwar Ibrahim. This turbulent period saw ASEAN’s credentials challenged on many fronts. Firstly, the ASEAN norm of non-interference became problematic when the organization deferred Cambodia’s membership as a result of the coup but it went ahead with admitting Myanmar in spite of protests against its poor human rights records. ASEAN got a lot of flak from the two cases and the grouping was heavily criticized for inconsistency and double standards. ASEAN, however, maintained the position that while Myanmar’s political conditions were regarded as internal matters of the state, Cambodia’s case was viewed differently. The latter case was regarded as one that had serious implications for ASEAN as a whole since the coup in Cambodia broke the regional norm of the non-use of force. As a consequence, ASEAN insisted that Cambodia meet certain conditions before its admission, which included, among others, the holding of free and fair elections and the establishment of the Cambodian Senate. ASEAN also formed the ASEAN Troika to deal with efforts at restoring political stability in Cambodia.10 Secondly, at the height of the Asian financial crisis, ASEAN was roundly criticized for its inability to respond urgently and cohesively to address the devastating consequences of the crisis that threatened the economies of many member countries. In spite of the fact that ASEAN had initiated various measures to contain the damage and instituted rescue packages that saw Singapore and Malaysia extending financial support to crisis-stricken members like Indonesia, its responses were widely regarded as generally inadequate to address what was at that time a spiralling economic crisis.11 Nevertheless, it is important to note some of the key initiatives undertaken by ASEAN in response to the financial crisis. These included:

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The Bilateral Swap Arrangements (also known as the Chiang Mai Initiative) which was a mechanism that allowed for stand-by emergency funds to assist economies badly affected by the crisis, aside from the financial assistance provided by multilateral financial institutions like the International Monetary Fund (IMF). The promotion of trade within Southeast Asia and East Asia using local currencies. The establishment of a regional surveillance mechanism which was essentially aimed at promoting a more effective surveillance over the economic policies and practices of ASEAN members, facilitated by a fuller disclosure of relevant economic data.12

More importantly, the crisis did not deter ASEAN from pushing ahead with its commitment to the ASEAN Free Trade Area (AFTA). In December 1998 its leaders declared: “We reaffirm out commitment to the greater integration of our economies as a primary expression of our cooperation and solidarity … ASEAN reaffirms its commitment to trade and investment liberalisation and facilitation, at the multilateral and regional levels and will continue to undertake concrete measures towards these objectives”.13 Moreover, ASEAN pushed ahead with the institutionalization of the ASEAN Investment Area (AIA) in 1998 to facilitate liberalization of investment flows within the region. Thirdly, the environmental damage brought on by the haze problem became a test case of ASEAN’s ability to deal co-operatively with problems in one country that had severely affected its neighbours. In the case of the haze, although the environmental disaster happened in Indonesia, it inflicted considerable damage to neighbouring countries — Singapore, Malaysia, and Brunei. At the height of the problem, it was estimated that Malaysia and Singapore suffered about US$1 billion losses in economic activity, such as tourism and air travel, and immediate health cost.14 In response, ASEAN instituted the Regional Haze Action Plan (RHAP), which the ASEAN Ministers of the Environment endorsed in 1997. The RHAP called for each ASEAN member to develop a National Haze Action Plan that would require each of them to report its plans to combat fires and haze in its respective environment. ASEAN also put into place a joint regional technical assistance project with the Asian Development Bank to assist member countries requiring technical support in fire-fighting procedures. But in spite of the regional agreement and co-operation that had been instituted, some haze returned in late 1998 and mid-1999.

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Finally, the most difficult challenge to ASEAN’s modalities involved the tragic events in East Timor in 1999. ASEAN and even the ASEAN Regional Forum (ARF) came under severe criticisms for their inability to stem the violence and gross violations of human rights that followed. As noted in many accounts, ASEAN was not able to initiate any form of conflict preventive action to stop the atrocities that occurred in many parts of the territory soon after the East Timorese voted for independence from Indonesia. It was not until the United Nations organized a peacekeeping mission under the framework of the International Force for East Timor (INTERFET) that violence was controlled and large-scale humanitarian relief operations could be carried out.15 The East Timor crisis was viewed by many as a humanitarian disaster that was waiting to explode and which ASEAN, conscious of its policy of nonintervention, did not do anything to prevent. Although ASEAN member countries actually became active participants of INTERFET, its contributions were lost in the barrage of criticisms against the extent to which ASEAN went to “intervene” in what was considered by the organization as an intra-state conflict. Its inability to respond to the humanitarian crisis in East Timor was seen as a litmus test of its inadequacy as a regional institution to respond to this type of crisis or prevent this type of crisis from happening.

3.2. Post-11 September and Regional Security The impact of the 11 September terrorist attacks in the United States has had a great bearing on the political, security, and economic environment in the region. The event and its aftermath saw the region embarking on its “own war” against terrorism amidst prevailing fears and concern that Al-Qaeda or Al-Qaeda-linked terrorist networks may be operating in the region. This threat became more stark with the bombing incidents in Bali, Indonesia, which occurred in October 2002 and, more recently, in Jakarta with the Marriott Hotel bombings, which happened on 5 August 2003. Some of the Southeast Asian groups that were reported to have alleged links with the Al-Qaeda network were Jemaah Islamiya (JI), which is reported to have operated in Singapore and Indonesia, Kumpulan Mujahiddeen (in Malaysia), Laskar Jihad (Indonesia), and the Moro Islamic Liberation Front (MILF) and the Abu Sayaff Group in the Philippines. Soon after the 11 September attacks, ASEAN acted expeditiously and issued an ASEAN Declaration on Joint Action to Counter Terrorism during the Seventh ASEAN Summit. The statement outlined several measures to fight terrorism, which included, among others:

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“Reviewing and strengthening national mechanisms to combat terrorism; Deepening co-operation among front-line law enforcement agencies in combating terrorism and sharing ‘best practices’; Enhancing information/intelligence exchange to facilitate the flow of information, in particular, on terrorists and terrorist organizations, their movement and funding, and any other information needed to protect lives, property, and the security of all modes of travel; Strengthening existing co-operation and co-ordination between AMMTC and other relevant ASEAN bodies in countering, preventing, and suppressing all forms of terrorists’ acts. Particular attention would be paid to finding ways to combat terrorist activities, support infrastructure and funding and bringing the perpetrators to justice; and Strengthening co-operation at bilateral, regional and international levels in combating terrorism in a comprehensive manner and affirm that at the international level the United Nations should play a major role in this regard.”16

Under the ASEAN framework, member states also signed the Agreement on Information Exchange and Establishment of Communication Procedures on 7 May 2002 to promote co-operation in combating transnational crimes, including terrorism. These include combined training, hotlines, and border controls. The signatories to this Agreement now include Malaysia, the Philippines, Indonesia, Cambodia, and Thailand. Similarly, ASEAN and the United States issued a Joint Declaration for Co-operation to Combat International Terrorism on 1 August 2002, which committed the United States and all ten ASEAN members to improve intelligence-gathering efforts, strengthen capacity-building measures, and enhance mutual co-operation.17 As ASEAN countries grappled with the intractable problems of terrorism unfolding in the region, the threats threw another dimension to the nature of challenges confronting the existing regional mechanisms in dealing with this problem. Although ASEAN countries presented a united front in combating terrorism, regional efforts and co-ordination have been hampered by the domestic politics of member states.18 Countries like Indonesia and Malaysia that have large Muslim populations have had to tread carefully in handling this problem and to be cognizant of the domestic sensitivities involved in apprehending Muslim militant groups. Indonesia, for example, was initially perceived to be in a denial mode. The government was slow in responding to calls for the arrest of certain individuals who were reported to be involved directly in the terrorist acts perpetrated by terrorist groups. And, it was not

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until the Bali incident that the Indonesian Government was finally seen to have acted more decisively with the arrests and trials of suspected terrorists like Abu Bakar Bashyir, alleged leader of JI, and Amrozi.19 What was also significant was how the “war on terrorism” and the role of the United States appeared to be a divisive issue among ASEAN states. Indonesia and Malaysia, for example, did not endorse the U.S.-led attack on Afghanistan, while the Philippines and Thailand tacitly supported it by allowing U.S. overflights over their territories. In contrast, Brunei and Singapore endorsed the war by pointing to the UN resolution. There had also been discomfort with the possibility of the U.S. military presence in the region, given the close co-operation between the United States and the Philippines in the latter’s battles against the MILF and Abu Sayaff.

3.3. SARS and the Health Crisis While fighting terrorism has been the common issue that has preoccupied ASEAN states lately, the unexpected onset of the infectious disease Severe Acute Respiratory Syndrome (SARS) triggered another crisis in the region. SARS was a rude awakening to the region whose already expanding list of non-traditional security issues did not include health and human security. The extent of the SARS crisis had been clearly reflected in the sudden disruption of economic activities in several economies in Asia. With travel advisories issued against SARS-affected countries, there was a drastic fall in tourism and travel, making these two sectors the most badly hit sectors in most economies. However, there were also fears of a possible domino effect. Starting with the fall in consumer confidence, drop in domestic demands, and poor business sentiments, many businesses were threatening to be on the brink of collapse as the cost of SARS started to rise. Economic growth prospects were reassessed and forecasts for gross domestic product (GDP) growth in Asia were reduced to fall between 0.5–1 per cent. The World Health Organization (WHO) put the cost of SARS to Asia at US$30 billion, while a health expert of BioEnterprise Asia projected that the cost stood at US$50 billion for the region and up to US$150 billion globally. In Hong Kong, for example, which recorded the second highest number of SARS cases, government estimates placed the cost of SARS at about US$1.7 billion, while in Singapore the government forecast indicated that SARS shaved as much as a half to one percentage point off its GDP growth forecast for 2003.20 In containing and fighting SARS, ASEAN acted very fast to put in place several mechanisms to address the health crisis. Two months after the outbreak,

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ASEAN convened an emergency meeting among its health ministers and its leaders. A special ASEAN plus Three meeting was also held back-to-back with the ASEAN meetings.21 These meetings outlined several measures to address the SARS epidemic, such as: • • • •

Exchanging information and best practices in containing infectious diseases, even legislation (quarantine laws); Strengthening co-operation among front-line enforcement agencies such as health, immigration, customs, transport and law enforcement; Harmonization of travel procedures to ensure proper health screening at the points of origin and arrival; and Protection of foreign nationals who may be suspect or actual SARS cases.

Other measures in the short to medium term were also discussed, such as enhancing co-operation between ASEAN and WHO; developing an ASEAN Centre for Disease Control; and developing a regional surveillance system to complement the WHO-inspired Global Outbreak Alert and Response Network.22

3.4. Assessing Regional Capacities and Their Impact on Regional Economic Co-operation The foregoing discussion on regional challenges and regional responses presents a mixed picture of the capacities of ASEAN and could have a bearing on the prospects of deepening and widening economic co-operation. But before one could summarily dismiss the efforts taken by ASEAN in responding to various multi-dimensional security challenges, a few observations must be made: 1. It has been argued that ASEAN had been mostly an “enterprise” for regional reconciliation. As such, the institutional development of ASEAN was parsimonious, and whatever institutions it has had, were geared mainly for engendering an environment for trust and confidence building among members which, during the establishment of ASEAN, were not exactly the best of friends. Over the past three decades, ASEAN has chosen to take a very conservative path to ensure a stable transition and to the extent possible — a smoother calibration of relationships among its members. As a consequence, when certain crises occurred that needed specialized expertise to respond — issues like financial meltdowns,

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environmental disasters, peacekeeping operations, and highly infectious epidemics — ASEAN was very often lost and unprepared. The kinds of crises and challenges that confront the region today require much more than what a loosely structured organization can provide. 2. Against the lack of institutional capacity and/or expertise, it followed that ASEAN’s responses to crises had also been mostly ad hoc. These types of responses were most visible during the 1997–98 period when the region was hit by a series of crises. To recapitulate, ASEAN’s ad hoc responses included: (a) Establishing the ASEAN Troika to help Cambodia in restoring the country’s political stability. (b) Instituting the Bilateral Swap Arrangement as a mechanism to help members that were badly affected by the 1997–98 financial crisis, as well as adopting the regional surveillance mechanism as a form of an early-warning system to avert potential financial crisis in the future; (c) Adopting the Regional Haze Action Plan (RHAP) to fight regular forest fires and manage the resulting haze/environmental problems. (d) The signing of the ASEAN Agreement on Information Exchange and Establishment of Communication Procedures to promote cooperation in combating transnational crime, including terrorism. (e) Instituting several measures to jointly contain infectious diseases, including the development of an ASEAN Centre for Disease Control. 3. But while the above responses may have been ad hoc, ASEAN had nevertheless demonstrated that it could act and work together in times of crises. Hence, one could and should not dismiss the efforts taken by ASEAN members to co-operate in addressing certain problems that were within their capabilities to do. To be sure, there were certain crises that were clearly beyond the limited capacities of ASEAN and its member states to resolve. 4. On the other hand, the question of effectiveness of the types of ad hoc responses remains. In this regard, one would agree that without a strong Secretariat, the effectiveness of initiatives taken by ASEAN, which require — at the very least — close co-ordination and constant monitoring of responses among member states, would be severely handicapped. Unlike the European Union, which has a huge reservoir of human resources to support its activities, ASEAN only has a paltry number of staff in its Secretariat to attend to its burgeoning activities. This would mean that

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many of the ASEAN initiatives languish through a lack of resources — both financial and human. 5. Given the above factors, the nature of regional capacities and responses indicates one crucial fact, that is, that ASEAN can only be as strong and as effective as how member states want it to be. And, whether or not member states agree to push the limits of their organization would also depend on their respective domestic capacities to cope with their own domestic challenges. Against these observable trends, it is not surprising that one often comes up with a mixed — perhaps even ambivalent — assessment of ASEAN. But the point in going back to the basics of understanding the nature of ASEAN’s political and security co-operation and highlighting the efforts taken by this grouping to respond to various challenges was to argue that in spite of obvious limitations, ASEAN has attempted to adapt and adjust to changing circumstances. The other salient point is that in spite of the emerging new challenges and the prevalence of old problems, the nature of co-operation within ASEAN — be it in the political, security, or economic-related areas — has remained. One could in fact push the argument further by stressing that co-operation has deepened in certain areas, in contrast to the expectations that regional crises and domestic problems would preoccupy most member states, make them inward-looking, and would consequently make them disinterested in regional initiatives. A solid case in this instance is the realization and the progress of AFTA. AFTA has been showcase of how “bold” ASEAN has gone to change the modalities of ASEAN from one based mainly on informal agreements to more rule-based arrangements. One should also not forget to mention the recent launching of the Initiatives for ASEAN Integration (IAI) in November 2000, which aimed to assist the new members (Cambodia, Laos, Myanmar, and Vietnam) in the economic integration process and avoid the emergence of a two-tier ASEAN. In summary, it can be argued that even against the backdrop of an unending list of political and security challenges, ASEAN has managed to push ahead with its aim of enhancing economic co-operation, albeit at a slower pace than most would have expected. More significantly, ASEAN members, in spite of obvious limitations, have not wavered in their determination to push for deeper economic integration and no better example can more convincingly demonstrate this drive than the recent move to create the AEC.

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4. The Road Ahead for the AEC The previous sections have highlighted how the relatively benign security environment and close political co-operation among ASEAN states have made it possible for closer and deeper economic co-operation to take place. In sustaining such a co-operative environment and in coping with challenging times, ASEAN’s emerging modalities have stuck very closely to the “comfort zone”, that is, the extent to which ASEAN members are still able to remain reassured that things will not change, in spite of the dramatic developments in the region. Thus most of the “new” modalities have not been necessarily bold but rather incremental in nature. New modalities have also been tailored to be flexible and non-threatening to the regime security of ASEAN states. For example, in pushing ahead with ASEAN’s economic agenda, AFTA was made possible and has progressed tremendously since its inception in 1992 largely because of the flexible and incremental approach that was adopted in the reduction of tariffs among member states. One also notes the developments in other important areas, such as the adoption of new institutional arrangements to deal with issues like managing environmental problems, surveillance mechanisms for financial co-ordination, and enhanced intelligence sharing to fight terrorism, leading to harmonization of certain domestic laws and procedures. All these are indicative of the new tools that ASEAN has crafted to address new challenges. Therefore, the much-feted “ASEAN Way” is not static. On the contrary, the new mechanisms that have evolved signal a nascent trend towards greater institutionalization of ASEAN. However, much of the comments on the prospects of the AEC have underscored the need for ASEAN to change and become much more institutionalized. In this regard, one must therefore be able to clearly define what and how this change can be defined. If change means to reform ASEAN and transform it by establishing supranational institutions which can develop norms and rules that both guide and restrain the actions of states, and in effect make these supranational institutions as actors in their own right with the ability to both influence and be influenced by states — then the road ahead would be extremely bumpy, at least in the immediate and short-term future. ASEAN, after all, has been largely a political decision by states to remain a co-operative enterprise of separate, sovereign states. Hence, unless member states could muster the political will to drastically change the modalities of ASEAN, much of the old “ASEAN Way” would still remain. One must also be aware that while the ASEAN Way has engendered shared norms that form that basis of a regional community, these shared norms are not sufficient enough to alter significantly members’ actions,

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particularly when national interests are competing. Two salient points arise from this issue of competing interests: 1. The Perils of Expansion Considering that ASEAN consists of ten states, almost half of which are relatively new members with political and economic attributes that are very much different from the “old” members, instituting new and bold changes to ASEAN modalities would not be easy. The differential nature of the new members has consequently widened the diversity of political identities and interests within the group. Moreover, diversity has also been linked to political controversy (such as what is happening in Myanmar today) with the effect of exposing internal divisions within ASEAN. As argued by the late Michael Leifer, regardless of the benefits ASEAN has had with institutional enlargement so as to enhance diplomatic weight, “the key to the efficacy of any regional institution is its ability to display consensus with credibility”.23 ASEAN’s expansion is therefore a major drawback in pushing for change in ASEAN modalities. The comfort level among members in the old ASEAN is no longer the same with an expanded grouping. In this regard, the issue here is not about stretching the comfort level among the ASEAN leaders but to the extent possible, maintaining or keeping it as close to the previous levels as possible in order to maintain cohesion within the organization. 2. Domestic Capacity for Change Another significant factor in determining prospects for change is the domestic capacity of ASEAN states to cope with their own internal challenges. One need not go into details about the complex fault lines that beset each and every member of ASEAN. The Indonesian story is more than sufficient to demonstrate how crucial it is for members, particularly the leading countries in the region, to manage their own domestic issues to enable them to assume leadership and commitment in regional activities. What happens in these countries, like in Indonesia, which has been the epicentre of ASEAN, is of great consequence to other members as well as to the prospects of the grouping. Similarly, the capacities of new members, which are comparatively handicapped in more ways than one to cope with the emerging challenges — both locally and regionally — would also have implications for other ASEAN members. The development gap between the richer and poorer member states in ASEAN is considerable, with Singapore having the highest per capita income of more than US$25,000, followed by Brunei with US$18,500,

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Malaysia and Thailand with about US$3,000–4,000, and the Philippines and Indonesia with US$1,000. In sharp contrast, Cambodia, Laos, Myanmar, and Vietnam have an average of only about US$300 per year! Thus, pushing for drastic changes in the modus operandi of ASEAN, particularly in certain issue areas, would not be realistic given the kinds of limitations cited above. Against these reservations, are there any windows for change?

4.1. Windows for Change? If one views the progress of ASEAN from the perspective of a glass half full rather than half empty, then one should be cautiously optimistic of prospects for change. The optimism is based on the notable changes in ASEAN’s modalities, albeit often lost in the analyses and criticisms of the grouping. The changes serve as building blocks in pushing for more change in the direction of a more rule-based rather than a largely informal process. Some of these building blocks are highlighted below. 4.1.1. Consensus Decision-making: “Ten-X” Modality The criticisms of ASEAN’s decision-making by consensus may have to be reassessed given that this practice has not necessarily been absolute. In keeping with the practice of flexibility to stretch the comfort zone among old and new members, ASEAN since the 1980s has actually allowed members to defer agreement on certain issues and projects. This practice had been applied particularly in decisions relating to economic co-operation. This practice was then known as the “five minus one” formula and originated with the ASEAN Industrial Projects programme.24 With the expansion of ASEAN membership, it is now known as the “Ten-X” formula. With this modified decision-making procedure already in place, plans and projects for the AEC will not be unnecessarily bogged down by member states that may not be ready to move on certain projects. In this regard, the experience in the reduction of tariff rates among members under AFTA should be instructive. 4.1.2. Dispute Settlement Mechanism As ASEAN moves towards a more structured and rule-based system to promote and enhance economic integration, binding rules and procedures are now more clearly set out in many of these economic agreements. In this regard, the adoption of the “Protocol on Dispute Settlement Mechanism”

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(DSM) in 1996 has been hailed as a significant step in facilitating the economic integration of ASEAN. However, there have been serious reservations about the DSM as this has not been used; instead members have preferred to use bilateral negotiations as the alternative mechanisms to settle disputes. In effect, there has yet to be a credible dispute settlement mechanism in ASEAN with judicial powers. Since the ASEAN Economic Ministers (AEM) is the highest authority on economic matters, a proposal floated regarding this problem is to take the dispute settlement out of the political realm and bring it into the legal realm.25 Similarly, in the Institute of Southeast Asian Studies (ISEAS) Paper on the AEC, there has been the recommendation to establish a high-level judicial body, staffed by judges from every ASEAN member country, to enforce the DSM.26 To be sure, this move will take some time to materialize. But given the experience of bilateral negotiations already taking place in cases of bilateral disputes and the precedent by certain ASEAN members to seek international arbitration once bilateral negotiations fail, the possibility of establishing a judicial body of some kind is no longer impossible. ASEAN’s experience with AFTA has shown that slowly, the reticence towards supranational jurisdiction among member states for the attainment of regional good is being overcome. 4.1.3. Strengthened Secretariat Since the AEC would certainly require more support and monitoring of activities, strengthening the Secretariat is now more urgent than ever. Once again, in ASEAN’s experience when the need came to “empower” the Secretariat, member states have shown that they can in fact generate the political will to allow the Secretariat more political space, just as it did in 1993. One could then argue that since the imperative to be competitive is now more compelling than ever, member states would now be more amenable to let the Secretariat function as the “driver and guard of the integration objective”.27 One suggestion offered to meaningfully start the empowering process is to create “regional units” within the Secretariat which are staffed by nationals who are formally independent of governments. These regional units would initially take charge of issue areas where common policy approaches have been adopted. These would include, for example, the management and monitoring of progress of various economic initiatives.28 The creation of regional units once again fits in well with ASEAN’s practice of incrementalism and flexibility.

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5. Conclusion It is a much-cited cliché that ASEAN is once again at the crossroads. Against the unending list of political, security, and economic challenges, ASEAN finds itself having to continually evolve into a much more competent organization to address the many issues that confront it today. As this chapter has discussed, the ASEAN process of evolution is best depicted in “patchwork institutionalization” that has taken place. It has been argued that any assessment of ASEAN’s capabilities must take into account the extent to which the organization has moved towards more institutionalization, specifically in the direction of adopting a more rule-based approach to managing crises. And in doing so, one should also recognize the extent to which ASEAN has taken the pains to ensure that political and security co-operation is not to be sacrificed given the understanding that without both economic co-operation and integration would not make further advances. It merits reiterating here the dynamics of the close nexus between politics/ security and economics. In moving ahead with a bolder integrative agenda, the ASEAN members have maintained that extra care has to be taken to sustain the peace dividend among them. While progress in economic and political/security co-operation should ideally move in tandem, the ASEAN experience has shown that often it is the latter concern that must take precedence over the other. Nevertheless, ASEAN has also shown how important it is to provide the right political and security environment to move ahead with economic co-operation and integration. This only serves to reinforce the idea that for ASEAN to progress, the pillars of political, economic, and security co-operation must be secured. The idea of an ASEAN economic community therefore provides a timely impetus to speed up ASEAN’s patchwork institutionalization to enhance its capacity to manage the multi-dimensional challenges that it faces. Moreover, with the Indonesian initiative of an ASEAN security community, it provides yet another blueprint for ASEAN to revisit its current modalities and address the issues that need to be tackled. The ASEAN Security Community as explained in the ASEAN Bali Concord II outlined several mechanisms to improve the capacity of the organization in dealing with new security threats. These mechanisms included: co-operation and co-ordination in efforts to counter terrorism, drug trafficking, trafficking in persons, and other transnational crimes; and co-operation to ensure that the Southeast Asian region remains free of all weapons of mass destruction. Outlined in the Bali Concord II are also enhanced mechanisms that would cover new areas to include approaches to conflict resolution and post-conflict peace building.29

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Taken together, these are indeed positive indications of an active, rather than a sunset organization. Although the challenge of reconciling statecentric interests would remain crucial to the future of regional stability, the ASEAN story has proven that there has been scope for accommodation and improvement. No one but the member states themselves recognize that it is only through deepening and widening co-operation that ASEAN and other regional institutions can best be equipped to deal with future challenges. NOTES 1. Since the idea of an AEC by 2020 was proposed by Singapore’s Prime Minister Goh Chok Tong, at the Eighth ASEAN Summit in 2002, a number of studies have since been developed to flesh out the elements of AEC. These include the “Concept Paper on the ASEAN Economic Community” prepared by the Institute of Southeast Asian Studies (ISEAS); the ASEAN–ISIS (Track-Two) Report entitled “Towards an ASEAN Economic Community”; and the “ASEAN Competitiveness Study”, a study by Mckinsey Company commissioned by the ASEAN Economic Ministers (AEM). Broad details of the AEC have also been outlined in the “Declaration of ASEAN Concord II (Bali Concord II)” adopted by the ASEAN leaders at the Ninth ASEAN Summit in October 2003 in Bali, Indonesia. See “Declaration of ASEAN Concord II”, accessed from . 2. For current writings critical of ASEAN see, for example, Jurgen Ruland, “ASEAN and the Asian Crisis: Theoretical Implications and Practical Consequences for Southeast Asian Regionalism”, The Pacific Review 13, no. 3, pp. 421–51; and Jeannie Henderson, Reassessing ASEAN, Adelphi Paper 323 (London: Oxford University Press for IISS, 1999). 3. The notion of an ASC was introduced by Indonesia at the Thirty-sixth ASEAN Ministerial Meeting in June 2003 to enable ASEAN to respond more effectively to new security challenges in the region. The modalities of an ASC were defined in the Declaration of ASEAN Concord II (Bali Concord II) adopted by the ASEAN Heads of Government at the Ninth ASEAN Summit held in Bali, Indonesia, on 7 October 2003. 4. The five original members of ASEAN were Indonesia, Malaysia, the Philippines, Singapore, and Thailand. Brunei Darussalam joined the grouping in 1984, followed by Vietnam in 1995, Laos and Myanmar in 1997, and Cambodia in 1999. 5. These major conflicts were in fact stumbling blocks to earlier efforts to form a regional association and became the major reasons why the attempts to establish the Association of Southeast Asia (ASA) in 1961 and MAPHILINDO in 1963 failed. For accounts on earlier attempts to form a sub-regional organization in Southeast Asia, see, for example, Arfinn Jorgensen-Dahl, Regional Organisation

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6.

7. 8.

9.

10.

11.

12.

13. 14.

and Order in Southeast Asia (New York: St. Martin’s Press, 1982); Michael Leifer, ASEAN and the Security of Southeast Asia (London: Routledge, 1989); and Michael Antolik, ASEAN and the Diplomacy of Accommodation (Armonk, New York: M.E. Sharpe, Inc., 1990). For an excellent account of ASEAN’s concept of comprehensive security, see Muthiah Alagappa, “Comprehensive Security: Interpretations in ASEAN Countries”, in Asian Security Issues Regional and Global, edited by Robert A. Scalapino et al. (Berkeley: Institute of East Asian Studies, University of California, 1998), pp. 50–78. See the “ASEAN Declaration”, Bangkok, 8 August 1967, sourced from the Handbook on Selected Political Documents (ASEAN Secretariat, 1998). Alagappa, op. cit. See also Amitav Acharya, “Human Security: What Kind for the Asia-Pacific” and Mely Caballero-Anthony, “Human Security in the AsiaPacific: Current Trends and Prospects”, in The Human Face of Security: AsiaPacific Perspectives, edited by David Dickens, Canberra Papers on Strategy and Defence no. 144 (Canberra: Strategic and Defence Studies Centre, Australian National University, 2002). Carolina G. Hernandez, “ASEAN 10: Meeting the Challenges”, in Beyond the Crisis: Challenges and Opportunities, vol. 1, edited by Mely Anthony and Mohamed Jawhar Hassan (Kuala Lumpur: Institute of Strategic and International Studies, 2000), p. 241. For a detailed account of ASEAN’s initiatives in getting Cambodia to agree to its terms to restore political stability in the country, see Juanito Jarasa, “The ASEAN Troika on Cambodia: A Philippine Perspective”, in The Next Stage: Preventive Diplomacy and Security Cooperation in the Asia-Pacific, edited by Desmond Ball and Amitav Acharya (Canberra: Strategic and Defence Studies Centre, Australian National University, 1999), pp. 209–14. There have been numerous accounts on ASEAN’s concerted response to the currency crisis. See for example, Hadi Soesastro, “ASEAN During the Crisis”, ASEAN Economic Bulletin 15, no. 3 (December 1998); and John Funston, “ASEAN: Out of Its Depths”, Contemporary Southeast Asia 20, no. 3 (April 1998): 22–37. This idea was later on expanded within the ASEAN plus Three (APT) framework in the establishment of the APT early warning systems. See the Asian Development Bank, Asian Economic Monitor, July 2002, p. 24. Quoted in Rodolfo C. Severino, ASEAN Today and Tomorrow (Jakarta: ASEAN Secretariat, 2002), p. 95. Simon Tay, “The Environment and Security in Southeast Asia”, in Beyond the Crisis: Challenges and Opportunities, edited by Mely C. Anthony and Mohamed Jawhar Hassan (Kuala Lumpur: Institute of Strategic and International Studies, 2001), p. 154.

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15. For a more detailed discussion on the East Timor crisis, see Ian Martin, SelfDetermination in East Timor, International Peace Academy Occasional Paper Series (Boulder: Lynne Reinner Publishers, Inc., 2001). See also Leonard S. Sebastian and Anthony L. Smith, “The East Timor Crisis: A Test Case for Humanitarian Intervention”, Southeast Asian Affairs 2000 (Singapore: Institute of Southeast Asian Studies, 2000), pp. 64–83. 16. See “Joint Communiqué of the Special ASEAN Ministerial Meeting on Terrorism”, Kuala Lumpur, Malaysia, 20–21 May 2002. See also 2001 “ASEAN Declaration on Joint Action to Counter Terrorism”, Bandar Seri Begawan, 5 November 2001. 17. U.S. State Department, 2002. 18. Barry Desker, “Islam and Society in Southeast Asia After September 11”, IDSS Working Paper no. 3 (Singapore: Institute of Defence and Strategic Studies, 2002). 19. Tatik S. Hafidz, “The War on Terror and the Future of Indonesian Democracy”, IDSS Working Paper no. 46 (Singapore: Institute of Defence and Strategic Studies, 2002). 20. “The Cost of SARS: US$11 billion and Rising”, Far Eastern Economic Review, 24 April 2003. 21. “Joint Statement of the Special ASEAN + 3 Health Ministers Meeting on Severe Acute Respiratory Syndrome (SARS)”, Siem Riep, Cambodia, 10-11 June 2003, accessed from . 22. Ibid. 23. Michael Leifer, “Regionalism Compared: The Perils and Benefits of Expansion”, in The Asia Pacific in the New Millennium, edited by Mely C. Anthony and Jawhar Hassan (Kuala Lumpur: Institute of Strategic and International Studies, 2001), p. 504. 24. When the ASEAN Industrial Projects programme was started, Singapore decided not to go along with the diesel-making project but did not object to the others’ participation in it. See Phar Kim Beng, “The Problems of a Two-Tiered ASEAN”, ASIA Times Online, 20 February 2003. 25. See Hadi Soesastro, “ASEAN Economic Community: Ideas, Significance and Feasibility” (Paper delivered at the Seventeenth Asia Pacific Roundtable, Kuala Lumpur, Malaysia, 7–9 August 2003). 26. Ibid. 27. Ibid. 28. Ibid. 29. See “Declaration of ASEAN Concord II (Bali Concord II)”, accessed from .

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REFERENCES Acharya, Amitav. “Realism, Institutionalism and the Asian Economic Crisis”. Contemporary Southeast Asia 21, no. 1 (1999). ———. Constructing a Security Community: ASEAN and the Problem of Regional Order. London and New York: Routledge, 2001. ———. “Human Security: What Kind for the Asia-Pacific”. In The Human Face of Security: Asia-Pacific Perspectives, edited by David Dickens. Canberra Papers on Strategy and Defence no. 144. Canberra: Strategic and Defence Studies Centre, Australian National University, 2002. Alagappa, Muthiah. “Comprehensive Security: Interpretations in ASEAN Countries”. In Asian Security Issues Regional and Global, edited by Robert A. Scalapino et al., pp. 50–78. Berkeley: Institute of East Asian Studies, University of California, 1998. Antolik, Michael. ASEAN and the Diplomacy of Accommodation. Armonk, New York: M.E. Sharpe, Inc., 1990. ASEAN. “ASEAN Joint Statement on the Situation in the Philippines”. Jakarta, 23 February 1986. Accessed from . ———. “ASEAN Declaration on Joint Action to Counter Terrorism”. Bandar Seri Begawan, 5 November 2001. ———. “Joint Communiqué of the Special ASEAN Ministerial Meeting on Terrorism”. Kuala Lumpur, Malaysia, 20–21 May 2002(a). ———. Chairman’s Statement at the Eighth ASEAN Summit, Phnom Penh, Cambodia, 4 November 2002(b). ———. “Joint Statement of the Special ASEAN + 3 Health Ministers Meeting on Severe Acute Respiratory Syndrome (SARS)”. Siem Reap, Cambodia, 10–11 June 2003(a). Accessed from . ———. “Joint Communiqué of the Thirty-sixth ASEAN Ministerial Meeting”. Phnom Penh, Cambodia, 16–17 June 2003(b). ———. “Declaration of ASEAN Concord II (Bali Concord II)”. Bali, Indonesia, 7 October 2003(c) at . Buszynski, Leszek. “ASEAN’s New Challenges”. Pacific Affairs 70, no. 4 (Winter 1997–98). Caballero-Anthony, Mely. “Mechanisms of Dispute Settlement: The ASEAN Experience”. Contemporary Southeast Asia 20, no. 1 (April 1999): 38–66. ———. “Human Security in the Asia-Pacific: Current Trends and Prospects”. In The Human Face of Security: Asia-Pacific Perspectives, edited by David Dickens. Canberra Papers on Strategy and Defence no. 144. Canberra: Strategic and Defence Studies Centre, Australian National University, 2002. Desker, Barry. “Islam and Society in Southeast Asia After September 11”. IDSS Working Paper no. 3. Singapore: Institute of Defence and Strategic Studies, 2002. Far Eastern Economic Review, 24 April 2003.

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Funston, John. “ASEAN: Out of Its Depths”. Contemporary Southeast Asia 20, no. 3 (April 1998): 22–37. Garofano, John. “Flexibility or Irrelevance: Ways Forward for the ARF”. Contemporary Southeast Asia 21, no. 1 (1999): 74–94. Haacke, Jurgen. “The Concept of Flexible Engagement and the Practice of Enhanced Interaction: Intramural Challenges to the ASEAN Way”. The Pacific Review 12, no. 4 (1999). Hafidz, Tatik S. “The War on Terror and the Future of Indonesian Democracy”. IDSS Working Paper no. 46. Singapore: Institute of Defence and Strategic Studies, 2002. Henderson, Jeannie. Reassessing ASEAN. Adelphi Paper 323. London: Oxford University Press for IISS, 1999. Hernandez, Carolina G. “ASEAN 10: Meeting the Challenges”. In Beyond the Crisis: Challenges and Opportunities, edited by Mely Anthony and Jawhar Hassan, p. 241. Kuala Lumpur: Institute of Strategic and International Studies, 2000. Jarasa, Juanito. “The ASEAN Troika on Cambodia: A Philippine Perspective”. In The Next Stage: Preventive Diplomacy and Security Cooperation in the Asia-Pacific, edited by Desmond Ball and Amitav Acharya, pp. 209–14. Canberra: Strategic and Defence Studies Centre, Australian National University, 1999. Jorgensen-Dahl, Arfinn. Regional Organisation and Order in Southeast Asia. New York: St. Martin’s Press, 1982. Leifer, Michael. ASEAN and the Security of Southeast Asia. London: Routledge, 1989. ———. “Regionalism Compared: The Perils and Benefits of Expansion”. In The Asia Pacific in the New Millennium, edited by Mely C. Anthony and Jawhar Hassan. Kuala Lumpur: Institute of Strategic and International Studies, 2001. Martin, Ian. Self-Determination in East Timor. International Peace Academy Occasional Paper Series. Boulder: Lynne Reinner Publishers, Inc., 2001. Phar Kim Beng. “The Problems of a Two-Tiered ASEAN”. ASIA Times Online, 20 February 2003. Pitsuwan, Surin. “Regional Efforts in Peace Operations”. Address delivered at the Wilson Park Conference, 2 July 2002, at Wilson Park, Essex, United Kingdom. Ramchara, Robin. “ASEAN and Non-Interference: A Principle Maintained”. Contemporary Southeast Asia 22, no. 1 (April 2000). Ruland, Jurgen. “ASEAN and the Asian Crisis: Theoretical Implications and Practical Consequences for Southeast Asian Regionalism”. The Pacific Review 13, no. 3 (2000): 421–51. Sebastian, Leonard S. and Anthony L. Smith. “The East Timor Crisis: A Test Case for Humanitarian Intervention”. Southeast Asian Affairs 2000, pp. 64–83. Singapore: Institute of Southeast Asian Studies, 2000. Severino, Rodolfo C. “Sovereignty, Intervention and the ASEAN Way”. Address delivered at the ASEAN Scholars’ Roundtable, 3 July 2000, in Singapore. ———. ASEAN Today and Tomorrow. Jakarta: ASEAN Secretariat, 2002.

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Soesastro, Hadi. “ASEAN During the Crisis”. ASEAN Economic Bulletin 15, no. 3 (December 1998). ———. “ASEAN Economic Community: Ideas, Significance and Feasibility”. Paper delivered at the Seventeenth Asia Pacific Roundtable, 7–9 August 2003, in Kuala Lumpur, Malaysia. Tay, Simon.“The Environment and Security in Southeast Asia”. In Beyond the Crisis: Challenges and Opportunities, edited by Mely C. Anthony and Mohamed Jawhar Hassan. Kuala Lumpur: Institute of Strategic and International Studies, 2001. ———. “The Relevance of ASEAN: Crisis and Change”. In Reinventing ASEAN, edited by Simon Tay, Jesus Estanislao, and Hadi Soesastro. Singapore: Institute of Southeast Asian Studies, 2003.

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6

ASEAN Economic Community: Perspective from ASEAN’s Transitional Economies Vo Tri Thanh

1. Introduction At the ASEAN Summit on 7 October 2003 in Bali, the ASEAN leaders agreed to establish an ASEAN Economic Community (AEC) by 2020. Although the AEC has yet to be clearly conceptualized, it is the next logical step in ASEAN economic integration. The AEC builds upon existing economic programmes such as the ASEAN Free Trade Area (AFTA), the ASEAN Framework Agreement on Services (AFAS), and the ASEAN Investment Area (AIA). The idea of an AEC is consistent with the realization of the ASEAN Vision 2020.1 The AEC can be also be seen as an appropriate response to recent developments in East Asia and greater regional integration in the world. The realization of the AEC is considered very ambitious but not beyond reach. Some observers may be sceptical about the realization of the AEC given the rather weak ASEAN institutions and the modest success thus far in regional economic co-operation and integration. The newer members of ASEAN, namely Cambodia, Laos, Myanmar, and Vietnam (CLMV) see deeper regional economic integration as a necessary

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and unavoidable process, which would bring about benefits as well as challenges to them. In this context, the key question for CLMV is how they can catch up with the more advanced economies in the region, given their limited resources. The concerns of CLMV about the widening development gap between the newer and older ASEAN members have been expressed many times. This problem is not easy to tackle because of the limitations of knowledge and practical experience. As noted by Schiff and Winters (2003, p. 11): regionalism is still a very fertile area for research, with new results and interpretations emerging every day … there are not many regional integration agreements of sufficient longevity and consistency of application to provide convincing historical evidence, and each case has so many different characteristics and is so confounded by other factors (such as development in politics, economic policy, and the world economy) that disentangling the various effects becomes difficult.

Moreover, to some extent, CLMV themselves are also different in terms of their economic institutions and the pace of reforms and international integration. Therefore, it is difficult to generalize any proposition or conclusion for CLMV as a whole. This chapter examines the challenges arising from deeper ASEAN economic integration (with the AEC as the ultimate goal) and the possible impact on CLMV. In this context, this chapter suggests that key external assistance and policy responses may be necessary in order to accelerate regional economic integration and narrow the development gap between the older and newer ASEAN members. The remainder of the chapter is structured as follows: section 2 examines briefly CLMV’s economic positions in the context of the AEC and regional integration; section 3 analyses the possible configurations of the AEC and the resulting challenges and impact on CLMV; section 4 considers the significance of ASEAN’s assistance to CLMV and the appropriate policies needed to respond to the process of regional integration; the chapter concludes in section 5. 2. The AEC and CLMV in the Context of Regional Integration There is a theoretical belief that multilateralism is much better than regionalism in terms of trade liberalization since the former suffers no trade diversion effect. However, virtually all countries in the world are members of a trade bloc (in fact many belong to more than one) while regional integration and

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bilateral trade agreements have intensified recently. This trend can be also observed in Southeast Asia over the last five years and it can be attributed to the following: 1. It was generally agreed that after the Asian financial crisis of 1997–98, Southeast Asia should play a proactive role in ensuring regional economic stability and preventing future financial crises. This role can be strengthened through trade, investment, and financial liberalization and in solving the transnational issues such as environmental degradation, infectious diseases, terrorism, and illegal migration. 2. Regional integration is seen as an appropriate response to rapid trade expansion in Southeast Asia as well as to the emergence of China as the fastest growing economy in the world (and new member of the World Trade Organization [WTO]). 3. Regional integration in Southeast Asia can be seen as a response to the uncertain future of the multilateral trading framework. At the same time, it is clear that the process of Southeast Asian integration is complicated. Although the region shares similar cultural values, it is very diversified in terms of economic development, institutional setting, and political systems. This creates many problems in the process towards realizing an Southeast Asian economic community as a long-term goal. Given this complexity, a more realistic approach is to develop regional integration and co-operation gradually through sub-regional integration. Although there are some risks, for example, diversion effects of different free trade areas (FTAs), the gradual approach seems to be the second-best option for Southeast Asian integration. In order to minimize the political and economic risks, “it is important for all of the East Asian economies to promote individual subregional FTAs, while sharing the ultimate goal of an East Asia FTA embracing all sub-regional FTAs” (Yamazawa 2003, p. 5). The idea of an AEC is, therefore, a positive step in strengthening the cooperation and integration not only among ASEAN countries, but also the entire East Asian region. Moreover, this is a way for ASEAN to play a central position by being a “hub” for East Asia. “The only way ASEAN stands a chance of effectively checking the power of the plus 3 nations (i.e.China, Japan, Korea) is if it is united” (Ong 2003, p. 66). The present global and regional environment provides CLMV with many opportunities for development. However, CLMV are concerned with their roles and positions due to development gaps with the older ASEAN

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members.2 The fear is that CLMV would be marginalized and they could only act as passive players in the process of regional integration, that is, as followers asking for concessions and assistance. The lack of suitable institutions as well as the present tendencies for individual countries in ASEAN to seek bilateral trade agreements can have a negative impact on CLMV due to trade diversion effects. This would further marginalize CLMV. Due to the “spaghetti-bowl” syndrome3 created by this complex bilateral trade structure, a “hub” country usually has considerable advantages as a location for economic activity and may suck firms and investment out of the spokes (Schiff and Winters 2003). It is also important to examine the possible impact of the “China factor” on CLMV in the context of the “spaghetti-bowl” syndrome and the establishment of the AEC. There is general agreement that “([the] only thing worse than a two-tier ASEAN is a two-tier Southeast Asia — one in ASEAN and the other outside it”.4 But the ASEAN institutional status quo has created a difficult situation for ASEAN to manoeuvre appropriately. ASEAN consensus-based principle has allowed CLMV to have a voice in dealing with ASEAN issues. On the other hand, this principle seems to be, in many cases, an impediment for more advanced ASEAN members to move forward. In order to accelerate the progressive liberalization in services trade, member countries have recently decided to adopt a more flexible approach, namely the “ASEAN minus X” or “Ten-X”, whereby agreements can be concluded by countries that are ready, while the others can accede at a later time. Nevertheless, this approach is selective and it could ultimately make the “spaghetti-bowl” effect even more complex. A key question for ASEAN now is whether it can have an effective institutional infrastructure while narrowing the development gap between the older and newer members. At present, ASEAN remains largely a consensusand co-ordination-based organization with weak enforcement mechanisms. Harding (2001) argued that the “ASEAN Way”5 is suitable for ASEAN in terms of its political diversity and common culture. It seems, however, that any real intensification of regional integration will require a modification of this approach. Thus far, the “soft institutional” approach has resulted only in “soft results”. 3. AEC: Possible Configurations and Their Impact on CLMV Regional economic integration is often defined as the discriminatory removal of all trade impediments between at least two participating nations and with the establishment of certain elements of co-operation and co-ordination

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between them (El-Agraa 1999). Regional economic integration has four major forms, namely FTA, customs union, common market, and economic union (Table 6.1). There are already some possible configurations for the AEC. Existing ASEAN economic programmes such as AFTA, AIA, and AFAS suggest that some of the building blocks for the AEC are already in place (ISEAS 2003). The key problem now is the implementation or enforcement of these programmes, especially those related to investment and liberalization of the services trade.6 Also, the AEC needs to take into account factor mobility and financial and macroeconomic policy co-operation and integration. A study by McKinsey & Company (2003) recommended that the AEC should be a kind of “FTA plus” arrangement, including the removal of nontariff barriers for services, liberalization of regional capital flows with a focus on microeconomic investment policies, and establishment of greater mobility for skilled labour in the region. In general, the AEC can be configured as an “FTA plus” arrangement that includes some elements of a common market, namely free movement of factors of production such as capital and skilled labour (ISEAS 2003). The other way is to see the AEC as a “common market minus” arrangement, which can be a more radical approach. Its advantage lies in the explicit formulation of some kind of a “negative list” that can be brought under the umbrella of the integration project (AEF 2003). The possible impact of the AEC on CLMV can be examined on the basis of the key elements of the aforementioned four forms of regional economic integration. An FTA should be the minimum platform for realizing the AEC. The expected effects of an FTA (AFTA in the case of ASEAN) are the promotion of regional competitiveness and economic efficiency. In the mid-1990s, the ASEAN shares of CLMV trade were 35 per cent, 54 per cent, 58 per cent, Table 6.1 Forms of Regional Economic Integration

Free trade area (FTA) Customs union Common market Economic union

Free IntraScheme Trade

Common Trade Policy

Free Factor Mobility

Common Monetary & Fiscal Policy

Yes Yes Yes Yes

No Yes Yes Yes

No No Yes Yes

No No No Yes

Source: El-Agraa (1999).

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and 21 per cent respectively (Mya Than 2000). During 1998–2000 these shares declined in line with the trend in intra-regional trade (Table 6.2). For Cambodia and Vietnam, these shares have recently declined significantly as both countries signed bilateral trade agreements with the United States and, therefore, their exports to the United States have expanded substantially. This may indicate that only Laos and Myanmar could gain a rather large welfare benefit from joining AFTA since trade creation would considerably outweigh trade diversion. In reality, this analysis could be more complicated due to the “spaghetti bowl” effect. The substantial benefits gained by CLMV would largely come from the dynamic effect of trade liberalization through increased competition, economies of scale, and spillover effects of foreign direct investment (FDI), especially in terms of technological and management skills transfers. Multinational corporations (MNCs) are gradually starting to adjust their operations to take AFTA into account (Fujita 2001). Moreover, at present the production and trade structure between CLMV and other ASEAN members are more complementary than competitive as the ASEAN-Six countries (that is, Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand) move towards producing more capital- and skill-intensive products. This means that CLMV have a chance to become attractive investment locations in international or regional production networks. However, this opportunity depends very much on the reform efforts made by the CLMV governments and the capability of domestic business communities in identifying comparative advantages not just in terms of particular industries but also specific areas within those industries.

Table 6.2 Total Trade Share, 1998–2000 (In percentages)

Cambodia Laos Myanmar Vietnam ASEAN ASEAN+Three

Cambodia

Laos

Myanmar

Vietnam

– 0.0 0.0 10.9 33.9 44.0

0.0 – 0.0 2.7 48.0 72.4

0.0 0.0 – 0.0 29.8 59.0

1.3 0.4 0.0 – 22.2 51.0

Note: Total trade = sum of imports and exports. Table read as total trade share of a country in the top row with a partner in the left-hand column. Source: Sakakibara and Yamakawa (2003, Table 4.1).

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The increasing openness to international markets can result in higher income inequality and this will further marginalize the poorest groups, especially those in isolated areas. At present, fiscal adjustment is under strong pressure due to the loss of customs revenues as AFTA and other international commitments are being implemented. Note that for CLMV, customs duties constitute a large part of the government budget. There is also a short-run social cost due to the restructuring of uncompetitive industries and the state sector. Without competitive services sectors — especially those which are knowledge-intensive and have high value added — an FTA framework such as AFTA will not be sufficient to develop a dynamic economic region. The welfare gains from preferential liberalization in the services trade could be substantial since the costs of trade diversion are likely to be small (many restrictions increase the costs of foreign providers without generating any benefits for the importing countries). As in the case of the goods trade, the scope for dynamic gains is very broad due to increased competition, exploitation of large-scale economies, and knowledge spillovers. Also, non-preferential liberalization based on the most-favoured-nation (MFN) principle is likely to produce larger gains than preferential liberalization. Services trade liberalization through AFAS is a replication of the WTO General Agreement on Trade in Services (GATS) but with a less formal framework, given the absence of a dispute settlement mechanism (Stephenson and Nikomborirak 2002). So far, the content of services trade liberalization in most of the ASEAN countries “can at best be termed as weak” (ISEAS 2003, p. 8). This is quite understandable since services trade liberalization is much more complicated than conventional trade agreements. Firstly, preferential treatment is granted mostly through discriminatory restrictions on the movement of labour (temporary or permanent) and capital and a variety of domestic regulations and national laws. Secondly, it may touch on strategic or politically sensitive sectors such as telecommunication, transportation, and utilities, which are either dominated or monopolized by inefficient state-owned enterprises (SOEs). The governments, therefore, are under tremendous pressure to protect these industries. For CLMV institutional weaknesses, the lack of human resources, the ineffectiveness of administrative machinery and authorities’ co-ordination, and state monopoly in some key services sub-sectors have posed huge constraints on the scope and the depth of commitments to services trade liberalization. As comparative advantages in the services sectors are in favour of skilled labour, there is also the fear that services trade liberalization would

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further magnify the income gap between the older and newer ASEAN members and even within CLMV. It is worth noting that the sequencing of liberalization matters more in the services trade than in the case of the goods trade. This is because the location-specific sunk costs of production (in a large number of sectors, ranging from professional to telecommunications and financial services) can make temporary privileged access for an inferior supplier translate into longterm advantage in the market. Thus, the entry of more efficient service providers could be permanently prevented if their competitive advantage does not offset the advantages conferred by incumbency (Mattoo and Fink 2002). In that sense, the case of Cambodia’s accession to WTO with a relatively wide coverage of deep commitments to services trade liberalization is interesting and should be considered by other countries in CLMV. As tariff regimes with non-members are different, an FTA can create trade deflection (that is, importation of products originating outside the region from the lowest external tariffs), which undesirably redirects production and investments. The usual solution for the deflection effect is the “rules of origin”. But they can lead to trade diversion. Moreover, they also pose governance and administration problems. In general, a customs union is more efficient than an FTA and allows greater market integration. However, of the 162 Regional Integration Agreements notified to the General Agreement on Tariffs and Trade (GATT)/WTO as of August 1998, 143 were FTAs and only nineteen were customs unions.7 For ASEAN, although the harmonization of product standards and customs procedures is recognized as being very important, the establishment of the ASEAN common trade policy is not under consideration for the AEC. A customs union requires more co-ordination among members and creates tighter constraints on the individual member’s policies. These requirements are very challenging for all ASEAN countries (not just CLMV), especially when they already have different trade commitments through GATT and bilateral agreements.8 In that sense, obviously, the “spaghettibowl” syndrome has already created some problems for advancing ASEAN economic integration. At the same time the argument in the ISEAS Concept Paper on the AEC that outsiders would view the formation of a customs union as a setback for ASEAN and as a protectionist move is not very convincing. This seems to be not a problem if ASEAN’s trade and investment barriers with outsiders would be as low as possible. A common market with free factor mobility is believed to enhance efficiency through a more rational resource allocation. Net benefits gained,

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however, depend on the changes in total output and factor returns from abroad. Also, pecuniary rewards are not the only consideration: other factors such as income tax, health and education benefits, housing allowances, and social-political environment are also essential (El-Agraa 1999). Once again, it is necessary for all ASEAN countries to undertake comprehensive domestic reforms and to have better regional co-ordination. For ASEAN, the objective of the AIA is to make the region a competitive, open, and liberal investment area. The AIA binds member countries to gradually eliminate investment barriers, liberalize investment rules and policies, grant national treatment, and open industries to ASEAN investors by 2010 and to all investors by 2020. However, the granting of national treatment and opening of industries have exemptions as embodied in the temporary exclusion list and sensitivity list. The investment measures seem to apply initially only to the manufacturing sector as the timetable has yet to be defined for other sectors (Austria and Avila 2001). In the meantime, ASEAN is facing several competitive challenges (Fujita 2001). First, China has emerged as a major competitor in attracting FDI and is a major exporter to world markets. Second, many regional arrangements in the world could also be good production sites for industries like electronics, textiles and garments, and footwear. Third, the MNCs increasingly look at ASEAN in the context of their wider regional and global strategies and are becoming increasingly selective in where they want to invest. Measures to implement the AIA are, therefore, not far-reaching enough. Moreover, it would be difficult for ASEAN to undertake deeper economic integration if the pace and the extent of services trade liberalization within ASEAN are not accelerated.9 As net “capital importers”, CLMV would gain more benefits from an ASEAN common market, but only if they can accelerate domestic economic and institutional reforms. The idea of establishing greater mobility for skilled labour in the region is a good one. The meaning of “skills” (viz. the harmonization of the labour skills standards), however, may not be in CLMV’s favour. A formal framework for the export and import of less skilled labour should also be considered. The main concern is that if capital and skilled labour move predominantly in only one direction, then some areas may be adversely affected and regional imbalance would be aggravated. There is also the idea of consolidating the stock markets in Southeast Asia into a single trading platform for equity securities in the region. The aim of such a proposal is to enlarge the investor base, enhance the liquidity for individual stocks, and create a critical mass compared with major stock markets in the world (Freeman 2003; Jin 2003). It is hoped that a greater

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integration of the financial markets would help prevent the marginalization of some of the financial markets in the region. This proposal, however, relates only to the stock markets in the ASEAN-Five (that is, Indonesia, Malaysia, the Philippines, Singapore, and Thailand); in CLMV stock markets are either absent or still at a very early stage of development.10 Economic union as the highest level of regional economic integration also involves fiscal harmonization and monetary integration.11 Fiscal harmonization may improve efficiency by eliminating non-tariff measures and market distortions. Co-ordination of fiscal and monetary policies, which is implied by monetary integration, may result in greater cost effectiveness through transaction costs reduction and economies of scale. Moreover, they promote macroeconomic stability and possibly income equality (El-Agraa 1999). As surveyed by Rana (2002), the benefits from monetary and financial co-operation increase with the level of trade integration. Fiscal harmonization and monetary integration are very complicated — even more so when they interact with trade integration and factor mobility. (Even the European Union [EU] is not considered strong in fiscal harmonization.) Exchange rate policy can hardly be used for macroeconomic stabilization if the labour market is not flexible and fiscal policies still lack the necessary co-ordination. Moreover, member countries have to sacrifice some degree of sovereignty and monetary policy control. Monetary and financial co-operation in East Asia could include:12 (1) a self-help regional financial facility; (2) a regional monitoring and surveillance process; and (3) a better exchange rate co-ordination mechanism. Regarding the first area, some rather significant progress — for example, the Chiang Mai Initiative (CMI) with the expansion of ASEAN Swap Arrangement (ASA) and the network of Bilateral Swaps and Repurchase Agreements (BSAs)13 — has been made. The surveillance mechanism has been developed but it is not likely to be effective soon. Another pillar yet to be developed is exchange rate co-ordination, without which incentives for mutual surveillance will be limited. Leadership is also critical: the strong underlying competition between China and Japan may be the most serious roadblock to the further development of the CMI as well as the ASEAN + Three process in general. Also, the trend towards FTAs is diverting attention away from efforts to promote monetary and financial co-operation and integration (Soesastro 2003). In the process of monetary and financial co-operation and integration, CLMV can hardly be expected to take the lead, given their very weak financial strength and position. The major task for CLMV now and in the near future is to improve the effectiveness of their monetary policies and to restructure their fragile banking systems.

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In CLMV the effectiveness of monetary policy is still limited due to the lack of indirect monetary instruments and/or an effective money market, and the existence of a high degree of dollarization. The central banks are still forced to create money to finance budget deficits (as in the case of Laos, Cambodia,14 and Myanmar recently). The financial systems are shallow, as indicated by a rather low M2/GDP ratio compared to other ASEAN countries (Cambodia: 15 per cent; Myanmar: less than 40 per cent; Vietnam: 45 per cent).15 In general, the banking systems are characterized by weaknesses in prudential supervision, inefficiency in financial intermediation, the dominant role of state-owned commercial banks, and heavy government intervention in bank lending. In Cambodia public confidence in the banking system is very low. A recent monetary survey has revealed that the net domestic credit is largely negative and the Cambodian savings placed outside the country (about US$800 million) is almost twice the amount of loans which multilateral institutions provided to Cambodia between 1994 and 2000 (Sok Hach 2001). In Laos and Vietnam (and perhaps in Myanmar as well) the nonperforming loans (NPLs) reach a high level.16 Bad debts have also been associated with the inefficient SOE sector. State-owned commercial bank restructuring will be a key component of banking reforms and should be undertaken simultaneously with SOE reforms. CLMV could also face difficulties in having a consistency between monetary policy (including interest rate policy) and exchange rate policy while liberalizing the financial sector and gradually opening the capital account in the balance of payments. Therefore, the roadmap of financial liberalization to be followed by CLMV is very different from that of the older ASEAN members. 4. ASEAN’s Assistance and Support Activities for CLMV Even in an integrated ASEAN, there will continue to be a wide development gap between the new and older member countries. Having the appropriate responses to address the challenges and possible unfavourable effects of integration on CLMV will be critical. There are three inter-related angles in which these responses could be examined: ASEAN assistance, cooperation among CLMV, and the policy pursued by each individual CLMV country. Like other external assistance for CLMV, assistance from the older members of ASEAN has two major components. The first is the special and differential treatment (SDT) notified in ASEAN agreements, for example, by

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allowing a longer period of implementation of liberalization or easier access to other members’ markets. The second is technical assistance. The idea behind the SDT is the recognition of the different capacities of adjustment and adaptation during the liberalization process. However, it is widely recognized that the SDT makes it easier for governments in developing countries to surrender to pressure-group demands for import restrictions, and as a result encourage rent-seeking activities. That is why such special treatments should be temporary and firmly implemented. In some cases, it would be better for CLMV to have easier access to the markets which offer special treatment to goods imported from CLMV. At the Fourth ASEAN Informal Summit in Singapore in November 2000, the ASEAN leaders agreed to launch the Initiative for ASEAN Integration (IAI) with the aim of narrowing the development gap within ASEAN and assisting the newer members in the process of regional integration. The IAI Action Plan for 2002–08 focuses on four priority areas, namely infrastructure, human resource development, information and telecommunication technology, and capacity building for regional economic integration (Box 6.1). The areas the IAI focuses on are undoubtedly essential for CLMV but the problem lies in the effectiveness of the programmes. The financial resources committed to the IAI programmes are relatively small compared with other official development assistance (ODA) received by CLMV. There is also the problem of co-ordination between the IAI programmes. ASEAN’s support for CLMV, therefore, should be incorporated with other external assistance (for example, with Japan’s ODA). Throughout the 1990s, Japan increased ODA to CLMV with a shift in emphasis from infrastructure building to technical assistance. The Japan International Co-operation Agency (JICA) has implemented new policy assistance programmes to Vietnam and Laos, which will be extended to Cambodia and Myanmar in the near future. They could be incorporated in various support activities under ASEAN and ASEAN–Japan Comprehensive Economic Partnership framework (Yamazawa 2003). It could also be possible to enlarge technical assistance to involve greater ASEAN participation. This would not only improve the integration capacity of CLMV, but also strengthen the solidarity of ASEAN. Moreover, ASEAN’s assistance for CLMV needs to cover the area of institutional building (which again needs to be incorporated with other donors’ assistance). Institutions do matter for economic growth and sustainable development. Trade liberalization and integration can be viewed as institutional changes and reform. ASEAN could develop an exchange programme on building market institutions in the context of globalization and regional

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Box 6.1 Current Performance by the IAI 1. Infrastructure development: Fifteen projects have been approved with a total committed fund of US$15.5 million and about Rp 6 million. The programmes supporting infrastructure development include projects such as the ASEAN highway (crossing CLMV) and the Singapore–Conminh railway. 2. Human resource development: The projects are largely bilateral. Singapore has established four training centres in CLMV and organized several training courses on information technology (IT). Thailand has undertaken fifteen technical assistance projects in the form of conferences, training courses, and experts programmes. Malaysia has committed to an assistance package of US$1.3 million for CLMV, which comprises the short and full training courses undertaken during 2002–04. Up to now, CLMV have got thirteen projects with a total value of about US$4 million and Peso 1 million. 3. Information and telecommunication technology: The assistance of the older ASEAN members seems to be most active in this area. The ASEAN-Six have committed to assist CLMV through six projects with a total committed capital of about US$25.5 million. 4. Capacity building for regional economic integration: ASEAN has approved the ASEAN Integration Preferential System (AIPS), by which since January 2002 the ASEAN-Six have offered preferential tariffs to CLMV on a voluntary and bilateral basis (Indonesia: 25 goods from Cambodia, 222 goods from Myanmar, and 50 goods from Vietnam. Malaysia: 12 from Laos, 345 from Myanmar, and 172 from Vietnam. Thailand: 19 from Vietnam; from Cambodia under consideration). CLMV are also supported through the projects facilitating their goods trade, trade in services, and investment. The total fund committed to these projects is about US$12.7 million. Source: Ministry of Foreign Affairs, Vietnam.

integration. The exchange programme can play a role in building more appropriate institutions for individual economies, especially those in transition as well as ASEAN as a whole. Moreover, this would make a positive contribution to the process of building a political convergence in Southeast Asia (perhaps the most important factor in guaranteeing the success of Southeast Asian integration). It would be useful for the newer ASEAN members to exchange views and share information on various issues relating to economic development and reforms. Also, forging closer business linkages in CLMV needs to be encouraged.

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However, there are many constraints in developing effective and efficient co-operation among CLMV. This would include limitations in both human and financial resources as well as the small domestic market size. Moreover, CLMV have similar comparative advantages and their trade structure is more competitive than complementary. This would provide limited business opportunities. (Note that Vietnam has a stronger comparative advantage in manufacturing exports since it has a higher skills–land ratio.) In fact, the volume of trade between Vietnam and the other three countries is very small and the trade value among these three countries is nearly zero (see Table 6.2). With regards to infrastructure linkages, there are currently nine land transport programmes in the Greater Mekong Sub-region, which includes CLMV, Thailand, and China’s Yunnan province. An agreement was reached among the Yunnan province, Laos, Myanmar, and Thailand on river transport. There is also a plan for a trans-regional energy network, which covers CLMV with six out of the fourteen power interconnection projects located inside their territories. The countries included in these projects reflect the fact that effective co-operation within CLMV should include other countries. The external assistance will not be fruitful unless CLMV continue their institutional and economic reforms to meet the requirements for further integration into the world economy and regional markets. However, CLMV still need to overcome many challenges in the reform process.17 Can CLMV co-ordinate integration with structural reforms? Trade liberalization and economic integration would achieve more if they are supported by reforms in the inefficient SOE sector and banking system. The key point for CLMV is to promote a fair and competitive business environment that would facilitate the development of the private sector (which is considered a dynamic force for economic development and a main source of employment). However, the time frame for trade policy reforms is limited given China’s accession to the WTO, the proposed establishment of an ASEAN–China FTA, and the need for CLMV to meet their international obligations. The question of structural reforms in CLMV is very much dependent on how these countries can overcome the legacy of a command economy. An appropriate strategy for CLMV is to take advantage of the pressure brought about by international integration to accelerate structural reforms domestically. Can CLMV build up a social consensus for further reforms and economic integration? The short-term social costs (in terms of unemployment) due to the structural adjustment under economic integration are unavoidable. Although trade liberalization and integration can have a considerably positive impact on employment creation (especially for lower skilled labour) and

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poverty reduction, it may widen the income gap in CLMV. There is also an asymmetry in incentives for different social groups, depending on whether they become “winners” or “losers” during the economic integration process. The potential benefits of trade liberalization and economic integration can be somewhat uncertain. However, interest groups that stand to lose out in such reforms are often in influential positions. Moreover, some interest groups may emphasize the dangers of exposure to global and regional markets, namely social instability and loss of sovereignty. Therefore, it may be difficult to find interest groups that would strongly support these reforms. These social costs can be reduced if the appropriate policies and reforms, such as the encouragement of private sector development, reform of the labour market, delivery of training services, and the establishment of social safety nets, are adopted.18 International commitment to assist CLMV is also essential to mitigate the social costs. The political will of leaders is also a decisive factor to overcome any opposition to reforms. Can CLMV overcome the institutional constraints to having a more proactive integration strategy? In general, the legal frameworks in CLMV are too weak to support a competitive market economy and further economic integration. Therefore, reforming economic institutions would first of all call for further improvement in the legal framework, particularly clarifying the “rules of the game” in an open, market-oriented economy. This would involve a comprehensive review of the existing system of regulations pertaining to international trade and investment. Legal requirements and commercial contracts need to be enforced effectively and this would very much depend on public administration reforms. In the context of the business sector and FDI, major concerns have been related to policy discretion and uncertainty, the multiplication of rules and the effective application of rules, and the administrative procedures (namely red-tape, complicated forms, and corruption). Transaction costs and business risk are still high, which in turn, induce rent-seeking behaviour that ultimately undermines the dynamic development of the business sector and the economy’s overall competitiveness. At the same time, a wider participation of the public in social, economic, and political activities needs to be promoted. This is important not only for empowering the public, but also for putting pressure on improving the capacity and quality of public services. Furthermore, the effectiveness of the public’s participation not only depends on opportunities, but also on their capabilities. Raising awareness and public education are essential in ensuring that the public have a better understanding of their rights and obligations.

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Can CLMV have a more appropriate roadmap for international economic integration? At present, in the context of the “spaghetti-bowl” syndrome, this question is not easily answered. But the first thing that policy-makers in CLMV should think about is whether it is better to multilateralize their commitments — especially those for trade in some services sectors — within the ASEAN framework as part of a more enlarged trade block accession. For example, Cambodia, Laos, and Vietnam would greatly benefit from accession to the WTO.19 Another problem is the roadmap for financial liberalization and capital account opening. International experience shows that the right sequence for opening an economy to the outside world is in this order: restructure the domestic economy; reform the domestic financial system; liberalize trade; and finally liberalize capital account. During this process the improvement in macroeconomic policies (namely monetary policy, fiscal policy, and exchange rate arrangement) is also essential for economic stability and financial integration. Can CLMV respond appropriately to the “China factor”? China’s WTO accession and the establishment of an ASEAN–China FTA can have a positive impact on ASEAN and CLMV (particularly in terms of trade expansion, GDP growth, and welfare improvement). More importantly, rising competition from China has put more pressure on CLMV to accelerate structural and institutional reforms as well as the integration process. Meanwhile, the China challenge has also raised some concerns for CLMV. The first is associated with the possible negative impact on their exports to third markets and even on their domestic markets due to more intense competition from China. The second is the possibility that CLMV would become less attractive to FDI in comparison to China. Moreover, CLMV may fall into the so-called “low-cost labour trap”20 and this will not be in their best long-term interest. (See Box 6.2.) Without the structural and institutional reforms, further economic integration will lead to the intensification of CLMV’s traditional comparative advantage. Moreover, CLMV need to take a broader approach to economic integration in order to enhance their attraction as a destination for FDI. (This will also depend on ASEAN’s common efforts in strengthening and deepening the process of regional integration.) Last but not least, avoiding this trap will depend increasingly on the quality of human resources in CLMV, which cannot be improved if these countries do not fundamentally change their education and training systems in order to meet technological and industrial needs.

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Box 6.2 CLMV–China Economic Relations: Some Stylized Facts In 2000 the shares of China in the total merchandise exports and imports of Cambodia were 1.74 per cent (US$23 million) and 7.96 per cent (US$12 million) respectively. For Laos, they were 1.98 per cent (US$6.42 million) and 6.37 per cent (US$34.42 million) respectively. During 1996–2000, on average these figures for Myanmar were 9 per cent and 11 per cent respectively. In 2001 China accounted for 9.44 per cent (US$1.42 billion) and 10.08 per cent (US$1.63 billion) of Vietnam’s total merchandise exports and imports respectively. It is worth noting some points about the CLMV–China merchandise trade relations. First, the trade structure between CLMV and China is both complementary and competitive. Second, at present the trade between CLMV and China can be somehow characterized as a “North– South” trade, meaning the relative weakness of the CLMV manufacturing industries. The major foreign investors in Cambodia are ASEAN (32.33 per cent of total FDI flows), China (17.73 per cent), the EU (13.69 per cent), and the United States (7.95 per cent). Note that the total FDI flow to Cambodia declined from about US$2 billion in 1995 to US$160 million in 2000. After the Asian financial crisis, the FDI flow to Laos also fell sharply from US$1.3 billion in 1996 to US$33.9 million in 2000. The investment flow from China, however, increased from US$3.1 million in 1996 to US$24.4 million in 1999, but fell significantly to US$5.3 million in 2000. During 1996–2000 China invested only US$26 million in Myanmar. As of end-2001, China accounted for a small share in total committed and realized FDI in Vietnam, only 0.6 per cent and 0.7 per cent respectively. (Even by taking into account Hong Kong, the share of total investment from these sources is still lower than that from ASEAN countries.) The recent trend of China’s FDI can be seen as an entry strategy to exploit the market opportunity created by AFTA. Sources: ASEAN–China Expert Group (2001); Vo Tri Thanh (2002).

5. Conclusion At present, both centrifugal and centripetal tendencies of economic integration can be observed in ASEAN. A commitment to establish the AEC can be seen as a very positive step in deepening ASEAN economic integration in all aspects, namely strengthening ASEAN’s bargaining power in the world economy and making ASEAN a “hub” for the whole of East Asia. But ASEAN’s weak institutions are a major obstacle to accelerating regional economic integration. However, there is a tendency for some ASEAN countries to move forward and escape the status quo through bilateral trade agreements. The risk associated with this tendency is the possibility of weakening the

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position of ASEAN as a group (and perhaps even the political stability of the region). The question is how ASEAN can have a more rule-based institutional infrastructure while maintaining some of the positive elements of the traditional “ASEAN Way”. Clearly, political will and strong leadership are essential for this change. It is also very important for ASEAN countries to effectively implement agreements that are already in place. The benefits gained from this action would surely support further regional integration. In general, ASEAN’s efforts to integrate can play an important role in promoting economic growth in CLMV and narrowing the development gap between CLMV and other ASEAN countries. This provides an opportunity for CLMV to learn from past international experiences in socio-economic development. ASEAN can be seen as a “fitness gym”, which allows CLMV to conduct a training “work out” in preparation for the serious exercise of competing in the global economy (Freeman 2001). Apart from its internal effects, ASEAN integration is also a means for CLMV (and other members as well) to explore stronger relationships with external economic partners and improve their international positions. ASEAN integration — and particularly the establishment of the AEC — could pose economic challenges and possible unfavourable effects on CLMV. Given resource limitations and the weaknesses of their institutions, CLMV will be concerned about being marginalized during the process of regional integration. Other concerns include the widening of the development gap between the older and newer ASEAN members, the huge social costs due to structural adjustment, and the possibility of falling into a “low-cost labour trap”. To benefit from regional integration, external assistance for CLMV and the implementation of further economic and institutional reforms by CLMV themselves are crucial. It is recognized that ASEAN’s assistance to CLMV has its limitations. Therefore, ASEAN’s assistance to CLMV should be incorporated with projects supported by other international donors. Furthermore, external assistance needs to have more emphasis on institutional building and human resource development. As low-income transitional economies, CLMV are facing numerous challenges to sustain their economic development and catch up with the more advanced ASEAN countries. These challenges become amplified in the context of globalization and rapid technological development. CLMV would therefore need to accelerate the reform process, which includes institutional development, macroeconomic policy improvement, structural reforms, poverty reduction, and human resource development. Some of the challenges that CLMV need to overcome are as follows:

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1. Changing the present state-led and state-controlled economic institutions into efficiency-enhancing institutions; 2. Overcoming the obstacles to reforms rooted in the opposition by certain influential interest groups; and 3. Moving steadily up the production value chain by adopting a broader approach to integration and by improving the quality and skills of their human resources.

NOTES 1. The ASEAN Vision 2020 (Hanoi Plan of Action 1998) envisaged “a stable, prosperous and highly competitive ASEAN Economic Region in which there is a free flow of goods, services and investments, a freer flow of capital, equitable economic development and reduced poverty and socio-economic disparities” (p. 12). 2. The gaps can be seen in terms of knowledge, economic institutions, human resources, physical and “soft” infrastructure, finance, and information and communication technology (ICT). 3. It refers to the inconsistency of the rules of origin, standards and conformance, customs, and quarantine procedures that could develop, imposing substantial transaction costs on business involved in exporting and importing activities. 4. Cited from Ong (2003, p. 64) (the remark by Rodolfo Severino at the European Centre, Brussels, 23 March 2001). 5. The “ASEAN Way” is very much entrenched in the idea of musyawarah (discussion and consultation) and mufakat (decision by consensus) — see the ISEAS Concept Paper (2003, p. 13). 6. So far, ASEAN integration has had only a limited impact. Less than 5 per cent of intra-ASEAN trade makes use of AFTA tariff concessions. Although ASEAN’s overall trade has grown, intra-trade as a percentage of total trade declined from 26 per cent in 1994 to 21 per cent in 2001. Another indication is the high divergence of consumer prices in the region (McKinsey & Company 2003). 7. Of course, many regional integration agreements contain other elements as well; this classification refers only to their goods trade policies (Schiff and Winters 2003). 8. To implement a customs union, all members would be required to lower their tariff for each product to the lowest level committed by any one ASEAN country for that product (ISEAS 2003). 9. This is because commercial presence (or right of establishment) regarding foreign investment is a major mode of service provision. 10. Cambodia and Laos do not yet have a stock market. Myanmar piloted a single stock market in the mid-1990s but this project was not subsequently developed (Freeman 2003). In Vietnam the securities market was opened in July 2000, but

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11.

12.

13.

14. 15.

16.

17.

18.

19.

by mid-2003 it had only twenty-one listed companies with a capitalization of about 0.5 per cent of GDP. Fiscal harmonization is a very complex issue, consisting of several things such as size of public sector, central and local authorities; tax and expenditure; criteria of resource allocation; equity and stabilization; and administration. Monetary integration has two essential components: unification and joint management of monetary and exchange rate policies and capital market integration. In practice, monetary integration includes an explicit harmonization of monetary policy, a common pool of foreign exchange reserves, and a single central bank (El-Agraa 1999). As suggested by the East Asia Study Group, which was established by the ASEAN + Three in 2001 to study the possibilities of strengthening regional cooperation and integration. The ASA expansion in November 2000 covers all ASEAN members with a total amount of US$1 billion. The contributions of the ASEAN-Six amount to US$150 million each, Vietnam US$60 million, Myanmar US$20 million, Cambodia US$15 million, and Laos US$5 million. As of June 2002, eight BSAs between individual ASEAN countries and Japan, China, and South Korea had been concluded, with a total amount of more than US$20 billion. (So far CLMV are not involved in any BSA.) See ADB (2001), Leebouapao (2001), and Sok Hach (2001) Vietnam: author’s estimate for 2001; Myanmar: see ADB (2001); Cambodia: Sok Hach (2001). Note that Cambodia’s economy is highly dollarized and the figure of 15 per cent includes the liquidity in domestic currency (4 per cent) and the amount of foreign currencies, mainly U.S. dollars, in the banking system (11 per cent). For Vietnam NPLs as a percentage of total loans declined from about 13 per cent in 2000 to 5 per cent by the end of 2002. These official figures seem to be underestimated. Using international accounting standards, the ratio of NPLs could be three times higher than official figures. According to the IMF (2001), the cost of restructuring of Vietnam’s banking system would be about 7 per cent of GDP. For Laos, with an NPL ratio of 60 per cent, the provisioning and recapitalization of state-owned commercial banks would cost 4 per cent of GDP (ADB 2001). This section consists largely of ideas from Vo Tri Thanh (2002), which are for Vietnam but seem to be applicable in several aspects for other countries in the CLMV group as well. It is, of course, not easy to search for a low-cost social safety net. Nevertheless, family and kinship ties are strong in CLMV. The state could perhaps combine some elements of the social safety net not only with private participation, but also with family and kinship support. Cambodia became a member of the WTO in 2003. Vietnam hopes to join the WTO in 2005.

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20. This means that only low labour cost comparative advantages would be intensified during the integration process and, therefore, the economy would become marginalized at the lower end of the value-added chain.

REFERENCES ASEAN–China Expert Group on Economic Co-operation. “A Report on Forging Closer ASEAN–China Economic Relations in the Twenty-first Century”. October 2001. ASEAN Economic Forum (AEF). “Towards an ASEAN Economic Community”. A Track-Two Report to ASEAN Policy-Makers. April 2003. Asian Development Bank (ADB). Asian Development Outlook 2001. New York: Oxford University Press, 2001. Austria, Myrna S. and John Lawrence V. Avila. “Looking Beyond AFTA: Prospects and Challenges for Inter-Regional Trade”. Discussion Paper Series no. 2001-10. Manila: Philippine Institute for Development Studies, April 2001. El-Agraa, Ali M. Regional Integration: Experience, Theory, and Measurement. London: Macmillan Press, 1999. Freeman, Nick J. “Challenges and Opportunities for the Transitional Economies in Joining ASEAN”. Paper presented at the workshop on Economic Co-operation of the Indochina Countries in the Context of International and Regional Integration: Recent Developments and Perspectives, 11–12 July 2001, in Hanoi. ———. “Developing and Deepening the Equity Markets of Southeast Asia”. In Financing Southeast Asia’s Economic Development, edited by Nick J. Freeman. Singapore: Institute of Southeast Asian Studies, 2003. Fujita, Mai. “Regional Trade Arrangement and Strategies of Multinationals: Implications of AFTA for Economic Integration”. In APEC in the 21st Century (Selected Issues for Deeper Economic Cooperation), edited by Satoru Okuda. Tokyo: APEC Study Center–Institute of Developing Economies, March 2001. Harding, Andrew. “Legal Aspects of Regional Integration: The EU and ASEAN Compared”. In Strengthening ASEAN Integration: Lessons from the EU’s Rule of Law, edited by Apirat Petchsiri, Alfred E. Kellermann, Charit Tingsabadh, and Pornsan Watananguhn. Conference proceedings. Bangkok: Centre for European Studies, Chulalongkorn University, 2001. Institute of Southeast Asian Studies (ISEAS). “Concept Paper on the ASEAN Economic Community”. Singapore: ISEAS, February 2003. International Monetary Fund (IMF). Vietnam: Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility. Washington, D.C.: Asia and Pacific Department, IMF, 2001. Jin Ngiam Kee. “Regional Financial Integration in Southeast Asia”. In Financing Southeast Asia’s Economic Development, edited by Nick J. Freeman. Singapore: Institute of Southeast Asian Studies, 2003.

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Leebouapao, Leeber. “Challenges and Prospects of Economic Development in the Lao PDR”. Paper presented at the workshop on Economic Co-operation of the Indochina Countries in the Context of International and Regional Integration: Recent Developments and Perspectives, 11–12 July 2001, in Hanoi. Mattoo, Aaditya and Carsten Fink. “Regional Agreements and Trade in Services: Policy Issues”. Policy Research Working Paper no. 2852. Washington, D.C.: World Bank, June 2002. McKinsey & Company. “ASEAN Competitiveness Study”. Final Report, March 2003. Mya Than. “Development in the CLM: Economic Transition, ASEAN Membership, and the East Asian Crisis”. In Trends and Issues in East Asia 2000, edited by Ng Chee Yuen and Charla Griffy-Brown. Tokyo: IDRI/FASID, 2000. Ong Eng Chuan. “Anchor East Asian Free Trade in ASEAN”. The Washington Quarterly. The Center for Strategic and International Studies, Massachusetts Institute of Technology, Spring 2003. Rana, Pradumna B. “Monetary and Financial Cooperation in East Asia: A Survey”. Panorama, no. 2 (2002). A publication of the Konrad-Adenauer-Stiftung’s Regional Program for Southeast Asia, Singapore. Sakakibara, Eisuke and Sharon Yamakawa. Regional Integration in East Asia: Challenges and Opportunities. World Bank East Asia Project. Tokyo: Global Security Research Center, Keiko University, 2003. Schiff, Maurice and L. Alan Winters. Regional Integration and Development. Washington, D.C.: World Bank, 2003. Soesastro, Hadi. “The Political Economy of Financial Cooperation and Integration in East Asia”. Paper presented at the conference Regimes and Surveillance in East Asia, organized by the Malaysian Institute of Economic Research and the ANU, 27–28 March 2003, in Kuala Lumpur. Sok Hach. “Economic Development and Reform Policy in Cambodia: Challenges and Prospects in the Integration Process”. Paper presented at the workshop on Economic Co-operation of the Indochina Countries in the Context of International and Regional Integration: Recent Developments and Perspectives, 11–12 July 2001, in Hanoi. Stephenson, Sherry M. and Deunden Nikomborirak. “Regional Liberalization in Services”. In Services Trade Liberalization and Facilitation, edited by Sherry Stephenson and Christopher Findlay. Canberra: Asia Pacific Press, 2002. Vo Tri Thanh. “Dream of Future Prosperity and the Wave of Change: Challenges on Vietnam’s Journey of Trade Liberalization and Economic Integration”. Paper presented at the Fifth Asian Development Research Forum General Meeting, 2–3 December 2002, in Bangkok. Yamazawa, Ippei. “Japan–ASEAN Comprehensive Economic Partnership: Vision and Agenda”. Paper presented at ASEAN–Japan Research Institute Meeting on ASEAN–Japan Comprehensive Economic Partnership: Vision and Tasks Ahead, July 2003, in Tokyo.

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7

Role of AFTA in an ASEAN Economic Community Jose L. Tongzon

1. Introduction The Asian financial crisis of 1997 and 1998 has significantly stalled the economic progress experienced by the ASEAN countries and set back the economic and social gains they have achieved in the past decades. The tragic terrorist attacks of 11 September 2001, the Iraq war, and the Severe Acute Respiratory Syndrome (SARS) outbreak have further exacerbated their postcrisis economic malaise and dampened the outlook for greater trade liberalization and economic integration, as envisioned under the ASEAN Free Trade Area (AFTA). Despite these unfavourable external events, the ASEAN countries have remained politically committed to the vision of transforming ASEAN into an economically integrated grouping within the framework of an ASEAN Economic Community (AEC). This AEC concept, which was first proposed in the 2002 ASEAN Summit, is based on the ASEAN Vision 2020, which foresees a more economically integrated ASEAN. The ASEAN Vision 2020 envisioned “… a stable, prosperous and highly competitive ASEAN economic region in which there is a free flow of goods, services and investments, a freer flow of capital, equitable economic development and reduced poverty and socio-economic disparities” (ASEAN 1999, p. 12).

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The AEC, whether it is envisaged to be a customs union or viewed to be more of a “free trade agreement plus” arrangement (with the inclusion of some common market elements such as the free movement of factors of production, for example, capital and labour), certainly requires the success of ASEAN’s existing economic integration programmes (ISEAS 2003). In particular, a successful AFTA can provide an important building block for the establishment of an AEC. In this context, this chapter will try to assess the progress made in the implementation of AFTA, and identify and evaluate the key challenges and obstacles faced by the ASEAN countries in the process of implementation. This chapter will also suggest strategies and policies to deal with these challenges and thus contribute to the realization of the AEC. 2. Progress of the Implementation of AFTA When the ASEAN founding members decided to establish AFTA in 1992, it was meant to be a rallying point for greater economic integration within the member countries and as an instrument for making their economies more internationally competitive and an attractive place for foreign direct investments. Over the years since its establishment, despite the significant differences in economic development levels and different degrees of readiness in facing the forces of global and regional competition, significant progress has been made in the area of tariff reforms, liberalization of investment regimes leading to more efficient allocation of foreign direct investments, and in attracting new members to the fold. These factors have greatly contributed to the continued economic growth and dynamism in the region, at least before the 1997–98 Asian financial crisis. With the admission of the transitional economies of Southeast Asia to the fold, the organization is now made up of the older and more developed economies of Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand (ASEAN-Six) and the younger and less developed economies of Cambodia, Lao PDR, Myanmar, and Vietnam (CLMV). Their admission has further exacerbated the significant differences in economic development and degrees of readiness for trade liberalization within the grouping. To allow more time for these new members to be ready for AFTA, they have been given different deadlines and timetables for the implementation of their AFTA commitments.

2.1. ASEAN-Six With few exceptions, the 2002 accelerated deadline for reducing tariffs to a maximum of 5 per cent for the ASEAN-Six countries was met. It was earlier

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agreed that 2002 was the target year for the final implementation of the ASEAN-Six countries’ tariff reduction commitment to between 0 and 5 per cent. Interestingly, by 1 January 2002 only the following tariff lines, as listed in their respective Inclusion List (IL), did not have their duties reduced to 0–5 per cent: 16 items (0.25 per cent) of Brunei’s 2002 IL; 66 items (0.92 per cent) of Indonesia’s 2002 IL; 922 items (9.2 per cent) of Malaysia’s 2002 IL; 199 items (3.57 per cent) of the Philippines’ 2002 IL; and 472 items (5.18 per cent) of Thailand’s 2002 IL (ASEAN Secretariat 2002). (Please refer to Table 7.1 for more details.) As pointed out by the ASEAN Secretariat, the ASEAN-Six member countries have always made clear that their objective for 2002 was to reduce the duties for the products in the IL to 0–5 per cent (with some flexibility allowed). If this is the case, then one can say that the ASEAN-Six countries have successfully realized the first phase of regional economic integration. Apart from the deepening of tariff cuts, they have also expanded further the commodity coverage of AFTA. Some progress has been made with regards to the inclusion of sensitive products. Some unprocessed agricultural products

Table 7.1 AFTA: Implementation of Tariff Reduction Commitments (As of 1 January 2002) Number of Tariff Items

Percentages

Countries 0–5%

>5%

Total

0–5%

>5%

Total

Brunei Indonesia Malaysia Philippines Singapore Thailand

6,260 7,147 9,117 5,372 5,859 8,632

16 66 922 199 472

6,276 7,213 10,039 5,571 5,859 9,104

99.75 99.08 90.82 96.43 100 94.82

0.25 0.92 9.18 3.57 0 5.18

100 100 100 100 100 100

ASEAN-Six

42,337

1,685

44,022

96.17

3.83

100

Cambodia Lao PDR Myanmar Vietnam

238 1,297 2,848 3,566

2,877 801 732 1,939

3115 2,098 3,580 5,505

7.64 61.82 79.55 64.78

92.36 38.18 20.45 35.22

100 100 100 100

ASEAN-Four

7,949

6,349

14,298

55.6

44.4

100

ASEAN-Ten

50,286

8,034

58,360

86.17

13.83

100

Source: ASEAN Secretariat (2002).

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(UAPs) are classified as “sensitive” or “highly sensitive”, which called for a special arrangement. At the Thirty-first ASEAN Economic Ministers Meeting in October 1999 a Protocol on the Special Arrangement for Sensitive and Highly Sensitive Products was endorsed, which set out the mechanism for the integration of sensitive products into the Common Effective Preferential Tariff (CEPT) scheme by 2010 with 0–5 per cent tariff rates subject to no quantitative restrictions (QRs) or non-tariff barriers (NTBs). After deciding to include the politically sensitive UAPs into the CEPT scheme, to be phased into the IL in five equal instalments, a number of sensitive items have been transferred into the ILs. Out of a total of 1,995 UAP tariff lines, 1,358 tariff lines were phased into the IL in 1996 and another 402 tariff lines were given Temporary Exclusion List (TEL) status to be phased into the CEPT scheme in seven equal instalments between 1997 and 2003. Rice was, however, exempted from this mechanism by allowing it to have an end-tariff of over 5 per cent, but with no QRs or NTBs. Rice has always been a very difficult commodity to be liberalized due to the fact that each ASEAN member country, particularly Malaysia, Indonesia, and the Philippines, would like to develop self-sufficiency in this commodity as a matter of economic and political security. Due to ASEAN efforts to review and shorten the General Exclusion List (GEL), some 230 tariff lines (29 per cent) were transferred out of the GEL into the IL at the Thirteenth AFTA Council meeting in September 1999. Consequently, by 2002 the IL covered over 98 per cent of all tariff lines for the ASEAN-Six countries, as shown in Table 7.2, with most of those temporarily excluded products consisting of motor vehicles and parts.1 The progress in the implementation of AFTA commitments by the ASEAN-Six and CLMV as of August 2003 is shown in Tables 7.3 and 7.4. As shown in Table 7.3, there has been a noticeable decline in the number of tariff items in the GEL and Sensitive List (SL). Only Malaysia among the ASEAN-Six has not completed the phasing-in of all the products in its TEL. These remaining tariff items (consisting of motor vehicles and parts) will only be liberalized by January 2006. It should, however, be noted that the Philippines has recently decided to suspend the implementation of CEPT concessions for some of its petrochemical products until the end of 2004.2 In terms of tariff reduction, it can be seen from Table 7.4 that more than 99 per cent of items in the ASEAN-Six countries’ ILs are now subject to between 0 and 5 per cent tariff. Only a fraction of tariff lines in the IL are subject to greater than 5 per cent tariff and these tariff lines have just been phased in from their SL and GEL.

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Table 7.2 ASEAN-Six: CEPT Product List (As of 1 January 2002) Country Brunei Indonesia Malaysia Philippines Singapore Thailand ASEAN-Six

Inclusion List

Temporary Exclusion List

General Exclusion List

Sensitive List

6,276 (96.67) 7,213 (99.01) 10,039 (96.59) 5,571 (98.79) 5,859 (100.0) 9,104 (99.92)

218 (2.1) 6 (0.11)

202 (3.11) 68 (0.93) 53 (0.51) 16 (0.28)

14 (0.22) 4 (0.05) 83 (0.8) 46 (0.82)

44,062 (98.4)

224 (0.50)

Total 6,492 7,285 10,393 5,639 5,859

339 (0.76)

7 (0.08)

9,111

154 (0.34)

44,779

Note: The figures in brackets are percentage shares for the various categories. Source: ASEAN Secretariat (2002).

Although the objective of CEPT to bring about the average tariff rates to a maximum of 5 per cent for those products in the ILs by 2003 has been realized, the objective of reducing the average tariff rates for at least 60 per cent of their CEPT products to zero, as agreed in the Hanoi Plan of Action, has not been realized by the ASEAN-Six countries, as Table 7.5 shows. In particular, in the case of the Philippines and Thailand only 3.66 and 2.00 per cent of the tariff lines in their respective ILs are subject to zero rates. Indonesia has more than 54 per cent of its CEPT products subject to zero tariff rates, but is still short of the target.

2.2. CLMV The progress in the implementation of CEPT commitments by the transitional economies of CLMV has also been on track and consistent with their respective timetables, with some exceptions, as shown in Table 7.3. Although Vietnam, which joined ASEAN in 1995, has deferred the transfer of its automotive items to the IL indefinitely, the country was expected to phase in all its TEL products into its IL by the end of 2003. The products in its IL in 2002 accounted for about 86 per cent of its total tariff lines —

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Note: Data as of August 2003. Source: ASEAN Secretariat (2003).

65,347

Total ASEAN

3,115 2,535 4,182 6,297

Cambodia Lao PDR Myanmar Vietnam 16,129

44,361

ASEAN-Six

CLMV

6,337 7,206 10,116 5,632 10,716 9,211

IL

Brunei Indonesia Malaysia Philippines Singapore Thailand

Country

5,829

5,611

3,523 864 1,224 –

218

– – 218 – – –

TEL

687

395

134 74 48 139

292

155 68 53 16 – –

GEL

226

197

50 78 18 51

29

– 11 8 10 – –

SL/HSL

Number of Tariff Lines

72,089

22,332

6,822 3,551 5,472 6,487

49,757

6,492 7,285 10,395 5,658 10,716 9,211

Total

90.65

72.22

45.66 71.39 76.43 97.07

98.92

97.61 98.92 97.32 99.54 100 100

IL

8.09

25.13

51.64 24.33 22.37 –

0.44

– – 2.1 – – –

TEL

0.95

1.77

1.96 2.08 0.88 2.14

0.59

2.39 0.93 0.51 0.28 – –

GEL

Percentage

Table 7.3 AFTA: Number of Tariff Lines in the Tentative 2003 CEPT Package

0.31

0.88

0.73 2.20 0.33 0.79

0.06

– 0.15 0.08 0.18 – –

SL

100

100

100 100 100 100

100

100 100 100 100 100 100

Total

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Table 7.4 AFTA: Number of Tariff Lines at 0–5 per cent in the Tentative 2003 CEPT Package Number of Tariff Lines

Percentage

Country 1

0–5%

> 5%

Other

Brunei Indonesia Malaysia Philippines Singapore Thailand

6,285 7,206 10,041 5,565 10,716 9,204

282 – – 233 – –

24 – 75 44 – 7

6,337 7,206 10,116 5,632 10,716 9,211

99.18 100 99.26 98.81 100 99.92

ASEAN-Six

49,017

51

150

49,218

Cambodia Lao PDR Myanmar Vietnam

831 1,497 3,332 4,120

2,284 1,038 850 1,439

– – – 738

3,115 2,535 4,182 6,297

CLMV

9,780

5,611

738

58,797

5,662

888

Total ASEAN

Total

0–5% > 5%

Other

Total

0.44 – – 0.41 – –

0.38 – 0.74 0.78 – 0.08

100 100 100 100 100 100

99.60

0.10

0.30

100

26.68 59.05 79.67 65.43

73.32 46.95 22.33 22.85

– – – 11.72

100 100 100 100

16,129

60.64 34.79

4.58

100

65,347

89.98

1.36

100

8.66

Notes: Data as of August 2003. 1 Items with no known CEPT rates (for example, items that are scheduled to be phased into IL by 2003). 2 Items that have just moved from GEL into IL. 3 Items that have just moved from SL into IL and petrochemical products. Source: ASEAN Secretariat (2003).

Table 7.5 AFTA: Number of Tariff Lines at 0 per cent by 2003 for ASEAN-Six Number of Tariff Lines

Percentage

Country 0%

> 0%

Total

0%

> 0%

Total

Brunei Indonesia Malaysia Philippines Singapore Thailand

5,110 3,938 6,100 216 10,716 186

1,227 3,268 4,016 5,426 0 9,018

6,337 7,206 10,116 5,632 10,716 9,204

80.64 54.65 60.30 3.66 100.00 2.00

19.36 45.35 39.70 96.34 0.00 98.00

100 100 100 100 100 100

Total ASEAN-Six

26,256

22,955

49,211

53.35

46.65

100

Notes: 1. Data as of August 2003. 2. Based on the tentative 2003 IL. Source: ASEAN Secretariat (2003).

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a significant increase from its initial IL in 1996, which accounted for about 39 per cent of its total tariff lines for that year. Cambodia, which joined ASEAN last, has the largest proportion of items in the TEL. Although there has been an expansion of their ILs in absolute and proportional terms since their membership in ASEAN, the CLMV group’s ILs, however, are not as large in terms of value. Most of the items in their ILs either are of insignificant value to their total trade or have already enjoyed 0 to 5 per cent tariff rates prior to their inclusion. In terms of tariff reduction, based on Table 7.4, Myanmar has the highest proportion of tariff lines within the 0–5 per cent tariff range, followed by Vietnam while Cambodia has the lowest. This is generally in line with their tariff reduction timetables, except for Myanmar which has already enjoyed low tariff rates. Tables 7.6 and 7.7 project the number and proportion of tariff lines at 0–5 per cent and at 0 per cent rates based on their indicative ILs. Based on these projections, it is noted that Vietnam and Lao PDR would have the highest proportions of tariff lines subject to zero rates by their respective deadlines. But Lao PDR would be the only country in the CLMV group that meets the target of zero per cent for at least 60 per cent of the tariff lines. 3. AFTA, the AEC, and Key Challenges Although the implementation of tariff reduction commitments and the transfer of products to the ILs can be said to be generally successful and is likely to be completed by the mutually agreed deadlines, the ASEAN countries are faced with the formidable and more difficult task of overcoming

Table 7.6 AFTA: Number of Tariff Lines at 0–5 per cent by 2003/2005/2007 for New Members Number of Tariff Lines

Percentage

Country Vietnam (2003)1 Lao PDR (2005)2 Myanmar (2005)2 Cambodia (2007)1

0–5%

> 5%

Total

0–5%

> 5%

Total

4,120 2,945 4,420 2,864

1,439 444 896 251

5,559 3,389 5,316 3,115

74.11 86.90 83.15 91.94

25.89 13.10 16.85 8.06

100 100 100 100

Notes: 1 Based on the 2002 IL. 2 Based on the indicative 2005 IL. Source: ASEAN Secretariat (2003).

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Table 7.7 AFTA: Number of Tariff Lines at 0 per cent by 2006/2008/2010 for New Members Number of Tariff Lines

Percentage

Country Vietnam (2006)1 Lao PDR (2008)2 Myanmar (2008)2 Cambodia (2010)3

0%

> 0%

Total

0%

> 0%

Total

1,999 2,489 213 238

3,560 900 5,200 2,877

5,559 3,389 5,413 3,115

35.96 73.44 3.93 7.64

64.04 26.56 96.07 92.36

100 100 100 100

Notes: 1 Based on the 2002 IL 2 Based on the indicative 2008 IL 3 Based on the 2002 IL Source: ASEAN Secretariat (2003).

the following key challenges and obstacles in the economic integration process towards realizing the AEC. First, although the implementation of tariff reduction has been generally a success, the utilization of the concessions under CEPT has been very low due to the following factors: lack of clear and transparent procedures for obtaining the Form D, lack of credibility and mutual trust between the preference-receiving and preference-granting country, low margins of preference which make the whole process of filling in the Form D unattractive, lack of awareness about the concessions under AFTA, and bureaucratic inefficiencies.3 Second, the NTBs and transportation costs that exist significantly in the region still need to be eliminated or harmonized. Licensing procedures, technical standards, and customs procedures have remained the major obstacles to the trade liberalization process. Third, the lack of a supranational institution within ASEAN to enforce mutually agreed decisions among the member countries and the traditional ASEAN way of doing things (that is, the consensus-based decision-making process) have slowed the progress of the implementation of AFTA commitments. Fourth, with the extension of AFTA membership to the transitional economies of CLMV, the grouping has become more diversified in terms of political regimes, economic development, and economic priorities. Although there has been more differentiation in the commodities produced in these economies and thus creating more scope for greater complementarity among them, the increased size and greater diversity in terms of political orientation, economic development, and readiness towards economic liberalization within

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the grouping have made the decision-making process more time-consuming and thus slowed down the progress of economic integration. Fifth, with the proliferation of bilateral free trade agreements (FTAs) initiated by some member countries, the effectiveness of AFTA as a preferential trading arrangement could be undermined.4 Although these extra-ASEAN FTAs could bring some indirect benefits for the ASEAN countries, they could also present some risks and challenges for ASEAN as a preferential economic grouping. These FTAs could be perceived by other ASEAN countries as providing “backdoor” entries for non-ASEAN countries to the region and thus as undermining the effectiveness of AFTA. Critics have alleged that Singapore’s FTA partners would be able to gain tariff-free access into ASEAN markets through Singapore, without providing reciprocal access to the ASEAN countries (Asiaweek, 8 December 2000). Whether this perception is groundless or not, it could undermine intraASEAN relationships. Corollary to this is the risk that increased extraregional trade could occur at the expense of intra-regional trade. There is a strong possibility that trade diversion effects resulting from the bilateral FTAs would be significant, as many of the goods and services traded within ASEAN would be substituted by similar goods and services produced by the extra-ASEAN partners.

3.1. Low Utilization of CEPT Concessions The low margin of tariff preferences is one of the major factors which make the benefits of CEPT less attractive. This can be illustrated by examining the case of the founding members of ASEAN. Although CEPT rates for each ASEAN-Five country have been continuously declining, the margins of tariff preferences did not increase steadily as each country has the freedom to set its own most-favoured nation (MFN) tariff rates. Tables 7.8 and 7.9 show the simple average ASEAN-Five MFN tariff rates and the average margin of ASEAN tariff preferences from 1996 to 2000. It can be observed that, except for Thailand, the average margins of tariff preferences offered are not substantial and vary throughout the years due to the different extents of reductions in CEPT and MFN tariffs.

3.2. Non-tariff Barriers (NTBs) Although significant progress has been made in terms of tariff reduction, there has been little progress made in eliminating or harmonizing the NTBs that have been prevalent in the trade regimes of ASEAN countries. Some

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Table 7.8 ASEAN-Five: Average MFN Tariff Rates (In percentages)

1996 1997 1998 1999 2000

Philippines

Thailand

Malaysia

Singapore

Indonesia

14.3 13.4 10.7 10.1 7.8

23.2 21.7 20.1 17.1 16.6

8.7 9.1 7.1 6.5 8.6

0.4 0.4 0 0 0

13.2 11.6 9.5 10.9 8.4

Source: World Bank, World Development Indicators (various issues), .

Table 7.9 ASEAN-Five: Average Margin of Tariff Preferences (In percentages)

1996 1997 1998 1999 2000

Philippines

Thailand

Malaysia

5.08 4.20 3.27 2.74 2.83

8.79 8.60 9.54 7.36 10.53

4.08 5.06 3.70 3.50 5.75

Singapore 0.40 0.40 0 0 0

Indonesia 4.15 3.07 3.38 5.53 3.63

Source: Author’s calculations.

countries have not yet completed their identification of NTBs which are supposed to be submitted to the ASEAN Secretariat. To expedite this process, the ASEAN Secretariat has recently issued a list of NTBs to the ASEAN member countries for verification. Licensing procedures are still unclear and not transparent. Customs procedures remain unco-ordinated and unharmonized. The use of a common ASEAN tariff nomenclature, which has been long agreed, has not yet been implemented by all countries. A mutual recognition agreement for technical standards has been signed, but the harmonization of technical standards for twenty priority groups (consisting of electronics and electrical appliances, rubber products, and machinery) is still to be completed and conformance with internationally acceptable standards has yet to be met by all ASEAN countries. Liberalization in the services sector, which is complementary to the liberalization of trade in goods, has been quite slow (Straits Times, 11 July 2003).

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3.3. Institutional Barriers The slow progress in economic integration is also partly due to the lack of a supranational institution with powers to enforce the principles and decisions made in relation to regional economic integration. Although the commitments made by individual countries with regards to AFTA are legally binding, there is no mechanism within ASEAN whereby sanctions and punishments can be meted out to members which fail to comply with their AFTA obligations. However, the creation of a supranational institution with enforcement powers may run counter to the age-old principle of non-interference and consensus which still has some appeal and support from some member countries. One of the challenges for ASEAN, therefore, is to set up some kind of supranational institution that may not have exactly the same structure as that in the European Union (EU), but with strong support and endorsement from the member countries.

3.4. Growing Divergence and Cautious Approach of CLMV The cautious approach (that is, by deferring the phasing in of important products until the deadline, which is also called “bunching of tariff rates”) adopted by CLMV in implementing their AFTA commitments is motivated by the growing concern that, as their economies are fully liberalized in accordance with the AFTA guidelines, their respective industries will not be sufficiently prepared to face the forces of regional competition and unable to take advantage of the economic opportunities provided by AFTA. Much of this concern is related to their infant industries, including agricultural products and other processed foods, which they think will face greater competition from their ASEAN neighbours, particularly from Thailand and Vietnam. There is also a lack of confidence in their growing garments sector, which will face greater foreign competition upon the abolition of the Multi Fibre Agreement in 2005. Another source of concern for CLMV in the process of tariff liberalization is the anticipated reduction in their tariff revenues, as they are particularly highly dependent on international trade as their source of government revenue. This concern has so far resulted in some degree of ambivalence in their policy initiatives or slower implementation of their AFTA commitments. Tongzon (1999) has discussed this ambivalence in great detail with respect to Vietnam, the first country in the CLMV group to join ASEAN. Consequently, this strategy has resulted in a delayed implementation of AFTA commitments, which could lead to the “bunching of tariff rates” —

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the AFTA Council has required all members to avoid this in the process of tariff reduction. Given that the other countries in the CLMV group have almost the same level of economic development and have similar economic backgrounds, it is understandable that the most recent members — Cambodia, Laos, and Myanmar — could face similar difficulties in implementing their AFTA commitments.

3.5. AFTA and Intra-ASEAN Trade The above challenges and obstacles largely explain the insignificant impact of AFTA on intra-ASEAN trade. Although there is an overall increase in intraASEAN trade since 1992, when AFTA was established, the increase is not significant, as shown in Figure 7.1. To examine more deeply into the role of AFTA tariff preferences (MFN tariff rates minus CEPT tariff rates) in intra-ASEAN trade, a correlation analysis is conducted for individual ASEAN-Five countries to see if there is any significant positive correlation between average tariff preferences and proportions of intra-ASEAN imports.5 Figures 7.2 to 7.6 present the trends of the ASEAN-Five countries’ average tariff preferences as a result of the CEPT tariff reductions, and the proportions of intra-ASEAN imports for the years 1996 to 2000. It can be seen that there is no consistent correlation at the aggregate level between average tariff preferences offered and the proportions of intra-ASEAN imports. Figure 7.1 Intra-ASEAN Trade, 1992–2001 0.2500 0.2000 0.1500 0.1000 0.0500 0.0000 1992

1993

1994

1995

1996

1997

1998

1999

2000

Year

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Figure 7.2 shows a positive correlation between average tariff preferences and the proportion of intra-ASEAN imports for the Philippines, except in the period from 1997 to 1998, where the share of intra-ASEAN imports increased although tariff preferences declined from 4.2 per cent in 1997 to 3.27 per cent in 1998. Average tariff preferences from 1996 to 2000 generally fell even though the Philippine CEPT rates had been declining, but the proportion of intra-ASEAN imports rose over this period. Similarly for Thailand, a positive correlation between average tariff preferences and the proportion of intra-ASEAN imports can be observed (from Figure 7.3), except during the period from 1998 to 1999 where the share of intra-ASEAN imports increased from 14.05 per cent to 16.53 per cent, despite average tariff preferences falling from 9.54 per cent to 7.36 per cent. In general, both average tariff preferences and the proportion of intraASEAN imports increased from 1996 to 2000. From Figure 7.4 it can be seen that Malaysia’s tariff preferences increased from 1996 to 1997 and then decreased from 1997 to 1998. However, the percentage share of intra-ASEAN imports fell slightly from 1996 to 1997, and then increased from 1997 to 1998. From 1998 onwards, a positive correlation can be observed between average tariff preferences and the proportion of intra-ASEAN imports. Overall, Malaysia’s average tariff preferences and the proportion of intra-ASEAN imports increased over the five-year period. Figure 7.2 Philippines: Average Tariff Preferences and Proportion of Intra-ASEAN Imports

Percentage

20 15

14.13

13.56

5.08

4.2

14.93

14.51

3.27

2.74

15.79

10 5

2.83

0 1996

1997 Average Tariff Preferences

1998 Year

1999

% of Intra-ASEAN Imports

Source: IMF (2001), Tables 4.1 and 4.2.

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Figure 7.3 Thailand: Average Tariff Preferences and Proportion of Intra-ASEAN Imports

Percentage

20 15 10

16.53 13.47

12.87

8.79

8.6

16.92

14.05 10.53

9.54 7.36

5 0 1996

1997 Average Tariff Preferences

1998 Year

1999

2000

% of Intra-ASEAN Imports

Source: IMF (2001), Tables 4.1 and 4.2.

Figure 7.4 Malaysia: Average Tariff Preferences and Proportion of Intra-ASEAN Imports 25 Percentage

20

19.5

19.28

4.08

5.06

21.22

19.49

20.01

15 10 5

3.7

3.5

5.75

0 1996

1997 Average Tariff Preferences

1998 Year

1999

2000

% of Intra-ASEAN Imports

Source: IMF (2001), Tables 4.1 and 4.2.

Singapore’s experience with tariff preferences is a special one in that Singapore’s average tariff preferences have been almost 0 per cent since 1996, but its intra-ASEAN imports as a proportion of total imports rose continuously from 1996 to 2000 despite the 0 per cent preference it offers to other ASEAN countries, as shown in Figure 7.5.

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Figure 7.5 Singapore: Average Tariff Preferences and Proportion of Intra-ASEAN Imports 30 Percentage

25 20

22.17

22.36

23.3

0.4

0.4

0

23.64

24.72

15 10 5

0

1996

1997 Average Tariff Preferences

1998 Year

0 1999

0 2000

% of Intra-ASEAN Imports

Source: IMF (2001), Tables 4.1 and 4.2.

Finally, in the case of Indonesia, average tariff preferences have a positive correlation with the proportion of intra-ASEAN imports, except during periods from 1996 to 1997, and 1999 to 2000 (Figure 7.6). Average tariff preferences fell from 4.15 per cent in 1996 to 3.07 per cent in 1997 but the share of intra-ASEAN imports increased from 11.90 per cent to 12.99 per cent. A similar trend was also observed from 1999 to 2000, with average tariff preferences falling and the share of intra-ASEAN imports rising slightly. On the whole, Indonesia’s average tariff preferences fell from 1996 to 2000, but its proportion of intra-ASEAN imports increased. It can be observed that AFTA’s impact on the proportion of intraASEAN imports, in the area of the deepening of intra-ASEAN tariff cuts, has been ambiguous. Although average CEPT tariffs for each ASEAN-Five country have been successfully decreased to very low levels, due to other factors discussed above, the impact of AFTA on intra-ASEAN trade has so far been quite ambiguous. One would usually anticipate a positive correlation between average tariff preferences and the proportion of intra-ASEAN imports, but such a trend was inconsistent among the ASEAN countries. With the exception of Malaysia during 1996 to 1997, all other instances when a positive correlation was not observed occurred when the average tariff preferences fell, but the proportion of intra-ASEAN imports still increased. This must be due to other significant factors contributing to the increase in the proportion of intra-ASEAN trade such as the increasing coverage of the CEPT scheme,

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Figure 7.6 Indonesia: Average Tariff Preferences and Proportion of Intra-ASEAN Imports 25 19.93

Percentage

20 15 10 5

20.23

16.68 11.9

12.99

4.15

3.07

3.38

5.53

3.63

0 1996

1997 Average Tariff Preferences

1998 Year

1999

2000

% of Intra-ASEAN Imports

Source: IMF (2001), Tables 4.1 and 4.2.

growth of intra-industry trade within ASEAN, and the impact of the 1997–98 Asian financial crisis which saw a significant depreciation of the ASEAN currencies against its major non-ASEAN trading partners and initiatives to reduce the dependence on the use of the U.S. dollar by encouraging the use of its currencies in intra-ASEAN trade.6 4. Recommended Policies and Strategies It is clear from the preceding section that for AFTA to provide an adequate building block for the establishment of an AEC, the challenges and obstacles discussed above would have to be resolved before the 2020 deadline. To help ASEAN countries overcome and resolve these key challenges and obstacles, policies and strategies that are directed at the underlying cause of these problems should be adopted. It is argued that the root cause of the slow implementation of trade liberalization in the area of NTBs is the sense of apprehension that less efficient sectors will not be able to compete in a liberalized trading environment without protection. Opposition against trade liberalization from interest groups is particularly strong in those sectors that are relatively inefficient and have a long history of protectionism. The fear that there would be massive unemployment in these sectors resulting from trade liberalization has further reinforced the reluctance to open up. Thus, to address the root cause of the problem, the following policies and strategies are recommended.

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First, a policy of promoting awareness and understanding of the longerterm economic benefits of regional economic integration under AFTA is suggested for the private sector. It has been observed that, although the concept of AFTA has already been discussed since its inception in 1992, there are still some segments in the private sector that are unsure of its concept, mechanisms, and economic implications. Since the opposition to trade liberalization has come mostly from the private sector, it is critical to the success of AFTA that the private sector is supportive of policy initiatives. After all the private sector will drive the actual operations of the envisioned economic integration. Second, a policy of improving the international competitiveness of the less developed ASEAN members by building their institutional and technical capacity (including development of an adequate and transparent legal framework, adequate human resources with appropriate skills, and export capacity) is suggested so that they can benefit from the economic opportunities of regional economic integration. In this regard, continued provision of financial and technical assistance from the more developed members to the less developed members of ASEAN is important as the latter have been constrained by limited financial and technical resources. This will also contribute to the narrowing of the development gaps within ASEAN which have been a cause of the slow progress in economic integration. Third, a collective effort to enhance the social safety nets for the respective ASEAN member countries is recommended to deal with the anticipated adjustment costs associated with trade liberalization. Although some forms of social safety nets are already in existence in the ASEAN countries, they have varied in terms of coverage and effectiveness and may not be adequate to deal with major structural adjustments. The establishment of adequate and regionally co-ordinated social safety nets (including retraining programmes) can allay the prevalent fear among the less efficient member countries that the opening up of their economies under AFTA will result in severe industry disruptions with serious social consequences. Fourth, work should commence to set up some form of an arbitration body or tribunal within the ASEAN institutional framework to perform legislative and enforcement functions. The introduction of this supranational institution should be made gradually, taking into consideration the member countries’ political sensitivities. Fifth, to avoid the perception that the extra-ASEAN FTAs are undermining the effectiveness of AFTA, the rules of origin must be effectively implemented and the effects of these FTAs must be seen as beneficial to the ASEAN region and to the strengthening of regional economic integration by contributing to the narrowing of the development gaps within ASEAN.

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Finally, there should be no let-up in the implementation of internal economic and political reforms aimed at addressing the root causes of the recent Asian financial crisis and other collective measures to avoid a recurrence of another economic crisis. 5. Conclusion Regional economic integration under AFTA can provide an important building block for the establishment of an AEC. Regardless of what form the AEC will take, whether it is an “FTA plus” or a “common market minus” arrangement, the establishment of an AEC requires a free flow of goods and services among member countries — which is what AFTA aims to achieve. Apart from providing opportunities for greater regional trade and investments and other economic spill-over effects of trade liberalization, a successful AFTA is vital for maintaining regional peace and security, which is essential for long-term economic progress. Recent empirical evidence suggests that, despite the anticipated shortrun costs of trade liberalization, the ASEAN countries have remained determined to realize their vision to establish a regional free trade area by 2015. Already significant progress has been made in the implementation of their tariff reduction commitments under AFTA, despite the growing economic and political difficulties faced by some member countries engendered by the recent Asian financial crisis and other inherent structural and institutional weaknesses. However, the second phase of economic integration, which entails the removal or harmonization of NTBs, poses a more challenging and difficult task due mainly to the significant differences that exist among these countries in terms of economic development, national priorities, and levels of efficiency. To ensure that AFTA can provide a building block towards the establishment of an AEC, appropriate policies and strategies should therefore be adopted to deal with the causes underlying the discussed obstacles to ASEAN economic integration. NOTES 1.

2.

These are exempted from the 2002 deadline and given an extra grace period of four years before their inclusion, mainly due to the strong objection from Malaysia. The Philippines’ recent refusal to cut tariffs on eleven petrochemical products to 5 per cent under the AFTA scheme has caused Singapore to consider withdrawing some tariff concessions to the Philippines (Straits Times, 17 June 2003, p. A14). The Philippines was supposed to have cut tariffs on those products to 5 per cent on 1 January 2003 under its commitment to the CEPT. Singapore

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3. 4.

5.

6.

had abolished all import tariffs on ASEAN goods at the start of 2001 and its companies would have enjoyed preferential tariffs on their exports to fellow ASEAN countries. But Manila gave notice in December 2002, saying that it wished to invoke the so-called TEL protocol on the eleven petrochemical products, keeping tariffs on those products at between 7 and 10 per cent. The utilization rates and reasons for low utilization rates vary, with lowest utilization rates observed in the transitional economies of ASEAN. Singapore has already concluded FTAs with New Zealand, Japan, Australia, and the United States. Negotiations are currently under way to forge FTAs with other countries. It has also been reported that the Philippines and Thailand are currently negotiating with the United States while Malaysia and Myanmar have almost concluded an FTA with Japan and India respectively. The exclusion of other ASEAN countries is due to data availability and the fact that most of the countries in the CLMV group have just started implementing their CEPT commitments. However, recent indications point to the failure of CEPT to stimulate CLMV’s intra-ASEAN trade, as shown by the absence or small proportion of preferential imports out of their total intra-ASEAN imports. Using the Pearson product moment correlation coefficient test to determine the correlation between the percentage of products in the IL and the share of intraASEAN imports, the results showed that for all five individual countries and for ASEAN-Five as a whole, there is a positive correlation between the percentage of products in the IL and the share of intra-ASEAN imports. However, the degree of correlation differs for each ASEAN country. Indonesia, the Philippines, and Thailand have high correlation coefficients, indicating that the two variables tested are more strongly correlated in these three countries. Singapore has a moderately high correlation coefficient (0.6097) whereas Malaysia has the lowest among the ASEAN-Five countries (0.3058). A high degree of correlation is also observed for the ASEAN-Five countries as a whole (0.9647), indicating the strong positive movements between the percentage of products in the ASEANFive’s IL and the share of their intra-ASEAN imports.

REFERENCES ASEAN. “ASEAN into the Next Millennium: ASEAN Vision 2020, Hanoi Plan of Action”. Jakarta: ASEAN Secretariat, 1999. ASEAN Secretariat. AFTA Reader. Vol. 1: Questions and Answers on the CEPT. Jakarta, 1993. ———. Unpublished mimeographs. Jakarta, 2002. ———. Unpublished statistics. Jakarta, 2003. Asiaweek, “Keeping up with the Singaporeans”, 8 December 2000, p. 22. Business Times, “Will Indonesia break ranks with ASEAN?”, 27 November 2000. ———, “Next WTO chief endorses Singapore free trade deals”, 21 February 2001.

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Institute of Southeast Asian Studies (ISEAS). “Concept Paper on the ASEAN Economic Community”. Singapore: Institute of Southeast Asian Studies, 26 February 2003. International Monetary Fund (IMF). Direction of Trade Statistics Yearbook. Washington, D.C.: International Monetary Fund, 2001. Straits Times, “Singapore may drop some Manila tariff concessions”, 17 June 2003a, p. A14. ———, “Private equity flowing faster to ASEAN”, 17 June 2003b, p. A14. ———, “Long and bumpy road to Asian integration”, 11 July 2003c, p. 20. Tongzon, J. “The Challenge of Regional Economic Integration: The Vietnamese Perspective”. The Developing Economies 37, no. 2 (1999): 137–61. World Bank. World Development Indicators (various issues). .

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8

FDI and the Free Movement of Investments in ASEAN Tham Siew-Yean

1. Introduction The ASEAN-Five economies (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) were identified among the twenty economies that had raised their world market shares of non-resource-based technology manufactures by at least 0.1 per cent between 1985 and 2000 (UNCTAD 2002). How did these economies manage to become global export winners given that global market shares are exceedingly hard to gain and even harder to sustain? In this regard, these five economies share a common contributory factor: all have benefited from the extensive presence of foreign direct investments (FDIs) and multinational corporations (MNCs) in their respective economies. These MNCs have contributed to the export competitiveness of the ASEAN-Five in non-resource-based industries in three ways: First, the MNC operations are export-oriented from the start due to the fragmentation and globalization of the production process, especially in the electronics industry that has spawned across the region. Second, the MNCs, through their backward linkages with local firms, assist local firms to become indirect exporters. Third, MNCs also indirectly promote the export activities of local firms that manage to copy the operations of foreign affiliates, employ staff trained by foreign affiliates, and benefit

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from improvements in infrastructure and reductions in trade barriers undertaken in response to the demands of foreign companies. Given the important role played by FDI in enhancing the export competitiveness of the ASEAN-Five, the objective of this chapter is to assess the progress of the ASEAN Investment Area (AIA) and its contribution to FDI in ASEAN. Based on this analysis, the chapter then identifies the main challenges posed towards the free movement of investment within ASEAN. After the introduction in section 1, the salient features of the AIA and its progress are analysed in section 2. The pattern and trend of FDI in ASEAN is presented in section 3 in order to assess the contribution of the AIA to the flows of investments in ASEAN while the main challenges confronting the free movement of investments in ASEAN are discussed in section 4. The concluding section summarizes the main findings. 2. ASEAN Investment Area (AIA)

2.1. Main Features of the AIA The Framework of Agreement on the AIA was signed on 8 October 1998, with the objective of establishing a competitive AIA in order to attract greater and sustainable levels of FDI into the region and to realize substantially increasing flows of FDI from both ASEAN and non-ASEAN sources by making ASEAN an attractive, competitive, open, and liberal investment area. The agreement binds the member countries to progressively reduce or eliminate investment regulations and conditions which may impede investment flows and the operation of investment projects in ASEAN and to ensure the implementation of the AIA within the agreed time frame. It is based on the three pillars of broad-based programmes for encouraging investment in the ASEAN region, that is, co-operation and facilitation, promotion and awareness, and liberalization (see Table 8.1). Moreover, under Article 4 of the agreement, the AIA is also expected to be an area for the free flow of skilled labour and professionals and technology among the member countries of ASEAN. Under the first pillar, members agree to take individual initiatives to increase the transparency of their respective investment rules, to simplify and expedite procedures for applications and approvals of investment projects at all levels as well as to expand the number of bilateral Double Taxation Avoidance Agreements among member countries. Collective initiatives will be undertaken to establish a Database for ASEAN Supporting Industries and ASEAN Technology Suppliers, a database to enhance the flow of ASEAN

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Table 8.1 ASEAN Investment Area (AIA) Major Provisions

AIA

Definition of Investment

All direct investments other than portfolio investments and matters relating to investments covered by other ASEAN Agreements such as the ASEAN Framework on Services

Scope of Framework

1. 2. 3.

National Treatment (NT)

NT for both ASEAN and all other investors; implementation of NT is subject to a ten-year differential between ASEAN investors and non-ASEAN investors

Most-Favoured-Nation (MFN) Treatment

ASEAN investors only

Investment Protection

ASEAN Agreement for the Promotion and Protection of Investment, 1987 and the Protocol to amend the Agreement, 1996

Dispute Settlement

The Protocol on ASEAN Dispute Settlement Mechanism (DSM) adopted in 1996 provides the ASEAN members with a regional dispute settlement mechanism

Co-operation and Facilitation Promotion and Awareness Liberalization: Uses a Negative List Approach

Source: Adapted from Somkiat, Deunden, and Busaba (2003).

investment data and opportunities for investment in ASEAN, promote public– private sector linkages, identify target areas for technical co-operation, review and where possible improve the ASEAN Agreement for the Promotion and Protection of Investment, and examine the possibility of an ASEAN Double Taxation Agreement. Investment promotion and awareness involves the organization of joint investment promotion activities, regular consultation among the investment agencies of ASEAN on investment promotion matters, the organization of investment-related programmes for officials of the investment agencies of ASEAN, exchanging lists of promoted sectors/industries as well as examining possible ways by which the investment agencies of member countries can support the promotion activities of other member countries. Investment liberalization measures accord national treatment (NT) and most-favoured-nation (MFN) treatment to ASEAN investors (Table 8.1).

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However, all privileges granted by ASEAN countries are subject to specific conditions: the investors must meet the minimum investment level specified by the host country, if any; the industry must be in the published priority list; the industry must not be in the negative list, if any; and the investors must show proof that foreign funds have been brought in for the entire amount of the investments, if required by the host country.1 The AIA also binds all member countries to eliminate investment barriers, liberalize investment rules and policies, and open up industries, initially in the manufacturing sector and later to cover the other sectors, using a negative list approach based on the model of tariff liberalization under the ASEAN Free Trade Area (AFTA). The main institutional arrangement is the AIA Council that is established under Article 16, to supervise, co-ordinate, and review the implementation of the Framework Agreement. The Council comprises the ministers responsible for investment and the Secretary-General of ASEAN. There is also the Co-ordinating Committee on Investment (CCI), comprising senior officials responsible for investment and other senior officials from relevant government agencies. The CCI reports to the AIA Council through the Senior Economic Officials Meeting (SEOM).

2.2. Achievements of the AIA In terms of the first two pillars of the AIA, ASEAN countries have collectively undertaken a series of joint investment missions to promote ASEAN as an investment region (ASEAN Secretariat 2000). However, given the intense rivalry in the region for FDI, it is unclear whether these promotional efforts can work towards promoting ASEAN as an investment region as a whole or whether they end up promoting individual economies within ASEAN. A working group has been established to harmonize the FDI Statistical System so as to improve the monitoring of the FDI flows in the region and in supporting the AIA process. An ASEAN Supporting Industry Database has also been established under the co-ordination of the Board of Investment of Thailand. In addition, an ASEAN Investment Portal has been developed to provide investors with easy access to a comprehensive and current investment and business information on the region. The AIA Ministerial Council has also planned to convene regular forums with selected business organizations from the major FDI source economies such as the United States, Japan, and the European Union (EU). There is also an increase in regional investment publications in line with the aim of enhancing transparency. A number of regional training workshops are being conducted

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by the ASEAN Secretariat to enhance the capacity of human resources for the newer ASEAN member countries. In September 2002 a two-year ASEAN Investment Initiative was launched with the aim of improving the competitiveness and attractiveness of the region. The initiative contains specific activities such as the ASEAN Investment Fair, ASEAN Business Summit, industry events, and the ASEAN Investment Networking and Outreach Programme to increase the participation of the private sector, narrow the development gap, and enhance the AIA process. Liberalization activities under the bold measures launched at the Sixth ASEAN Summit accorded a set of privileges for projects submitted before 31 December 2000 and approved thereafter: minimum three-year corporate income tax exemption or a minimum of 30 per cent corporate investment tax allowances; 100 per cent foreign equity ownership; duty-free imports of capital goods; domestic market access; minimum industrial land leasehold period of thirty years; employment of foreign personnel; and speedy customs clearance. These measures are applicable to all investors. At the same time, each ASEAN member country also extended specific measures and privileges under the bold measures (see Table 8.2). It is important to note, however, that the specific measures and privileges which determine the pace of liberalization depend very much on the individual country’s commitment to the AIA. Moreover the ASEAN investors are still subject to the negative lists of the individual ASEAN country as well as its local equity requirements. For example, Malaysia’s offers for ASEAN investors as announced in 1998 are no different from those offered to non-ASEAN investors (see Table 8.2). Therefore, while the AIA advocates the elimination of investment barriers, it is still subject to the individual countries’ investment laws and regulations such as restricted investment sectors, the screening process, and limited ratio of foreign shareholding. Consequently, while there are considerable efforts made to attain the first two pillars of the AIA, the liberalization process is still fraught with difficulties. This is because the Framework Agreement merely states the intention and objectives for integration while its implementation is left to each individual country through its laws and regulations at the national level. 3. Pattern and Trend of FDI in ASEAN The upturn in the trend of inflows of FDI in ASEAN occurred in the late 1980s when the ASEAN-Five economies experienced a surge in inflows of FDI. Both external and internal factors contributed to this extraordinary surge in FDI inflows. Externally, the Plaza Accord and subsequent appreciation

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Table 8.2 Liberal Investment Measures Announced by ASEAN Member Countries in 1998 Country

Liberal Investment Measures

Brunei Darussalam

100 per cent foreign equity ownership in high-technology manufacturing and export-oriented industries. 100 per cent foreign equity ownership in many sectors. Very few sectors are closed for foreign investment. Up to100 per cent foreign equity ownership for wholesale and retail trade to qualified investors, in addition to 100 per cent equity in all areas of the manufacturing sector. Indonesia has also reduced the processing time for approval, for investments less than US$100 million, to ten working days. In the banking sector, listed banks are open to 100 per cent foreign equity ownership. Allows duty exemption on imported capital goods required by the promoted investment projects. 100 per cent foreign equity ownership in the manufacturing sector with no export conditions imposed on all new investments, expansions, and diversifications (except for seven specific activities and products). With limited exceptions, foreigners can also own land in Malaysia. Extends minimum of three years corporate tax exemption to all investment projects in all sectors. Also extends duty-free import of raw materials to all industrial investments for the first three years of operation. Opens retail trade and distribution business to foreign equity. Also opens private construction in the domestic market to foreign companies. Reduces business costs as part of a cost-reduction package that amounts to S$10 billion in savings in addition to extending 30 per cent corporate investment tax allowance on a liberal basis to industrial projects and to selected service industries in respect of productive equipment. These activities include manufacturing, engineering, or technical services and computer-related services. Allows 100 per cent equity ownership for manufacturing projects, regardless of location. Extends duty exception on imported capital goods for all projects. In respect of import of raw materials for production for specially encouraged investments and for projects located in mountainous regions for the first five years of operation. Issuance of investment licences for several types of projects has been reduced to fifteen days from the receipt of proper simplified documents. In addition, investment licensing for projects under US$5 million has been decentralized to all provinces and cities.

Cambodia* Indonesia

Lao PDR Malaysia

Myanmar

Philippines

Singapore

Thailand Vietnam

Note: * Cambodia joined ASEAN in April 1999. Source: ASEAN Secretariat (2000).

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of the yen as well as other East Asian currencies and loss of preferential access to major developed markets for the newly industrializing economies (NIEs) of Asia played an important part in the relocation of labour-intensive production from Japan and the NIEs to these countries. Concurrently, progressive trade and investment liberalization in the ASEAN-Five, together with their relatively low labour costs, enabled these economies to benefit from the outflows of capital in these countries (Tham 1998). Consequently in 1993, the ASEAN-Four (Indonesia, Malaysia, Singapore, and Thailand) were listed as among the ten largest developing host economies for both FDI flows and stocks (Tham 1998). Within ASEAN, Singapore was the largest recipient of FDI inflows, followed by Malaysia, Thailand, Indonesia, the Philippines, Myanmar, Vietnam, Lao PDR, and Brunei until 1992. Between 1992 and 1994, Indonesia took over from Thailand as the third largest recipient of FDI inflows into the ASEAN economies. However, increasing competition from China and other emerging economies, together with the resurrection of Latin America after its debt crisis of the 1980s and the formation of the South American common market (MERCOSUR), contributed to a sharp drop in the share of ASEAN’s FDI in world FDI as these negative external factors coincided with the deteriorating locational advantages within some of the older ASEAN countries. Based on Table 8.3, ASEAN’s share in world FDI dropped from an annual average of 7.5 per cent between 1990 and 1995 to 6.3 per cent in 1997. In 1998 the economic turbulence in the region resulting from the financial crisis contributed to an even sharper drop of this share to 2.7 per cent. This fell further to 0.8 per cent in the year 2000 although it subsequently improved to 1.6 per cent in 2001 and further to 2.1 per cent in 2002. Similarly, ASEAN’s share of the FDI flowing into the developing economies dropped from an annual average of 22.8 per cent between 1990 and 1995 to 15.7 per cent in 1997 before plummeting to 9.7 per cent in 1998. The downward trend in the share of ASEAN’s FDI among the developing economies persisted to the year 2000 (4.5 per cent) before increasing to 6.3 per cent in 2001 and to 8.6 per cent in 2002. The fall in the relative attractiveness of ASEAN as host economies can be attributed to several reasons. First, it should be noted that FDI projects in ASEAN are, on average, financed by reinvestment (30 per cent), intercompany loans (30 per cent), and foreign equity (40 per cent) (ASEAN Secretariat 2000). Thus the Asian financial crisis in 1997 has affected inflows of FDI into the region as it affected the corporate profits and retained earnings of the MNCs that are operating in the region. Although Malaysia, Singapore, and Thailand have since recovered from the financial crisis,

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Source: UNCTAD (2003), Annex Table B.I.

16,932 102 80 2,135 33 4,655 180 1,028 5,782 1,990 947

225,321 145,019 74,288 19,360

World Developed economies Developing economies China

ASEAN Brunei Darussalam Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam

1990–95 (Annual average)

Host Region/Economy

29,370 654 586 6,194 128 7,296 310 1,520 8,608 2,271 1,803

386,140 219,908 152,685 40,180

1996

30,369 702 168 4,678 86 6,324 879 1,261 13,533 3,882 2,587

481,911 269,654 193,224 44,237

1997 1999 2000

18,504 573 243 –356 45 2,714 684 1,718 7,594 7,491 1,700 19,691 748 230 –2,745 52 3,895 304 1,725 13,245 6,091 1,484

11,056 549 149 –4,550 34 3,788 208 1,345 12,464 3,350 1,289

686,028 1,079,083 1,392,957 472,265 824,642 1,120,528 191,284 229,295 246,057 43,751 40,319 40,772

1998

Table 8.3 FDI Inflows, by Host Region and Economy, 1990–2002 (US$ million)

13,241 526 148 –3,279 24 554 192 982 10,949 3,813 1,300

823,825 589,379 209,431 46,846

2001

13,957 1,035 54 –1,523 25 3,203 129 1,111 7,655 1,068 1,200

651,188 460,334 162,145 52,700

2002

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Indonesia continues to struggle with economic growth and, at the same time, it continued to experience a net outflow of capital from 1998 to 2002. Second, the prolonged stagnation of the Japanese economy is another contributory factor due to its significant presence in the region (Tham 2003). Based on Table 8.4, it can be seen that Japan was the second largest source country for inflows of FDI into ASEAN between 1995 and 1998 but it subsequently became the third largest source country between 1999 and 2001, while North America took over its position as the second largest source of FDI in the region. The substantial drop in Japanese direct investment in the region after the crisis in 1997 caused Japan to be the third largest source country in ASEAN, after Europe and North America for the overall period 1995–2001. Japanese direct investment, for example, fell from US$6,810 million in 1997 to US$1,300 million in 1999. Third, within ASEAN, some countries like Malaysia have lost their relatively low labour cost advantage. Unfortunately for Malaysia it has not been able to supply the right kind of labour for the higher value-added FDI that is aspired by the country. This mismatch between the supply conditions of the host economy and the demand conditions from the type of MNCs that are preferred by the government led to the loss in the relative attractiveness of the country as a host economy for FDI. Other countries such as Indonesia face internal political problems that may have contributed to the loss in their relative attractiveness for hosting FDI. In terms of sectors, Table 8.5 shows that the manufacturing sector is the main beneficiary of FDI in ASEAN between 1999 and 2001, followed by financial intermediation and services and, in the third position, trade. Within manufacturing, between 1995 and 2001 the top four recipients of FDI by industry are coke, refined petroleum products, and nuclear fuel (20.4 per cent); radio, television, and communication equipment and apparatus (18.4 per cent); chemical and chemical products (18.2 per cent); and paper and paper products (7.7 per cent) (Table 8.6). These four sub-sectors absorbed a total of 64.7 per cent of the total FDI that flowed into the manufacturing sector in ASEAN. Malaysia, Singapore, and Thailand are similar in that FDI in manufacturing is dominated by electronics, with significantly more investment in that sector than in any other manufacturing activity (Thomsen 1999). At the same time, the electronics sector in both the Philippines and Indonesia is growing. However, in Thailand manufacturing absorbs only onethird of total inflows while a large share of the total goes to distribution and finance, as well as construction and real estate. In Indonesia manufacturing investments have tended to be in resource-based activities such as the

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2,033.06 555.02 630.11 846.92 3,516.91 54.94 0.50 197.39

ANIEs South Korea Hong Kong Taiwan (ROC)

ASEAN Brunei Darussalam Cambodia Indonesia 3,121.65 104.47 0.81 404.22

2,029.41 465.78 821.37 742.26

342.92 103.74 40.24 3.00 195.93

8,207.53

209.58 152.29 (19.30) 4.14 72.45

6,831.24

Asia China India Pakistan Others1

Europe

4,761.36 4,586.45 174.91

4,192.75 2,119.04 2,073.72

North America United States Canada

4,955.42

1996

4,263.04

1995

Japan

Source Countries

Year

3,962.94 24.65 – 152.03

3,387.18 728.62 1,753.21 905.35

285.97 74.87 86.18 5.00 119.92

7,561.57

4,141.37 3,669.42 471.95

6,810.04

1997

2,073.05 11.09 0.04 154.95

1,803.08 139.37 1,031.29 632.42

206.17 272.17 55.19 2.40 (123.59)

6,619.56

3,359.65 3,427.08 (67.43)

4,056.92

1998

934.57 11.54 1.45 125.04

1,594.35 598.43 660.09 335.83

(4.45) 43.58 16.58 (1.96) (62.66)

9,035.96

5,656.50 4,992.31 664.19

1,300.32

1999

714.35 13.18 2.21 129.06

1,233.23 80.71 670.85 481.67

383.90 26.44 40.27 2.23 314.96

4,310.50

1,816.45 2,404.62 (588.17)

(134.97)

2000

1,520.26 821.36 225.27 11.16 462.47

48,240.27

27,185.17 24,348.94 2,836.22

22,151.24

1995– 2001*

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15,256.71 244.12 5.79 1,179.13

continued on next page

933.24 24.25 0.77 16.42

(387.02) 11,693.29 (271.58) 2,296.35 (451.22) 5,115.70 335.78 4,280.24

96.17 148.26 6.12 (3.66) (54.55)

5,673.92

3,257.09 3,150.03 107.06

900.47

2001

Table 8.4 FDI in ASEAN (Balance-of-Payments Basis) by Selected Countries of Origin, 1995–2001 (US$ million)

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Year

303.18

– 512.29 2.21 61.21 1,714.81 321.23 0.40

1996

155.36

– 577.19 5.70 38.03 2,605.37 558.89 1.08

1997

(175.13)

– 337.77 1.31 (0.96) 1,416.08 151.42 1.35

1998

(967.29)

0.67 75.25 0.35 (16.08) 629.22 103.72 3.40

1999

23,540.09 25,848.10 29,780.44 21,899.25 22,313.33

135.35

(0.40) 607.82 (0.30) 50.30 2,285.60 320.20 0.86

1995 10.03 2,190.48 19.21 236.32 9,936.68 1,419.83 15.12

1995– 2001*

(450.41) (1,277.94)

0.03 (9.55) 1.13 2.49 980.83 (84.90) 1.75

2001

8,625.29 10,352.17 142,358.68

(279.00)

9.72 89.71 8.81 101.33 304.78 49.27 6.28

2000

Notes: 1. * Total cumulative figures for 1995–2001 exclude data on FDI in Cambodia. 2. Data on reinvestment earnings by detailed country breakdown (source countries) for almost all ASEAN countries are not available. 3. Brunei Darussalam figures for 1995–2001 include reinvestment earnings. 4. Singapore’s figures for 1995, 1996, and 2001 include equity and reinvestment earnings, and exclude inter-company loans. Figures for 1997–2000 include equity, reinvestment earnings, and inter-company loans. 5. ( ) means disinvestment. 6. 1 Refers to West, Central, and South and East Asia except ANIEs and ASEAN. Source: ASEAN Secretariat (2002).

Total

Australasia

Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam

Source Countries

Table 8.4 – cont’d

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Table 8.5 FDI in ASEAN (Balance-of-Payments Basis) by Main Economic Sectors, 1999–2001 (US$ million) Year Economic Sectors

1999

2000

2001

1999–2001*

Agriculture, fishery, and forestry Mining and quarrying Manufacturing Construction Trade/commerce Financial intermediation and services (including insurance) Real estate Services Others (not elsewhere classified)

22 1,059 5,083 (72) 4,402

114 648 3,932 (281) 1,074

13 1,123 5,468 (367) 2,070

149 2,831 14,483 (720) 7,546

5,047 (148) 1,981 4,245

1,096 (303) 382 1,555

2,246 (116) 1,255 (1,869)

8,390 (567) 3,618 3,931

8,218

9,824

Total

21,620

39,661

Note: * Total cumulative figures for 1999–2001 exclude data on FDI in Brunei Darussalam and Cambodia. Source: ASEAN Secretariat (2002).

production of chemicals and paper. On the other hand, investment in the Philippines is more diversified. Outward flows of investment from the older ASEAN members became increasingly apparent between 1986 and 1996 due to the increasing prosperity in the region at that time, rising labour costs within the region, and the need to form strategic alliances (Tham 2000). These flows contributed to the increasing intra-ASEAN investment observed during this period. However, the amount of intra-ASEAN inward investment shrank from 1998 to 2000 due in part to the financial crisis in 1997, though it registered an increase in 2001 (Table 8.7). It would appear that intra-ASEAN investment continued to fall between 1998 and 2000, despite the formation of the AIA. How important is intra-ASEAN FDI as a source of investment compared to other source countries? Table 8.8 shows that its importance as indicated by its share in total FDI inflows for each member country varies considerably among the ASEAN members. It is significantly more important for the newer ASEAN members (Cambodia, Lao PDR, Myanmar, and Vietnam) than the ASEAN-Five. However, it comprised more than 50 per cent of the FDI inflows of Brunei between 1995 and 2001. For ASEAN as a whole, it constituted only 10.8 per cent of its total FDI inflows for the same period. Moreover, this percentage is observed to fall from 15 per cent in 1995 to an

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30

29

24 25 26 27 28

23

21 22

20

19

15 16 17 18

Food Products and Beverages Tobacco Products Textiles Wearing Apparel, Dressing, and Dyeing of Fur Tanning and Dressing of Leather, Luggage, Handbags, Saddlery, Hamess, and Footwear Wood and Wood Products and Cork, Except Furniture; Articles of Straw and Plaiting Materials Paper and Paper Products Publishing, Printing, and Reproduction of Recorded Media Coke, Refined Petroleum Products, and Nuclear Fuel Chemical and Chemical Products Rubber and Plastics Products Other Non-Metallic Mineral Products Basic Metals Fabricated Metal Products, Except Machinery and Equipment Machinery and Equipment (not elsewhere classified) Office, Accounting, and Computing Machinery

ISIC Code

34 133.06 (0.47)

777.90 (2.75)

659.06 (2.33)

190 171

3,803.25 (13.42) 3,857.65 (13.61) 3,871.56 (13.66) 805.56 (2.84) 939.08 (3.31)

294.36 (1.04)

19 12 133 236 64 38

190.20 (0.67) 87.89 (0.31)

94 27

214.87 (0.75)

229.24 (0.81)

179 67

965.03 (3.41) 14.55 (0.05) 746.91 (2.64)

Value of Projects

170 4 93

No. of Projects

2000

20

188

141

9 134 207 55 47

15

85 49

62

180

136 5 78

No. of Projects

69.66 (0.33)

764.25 (3.64)

685.07 (3.26)

2,109.23 (10.03) 3,383.57 (16.10) 920.84 (4.38) 702.70 (3.34) 300.39 (1.43)

134.11 (0.64)

161.71 (0.77) 2,065.60 (9.83)

105.80 (0.50)

215.39 (1.02)

964.20 (4.59) 54.87 (0.26) 734.21 (3.49)

Value of Projects

2001

6

93

74

5 49 84 18 24

7

41 11

20

103

79 – 43

No. of Projects

13.68 (0.23)

490.26 (8.27)

250.19 (4.22)

10.01 (0.17) 863.33 (14.55) 365.42 (6.16) 283.16 (4.77) 257.90 (4.35)

32.65 (0.55)

107.85 (1.82) 49.07 (0.83)

125.83 (2.12)

158.78 (2.68)

414.61 (6.99) – 160.06 (2.70)

Value of Projects

January–June 2002

161

966

966

108 930 1,312 444 347

92

503 256

319

1,009

815 34 474

No. of Projects

801.27 (0.32)

7,102.09 (2.84)

6,720.97 (2.69)

51,060.85 (20.42) 45,567.08 (18.23) 10,605.32 (4.24) 10,286.91 (4.11) 12,378.59 (4.95)

1,159.47 (0.46)

2,481.65 (0.99) 19,215.38 (7.69)

902.92 (0.36)

1,320.36 (0.53)

7,937.81 (3.18) 334.31 (0.13) 4,027.00 (1.61)

Value of Projects

1995–99

Table 8.6 ASEAN: FDI Flow to the Manufacturing Sector in Projects with Foreign Interest by Industry Classification (Approval and Total Project Cost Basis),* 1995 – June 2002 (US$ million)

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158.38 (0.56) 231.37 (0.82) 580.44 (2.05)

28 57 51

2,191 21,022.19 (100.00) 988

988

5,931.61 (100.00)

5,931.61 (100.00)

79.54 (1.34) 3.47 (0.06) – –

243.28 (4.10) 105.06 (1.77)

121.73 (2.05)

1,444.04 (24.34)

657.08 (11.08)

2,690.99 (1.08) 250.83 (0.10) 217.17 (0.09) 1,929.20 (0.77)

5,295.86 (2.12) 3,926.44 (1.57)

1,417.87 (0.57)

45,908.62 (18.36)

5,138.24 (2.06)

11,197.25 (4.48)

13,468 238,797.31 (95.52)

784 76 94 2

408 336

183

2,190

659

Notes: 1. * Total Project Cost = Fixed Assets + Working Capital + Pre-operational Cost. Includes both projects that are new and expansion. 2. ** Sub-total for 1995–99 excludes data on Vietnam. 3. *** Vietnam’s data for 1995–99 are classified into five industries: heavy industry, light industry, construction, food processing, and aquaculture. 4. Data for January–June 2002 exclude Brunei Darussalam. 5. Singapore has no breakdown of foreign investment by industry to avoid identifying the individual company/country investors. 6. Data in parentheses show percentage of total. Source: ASEAN Secretariat (2002).

28,338.03 (100.00)

21,022.19 (100.00)

61 5 – –

34 38

11

124

58

14,665 249,994.56 (100.0)

2,318

2,191

301.95 (1.44) 2.96 (0.01) 21.25 (0.10) –

571.69 (2.72) 543.38 (2.58)

386.37 (1.84)

6,884.09 (32.75)

353.58 (1.68)

Total ASEAN

28,338.03 (100.00)

119 3 7 –

95 63

35

357

101

1,197

2,318

287.85 (1.02) 2.56 (0.00) 20.72 (0.07) 1,901.24 (6.71)

8,342.98 (29.44)

390

150 3 10 1

367.10 (0.13)

97

Foreign investment flow to the manufacturing sector in Vietnam

Sub-total**

31 Electrical Machinery and Apparatus (not elsewhere classified) 32 Radio, Television and Communication Equipment and Apparatus 33 Medical, Precision, and Optical Instruments, Watches and Clocks 34 Motor Vehicles, Trailers, and Semi-Trailers 35 Other Transport Equipment 36 Furniture; Manufacturing (not elsewhere classified) 37 Recycling Others Natural Gas

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1

1997

353.12 384.94 – – 193.33 272.48 102.57 64.36 730.55 1,217.69 228.60 323.30 74.88 142.87 801.80 712.60 308.10 297.50 328.70 547.20

1996 247.18 – (38.36) 28.34 254.91 153.90 106.89 351.90 569.60 398.70

1998 275.08 – (427.83) 31.36 226.95 41.20 110.92 86.40 572.04 289.26

1999

3,516.91 3,121.65 3,962.94 2,073.05 1,205.38

311.32 – 608.88 6.53 908.39 96.70 241.59 795.70 160.56 387.25

1995 2001

921.24 1,010.93

217.48 88.29 – – (232.55) (239.98) 13.72 3.06 (111.58) (804.84) 74.02 67.36 126.53 222.30 242.20 (173.00) 389.03 1,606.25 202.39 241.49

2000

223.75

0.46 – (109.71) 2.30 (159.73) n.a. 3.16 n.a. 415.93 71.34

January–June 2002

15,812.10

1,877.41 – 135.97 249.92 2,422.07 985.08 1,025.98 2,817.60 3,903.08 2,394.99

1995–2001

Total

2

Cambodia’s data by source countries are not available. Indonesia’s figures for January–June 2002 are preliminary figures. 2 Lao PDR’s figures are based on the real inflow of investments. 4 Malaysia’s figures for January–June 2002 are Bank Negara Malaysia estimates. Data on reinvested earnings refer to first quarter 2002 only. Reinvested earnings for second quarter 2002 are not available. 5 Myanmar’s figures are for fiscal year which ends in March of the following calendar year. 6 Philippines’ figures for January–June 2002 are preliminary figures. 7 Singapore’s figures for 1995, 1996 and 2001 include equity and reinvestment earnings, and exclude inter-company loans. Figures for 1997–2000 include equity, reinvestment earnings, and inter-company loans. Source: ASEAN Secretariat (2002).

Notes:

Total ASEAN

Brunei Darussalam Cambodia1 Indonesia2 Lao PDR3 Malaysia4 Myanmar5 Philippines6 Singapore7 Thailand Vietnam

Host Country

Year

Table 8.7 Inward Intra-ASEAN Direct Investment Flows, 1995 – June 2002 (US$ million)

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Table 8.8 Share of Intra-ASEAN FDI in FDI Inflows into ASEAN Countries, 1995–June 2002 (In percentages) January– June 1995– 2002 2001

1995

1996

1997

1998

1999

2000

2001

Brunei Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam

53.4 n.a. 14.0 7.4 30.2 30.4 15.3 8.2 8.0 21.8

54.0 n.a. 3.1 80.1 19.8 39.4 4.6 9.3 13.6 18.2

54.9 n.a. 5.8 74.6 41.2 36.8 11.3 5.6 8.2 21.2

43.1 n.a. 10.8 62.9 14.4 22.5 6.2 4.3 7.7 23.5

0.6 n.a. 15.6 60.8 11.4 13.5 6.4 0.7 9.3 19.5

1.9 n.a. 5.1 40.3 –14.2 35.6 9.3 4.5 11.9 15.7

2.0 n.a. 7.3 12.8 41.5 35.1 14.5 –2.0 42.5 18.6

0.4 n.a. 9.4 10.5 163.6 n.a. 0.2 n.a. 120.7 15.9

53.4 n.a. 3.2 54.6 19.7 31.1 9.5 4.3 13.7 20.1

ASEAN

15.0

12.2

13.4

9.5

4.2

8.4

9.1

n.a.

10.8

Note: n.a. – not available. Source: ASEAN Statistical Yearbook 2003, Table VI.9.

all-time low of 4.2 per cent in 1999 before increasing to 8.4 per cent in 2000 and further increasing to 9.1 per cent in 2001. Thus, while non-ASEAN sources of investment are falling in the region, intra-ASEAN investment is still small although it has improved with economic recovery in the region. Within ASEAN, the largest recipient was Thailand (25.6 per cent), followed by Singapore (18.5 per cent), Malaysia (15.9 per cent), and Vietnam (15.7 per cent) between 1995 and 2001 (Table 8.9). These four countries garnered a total of 75.7 per cent of all the inward intra-ASEAN investment for that period. Hence of the newer ASEAN members, Vietnam had attracted the most of the inward intra-ASEAN investment. In terms of the main source countries, the four main suppliers of capital to the ASEAN economies between 1995 and 2001 were the four older members of ASEAN, that is, Singapore (65.5 per cent), followed by Malaysia (14.5 per cent), Thailand (9.0 per cent), and Indonesia (7.6 per cent) (Table 8.10). 4. Main Challenges Confronting the Free Movement of Investment in ASEAN Based on Dunning’s ownership, locational, and internalization (OLI) model, widening and deepening integration will enhance the locational advantages of a region as the former will magnify the impact of market size on FDI while

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Table 8.9 ASEAN Countries’ Share in Intra-ASEAN FDI Inflows, 1995–2001 (In percentages) Host Country

1995

1996

1997

1998

1999

2000

2001

1995– 2001

Brunei Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam

8.9 n.a. 17.3 0.2 25.8 2.7 6.9 22.6 4.6 11.0

11.3 n.a. 6.2 3.3 23.4 7.3 2.4 25.7 9.9 10.5

9.7 n.a. 6.9 1.6 30.7 8.2 3.6 18.0 7.5 13.8

11.9 n.a. –1.9 1.4 12.3 7.4 5.2 17.0 27.5 19.2

0.5 n.a. –45.8 3.4 24.3 4.4 11.9 9.2 61.2 31.0

1.5 n.a. –32.6 1.9 –15.6 10.4 17.7 33.9 54.5 28.3

1.1 n.a. –25.7 0.3 –86.2 7.2 23.8 –18.5 172.1 25.9

8.7 n.a. 0.9 1.6 15.9 6.5 6.7 18.5 25.6 15.7

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

ASEAN

Note: n.a. – not available. Source: ASEAN Statistical Yearbook 2003, Table VI.5.

the latter will strengthen the impact of increasing openness on inflows of FDI. Hence, for example, current efforts to widen ASEAN integration such as the formation of a free trade area (FTA) with China will increase significantly the market size of the region to 1.7 billion consumers, a regional gross domestic product (GDP) of about US$2 trillion, and total trade estimated at US$1.23 trillion (ASEAN Secretariat 2001). Similarly, accelerating the schedule of tariff liberalization under AFTA and the AFTA-Plus initiatives to deepen integration, including the AIA, represent appropriate moves towards regaining investors’ interest in the region. Nevertheless, both the widening and deepening exercises in ASEAN pose challenges to the free movement of investment in ASEAN. Moreover, the current move towards bilateral FTAs in some ASEAN countries may also create further impediments towards the free movement of investment within ASEAN.

4.1. Widening Integration under ASEAN At the ASEAN level, apart from the ASEAN–China FTA, ASEAN has also signed an agreement with Australia and New Zealand or the AFTA–CER Closer Economic Partnership (CEP). There is also an agreement to start the process towards realizing an ASEAN–Japan Closer Economic Partnership (AJCEP) while India has also proposed an FTA with ASEAN at the Phnom Penh Summit. An ASEAN–Plus Three grouping with the three individual

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1,877.41

Total ASEAN –

– – – – – – – – – – 135.97

(26.84) – – – 78.20 – (1.70) (49.15) 135.45 –

Indonesia

249.92

– 0.04 – – 93.74 0.01 – 5.52 146.73 3.90

Lao PDR

2,422.07

* 177.76 1.70 124.13 0.06 – (0.98) 56.40 2,047.74 13.37 1.89 6,757.87

** 292.39 2.92 243.81 0.16 – (0.06) 90.83 6,072.04 50.45 5.33

Malaysia

985.08

– – 23.79 – 57.04 – 3.80 716.90 183.55 –

Myanmar

1,025.98

– – 38.57 – 77.74 – – 886.19 23.48 –

Philippines

2,817.60

93.00 (1.00) 849.50 (0.50) 1,149.70 19.50 104.50 – 594.30 8.60

Singapore

3,903.08

0.21 4.44 37.23 4.75 151.88 0.68 24.64 3,678.52 – 0.73

Thailand

2,394.99

– 0.60 58.08 5.72 400.07 – 46.08 1,567.05 317.39 –

Vietnam

15,812.10

244.12 5.79 1,207.23 10.03 2,297.00 19.21 237.97 10,349.95 1,423.68 15.12

1995 – 2001***

Cambodia’s direct investment data by source country are not available. Lao PDR’s figures are based on the real inflow of investment figures provided by the Bank of Lao PDR. Figures by source country for 1995–98 are estimates. Myanmar’s figures are for fiscal year, which ends in March of the following calendar year. Singapore’s figures for 1995–96 and 2001 include equity and reinvestment earnings, and exclude inter-company loans. Figures for 1997–2000 include equity, reinvestment earnings, and inter-company loans. 5. ( ) Means disinvestment. 6. * Consists of equity and loans. 7. ** Includes reinvestment earnings. 8. *** Total cumulative figures for 1995–2001 by source country exclude data on Cambodia. Source: ASEAN Secretariat (2002).

Notes: 1. 2. 3. 4.

– – 75.92 – 288.64 – 6.26 1,497.18 9.42 –

Brunei Darussalam Cambodia

Brunei Darussalam Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam

Source Country

Host Country

Table 8.10 Intra-ASEAN Direct Investment Flow (Balance-of-Payments Basis) by Country of Origin, 1995–2001 (US$ million)

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economies in Northeast Asia (China, Japan, and South Korea) has also been proposed. In each of these arrangements, ASEAN is supposed to be the “hub” or centre of the arrangement. However, as noted by Lim (2003), the arrangements that are currently in place and being negotiated did not originate from ASEAN. Moreover, they are also not derived from a single overall framework that is designed by ASEAN. Thus in the case of the ASEAN–China FTA, although investment diversion may serve to increase the flows of investment into the proposed new region, there are some reservations on the distribution of these gains between ASEAN and China. On the other hand, if ASEAN aspires to be the “hub” of all these ASEAN–Plus One or ASEAN–Plus Three arrangements, ASEAN would need to have a clear vision and strategy for responding towards regionalism that would require ASEAN to be more proactive in the ASEAN–Plus arrangements. More importantly it would require a stronger and more integrated ASEAN market as a fragmented ASEAN cannot possibly dictate terms in any of these arrangements, much less to utilize these arrangements to further ASEAN goals such as increasing investment flows for the region.

4.2. Bilateral Free Trade Areas The move towards bilateral FTAs in some ASEAN countries was initiated by Singapore due to increasing pessimism in the multilateral trading system after the Seattle debacle, the slower than expected pace of economic integration within ASEAN, and the concurrent desire to reduce its regional dependence on the region after the severe impact of regional contagion in the Asian financial crisis of 1997 (Tongzon 2002). In response, Thailand has also initiated several bilaterals while Malaysia is also currently negotiating or proposing to negotiate bilateral FTAs with six countries. Similarly the Philippines is also negotiating an FTA with Japan. However, not all the initiatives are started by individual ASEAN countries. For example, during the October 2002 Asia-Pacific Economic Co-operation (APEC) Meeting, the United States had proposed an Enterprise for ASEAN Initiative which would have bilateral trade, investment, and facilitation agreements (TIFA) as the basis. These bilateral FTAs are supposed to provide a catalytic role for accelerating the process of liberalization within ASEAN through its domino effect on other member countries as well as by overcoming the “convoy problem” where the pace of liberalization is held back by the least “willing partner” (Mahani 2002). Certainly based on the agreement between the Republic of

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Singapore and Japan for a New-Age Economic Partnership, the issues covered under investment in this agreement far exceed the issues covered in the AIA. For example, the scope of investment extends beyond FDI and performance requirements are also prohibited. Given the tendency for the major industrialized countries to use the Singapore FTA as a blueprint for the FTAs with other individual ASEAN countries, it is therefore expected that these bilateral FTAs will have a similar coverage although the final outcome is still to be determined. Hence the bilateral FTAs will definitely accelerate the pace of liberalization between the two countries that are involved in each FTA. While it is hoped that these bilateral arrangements will lead to freer trade on a regional and eventually on a multilateral basis, there is really no theoretical nor empirical evidence to support this aspiration. Moreover, the pursuit of individual FTAs is also perceived to undermine the sense of ASEAN as a community, thereby weakening the cohesiveness of economic integration within ASEAN. Thus further economic integration within ASEAN may be stalled or distracted by the numerous bilaterals that are currently being negotiated by the individual ASEAN members.

4.3. Strengthening ASEAN Both the widening and bilateral arrangements as explained above show clearly that the process of economic integration in ASEAN may be sabotaged by stronger partners from outside the region. Consequently strengthening economic integration within ASEAN is imperative and the ASEAN Economic Community (AEC) needs to ensure that ASEAN economic integration will deepen with appropriate institutional reforms. 4.3.1. Deepening Integration within ASEAN Deepening integration within ASEAN will require first that all ASEAN members adhere strictly to the Common Effective Preferential Tariff (CEPT) rate that has fallen substantially since AFTA was launched in 1993. For example, the average tariff for the ASEAN-Six under the CEPT scheme stood at 2.39 per cent in 2003 as compared to 12.76 per cent in 1993. However, Schwarz and Villinger (2004) have found that unpredictable policy implementation has contributed to the low usage of the CEPT scheme. Apparently investors are frequently frustrated over policy implementation as a common complaint among them is the implementation of ASEAN’s tariff rates by the customs officials in the region. Deviations from the agreed 0–5 per cent can add millions to a company’s charges while

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slow customs clearance can also escalate the costs incurred by the companies that are operating in the region. Apart from adhering to the CEPT schedule, deepening integration will also require the AFTA-Plus programmes to function better. It would appear that these programmes have met with limited success thus far as co-operation has been confined to harmonizing customs procedures and tariff nomenclature and fast-tracking a common customs valuation method (Menon 2000). Why is this so? While there are numerous reasons for the failure of regional integration, institutional weakness in terms of inadequate legal structures for facilitating the implementation of agreements of the regional grouping appear to be a common causal factor (Lawan 2002). Consequently, Lawan postulated that the implementation of liberalization arrangements based on the principle of consensus may have outgrown its suitability for the new schemes of liberalization under the AFTA-Plus programmes. As a result, institutional reform may have to be considered in order for the liberalization process, as envisaged by the AFTA-Plus programmes, to take off. 4.3.2. Institutional Reform Unlike the EU, which is based on a supranational legal system that is facilitated by centralized regional institutions, ASEAN does not have such institutions. Instead, as noted by Lawan,2 individual ASEAN countries liberalize unilaterally their trade and investment regime, based on mutually agreed consensus. But consensus is harder to attain now. First, the enlargement of ASEAN from six to ten members has increased diversity within ASEAN and there are considerable gaps between the older ASEAN economies and the newer ASEAN economies in terms of the stages of economic development, development priorities, and their readiness to liberalize. At the same time, going beyond tariff liberalization inevitably encroaches into national sovereignty in highly sensitive issues as, for example, in the case of according NT to foreign investors. For example, an investment agreement such as the AIA requires member countries to surrender their sovereign rights to control the entry and establishment of foreign investors in their own countries. Moreover, consensus may not appease firms that have been denied the agreed CEPT rates when they are exporting their goods to member countries. Hence, ASEAN needs to form a mechanism for the implementation of its agreements. It does not necessary mean that ASEAN has to adopt the institutionalized approach of the EU where supranational institutions are utilized for the implementation of its agreements. But it does imply that integration in ASEAN has to be more rule-based.

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5. Conclusion The economic development of ASEAN has benefited from the large inflows of FDI in the late 1980s and early 1990s. In turn, the MNCs that have chosen to locate their production plants in the region have contributed to the growth in export competitiveness of the region. While conducive external circumstances have contributed to the surge in inflows of FDI into the region, domestic liberalization of trade and investment in the older ASEAN members has also played an important role in the gain in FDI inflows by these countries. However, since the advent of the Asian financial crisis in 1997, inflows of FDI have been much less than the pre-crisis days. Hence the launch of the AIA represents an appropriate strategy to facilitate the region’s recovery of its former attractiveness as host economies for FDIs. Nevertheless, while there have been numerous efforts made in terms of co-operation and facilitation as well as promotion and awareness of investment in the region, the liberalization of investment itself is basically dependent on the individual country’s plan of action. This is due to the fact that the framework of agreement, though legally binding, lacks substantive details as the implementation is left to the individual member country. Based on this nationalistic approach towards regional integration, the progress of AFTAPlus initiatives such as the AIA is distinctly slow. This slow progress in turn has led to an emerging new trend for some of the ASEAN members to engage in bilateral arrangements that will add to the cost of doing business in the region as firms have to sort out the commitments under the individual bilateral arrangements as well as the ASEAN commitments. At the same time, ASEAN has offered to widen its market in partnership with other non-ASEAN countries. Although ASEAN aspires to be the centre or “hub” of these widening activities, this aspiration is very much dependent on the liberalization within ASEAN itself; otherwise the “hub” can be easily usurped by the non-ASEAN partner. Therefore, deepening of integration within ASEAN is critical in the face of the challenges of bilaterals and extra-ASEAN arrangements. The AEC is timely, especially if it is envisaged to be more of an “FTA-Plus” arrangement, thereby meeting the pressing need for ASEAN economic integration to proceed beyond the tariff liberalization that has been achieved under AFTA.3 Nevertheless the progress of the AFTA-Plus programmes such as the AIA demonstrates that it is insufficient to develop more liberalization initiatives alone. Rather for these initiatives to work, it is necessary to review the implementation mechanism in ASEAN and to consider the use of more rulebased arrangements that can enforce and hasten the process of liberalization

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more effectively. Consequently, institutional reform has to accompany the building of a roadmap for a more economically integrated ASEAN. NOTES 1. 2. 3.

T. Lawan, . Ibid. See ISEAS (2003).

REFERENCES ASEAN Secretariat. ASEAN Investment Report 2000: Challenges and Development. Jakarta: ASEAN Secretariat, 2000. ———. Joint Expert Group Study on ASEAN–China Integration: Forging Closer ASEAN–China Economic Relations in the Twenty-First Century. Jakarta: ASEAN Secretariat, 2001. ———. Statistics of Foreign Direct Investment in ASEAN. Jakarta: ASEAN Secretariat, 2002. ———. ASEAN Statistical Yearbook 2003. Jakarta: ASEAN Secretariat, 2003. . Accessed 23 March 2004. ———. . Accessed on 1 May 2003. ———. . Accessed on 29 July 2003. Institute of Southeast Asian Studies (ISEAS). “Concept Paper on the ASEAN Economic Community”. Singapore: Institute of Southeast Asian Studies, 26 February 2003. Lawan, Thanadsillapakul. “Open Regionalism and Deeper Integration: The Implementation of ASEAN Investment Area (AIA) and ASEAN Free Trade Area (AFTA)”. 2002. . Accessed on 30 July 2003. ———. . Accessed on 1 May 2003. Lim, H. “Free Trade Agreement (FTA) and Market Liberalization: A Regional Perspective”. Paper presented at the Taiwan–ASEAN Business Forum 2003: Strengthening Economic Co-operation in the WTO Era, 25 July 2003, in Kuala Lumpur, Malaysia. Mahani, Z.A. “ASEAN Integration: At Risk of Going in Different Directions”. The World Economy 25, no. 9 (2002): 1263–77. Menon, J. “The Evolving ASEAN Free Trade Area: Widening and Deepening”. Asian Development Review 18, no. 1 (2000): 49–72. Schwarz, A. and R. Villinger. “Integrating Southeast Asia’s Economies”. The Mckinsey Quarterly, no. 1 (2004), pp. 1–10. Somkiat, T., N. Deunden, and K. Busaba. “Foreign Direct Investment in Thailand”. First draft of Country Report submitted to the Asian Development Bank. Manila, 7 May 2003.

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Tham Siew-Yean. “Competition and Cooperation for Foreign Direct Investment: An ASEAN Perspective”. Asia-Pacific Development Journal 5, no. 1 (June 1998): 9–36. ———. “AFTA and Japanese Investment in Malaysia”. In Proceedings of the 1st Joint Seminar Thammasat-Kobe Gakuin University on AFTA and Industrial Restructuring beyond 2000. Thammasat University, Bangkok, 2000. ———. “Learning from Japan’s Response Toward Globalization: The Case of Japanese Direct Investment”. IKMAS Working Paper Series, no. 3 (May 2003), pp. 1–36. Thomsen, S. “Southeast Asia: The Role of Foreign Direct Investment Policies in Development”. Working Papers on International Investment, OECD, 1999. Tongzon, J.L. “The Devastating Crisis, Singapore’s Extra-ASEAN Free Trade Agreements and Their Implications for ASEAN”. Paper presented at the Second Workshop on Institutional Change in Southeast Asia in the Wake of the Asian Crisis, 10–11 June 2002, at Stockholm School of Economics, Sweden. United Nations Conference on Trade and Development (UNCTAD). World Investment Report, 2002: Transnational Corporations and Export Competitiveness. Geneva: UNCTAD, 2002. ———. World Investment Report 2003. FDI Policies for Development: National and International Perspectives. Geneva: UNCTAD, 2003.

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9

Services Trade Liberalization in ASEAN Christopher Findlay

1. Introduction The common assessment of progress on the service sector liberalization in ASEAN, based on the ASEAN Framework Agreement on Services (AFAS), is that little progress has been made. Recent research indicates that serious impediments to trade and investment in services remain, and that these impediments are costly. New momentum for services reform in ASEAN would be timely and valuable. The Doha Round of the World Trade Organization (WTO) negotiations is in progress but even before the Ministerial Meeting at which the Round was established, the services negotiations had begun. One of the questions examined in this chapter1 is how to manage the overlap between the forums of activity at the regional level (both in ASEAN and in the Asia-Pacific Economic Co-operation [APEC]) and at the global level. The discussion of these questions of service sector reform is relevant to the work in progress on the architecture of a new ASEAN Economic Community (AEC). Proposals for the AEC agenda include the establishment of clear deadlines for work on services, a commitment to implementing domestic reforms in services, the removal of work permits for skilled and creative workers moving between member economies, and the establishment

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of a visa-free region for ASEAN tourists. Suggestions of this type are also reviewed in the chapter. The next section provides some background on the services trade in ASEAN economies. Materials on issues in the design of reform agendas in the service sector are then presented. These include the progress made to date in regional agreements applied to the service sector. The following sections then review some specific suggestions in relation to the AFAS and the concluding section identifies two broad paths for consideration in further work. 2. Background on the Service Sector and Trade in Services There is a wide variation in the significance of the service sector in the ASEAN economies. Figure 9.1 shows the service sector shares of employment in ASEAN countries. The sector’s significance in Singapore is similar to that of developed economies. Malaysia, the Philippines, Indonesia, and Thailand show shares ranging from 30 to 50 per cent while the sector’s share of employment in Vietnam and Cambodia is much lower. In most cases, employment shares in services are rising. The ASEAN economies as a group are relatively large services exporters. The group ranks fifth in the world after the United States, the United Kingdom, France, and Germany (Table 9.1). The highest ranked individual economy is Singapore (17th), followed by Malaysia (27th), Thailand (28th), Indonesia (39th), the Philippines (49th), Vietnam (52nd), Myanmar (92nd), Cambodia (114th), and Lao PDR (120th). The share of services in total exports of goods and services for the ASEAN countries is less than the world average (Figure 9.2). The services share in world exports is about 19 per cent while for the ASEAN-Nine it is less than 15 per cent. Even the services share in Singapore’s exports is less than that of the world average. The significance of services in ASEAN imports is about the same as that in the world on average (Figure 9.3). In terms of the relative importance of services in exports and imports, one outlier is Indonesia. Its services share of total exports is very low while that of imports is relatively high. An economy in the opposite situation is Lao PDR, whose services share of imports is relatively low. Figure 9.4 shows the net export ratios (the ratio of the difference between the value of exports and imports relative to their sum) for those ASEAN members with relatively large trade flows in services. Most are negative (Singapore is the exception) but close to zero (including Singapore), indicating a relatively high level of two-way trade in services. As just noted, Indonesia is an outlier with a relatively large negative net export ratio.

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Table 9.1 Rankings of Service Exports, Top 24 and ASEAN, 2001 (US$ million) 2001 Rankings

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 27 28 39 49 52 92 114 120

2000

2001

World Western Europe European Union (15) Asia North America ASEAN (9)

1,465,100 674,800 605,900 304,200 309,700 66,895

1,458,200 678,700 611,500 302,600 299,000 65,353

United States United Kingdom France Germany ASEAN (9) Japan Spain Italy Netherlands Belgium-Luxembourg Hong Kong, China Canada China Austria South Korea Denmark Singapore Switzerland Sweden India Taiwan Ireland Greece Norway Malaysia Thailand Indonesia Philippines Vietnam Myanmar Cambodia Lao PDR

272,110 115,030 81,153 80,480 66,895 68,303 53,199 55,998 51,506 42,776 41,548 37,550 30,146 31,060 29,746 24,385 26,960 26,203 20,014 17,670 19,832 16,638 19,181 14,969 13,649 13,785 5,060 3,935 2,702 509 159 136

263,380 108,366 79,848 79,651 65,353 63,670 57,416 56,970 51,672 42,552 42,426 35,643 32,903 32,535 29,602 26,913 26,358 25,178 21,758 20,390 20,303 20,032 19,384 16,715 14,034 12,932 5,339 3,115 2,810 453 184 129

Note: Figures for 2001 are estimates. Source: International Economic Data Bank, Australian National University.

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Figure 9.1 ASEAN: Service Sector Share in Employment 80% 70% 1996-2000

2002

60% 50% 40% 30% 20% 10% 0% Indonesia

Malaysia Philippines Singapore

Thailand

Vietnam

Cambodia

Source: International Economic Data Bank, Australian National University, compiled from the International Monetary Fund, International Financial Statistics and national account statistics of the listed countries. Figure 9.2 Share of Services in ASEAN’s Exports of Goods and Services 30.0% 2000

25.0% 2001

20.0% 15.0% 10.0% 5.0%

C

ld W or

am

bo d

ia In do ne si a La o PD R M al ay si a M ya nm ar Ph ili pp in es Si ng ap or e Th ai la nd Vi et na m A SE A N -N in e

0.0%

Note: Figures for 2001 are estimates. Source: International Economic Data Bank, Australian National University.

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Figure 9.3 Share of Services in ASEAN’s Imports of Goods and Services 35.0% 2000

30.0%

2001

25.0% 20.0% 15.0% 10.0% 5.0%

e

A

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ai

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ay

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si La

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a

0.0%

Note: Figures for 2001 are estimates. Source: International Economic Data Bank, Australian National University. Figure 9.4 ASEAN: Net Export Ratios 0.50 0.40 0.30 0.20 0.10 0.00 -0.10 -0.20 -0.30 -0.40

e -N in N

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A

et Vi

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ili Ph

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-0.50

Source: International Economic Data Bank, Australian National University.

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Overall, the ASEAN members have significant interests in services reform issues, including market access questions. Other than Cambodia, Lao PDR, Myanmar, and Vietnam (CLMV), they are among the top fifty services exporters in the world, and as a group they account for a significant part of the world trade in services (4.5 per cent of world services exports and 5.3 per cent of imports in 2001). 3. Issues in the Services Reform Agenda Recent research on impediments to trade and investment in services has revealed the following key results: • • • •

• •

Substantial barriers to trade and investment in services exist, including among the ASEAN countries. The barriers are the result of the application of a variety of government policies, and the gains from their reform are significant. Developing economies also have market access interests in services. The specification of trade policy goals in relation to services “starts at home” and is best derived from a national development plan, but this process is made more difficult by the nature of the impediments to services trade and investment. There has been a surge in interest in the application of regional trade arrangements to services liberalization but with limited results. In ASEAN the progress on services reform on a preferential basis is so far not substantial.

Further detail on each of these points is now provided. Substantial barriers to trade and investment in services exist, including among the ASEAN countries. Recent research has revealed the extent of impediments to trade and investment in services. Findlay and McGuire (2003) summarize this material as follows: 1. There are significant impediments to trade in services, particularly in telecommunications, banking, and transport as well as some of the professional services. High levels of impediments in these fields are likely to have significant effects on other goods and services exporters. A service sector reform programme which ignores the highly protected sectors could even reduce the efficiency of the allocation of resources.

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2. In policy applying to the services sector, there is usually significant discrimination against foreign suppliers, which is observed at levels higher than expected in banking and in maritime and distribution services. 3. The relative importance of barriers to establishment and operation varies between sectors, with establishment barriers being regarded as more important in the professions. 4. In general, impediments to international services transactions tend to fall as income rises, except in some professional service activities. Thus developing economies, even if they wish to focus on various cross-border activities, also face some important domestic policy challenges to reduce the burdens that are now carried by those exportable sectors. Various ASEAN economies, according to the data reviewed by Findlay and McGuire, also show high levels of impediments in a number of sectors, including banking, distribution, maritime, professional, and telecommunications services. Stephenson and Nikomborirak (2002) report that commonly used restrictions in the ASEAN service sector, apart from licensing and other restrictions on entry by either local or foreign firms, include caps or ceilings on foreign equity, rules on the forms of business which can be established, limits on the scope of services by foreign providers, and limits on the employment of foreign personnel. The barriers are the result of the application of a variety of government policies, and the gains from their reform are significant. Findlay (2003) observes that, as a result of reform and liberalization, not only the changes in relative prices but also increments to the capacity of the service sector and the quality of its output are important. Examples include the gains from removing the bottlenecks in the infrastructure sector by facilitating public–private partnerships with foreign investors, the ability of foreign competitors to provide access to the “soft” technology associated with new ways of organizing businesses in the logistics sector, and the strengthening of the banking systems by the introduction of new risk-management technology. The capacity of other trade-oriented sectors of the economy to operate competitively in open markets is supported by the development of a service sector whose participants are at the global frontier. Back-office data processing, customer service centres, and diagnostic health services, all areas in which developing countries have export ambitions, depend on access to high-quality telecommunications and financial services (the latter to facilitate payments). The tourist sector depends on access to world-quality transport and

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accommodation service suppliers. The integration of the agriculture sector within economies and between economies depends on access to transport services, and the gains of market integration for producers in isolated areas are especially important. Dee, Hanslow, and Phamduc (2000) look at the question of which sectors can gain from multilateral services trade liberalization. A service sector may not lose from liberalization because there are different forces at work. •

• •

•

Not all services trade barriers discriminate against foreign services suppliers, so a service sector could expand because of new entry by domestic services suppliers. Some services trade barriers restrict inward foreign direct investment (FDI), so a service sector could expand because of new foreign entry. Some services barriers discriminate against foreign services delivered cross-border, so a service sector could contract in the face of additional import competition. Services trade liberalization may benefit downstream using industries, and a service sector may lose out in the competition for domestic resources (for example, labour).

The main challenge, therefore, is to stimulate the domestic reform process and the design of the trade policy agenda starts is driven by that objective. Developing economies also have market access interests in services. The movement of labour is one market access interest for some developing economies. However, there are examples of other areas in which developing economies might be competitive suppliers of services. The service sector is not just one activity but a set of activities with a wide range of technologies and factor intensities in place. The same processes of shifts in comparative advantage apply in services as they do in goods. As economies develop and lose their competitiveness in some sectors, new opportunities are created for the next round of suppliers. Given the nature of the provision of services, and the importance of direct interaction with customers, there is scope to offer highly differentiated services in world markets. Developing countries can, for example, offer a range of personal services in competition with those already provided by developed economies. The possibility of the gains from improved market access as well as those from domestic reform for other tradeable sectors, as a consequence of

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participation in international negotiations on services trade policy, can also be used to mobilize wide-ranging business sector support for a reform programme. This perspective also suggests that it is not productive in a negotiating process to build a strategy based on the proposition of “let’s not liberalize too much”. There is scope in the General Agreement on Trade in Services (GATS), and in AFAS, to find the basis for that strategy. But if that position is taken, then offers by trading partners will be small. Significant opportunities will be lost for both domestic reforms and better access to other markets (the latter stimulated by a wider range of offers for policy change at home). The specification of trade policy goals in relation to services “starts at home” and is best derived from a national development plan, but this process is made more difficult by the nature of the impediments to services trade and investment. Findlay (2003) suggests that the first step in the design of the services trade policy agenda is to specify a development plan, which includes the priorities for policy reform. The design of a strategy for international commitments then follows from that plan. If this sequence is not followed, experience elsewhere suggests that it will be difficult for developing countries to resist the specific requests by trading partners. If their own policy changes are driven solely by those requests, then policy development will tend to be haphazard and partial. As a result, there is a risk that foreign participants may capture a large part of the gains and it is more likely that serious issues in implementation will arise. A further challenge lies in the specification of commitments. One source of this problem is that the GATS categories of service activities do not always match business models, for example, in logistics, express delivery, or energy services. It is useful to have in place some model sets of commitments to illustrate how to match policy changes with business models. Failure to achieve the appropriate coverage may leave some bottlenecks in place, at which point rents can be collected, by either local or foreign firms. Even more important is the matter of the scope of the work. As already noted, the impediments are related to policy which operates behind the border, including domestic regulation. A wide range of policy measures can affect the scope for both local and foreign entry.2 Their effects are complex and the reforms are demanding, requiring, for instance, the creation in some cases of new institutions (for example, with respect to competition policy in general or prudential regulation of financial institutions).

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There has been a surge in interest in the application of regional trade arrangements to services liberalization but with limited results. There has also been in the last few years a new surge of interest in preferential small group agreements on trade. Many of these have a significant focus on service sector commitments. It might be expected that a smaller group could deal with some of the difficult issues in services negotiations more easily than a large group. However this need not be the case. A small group approach, for example, risks the proliferation of solutions to regulatory problems which are much harder to integrate later. Another problem is the negotiation of preferential access to protected markets. Some commentators observe that commitments made in a preferential agreement are very difficult to actually implement in a preferential manner. This may be the case for some types of regulation, as noted above, but in others it is easy to see how a preferential position could be sustained. For example, many impediments to trade and investment in services take a form similar to quantitative limits. Clearly those instruments can be managed in a preferential manner. If so, the first mover in these circumstances may not be a world-class supplier, and given the nature of competition in the service sector, that supplier may lock in its position and continue to retard the growth of competitiveness of other tradeable goods providers (Mattoo and Fink 2002). There is, in other words, a risk of both trade and investment diversion in preferential services agreements. The assessment by the OECD (2002) of coverage of regional trade agreements (RTAs) in services is that: •

•

•

•

RTAs covering services show a broadly common approach among themselves and with the GATS to the progressive opening of services markets, but in some areas, including quantitative restrictions and domestic regulation, the disciplines of the GATS go further than those found in a number of RTAs. Both positive and negative list approaches to making commitments have been used in RTAs, but governments, particularly those adopting a negative list approach, have subsequently extended regional preferences on a most-favoured nation (MFN) basis under the GATS. RTAs have made little progress on the “rule-making interface” between domestic regulation and trade in services and progress on domestic regulation in RTAs has been “slow and generally disappointing”. RTAs have also not made much progress on other rule-making issues

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which were left unfinished in the GATS; nor have they made much progress on sectors which were also difficult to deal with at the multilateral level. The OECD concludes that “in some sectors, the political economy of multilateral bargaining, with its attendant gains in critical mass, may help overcome the resistance to liberalisation arising in the narrower or asymmetrical confines of regional compacts”. Drake-Brockman (2003) reviews some of the recent free trade agreements involving Singapore. Her assessment is that these agreements tend to focus on specific bilateral market access issues rather than working on issues which are still evolving under the GATS, such as competition policy, mutual recognition, and domestic regulation, though she notes some exceptions to some of these points in specific agreements. She suggests that the agreements follow other precedents applied to the movement of people, but that their treatment varies in terms of the architecture. The agreement between Singapore and the United States has separate sections on investment and the movement of people, so that the services sections cover only modes 1 and 2. The agreement between Singapore and Australia covers mode 3 in the services chapter. Drake-Brockman also makes the point that there is a risk in these smallgroup negotiations as their terms establish a precedent which could affect “in a preemptive manner … the structure of the GATS and the modalities for future investment … negotiations in Geneva”. For this reason, she is concerned that agreements that have that effect, especially those involving the United States, can be classified as “GATS minus”. In summary, there are substantial risks in the preferential route to reform. Emerging in the work on these issues is a suggestion that any commitments made in small-group preferential arrangements should include another to extend the agreement without preference to all other trading partners. Scollay (2003), for example, argues that “progressive MFN liberalisation…provides the ultimate assurance that the negative effects of preferential liberalisation will be minimised…”. Issues which can only be dealt through explicit co-operation between trading partners might also be managed in a “trade and investment facilitation agreement” (TIFA) which would not trigger the requirements of Article V of the GATS on RTAs. The issue remains, however, of how to ensure that these agreements are genuinely liberalizing, and a common suggestion for a test for that purpose focuses on the terms of accession of new members (Drysdale, Elek, and Soesastro 1998).

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In ASEAN the progress on services reform on a preferential basis is so far not substantial. Stephenson and Nikomborirak (2002) review the progress in services negotiations in ASEAN. They note that there have been three rounds of negotiations, starting in 1995, with widening sectoral coverage (now including banking, telecommunications, transport [maritime and air], tourism, professional services, and construction). AFAS operates like the GATS on a positive list approach. Stephenson and Nikomborirak (2002) conclude that “on the whole, regional liberalisation has not been significantly bolder and more farreaching under the AFAS than under the GATS” (p. 95). They do, however, note some examples where the extent of attention under AFAS does exceed those under the GATS, especially in sectors where the GATS has made relatively less progress. One issue in this sort of comparison is to define the nature of “GATS plus”. Some sectors may receive more attention than in the GATS or the commitments may be less binding (for example, higher levels of foreign ownership permitted). But the commitments are preferential and without moving to a non-discriminatory regime the commitments established in a preferential agreement cannot be assessed as “GATS plus” (Drake-Brockman 2003). Stephenson and Nikomborirak (2002) suggest that the contributors to the lack of progress in AFAS include: • • •

political constraints, associated with the protectionist interests of those who might lose from reform; mechanical constraints, related to features of AFAS; and policy constraints, due to the complexity of policy applying to services.

Features of the AFAS, or the mechanical constraints, that concern Stephenson and Nikomborirak include (1) the lack of specification of progressive liberalization (in terms of coverage and time lines); (2) the constraints imposed by horizontal restrictions (for example, those applying to the movement of people); (3) the lack of a safeguard measure; and (4) the impact of domestic regulations, which remain as an impediment even as other policies are reformed. Selected proposals for reform of AFAS are reviewed in the next section. The significance of the political constraints to reform also deserves further attention. Small-group arrangements run the risk of lack of progress

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because of their inability to mobilize sufficient political interest to meet and offset the resistance to significant reform, as noted by the OECD (2002). When the sectoral coverage of a small-group arrangement is also constrained, as it was in the AFAS procedures, then this risk is exaggerated. The last section of the chapter examines suggestions for more substantial changes in strategy. 4. ASEAN Economic Community A number of specific suggestions for further co-operation in the development of the AEC are examined in this section. These are options that could be developed from within the existing AFAS.

4.1. Capacity Building The variety and extent of impediments to trade and investment in services create significant policy challenges. Many of these impediments operate “behind the border”. Substantial research is required to establish their relative importance. In the context of international negotiations, an effort is also required to identify key impediments on which to demand action by trading partners. There is value in compiling information on the nature and extent of the impediments. A considerable amount of research has been completed on this matter (Findlay and McGuire 2003). Success in this form of analysis also depends on effective consultation with business, both at home and business based offshore but with an interest in entering the home market. Establishing the links with the domestic development agenda is a critical part of building an international strategy. While the specification and implementation of a strategy ultimately requires substantial knowledge and understanding of the provisions of the GATS or of AFAS, the first step is, as always, strategic rather than tactical. Sharing of ideas about strategy is likely to be a key element in the development of a successful AEC.

4.2. More Details on Time Frame Stephenson and Nikomborirak (2002) argue that a “a modified and clearer negotiating framework with specific deadlines would help move the services liberalisation progress along in ASEAN”. Whichever mode of liberalization is adopted, a time frame is critical for success. A readily available and credible agenda would be to liberalize at or faster than the rates implied by the time frame in APEC’s Bogor goals.

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4.3. Sectoral Priorities ASEAN members have considered a negotiating framework similar to that of goods, namely adopting a classification system for services, then setting target dates for liberalization of certain proportions of the classifications, with the ultimate goal of free trade and investment by 2020. Instead of focusing on the sectors covered, an alternative is to assess the importance of various sectors and negotiate first on the most important, again with a target date for liberalization. Generally, as already noted, the trade-offs are not sufficient within sectoral negotiations to mobilize political commitments for reform and this problem is acute for the so-called sensitive sectors. An alternative track within a strategy designed to identify sectoral priorities is to focus on sectors where at least some progress can be made and to leave the sensitive sectors to a later stage in the negotiations. However, the Pacific Economic Co-operation Council (PECC) has stressed that “the arguments against the exclusion of sensitive sectors carry greater weight” (Scollay 2003). Bosworth (2002) also points out that this approach would lead to widening disparities in levels of protection in the service sector, which reduces the efficiency gains from reform. Comprehensiveness, in other words, is an important principle to maintain. Further comments on the treatment of various categories of sectors are provided in the final section of the chapter.

4.4. Domestic Regulation Trade and investment in services are subject to a variety of rules or regulations. Different departments or ministries often administer these procedures. The complexity of the rules and of their administration adds to the difficulty of arriving at a negotiating position.3 Reform of regulation is critical to reaching more open markets, since if left unattended it may emerge as the source of new barriers to trade and investment in services. But reform of regulatory arrangements in a discriminatory manner adds to their complexity, to the demands on the bureaucracy and to the scope for discretion. Regulatory reform that accompanies services liberalization is best managed in a non-discriminatory manner. However, even with that objective, the management of the reform process may be organized effectively at a regional level. An important first step in this area is to improve the transparency of regulation, which is the subject of many suggestions (Yi 2002). More difficult is the issue of the manner in which trading partners might become involved

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in the consideration of new regulation at an early stage. At this time a focus on transparency is likely to be more valuable. The management of the intrusion of foreign interests in domestic policy-making processes is a topic likely to require longer-term attention. This assessment also applies to other aspects of the domestic regulation agenda, including the specification of the legitimacy of the motive for regulation and whether any instrument adopted is more burdensome than necessary. Issues remain about recognition of standards but these are the sorts of regulatory issues that might be better handled at a regional level, including at ASEAN level.

4.5. Switch to a Negative List AFAS works, like the GATS, on a positive list approach. Findlay, Stephenson, and Prieto (2003) review the application of negative and positive lists in regional agreements and conclude that agreements based on a negative listing provide information in a transparent form on the existing barriers to trade in services, thus giving service providers precise knowledge of foreign markets. In agreements based on a positive listing the sectoral coverage of commitments as well as the type and comprehensiveness of information provided on the commitments may vary significantly between the members… Neither modality guarantees open markets. The establishment of an agreement might be easier using a positive list approach, because of the degree of flexibility and options it provides to participants in the negotiating process. But once in place, our expectation is that the negative list is the superior method for carrying out liberalisation because of the higher degree of transparency and lower level of uncertainty that it provides.

Another consideration in the choice between positive and negative lists is the impact of technological change, which provides new modes of supply, leading to options for escaping impediments to trade which apply to the currently popular modes of supply. Stephenson and Nikomborirak (2002) stress the impact of new technology and options for new modes of supply, including through e-commerce. They argue that it is important to “start thinking about how to make the entire economy more efficient in order to take advantage of the greater choices offered by these means of electronic services trade, rather than protecting a few interest groups of local operators” (p. 101). One option for avoiding this outcome is to adopt a negative list approach to commitments in services liberalization. Under the positive list

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framework of the GATS and AFAS, commitments apply only to those sectors which are listed. Under the negative list, commitments are excluded from those sectors which are listed, and therefore new services or new modes of delivery are automatically covered.

4.6. Accession and the ASEAN – X Rule Akin to APEC’s adoption of the “pathfinder” approach, it is possible for some members of a regional agreement to move faster than others, with the expectation that the others will join the same arrangement at a later date when their calculus of costs and benefits has altered to support membership. This is the scope of the ASEAN – X approach, in which X members adopt a liberalizing measure with a time lag. Differences in timing are also possible in the GATS, where members can provide schedules for the implementation of commitments (schedules of this type are features of China’s WTO accession commitments). The subgroup approach works best when all the potential members agree at the outset on the terms of membership and the only issue is the time at which they join. However, the very reasons that lead some to wait also inhibit their participation in setting the rules of the arrangement. In their absence, the rules can be set to benefit the foundation members of the arrangement, reducing the incentives for the others to join later. This approach works best where relevant global standards already exist. Further, once an arrangement is established, the foundation members may try to deny the extension of the membership, because of their loss of rents as the group size increases. It is important, therefore, to establish, and for the foundation members to commit to, the open nature of the arrangement at its foundation. The subgroup approach might be appropriate for the movement to international standards applied to merchandise products or, more relevant to services, the recognition of professional qualifications. Regional co-operation can make a substantial contribution in these areas. Within the overall liberalization process, however, the active participation of all the members at all times remains valuable. Otherwise protected positions become entrenched and the rest of the outwardly oriented economy continues to be burdened by costs imposed by the protected sectors. The pay-off to the effort to reform is reduced. Economies may move at different speeds, but success is more likely when all are changing, driven by their commitments to the time frame discussed above.

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4.7. Scorecarding As reported above, it is possible to develop indicators of the extent of impediments to trade and investment in services. These sorts of indicators could be used for the purpose of developing scorecards of reform. However, direct comparison of policy regimes, especially with respect to non-tariff measures like those which apply in services, can sometimes generate an antagonistic debate about the methodology being employed. Even more important than the documentation of the current policy positions is the sharing of experience on the impact of reform and its contribution to growth. This is more important for sustaining the progress for reform than direct policy benchmarking. In other words, the outputs or consequences of the reforms in other countries are more important sources of pressure for reform than the scorecarding of current positions, although work on policy changes using this methodology is important for understanding the contribution of reform to growth. The work on scorecarding is more valuable within an economy when policy-makers work to establish their own reform priorities.

4.8. Safeguards The application of safeguards remains a contentious issue. It could be a “deal breaker” in the Doha negotiations. The European Union (EU), for example, is vehemently opposed to the application of safeguards but a number of ASEAN members are associated with a position among developing countries that requires a commitment on safeguards in order to accept the requests for liberalization from their trading partners. Stephenson and Nikomborirak (2002) suggest that the lack of safeguards in AFAS is a contributor to its lack of progress, because policy-makers have no capacity to respond when there is a negative effect from liberalization that had not been originally anticipated. There is debate about whether it is possible to implement a safeguards regime in the service sector (Sauve 2002) since, when establishment is involved, the use of safeguard provisions appears to imply a reversal of a previously given permission for a foreign firm to invest. Sauve (2002) reviews the options for safeguards, some of which focus on sectors in which the situations leading to demands for safeguards might arise (mainly in financial services). If safeguards are to be made available in a regional agreement, their application will have to be made subject to effective disciplines on their use, and those disciplines should be consistent with the treatment of this issue in the GATS.

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4.9. Rules of Origin A variety of rules of origin can be applied to services. Principal place of business is a relatively liberal rule. A rule requiring ownership and control by nationals of the partner economy is more restrictive. A more liberal rule is preferable and the OECD (2002) found that RTAs applied to services tend to use relatively liberal rules. A related point stressed by Scollay (2003) is that rules of origin should not be used to protect sensitive sectors or to facilitate adjustment to liberalization. Rules of origin should be straightforward, transparent, and not impose unnecessary compliance costs. Understanding then demonstrating compliance with the rules can be costly and an inhibitor to the development of trade under the preferential arrangements. The simplest rule is no rule at all, a topic which is discussed further below. As Findlay, Stephenson, and Prieto (2003) point out, many countries frequently require a local presence (that is, an established trade presence) as a condition for foreign individuals or juridical persons wishing to provide services within their territory. This is usually the case with services that require close supervision to guarantee better consumer protection. This requirement may hinder international trade because it may impose higher costs to foreign suppliers who are not allowed to use the other modes of supply. Thus, allowing service providers to choose their preferred mode of supply can be expected to lower their costs and stimulate trade.

4.10. Mode 4 The movement of people is a substantial interest of many developing countries (Chanda 2002). Recent modelling results also stress the scale of benefits from the reform of this mode of supply (Winters, Walmsley, Wang, and Grynberg 2002). As Findlay (2003) points out, wide-ranging reform in the movement of people is constrained by the challenges it poses for migration policy. However, a range of types of workers might not trigger these issues. Some developing countries, including ASEAN members, would be expected to have interests in the low to middle range of skills. There is some overlap of interest in this group of people within developed countries, which provides the basis for discussion of these issues at a global as well as ASEAN level. Business in the EU, for example, has stressed its interest in the treatment of not just executives, already well covered in the Uruguay Round outcome, but also service contractors. This overlap suggests that at least some agreement could emerge on a wider coverage of this mode of supply.

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On the other hand, since the events of 11 September 2001 many economies are now much more concerned about the management of movement of people (workers and customers) and less inclined to liberalize mobility. It may, therefore, be even more difficult now to reach a consensus on methods to facilitate the movement of people even in these categories. A significant impediment to the movement of people between labour markets is the application of the economic needs tests (ENTs). These tests are similar to safeguards provisions but applied in advance of making a commitment — they are designed to check for anticipations of market disruptions and have been called “super-safeguards”. These tests are also listed as market access issues in the GATS, so the first preference is to negotiate their removal. One side benefit of a more extensive discussion of safeguards in services could be support for the removal of the ENTs. 5. Concluding Remarks AFAS has made little progress so far in liberalization. It is constrained by some structural features and options for their reform were reviewed in the previous section. However, the inability of AFAS to mobilize sufficient political resources to support wide-ranging reforms is a more important constraint. Therefore, rather than remain within the AFAS structure, it is worth considering some other paths designed to meet this challenge. In this concluding section two paths for resolving some of the issues in the role of regional arrangements and the application of preferential policies are reviewed. One focuses on a categorization of sectors and the other concentrates on modes of supply. If implemented as outlined below, these paths could both be taken up and would complement each other. The strategy in both options under consideration here is to try to shift to a wider setting to deal with the political constraints on reform at the sectoral level, while continuing to look for opportunities for work within the regional architecture to contribute genuine “GATS plus” initiatives. Both approaches also require a renewal of the co-operation among ASEAN members which was evident in the Uruguay Round but which now appears to be absent (Sally 2002).

5.1. Sectoral Categories Work on building the AEC has focused on particular service sectors. At their meeting in Bali in October 2003, the ASEAN leaders adopted the recommendations of the High-Level Task Force on ASEAN Economic

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Integration to accelerate eleven priority sectors, which included air transport and tourism, health care, and e-ASEAN (which has implications for a number of service sectors, including telecommunications). The leaders also agreed to accelerate liberalization through the application of the ASEAN-X formula, discussed above. They also adopted the goal of establishing mutual recognition agreements for qualifications in the major professional services by 2008. There has been a concern, however, that the focus on sectoral reform is the source of slow progress in the GATS-type agreements on services. Rather than concentrating on reform in specific sectors, further progress may be possible by developing a strategy for broad aggregates of service activities at the same time as linking work at the regional level to that in the WTO. Findlay, Stephenson, and Prieto (2003), for example, suggest the following allocation of tasks for regional agreements on services, focusing on a division between infrastructure services, commercial services, and professional services. Preferential liberalization of infrastructure or network-type services (financial, telecommunications, energy, transport, and possibly distribution) would limit the ability of a country to draw upon the most efficient suppliers and they would, therefore, maintain a higher-cost, less-efficient national market for such critical services. The global market is the logical forum to target for the liberalization of infrastructure services. Regional negotiations and agreements play a role in this process, through capacity building to design commitments, and sharing experiences about reform paths. Specific commitments could be made in these sectors but only as long as that process involves (1) the binding of liberalizing commitments that have not yet been undertaken under the GATS and (2) extending any commitments made as a result of local negotiations de facto to other WTO members on an MFN basis. Commercially oriented services include distribution, business services, professional services, tourism, construction/engineering services, environmental services, and certain categories of specialized health and educational services. Several of these sectors (tourism and business services in particular) are already quite open in most countries, and Findlay, Stephenson, and Prieto (2003) suggest that it would make little sense to think of restricting such open markets to a regional level. Discussion at a regional level might be useful for identifying new commitments in these sectors which could be carried over into the GATS for subsequent application on an MFN basis. Other sectors, such as construction/engineering and professional services, are subject to strictly regulated national standards. Regional agreements could have a useful role to play. It should be easier to develop a common set

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of criteria for the recognition of the equivalence of standards, as proposed in the development of the AEC, and/or the equivalence of diplomas and educational and professional training for the granting of licences to practise various professional services when this is carried out among a small or smaller subset of member countries. Similar national educational and legal systems that are often found in countries of the same geographic region or those of the same legal/cultural background facilitate such recognition agreements. However, it would also be important to establish these arrangements in a manner consistent with principles emerging from the GATS negotiations and from discussion in APEC.4 In this framework co-operation at the ASEAN level concentrates on: •

• •

initial rounds of discussion in relation to liberalization in infrastructure services but with the aim of a non-discriminatory application of liberalizing measures; work to sustain open markets in commercial services or to develop new commitments in those areas which can be bound in the GATS; and work on facilitation measures which are relevant to a variety of services, including construction or professional services, with a view to transferring the lessons of this experience to the GATS processes.

5.2. Modes of Supply The second approach focuses on modes of supply rather than categories of sectors and is designed to respond to concerns about the lack of momentum for reform in structure based on sectoral negotiations. A focus on modes of supply may appear to place ASEAN at a disadvantage, within an architecture that is not the same as that in the WTO. Arrangements that develop in ASEAN under this alternative path may come under pressure for subsequent change if the principles developed in ASEAN are not similar to those which emerge from the WTO. At the same time the WTO may move in a new direction, and experience in this approach would enable ASEAN to participate effectively in discussion about that evolution. The WTO architecture has been the topic of some debate. Bosworth (2002), for example, is concerned about the lack of liberalization impetus in the GATS. Bosworth discusses structural changes in which the coverage of the GATS is narrowed to cross-border supply and separate agreements are developed on competition policy (which would cover market access), investment, and the movement of service providers. He says, “[W]ithout [these changes], services liberalization will continue to be negotiated

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sectorally, based on limited scheduled commitments that could slow reforms” (p. 32). This second path would put more weight within ASEAN agreements on cross-border supply, movement of people, and investment.5 The investment arrangements would be extended to cover establishment for goods and services production. The movement of people would be treated in a stand-alone agreement. Only services transacted by the movement of consumers or by cross-border modes would be covered in the services agreement, with a focus on differences in treatment between national and foreign suppliers. In this case the work at regional level would include: •

• •

discussions on commitments to be made in relation to investment liberalization in all sectors, while those commitments made in relation to services can subsequently be bound in the GATS; establishment of a new regime for the movement of service suppliers, especially skilled or creative workers; and in relation to the first two modes of supply, work to move to a negative list to apply to those sectors which subsequently would highlight further steps in liberalization and options for binding commitments in the GATS.

As Bosworth (2002) points out, some consideration would also need to be given to the treatment of market access in services, perhaps through complementary work on competition policy. NOTES 1.

2.

3.

4.

This chapter applies to the ASEAN context a number of the observations in Findlay (2003). Work on this paper, which was presented at the ASEAN Roundtable 2003, was supported in part by a grant from the Australian Research Council. My thanks to the Roundtable participants for their comments, especially Rahul Sen. WTO members have made commitments with respect to market access in a series of specified sectors. The scope of market access is defined by reference to six types of restrictions, mostly quotas. The recommendations of the High-Level Task Force on ASEAN Economic Integration included a proposal to shift responsibilities for services negotiations from officials with sectoral responsibilities to those reporting to Economic Ministers. Not only movement of service providers matters. Also important are impediments to the movement of service consumers. The report of the High-Level Task Force

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5.

on ASEAN Economic Integration also refers to the goals of visa exemption for ASEAN nationals travelling within ASEAN (by 2005) and harmonizing the procedures for issuing visas to international travellers in ASEAN (by 2004). The report of the High-Level Task Force on ASEAN Economic Integration gives considerable attention, as already noted, to the movement of people. It lists e-ASEAN as a priority. It contains references to investment, but not in terms of the approach proposed here.

REFERENCES Bosworth, Malcolm. “Most-favoured Nation and National Treatment”. In Services Trade Liberalisation and Facilitation, edited by S. Stephenson, C. Findlay, and S. Yi. Canberra: Asia Pacific Press, 2002. Chanda, R. “Movement of Natural Persons”. In Services Trade Liberalisation and Facilitation, edited by S. Stephenson, C. Findlay, and S. Yi. Canberra: Asia Pacific Press, 2002. Dee, P., K. Hanslow, and T. Phamduc. “Modelling the Liberalising of Services”. In Productivity Commission and Australian National University, Achieving Better Regulation of Services. Conference proceedings, Ausinfo. Canberra, 2000. Drake-Brockman, Jane. “Regional Approaches to Services Trade and Investment Liberalisation”. Paper presented to the East Asia Trade Strategy Conference, 20–21 March 2003, at the Australian National University. Drysdale, P., A. Elek, and H. Soesastro. “Open Regionalism: The Nature of Asia Pacific Integration”. In Europe, East Asia and APEC: A Shared Global Agenda, edited by Peter Drysdale and David Vines. Cambridge: Cambridge University Press, 1998. Findlay, Christopher. “Services”. Background paper for the United Nations Millennium Project Task Force on Trade, 2003. Findlay, Christopher and Greg McGuire. “Restrictions on Trade in Services for APEC Member Economies”. Report prepared for distribution by the Pacific Economic Co-operation Council, January 2003. Findlay, Christopher, Sherry Stephenson, and Francisco Javier Prieto. “Services in Regional Trading Arrangements”. Mimeographed. 2003. Mattoo, A. “Negotiating Improved Market Access Commitments”. In Development, Trade and the WTO: A Handbook, edited by B. Hoekman, A. Mattoo, and P. English. Washington, D.C.: World Bank, 2002. Mattoo, A. and C. Fink. “Regional Agreements and Trade in Services: Policy Issues”. World Bank Policy Research Working Paper no. 2852, June 2002. Organization for Economic Co-operation and Development (OECD). “The Relationship between Regional Trade Agreements and the Multilateral Trading System: Services”. Working Party Paper of the Trade Committee, TD/TC/ WP(2002)27. Paris: OECD, 2002.

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Sally, Razeen. “Southeast Asia in the WTO: Hanging Together or Bowling Alone”. Mimeographed. Institute of Southeast Asian Studies, 2002. Sauve, P. “Completing the GATS Framework: Safeguards, Subsidies and Government Procurement”. In Development, Trade and the WTO: A Handbook, edited by B. Hoekman, A. Mattoo, and P. English. Washington, D.C.: World Bank, 2002. Scollay, Robert. “Asia Pacific RTAs as Avenues to Achieving the Bogor Goals: Analysis and Ways Forward”. Accessed from , 2003. Stephenson, Sherry and Deunden Nikomborirak. “Regional Liberalisation of Services”. In Services Trade Liberalisation and Facilitation, edited by S. Stephenson, C. Findlay, and S. Yi. Canberra: Asia Pacific Press, 2002. Winters, L.A., T.L. Walmsley, Wang Z.K., and R. Grynberg Negotiating the Liberalisation of the Temporary Movement of Natural Persons. Economic Paper. London: Commonwealth Secretariat, 2002. Yi, S. “Promoting Transparency in Services”. In Services Trade Liberalisation and Facilitation, edited by S. Stephenson, C. Findlay, and S. Yi. Canberra: Asia Pacific Press, 2002.

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Labour Mobility within ASEAN: Issues and Policy Implications for the ASEAN Economic Community Carunia Mulya Firdausy

1. Introduction The proposal at the ASEAN Summit in Cambodia on 4 November 2002 to transform ASEAN into an ASEAN Economic Community (AEC) by 2020 will undoubtedly have many implications to the economic development of ASEAN countries. However, it is important to note that an AEC without a clear vision and mission as well as detailed policy management will create social-economic and political problems. One of the many problems that will surely emerge is the rapid increase in labour mobility, especially of migrant workers (semi-skilled and unskilled), within ASEAN. If the end goal of the AEC is a common market, there will be free movement of labour and capital among ASEAN member countries. Capital in the form of foreign investments is relatively free to move internationally to a more competitive wage environment. However, workers will bear most of the costs if they encounter problems abroad.

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Since the AEC has no details yet on regulating labour mobility, it is important for ASEAN countries to think of policy measures that regulate or deregulate the free movement of labour from one country to another within the region. These policy measures become critical as the movement of labour continues to grow. Also, based on previous experiences, the movement of labour (especially semi-skilled and unskilled workers) without any clear policy and a good management system to deal with foreign workers has resulted in bilateral tensions in a number of ASEAN countries. This has been particularly the case with the movement of labour from Indonesia to Malaysia and Singapore, and from the Philippines to Malaysia. This chapter aims to address key issues and policy implications related to the movement of labour within ASEAN as the region moves towards an AEC. Based on available data, lessons will be drawn from four labourexporting ASEAN countries, that is, Indonesia, Thailand, the Philippines, and Vietnam, and to a lesser extent Laos and Myanmar, as well as three labour-importing ASEAN countries, that is, Malaysia, Brunei, and Singapore. The following section provides background information on the present situation of labour mobility in the labour-importing countries of Singapore, Malaysia, and Brunei. This is then followed by the current patterns and direction of labour mobility, and the possible main problems and issues with regards to labour mobility in the AEC. The last section provides policy recommendations and concluding remarks. 2. The Present State of Labour Mobility within ASEAN Labour mobility within ASEAN is occurring at an unprecedented rate and will continue to increase in scale and impact as the forces of globalization become more pervasive and the distance separating nations is further eroded in the region. Of the ten ASEAN member countries, Singapore, Brunei, Malaysia, and, to a lesser extent, Thailand are presently under great pressures of labour migrants from other ASEAN countries. The rapid increase of labour mobility to these countries is due to a number of push and pull factors. These four labour-importing countries are the most advanced economies of ASEAN and they tend to pay relatively higher wages and provide better working conditions than other countries in the region. These countries, therefore, attract migrant workers from the less developed countries of ASEAN. For the labour-exporting countries, a combination of economic, demographic, and political forces in these countries have generated labour mobility and emigration pressures. Other factors serve to facilitate and channel actual migration flows, namely readily available information about potential destination countries, historical ties between immigration and emigration

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countries, reduced transportation and communication costs, the development of migration networks based on kinship and locality ties, the growth of an immigration industry, and the internationalization of education and training (Stahl 2000). However, the quality of data on the present number of migrants in ASEAN countries is poor and limited. According to Hayase (2003), the present number of international migration1 in ASEAN countries is about 4.12 million people. It can be seen from Table 10.1 that Singapore and Brunei have the highest migrant stocks at 33.6 per cent and 31.7 per cent of total population respectively while in Malaysia, it is only 6.3 per cent. The rest of the ASEAN countries (that is, Indonesia, Laos, Vietnam, Myanmar, Thailand, and the Philippines) have migrant stocks below 1 per cent of their total population, with the exception of Cambodia (1.6 per cent). Indonesia and the Philippines have net emigrants of almost 200,000 per year between 1995 and 2000.

Table 10.1 International Migration within ASEAN

Country or Area

Total Population (thousands)

Migrant Stock

Number (thousands)

2000 ASEAN Brunei Cambodia Indonesia Laos Malaysia Myanmar Philippines Singapore Thailand Vietnam

517,366 328 13,104 212,092 5,279 22,218 47,749 75,653 4,018 62,806 78,137

Percentage of Population

2000 2,769 104 211 397 16 1,392 113 160 1,352 353 22

Net Migration (average annual) Number (thousands)

Rate per 1,000 Population

1995–2000 0.5 31.7 1.6 0.2 0.3 6.3 0.2 0.2 33.6 0.6 0.0

1 8 –180 –1 9 4 –190 74 –5 –40

2.6 0.7 –0.9 –0.3 0.4 0.1 –2.6 19.6 –0.1 –0.5

Source: Population Division, Department of Economic and Social Affairs, United Nations, International Migration 2002, as of October 2002, cited in Hayase (2003, p. 26).

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The figures in Table 10.1 only show the number of migrant stocks in ASEAN, with no detailed explanations on the migrants’ country of origin. In addition, the data do not include undocumented migrants2 in ASEAN. The largest number of international migrants found in Singapore is not so surprising. This is because during the 1960s and 1970s, the country had been successful in implementing import-substitution development policies, resulting in high, export-led economic growth which generated a gap between labour demand and available domestic labour supply. This excess demand, consequently, had been met through the use of foreign workers (including migrant workers). According to Hui (2000), among others, the influx of international migrants to Singapore has made a great contribution in sustaining high real economic growth rates, reaching per capita real GDP of S$32,555 in 1999,3 although income inequality was considered high, especially before the 1990s. International migrants in Singapore can be grouped into two. The first group consists of foreign workers4 and the second group of permanent residents. In 2000 the number of foreign workers was estimated at about 755,000 out of 4.02 million people, constituting 19 per cent of the total population, while permanent residents made up only 7 per cent or 290,000 of the total population. Of the foreign workers, it is estimated that about 600,000 were in the workforce,5 accounting for 30 per cent of total employment in the country. These comprised an estimated 110,000 who were higher skilled and better educated work-pass holders in the manufacturing, commerce, finance, and business sectors of the economy. The estimated remaining 490,000 consisted of lower-skilled work-pass holders which included about 130,000 domestic maids, 210,000 construction workers and about 150,000 working in the manufacturing, marine, and service industries (Hui 2000). Therefore, many of the foreign workers in Singapore are semi-skilled and unskilled workers, who can only work if their prospective employers apply to the Ministry of Manpower for work permits. Each permit is for a specific period of employment and there is no automatic renewal. The foreign workers in Singapore, especially semi-skilled and unskilled migrant workers, are mostly from Malaysia, Indonesia, Thailand, the Philippines, and South Asian countries (namely India and Bangladesh). The large inflow of Malaysian workers to Singapore occurred in the early postindependence period. The influx of a large number of migrant workers from other ASEAN countries to Singapore was due to the demand for construction workers and domestic workers, while the influx of expatriates or professional and technical workers from other countries was because of the sharp rise in foreign investment flows to this country.

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Like Singapore, the large influx of international migrants to Malaysia was also associated with labour shortages as a result of rapid and sustained economic growth from the 1970s onward. Labour shortages occurred not only in the agricultural sector (especially the plantation sector), but also in the construction sector, manufacturing, and certain service sectors (Watanabe 2002; Kassim 1998). To fill the shortage of labour in these sectors, Malaysia, like Singapore, introduced a foreign worker recruitment policy. The major instrument used to regulate the inflow of foreign workers is the work permit. Unlike some developed countries, Malaysia does not have an official policy to offer residential status to foreign workers. Hence, it uses work permits to allow foreigners to stay and work temporarily to meet its labour market needs. Work permits are issued to all foreign workers to authorize their entry and employment. By varying the terms and conditions attached to the work permits, immigration policies are used to target labour and skills needs (Kanapathy 2000). The composition of foreign workers in Malaysia is dominated by the semi-skilled and unskilled workers. According to Kassim (1998), the increase in these types of workers occurred from 1993. In 1993 the number of semiskilled and unskilled workers was estimated to be about 532,723 and it increased to 1,471,652 in 1997. The number of these workers then decreased significantly to 769,566 in 2002 as the result of changes in the management policy associated with the economic crisis (Table 10.2).

Table 10.2 Malaysia: Estimates of Legal Migrant Workers (Semi-skilled and Unskilled)

19931 1994 1995 1996 1997 1998 1999 2000 20012 20023

Malaysia

Peninsular

Sabah

Sarawak

532,723 642,057 726,689 745,239 1,471,652 1,127,652 897,705 799,685 807,984 769,566

414,336 515,983 576,441 586,796 1,190,437 789,684 680,846 632,720 618,946 –

100,000 100,000 120,719 121,144 226,565 283,968 162,269 75,232 99,281 –

18,387 26,074 29,529 37,299 54,643 54,000 54,590 91,733 88,120 –

Notes: 1 Data from July to December 1993. 2 Data from January to July 2001. 3 In January 2002. Sources: Kassim (2002) for 1993–2000; Department of Immigration, Malaysia, for 2002.

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Out of the total of 769,566, Indonesians form the largest group (73.7 per cent), followed by Bangladeshis (13.7 per cent), Nepalese (6.3 per cent), and Filipinos (2.2 per cent). The most common occupation category is manufacturing (36.8 per cent), followed by plantation workers (27.9 per cent), and domestic maids (20.3 per cent). These three occupation categories account for 85 per cent of foreign workers in Malaysia (Table 10.3). From this table, it is confirmed that the decision of migrant workers to work abroad is not only for economic factors but also for non-economic factors such as language, historical ties, and close geographic location between the destination countries and the labour-exporting countries. By occupation categories, Table 10.4 shows that foreign workers from Indonesia are widely distributed in all the categories. However, a large number of them are engaged as plantation workers and domestic maids, accounting for 93 per cent and 94 per cent of total foreign workers in these categories respectively. Indonesians also account for 47 per cent of manufacturing workers and 45 per cent of service workers. The second largest number of foreign workers are from Bangladesh. They work mainly in the manufacturing sector (70 per cent). The majority of Filipinos, however, work as domestic maids (88 per cent). Note that in this table, the number of Bangladeshis was Table 10.3 Foreign Workers in Malaysia (1 January 2002) Number (persons)

Share (%)

Country of Origin Indonesia Bangladesh Nepal Philippines Myanmar Thailand Pakistan Others

566,983 105,744 48,257 17,287 6,539 2,440 2,218 20,098

73.7 13.7 6.3 2.2 0.8 0.3 0.3 2.6

Occupation Category Construction workers Plantation workers Manufacturing workers Service workers Domestic maids Others

60,197 214,595 283,401 55,309 155,883 181

7.8 27.9 36.8 7.2 20.3 0.0

Total

769,566

100.0

Source: Department of Immigration, Malaysia, 2002.

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Table 10.4 Issuance of Temporary Work Permits to Foreign Workers in Peninsular Malaysia (January–Mid-September 2000) Construction Workers

Plantation Workers

Manufacturing Workers

Service Workers

Domestic Maids

Total

Indonesians Thais Filipinos Cambodians Myanmarese Bangladeshis Indians Pakistanis Sri Lankans Nepalese

110,764 1,121 49 – 1,369 29,275 3,305 3,115 – –

175,380 1,322 – 16 – 11,695 204 – 214 223

138,767 1,774 336 356 3,977 144,514 2,654 2,386 1,015 32

37,765 2,123 1,026 – 3,027 20,126 17,033 1,684 5 396

163,129 1,175 9,949 – – 8 39 – – –

625,805 7,515 11,360 372 8,373 205,618 23,235 7,185 1,234 651

Total

148,998

189,054

295,811

83,185

174,300

891,348

Source: Kassim (2002) in Hayase (2002).

reduced by half from over 200,000 in 2000 to a little over 100,000 in 2002, due to policy changes in mid-2001. The significant reduction of Bangladeshi workers appears to have been compensated by workers from Nepal and other South Asian countries (Watanabe 2002). Apart from unskilled and semi-skilled workers, professional and technical workers are also welcomed in Malaysia. This is particularly so when companies are unable to fill such positions with Malaysian nationals. Foreign professional and technical workers are expected to transfer their skills to Malaysian workers during their stay. However, the number of expatriates is small compared to unskilled and semi-skilled workers. According to the Immigration Department, the number of employment passes and visit passes for professional employment issued increased from 8,142 in 1981 to 12,011 in 1988 and to 20,000 to 30,000 in the 1990s. This is due to the increase in direct foreign investment from Europe, the United States, Japan, and the newly industrializing countries. As shown in Table 10.5, a total of 31,949 passes were issued to mostly Japanese and Indian nationals in 2001. The predominance of these nationalities is related to the size of direct investment from Japan and the growth of the information and communication technology industry in India. In terms of the kind of work undertaken by these nationalities, manufacturing is the most common, followed by services. These two industries combined account for about 83 per cent of the total (Watanabe 2002; Kanapathy 2000).

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Table 10.5 Number of Expatriates in Malaysia, 1998 and 2001 1998

2001

Total Number of Passes

21,484 31,949

Nationality

Percentages

Japan India Singapore China United Kingdom Taiwan Philippines Indonesia Australia United States South Korea Pakistan Germany Thailand Others Total

12.5 16.1 3.4 5.7 8.7 2.0 11.1 4.5 4.3 4.0 3.0 5.1 1.8 1.5 16.3

17.2 17.2 9.3 7.4 5.8 4.0 3.9 3.3 3.3 3.2 3.0 2.2 2.0 2.0 16.2

100.0

100.0

1998

Industry Manufacturing Services Commerce Construction Petroleum Education Transport Sports Agriculture Others Total

2001

Percentages 22.9 30.4 3.8 34.7 1.1 1.7 1.0 0.3 0.2 3.9

46.1 36.5 5.4 5.0 3.0 2.5 0.7 0.6 0.3 0.0

100.0

100.0

Source: Kassim (2002) in Watanabe (2002).

For Brunei data on the present number of international migrants are not available in the literature. Previous estimates by Hugo (1998) indicated that there had been a substantial movement of foreign workers to Brunei, with 62,326 of the nation’s 100,000 workers being foreigners. The main countries of origin were neighbouring ASEAN countries, especially Indonesia, Malaysia, Thailand, and the Philippines. Males dominated and the bulk of the migrants worked in construction, manufacturing, and the petroleum industry as well as in services (Hugo 2000). Since this information is dated, the present number of migrant workers in Brunei might have increased since the 1997 Asian financial crisis, especially migrant workers from neighbouring countries, namely Indonesia and the Philippines. This is because of high unemployment and poverty in these two countries. It should be noted that apart from ASEAN countries (Malaysia, Singapore, and Brunei), labour migrants from the seven ASEAN countries (Indonesia, the Philippines, Thailand, Vietnam, Laos, Myanmar, and Cambodia) also migrated to other non-ASEAN countries (for example, countries in the Middle East, Japan, South Korea, Hong Kong, Taiwan, Canada, the United

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States, and Australia). However, the number and destinations of labour movement from these seven ASEAN countries to other non-ASEAN countries vary from country to country. In general, ASEAN labour migrants who have high skills abilities (namely professionals and technical and related workers) will migrate to Australia, Canada, New Zealand, the United States, and even to Europe. Generally, countries like Indonesia, Thailand, and the Philippines export primarily low-skilled workers. Finally, besides documented migrant workers, there are a large number of undocumented migrant workers within ASEAN countries (Table 10.6). While the figures are notoriously inaccurate, these undocumented migrants should be given particular attention by ASEAN governments, especially illegal migrants from the Philippines, Indonesia, and Myanmar. In summary, the present labour mobility within ASEAN countries has been great indeed. The main reason for this is due to economic reasons to seek better income and working conditions. Three particular ASEAN countries, namely Singapore, Malaysia, and Brunei, are the main destination countries of workers from Indonesia, the Philippines, Thailand, Vietnam, Laos, Cambodia, and Myanmar. However, labour mobility to these three labourimporting countries is the highest from Indonesia, the Philippines, and Thailand. While the movement of highly skilled professionals to these countries appears to be associated with the inflow of foreign direct investment (FDI), the movement of a large number of semi-skilled and unskilled migrant workers is mostly associated with labour shortages in the destination countries, and socio-economic and political pressures in the labour-exporting countries. Therefore, the proposal to transform ASEAN into an AEC will create economic opportunities as well as threats to the region. ASEAN countries with better social, economic, and political conditions will have greater opportunities to sustain their economic growth from the inflow of investment and from labour mobility. At the same time these countries could face economic threats from the influx of semi-skilled and unskilled migrants from less-developed ASEAN countries. These economic threats will mount if the governments in the ASEAN countries make no effort to work together in stabilizing the social, economic, and political conditions within the region. 3. Patterns and Directions of Labour Migration The patterns and directions of labour migration within the ASEAN countries at the present time show no differences with the situation before the 1997 Asian financial crisis. Singapore, Malaysia, Brunei, and, to a lesser extent, Thailand are the main destination countries of migrant workers within the

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Table 10.6 ASEAN: Estimates of Undocumented Migrants in the 1990s Country

Year

Number

Immigrants To

Source

Origins

Malaysia

1997

1.4 million

Indonesia, Bangladesh, India, China, Thailand

Myanmar Singapore

1997 1993

n.a. 150,000

Thailand

1997

1 million

China Indonesia, Thailand, Malaysia Myanmar, Cambodia, Laos, China

Philippines

1995

200,000

China, India

Brunei

1997

1,000

Malaysia, Indonesia

Cambodia

1995

1 million

Vietnam

Emigrants From

Far Eastern Economic Review, 22 January 1998, p. 22; Kassim (1998, p. 285) Lintner & Saen (1994) Prasai (1993, p. 23) Far Eastern Economic Review, 22 January 1998, p. 22 Manila Chronicle, 26 June 1995 Business Times, 28 April 1997 Reuters, 23 February 1995

Destination

Indonesia

1997

1 million

Philippines

1995

1.8 million

Myanmar

1997

1 million

Malaysia Thailand

1998 1993

50,000 55,483

Vietnam

1997

100,000

Malaysia, Singapore, Japan Middle East, Japan, Europe, Taiwan, South Korea Thailand, Pakistan, Japan, South Korea Japan, Taiwan Japan, Taiwan, Malaysia, Singapore China, Germany

Laos

1995

10,000

Thailand

Straits Times, 11 November 1997 Migration News 6, no. 7 (1995) Bangkok Post, 5 December 1997 Dawn, December 1997 The Star, 25 January 1998 Asian Migrant News, July 1997 Deutscher Press, 23 October 1996

Source: Hugo (1998).

ASEAN region. These four ASEAN countries are more economically developed and have transnational linkages through economic and historical ties with the rest of ASEAN. However, temporary labour migration, rather than permanent migration, has become an increasing important feature within the ASEAN region. The main reason for this is because of government regulations to limit permanent migration, especially in Malaysia and Singapore.

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The types of work done by temporary migrant workers in these four ASEAN countries are mostly “3D” (dirty, dangerous, and difficult). These include construction, plantation, agriculture, and domestic services jobs. Female migrant workers have shown an increasing presence in recent years. They have been working as domestic helpers and in related sectors and, to a lesser extent, in factories, the informal sector, and the entertainment industry. The increasing trend of women working overseas began in the 1980s. Prior to this, women were limited in number since female migration was considered as something “associational”, occurring purely as a passive addition to the real decision-making by males (United Nations 1995). However, things have changed as women are now better educated and also because of the economic pressure that they have to bear in the family. In Indonesia, for instance, the bulk of migrant workers are now female. Malaysia, Singapore, and Saudi Arabia are the main destination countries for Indonesian female workers (Table 10.7). Most of them come from West Java and work as domestic workers (including house maids, cleaners, canteen assistants, and launderers). The pattern and direction of labour migrants from Vietnam have been partly associated with government policy. The government even subsidized the Vietnamese workers to go abroad. Eastern European countries have been the main destinations of Vietnamese workers since the early 1980s. However, since 1992 workers from Vietnam have been sent to other countries. Major destinations for these Vietnamese migrant workers are now South Korea, Japan, Taiwan, Kuwait, and Libya. Within ASEAN, workers from Vietnam mostly head to Singapore. From 1991 to 1999, it was estimated that the number of Vietnamese labour migrants to Singapore was only 490. High Table 10.7 Destinations of Indonesian Migrant Workers by Sex and Region (In thousands) Destination

1997

1998

2000

Males

Females

Total

Males

Females

Total

Males

Females

Total

Asia-Pacific America Europe Middle East and Africa

216.5 0.8 0.6

158.8 0 0.001

375.3 0.8 0.7

53.6 2.5 1.2

129.1 0.002 0.013

182.7 2.7 1.2

104.2 3.5 1.6

163.6 0.02 0.06

267.8 3.7 1.7

8.8

117.6

126.4

14.7

179.3

194.0

16.7

149.6

166.3

Total

226.7

276.4

503.1

71.9

308.4

380.6

126.0

314.3

439.5

Source: Department of Manpower, Indonesia (2000).

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economic growth and labour shortages have led to considerable demand for foreign manpower and guest workers in Japan, South Korea, Taiwan, and Singapore. Since these economies have emerged as sources of FDI to Vietnam, gross outflows of workers from Vietnam to East Asia have rapidly increased. As of July 2000, a total of 118,756 labour migrants from Vietnam were working in over thirty-five economies (Anh 2000). In the Philippines the movement of labour abroad is unusual. Confluence factors, including its colonial history and labour market flexibility, play a critical role. Consequently, Filipinos have migrated in large numbers to varied destinations, virtually all the continents, first in North America, then to Africa and the Middle East, Europe, Australia as well as within Asia. In 1998 it was estimated that about 7.2 million Filipinos were in foreign countries, of which 2.33 million were on permanent resident status and 2.96 million were overseas workers (OW). A very large number was classified as irregular migrants, some likely to be overstaying tourists who worked illegally and also the large community of farming families that have settled in the neighbouring Malaysian state of Sabah. Since the early 1990s more than 600,000 Filipinos have been leaving for overseas employment each year, for example 755,000 Filipinos left in 1998. The recent increasing trend of temporary contract workers was triggered by the recruitment of Filipinos by the oil-producing countries of the Middle East. Meanwhile, in ASEAN high economic growth and labour shortages have been the critical factors that attract Filipinos to migrate to ASEAN countries (especially Malaysia and Singapore). Like Indonesia, among the temporary labour migrants, women represent around half of officially deployed workers and the other half of women migrants migrate illegally. Female migrants from the Philippines fill many categories of jobs. Apart from being domestic workers, there are Filipino women working in the entertainment and nursing industries (Hugo 1998). It was recorded that remittances from Filipino workers overseas now equal 20 per cent of exports and have become one of the nation’s most important means of obtaining foreign exchange (Tan 2000). Tan (2000, pp. 72–73), for instance, argued: Migration from Philippines entailed little economic costs to the economy considering that it occurred during the periods of high unemployment. The emigrants bring with them their human capital, they also send back monetary and other gifts and release the economy from the future burden of their social security and children’s educational and other social costs. The labour migration was largely in skills that have elastic supply. The education market was flexible enough to supply the skills that were admitted in large number in foreign countries.

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Thailand differs from the countries considered so far in that it is both a country of origin and destination country for labour migrants. Also, not only do females dominate Thai immigrants, but most of them arrive under the family migration category. Thailand is second only to the Philippines in the mail-order bride system in Australia. Moreover, there are a significant number of Thai sex workers in Australia (Hugo 1998). The outflow of Thai labour has increased again since the Asian financial crisis, from 163,986 workers in 1997 to 167,998 and 179,107 workers in 1998 and 1999 respectively. ASEAN countries such as Singapore, Malaysia, and Brunei have been destination countries for Thai migrant workers. Other destination countries are Taiwan, Israel, and Japan. Taiwan has become the largest new market for Thai workers. The outflow of Thai labour to Taiwan has increased by more than 100,000 each year since the 1997 financial crisis. (See Soonthorndhada [2000] for a detailed explanation of the current migration pattern of Thai labour.) There is also a significant movement of labour into Thailand, especially from Myanmar, Cambodia, Laos, and South Asia. A great deal of this movement is undocumented. There has been a substantial refugee presence in Thailand for the last twenty years. The movement of Vietnamese, Laotian, and Cambodian refugees to countries from which they have either been resettled (in third countries) or repatriated to their homeland has been restricted. More recently there has been an influx of around 115,000 refugees from Myanmar, many of whom have settled near the Myanmar border in northwest Thailand. This movement of refugees has included more females than males (Hugo 1998; Soonthorndhada 2000). In recent years there has been a huge influx of undocumented migrants from Myanmar to Thailand. The number of these migrants is estimated to be from 780,000 to 1 million. Others estimate up to 2 million. Most of the undocumented migrants in Thailand are from Myanmar, Cambodia, Laos, southern China, and South Asia (Table 10.6). Most of these migrants work in jobs eschewed by the Thais, including construction, agriculture, warehouses, small factories, and restaurants (for the male workers) and in domestic service and in the sex industry (for the female workers) (Hugo 1998; Soonthorndhada 2000). The patterns and directions of labour mobility from the other ASEAN countries of Myanmar, Cambodia, and Laos are not well documented in the literature. The only information available is that most of the labour migrants from these countries are unskilled workers. They migrate particularly to Thailand, North America, France, and Australia. For Cambodia and Laos, the movement of labour tends to be associated with the political instability in

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the two countries. Details of the movement of labour from these three countries are provided in Hugo (1998). Therefore, the conditions that initiate labour movements are different across time and space. The pattern and directions of labour mobility within ASEAN differ from country to country, depending on the policy in each country as well as the needs of the labour migrants. Women migrant workers now show an increasing trend. However, the causes of labour migration tend to be associated with the pressure from the internal labour market, the response to migration policies and measures, the consequences of migrant recruiting and social network, the international flow of capital, and many other factors. 4. Problems Arising from Labour Mobility The issue of labour mobility will never be problem-free. However, the movement of labour within ASEAN becomes increasingly problematic when the management of labour mobility within the region is poor. Problems will also arise if labour mobility destabilizes human life activities or the population capacity in the destination countries. Although labour mobility within ASEAN cannot be stopped, it should be regulated by the ASEAN governments. The proposal to transform ASEAN into an AEC has to seriously take into consideration the problems associated with labour mobility in the region. This is because future economic, political, and social conditions in each ASEAN country as factors required for mitigating labour mobility cannot be accurately predicted. It is also because the formation of an AEC will increase the degree of economic integration in the form of trade and foreign investment and further significant structural changes in ASEAN countries. While tradeinduced structural transformations taking place in the region will provide wide-ranging benefits for both capital and labour, there will also be costs associated with these changes that may not be evenly distributed. Workers in declining industries will disproportionately bear these costs. Whereas capital in declining industries will be relatively free to move internationally to a more competitive wage environment, workers generally are not. Although most displaced workers can find employment in newly emerging industries in ASEAN or outside ASEAN, many others find the transition difficult. Their lack of skills and education, or their location, may result in a period of longterm unemployment or underemployment in the ASEAN region. There are also many other problems to consider. Previous experiences have shown that apart from cultural problems, there have been problems associated with economics, politics, security, environment, and many others.

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The recent tension between Indonesia and Malaysia with regards to the influx of Indonesian labour migrants (especially illegal labour migrants) to the latter is one clear example of the adverse consequence of labour mobility within ASEAN. Similarly, tensions between Thailand and its neighbouring countries (that is, Myanmar, Laos, Cambodia, and Vietnam) are another example. This is because the influx of labour from these countries increases the competitiveness of Thailand’s employment market, which could result in the displacement of Thai workers. The International Labour Organization (ILO) review in August 2001 also recorded many problems associated with labour mobility in ASEAN. These problems are violation of basic human rights of workers, physical and sexual abuse of female workers, recruitment fraud and malpractices, no social security membership whilst working overseas, clandestine migration and forced return of workers without official documentation, low wages and poor working conditions, imprisonment of some workers for serious crimes in foreign countries, graft and corruption in the public services, victimization by hustlers immediately upon return, and consequences of family disruption caused by migration. Most of these problems are not unique to Indonesia and are common to most countries that have high rates of low- and semi-skilled workers. Apart from the above problems, the formation of the AEC should also give serious attention to the following issues. First, the lack of attention given to the welfare of the semi-skilled, unskilled, and low-wage migrants in ASEAN. In fact, there are ASEAN countries that do need low-skilled workers, but appear reluctant to formally accept this dependence (Stahl 2000). Second, the shortage of highly skilled professional workers in ASEAN. This issue is important because economies that can offer better economic benefits (for example, the United States, Canada, and Australia) will become the destination countries of highly skilled professional workers from ASEAN. This “braindrain” will result in labour scarcity of highly skilled workers in ASEAN, and intense competition between ASEAN and other economies to attract such labour to work in the region. While this phenomenon may be a longer-term problem, it could be resolved through increasing tertiary educational and training co-operation programmes within the ASEAN region. The third issue is related to wages differences within the ASEAN countries, and between ASEAN and other countries. Wages differences within the ASEAN countries could lead to more pressures on labour mobility as well as investments within ASEAN countries. ASEAN countries which can offer higher wages for the same kind of labour will become the major destinations

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of migrant workers within ASEAN and from outside ASEAN, while ASEAN countries that cannot offer higher wages suffer labour scarcity, jeopardizing their own economic development. This suggests that there is a need to determine the level of wages that can equally distribute the pressure of labour migration from the less-developed ASEAN countries to the more-developed ASEAN countries. This wage determination, however, should consider its possible impact on the further expansion of investments in ASEAN from non-ASEAN countries. Therefore, the formation of the AEC by 2020 will not only provide economic benefits for ASEAN countries, but there will also be economic costs associated with labour mobility. Economic strategy and policy measures will need to take into account these costs if the AEC is expected to benefit each member country of ASEAN. 5. Policy Measures towards Labour Mobility under the AEC Two sets of policy measures should be introduced under the AEC with regards to labour mobility within ASEAN. The first set of policy measures aims to optimize labour mobility to ensure better future economic, political, and social conditions within the region. Meanwhile, the second set aims to mitigate or minimize the adverse impacts of labour mobility. Optimizing labour mobility within ASEAN can be done, for instance, by strengthening and empowering the present social, economic, and political cooperation under the ASEAN Free Trade Area (AFTA) as well as other ASEAN agreements. However, if necessary, the AEC should also introduce new policy measures to optimize labour mobility within the region. In terms of economic aspects, economic co-operation policies, especially in trade and investment, should be strengthened under the pillar of the AEC. Economic policies should be formulated in detail with given time limits for implementation, so that there will be clear targets that have to be achieved under the AEC. Regulations in relation with the expansion of trade and investment within ASEAN that do not conflict with global economic regulations should also be established further. This suggests that any trade and investment barriers (for example, tariffs and quotas) that still exist in each ASEAN country should be abolished. However, these policies could adversely impact the domestic economy and environment as well as labour opportunities in less-developed ASEAN countries. ASEAN should, therefore, consider formulating a redistribution income policy for the AEC to compensate economic and environmental losses as well as workers in less-developed ASEAN countries who are adversely affected by deeper economic integration.

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In terms of social aspects, policies to improve the quality of human resources through education and skills training within the ASEAN countries should be formulated for the AEC. This can be done, for instance, through the electronic medium (the virtual education training centre) as it can reach a vast market of workers who are unable for various reasons to attend either domestic or international skills training institutions. In this context priority should be given to small- and medium-sized enterprises (SMEs) as they dominate most ASEAN economies. This policy measure will not only improve the quality of labour in the SMEs, but it can also mitigate threats of rapid flow of low-skilled and unskilled labour migrants to an ASEAN country. In addition, there is a need for the AEC to establish an ASEAN Common Educational Programme (ACEP) to mitigate highly skilled labour scarcity within ASEAN as the result of any “brain-drain” to developed economies. In terms of political aspects, the AEC should introduce policies that protect migrant workers from ill-treatment. This is particularly important for low-skilled migrant workers as there are no international rules to formalize and facilitate their movement to other countries. This policy void is an issue in serious need of redress. To mitigate or minimize the adverse impacts of labour mobility within ASEAN, two policy measures need to be established. The first policy measure should be established by the AEC while the second measure should be established by each ASEAN country to mitigate the influx of labour mobility. With regards to policy measures that have to be formulated by the AEC to mitigate the adverse impacts of migrant flows, the AEC should establish regulations to restrict the future flows of migrant workers. While this policy can be certainly difficult to implement politically, and some could argue that it goes against basic human rights, the AEC must decide the extent to which it is willing to sanction and regulate the flow of migrant workers. Perhaps the mobility of unskilled migrant workers and illegal migrants should be limited. Policies that have already been established in Singapore and Malaysia to restrict migrant workers could be good examples to follow. Since the number of unskilled workers in most ASEAN countries is large, it will be very difficult to control the flow of illegal migrant workers to more-developed ASEAN countries (namely Singapore, Malaysia, and Brunei). Therefore, it is critical that policies to realize the AEC should include assisting the economic development of less-developed ASEAN countries. Furthermore, the AEC should determine the level of wages that would discourage an increase in labour mobility within the ASEAN countries for both skilled and unskilled workers. This

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wage determination policy should also consider the possibility of attracting FDI from outside ASEAN economies, especially those bound towards China and India. This is because the level of wages is one critical factor to attract investors to invest in a country or region. Apart from AEC policy measures to restrict migrant workers, governments in ASEAN countries should continue to develop their own economies. Experiences have shown that countries that have linkages with the international economy and actively attract multinational corporations, banks, and other trade and investment activities in their countries tend to experience faster economic growth. These activities, in relation to labour mobility within ASEAN, might lead to two possible scenarios. The first scenario is that economic growth could increase the supply of outward labour migrants by raising the ability to meet the costs of migration. Meanwhile, the economic linkages between industrialized and developing countries could serve as bridges for international migration. The second possible scenario is that by stimulating economic growth, trade and FDI would widen the range of economic opportunities and thereby reduce the incentive for migrants to leave their home country. Hayase (2003), from her study, found no inverse relationship between trade and migration, as well as a nexus between investment and migration. The implications suggest that the question of whether growth of trade or FDI will ease the pressures for international migration cannot be answered in the short run as free trade agreements (FTAs) are a relatively new phenomenon in East Asia, and there are many other socio-economic and political factors that affect labour migration, such as immigration policy, remittance, and kinship network. She further suggests that more sophisticated examinations are required for further studies. Thus, taking this observation for the case of ASEAN, it may be too simplistic to suggest that trade and investment would increase labour mobility in ASEAN countries. Finally, there is a need for governments in ASEAN countries to protect migrant workers by developing social insurance. The Philippines can be one good example, in that the Overseas Migrant Workers Fund provides social insurance to overseas workers from a trust fund managed by a tripartite board. This fund, in addition to social insurance, provides an overseas banking facility, credit facilities, and small business loans. The funds and investment earnings remain in trust solely for the purpose of supporting migrant workers. A feature of this fund is that it maintains its own fiscal inspectors to ensure compliance of contributions and services. However, further studies need to be undertaken in this respect for other countries in ASEAN.

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6. Concluding Remarks Labour mobility is a phenomenon that cannot be avoided by any ASEAN country. This is because of the unequal levels of economic development within the region as well as the forces of globalization that are creating an increasingly borderless world.. The only thing that can be done is to mitigate the rate of labour mobility in the region. This can be done partly at the policy level where limiting the flow of migrant workers should be integral to national development planning as well as through negotiations between one country and another. ASEAN’s efforts in transforming itself into an AEC by 2020 should be undertaken with great care. This is not only because of the possible adverse impacts that might occur as a consequence of deeper economic integration, but, more importantly, past experiences in ASEAN economic co-operation have showed little benefits for each ASEAN country’s development. Therefore, the formation of the AEC should not only take into account the benefits to the ASEAN economies, but also the possible economic costs. One example is the economic costs that have to be borne by the marginal workers (namely the unskilled, older workers, and others), especially in the less-developed ASEAN countries. In fact, there is evidence that countries that clearly need low-skilled workers are reluctant to formally accept this dependence. It is too simplistic to suggest that ASEAN countries would not gain economically by halting the flow of migrant workers. Therefore, ASEAN policy-makers should be concerned about this issue, especially if ASEAN’s vision of “a stable, prosperous and highly competitive ASEAN economic region in which there is a free flow of goods, services and investment, a freer flow of capital, equitable economic development and reduced poverty and socio-economic disparities”6 is to be successfully realized. NOTES The author would like to thank Dr Aris Ananta, Senior Research Fellow at the Institute of Southeast Asian Studies (ISEAS), Singapore, for his valuable comments on this chapter. 1. International migrants are defined as persons who have crossed a border, change their place of residence, and have a foreign nationality at the time of entry to the country of immigration. 2. Hugo (1998) defines undocumented international migrants as the movement which occurs outside of official government regulations of the migrant’s country of origin and destination. It can occur through a number of means: migrants may enter a country in a clandestine way, not passing through official immigration

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5. 6.

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control points; migrants may enter a country legally and overstay the period which they were granted to reside within the country; and migrants may enter a country legally under certain conditions (for example, not to engage in work) but not abide by these conditions. Note that usually undocumented migrants are workers but there are instances where people move illegally for political reasons or to accompany family members. Measured in 1990 constant price. The foreign worker population is distinguished between expatriates or the professional and technical workers, and the migrant workers or the semi-skilled and unskilled. Note that the number of expatriates or the professional and technical workers is associated with the inflow of foreign investment. The number of foreign workers is estimated from the population figures by excluding those who are below 20 years and above 60 years of age. ASEAN Secretariat (1999, p. 12).

REFERENCES Ananta, A., ed. The Indonesian Crisis: A Human Development Perspective. Singapore: Institute of Southeast Asian Studies, 2003. Anh, N.G. “Foreign Direct Investment, Government Policy and International Labor Migration in Vietnam”. Paper presented at the international workshop on International Migration and Structural Change in the APEC Member Economies, 19–20 October 2000, in Taipei. ASEAN Secretariat. “ASEAN into the Next Millennium: ASEAN Vision 2020, Hanoi Plan of Action”. Jakarta: ASEAN Secretariat, 1999. Aswatini, R. “Indonesian Female Labor Migrants: Experiences Working Overseas (A Case Study among Returned Migrants in West Java)”. Working Paper no. 32, Research Centre for Population, Indonesian Institute of Sciences. Jakarta, 2002. Department of Manpower, Indonesia. “Indonesian Labour Migrants Abroad: Issues and Problems”. Paper presented at the International Labour Organization seminar on International Labour Migration from Southeast Asia, 23 September 2000, in Jakarta. Firdausy, C.M., ed. International Migration in Southeast Asia: Trends, Consequences, Issues and Policy Measures. Jakarta: Toyota Foundation–Southeast Asian Studies Program, Indonesian Institute of Sciences, 1998. ———. “International Labor Migration Policy and Development Strategy in Indonesia”. Paper presented at the international workshop on International Migration and Structural Change in the APEC Member Economies, 19–20 October 2000, in Taipei. Fukumoto, M. “Liberalization of Trade and Investment and Its Effects on International Migration”. In A Study on Trade, Investment and International Labor Migration in the APEC Member Economies, edited by Y. Hayase. Japan: APEC Study Centre, Institute of Developing Economies–JETRO, 2002.

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Hayase, Y., ed. A Study on Trade, Investment and International Labor Migration in the APEC Member Economies. Japan: APEC Study Centre, Institute of Developing Economies–JETRO, 2002. ———. International Migration in APEC Member Economies: Its Relations with Trade, Investment and Economic Development. Japan: APEC Study Centre, Institute of Developing Economies, 2003. Hugo, G. “Undocumented International Migration in Southeast Asia”. In International Migration in Southeast Asia: Trends, Consequences, Issues and Policy Measures, edited by C.M. Firdausy. Jakarta: Toyota Foundation–Southeast Asian Studies Program, Indonesian Institute of Sciences, 1998. ———. “Labor Export from Indonesia: An Overview”. Asean Economic Bulletin 12, no. 2 (2000): 175–298. Hui W.T. “Foreign Manpower and Development Strategy in Singapore”. Paper presented at the international workshop on International Migration and Structural Change in the APEC Member Economies, 19–20 October 2000, in Taipei. Ishido, H. “Linkages among Trade, Investment and Migration: Theory and Empirical Evidence”. In International Migration in APEC Member Economies: Its Relations with Trade, Investment and Economic Development, edited by Y. Hayase. Japan: APEC Study Centre, Institute of Developing Economies, 2003 Ishizuka, F. “Vietnam’s Labor Export: Policy, Performance and Issues”. In A Study on Trade, Investment and International Labor Migration in the APEC Member Economies, edited by Y. Hayase. Japan: APEC Study Centre, Institute of Developing Economies–JETRO, 2002. Ito, S. “Labor Markets and Direct Investment of Hong Kong and Singapore”. In A Study on Trade, Investment and International Labor Migration in the APEC Member Economies, edited by Y. Hayase. Japan: APEC Study Centre, Institute of Developing Economies–JETRO, 2002. Kanapathy, V. “International Migration and Labor Market Adjustment in Malaysia”. Paper presented at the international workshop on International Migration and Structural Change in the APEC Member Economies, 19–20 October 2000, in Taipei. Kassim, Azizah. “Household Study on Indonesian Immigrants in Malaysia: An Insight into the Consequences of Their Migration and Their Problems”. In International Migration in Southeast Asia: Trends, Consequences, Issues and Policy Measures, edited by C.M. Firdausy. Jakarta: Toyota Foundation–Southeast Asian Studies Program, Indonesian Institute of Sciences, 1998. ———. “Indonesian Labor Migration in Malaysia”. In International Movement of People in Southeast Asia, edited by C.M. Firdausy. Jakarta: Toyota Foundation– Southeast Asian Studies Program, Indonesian Institute of Sciences, 2002. Skeldon, R. “The Relationship between Migration and Development in Asia and the Pacific”. In International Migration in Southeast Asia: Trends,Consequences, Issues and Policy Measures, edited by C.M. Firdausy. Jakarta: Toyota Foundation– Southeast Asian Studies Program, Indonesian Institute of Sciences, 1998.

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Soonthorndhada, K. “Changes in the Labor Market and International Migration since the Economic Crisis in Thailand”. Paper presented at the international workshop on International Migration and Structural Change in the APEC Member Economies, 19–20 October 2000, in Taipei. Stahl, C.W. “The Impacts of Structural Change on APEC Labor Markets and Their Implications for International Migration”. Paper presented at the international workshop on International Migration and Structural Change in the APEC Member Economies, 19–20 October 2000, in Taipei. Tan E.A. “Labor Market Adjustment to Large-Scale Emigration: The Philippine Case”. Paper presented at the international workshop on International Migration and Structural Change in the APEC Member Economies, 19–20 October 2000, in Taipei. Tirtosudarmo, R. “Population Mobility and Social Conflict: The Aftermath of the Economic Crisis in Indonesia". In The Indonesian Crisis: A Human Development Perspective, edited by A. Ananta. Singapore: Institute of Southeast Asian Studies, 2003. Tsay C.L. “International Labor Migration and Foreign Direct Investment in East Asian Development: Taiwan as Compared with Japan”. In International Migration in APEC Member Economies: Its Relations with Trade, Investment and Economic Development, edited by Y. Hayase. Japan: APEC Study Centre, Institute of Developing Economies, 2003. United Nations. International Migration Policies and the Status of Female Migrants. Proceeding of the United Nations Expert Group meeting on International Migration Policies and the Status of Female Migrants, 28–31 March 1990, in San Miniato, Italy. New York: United Nations, 1995. Watanabe, M. “The Labor Market and International Migration in Thailand”. In A Study on Trade, Investment and International Labor Migration in the APEC Member Economies, edited by Y. Hayase. Japan: APEC Study Centre, Institute of Developing Economies–JETRO, 2002.

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11

ASEAN Economic Community: Implications for Poverty Reduction in Southeast Asia Abuzar Asra, Gemma Esther Estrada, and Ernesto M. Pernia

1. Introduction The rapid pace of globalization is exerting pressure on both developed and developing countries to devise strategies to be competitive. One such strategy being adopted by an increasing number of countries is the formation of regional integration agreements (RIAs). Since the 1950s at least thirty-five RIAs have been established, taking on various forms, ranging from a free trade area to an economic union.1 In 1992 six Southeast Asian countries agreed to establish an RIA through the creation of the ASEAN Free Trade Area (AFTA). Years later, they were joined by four other countries and the scope of trade agreements was expanded from merchandise trade to include liberalization of trade in services and investment flows within the region. Owing to recent developments, the ASEAN leaders have recognized the need for deeper regional economic

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integration. In November 2002 it was agreed that this was to be realized through the formation of an ASEAN Economic Community (AEC) by 2020. The ASEAN Vision of 2020 (Hanoi Plan of Action) specifically highlights a vision of free flow of goods, services, and investments, along with reduced poverty and socio-economic disparities in the region. This chapter aims to explore how fostering wider economic openness through the AEC would impact on poverty and inequality in the ASEAN region, as well as mull over strategies and policies that could be adopted to address likely adverse effects on the poor. The next section discusses the variation in growth, level of development, poverty, and other measures of well-being among the member countries in the region. The third section examines the rationale for deeper economic integration and explores the possible negative impacts of trade openness and economic integration on poverty reduction and income inequality. The chapter ends with some key challenges and strategies for poverty reduction. 2. Growth, Poverty, and Well-being Since initial conditions matter to the success of economic integration, it is important to examine how countries covered in the AEC have performed in terms of economic growth, poverty, and other measures of well-being. Differences in initial conditions have both advantages and disadvantages in the formation of the AEC.

2.1. Economic Growth There was a wide variation in the income per capita levels of ASEAN countries in 2001 (Table 11.1). At the extreme high end is Singapore, with income per capita of more than fifty times that of Cambodia at only about US$300 per year. Like Singapore, Brunei Darussalam is another relatively high-income country, followed in descending order by the four other original member countries, namely Malaysia, Thailand, the Philippines, and Indonesia. At the low end of the income range are Cambodia, Lao People’s Democratic Republic (Lao PDR), and Vietnam.2, 3 Such income ranking among the countries has practically prevailed since the mid-1970s (Figure 11.1). The 1970s and 1980s witnessed dramatic GDP per capita growth for Singapore and, to a lesser extent, Indonesia, Malaysia, and Thailand (Table 11.1). By the 1990s economic growth in most ASEAN countries began to slow. In the case of low-income countries, while they started with lower growth in the 1970s, macroeconomic reforms and investments in human

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Table 11.1 ASEAN: Real GDP Per Capita Growth Rates and Levels Real GDP Per Capita Growth (% Annual Average) 2000

2001

GDP Per Capita in US$ at 1995 Prices (2001)

2.5 5.3 3.5 3.4 5.6 12.4 1.6 8.4 3.8 5.4

1.2 4.2 2.0 3.3 –1.9 8.4 1.2 –4.7 1.0 5.5

18,895 317 1,034 465 4,708 – 1,165 27,118 2,853 390

Country 1970s 1980s 1990s Brunei Darussalam Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Vietnam

4.4 – 5.3 0.7 5.2 2.0 2.9 7.7 4.6 2.2

–5.2 4.4 5.8 3.3 6.2 –5.5 4.0 7.6 10.8 3.0

–0.7 1.7 3.3 3.8 4.6 4.3 0.5 4.6 4.2 5.5

GDP Per Capita at 1999 PPP (2001)

17,963 1,362 3,598 2,118 8,709 – 4,401 21,441 6,410 2,099

Notes: 1. Average GDP per capita growth in the 1970s for Brunei Darussalam refers only to the years 1974–79. 2. The 1980s figure for Cambodia covers only 1987–89. Sources: World Development Indicators (WDI) (2003); World Economic Outlook (WEO) (2003); .

capital have enabled them to post higher growth than some of their ASEAN neighbours in recent years. By 2000 and 2001 Vietnam, Cambodia, and Myanmar had surpassed the growth rates of Indonesia, the Philippines, and Thailand. The expectation of the AEC is that fostering stronger intra-regional trade could help enhance the growth performance of member countries. Trade expansion leading to higher growth may help the less-developed countries in ASEAN to catch up with the more-advanced economies in the region. As has been found for the European Economic Community (EEC), there is a tendency for income convergence, rather than divergence, among economies integrated through international trade (Ben-David 2000).

2.2. Poverty and Inequality 4 Based on the most commonly used measure of poverty, Table 11.2 and Figure 11.2 show that poverty incidence (or the proportion of the population below the poverty line) has been on the downtrend for most of the ASEAN countries. It was only in the aftermath of the 1997/98 Asian financial crisis

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GDP Per Capita (US$)

Figure 11.1 ASEAN: GDP Per Capita at 1999 PPP, 1975–2001

25,000 20,000 15,000 10,000 5,000

tna m Vie

d an ail Th

po re ga Sin

es

sia

pin ilip Ph

La

Ma

lay

DR oP

ia es on Ind

od ia mb Ca

Br

un

ei

Da

rus

sa

lam

-

1975

1985

1995

2001

Note: The figures are three-year averages centred around the mean, except for 2001. Sources: WDI (2003); WEO (2003); .

that poverty worsened in some of these countries. While trade openness helped propel the growth of most ASEAN economies, it also made them more vulnerable to external shocks. The brunt of the financial crisis was particularly felt in Indonesia, Malaysia, the Philippines, and Thailand, where poverty rates increased in the late 1990s (Figure 11.2). Meanwhile, Vietnam and Cambodia were spared from the crisis and poverty rates continued to decline. Amid the declining trend in poverty was a relatively stable income inequality, as measured by the Gini coefficient, within each country. The Gini coefficients in Malaysia, the Philippines, and Thailand have ranged between 0.44 and 0.53 (Figure 11.3). In Indonesia the Gini coefficient has not gone beyond 0.36 since the 1980s. In the case of Cambodia and Vietnam, the dramatic improvement in their economies in the 1990s appears to have been accompanied by a deterioration in income inequality. To address poverty and income inequality, many Asian developing countries have adopted more direct poverty-reduction strategies. Land reform, microcredit, and special employment schemes are some of the main

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Table 11.2 ASEAN: Poverty Incidence (In percentages) Country

Early 1990s

Cambodia Indonesia Lao PDR Malaysia Philippines Thailand Vietnam

39.0 15.8 45.0 17.1 39.9 27.2 25.0

(1994) (1990) (1992) (1990) (1991) (1990) (1992)

1996/97 36.1 17.7 38.6 6.1 28.1 11.4 15.7

(1997) (1996) (1997) (1997) (1997) (1996) (1996)

Around 2000 35.9 (1999) 18.2 (2002) – 7.5 (1999) 28.4 (2000) 10.3 (2002) 13.3 (1999)

Notes: 1. Using national poverty lines. 2. For the Philippines, the incidence is based on the number of households. 3. There are no poverty incidence data for Brunei Darussalam, Myanmar, and Singapore. Sources: Asian Development Bank Statistical Data Base System (ADB SDBS); country sources.

poverty-alleviation measures adopted in these countries (Pernia and Deolalikar 2003). Still, much remains to be done. Based on national poverty lines, about 99 million people in ASEAN subsist on incomes that are insufficient to meet minimum basic needs. The estimate of the World Bank on the number of poor for East Asia (excluding China) as of the late 1990s, using a comparable norm across countries of US$1 a day, was about 56 million. Given the magnitude of poverty in the region, the drive for stronger economic integration that leads to higher growth and sustained poverty reduction may have some merit.

2.3. Other Measures of Well-being The poor are often characterized as those not having sufficient income to cover their food and non-food essentials. This measure, however, does not capture other dimensions of poverty. Poverty is also associated with not having adequate access to health, education, and basic infrastructure. Such lack of access makes it even more difficult for the poor to participate in the economic growth process. In ASEAN, a good part of the reduction in poverty stems from improvements in human capital. For example, it can be seen in Figure 11.4 how literacy rates improved in ASEAN over a span of thirty years. Substantial progress in literacy can be noted for Brunei Darussalam, Indonesia, and

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Figure 11.2 ASEAN: Poverty Incidence Using National Poverty Lines Cambodia

% Poor 50

Indonesia % Poor 50 40 30 20 10 0 '76 '78 '80 '81 '84 '87 '90 '93 '96 '98 '99 '00 '01 '02

40 30 20 10 0 '94

'97

'99

Old Methodology

Lao PDR

% Poor 50

Malaysia

% Poor 50

40

40

30 20

30 20

10

10

New Methodology

0

0 '92

Philippines

% Poor 50 40 30 20 10 0 '85

'84

'97

'88

'91

'94

'87

'89

'00

'92

'93

'95

'97

'99

Thailand

% Poor 50 40 30 20 10 0 '97

'90

'88 '90 '92 '94 '96 '98 '99 '00 '01 '02

Vietnam

% Poor 50 40 30 20 10 0 '90

'94

'95

'96

'00

Sources: ADB SDBS; country sources.

Singapore. Only Cambodia and Lao PDR now have literacy rates of less than 80 per cent. Aside from education, ASEAN countries have also experienced significant improvements in health. Since the 1970s, there have been notable increases in life expectancy, as well as declines in infant mortality (Figure 11.4). The most dramatic increase in life expectancy was achieved by Indonesia and Vietnam, where in 2001 people on average lived longer by eighteen years

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Figure 11.3 ASEAN: Income Inequality (Gini Coefficient) Cambodia

Gini 0.60

Indonesia

Gini 0.60

0.50

0.50

0.40

0.40

0.30

0.30

0.20

0.20 '94

'97

'76 '78 '80 '81 '84 '87 '90 '93 '96 '99 '02

'99

Malaysia

Gini

Philippines

Gini

0.60

0.60

0.50

0.50

0.40

0.40

0.30

0.30 0.20

0.20 '90

'92

'93

'95

'97

Thailand

Gini 0.60

'85

'99

'88

'91

'94

'97

'00

Vietnam

Gini 0.60

0.50

0.50

0.40

0.40

0.30

0.30

0.20

0.20 '88

'90

'92

'94

'96

'98

'00

'02

'94

'95

'96

'99

Note: Some countries (Cambodia, Indonesia, and Thailand) use expenditure, instead of income. Sources: ADB SDBS; country sources.

compared to their life expectancy thirty years before. Interestingly, Vietnam also had one of the fastest declines in infant mortality, at 30 per 1,000 live births in 2001, along with Brunei Darussalam, Malaysia, and Singapore, at 6, 8, and 3 per 1,000 live births respectively.

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Figure 11.4 ASEAN: Selected Social Indicators, 1970–2001

Literacy Rate

% 100

Brunei Darussalam

90

Cambodia

80

Indonesia

70

Lao PDR Malaysia

60

Philippines

50

Singapore

40

Thailand Vietnam

30 1970

1980

1990

2001

Life Expectancy

Years 90

Brunei Darussalam

80

Cambodia Indonesia

70

Lao PDR

60

Malaysia Philippines

50

Singapore Thailand

40

Vietnam

30 1970

1980

1990

2001

Infant Mortality 160

Brunei Darussalam

Per Births Per1,000 1,000Live livebirths

140

Cambodia

120

Indonesia

100

Lao PDR

80

Malaysia

60

Philippines

40

Singapore Thailand

20

Vietnam

0 1970

1980

1990

2001

Source: WDI (2003).

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One critical avenue to poverty reduction is improving the poor’s access to infrastructure. Investments in infrastructure can help raise productivity and generate employment. This is especially true for the rural sector, which is home to the majority of the poor. For many developing countries, the poor state of infrastructure has been a major constraint to growth. It can be seen in Figure 11.5 that countries with a smaller proportion of paved roads or lower electric power consumption per capita have a relatively low income or slower growth. Specifically, Cambodia, the Philippines, and Vietnam have the lowest proportion of paved roads while Indonesia, Myanmar, and Vietnam have the least electric power consumption per capita. However, access to water appears high for all ASEAN countries, ranging from 72 to 100 per cent of the population, except for Cambodia and Lao PDR. 3. Globalization, Regional Economic Integration, and Poverty Reduction This section first examines three major reasons why ASEAN countries should pursue deeper economic integration, namely rapid globalization, the challenge posed by China, and regional crises. Then it explores the implications for poverty of promoting greater trade openness based on studies of trade, growth, and poverty, and the experiences of other regional economic integration arrangements.

3.1. Globalization, the China Challenge, and Regional Crises Most countries now appreciate the benefits and pitfalls of globalization. Economic linkages are formed through international trade and capital flows. The improvements in transportation and communication technology and massive reduction in trade barriers are among the key elements that have led to rising global economic integration (Crafts 2000; Mussa 2000). Countries that were quick to open up their economies gained more than those that were not. Indeed, empirical evidence shows that the pursuit of globalization has led to rapid growth. In the 1990s globalizing developing countries grew at 5 per cent per capita, while non-globalizing countries lagged behind with 1.4 per cent per capita growth. The former also posted more remarkable growth than the developed countries, which grew by only 2.2 per cent per capita during the same period (Dollar and Kraay 2001b). Given the rapid pace of globalization and its tremendous impact on economies, the formation of the AEC merits serious consideration. Differences in initial endowments, structure of the economy, or level of development among ASEAN countries pose advantages as well as disadvantages in the

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Figure 11.5 ASEAN: Access to Infrastructure

Paved Roads,* 1999

% of Total Roads 100 80 60 40 20

bo di a C

Ph

am

ilip

Vi e

Br

pi ne s

tn am

un ei

a ne si In

do

al ay s

la nd

M

Si

Th

ai

ap or e ng

ia

0

Electric Power Consumption, 2000 Kwh/capita ('00) 80 60 40 20

ar M

Vi e

ya

tn

nm

am

a do In

Ph

Th

ilip

ai

pi

ne

si

ne

s

nd la

si ay al

Si

M

ng

Br

ap

un

or

ei

e

a

0

Access to Improved Water Sources, 2000 % of Population 100 80 60 40 20

am C

o La

bo

PD

di

a

R

ar ya

nm

am M

Vi e

ne

tn

si

a

nd do In

Th a

ne pi ilip

Ph

ila

s

a si ay M al

Si

ng

ap

or

e

0

Note: * Paved roads are those surfaced with crushed stones (macadam) and hydrocarbon binder or bituminized agents, with concrete, or with cobblestones. Sources: ADB SDBS; WDI (2003).

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creation of the AEC. Note that there are countries in ASEAN that remain heavily dependent on agriculture in terms of GDP share, namely Myanmar and Lao PDR (Table 11.3). Another group, composed of Indonesia and Malaysia, is heavily concentrated in the industry sector. In Brunei Darussalam, Cambodia, the Philippines, and Singapore services have become the predominant sector. In Thailand and Vietnam both the industry and service sectors have almost equal importance in terms of output shares. Differences in initial endowments may enable countries to exploit gains from trade. By specializing in products in which each has a comparative advantage, ASEAN countries can complement rather than compete with each other. Moreover, the more well-off countries like Singapore and Malaysia can use their surplus capital to invest in the region’s less-developed economies. In turn, growth in the latter group of economies can result in greater demand for imports from the former, thus further reinforcing intra-regional trade. The downside, of course, is that if complementation does not work, the less-developed economies could fall further behind. Another challenge for ASEAN economies is how to keep up with China’s booming economy that has benefited strongly from trade openness. Since opening up its economy in the late 1980s, China has experienced a surge in foreign direct investment (FDI), contributing to its phenomenal growth. This has been helped by its large market and wide pool of resources, especially human capital. Since the 1990s China has captured, on average, about half of the combined FDI in East Asia. It thus appears that China’s emergence poses another rationale for ASEAN countries to forge stronger economic coTable 11.3 ASEAN: Sectoral Shares in GDP, 2001 (In percentages) Country Brunei Darussalam Cambodia Indonesia Lao PDR Malaysia Myanmar* Philippines Singapore Thailand Vietnam

Agriculture

Industry

Services

2.8 36.9 16.4 50.9 8.5 42.2 15.2 0.1 10.0 23.6

44.4 21.9 46.5 23.4 49.1 18.1 31.2 31.6 44.2 37.8

52.7 41.2 37.1 25.7 42.4 39.6 53.6 68.3 45.8 38.6

Note: * Data for Myanmar pertain to year 2000, instead of 2001. Sources: WDI (2003); ADB Key Indicators (2002).

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operation. The task for ASEAN is to be more internationally competitive and find ways of taking advantage of China’s emergence through intra-Asian trade and investment flows. To deal with the China challenge, ASEAN leaders have recognized that greater gains can be had from co-operative arrangements with China rather than taking a defensive stance. In November 2001 ASEAN and China agreed to establish a bilateral free trade area. A year later the framework agreement for the ASEAN–China Free Trade Area (ACFTA) was signed which set 2010 as the completion date for the removal of tariff and nontariff barriers for the older ASEAN members (Brunei Darussalam, Indonesia, Malaysia, the Philippines, Singapore, and Thailand). The four new members (Cambodia, Lao PDR, Myanmar, and Vietnam) are expected to participate fully by adopting the terms of the ACFTA by 2015. In June 2003 the ASEAN Regional Meeting in Phnom Penh reaffirmed the move towards the ACFTA by 2010, with China declaring to carry out an early reduction of tariffs on products from Southeast Asian countries even before the 2010 deadline. Expected to cover about 1.7 billion people, a combined GDP of US$2 trillion, and total international trade of US$1.2 trillion, the ACFTA can expand further with the planned inclusion of Japan and South Korea (Huang 2002).5 Two major crises with profound economic repercussions have hit East Asia in recent years, providing additional bases for ASEAN’s move towards stronger co-operation. The 1997/98 Asian financial crisis has demonstrated the close interdependence among East Asian countries. It has shown how one country’s performance and policy decisions can have serious implications for the region as a whole. The AEC can take a cue from the European Union (EU) where a set of policy targets is expected from each member country, which could reduce the possibility of some countries adhering to unsound policies. Having a common set of policies can help minimize risks and uncertainties for the region as a whole. A more recent crisis to hit the region was the Severe Acute Respiratory Syndrome or SARS. It created deep anxiety in countries within the region, prompting governments to adopt swift measures to contain its spread and underscoring the need for transparency and accountability in the reporting and management of similar crises. Cheow (2003) points out that the spread of SARS had shown that the longer-term goal for an East Asian Community may already be taking shape. Instead of closing their borders, East Asian governments should continue to open up their economies and facilitate interaction and interdependence, while at the same time co-operating to

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address pressing concerns at hand. Since other cross-border issues may surface in the future, it is imperative for ASEAN countries to pursue closer cooperation and co-ordination.

3.2. Regional Economic Integration, Growth, and Poverty Reduction 3.2.1. Economic Integration and Growth There are two main types of welfare effects of regional integration. One refers to the static gains arising from one-time effects on the reallocation of existing stocks of capital, labour, and other resources. Another pertains to dynamic gains or those associated with the accumulation of capital and raising the annual rate of growth of the economy over time. Static gains arise from trade creation while losses are due to trade diversion. Trade creation occurs when countries import from the lowest-cost producer within the region. Consumers, therefore, gain from trade creation through lower prices and a greater variety of products, while they lose from trade diversion when countries shift to less-efficient suppliers within the region. On the other hand, dynamic gains arise through economies of scale, spillover effects, increased competition, improvement in investment climate, and technological change (dela Torre and Kelly 1992). By leading countries into a higher growth path, dynamic gains are said to have a more substantial impact than static gains. Reviewing the empirical literature on economic integration, Deardoff and Stern (2002) emphasize that past studies up to the 1990s mainly dealt with the impact of integration on trade, not on income or economic growth. Welfare effects of integration were viewed in most studies in terms of trade volume effects, particularly trade creation and trade diversion. In the experience of the EU, members’ imports from one another increased more than they decreased their imports from non-members, that is, trade creation exceeded trade diversion (Baldwin and Venables 1995).6 Srinivasan et al. (1993) likewise find support for the view that European integration has caused an expansion in member countries’ trade. While a number of studies have found trade to be important to growth, the fact that the EU has increased trade means that integration must also have increased growth. Unfortunately, there is still little basis to assume a similar causation between integration and growth. In addition to the issue about the direction of causation between trade and growth, there is the issue of which among the many causes of trade may lead to trade that is beneficial to growth (Deardoff and Stern 2002).

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An important point to consider is that while the EU has led to trade expansion among its members, a different picture emerges as regards integration among developing countries. Intra-regional trade was found to be low for most regional trading arrangements among developing countries (dela Torre and Kelly 1992). The failure of implementation stemmed from the incompatibility between the national development strategies of most members and the goal of intra-regional trade liberalization. Other factors that hampered the performance of regional integration among developing countries were vested interests in import-competing industries, weak external environment, absence of strong enforcement mechanisms, ineffective dispute settlement procedures, and lack of compensation mechanisms to address distributional concerns. The AEC should guard itself against such impediments. In ASEAN a relatively low level of intra-regional trade can also be noted despite the increase in the share of exports and imports within the region during the last decade. Merchandise exports within the region as a share of the group’s total exports increased to 23.1 per cent in 2000 from 19.9 per cent in 1990. There was a more appreciable increase in intra-ASEAN imports between 1990 and 2000 from 16.4 per cent to 26.5 per cent, well above the shares of imports from Japan (16 per cent), the United States (14 per cent), and the EU (11 per cent) (Sakakibara and Yamakawa 2003). In recent years a number of studies have attempted to capture the effects of integration on growth, that is, dynamic effects. Deardoff and Stern (2002) provide a summary of these studies. One of the studies they cite is by Coe and Moghadam (1993) who use French data to analyse long-run relationships between capital accumulation, growth, and trade integration, and find a positive effect of the level of integration on French growth level. Another study by Italianer (1994) also finds integration having a positive impact and contributing an average of 0.3 percentage point to economic growth. Baldwin and Seghezza (1996) find integration to have a positive effect on technology spillovers. Henrekson et al. (1997) use a large sample of both developed and developing countries, including a dummy for membership in the EU, and find a significant positive effect of EU membership, arising from technology. Still, no robust conclusions can be made on the impact of integration on growth as there are also studies showing no clear relationship between EU membership and growth. A mechanism by which integration can spur long-term growth is through an increase in investments within the region. Given the large regional markets, firms will find an incentive to direct their investments into the region to take advantage of economies of scale. Gains from scale economies internal to the firm would come from lower costs and increased productivity. When countries

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such as Mexico, Spain, and Portugal were almost certain of their entry into an integration area, there was a surge in investment inflows (Baldwin and Venables 1995). Brada and Mendez (1988) found a significant positive effect on investment due to membership in the EU. Such a favourable effect on investment, however, does not always seem to hold, according to some studies. There are studies on the EU’s experience with respect to the direction of investment flows that show no clear conclusions (Balassa 1966; Yannopoulos 1990). Another issue is which form of regional integration facilitates investment growth. As the World Trade Organization (1995) noted, the increase in investment inflows towards the EEC in the 1960s could not be fully attributed to the creation of a customs union as other variables such as market size and market growth, facilitated by the Single Market Programme, could be much more significant. In the 1980s ASEAN countries received a great deal of FDI because of their relatively high degree of openness. In the 1990s there was a remarkable rise in FDI inflows to East Asia, but there was a decline in inflows to ASEAN (Sakakibara and Yamakawa 2003). FDI inflows to the ASEAN countries weakened in the 1990s owing to the Asian financial crisis and diversion of FDI to China. It appears that the establishment of AFTA in the early 1990s was not effective in attracting huge amounts of FDI into the region. The move towards the AEC, therefore, aims to stimulate the inflow of FDI into the region. 3.2.2. Trade, Growth, and Poverty There are a number of cross-country studies, as well as individual country studies, that seek to establish the relationship between trade openness and economic growth. A common finding of these studies is that openness leads to growth. In a survey of cross-country studies, Berg and Krueger (2003) argue that while studies are often plagued with problems relating to the measurement of openness and establishing the causality between openness and growth, openness invariably comes out as an important contributor to growth. This is true of studies that examine the relationship between levels of income and trade openness across countries, as well as between changes in openness and changes in per capita GDP. The link between trade and growth remains robust even after using instruments to control for the possibility of reverse causality and including other determinants of growth such as institutional quality and geography.

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Some evidence of absolute convergence has also been found for countries that are integrated through trade (Berg and Krueger 2003; Ben-David 2000). There is a tendency for poor countries or regions to grow faster than rich regions if they are sufficiently integrated with each other. It is generally recognized that growth is the key to sustained poverty reduction. But it is important to find out how much the poor gain from growth. Dollar and Kraay (2001a) find a one-to-one correspondence between growth in overall incomes and mean income growth of the poor. Growth arising from open trade or other macro policies benefits the poor as much as the average household. However, country-specific studies, using subnational data, reveal that the poor typically benefit less from growth than do the higher-income groups (Balisacan, Pernia, and Asra 2002; Balisacan and Pernia 2002). Other than through growth, does trade have a direct effect on poverty? Dollar and Kraay (2001b) find no direct nexus between trade openness and the income of the poorest, beyond trade’s effect on overall growth. Further, they do not note any significant relationship either between changes in trade and changes in inequality or between changes in trade and changes in income share of the poorest quintile. Since trade is often accompanied by growth, then increase in trade generally leads to improvements in the well-being of the poor, given no change in income distribution. Individual country studies also indicate that economic openness contributes to poverty reduction through growth. Pernia and Quising (2003), for example, find that trade openness contributes through growth to an improvement in the welfare of the poor in the Philippines. 3.2.3. Investment, Growth, and Poverty Through its effect on economic growth, FDI can also contribute to poverty reduction. FDI can help stimulate growth in developing countries through technology improvements, employment creation, development of human capital, and greater access to world markets. Considering that the poor suffered disproportionately during the financial crisis, FDI can help protect the poor from the impact of volatility in international financial markets. FDI can also help raise government revenue, which can be used to fund social safety nets for the poor, through their own tax contribution and indirectly by stimulating growth and widening the tax base. In addition, FDI can be instrumental in bringing infrastructure services closer to the poor. For example, foreign investors in telecommunications, electricity, and water resources —

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through build-operate-transfer or public–private partnerships — have brought more and better services to millions of households, including the poor. FDI can impact most on growth and poverty reduction given the proper environment, that is, where there is a level playing field between foreign and domestic investors, and adequate levels of physical and social infrastructures (Klein et al. 2001; Mirza 2002). For ASEAN countries, Jalilian and Weiss (2002) find both direct and indirect links between FDI and poverty. A 10 per cent increase in FDI is associated with a 0.17 per cent growth in income per capita of the poor in ASEAN. About 40 per cent of the poverty-reducing effect of FDI is achieved through economic growth, while 60 per cent stems from direct impact through labour training and employment of the poor. 4. Key Challenges for Poverty Reduction in the ASEAN Economic Community By facilitating wider trade openness within the region, the AEC can contribute to growth and poverty reduction. It is also possible, however, that the formation of the AEC will have some undesirable poverty effects in the region.

4.1. Possible Negative Impacts of the AEC A proposed structure for the AEC is the “Free Trade Area plus” arrangement that includes some elements of a common market, namely free movement of factors of production such as capital and labour. In short, by 2020 the AEC is anticipated to reach the third stage (common market) of the five different stages of economic and monetary integration as clearly spelled out in Appendix II of the “Concept Paper on the AEC” prepared by the Institute of Southeast Asian Studies.7 The following proposed characteristics of the AEC by 2020 are important to note in investigating the AEC’s possible impact on poverty: (1) free movement of goods, services, and investments; (2) free movement of skilled labour and creative talent; (3) free movement of tourists across all ASEAN countries; and (4) an attractive regional production platform that would be a magnet for FDI. These features are expected to enhance trade and investment within the region, leading to growth and poverty reduction. 4.1.1. Greater Income Disparity between Countries Concerns have been raised on the likely negative effects of a higher level of economic integration. It is possible that the formation of the AEC would

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widen economic disparities within the region. In particular the AEC may lead to a two-tier ASEAN, where the already high-income countries such as Singapore and Malaysia (and probably Indonesia, the Philippines, and Thailand) would gain more of the benefits of the AEC, while the lessdeveloped ASEAN countries would at best remain where they are now. Based on the international trade theory, economic integration is expected to reduce factor price differences within a region. The presence of scale economies can, however, alter this view. With scale economies, firms would select a production area among different countries or regions which can offer the best possible returns. Production costs, access to factor supplies, size of markets, and trade costs in supplying different markets are among the key factors that firms consider in their location decision. Integration can thus lead to agglomeration of economic activities, concentration of industries, and divergence of income levels within the region. Regional integration that allows for migration is also expected to reduce differences in factor prices. However, with imperfect competition it can lead to disparities in income levels between regions. Krugman (1991) notes how economies of scale can lead to a concentration of industries in areas where there are large markets. However, areas with huge markets are those where there are already existing agglomerations of industries. As Baldwin and Venables (1995) contend, migration generates demand linkage, whereby the movement of firms is associated with the movement of workers and their expenditures. There is a tendency for people to migrate to areas where industries are concentrated owing to higher wages, as well as greater availability and lower prices of goods and services. As more and more people migrate from regions with smaller initial production, population would tend to be concentrated in regions with large production centres. Market size and production further increase in regions with a high concentration of economic activities, which would eventually lead to greater disparities in income levels between regions. Deardoff and Stern (2002) argue that differences in growth patterns among EU members can be understood in the context of an increasing returns to scale model. Increasing returns to scale at the country level may lead to greater specialization and gains from trade in large member countries than in small ones. Further, newer members may find it difficult to exploit comparative advantage in increasing-returns industries, and therefore may gain less compared to the earlier entrants. In the EU’s experience, the large countries among the original members grew more rapidly than other Organization for Economic Co-operation and Development (OECD) countries, and then settled onto new higher per capita income levels. Smaller original members, on the other hand, initially experienced minimal

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growth. But in later years, they attained higher levels of income with further expansion of the EU. Among those that joined the EU later, some gained while others did not. 4.1.2. Increasing Poverty in Some Member Countries? While member countries of the proposed AEC are already part of an existing economic integration, that is, AFTA, the move towards the AEC is seen as a major step towards greater trade liberalization among member countries. Note that intra-regional trade in ASEAN still accounts for only about onefourth of total trade in the region. By facilitating free movement of goods, services, investments, and skilled labour, intra-regional trade through the AEC is expected to rise in a significant way. This may, however, create unintended consequences. As seen in section 2, there are wide disparities in income per capita levels among ASEAN countries. Integration raises the possibility that income levels among countries would further diverge. Countries with higher income levels and bigger markets may stand to benefit more at the expense of less-developed ones. On the other hand, there are some member countries with similar economic structure or core resources. With the AEC, they may end up competing for exports of a few similar products or services. Since trade is expected to be heavily liberalized among member countries, a major issue is that the AEC may heighten competition, thereby creating, in the short run, winners and losers. In some instances, adjustment costs may be borne disproportionately by the poor and disadvantaged groups. While trade liberalization can be beneficial for the poor through growth, in other ways it can negatively affect the welfare of the poor (see Bannister and Thugge 2001; Winters 2000; Hoekman et al. 2001). First, trade can change the prices of tradable goods and improve access to new products. If the poor are net buyers of a particular good whose price has fallen due to trade reforms, then they stand to benefit; but they tend to lose if they are net sellers of that good. Second, trade can have an important effect on the employment and wages of the poor. The effect would depend on the type of labour provided by poor households prior to the trade reform as well as the initial pattern of protection. Trade reforms that lead to lower prices of initially highly protected agricultural products and labour-intensive products would have a negative effect on the employment of the poor. Further, the effect on the poor would depend on the speed by which firms respond to liberalization, as well the constraints they face on hiring or firing of workers and other labour regulations.

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A third concern is that trade reform may lead to reduced trade taxes, which can lower the government’s revenue and ability to finance programmes for the poor, including safety nets. Further, note that the greater mobility of capital and labour as envisioned under the AEC makes taxation of such mobile factors more difficult, which can lead to lower revenues. How the government adjusts its expenditure pattern in the light of the reduction in its revenues is an important policy issue. Domestic tax reforms and expenditure measures should be designed to mitigate adverse effects on the poor. Finally, while trade reform is usually associated with higher FDI inflows, some negative effects may arise from FDI. It is possible that the technology adopted by FDI is biased against labour, hence, limiting the already narrow employment opportunities for the poor. Another concern is the monopolistic tendencies of FDI, which may lead to the crowding out of domestic investment, leading to lower total industry size and employment. Further, since FDI tends to offer higher wages and provide employment to the more educated or the urban sector, higher income inequality can arise (Jenkins and Thomas 2002; Graham and Wada 2000).

4.1.3. Vulnerability of the Poor Trade reforms can affect the income opportunities of the poor. Lacking in financial and human capital, the poor would most likely be unable to cushion themselves against income shocks should trade reforms work against their favour. It would not be easy for the poor to shift to activities that can raise their incomes owing to risk aversion. Having few financial assets, the poor are less willing to undertake risky income-generating activities that can offer higher returns. There are cases when trade reforms result in the disappearance of markets that are linked to the employment or income-generating activities of the poor. For example, in Zambia the government abolished its monopoly control over the purchase of maize from farmers (Winters 2000a, 2000b). Two private firms undertook such activity but abandoned purchasing from remote areas, thereby resulting in the disappearance of markets for the farmers’ produce in such areas. Worse, the farmers who previously relied on maize farming found it hard to return to subsistence farming because they no longer had the seeds and necessary skills. There are other factors which make the poor even more vulnerable. The low level of education, training, and skills, and unavailability of social safety nets make it more difficult for the poor to bear the costs of adjustment.

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4.2. Possible New Strategies and Policies with Regard to Poverty Reduction 4.2.1. Selection of Sectors and Sequencing of Reforms In the selection of sectors to be liberalized under the AEC, it is important to identify the potential winners and losers, as well as the magnitude of gains or losses. Information on who are likely to gain or lose can help in crafting complementary policies to minimize adverse effects. Transparency and consistency in the selection of sectors and economic activities to be liberalized are important. The selection of sectors to be liberalized under the AEC should particularly take into account the likely impacts on the poor and other disadvantaged groups. The issue is in what ways can liberalization of certain sectors affect the welfare of the poor, for example, is it through their income-generating activities, consumption patterns, or access to basic services? The short-run likely negative effects of liberalization should be clearly communicated to the affected sectors to help them prepare through retraining, upgrade of skills, or gradual shift to other income-generating activities. The authorities should also point out to the affected sectors the positive effects of deeper liberalization for them to appreciate such a policy measure. Conducting intensive consultations with affected groups can help temper unfavourable reactions. Once sectors to be liberalized have been identified, careful thought should be paid to the sequencing of reforms. Some sectors may be liberalized ahead of the more sensitive sectors or those on which the poor and other vulnerable groups heavily depend. The timing and implementation of reforms should also be closely linked to the establishment of programmes that deal with their impact on the poor. However, even if specific safety nets for the poor have not yet been firmly established, reforms should not be postponed. Any move to backtrack from a pre-announced schedule for liberalization would only create uncertainties and impair the credibility of the reforms. Instead, there should be a gradual and well-sequenced implementation of reforms, with complementary measures to minimize the adverse effects on the poor. 4.2.2. Institutional Strengthening While the implementation of a trade reform is important for long-term growth and poverty reduction, it alone is not sufficient. There is a need to create a macroeconomic environment which promotes investment, competition, and private sector development. Important to growth are strong

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enforcement of property rights, a well-developed legal system, and a competent and efficient bureaucracy. Some institutions should be strengthened to prepare them for the opportunities, as well as challenges, brought about by rapid globalization. One such institution involves the financial sector, which should be strengthened to effectively manage the expected surge in capital inflows or outflows. A prudent regulation of the financial sector should also be undertaken to ensure that funds are channelled into the productive sectors and to reduce the chances of another regional financial crisis occurring. It is also crucial to strengthen institutions that are directly involved in the management of poverty-reduction programmes to make them efficient and effective in providing assistance to the poor or disadvantaged groups. Examples of such institutions are those involved in land redistribution schemes, microcredit, and social welfare programmes. It should be noted that since the majority of the poor are in the rural area, it is important to enhance the capacity of institutions that cater to this area. Lastly, there is a need to develop institutions which can help member countries in developing their core industries. It should be noted that the production of differentiated products and services in the region can help enhance intra-regional trade. For this, research and product innovation are called for so that each country can develop its own niche. The extent of support for research and technology development would impact on the trade and growth performance of member countries. There should be strong incentives for innovation, especially in less-developed economies to enable them to gain substantially from the bigger market made possible through integration. This also addresses the concern that income disparity between high- and low-income member countries may widen as the more developed and technologically advanced economies may benefit more from integration. 4.2.3. Creation of an ASEAN Committee on the Poverty Implications of Integration It is proposed that a ministerial-level ASEAN Committee on the Poverty Implications of Integration (ACPII) be created with the following objectives: (1) to regularly monitor and analyse the impact of economic integration on poverty across and within the AEC member countries; (2) to make provisions for safety nets for the poor and explore other mechanisms for minimizing the adjustment costs; and (3) to search for co-operative arrangements to deal with poverty and inequality over the long run. Composed of representatives from

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each member country, the ACPII would facilitate the pursuit of a concerted effort to address poverty in the region. 1. Poverty-reduction impact monitoring. Member countries may work towards designing a common set of indicators for poverty and welfare to track how each country fares with globalization and regional integration. Poverty monitoring can cover the extent of and changes in poverty, characteristics of the poor (for example, in what sectors do they belong and what are their sources of income or employment), and channels through which the poor are affected by integration. This would form the basis for designing an assistance package or safety nets for the poor and disadvantaged groups. There are two types of monitoring that can be undertaken by the ACPII. One is regular monitoring or that which may be done periodically, say, on an annual basis, covering a common set of indicators across member countries. The other is an in-depth analysis of the impact of integration on poverty which may be conducted every three years or so. The impact monitoring would cover the effects of integration on the poor’s income, employment, or well-being. A carefully designed framework for impact assessment should be able to isolate the effects of integration from other factors affecting poverty. 2. Safety nets and adjustment costs. Under the ACPII a subcommittee on Social Protection should be created to complement poverty-reduction efforts. Through the subcommittee, the AEC can work together in mitigating the possible adverse impacts of integration by designing and implementing a common social-protection strategy as has been developed and implemented in the EU. In the process of integration, member countries in the AEC may incur transitional adjustment costs, as in the case of other regional trading arrangements. The welfare losses relate to temporary labour unemployment and idle capacity as some firms are edged out by more efficient suppliers in the region. Part of the reason for the successful implementation of integration among industrial countries is their ability to address structural adjustment costs.8 The creation of compensatory mechanisms can be crucial for the AEC, where members are at varying stages of development. In addition to setting up formal compensatory mechanisms to address transitional costs, certain complementary reforms need to be in place to cushion the unfavourable impact of integration, especially on the poor. Wellfunctioning social-protection measures should also be in place to offset the adverse short-term effects of trade reforms on the poor. There are some sectors that are likely to lose from trade openness. Job training and other

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forms of assistance should be extended to those who lose jobs in these sectors. In addition to retraining, other proposed safety nets are temporary food subsidy and workfare. 3. Co-operative arrangements for poverty reduction. The ACPII can explore mechanisms for co-operation among the member countries in reducing poverty. One important co-operative arrangement is in the area of informationsharing among member countries, particularly on the mechanisms for designing and implementing a pro-poor development strategy that can be adopted in each country. Information on strategies which have been found to be effective, as well as those that have not worked, in substantially reducing poverty can serve as a guide for member countries in formulating their own povertyreduction strategy. The ACPII may also facilitate co-operative arrangements in the provision of technical assistance. Some countries may require technical assistance in the design or management of poverty-reduction programmes, including the provision of training and capacity-building. Member countries can submit to the ACPII the types of technical assistance they need to address poverty. The ACPII can then tap experts from the region who can help address the expressed needs of member countries. It is, therefore, crucial for the ACPII to identify a pool of experts involved in policy design or programme implementation for poverty reduction or social protection. Member countries, especially the more developed ones, may also present to the ACPII a menu of technical assistance programmes they can provide to other member countries. Through the ACPII the needs of member countries may be matched against the available types of assistance for poverty reduction. 5. Conclusion The ASEAN Vision of 2020 calls for stronger economic integration among ASEAN member countries through the formation of the AEC. The AEC may have significant effects on poverty and inequality in these countries which, despite the wide differences in average income levels and growth rates, have generally experienced in recent decades substantial progress in human capital development, declining poverty incidence, and relatively stable income inequality. Fostering wider trade openness through the AEC can contribute to further growth and poverty reduction, but it could also result in unintended negative effects on poverty and inequality. In particular, it may widen economic disparities in the region, where the more-developed countries would reap more of the benefits than the less-developed countries. Another issue is that

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the AEC may lead to poverty reduction reversals through its effects on prices of tradable goods, employment and wages of the poor, government revenue, and investments. Wider economic integration may also increase the vulnerability of the poor, who are most likely unable to protect themselves against income shocks owing to meagre financial assets, a low level of education and skills, and lack of access to social safety nets. To stave off the adverse effects on poverty, the AEC should adopt welldesigned strategies and policies. One is the judicious selection and sequencing of sectors to be liberalized, along with appropriate policy reforms. Another is the strengthening of institutions, especially the financial sector and those that can help develop core industries. Finally, it is important that a ministeriallevel ACPII be created to address poverty and related issues. In sum, the AEC appears promising in the context of globalization and increased competition. ASEAN member countries should actively participate in fostering closer regional economic integration to maximize the gains from globalization while minimizing its adverse effects. The AEC would have some positive impacts on poverty reduction in member countries through its effect on growth, but it could also create some unintended negative consequences. Deliberate efforts should be made to ensure that the positive effects significantly outweigh the negative ones. NOTES The views expressed in this chapter are those of the authors and do not necessarily reflect the views of the institutions to which they are affiliated. 1. Frankel (1997) distinguishes five levels of RIA: free trade area, preferential trade arrangement, customs union, common market, and economic union. 2. There are no data on GDP per capita level at US$ or Purchasing Power Parity (PPP) for Myanmar. 3. Using the GDP figures at 1999 PPP, marked differences among countries are still evident although the disparities are now lower. For example, the 2001 GDP per capita (at 1999 PPP) for Singapore was only around fifteen times more than that of Cambodia. 4. Inter-country comparisons pose some difficulties because countries use different concepts and definitions, methodologies, and data sets. See, for instance, Asra et al. (1997). Hence, it is better to look at trends over time rather than specific levels at a point in time. 5. There is still no specific timetable for the inclusion of Japan and South Korea in the ACFTA. It should be noted that in the ASEAN+Three Summit in November 2000, there was a proposal to establish an East Asian free trade zone comprising the ASEAN-Ten, Japan, South Korea, and China.

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But even prior to the formation of the EEC the eventual members were already engaged in heavy trade among themselves. See also Frankel (1997). In particular, the EU has put in place compensatory mechanisms known as “structural funds” to address adjustment costs. But in the case of several regional trading arrangements among developing countries, compensation funds were never established owing to design problems and budgetary constraints of member countries (dela Torre and Kelly 1992).

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Deardoff, A. and R.M. Stern. “EU Expansion and EU Growth”. Paper presented at the International Economic Association, 13th World Congress, 9–13 September 2002. dela Torre, A. and M.R. Kelly. “Regional Trade Arrangements”. International Monetary Fund Occasional Paper 93. Washington, D.C., 1992. Dollar, D. and A. Kraay. “Growth is Good for the Poor”. World Bank Policy Research Paper no. 2587. Washington D.C., 2001a. ———. “Trade, Growth, and Poverty”. World Bank Working Paper no. 2615. Washington, D.C., 2001b. Frankel, J.A. Regional Trading Blocs in the World Economic System. Washington, D.C.: Institute for International Economics, 1997. Graham, Edward and Erika Wada. “Foreign Direct Investment in Mexico”. World Economy 20, no. 6 (2000): 777–97. Henrekson, M., J. Torstensson, and R. Torstensson. “Growth Effects of European Integration”. European Economic Review 41 (1997). Hoekman, B., C. Michalopoulos, M. Schiff, and D. Tarr. “Trade Policy Reform and Poverty Alleviation”. World Bank Working Paper no. 2733. Washington, D.C., 2001. Huang K-B. “The China–ASEAN Free Trade Area: Background, Framework and Political Implications”. Available at . Accessed in 2002. Institute of Southeast Asian Studies. “Concept Paper on the ASEAN Economic Community”. Singapore, February 2003. Italianer, A. “Whither the Gains from European Economic Integration?” Revue Economique 45, no. 3 (May 1994). Jalilian, H. and J. Weiss. “Foreign Direct Investment and Poverty in the ASEAN Region”. ASEAN Economic Bulletin 19, no. 3 (2002): 231–53. Jenkins, C. and L. Thomas. “Foreign Direct Investment in Southern Africa: Determinants, Characteristics and Implications for Economic Growth and Poverty Alleviation”. Poverty and Globalisation Project funded by U.K. Department for International Development (DFID), October 2002. Klein, M., C. Aaron, and B. Hadjimichael. “Foreign Direct Investment and Poverty Reduction”. World Bank Working Paper no. 2613. Washington, D.C., 2001. Krugman, P.R. “Increasing Returns and Economic Geography”. Journal of Political Economy 99 (1991): 483–99. Mirza, H. “Regionalisation, FDI and Poverty Reduction: Lessons from Other ASEAN Countries”. Paper prepared for the DFID workshop on Globalisation and Poverty in Vietnam, 23–24 September 2002, in Hanoi. Mussa, M. “Factors Driving Global Economic Integration”. Paper presented at a symposium Global Opportunities and Challenges, sponsored by the Federal Reserve Bank of Kansas City, August 2000, in Jackson Hole, Wyoming. Pernia, E.M. and A. Deolalikar. Poverty, Growth, and Institutions in Developing Asia. London: Palgrave Macmillan, 2003.

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Pernia, E.M. and P. Quising. “Trade Openness and Regional Development in a Developing Country”. Annals of Regional Science 37, no. 3 (2003): 391–406. Sakakibara, E. and S. Yamakawa. “Regional Integration in East Asia: Challenges and Opportunities”. World Bank Working Paper no. 3079. Washington, D.C., 2003. Srinivasan, T.N., J. Whalley, and I. Wooton. “Measuring the Effects of Regionalism on Trade and Welfare”. In Regional Integration and the Global Trading System, edited by K. Anderson and R. Blackhurst, pp. 52–79. New York: Harvester Wheatsheaf, 1993. Winters, A.L. “Trade Liberalization and Poverty”. Project funded by U.K. Department for International Development (DFID). February 2000a. ———. “Trade and Poverty: Is There a Connection”. In Trade, Income Disparity and Poverty, edited by D. Ben-David, H. Nordstrom, and A.L. Winters. Geneva: World Trade Organization, 2000b. World Trade Organization. Regionalism and the World Trading System. Geneva: World Trade Organization, 1995. Yannopoulos, G.N. “Foreign Direct Investment and European Integration: The Evidence from the Formative Years of the European Community”. Journal of Common Market Studies 28, no. 3 (1990): 235–59.

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12

Financial Integration in ASEAN and Beyond: Implications for Regional Monetary Integration Ramkishen S. Rajan

1. Introduction The post-1997 period has not been very kind to Southeast Asia in general. The list of bad news that has recently hit the region has been daunting and appears never-ending. A non-comprehensive list includes: 1. the regional financial crisis in 1997–98 and its lingering after-effects; 2. the socio-political turmoil in ASEAN’s largest member, Indonesia, and consequent fears of regional instability; 3. continued recessionary environment in Japan and consequent curtailment of capital flows to the region from Japan; 4. intensified competition for foreign direct investment (FDI) and export markets from the emerging Asian giants, China and India;1 5. the sharp downturn in capacity utilization in the United States (Baily 2003) and consequent decline in external demand for ASEAN exports; 6. the seemingly more volatile international electronics cycle (IMF 2001); 7. the concerns about regional and international terrorism; and most recently

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8. the Severe Acute Respiratory Syndrome (SARS) outbreak and consequent decimation of the tourism industries, decline in business and consumer confidence, rise in health-care costs and their consequent budgetary impacts, not to mention the unfortunate loss of human lives.2 All these factors have worked in tandem to generate lower and more volatile post-crisis growth rates in the more-developed ASEAN members (Singapore, Malaysia, Thailand, the Philippines, and Indonesia), some economies being more adversely affected than others (Figures 12.1 and 12.2). During and immediately following the East Asian financial crisis of 1997–98 there were widespread concerns that ASEAN as an organization was disjointed, unco-ordinated, and altogether ineffective (Chang and Rajan 1999, 2001; Khoo 2003). To its credit, ASEAN has done remarkably well since then to rebuild its image, and is being actively courted by the larger economic powers once again. For instance, apart from the proposed ASEAN– China Free Trade Agreement (ACFTA), Japan, India, and South Korea have also sought out various types of trade pacts with ASEAN. In addition, the U.S. President, George W. Bush, launched the Enterprise for ASEAN Initiative

Figure 12.1 Annual GDP Growth Rates of Original ASEAN Members, 1987–2001

15.0

Percentage

10.0

5.0

0.0

-5.0

-10.0

-15.0 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Year Singapore

Malaysia

Indonesia

Thailand

Philippines

Note: Data for Brunei are unavailable. Source: CEIC Database.

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Figure 12.2 Annual GDP Growth Rates of New ASEAN Members (CLMV), 1987–2001

15.0

Percentage

10.0

5.0

0.0

-5.0

-10.0

-15.0 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Year Cambodia

Lao PDR

Myanmar

Vietnam

Note: Growth rate for Myanmar in 2001 refers to fiscal year beginning in April. Source: CEIC Database.

(EAI) during the Asia-Pacific Economic Co-operation (APEC) Summit in October 2002 to strengthen bilateral trade linkages with ASEAN.3 All of this in turn has offered ASEAN the potential to act as a hub with the consequent benefits of being one. In addition to this, many ASEAN members, such as Thailand and Singapore, are actively sourcing trade pacts with non-ASEAN members on a bilateral basis (Rajan and Sen 2002). Nonetheless, the ASEAN leaders recognize that current extra-regional initiatives ought not to distract ASEAN from furthering its own regional integration; renewed efforts are needed to deepen intra-ASEAN interactions. In view of this, the recently mooted ASEAN Economic Community (AEC) initiative by Singapore’s then Prime Minister, Goh Chok Tong, takes on particular relevance (ISEAS 2003). While a number of other papers have focused on trade integration and institutional mechanisms to further real sector economic integration in ASEAN, this chapter concentrates on the financial dimension of regional integration in ASEAN and the larger East Asia and its implications for regional monetary integration.

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The outline of this chapter is as follows. The next two sections explore the extent of intra-East Asian financial integration. Despite several empirical studies examining various facets of the topic, the degree of intra-regional financial integration in East Asia remains a matter of vigorous debate. Numerous methods have been employed to measure financial integration. We place them into three broad categories. The first category encompasses price conditions involving debt as well as equity flows. The former are largely embodied in the interest parity conditions, namely the covered interest parity (CIP), the uncovered interest parity (UIP), and the real interest parity (RIP). As will be discussed, the CIP is the narrowest of measures (of capital mobility per se), the UIP being a somewhat broader measure (of financial integration), while the RIP is the broadest of arbitrage measures (incorporating both financial and real integration). Apart from the arbitrage conditions, another set of price measures involves non-debt flows such as the co-movement of stock market returns. The second broad category involves quantity-based measures such as savings–investment correlations, consumption correlations, current account dynamics, and gross capital flows. The third category can be broadly classified as regulatory measures (such as capital controls and prudential regulations), or institutional ones (for instance, cross-listing of equities, creation of regional capital markets, and the like). Figure 12.3 summarizes the various measures of financial integration. Most empirical work on East Asia has focused on the first and third sets of measures (Cavoli, Rajan, and Siregar 2003). Section 2 details the arbitrage price measures. Section 3 considers simple measures of equity market integration. Section 4 focuses briefly on the literature on regulatory measures. Due to space constraints, we do not discuss institutional measures. In any event, these measures have been discussed in detail elsewhere (for instance, see Michael Plummer’s chapter in this volume and the references cited within). To preview the main conclusion, given definitional and data limitations, unsurprisingly, one would be hard-pressed to make any unambiguous conclusion about the extent of intra-regional financial integration. But even if one were able to do so, what are the implications of closer financial integration for monetary integration?4 The penultimate section explores this rather under-researched area. The final section offers a summary and brief concluding remarks on the issue of monetary integration in ASEAN and the larger East Asian region.5 A caveat is in order before proceeding. As the reader will no doubt have noticed, the focus of this chapter is on East Asia rather than ASEAN as most

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Figure 12.3 Categorizing Measures of Financial Integration: A Simple Framework

Price-based Measures

Arbitrage Conditions

Stock Market Co-variations

Real Interest Parity (RIP)

Quantity-based Measures

Regulatory or Institutional Measures

Savings–Investment Correlations

Capital Controls/ Prudential Regulations

Consumption Correlations

Institutional Measures, e.g. cross-listing of equities, creation of regional capital markets

Gross Capital Flows Relative PPP

Uncovered Interest Parity (UIP)

Covered Interest Parity (CIP)

Risk Premium

Source: Author.

recent empirical analyses on financial integration take a broader view of the region. More importantly, from a policy perspective there is a growing acceptance (certainly by the higher-income ASEAN members) that for the purposes of integrationist initiatives, ASEAN Plus Three or APT (China, Japan, and South Korea) or something even broader is the appropriate regional grouping, not ASEAN per se (Soesastro 2001).6 2. Arbitrage Measures of Financial Integration Price-based measures of financial integration or arbitrage conditions seek to equate rates of returns of comparable assets across different markets/economies.

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In this section we examine three common interest parity conditions, namely CIP, UIP, and RIP.7

2.1. The Covered Interest Parity (CIP) Condition 8 The CIP may be formally stated as follows: it = i*t + ft,t+n – et

(1)

where it is the domestic interest rate, i*t is the foreign interest rate (U.S. rate unless otherwise stated), ft,t+n is the forward rate for n periods into the future, and et is the spot exchange rate.9 The CIP indicates that the difference between the current spot rate and the forward rate will equal the interest differential between similar assets measured in local currencies. Therefore, in the absence of capital account restrictions and/or transactions costs, the covered interest differential (CID) ought not to differ significantly from zero. A negative differential suggests the existence of capital controls or transactions costs that restrict capital outflows. Investors would certainly not tolerate a lower domestic return in the absence of capital controls (Frankel 1991). While there have been a number of studies on the CIP involving industrial economies, there have been relatively fewer ones pertaining to developing economies. This is primarily attributable to the fact that many developing economies do not have sufficiently liquid forward foreign exchange markets, or if they do exist, the data on forward rates are not easily available. One of the most recent studies on CIP is by de Brouwer (1999) who estimates the following: ft,t+n = α + β (it – i*t ) + et

(2)

where the null for the CIP is α = 0, β = 1. The de Brouwer results, which are based on three-month assets between 1985 and 1994, are shown in Table 12.1. With the exception of Taiwan, the CIP in the strict sense is rejected due to the non-zero constant.10 However, focusing on the slope coefficient, Japan appears to be the country that comes closest to the CIP holding, as they do in the cases of Hong Kong and Singapore. Taiwan and Thailand have maintained restrictions on their capital account transactions. Yet there does not appear to be any obvious pattern emerging as a result — Taiwan seems to strongly deviate from the CIP while Thailand has a significant constant term but the slope coefficient is close to unity.

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Table 12.1 Covered Interest Parity (CIP), 1985–94 α = 0 (Std. Dev.) Hong Kong Japan Malaysia Taiwan Thailand Singapore

–0.04 –0.01 0.14 0.00 –0.30 0.20

β = 1 (Std. Dev.)

(0.01) (0.002) (0.03) (0.04) (0.16) (0.03)

0.97 1.01 0.87 0.59 0.99 0.96

(0.05) (0.05) (0.03) (0.20) (0.05) (0.03)

Source: de Brouwer (1999).

2.2. The Uncovered Interest Parity (UIP) Condition The UIP may be represented as follows: it = i*t + ∆eet,t+n

(3)

where ∆eet,t+n is the expected exchange rate change in time t+n. The nexus between the UIP and the CIP is apparent by decomposing equation (3) as follows: it – i*t – ∆eet,t+n = [it - i*t – ( ft,t+n – et )] + (ft,t+n – eet,t+n)

(4)

where the first bracketed term on the right-hand side is the CIP (sometimes referred to as country or political-risk premium) and the second term is the currency-risk premium. If the CIP holds but the UIP is rejected, this would imply that forward rates are biased predictors of future exchange rates. Before formally testing equation (3), the researcher needs to find a way of measuring the expectation of the future exchange rate. One way to make the leap from theory to empirical operationalization is by using ex-post differentials. This may be justified by assuming that rational expectations (RE) hold. This assumption — that the actual or ex-post spot exchange rate equals the expected spot exchange plus an uncorrelated error term — is a practical way of overcoming the problem of non-observable expected exchange rate changes. Another approach is to use surveys of exchange rate expectations of market agents. In his study, de Brouwer (1999) estimates the following equation assuming RE: ∆eet,t+n = α + β (it – i*t) + εt

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(5)

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where the null hypothesis for the UIP is α = 0 and β = 1. The results are presented in Table 12.2. When testing for the null of β = 1, the results are mixed. Curiously, the economies that would typically be regarded as having open capital accounts are the ones that largely reject parity, while those that are regarded as being quite closed have coefficient values that do not reject the UIP. This may be partially explained by observing that those economies perceived as closed are also the ones with managed exchange rates. Managed exchange rates are easier to predict than their floating counterparts, their expected depreciations being relatively easier to measure (de Brouwer 1999). The author also computed the uncovered interest differentials (UID), which are defined as follows: UIDt = it – i*t – ∆eet+n

(6)

If UID > 0, the expected rate of return on home assets is higher than foreign assets, resulting in capital inflows into the home country. Similarly, outflows take place if UID < 0. As expected, the UIDs of Hong Kong and Singapore are close to zero. The estimated UIDs show significant deviations for Indonesia, South Korea, the Philippines, Taiwan, and Thailand. This coincides with the existence of certain restrictions on the capital account for each of these economies. Flood and Rose (2002) test for the UIP using daily, weekly, and monthly Bank for International Settlements (BIS) exchange rate and Eurorate data for the 1990s. The regression equation estimated is similar to equation (5) above.

Table 12.2 Uncovered Interest Parity (UIP) and Uncovered Interest Differentials (UIDs), 1985–94 α = 0 (Std. Dev.) Hong Kong Indonesia Japan South Korea Malaysia Philippines Singapore Taiwan Thailand

–0.04 0.90 –2.80 –0.10 –0.51 0.34 2.03 0.14 –0.34

(0.03) (0.12) (0.65) (0.23) (0.19) (1.15) (0.40) (0.20) (0.20)

β = 1 (Std. Dev.) –0.29 0.02 –2.41 0.58 –1.04 0.23 –2.29 1.25 0.14

(0.07) (0.07) (0.75) (0.15) (0.20) (0.37) (0.47) (0.22) (0.20)

UID (Std. Dev.) 0.06 –0.69 –0.71 –0.59 0.49 –1.83 0.02 –0.58 0.71

Source: de Brouwer (1999).

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The results are more encouraging in that the estimated β is the correct sign for most of the economies in the sample. Even more encouraging results are obtained when pooling the data, and the results are better for daily data than weekly, monthly, or quarterly. Results for East Asia are summarized in Table 12.3. While the results for Japan appear rather dubious, comparison of Tables 12.2 and 12.3 reveals that the extent of openness in Indonesia and Thailand has increased over the latter half of the 1990s. This may, however, be an artifact of the currency crisis in 1997–98, an issue to be explored in more detail in the latter part of the chapter. Cavoli, Rajan, and Siregar (2003) computed the UIDs for commercial deposit rates offered by domestic banks of each relevant economy for three separate sub-periods: (1) the pre-crisis period (January 1995–December 1996); (2) the crisis period and immediate post-crisis period (January 1998–December 1999); and (3) the period of relative stability (January 2000–June 2002). The UIDs are the actual ex-post interest rate differentials received by the investors at the end of the six-month maturity period. The UIDs are reported in Table 12.4. The results reveal the existence of arbitrage opportunities throughout the three different periods among the East Asian economies. Furthermore, the results suggest that the markets became more segmented during the crisis period (1998) and the period immediately following that (period 2). The continued high degree of foreign exchange volatility may have contributed to the rise in the UIDs during this period. In contrast, the picture for the period of relative calm (2000–02) suggests the intensification of market integration among these economies during period 3. Only Thailand experienced widening absolute UIDs (see Bird and Rajan 2001; and Rajan, Siregar, and Sugema 2003 for elaborations on this issue).

Table 12.3 Uncovered Interest Parity (UIP), 1990s β = 1 (Std. Dev.) Hong Kong Indonesia Japan South Korea Thailand

–0.35 0.22 –0.82 3.41 0.52

(0.18) (2.05) (1.36) (4.12) (1.86)

Source: Flood and Rose (2002).

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Table 12.4 Uncovered Interest Differentials (UIDs) (In percentages) A. Domestic Economy: Indonesia Foreign Economy

Period 1

Period 2

Period 3

Malaysia Philippines Singapore Thailand South Korea China Hong Kong

2.98 2.53 4.83 1.98 5.26 1.02 3.84

21.4 20.6 24.7 17.8 13.1 23.4 22.8

0.04 2.80 3.30 3.60 2.04 0.60 –0.03

Average

3.21

20.54

1.76

B. Domestic Economy: Thailand Foreign Economy Malaysia Philippines Singapore Indonesia South Korea China Hong Kong Average

Period 1

Period 2

Period 3

1.01 0.54 2.85 –1.98 3.27 –0.96 1.73

2.74 1.73 5.99 –17.8 –4.81 5.09 4.40

–3.38 –0.78 –0.56 –3.60 –1.76 –2.82 –3.44

0.92

–0.38

–2.33

C. Domestic Economy: Malaysia Foreign Economy

Period 1

Period 2

Period 3

Indonesia Philippines Singapore Thailand South Korea China Hong Kong

–2.98 –0.45 1.85 –1.01 2.41 –1.96 0.66

–21.40 –0.65 3.53 –2.74 –7.11 2.68 1.99

–0.04 2.80 2.44 3.38 1.37 0.56 –0.07

Average

–0.21

–3.39

1.49

continued on next page

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Table 12.4 – cont’d D. Domestic Economy: Philippines Foreign Economy Indonesia Malaysia Singapore Thailand South Korea China Hong Kong Average

Period 1

Period 2

Period 3

–2.53 0.45 2.28 –0.54 2.87 –1.51 1.44

–20.6 0.65 4.00 –1.73 –6.21 3.08 2.39

–2.80 –2.80 0.02 0.78 –1.13 –2.24 –2.86

0.35

–2.63

–1.58

E. Domestic Economy: Singapore Foreign Economy

Period 1

Period 2

Period 3

Indonesia Philippines Malaysia Thailand South Korea China Hong Kong

–4.83 –2.28 –1.85 –2.85 0.54 –3.79 –1.23

–24.70 –4.00 –3.53 –5.99 –10.44 –0.86 –1.55

–3.30 –0.02 –2.44 0.56 –0.45 –1.94 –2.57

Average

–2.33

–7.30

–1.45

F. Domestic Economy: South Korea Foreign Economy

Period 1

Period 2

Period 3

Indonesia Philippines Malaysia Thailand Singapore China Hong Kong

–5.26 –2.87 –2.41 –3.27 –0.54 –4.37 –1.92

–13.10 6.21 7.11 4.81 10.44 9.65 8.95

–2.04 1.13 –1.37 1.76 0.45 –1.31 –1.94

Average

–2.95

4.87

–0.47

G. Domestic Economy: China Foreign Economy Indonesia Philippines

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Period 1

Period 2

Period 3

–1.02 1.51

–23.40 –3.08

–0.60 2.24

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Malaysia Thailand Singapore South Korea Hong Kong

1.96 0.96 3.79 4.37 2.68

–2.68 –5.09 0.86 –9.65 –0.69

–0.56 2.82 1.94 1.31 –0.63

Average

2.04

–6.25

0.93

H. Domestic Economy: Hong Kong Foreign Economy

Period 1

Period 2

Period 3

Indonesia Philippines Malaysia Thailand Singapore South Korea China

–3.84 –1.44 –0.66 –1.73 1.23 1.92 –2.68

–22.80 –2.39 –1.99 –4.40 1.55 –8.95 0.69

0.03 2.86 0.07 3.44 2.57 1.94 0.63

Average

–1.03

–5.47

1.65

Note: Period 1: January 1995–December 1996; Period 2: January 1998–December 1999; Period 3: January 2000–June 2002 Source: Cavoli, Rajan, and Siregar (2003).

For the five ASEAN economies, Indonesia is the only country which offered substantial and persistent positive interest rate spreads over other regional economies. It is possible that the positive UIDs offered on the rupiah are partly a reflection of the “peso problem”, that is, a small probability of a large rupiah devaluation as well as high country or currency risk premiums. Malaysia maintained a positive UID with all economies save Indonesia only during period 3. This is probably explained by the strength of the ringgit with respect to most other East Asian currencies. Thailand generally maintained positive UIDs in periods 1 and 2 against most economies except Indonesia and South Korea (in period 2). Note that Singapore’s commercial banks generally maintained the lowest returns on their deposit rates. With regard to the North Asian economies (China, South Korea, and Hong Kong), the UIDs are again at the highest during period 2 at the height of the financial crisis. The high interest rate policy adopted in South Korea created significant spreads against all other economies except Indonesia. In contrast, Hong Kong and China had negative spreads against all economies save Singapore. Contrasting trends appear during the last two periods (periods 2 and 3). A

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combination of a weaker won (especially against other crisis-affected currencies) and sharply lower key interest rates in South Korea led to its UIDs turning positive against Singapore, Thailand, and the Philippines in period 3. In contrast, the lowering of interest rates in many ASEAN economies post-crisis and the recovery of these currencies vis-à-vis the U.S. dollar (and thus the Hong Kong dollar and Chinese renminbi, both of which are firmly pegged to the U.S. dollar) were responsible for creating positive UIDs in period 3.

2.3. The Real Interest Parity (RIP) Condition The third arbitrage condition is the RIP which is derived by using the following UIP equation: ∆eet,t+n = it – i*t

(7)

and substituting it into an expression for relative purchasing power parity (PPP): et = pt – p*t or ∆eet,t+n = πet,t+n – πe*t,t+n

(8)

Combining the two with the Fisher equation, rt = it – πet,t+n, yields the expression for the RIP: rt = r*t

(9)

Clearly for the RIP to hold, the UIP, PPP, and the Fisher hypothesis also need to simultaneously hold. This is no easy task given the lack of empirical success of both the UIP and PPP over the short to medium terms. Thus, the RIP is generally considered to be a very long-run interest parity condition encompassing both real and financial linkages.11 There have not been many studies on estimated RIPs for the East Asian economies. de Brouwer (1999) provides differentials for the RIPs and also sub-divided the estimated RIPs into their constituent parts, that is, the UIP and PPP (Table 12.5). The results reveal that Japan, Malaysia, and Taiwan have non-divergent real rates against U.S. dollar rates, while the other East Asian economies tested have a lower likelihood of the RIP holding. In general, the RIP does not hold due to lack of empirical success of the UIP and relative PPP.

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Table 12.5 Decomposition of Real Interest Parity Differentials (RIDs), 1980–94 Country

RID

Hong Kong Indonesia Japan South Korea Malaysia Philippines Singapore Taiwan Thailand

1.03 –0.70 0.11 –0.62 0.05 –1.73 0.26 –0.24 –0.47

(0.13) (0.29) (0.11) (0.18) (0.14) (0.35) (0.10) (0.18) (0.20)

UID 0.05 –0.81 –0.94 –0.65 0.48 –1.97 –0.04 –0.49 –0.93

PPP

(0.07) (0.20) (0.87) (0.27) (0.34) (0.62) (0.31) (0.36) (0.23)

–0.98 –0.11 –1.05 –0.03 0.43 –0.24 –0.30 –0.25 –0.46

(0.15) (0.26) (0.85) (0.29) (0.32) (0.57) (0.33) (0.43) (0.18)

Source: de Brouwer (1999).

2.4. Summary of Arbitrage Measures The most popular methodology for determining the extent of financial integration is the UIP, which was emphasized above. Indeed, as Flood and Rose (2002) have noted, “the UIP is a classic topic of international finance, a critical building block of most theoretical models” (p. 252). However, it is important to keep a number of caveats in mind when interpreting the findings. One, the test for the UIP is in fact a joint test for the CIP and the currency-risk premium. Two, the test for the UIP usually assumes that all agents form expectations rationally. Thus, the failure of the UIP to hold (in the sense that there exists large and persistent UIDs) could be because (1) the CIP does not hold (imperfect capital mobility); (2) there may be large and time-varying currency-risk premiums (imperfect asset substitutability); or (3) rational expectations is an inappropriate assumption for the foreign exchange (forex) market (or that the financial market consists of heterogeneous agents).12 While the CIP is a generally preferred measure of financial integration in view of the preceding limitations of operationalizing the UIP (Frankel 1991), as noted, there needs to be a liquid forward foreign exchange market in the currency pair under investigation. While this is not problematic for industrialized economies, it is definitely a niggling problem for developing economies. In any case, Willett, Keil, and Ahn (2002) observe: [S]ubstantial deviations from covered interest parity are a good indication that capital mobility is less than perfect…[However]…[f ]inding that covered interest parity holds…is consistent with either high or low capital mobility,

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and there is no good reason to presume that the magnitudes of deviations from interest parity will provide a reasonable proxy for the degree of international capital mobility. In terms of modern theory, the appropriate measure of capital mobility is the extent to which uncovered rather than covered interest parity holds (pp. 424–25).

With regard to the third price measure of financial integration, the RIP, the conditions for it to hold are quite prohibitive as both the PPP and the UIP need to simultaneously hold. However, the RIP provides a useful general condition encapsulating both trade and financial linkages, and thus should not be dismissed as being altogether irrelevant. The RIP is more likely to hold over longer time horizons and acts as a useful proxy for the marginal cost of capital.13 3. Non-debt Price Measures: Stock Market Co-movements Financing involving non-bank and non-debt channels has grown in importance in developing economies. Thus, another measure of integration of regional capital markets would invariably involve examining the nexus between regional equity market returns. There have been a number of studies examining the extent of equity market integration in East Asia. In the main, these papers look at the univariate properties of the data and how movements in the equity market in one country influence the series in another country. In general, the methodological applications range from simple correlations and co-variances to VAR-based approaches such as Granger causality for the short-run analysis and co-integration tests for the long-run scenario.14 Cavoli, Rajan, and Siregar (2003) is a recent paper on the issue. They measure equity returns as the difference of the log of stock exchange index returns [1n(sxit) – 1n(sxit–1)]. To ensure the consistency of the results, all the index returns are in U.S. dollars. They divide the observation sets into three sub-periods: (1) the pre-1997 crisis period (1 January 1996 to 31 December 1996); (2) the height of the crisis period (1 January 1998 to 31 December 1998); and (3) the post-crisis period (1 January 2000 to 30 June 2001). Before considering the Granger-causality test results, the authors first consider some simple correlation test statistics reported in the paper (Tables 12.6–12.8).15 During the pre-crisis period there was a limited degree of integration among the returns of the stock exchange markets in ASEAN, reflected by correlation statistics ranging from around 30 per cent for Thailand to 48 per cent for Singapore (Table 12.6). The correlation test statistics confirm a limited extent of integration of the ASEAN markets with the Hong Kong

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0.292

0.399

1.000 0.444 0.407 0.269 0.478 –0.081 0.407 0.123

0.339

0.435

0.444 1.000 0.352 0.309 0.636 0.075 0.492 0.066

Malaysia

Source: Cavoli, Rajan, and Siregar (2003).

Total Average

Average for ASEAN

Indonesia Malaysia Philippines Thailand Singapore South Korea Hong Kong USA

Indonesia

0.260

0.346

0.407 0.352 1.000 0.244 0.379 0.031 0.314 0.095

Philippines

0.219

0.310

0.269 0.309 0.244 1.000 0.419 –0.029 0.269 0.056

Thailand

0.363

0.478

0.478 0.636 0.379 0.419 1.000 0.031 0.586 0.013

Singapore

Table 12.6 Correlations of the Stock Exchange Returns (1 January – 31 December 1996)

0.031

0.005

–0.081 0.075 0.031 –0.029 0.031 1.000 0.101 0.089

South Korea

0.325

0.419

0.407 0.492 0.341 0.269 0.586 0.101 1.000 0.081

Hong Kong

0.075

0.071

0.123 0.066 0.095 0.056 0.013 0.089 0.081 1.000

USA

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market, but a surprising lack of integration with the U.S. Dow Jones.16 As for the Korean Stock Exchange Composite Index (KOSPI) during the pre-crisis period, the correlation statistics suggest that the returns of the South Korean market were largely segmented from the performances of the ASEAN capital markets, the Hong Kong Hang Seng Index, and the Dow Jones index. Similar results are discernible for the post-crisis period (Table 12.8). The correlation statistics of the ASEAN markets were in fact moderately lower than the pre-crisis period. The returns on the KOSPI during the post-crisis period were substantially more correlated with the rest of the markets included in the test than during the pre-crisis period. However, the returns on the Dow Jones continued to experience very low correlations with the East Asian markets. All the crisis-affected economies, including Singapore and Hong Kong, appear to have been significantly more correlated with one another during the height of the crisis (Table 12.7).17 The positive correlation statistics for the Philippines, Thailand, and Singapore were well above 50 per cent. Interestingly, the Indonesian correlation statistics hovered at about the same rate as during the pre-crisis period. Among the ASEAN economies, Singapore and Thailand showed the highest degree of correlation. The returns on the KOSPI experienced the most significant increases in correlation statistics with the ASEAN markets. Tables 12.9 to 12.11 report the Granger-causality tests. For the sake of brevity we only report the significant test results. Apart from the regional economies, the role of the Dow Jones index in influencing the performance of the East Asian markets was also examined. Results indicate that a relatively high degree of integration among the ASEAN equity markets had already been established pre-1997 (Table 12.9). The returns in each of the ASEAN markets influenced the returns of at least two other neighbouring capital markets. The returns on the Indonesian stock exchange were significantly influenced by the performances of the rest of the ASEAN markets, except Malaysia. Furthermore, the fluctuations in the composite Dow Jones index strongly influenced the ASEAN markets during the pre-1997 crisis period. These findings are broadly consistent with those of Calvo, Leiderman, and Reinhart (1996) who stress the roles of global leaders in the world capital markets. In contrast, there was no evidence of Granger causality between the ASEAN markets and the South Korean capital market before the crisis. With regard to the second period (1998), the results indicate a closer link among the stock market returns of the crisis-affected economies (Table 12.10). In particular, the KOSPI was influenced by the returns in the ASEAN

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0.384 0.296

Average for ASEAN

Total Average

Source: Cavoli, Rajan, and Siregar (2003).

1.000 0.324 0.408 0.421 0.254 0.313 0.053

Indonesia Philippines Thailand Singapore South Korea Hong Kong USA

Indonesia

0.419

0.517

0.324 1.000 0.622 0.606 0.259 0.482 0.223

Philippines

0.465

0.569

0.408 0.622 1.000 0.677 0.304 0.577 0.199

Thailand

0.475

0.568

0.421 0.606 0.677 1.000 0.251 0.687 0.209

Singapore

Table 12.7 Correlations of the Stock Exchange Returns (1 January – 31 December 1998)

0.311

0.267

0.254 0.259 0.304 0.251 1.000 0.246 0.055

South Korea

0.432

0.515

0.313 0.482 0.577 0.687 0.246 1.000 0.289

Hong Kong

0.171

0.171

0.053 0.223 0.199 0.209 0.055 0.289 1.000

USA

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0.357 0.114

Average for ASEAN

Total Average

Source: Cavoli, Rajan, and Siregar (2003).

1.000 0.133 0.074 0.150 0.162 0.151 0.015

Indonesia Philippines Thailand Singapore South Korea Hong Kong USA

Indonesia

0.158

0.186

0.133 1.000 0.232 0.193 0.168 0.229 –0.005

Philippines

0.227

0.231

0.074 0.233 1.000 0.386 0.341 0.369 –0.043

Thailand

0.305

0.243

0.150 0.193 0.386 1.000 0.476 0.585 0.041

Singapore

Table 12.8 Correlations of the Stock Exchange Returns (1 January 2000 – 30 June 2001)

0.289

0.287

0.162 0.168 0.341 0.476 1.000 0.538 0.049

South Korea

0.306

0.334

0.151 0.229 0.369 0.585 0.538 1.000 –0.036

Hong Kong

0.004

0.002

0.015 –0.005 –0.043 0.041 0.049 –0.036 1.000

USA

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Table 12.9 Granger Causality on the Stock Exchange Returns (1 January – 31 December 1996) Null Hypothesis

# of Obs (Lags)

Hong Kong does not Granger cause Indonesia Hong Kong does not Granger cause Malaysia Hong Kong does not Granger cause Thailand Indonesia does not Granger cause Malaysia Indonesia does not Granger cause Hong Kong Malaysia does not Granger cause Hong Kong Malaysia does not Granger cause Singapore Philippines does not Granger cause Indonesia Philippines does not Granger cause Thailand Thailand does not Granger cause Indonesia Thailand does not Granger cause Philippines Singapore does not Granger cause Indonesia Singapore does not Granger cause Malaysia USA does not Granger cause Hong Kong USA does not Granger cause Indonesia USA does not Granger cause Malaysia USA does not Granger cause Philippines USA does not Granger cause Singapore

242 242 242 242 242 242 242 242 242 242 242 242 242 242 242 242 242 242

(2) (2) (2) (2) (2) (2) (4) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2)

F-stats (Prob) 9.9080 2.5121 2.2404 2.3579 5.0705 3.4824 2.1104 2.3529 6.9427 4.9711 3.7774 5.6611 3.4478 54.515 11.081 14.956 7.2885 20.033

(0.0001) (0.0832) (0.1000) (0.0968) (0.0069) (0.0323) (0.0803) (0.0973) (0.0018) (0.0077) (0.0243) (0.0039) (0.0334) (0.0000) (0.0000) (0.0000) (0.0000) (0.0000)

Source: Cavoli, Rajan, and Siregar (2003).

capital markets (except the Philippines), while reciprocally, the returns on the KOSPI significantly Granger caused the returns of two markets in ASEAN (the Philippines and Thailand) and Hong Kong. Not surprisingly, the test results reveal that the two worst crisis-affected stock exchanges, those in Indonesia and Thailand, had the most widespread negative spillover effects at the peak of the 1997 crisis. In contrast, the performance of the Jakarta Stock Exchange was influenced only by the performance of the Dow Jones, while the returns on the Thai stock exchange were significantly influenced by the performances of the Jakarta Stock Exchange, the KOSPI, and the Dow Jones. The Singapore stock exchange had limited impact on the region, only significantly Granger causing two markets — South Korea and the Philippines. The returns on the ASEAN markets (Indonesia, the Philippines, and Thailand) significantly determined the performance of the Singapore stock exchange. Due to the adoption of the comprehensive foreign exchange and capital controls in Malaysia during late 1998, the Kuala Lumpur Stock Exchange (KLSE) is excluded from the testing for the crisis and the post-crisis periods. As for the Dow Jones, the Granger-causality test statistics indicate that the performance of this key global market remains the most important market for the rest of East Asia.18

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Table 12.10 Granger Causality on the Stock Exchange Returns (1 January – 31 December 1998) Null Hypothesis

# of Obs (Lags)

Hong Kong does not Granger cause South Korea Hong Kong does not Granger cause Philippines Indonesia does not Granger cause Hong Kong Indonesia does not Granger cause South Korea Indonesia does not Granger cause Singapore Indonesia does not Granger cause Philippines Indonesia does not Granger cause Thailand Indonesia does not Granger cause USA South Korea does not Granger cause Philippines South Korea does not Granger cause Thailand South Korea does not Granger cause Hong Kong Philippines does not Granger cause Hong Kong Philippines does not Granger cause USA Philippines does not Granger cause Singapore Thailand does not Granger cause Hong Kong Thailand does not Granger cause South Korea Thailand does not Granger cause Philippines Thailand does not Granger cause Singapore Thailand does not Granger cause USA Singapore does not Granger cause South Korea Singapore does not Granger cause Philippines USA does not Granger cause Hong Kong USA does not Granger cause Indonesia USA does not Granger cause South Korea USA does not Granger cause Philippines USA does not Granger cause Thailand USA does not Granger cause Singapore

249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249 249

(2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2)

F-stats (Prob) 2.9842 3.3062 11.388 3.6757 4.7085 5.8752 4.1054 5.0108 7.7611 4.6059 3.7780 10.557 4.1743 6.1567 8.4097 2.6809 3.4172 2.8589 3.1102 4.1467 2.3565 9.6092 3.1401 3.6214 10.070 10.026 3.2541

(0.0525) (0.0383) (0.0000) (0.0268) (0.0099) (0.0032) (0.0176) (0.0074) (0.0005) (0.0109) (0.0242) (0.0000) (0.0165) (0.0025) (0.0003) (0.0705) (0.0344) (0.0593) (0.0464) (0.0169) (0.0969) (0.0000) (0.0451) (0.0282) (0.0000) (0.0000) (0.0403)

Note: Malaysia is excluded due to the capital control policy and fixed exchange rate policy adopted in September 1998. Source: Cavoli, Rajan, and Siregar (2003).

The Hong Kong Hang Seng Index only Granger caused the South Korean and the Philippine markets. Consistent with the correlation test statistics, the results for the postcrisis period (2000–01) reveal a pointed fall in the degree of regional equity market integration (Table 12.11). The returns on the Jakarta and the Philippine exchanges had no significant influence on any other regional market. As for South Korea, Singapore, and Thailand, the performances of these markets are only found to have significant effects on the stock markets in Indonesia and the Philippines. With regard to the previous sub-periods, the Dow Jones continues to be an important player. This is consistent with

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Table 12.11 Granger Causality on the Stock Exchange Returns (1 January 2000 – 1 July 2001) Null Hypothesis

# of Obs (Lags)

Hong Kong does not Granger cause Singapore South Korea does Granger cause Philippines South Korea does Granger cause Thailand Singapore does Granger cause Philippines Singapore does Granger cause Indonesia Thailand does Granger cause Philippines Thailand does Granger cause Indonesia USA does Granger cause Hong Kong USA does Granger cause South Korea USA does Granger cause Philippines USA does Granger cause Singapore USA does Granger cause Thailand

388 388 388 388 388 388 388 388 388 388 388 388

(2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2)

F-stats (Prob) 3.4139 7.0784 4.3598 3.2728 2.6593 4.3080 2.7565 53.262 24.342 6.0886 31.812 7.9173

(0.0339) (0.0009) (0.0135) (0.0390) (0.0714) (0.0132) (0.0648) (0.0000) (0.0000) (0.0025) (0.0000) (0.0004)

Note: Malaysia is excluded due to the capital control policy and fixed exchange rate policy adopted in September 1998. Source: Cavoli, Rajan, and Siregar (2003).

the findings of Park and Bae (2002) who further conclude that developing East Asian stock markets appear to be more integrated with the U.S. market than with Japan’s (p. 19). 4. Other Measures of Financial Integration Whichever arbitrage measure of financial integration is considered, there are two important points to note. One, arbitrage conditions are probably a more appropriate way of measuring integration for certain sectors (for example, the banking sector) rather than the whole economy (Chinn and Dooley 1995). Two, a perennial problem with using such price measures, especially in developing economies, is what interest rate should be used, and to what extent are the available interest rates comparable across countries. Given these concerns, there is a growing body of literature that has explored quantitybased measures of financial integration, such as savings–investment correlations and consumption correlations. There is limited empirical evidence on East Asia using such quantity measures. In any event, as with RIP, the quantitybased measures are probably more relevant over a much longer run and are more all-encompassing measures of integration (that is, financial-cum-real sector integration). Consequently, in the remainder of this section we concentrate on other regulatory measures of financial integration as well as the extent of equity market integration.19

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4.1. Regulatory Measures: Capital Controls Capital controls are often placed under the category of financial liberalization — rather than integration — but their connection to financial integration is straightforward. Financial liberalization is basically the process that policymakers engage in when attempting to achieve greater financial integration. We can measure the degree of financial integration by observing the extent to which a country has capital controls and we can assess whether a country is becoming more or less integrated by observing whether controls are being imposed or removed over time. The types of controls that might be in place are numerous (for instance, see Bird and Rajan 2000). Park and Bae (2002) specify three general categories that might be imposed: (1) those that relate to financial market regulations such as legislative control over deposit rates; (2) restrictions on capital account transactions such as restrictions on term or currency; and (3) regulations relating to the entry and exit of foreign financial services (see also Bird and Rajan 2001). How are these restrictions used to measure the extent of financial integration? A well-known paper is that by Grilli and Milesi-Ferretti (1995), who use the restrictions captured by the IMF Annual Report on Exchange Arrangements and Exchange Restrictions as dummy variables to measure their effect on variables such as capital flows. Johnston et al. (1999) do a similar thing using further disaggregated data (forty-four categories of capital account transactions). Table 12.12 reports the results for the Asian sample using the Johnston et al. index. It reveals a marked reduction in capital controls in South Korea and an increase in the extent of controls in Malaysia. These observations are consistent with the general observation of policy choices of the two economies in the latter half of the 1990s. The index also indicates a generally stable though gradual declining trend in capital account barriers in the cases of Indonesia and Thailand. Elson (2002) computes the extent of capital controls on eleven categories of capital account restrictions between 1995 and 2001 based on the International Monetary Fund (IMF) data. As Table 12.13 reveals, Hong Kong, Singapore, and Japan are the least restricted while China and India are the most restricted. There is little change in the extent of capital account restrictiveness in Indonesia and South Korea, but Malaysia and Thailand appear to have become more restricted. The IMF summary descriptions on capital account restrictions are highly aggregative and insufficiently informative. For instance, South Korea has taken a number of steps in the

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Table 12.12 Degree of Capital Controls

1995 1996 1997 1998 1999

Indonesia

South Korea

Malaysia

Thailand

0.53 0.53 0.51 0.48 0.49

0.68 0.67 0.58 0.48 0.42

0.71 0.71 0.71 0.76 0.76

0.72 0.72 0.70 0.70 0.70

Notes: 1. Based on Johnston et al. (1999) index. 2. Decline implies fewer restrictions. Source: Park and Bae (2002).

post-crisis period to relax prohibitions on foreign investment in the domestic share market. This is apparent from Table 12.14, which reveals the proportion of each market which is accessible to investors based on data from the Standard & Poor’s/International Finance Corporation (S&P/IFC). 20 Indonesia also appears to have lifted a number of restrictions on foreign investment since 1996, as has Thailand, though the latter remains highly restrictive. The level of restrictions on foreign participation in the Philippines has remained constant and is comparable to Thailand. China and India remain the most restricted, though there is a discernible trend towards a more liberal environment, especially in the former, which had been extremely tightly controlled until the mid-1990s. A fundamental assumption with all such indices of capital controls is that the removal of capital controls may, in some way, result in a more financially integrated economy. This may not be the case. There could well exist a situation where a country has very few capital controls and is yet not regarded as being integrated with other economies. This could be due to legal/political factors, cultural variables, business practices, or simply that the economy has not been noticed by others as a potential place to export capital flow, that is, it has “escaped the radar” of the international financial community. 5. Sequencing of Economic Integration: Financial Integration versus Monetary Integration The preceding section suggests that there is no obvious indication of intensified financial market integration in the region on the whole. The three East Asian financial centres and high-income economies of Hong Kong, Japan, and

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N N N N N N N N N N N 0/11

N N N N N N N N N N N 0/11

HK

Y Y Y Y Y Y Y Y Y Y Y 11/11

Y Y Y Y Y Y Y Y Y Y – 10/10

India

Y Y Y Y Y Y Y Y N Y N 9/11

Y – Y Y Y Y Y Y N Y N 8/10

Indo

Y Y Y Y Y Y Y Y N Y Y 10/11

2001 N N N N N Y N N N N N 1/11

Kor

Y Y Y Y Y Y Y Y N Y – 9/10

1995 Y Y N N N Y N N N N N 3/11

Jap

Y Y Y Y Y Y Y Y N Y Y 10/11

Y Y Y Y Y Y Y Y N Y N 9/11

Mal

Y Y Y Y Y Y Y Y N Y Y 10/11

Y Y Y Y Y Y Y Y N Y Y 10/11

Phi

Y N N Y N Y N N N Y N 4/11

N N N N Y Y N N N Y N 3/11

Sin

Source: Elson (2002) based on data from Annual Report on Exchange Arrangements and Exchange Restrictions (IMF).

Capital market securities Y Money market instruments Y Collective investment securities Y Derivatives and other instruments Y Commercial credits Y Financial credits Y Guarantees, sureties, financial facilities Y Direct investment Y Liquidation of direct investment Y Real estate transactions Y Personal capital movements Y Ratio of Y to Total 11/11

Type of Restriction

Capital market securities Y Money market instruments Y Collective investment securities Y Derivatives and other instruments Y Commercial credits Y Financial credits Y Guarantees, sureties, financial facilities Y Direct investment Y Liquidation of direct investment N Real estate transactions Y Personal capital movements Y Ratio of Y to Total 10/11

Type of Restriction

China

Table 12.13 Coverage of Capital Controls in Selected Asian Economies

Y Y Y Y N Y Y Y N Y Y 9/11

Y Y Y Y N Y N Y N Y N 7/11

Tha

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Table 12.14 Foreign Investment Ceiling for Listed Stocks in Selected Asian Markets, 1993–20011 (In percentages)

China India Indonesia South Korea Malaysia Philippines Thailand

1993

1994

1995

1996

1997

1998

1999

2000 20012

– 20.2 47.8 9.6 68.2 50.1 28.2

9.9 21.6 50.4 11.1 82.7 54.0 27.8

7.7 23.4 52.1 13.8 83.5 53.0 29.7

12.3 25.7 62.0 22.1 91.9 45.9 34.1

10.2 28.9 97.7 54.5 93.6 48.3 47.0

24.6 26.5 97.7 91.2 94.2 47.7 53.8

37.4 28.3 96.1 93.8 95.9 47.4 52.6

34.9 29.1 80.4 87.0 95.2 46.2 53.4

34.6 32.2 81.9 94.9 96.1 47.2 50.9

Notes: 1 Ratio of market capitalization of the Investable index (IFCI) and the global index (IFCG). 2 Based on end-November data. Source: Elson (2002).

Singapore are quite highly integrated with global capital markets. The recent pace of liberalization in South Korea in the post-crisis period is also intensifying the country’s extent of international financial integration. The lower middleincome ASEAN economies, Thailand and Indonesia as well as the Philippines, are relatively less financially integrated, though evidence suggests a gradual movement towards enhanced integration. The evidence on Malaysia is somewhat mixed. While not tested here due to data limitations, it is expected that the other smaller ASEAN economies (Brunei, Cambodia, Lao PDR, Myanmar, and Vietnam) are relatively segmented from regional and international capital markets, particularly in view of the heterogeneity of their financial structures vis-à-vis their more developed counterparts. As these countries and their neighbours continue with their ongoing liberalization efforts, one would expect their effective degree of financial integration to intensify. Nonetheless, it is unclear whether this necessarily implies that there would be a relatively greater degree of intra-regional integration. It is quite likely that the East Asian economies would get more closely integrated to international financial centres (in the United States and United Kingdom) rather than with regional ones (Elson 2002; Park and Bae 2002). In view of this, some observers have pointed out that there is not necessarily a direct link between financial liberalization, which may lead to

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more internationally integrated economies, on the one hand, and regional monetary integration on the other. For instance, Park and Bae (2002) conclude: [T]he growing dominance of western financial institutions and advances in financial globalization would diversify and deepen the region’s ties with global financial markets…[F]inancial liberalization leaves uncertain as to whether it will generate incentives to market pressure for the East Asian countries to join and remain in a regional common currency area (p. 34).

In contrast to this conclusion, McCauley et al. (2002) argue that when one considers the international bond and syndicated loan markets: East Asia’s finances are more integrated than is often appreciated. While firms headquartered outside the region figured prominently in the roles of book runners and loan arrangers, regional funds and banks are very well represented among the underlying investors, in the case of bonds, and among syndicate members, in the case of loans (p. 83).

But even assuming that financial liberalization does lead to greater regional financial integration, what does this imply for prospects for or viability of a regional common currency? The economic case for or against monetary integration inevitably tends to be based on the optimum currency area (OCA) criteria which are conceived in terms of weighing the microeconomic benefits of a common currency (that is, lower transactions costs, ability to economize on reserve holdings, reduction in regional price discrimination, and elimination of other costs of interregional exchange rate uncertainty), against the costs of forsaking exchange rate adjustments as a policy instrument and loss of monetary policy autonomy (Mundell 1961). So if a region does succeed in becoming more closely financially integrated, does it suggest that it is any closer to satisfying the conditions for being an OCA, therefore making a common currency more economically feasible? The answer to this question is not clear-cut. Indeed, the conventional OCA literature is rather unclear on the issue of financial integration (for instance, see Willett 2001). One, at a basic level, financial integration implies an enhanced degree of capital mobility and a consequent loss of monetary policy autonomy. This being the case, the next step to creating a common regional currency may not be very costly and could offer participants a number of microeconomic benefits. Indeed, forsaking monetary policy autonomy may be least costly — and offer greatest net benefits — to small and open emerging economies in view of the ongoing concerns about the general effectiveness of exchange rate

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adjustments as a demand management policy instrument in such economies, which tend to be characterized by high pass through (McKinnon 1963) and unhedged foreign currency debt (Frankel et al. 2000; Hausmann et al. 2000; McKinnon and Schnabl 2003).21 Two, as pointed out early on by Mundell (1973), agents in countries with open capital accounts are able to adjust their portfolio wealth holdings in response to country-specific shocks (by borrowing or lending/investing abroad) or can cushion themselves from idiosyncratic shocks by drawing on income on foreign asset holdings (rentals, dividends, etc). To the extent that this portfolio adjustment or income insurance mechanism reduces the need for exchange rate adjustments in the event of asymmetric shocks (that is, a shock that affects members of a union disproportionately), financial integration could help the region go some way towards satisfying the OCA criteria (see also Ingram 1973; Kalemi-Ozcan, Sorensen, and Yosha 2003).22 Three, a greater degree of financial integration implies that the regional economies are more likely to be similarly affected by common external/ symmetric shocks. For instance, it is generally accepted that currency crises often tend to have a regional dimension (for instance, see De Gregario and Valdes 2001; Krueger, Osakwe, and Page 2000) which in turn are largely — though not solely — attributable to financial linkages (either ex-ante or ex-post) (see Rajan 2003c and references cited within). Four, intensified financial integration may facilitate real sector integration. For instance, it is generally recognized that cross-border trade financing is a crucial determinant of trade flows. Similarly, FDI flows require complementary project financing. (As a rule of thumb, in the case of emerging economies in Asia, equity financing tends to constitute about a quarter of total project cost, the remainder being financed by lending — usually bank lending but increasingly through the bond markets.) The more financially integrated a region the more likely that some sort of trade and investment financing is available, thus ensuring real sector integration can take place unhindered.23 But does closer trade integration imply that a region is closer or further away from being an OCA? On the one hand, greater trade integration leads to a convergence in aggregate demand patterns in the trade partners, making them more likely to share common business cycles, making unilateral exchange rate adjustments relatively ineffective as an expenditure switching tool (Frankel and Rose 1998). On the other hand, if intra-regional trade is dominated by industrial specialization and inter-industry trade, or intra-industry trade involving vertical specialization (Rajan 2003b), the countries’ production

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structures may actually become more dissimilar and thus more vulnerable to asymmetric supply shocks.24 This in turn could weaken the case for monetary integration since independent monetary tools or a flexible exchange rate may be needed to compensate for asymmetrical shocks (Krugman 1993; Eichengreen 1992). It is, therefore, an empirical issue as to which of these effects will dominate. There is a growing body of literature which suggests that the tendency towards specialization in production could be fortified as financial integration permits the diversification or sharing of risks internationally (that is, insurance through financial markets), hence allowing firms to locate production in one country and benefit from scale economies (or market-size effects and linkages), ample labour markets, and pure external economies (Kalemi-Ozcan, Sorensen, and Yosha 2001, 2003).25 This consequent lower degree of industrial diversification in turn makes countries more susceptible to idiosyncratic — that is, sector-specific — shocks and, therefore, less likely to satisfy OCA criteria (Kenen 1969).26 This suggests that even while financial integration may exacerbate supply side asymmetries between members, synchronization of business cycles may not be a prerequisite for sharing a common currency if agents could insure themselves in international financial markets. Indeed, from the perspective of international risk-sharing it would be preferable if member economies’ financial market returns were not synchronized. Thus, there is a case for ensuring that the common currency area covers as wide an area as possible (Mundell 1973). Overall, it is far from clear whether financial integration makes a common regional currency more feasible. Indeed, by reducing transactions and information costs, a single currency may facilitate trade and financial flows among partners in a regional financial arrangement. There is a large and growing body of evidence based on gravity models using both cross-sectional and time series data that suggests a common currency stimulates trade.27 Similarly, and less controversially, it is generally recognized that elimination of costs that invariably exist with segmented domestic financial markets, as well as convergence in macro policies and micro-prudential statutes and regulations, would deepen and broaden regional financial markets and lessen the degree of intra-regional financial segmentation.28 Proponents of European integration used such an argument extensively to justify the region’s Economic and Monetary Union and seem to have been proved correct, at least in the case of the financial markets (Danthine, Giavazzi, and von Thadden 2000). In other words, OCA criteria may be endogenous, that is, the structure of the economy is endogenous to economic policy.29

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6. Summary and Concluding Remarks While the regional economies are taking noteworthy steps to strengthen, upgrade, and integrate their financial systems, the contagious nature of the 1997–98 crisis has led many observers and policy-makers to the view that there are positive externalities from co-operating to develop regional financial markets. While there have been a number of recent proposals and initiatives to enhance regional financial co-operation, many pertain to the development of regional bond markets. The latest manifestation of this has been the announcement on 2 June 2003 of the establishment of the Asian Bond Fund (ABF) by eleven East Asian and Pacific economies which essentially involves the regional governments voluntarily contributing about 1 per cent each of their reserves to a fund dedicated to purchasing regional sovereign and semisovereign bonds denominated in U.S. dollars (Rajan 2003a).30 Another proposal that is running in parallel with the ABF initiative involves the creation of an Asian Bond Corporation (ABC) which would purchase regional sovereign bonds denominated in domestic currencies, while simultaneously creating and issuing Asian currency bonds which are denominated in a basket of regional currencies (Ito 2003). The impetus behind the development of these initiatives is that if regional economies hold one another’s bonds, this ought to facilitate diversification of financing from bank lending to bond financing.31 This is particularly so if such actions help lower risk premiums of regional bonds, hence encouraging others to enter the market. But why is there a need to diversify away from bank lending? What is wrong with Asia’s continued heavy dependence on bank lending as a source of private market financing?32 Bond financing is considered a relatively more stable source of debt financing, as bank loans are primarily illiquid, fixed-price assets in the sense that the interest rate — which is the price of the loan — does not vary much on the basis of changing market circumstances. Thus, almost all the adjustment has to take place through rises and falls in the quantity of bank lending, which in turn leads to sharp booms and busts in bank flows. These sudden reversals in bank flows had calamitous and long-lasting effects on the domestic financial systems in the East Asian economies in 1997–98 (Rajan 2002b). In addition, if the regional bonds are issued in domestic or regional currencies as opposed to third-country ones (mainly the U.S. dollar), this in turn ought to reduce the vulnerability of the regional economies to currency mismatches). This is where the ABF, which only involves U.S. dollar denominated bonds, is found wanting compared to the ABC proposal.33

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While the successful implementation of these financial market initiatives ought to bolster the extent of regional financial integration, it is critical that they do not detract from domestic structural reforms to broaden and deepen individual capital markets. After all, a regional alliance is only as strong as its weakest link.34 In addition, any regional initiative must keep in mind the transactions costs of setting up such a scheme. Even if the ASEAN/East Asian economies do strengthen financial and, for that matter, trade links, does that necessarily imply that the region is any closer to monetary integration, that is, a common currency? As noted, there appears to be a complex and bi-directional nexus between monetary integration, on the one hand, and financial integration on the other. So the theory is not unambiguous. It may well be that monetary integration gives rise to selfvalidating processes which facilitate financial and overall economic integration. However, given the divergence in economic and institutional structures in the region, any attempt to create a common currency without macroeconomic policy co-ordination and a mechanism for automatic intraregional fiscal transfers is far too risky and premature and will, in all likelihood, be a failure, setting back prospects for other forms of economic integration. Of course, one might always argue that there is a degree of endogeneity in all OCA criteria. Willett (2001) notes that “if a country is close to meeting the criteria ex-ante, it may be wise to go ahead on the basis of the prediction that the criteria will indeed be met ex-post”. However, he goes on to add: “It would be dangerous to assume substantial rapid change...” (p. 18). Others like Goodhart (1995) dispute the relevance of economic criteria altogether, claiming that political consideration dominates the formation of currency areas. Eichengreen (2002b) notes: “If monetary union was attractive to Europe because it was integral to the larger project of economic integration, then it was feasible because it was part of the larger process of political integration” (p. 6).35 This type of political consensus, while gradually emerging in ASEAN and the larger East Asian region, is still far from being universal. To be sure, while “vision statements” by regional leaders for a currency union have become more common since the financial crisis, they have not been backed up by any serious discussion on the type of institutional structures or formal mechanisms and decision-making bodies needed for such regional economic integration of monetary and exchange rate policies to be a success (such as an independent, region-wide central bank, a system of inter-regional risk-sharing arrangements to facilitate fiscal transfers for redistributing income intraregionally, measures to ensure European-type macroeconomic convergence,

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and the like). In addition, substantial asymmetries in the sizes, levels, and stages of economic development of the economies in East Asia, on the one hand, and the de facto policy of strict non-intervention in one another’s affairs (economic and particularly political), on the other, makes it extremely difficult to envisage the successful introduction of “tie-in” clauses to create punishment mechanisms to ensure conformity of economic policies as was done in Europe. In the final analysis, Kenen’s (2000) general conclusion that solving the problems of governance and accountability needed to form a currency union may be far too herculean a task for most other groups of countries outside Europe appears especially pertinent to ASEAN and the larger East Asian region in the foreseeable future (see also Rajan 2002a). Thus, the balance of judgments suggests that from a practical policy perspective the aim should be to continue with steps to enhance financial and economic co-operation by reducing distortions and barriers to cross-border economic activity. As the regional economies get more interdependent, are more synchronized in terms of business cycles, experience greater convergence in economic structures, macroeconomic policies, and economic capacities, and develop greater labour market flexibility, then and only then should there be a serious attempt at a more formal monetary integration (Bayoumi, Eichengreen, and Mauro 2000). Even Europe, which appears to have experienced a greater degree of de facto economic integration post-monetary integration, expended a great deal of effort into ensuring satisfaction of preconditions prior to monetary integration (Eichengreen 2002c). Any attempt by ASEAN or the larger East Asia at a formal monetary integration in the near future is putting the cart before the horse and is doomed to failure; deeper integration is unlikely to occur dynamically following monetary integration. In this regard, Eichengreen (2002c) notes: The effort to construct a regional exchange rate stabilization agreement would only come to grief and discredit the wider project of economic integration. And, given the resistance in Asia to building strong regional institutions and countries’ lack of enthusiasm for political integration, a more ambitious step like a single Asian currency remains social science fiction” (p. 13).36

Given that monetary integration should only be a much, much longerterm goal, does this imply that efforts to promote closer regional monetary ties ought to be eschewed entirely for the time being? The answer surely is no. Eichengreen (2002a) reaches a similar conclusion, arguing that while monetary co-operation per se “is the wrong project for Asia…there is a case

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for cooperation to deepen and strengthen regional financial markets” (p. 17). As noted, the East Asian economies are taking steps in this direction. In addition, the regional economies ought to continue taking steps to promote regional monetary co-operation by fortifying regional liquidity arrangements like the Chiang Mai Initiative (CMI) and exert greater efforts at promoting serious macroeconomic policy dialogue and transparency of data and policy actions.37 In this regard, a natural starting point would be to continue to strengthen the ASEAN Surveillance Process (ASP) (Bird and Rajan 2002; Rajan 2000; Rajan and Siregar 2003). A major limitation of the ASP as it is currently structured is that there are no fact-finding missions as with the IMF. Participating governments (finance ministry and central bank officials) offer information to the ASP directly. Thus, the effectiveness of regional surveillance is still highly limited. Whether member countries are willing and able to move beyond the current peer review process to more formally engage one another, and confront/be ready to be confronted in the event of profligate policies, is unclear.38 However, as long as ASEAN members hesitate to be anything but fully open to “straight talk”, they should eschew any pretensions of wanting to create a common currency, or for that matter, any initiative that involves deep integration. A broad-based economic approach to integration that has been suggested as a means of fostering a “community spirit” in ASEAN is more realistic. In this regard, greater effort must be expended by ASEAN members to address and bridge the large and growing income gap between regional members. While a simple answer to this would be to pursue a two-tier or twospeed integration process — a preferred solution thus far — the concern with this strategy is that the degree of cohesiveness and, therefore, overall effectiveness of ASEAN may be eroded to the detriment of all members.

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Appendix 12.1 ASEAN Plus Three (APT) Bilateral Swap Arrangements under the Chiang Mai Initiative (as of Early 2003) Bilateral Swap Arrangements (BSAs)1

Currencies

Status

Size

Japan–South Korea US$/Won Concluded / 4 July 2001 Japan–Thailand US$/Baht Concluded / 30 July 2001 Japan–Philippines US$/Peso Concluded / 27 August 2001 Japan–Malaysia US$/Ringgit Concluded / 5 October 2001 China–Thailand US$/Baht Concluded / 6 December 2001 Japan–China2 Yen/Renminbi Concluded / 28 March 2002 Renminbi/Won Concluded / 24 June 2002 China–South Korea3 Concluded / 25 June 2002 South Korea–Thailand4 US$-Won/Baht South Korea–Malaysia4 US$-Won/Ringgit Concluded / 26 July 2002 US$/Peso Concluded / 9 August 2002 South Korea–Philippines4 China–Malaysia US$/Ringgit Concluded / 9 October 2002 Japan–Indonesia US$/Rupiah Concluded / 17 February 2003 China–Philippines Under negotiation Japan–Singapore Negotiations recently concluded Notes:

US$2.0 billion US$3.0 billion US$3.0 billion US$1.0 billion US$2.0 billion US$3.0 billion US$2.0 billion US$1.0 billion US$1.0 billion US$1.0 billion US$1.5 billion US$3.0 billion

1

These are in addition to the bilateral swaps amounting to US$7.5 billion that Japan is providing to South Korea and Malaysia under the New Miyazawa Initiative. 2 The Japan–China BSA is a two-way yen/renminbi swap arrangement where each party can request the other party to provide liquidity support in the specified currency up to the agreed amount. The overall availability for this BSA is, therefore, US$6 billion (equivalent) though the face value of the BSA is US$3 billion (equivalent). 3 The China–South Korea BSA is a two-way renminbi/won swap agreement where China and the Bank of Korea shall make available to each other convertible currencies equivalent to US$2 billion (US$4 billion in total) when necessary to overcome balance of payments difficulties. 4 A two-way swap transaction of U.S. dollars against the local currency in which either party could request the other party to enter into the swap transaction with the maximum drawing amount of US$1 billion; therefore it totals US$2 billion. Source: ADB (2003).

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NOTES This chapter draws and builds upon previous joint works by the author with Graham Bird, Tony Cavoli, and Reza Siregar. Assistance with data by Rahul Sen and comments by James Dean, Mohamed Ariff, Tom Willett, and ISEAS workshop participants helped in enhancing the quality of the paper, as did discussions with Richard Pomfret. This chapter was completed in December 2003 while the author was a Visiting Freeman Scholar at the Department of Economics, Claremont McKenna College. The author is grateful for the generous support provided by the Freeman Foundation as well as for the excellent research facilities made available to him at the Lowe Institute of Political Economy. 1. The economic rise of China and India ought to have longer-run benefits for ASEAN, though short-term adjustment costs are inevitable (Rajan 2003b). 2. See Fam (2003) for a discussion on the impact of SARS on Asian economies. 3. While details of the EAI remain unclear, the proposal essentially offers ASEAN economies the opportunity to sign bilateral trade pacts with the United States provided that they are members of the World Trade Organization (WTO) and signatories to trade and investment facilitations agreements (TIFAs) with the United States (implying that Malaysia and the non-WTO ASEAN members, that is, Cambodia, Lao PDR, and Vietnam, remain ineligible for the time being). While the EAI is viewed as a means of eventually networking ASEAN with the United States seamlessly, the initiative appears to have less to do with economics than it does with symbolism regarding the commitment of the United States to the ASEAN region at a time of global security and political tensions (Lien 2002). 4. We use the terms currency union, common currency, monetary union, and monetary integration interchangeably in this chapter. 5. The ASEAN Finance Ministers meeting in 19–20 March 1999 endorsed a plan for a Task Force to be established to study the feasibility of establishing an ASEAN common currency. 6. There have been recent suggestions that while the APT is a useful starting point it ought to be expanded to include Hong Kong, Taiwan, as well as India, which is a full dialogue partner and is one of the world’s fastest-growing economies. Another prominent suggestion is to extend effective membership to Australia and New Zealand (ISEAS 2003, Appendix 1). 7. Another arbitrage condition is the closed interest parity condition which essentially states that the returns on identical instruments of the same currency but traded in different markets (such as onshore and offshore markets) should be equalized. Any deviation arising from this condition can be interpreted as possible evidence of the existence of capital controls in one of the two countries or the existence of other political or country risks that may prevent interest rate equalization. The measurement of the closed interest differential is difficult for developing economies as it requires that a particular asset is traded sufficiently for there to be a liquid offshore market for it (see Frankel and Okwongu 1996).

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8. Despite its widespread application in the literature, strong objections have been raised against the use of the CIP as a measure of financial integration. See Willett, Keil, and Ahn (2002) and sub-section 2.4. 9. Throughout this chapter, the exchange rate is quoted as the domestic price of foreign currency. 10. The non-zero constant may be due to the presence of non-zero risk premiums (country or currency). 11. The RIP may be thought of as a proxy for the marginal cost of capital. 12. McCallum (1994) also believes that deviations from the UIP may be due to monetary policy decisions of central banks and proposes that a monetary policy reaction function be included in an expression for the UID. Bird and Rajan (2001) and Rajan, Siregar, and Sugema (2003) offer bank-based explanations for persistent interest rate differentials in East Asia. Also see Edwards and Khan (1985) and Willett, Keil, and Ahn (2002). 13. In fact, the UIP may also be more valid over longer time horizons — over one year (see Madarassy and Chinn 2002; Meredith and Chinn 1999). 14. Also see Park and Bae (2002) who use a series of common statistical tests to examine East Asian financial integration. The use of asset-pricing models has also become an increasingly popular technique to examine the degree of stock market integration (for instance, see Bekaert and Harvey 1995; Phylaktis and Ravazzolo 2002). 15. Dungey and Zhumabekova (2001) and Forbes and Rigobon (2001) offer important reminders about the shortcomings of correlation analysis, particularly for crisis periods. 16. The East Asian equity markets may be more closely correlated with the technologyheavy NASDAQ index. However, Amato and Tsatsaronis (2001) cast doubt on this thesis. 17. This directly contradicts the conclusion based on UIDs. 18. This contradicts the results of the correlation tests. 19. As noted in the Introduction, institutional measures are not taken up here. 20. Edison and Warnock (2001) use these data to construct a univariate quantitative measure of the degree of capital controls in developing economies. For their sample of Asian economies (the data used are of monthly frequency from 1988 to 2000), Edison and Warnock find that the initial restrictions were generally “quite high” but decreased markedly during the 1990s. The exceptions were the Philippines, whose level of controls remained fairly constant over the time period under consideration, and Malaysia, which appeared to have very few restrictions to begin with, but increased them significantly in the aftermath of the crisis as noted previously. The authors also compare their measure with some of the other techniques for measuring capital controls and find broad concurrence in the results. For a more complete comparison of various capital control measures, see Nitithanprapas, Rongala, and Willett (2002).

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21. As Pomfret (2003) notes, OCA literature implicitly assumes a “background of optimum monetary policy” (p. 17). Buiter (2000) refers to the “fine tuning fallacy” behind OCA theory (p. 49). 22. For a recent attempt at formalizing this insight, see Ching and Devereux (2000). Absent the risk-sharing mechanism and insufficient intra-regional mobility of other factors, a union requires compensatory intra-regional fiscal transfers to buffer against asymmetric shocks. 23. Conversely, bilateral trade flows appear to be an important determinant of crosscountry financial linkages (Forbes and Chinn 2003). In addition, trade agreements nowadays encourage financial trade liberalization, thus facilitating integration of capital markets (Rajan and Sen 2002). On the other hand, while higher integration lowers transactions costs, thus promoting greater intra-regional investment, insofar as it leads to synchronized business cycles and rates of return, there may be a case for increased diversification across sectors or regions. 24. Imbs (2003) confirms the direct impact of patterns of specialization on business cycle correlations. 25. While there is a growing body of business cycle literature examining this nexus, it is curious that trade patterns and production structures are considered in highfrequency business cycle theories and empirics despite the fact that they presumably change only gradually over time. There is a burgeoning body of literature examining the extent of correlation of business cycles or similarity of shocks (a la Blanchard and Quah 1989) in Asia. We do not examine this literature here, only noting that there has not yet been a systematic attempt to examine whether these business cycle correlations have been due to closer financial or trade integration in Asia. 26. This phenomenon of “firm-congestion” or bunching together spatially may in turn exacerbate intra-regional income inequities, at least in the short run. The rationale for firms not specializing geographically in the first instance may have been because of trade barriers or inability to obtain the necessary trade financing without a physical presence abroad. 27. Rose and Engel (2002) argue that a common currency area significantly increases international business cycle correlations. Frankel and Rose (2002), Glick and Rose (2002), and Rose (2000) estimate gravity models using both cross-sectional and time series data and conclude that a common currency is especially trade stimulating. Corsetti and Pesenti (2002) formalize the theory behind this catalyzing role of monetary unions and the possibility of OCA criteria being satisfied ex-post even if they fail ex-ante. 28. Imbs (2003) finds that countries which are more financially integrated also tend to be more synchronized, other things being equal. 29. This is a logical application of the “Lucas Critique”. 30. Countries involved thus far are Indonesia, Malaysia, the Philippines, Thailand, Singapore, China, Hong Kong, Japan, South Korea, Australia, and New Zealand. The initial size of the ABF is estimated at US$1 billion.

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31. There have been a number of papers recently describing the state of regional bond markets in Southeast Asia and institutional and regulatory constraints hindering their developments (for instance, see Fabella and Madhur 2003; Lamberte 2002; Sharma 2001). Elson (2002) discusses general issues pertaining to the development of bond markets in Asia. 32. To illustrate the dominance of bank financing: in 2000 domestic bank credit as a percentage of GDP in Indonesia, Malaysia, the Philippines, Singapore, and Thailand was 66, 111, 63, 80, and 112 respectively. In contrast, the figures for domestic bond financing in the five ASEAN countries were 35, 62, 31, 45, and 12 respectively (Elson 2002). 33. This said, the political viability of the ABC initiative is questionable. In addition, one must be concerned about the transactions costs of the ABC initiative. 34. In parallel with such initiatives to boost regional liquidity and financial market depth, individual countries have been actively developing their local bond markets and have been liberalizing their financial sectors and generally lifting restrictions on foreign ownership and involvement (see Elson 2002 for a discussion). At the same time, several ASEAN countries (Malaysia, Indonesia, and Thailand) have followed the Singapore example of tightening controls on the offshore trading of their currencies. While there may be a good rationale for these measures as a means of crisis prevention or safeguards (Ishii, Otker-Obe, and Cui 2001; Rajan 2003c), to the extent that these actions reduce the size and liquidity of the currency markets, they are working against the other goal of reducing the degree of fragmentation of ASEAN capital markets. 35. There may certainly be positive feedback from monetary integration to political integration. In other words, there may be a degree of endogeneity with regard to political integration. However, it is important for there to exist a high degree of will towards political integration in the first instance to make a currency area viable. 36. He makes a similar point in Eichengreen (2002a). 37. In May 2000 the APT Finance Ministers agreed, at a meeting in Chiang Mai (Thailand), to create a regional financing arrangement in East Asia. The socalled Chiang Mai Initiative (CMI) comprises an expanded ASEAN Swap Arrangement (ASA) and a network of bilateral swap arrangements (BSAs) among ASEAN economies, China, Japan, and South Korea. Since then the ASA has been increased to US$1 billion in size (effective November 2000) and a number of BSAs have been agreed upon with an aggregate size of US$31.5 billion (Appendix 12.1). 38. According to the ADB (2003): At the present time, the informal surveillance system that is in existence among the ASEAN+3 economies and their central banks is deemed adequate to oversee the operations of the CMI. The only efforts being made at an institutional level are to establish early warning systems and to monitor short-term capital flows.

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Ito, T. “The ABC of Asian Bonds”. Mimeographed. University of Tokyo, 25 June 2003. Johnston, R., M. Swinburne, A. Kyei, B. Laurens, D. Mitcham, I. Otker, S. Sosa, and N. Tamirisa. “Exchange Rate Arrangements and Currency Convertibility: Development and Issues”. In World Economic and Financial Surveys. Washington, D.C.: IMF, 1999. Kalemi-Ozcan, S., B. Sorensen, and O. Yosha. “Economic Integration, Industrial Specialization and the Asymmetry of Shocks Across Regions”. Journal of International Economics 55 (2001): 107–37. ———. “Risk Sharing and Industrial Specialization: Regional and International Evidence”. American Economic Review 16 (2003): 903–18. Kenen, P. “The Theory of Optimum Currency Areas: An Eclectic View”. In Monetary Problems of the International Economy, edited by R. Mundell and A. Swoboda. Chicago: University of Chicago Press, 1969. ———. “Currency Areas, Policy Domains, and the Institutionalization of Fixed Exchange Rates”. Mimeographed. Princeton University, April 2000. Khoo H.S. “ASEAN: Looking Ahead to New Relevance”. Asia Times (Bangkok), 22 March 2003. Krueger, M., P. Osakwe, and J. Page. “Fundamentals, Contagion and Currency Crises: An Empirical Analysis”. Development Policy Review 18 (2000): 257–74. Krugman, P. “Lessons of Massachusetts for EMU”. In Adjustment and Growth in the European Monetary Union, edited by F. Torres and F. Giavazzi. Cambridge: Cambridge University Press, 1993. Lamberte, M. “ASEAN’s Fledgling Debt Securities Markets: More Tasks Ahead”. Discussion Paper no. 2002-05, Philippine Institute for Development Studies, 2002. Lee J.W., Park Y.C., and K. Shin. “A Currency Union in East Asia”. Mimeographed. Korea University, March 2002. Lien, J. “Bush Targets FTAs with More ASEAN Nations”. Business Times (Singapore), 28 October 2002. Madarassy, R. and M. Chinn. “Free to Flow? New Results on Capital Mobility Amongst the Developed Countries”. Mimeographed. University of California, Santa Cruz, August 2002. McCallum, B. “A Reconsideration of the Uncovered Interest Parity Relationship”. Journal of Monetary Economics 33 (1994): 105–32. McCauley, R., Fung S.S., and B. Gadanecz. “Integrating the Finances of East Asia”. BIS Quarterly Review, December 2002, pp. 83–96. McKinnon, R. “Optimum Currency Areas”. American Economic Review 53 (1963): 717–25. McKinnon, R. and G. Schnabl. “The East Asian Dollar Standard, Fear of Floating, and Original Sin”. Mimeographed. Stanford University, January 2003. Meredith, G. and M. Chinn. “Long-Horizon Uncovered Interest Parity”. Mimeographed. International Monetary Fund, May 1999.

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Mundell, R. “A Theory of Optimum Currency Areas”. American Economic Review 51 (1961): 657–65. ———. “Uncommon Arguments for Common Currencies”. In The Economics of Common Currencies, edited by H. Johnson and A. Swoboda. London: Allen and Unwin, 1973. Nitithanprapas, I., S. Rongala, and T. Willett. “The Role of Capital Controls and Currency Regimes in the Asian Crisis”. Working Paper no. 2002-21, Claremont Colleges, California, 2002. Park, W. and G. Choi. “Assessment of Korea’s Financial Liberalization”. Mimeographed. Korea Institute of Finance, October 2002. Park Y.C. and Bae K.H. “Financial Liberalization and Economic Integration in East Asia”. Paper presented at the PECC Finance Forum Conference on Issues and Prospects for Regional Cooperation for Financial Stability and Development, 11–13 August 2002, in Hawaii. Phylaktis, K. and F. Ravazzolo. “Measuring Financial and Economic Integration with Equity Prices in Emerging Markets”. Working Paper no. 5/2002, Cass Business School, City of London, 2002. Pierdzioch, C. “Financial Market Integration and Business Cycle Volatility in a Monetary Union”. Working Paper no. 1115, Kiel Institute of World Economics, 2002. Plummer, M. “Creating an ASEAN Economic Community: Lessons from the EU and Reflections on the Roadmap”, this volume. Singapore 2005. Pomfret, R. “Why Does Optimal Currency Area Theory Fail to Predict Changes in Currency Areas? Evidence from Europe and Lessons from Elsewhere”. Mimeographed. University of Adelaide, March 2003. Rajan, R. “Financial and Macroeconomic Cooperation in ASEAN: Issues and Policy Initiatives”. In ASEAN Beyond the Regional Crisis: Challenges and Initiatives, edited by M. Than. Singapore: Institute of Southeast Asian Studies, 2000. ———. “(Ir)relevance of Currency-Crisis Theory to the Devaluation and Collapse of the Thai Baht”. Princeton Studies in International Economics no. 88, International Economics Section, Princeton University, 2001. ———. “Exchange Rate Policy Options for Post-Crisis Southeast Asia: Is There a Case for Currency Baskets?”. The World Economy 25 (2002a): 137–63. ———. “International Financial Liberalisation in Developing Countries: Lessons from Recent Experiences”. Economic and Political Weekly 37 (20–26 July 2002b): 3017–21. ———. “Is There a Case for an Asian Bond Fund? — It Depends!”. Economic and Political Weekly 38 (17 May 2003a): 1919–21. Abbreviated version published as “A Bond Fund for Asia”. Far Eastern Economic Review, 20 March 2003. ———. “Implications of the Emergence of the PRC as an Economic Power for ASEAN: Threat, Opportunity, or Both?”. Report prepared for the Regional Economic Monitoring Unit of the Asian Development Bank, April 2003b.

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———. “Safeguarding Against Capital Account Crises: Unilateral, Regional and Multilateral Options for East Asia”. In Financial Governance in East Asia, edited by G. de Brouwer. London: Routledge, 2003c. Rajan, R. and R. Sen. “Singapore’s New Commercial Trade Strategy: Examining the Pros and Cons of Bilateralism”. In Singapore Perspectives 2002, edited by Chang L.L. Singapore: Times Academic Press, 2002. Rajan, R. and R. Siregar. “Boom, Bust and Beyond”. In Financial Markets and Policies in East Asia, edited by G. de Brouwer. London: Routledge, 2002. ———. “Centralized Reserve Pooling for the ASEAN Plus Three (APT) Countries”. In Monetary and Financial Cooperation in East Asia. United Kingdom: McMillan Press for the Asian Development Bank, 2003. Rajan, R., R. Siregar, and I. Sugema. “Capital Flows and the Credit Transmission Channel in Southeast Asia”. Journal of International Development 15 (2003): 265–83. Rose, A. “One Money, One Market: Estimating the Effect of Common Currencies on Trade”. Economic Policy 15 (2000): 7–46. Rose, A. and C. Engel. “Currency Unions and International Integration”. Journal of Money, Credit and Banking 34 (2002): 804–26. Rowley, A. “East Asia Sets Course for Local Currency Bonds: ASEAN+3 Finance Officials Agree to Proceed with Plan”. Business Times (Singapore), 3 March 2003. Sharma, K. “The Underlying Constraints on Corporate Bond Market Development in Southeast Asia”. World Development 29 (2001): 1405–19. Soesastro, H. “Wither ASEAN Plus Three?”. Paper presented at the PECC Trade Policy Forum, 12–13 June 2001, in Bangkok. Stock, J. and M. Watson. “Testing for Common Trends”. Journal of the American Statistics Association 83 (1988): 179–97. Willett, T. “The OCA Approach to Exchange Rate Regimes: A Perspective on Recent Developments”. Working Paper no. 2001-04, Claremont Colleges, California, 2001. Willett, T., M. Keil, and Y.S. Ahn. “Capital Mobility for Developing Countries May Not be So High”. Journal of Development Economics 68 (2002): 421–34. World Bank. Global Economic Prospects and the Developing Countries. New York: Oxford University Press, 1999.

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Reproduced from Roadmap to an ASEAN Economic Community edited by Denis Hew (Singapore: Institute of Southeast Asian Studies, 2005). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available at < http://bookshop.iseas.edu.sg >

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ISEAS Concept Paper on the ASEAN Economic Community Denis Hew, Rahul Sen, Lee Poh Onn, Maghaisvarei Sellakumaran, Sakulrat Montreevat, and Ngiam Kee Jin

1. The AEC Proposal Since the Asian financial crisis of 1997–98, ASEAN leaders have been concerned by the increasingly competitive global environment, especially the competitive challenge from China. According to the United Nations Conference on Trade and Development (UNCTAD), China is now the largest recipient of foreign direct investment (FDI) flows in the Asia-Pacific region. There is a growing perception that China’s rise would divert FDI inflows from ASEAN towards China, and would also enhance export competition in third markets for products in which both China and ASEAN enjoy a strong comparative advantage, thus affecting ASEAN’s competitiveness (see Appendix Figures 1 and 2 in Appendix 1 on ASEAN and China’s FDI inflows). In an increasingly globalized economy, it has become critical for Southeast Asia to stay competitive in order to remain an important growth pole in Asia, along with the emerging market economies of China and India. For ASEAN, this would involve the restructuring and integration of its economies. Clearly, an economically integrated ASEAN with a combined population of more than 500 million could keep the region competitive vis-à-vis China and India. Furthermore, ASEAN should also remain relevant by maintaining

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economic linkages with its major trading partners as well as countries outside the region (see Appendix Figure 3 in Appendix 1 on the network of cooperation involving East Asian countries, including ASEAN). A recent study by McKinsey & Company observed that opportunities existed for ASEAN to enhance its economic competitiveness. The study recommended the acceleration of the ASEAN economic integration programme. This would include the fast-track integration of two key sectors (that is, electronics and consumer goods) and the strengthening of ASEAN institutions, such as the ASEAN Secretariat, to drive economic integration. At the ASEAN Summit on 4 November 2002 in Phnom Penh, Cambodia, ASEAN leaders agreed to explore the possibility of transforming ASEAN into an ASEAN Economic Community (AEC) by 2020. Although the concept of an AEC and how this would be achieved were not elaborated on at the Summit, it was clear that the fostering of closer economic cooperation and the expediting of the current economic integration process required urgent attention. What would be the benefits of forming an AEC? The proposed AEC could provide the means for ASEAN to revitalize and remain competitive in the face of rising challenges from globalization. It would also stand to benefit from the global trends in trade liberalization and manufacturing (by creating an attractive regional production base). In forming an AEC, the European Economic Community (EEC) of the 1950s could be used as a possible model. Although the EEC was focused on the formation of a customs union and provided a basis for a common market in terms of factor mobility, many of the founders of the EEC saw it as a “phase in” process culminating in complete economic and political integration (see Appendix 2 for a brief description of the different forms of economic and monetary integration). But the world has changed dramatically since the signing of the Treaty of Rome in 1957 that established the EEC, with greater liberalization efforts at the World Trade Organization (WTO) as well as the proliferation of bilateral and regional trading agreements. Nevertheless, the European experience was the first successful economic integration exercise and formed part of the post-war drive for closer economic and political co-operation in Europe. There were several factors that were conducive to European integration, such as rapid economic growth in the post-war era; similar economic and political systems, given that the states were liberal democracies with market economies; and geographical proximity among the member states. Furthermore, the devastation and moral exhaustion of the two world wars provided the much-needed impetus for change and the member states were prepared to cede a certain level of

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sovereignty in order to achieve their long-term objective of an ever-closer union. See Appendix 3 on the European experience of economic integration in the 1950s and 1960s. While there are significant differences between Western Europe and Southeast Asia, especially the greater economic and cultural diversity in the ASEAN region, there are nevertheless several valuable lessons to be drawn from the European experience. For instance, despite the challenges that the European nations faced in the process of integration, they were able to successfully overcome their difficulties and differences because the governments displayed strong political will and a sense of solidarity to push the project forward. ASEAN can learn from its Western counterpart in terms of strengthening its regional institutions, and acknowledge the need to evolve into a rule-based economic regime (see section 4 for more details on the institutional infrastructure to facilitate economic integration). 2. Objective and Scope of Paper The objective of this paper is to elaborate on the concept of an AEC. There is already an ASEAN Vision 2020 (Hanoi Plan of Action) document that was unveiled in 1998 which, among other things, envisioned a more economically integrated ASEAN. In particular, the ASEAN Vision 2020 envisaged “a stable, prosperous and highly competitive ASEAN Economic Region in which there is a free flow of goods, services and investments, a freer flow of capital, equitable economic development and reduced poverty and socioeconomic disparities” (p. 12). Therefore, the scope of this paper would be to examine how the AEC can be realized by building on the economic element of this vision. The AEC can be achieved through a broad-based economic integration approach. In fact, ASEAN is already working towards eliminating the intraregional trade restrictions in goods, services, and investment, with the aim to achieve the ASEAN Vision 2020. ASEAN could first strive for the total removal of barriers on goods among the ASEAN-Six countries (that is, Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand), followed by the removal of barriers on services and capital. Other members can join in as and when they are ready. The recent adoption of “ASEAN minus X” principle could be used to facilitate this integration process. Given the wide economic disparities among the ASEAN countries, the free mobility of labour will need to be a longer-term objective. In this regard, the experience of member countries of the North American Free Trade Agreement (NAFTA) in dealing with labour mobility can serve as a useful guide.1

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Thus, the AEC would provide a comprehensive framework to build on existing ASEAN economic integration programmes, such as the ASEAN Free Trade Area (AFTA), ASEAN Framework Agreement on Services (AFAS), and the ASEAN Investment Area (AIA). The proposed AEC could offer a practical ASEAN roadmap to strengthen ASEAN’s effectiveness in trade and investment creation in dealing with the growing interdependence of all ASEAN economies. In merchandise trade, intra-ASEAN trade now accounts for nearly onefourth of ASEAN’s total trade, slightly up from 21.4 per cent in 1993. This may seem relatively low and some academics have argued that the 1997 Asian financial crisis has adversely affected intra-regional trade more than trade with the rest of the world (Avila 2000). Also, there still exist a substantial number of non-tariff barriers to intra-ASEAN trade. Nonetheless, the implementation of AFTA should lead to a pick-up in intra-ASEAN trade from 2002 onwards. ASEAN needs a higher level of economic integration in order to achieve closer cohesion. Economic integration would, among other things, allow countries to focus on their comparative advantages as well as create an attractive destination for FDI. Deeper economic integration would also benefit the less-developed ASEAN countries, namely Cambodia, Laos, Myanmar, and Vietnam (CLMV). Appropriate resources should be allocated to ensure the full participation of these countries in the integration process. These would include financial and technical assistance, transfer of technology, education, and training facilities to reduce the economic divide between the more-developed ASEAN-Six countries and CLMV. At the Fourth ASEAN Informal Summit in Singapore in November 2000, ASEAN leaders agreed to launch the Initiative for ASEAN Integration (IAI) with the aim of narrowing the development gap within ASEAN and assist the newer members in the process of regional integration. To implement this initiative, a work plan was drawn up in November 2001 (that is, the IAI Work Plan) that would focus on programmes and projects in four priority areas: infrastructure, including energy; human resource development; information and communication technology; and capacity-building for regional economic integration. The establishment of an AEC should also strengthen the position of member states with regards to their participation in the WTO and in their collective negotiations on free trade agreements (FTAs) with major trading partners. Moreover, the proposed AEC should further stimulate intra-ASEAN trade. In Europe, for example, intra-EC2 trade increased from 35.2 per cent in 1958 to 50.3 per cent in 1970.

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3. Key Issues Relating to ASEAN Economic Integration The movement towards economic integration in ASEAN started with the establishment of AFTA, and the signing of a Common Effective Preferential Tariff (CEPT) Scheme in 1992 to eliminate tariff barriers among Southeast Asian countries, with a view to integrating the ASEAN economies into a single production base and regional market. Over time, other areas of economic co-operation, apart from merchandise trade, have been decided upon. These include AFAS, signed in 1995, aimed at liberalizing trade in services within ASEAN, and the AIA, signed in 1998, to facilitate liberalizing investment flows within the region. This section reviews the present state of economic integration in ASEAN by analysing the developments in each of these components of regional integration involving merchandise trade, services trade, and investment flows. It also analyses the trade facilitation measures undertaken to support these components and the ways in which these can help in the realization of an AEC.

3.1. Merchandise Trade CEPT, under AFTA, was fully implemented in 2003 with the original six members (Malaysia, Singapore, Indonesia, the Philippines, Thailand, and Brunei) complying with the agreement on the CEPT Scheme, which requires that tariff rates on a wide range of products traded within the region be reduced to between 0 and 5 per cent. Some of the earlier targets for newer ASEAN members have been advanced in the light of rapid changes in the global economy. Thus, while Vietnam is expected to reach its target for tariff reduction to the 0–5 per cent range for its items in the Inclusion List (IL) by 2006, Laos and Myanmar are expected to do so by 2008 and Cambodia by 2010. As of 1 January 2001, 92.8 per cent (40,856 tariff lines out of the total 44,037 tariff lines) of products in the IL of the six original signatories to the CEPT agreement (Malaysia, Singapore, Indonesia, the Philippines, Thailand, and Brunei) fell in the tariff range of 0 to 5 per cent (Appendix Table 1). These six signatories accounted for about 96 per cent of the total trade of ASEAN. Among the new members of ASEAN, Vietnam was expected to maximize the number of tariff lines in the 0–5 per cent range by 2003, while 2005 is set as the deadline for Laos and Myanmar. By the second quarter of 2002,

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Appendix Table 1 ASEAN-Six: Number of Tariff Lines with Tariffs of 0–5 Per Cent, 2001 Number of Tariff Lines in IL

Percentage

Country 0–5% Brunei Darussalam Indonesia Malaysia Philippines Singapore Thailand Total

>5% Other

Total

6,107 6,483 9,198 5,016 5,859 8,193

157 709 841 551 0 911

12 – – – – –

6,276 7,192 10,039 5,567 5,859 9,104

40,856

3,169

12

44,037

0–5% >5% Other Total 97.3 2.5 90.1 9.9 91.6 8.4 90.1 9.9 100.0 0 90.0 10.0 92.8

7.2

0.2 – – – – –

100 100 100 100 100 100

0.2

100

Source: ASEAN Secretariat.

Vietnam had nearly 5,500 tariff lines in the IL, of which 2,002 lines were in 0 per cent and over 3,400 lines in the 0–5 per cent range. By 2003, Vietnam would have moved all tariff lines from the Temporary Exclusion List (TEL) to the IL. The 2001 legal enactments of Laos and Myanmar showed that 61.4 per cent and 81.3 per cent, respectively, of their IL had tariffs at 0–5 per cent. Cambodia, which joined ASEAN in 1999, had 7.6 per cent of its IL with tariffs at 0–5 per cent. Cambodia is expected to reduce the tariffs on 91.94 per cent of its current IL items to 0–5 per cent by 2007. The above indicates that significant progress has been made on CEPT, and reflects the determination among all ASEAN members to achieve a free trade area much earlier than planned. In November 1999 ASEAN Economic Ministers went further in their efforts to realize the vision of a regional free trade area by agreeing to adopt a target of zero tariff by 2010 for the ASEAN-Six countries — five years earlier than the original deadline. The deadline for newer ASEAN member countries was also advanced from 2018 to 2015 although some sensitive products would be allowed to follow the original 2018 deadline. Hence, the full implementation of CEPT by 2010 and zero-tariff AFTA by 2015 for all ASEAN countries would be important building blocks to the AEC.

3.2. Services AFAS is a regional agreement on services trade co-operation involving the member countries of ASEAN. This was signed during the Fifth ASEAN

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Summit on 15 December 1995. AFAS was aimed at enhancing co-operation in the service sector among ASEAN members by eliminating intra-regional trade restrictions and expanding the scope of liberalization in services beyond those already undertaken under the General Agreement on Trade in Services (GATS).3 In other words, AFAS is meant to be GATS-plus.4 Under AFAS, initial negotiations focused on financial services, transport, telecommunications, tourism, and professional business services. Currently, AFAS has concluded two rounds of negotiations, completing three packages of commitments in seven service sectors, adding construction and maritime transport services to its initial list of five sectors. The initial package of commitments was endorsed during the Twenty-ninth ASEAN Economic Ministers (AEM) meeting on 16 October 1997 in Kuala Lumpur, Malaysia. A second package of commitments was concluded at the Thirtieth AEM on 7 October 1998 in Makati City, Philippines. Subsequently, a third package of commitments was approved during the Seventh ASEAN Transport Ministers meeting in Kuala Lumpur in October 2001. The third round of negotiations, which was launched during the Thirty-third AEM meeting at Hanoi, Vietnam, was supposed to end in 2004, covering all service sectors and all four modes of service provision (ASEAN Secretariat 2004). With a view to accelerating progressive liberalization, the ASEAN Economic Ministers have decided that, for the third round of negotiations, member countries adopt the “Ten-X” approach (also known as the “ASEAN minus X” principle) whereby agreements could be concluded by those countries that are ready while others could accede at a later time. Thus, over a span of about eight years since AFAS was signed, three rounds of negotiations have taken place. However, an analysis of commitments by individual ASEAN countries for liberalizing important service sectors indicates that not much progress in terms of substance had been achieved during the first two rounds of negotiations. Indeed, if one examines the various specific AFAS commitments offered by the ASEAN economies, it can be concluded that the content of services trade liberalization in most of these countries can at best be termed as “weak”. The common trade barriers as evinced by these commitments are mainly in the form of restrictions on equity participation, on the type of commercial establishment that is allowed to be set up by the foreign company (that is, joint ventures, representative offices, branches, or wholly foreign-owned), and on the movement of natural persons (mode 4). They are common for other categories of services trade as well. These barriers continue to affect the efficiency and competitiveness of the service sector in these countries, but are retained since they serve domestic business interests.

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One of the key challenges before AFAS is, therefore, to accommodate the differences in readiness to liberalize among the ASEAN members, and gain technical expertise in legal and sectoral aspects of services trade liberalization, and at the same time ensure that the process of liberalization continues on a progressive path. Some analysts argue that AFAS should have a multi-track approach wherein some industries that are growing more rapidly and are less affected by national interests be liberalized faster than others. This indicates that in the context of the proposed AEC, it is this area of services trade liberalization among ASEAN economies that would be the most challenging of all to implement, especially as it would affect the domestic interests of each member country in a different manner.

3.3. Investment ASEAN Ministers signed the Framework Agreement on the AIA on 7 October 1998 in Manila. The AIA aims to make ASEAN a competitive, conducive, and liberal investment area. The privileges offered by the AIA in investment, market access, and the granting of national treatment take immediate effect for ASEAN investors, with the exception of those sectors in the list of exclusions, which comprise a TEL, Sensitive List, and a General Exception List. Under the AIA, Brunei Darussalam, Indonesia, Malaysia, Myanmar, the Philippines, and Thailand had to meet the deadline of 1 January 2003 to phase out their TEL for the manufacturing sector. The newer members of ASEAN, Cambodia, Laos, and Vietnam, have until 1 January 2010 to do so. The AIA is expected to have important implications for investment strategies and production activities in the region. For instance, the AIA will encourage investors to think increasingly in regional terms and to adopt a regional investment strategy and network of operations. It is thus expected to provide a greater scope for division of labour and industrial activities across the region, creating opportunities for greater industrial efficiency and cost competitiveness. Current and potential investors are thus expected to benefit from the AIA arrangements through greater investment access to industries and economic sectors, national treatment as ASEAN investors, greater transparency, a more liberal and competitive investment regime, and lower transactions costs for business operations across the region. A ministerial-level AIA Council has been established to oversee the implementation of the Framework Agreement. This Council is assisted by the ASEAN Co-ordinating Committee on Investment. There are currently three programmes that constitute the building blocks for the AIA: (1) Co-operation

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and Facilitation Programme to promote ASEAN’s competitiveness and to provide investors with an efficient and low transactions cost investment environment; (2) Promotion and Awareness Programme to promote ASEAN as a single investment destination, and to give investors a better understanding and awareness of the region’s investment opportunities; and (3) Liberalization Programme to open up investment regimes throughout the region by eliminating investment barriers, liberalizing investment rules and policies, and granting national treatment. The AIA programme is also supported by the industrial co-operation programme, namely the ASEAN Industrial Co-operation (AICO), which was initiated in 1996 to encourage companies across ASEAN economies to cooperate in the manufacturing of selected products, which could enjoy preferential tariff rates of 0–5 per cent as in the CEPT scheme and other privileges. Thus, through the AIA and AICO, ASEAN economies already have a framework agreement in place for regional industrial and investment cooperation, which, once fully implemented, would be an important element of the proposed AEC. This is so because it will not only help in attracting greater foreign investment to the ASEAN economies from abroad, but would also help in fostering greater intra-regional investment within ASEAN. However, it is to be noted that since commercial presence through foreign investment is a major mode of service provision, the success of the AIA would critically depend on the pace and extent of services trade liberalization within ASEAN, under AFAS.

3.4. e-ASEAN The ASEAN leaders, at their summit meeting in Manila in November 1999, endorsed the e-ASEAN initiative. This aims to develop a broad-based and comprehensive action plan, including physical, legal, logistical, social, and economic infrastructures needed to promote an ASEAN e-space, as part of an ASEAN positioning and branding strategy. e-ASEAN would cover the economy, society, and government. A high-level e-ASEAN Task Force comprising government and private sector representatives has worked out concrete ways to realize the initiative. While focusing on encouraging and facilitating the growth of e-commerce, e-ASEAN would include prescriptive measures to narrow the digital divide within the region. The proposed ASEAN e-space, as envisaged by this initiative, would be vital for efficient networking and co-ordination within the AEC.

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3.5. Trade Facilitation Trade facilitation measures constitute a vital support framework for ensuring the success of any regional trade and investment programmes. In this context, it is important to note that an ASEAN Agreement on Customs (AAC) was signed in 1997, which is aimed at enhancing customs cooperation and harmonization of procedures and to ensure an efficient administration and expeditious clearance of goods to facilitate intra-regional trade and investment across ASEAN countries. This agreement was aimed at ensuring consistency, transparency, and fair application of customs laws and regulations, procedures, and other administrative guidelines within each ASEAN member state. It has been established as part of the broader ASEAN Customs Vision 2020.5 The adoption of an ASEAN Harmonized Tariff Nomenclature by 2002 was also targeted. Further, two important developments in this area have taken place. The first relates to the harmonization of product standards for priority sectors. Thus far, ASEAN has identified twenty priority sectors, mainly electrical and electronic products, whose product standards would be harmonized to international standards. The second relates to the development of Mutual Recognition Agreements (MRAs) across ASEAN countries. A Framework Agreement on Mutual Recognition Agreements was signed in December 1998. It is proposed that ASEAN would use the value of intra-regional trade, existence of technical barriers, and indication of strong interest from member countries as criteria for identifying the sectors that would be suitable for MRAs. To date, MRAs have been considered for cosmetics, pharmaceuticals, and electrical and electronic products.

3.6. Future Directions and Challenges The above review of the present state of economic integration programmes in ASEAN suggests that the elements for achieving regional economic integration through trade and investment are already in place, with an implementation deadline of 2010, except for AFAS and e-ASEAN. In other words, some of the building blocks for the proposed AEC by 2020 seem to be already in place. However, there are still some serious commitments to be undertaken by both ASEAN as an entity as well as individual member countries, in order to bring the proposed AEC to a reality. First, with the implementation of CEPT on target for the ASEAN-Six economies by 2010, and subsequently for newer members by 2015, services trade liberalization under AFAS should be accorded top priority. It is hoped that the current round of negotiations as well as future ones would yield more

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bold and substantial commitments for market access in important service sectors, namely telecommunications, energy services, financial services, travel, and transport. Progress in these sectors is vital for enhancing the competitiveness of ASEAN countries in an increasingly knowledge-based and rapidly globalizing world. Although the “ASEAN minus X” principle is useful in this regard to allow faster members to liberalize earlier, it is important to ensure that slower members are assisted to catch up in this area. Establishment of deadlines for implementation of negotiations under AFAS is thus critical to provide a sense of urgency in this respect. As mentioned earlier, rapid progress and implementation of trade liberalization in services would be central to an early realization of the AEC. Second, it is important to note that for the above to be successful, many of the individual member countries within ASEAN would have to focus on domestic reforms, and would need to enhance their competitiveness in these sectors. This is particularly so in the case of the financial services sector, which was the most affected during the financial crisis of 1997–98. While some ASEAN countries have made important progress in these directions, others have fallen back on the pace of domestic reforms and would need to step up the pace. Finally, it is important to note that although individual programmes and framework agreements for regional economic co-operation are in place, they are inadequate to help achieve the realization of the AEC without the establishment of a stronger institutional structure and an effective enforcement mechanism. There is thus a need to streamline, strengthen, and enhance coordination among the existing institutions and design an enforcement mechanism with appropriate powers. In this regard, the setting-up of new institutions within the ASEAN framework would require serious consideration. 4. Development of Institutional Infrastructure to Facilitate Economic Integration ASEAN still maintains a very loose institutional structure although there has been a steady strengthening in recent years. ASEAN does not presently operate on the overriding principle of using a formal, detailed, and binding institutional structure to prepare, enact, and execute policies for economic integration. The “ASEAN Way” is still very much entrenched, with musyawarah (discussion and consultation) and mufakat (decision by consensus) being the modus operandi of the organization. In recent years, though, ASEAN has been moving towards a more structured and rule-based system to regulate and enhance economic relations

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and integration among its members. Progressive steps have been taken to implement the directives contained in the newer ASEAN trade and investment agreements since the 1990s. Binding rules and procedures are now more clearly set out in these agreements. The recent and more structured, detailed, and binding procedures adopted in the Protocol on Dispute Settlement Mechanism (DSM) is a step in the right direction for the formation of a formal institutional infrastructure facilitating the integration of ASEAN. However, this Protocol has yet to be used by any member country. What institutional reforms would ASEAN need to undertake in order to achieve an integrated regional grouping of some stature? Lessons could perhaps be drawn from institutional developments in the European Union (EU), where the provision of a clearly set out legal infrastructure has aided member states in the integration process and has enhanced trading and investment activities. Institutions have allowed a “locking in” of the fruits of economic development of the member countries since the 1950s. Institutions in the EU have also depended on both a supranational structure as well as interaction among the various national governments (inter-governmental structures within the EU represented by the heads of governments and officials from all member states) to maintain an effective economic and political role. In the EU the legislative, executive, and judicial organs, namely the European Parliament, the European Commission, and the European Court of Justice, provide for a streamlined and clearly delineated structure of governance towards the various activities within the EU. Legislative: The European Parliament plays the legislative role of debating and voting like a legislature, although it does not have the ultimate powers to legislate laws. Election to the Parliament is by direct universal suffrage. This legislative role is shared by the Council of the European Union, which is the legislative body consisting of the head of government of each member state and the president of the European Commission. Executive: The European Commission is the executive body that initiates legislation for the council to subsequently decide upon. Such legislation is drafted in consultation with the Economic and Social Committees. The Commission is also responsible for overseeing the implementation and monitoring of legislation. Together with the Court of Auditors, it is responsible for the collection and expenditure of funds within the EU. Members of the European Commission are appointed by the respective member states. Judicial: The enforcement of decisions against firms and individuals is undertaken by the European Court of Justice (ECJ), which forms the judicial body of the EU. Each member state puts forward one candidate who must be

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approved by the governments of the other member states. The ECJ ensures that EU laws are uniformly interpreted across member states. The ECJ, however, still has to depend on national enforcement agencies in the respective member states and the Council of the European Union to enforce its judgements. While the above organizational structures of the EU might not be wholly applicable to ASEAN at this stage of its development, it is clear that a similar form of institutional structure to promote economic integration effectively among the ASEAN member states would have to be considered.

4.1. The ASEAN Secretariat For ASEAN to move towards the formation of a viable and vibrant AEC, there needs to be a principal body with supranational powers to oversee and co-ordinate the administrative tasks of establishing and setting policies, coordinating, implementing, and enforcing present and future agreements and protocols. Such a body already exists in the present ASEAN Secretariat, although in its present form, the Secretariat still does not have the resources, nor the power and adequate expertise to co-ordinate and administer such tasks effectively. The ASEAN Secretariat needs to continue to work closely with the inter-governmental entities discussed below, disseminating their decisions and policies, co-ordinating subsequent implementation, and prioritizing initiatives that would bring about the establishment of the AEC. The ASEAN Secretariat in Jakarta, Indonesia, was established in 1976 during the Bali Summit as a central administrative organ for the Association, to provide greater co-ordination of ASEAN organs and for more effective implementation of ASEAN projects and activities. In 1993 the ASEAN Secretariat was restructured with the Secretary-General now redesignated the Secretary-General of ASEAN. The Secretary-General was also given an enlarged mandate to initiate, advise, co-ordinate, and implement ASEAN activities. He was accorded ministerial status in 1993 (Davidson 2002, p. 25). The Secretary-General is responsible to the Heads of Government Meeting, and to all meetings of ASEAN Ministers when they are in session.

4.2. Inter-governmental Entities Legislative: Presently, the supreme decision-making authority is the ASEAN Heads of Government Meeting (AHGM) — the ASEAN Summits, which provide, among other matters, initiatives and directives focusing on economic co-operation and integration (AFTA) among its member countries. The

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AHGM, as its name implies, consists of the Heads of Government from the ASEAN member countries. The AMM, or annual meeting of the Foreign Ministers, remains the most important organ for formulating and co-ordinating all the policies of the different ASEAN working units (economic and noneconomic). Another important ministerial-level meeting established by ASEAN in 1976 is the AEM (ASEAN Economic Ministers), which is given the responsibility of overseeing economic co-operation. In this respect, the AHGM, together with the AMM and the AEM, approximates the legislative role of the European Parliament in the EU. Executive: The SEOM (Senior Economic Officials Meeting) is tasked with assisting the AEM in all matters related to economic co-operation, to help to co-ordinate and implement ASEAN economic activities. This is broadly similar to the role of the European Commission (EC) in the EU. However, there are important differences between the SEOM and the EC. One key difference is that each SEOM leader represents his country while the EC represents the entire grouping. A set of institutions may have to be put in place for the various SEOM leaders to resolve their differences and to come up with a group consensus similar to what is often arrived by the EC. This could possibly follow closely to measures set out in the DSM, perhaps more structured and empowered with a high-level judicial body (equally staffed by representatives from all ASEAN members), in order to arrive at a common accord. Naturally, the consensus arrived at by the SEOM leaders must be based on the principles and items already detailed in the various ASEAN trade and economic agreements. Also, the SEOM, together with the ASEAN Secretariat as the supranational entity, needs to work out a procedure to monitor the various agreements in place: to establish a scorecard system to ascertain the extent to which the agreements in place have been implemented, and perhaps to directly resort to the use of the DSM to resolve the issue at hand. Judicial: There is currently no judicial body in ASEAN that can legally enforce agreements signed by the ASEAN member countries. Following the example of the EU, the ASEAN Secretariat needs to continue, on a supranational level, with its administrative role of working with the various inter-governmental entities to independently administer the implementation of the DSM in ASEAN. However, as the nature of penalties is not detailed in the DSM, the Secretariat would be constrained in its task of resolving disputes and ensuring compliance. In addition, it may seem to be more appropriate if a separate entity, similar to that of the ECJ, is established in ASEAN to enforce the DSM rather than the present ad hoc panel selected by

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the SEOM to resolve disputes. This proposed court could be staffed by judges from each member country. 5. Concluding Remarks The overall objective of the ASEAN Vision 2020 is to create an ASEAN which is outward looking, living in peace, stability, and prosperity, bonded together in partnership in dynamic development and in a community of caring societies. The AEC could provide the necessary framework to enhance economic integration within ASEAN and to realize the economic element of this Vision. The AEC is not a replacement for existing economic integration programmes such as AFTA, AFAS, and the AIA. On the contrary, it would build on these programmes and provide a practical roadmap to an economically integrated ASEAN market. However, the end goal of the AEC should not be a customs union, where the minimum would be the removal of trade barriers among member countries and the setting-up of a common external tariff vis-à-vis non-member countries. ASEAN countries have committed to certain tariff rates through the General Agreement on Tariffs and Trade (GATT) and bilateral agreements. Hence, to implement a customs union would require all member countries to lower their tariff for each product to the lowest level committed to by any one ASEAN country for that product, since these countries would not be able to raise their tariff rates. This would create difficulties for countries that are not ready to lower tariffs to such low levels. Moreover, forming a customs union can be a setback for ASEAN as a whole as outsiders will view it as a protectionist move — the creation of a “Fortress ASEAN”. The AEC should be more of an “FTA plus” arrangement that includes some elements of a common market, namely free movement of factors of production such as capital and labour. With the realization of the AEC by 2020, ASEAN would be a vibrant regional market and have the following characteristics: •

• • •

Free movement of goods, services, investment, and capital. This would include achieving a zero-tariff AFTA as well as the elimination of all nontariff barriers; An attractive regional production platform that would be a magnet for FDI; Free movement of skilled labour and creative talent; Free movement of tourists from all ASEAN countries;

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• • •

Harmonization of customs procedures and minimization of customs requirements; Harmonization of standards which are consistent with international standards; and A well-developed institutional and legal infrastructure to facilitate the economic integration of ASEAN.

There will certainly be some major challenges to be overcome in order to achieve the above goals. Nevertheless, ASEAN would not be starting from scratch as some of the building blocks towards an economically integrated ASEAN are already in place. Although the AEC is a long-term goal, the fasttrack integration of priority sectors by making comprehensive policy changes (that cover customs, standards, investment rules, etc.) for these sectors — as recommended in the McKinsey & Company study — could be undertaken in the short to medium term. If the ASEAN governments can commit to speedy implementation of economic integration programmes as well as agree on the need for setting up suitable institutions with supranational powers to facilitate integration, the proposed AEC could be realistically achieved by 2020. Most importantly, for the AEC to succeed, there must be a strong political will to drive the integration process to achieve this end goal. The key policy recommendations in this study are as follows: • • •

• • • •

•

Establish clear deadlines for the implementation of services trade liberalization under AFAS. All ASEAN countries should be committed to implementing domestic reforms, especially in the services sector. National customs agencies should be linked electronically so that submissions and processing between customs agencies and traders are paperless. Abolish work permits for ASEAN skilled and creative workers who are employed in an ASEAN country outside their home country. Create a visa-free region for ASEAN tourists. Strengthen the ASEAN Secretariat so that it can effectively co-ordinate, implement, and enforce policies, agreements, and protocols. Establish suitable institutions with supranational powers to facilitate economic integration, for example, the establishment of a high-level judicial body to enforce the DSM. Establish a scorecard system to ascertain the extent to which agreements signed by ASEAN countries have been implemented.

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Appendix 1

Appendix Figure 1 ASEAN and China FDI Inflows Compared, 1992–2001 50,000 45,000

US$ million

40,000 35,000 30,000 ASEAN

25,000

China

20,000 15,000 10,000 5,000 -

1992 1993

1994 1995 1996 1997 1998 1999 2000 2001

Source: UNCTAD.

Appendix Figure 2 ASEAN’s FDI Inflows Compared, 1992–2001 120

Percentage

100

ASEAN's FDI Inflows as % of China's

80 ASEAN's FDI Inflows as % of Asia-Pacific Region's

60 40

ASEAN's FDI Inflows as % of Developing Countries'

20 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Source: UNCTAD.

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Appendix Figure 3 Network of Co-operation Involving East Asian Countries, Including ASEAN Hong Kong Taiwan

APEC Russia Mongolia North Korea

Papua New Guinea

USA Canada

NAFTA Mexico

ASEAN ASEM 15 EU member states and the European Commission

Thailand Singapore Malaysia Brunei Indonesia Philippines Vietnam

EALAF

China South Korea Japan

Chile Peru

Panama Paraguay Uruguay Venezuela

Australia New Zealand Cambodia Laos Myanmar India Bangladesh The Maldives Pakistan

Bhutan Nepal Sri Lanka

ASEAN Regional Forum

SAARC

Notes: ASEM — ASEAN–Europe Meeting ASEAN — Association of Southeast Asian Nations APEC — Asia-Pacific Economic Co-operation EALAF — East Asia–Latin America Forum NAFTA — North American Free Trade Agreement SAARC — South Asian Association for Regional Co-operation Sources: Park (2002) and authors.

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Appendix 2 Forms of Economic and Monetary Integration

Free Trade Area Elimination of all tariffs and other trade barriers among the member states of the area; but no common trade policy, that is, no common external tariffs and quotas with respect to third parties. Examples include (1) the ASEAN Free Trade Area (AFTA), (2) the European Free Trade Area (EFTA), and (3) the North American Free Trade Agreement (NAFTA). AFTA came into full effect on 1 January 2003. On that date, tariffs on 95 per cent of the goods entering the ASEAN-Six were lowered to between 0 and 5 per cent. The ASEAN-Six have committed to remove all the remaining tariffs on intraASEAN trade by 2010. The four new ASEAN members (Vietnam, Laos, Myanmar, and Cambodia) are scheduled to reduce tariffs to no more than 5 per cent from 2006. Customs Union Elimination of all tariffs and other trade barriers among members (as in a free trade area). However, it has a common trade policy (such as the setting of common tariff rates) towards the rest of the world. The most famous example of this is the European Economic Community (EEC), or the European Common Market, formed in 1958 (a year after the Treaty of Rome was signed) by West Germany, France, Italy, the Netherlands, and Luxembourg. In 1995 Mercosur (comprising Argentina, Brazil, Uruguay, and Paraguay), which was formed in 1991 as a free trade area, evolved into a customs union with common external tariffs. Common Market Goes beyond a customs union by also allowing the free movement of labour and capital among member nations. The Treaty of Rome (signed in 1957) establishing the EEC provided for free movement of labour and capital within a twelve-year timetable (that is, before 1970). However, the EEC did not meet the target. Indeed, the principle of free movement of people was introduced only in 1986 with the signing of the Single European Act (SEA), which laid down the detailed legal framework for establishing the European Single Market by the end of 1992.

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Economic Union Goes still further than a common market by harmonizing or even unifying the monetary, fiscal, and tax policies of member states. This is the most advanced type of economic integration. An example is Benelux, which is the economic union of Belgium, the Netherlands, and Luxembourg formed in 1960 (and now part of the EU). Monetary Union Usually considered as the ultimate stage of economic integration, with the following conditions: the guarantee of a complete and irreversible convertibility of the currencies; the full liberalization of capital flows among the member states; the complete integration of the banking and financial markets among the member states; the irrevocable fixing of exchange rates without any margin of fluctuation; and a single monetary policy managed by a single central bank. The national currencies may eventually disappear, to be replaced by a single currency. Examples include the monetary union outlined in the Maastricht Treaty of 1992, and the Brunei–Singapore Currency Interchangeability Arrangement.

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Appendix 3 European Experience of Integration in the 1950s and 1960s

During the early post-war period, the challenge facing Western Europe was to come up with a framework for economic recovery that would establish the basis for permanent peace. It was during this time that the European Coal and Steel Community (ECSC) was established. The Paris treaty was signed on 18 April 1951 by six European states — West Germany, France, Belgium, the Netherlands, Luxembourg, and Italy.6 The ECSC was essentially a free trade area in coal and steel, and it aimed to provide a unified market for these products, dismantling the trade barriers among the six states. The coal and steel industries were chosen for several reasons. Firstly, no country could arrogate to itself these vital materials of a war effort, and this would render war unthinkable and impossible between France and Germany.7 Secondly, the development of these industries was blocked by the existence of high tariffs. Thirdly, coal and steel were industries that posed immediate problems: coal was in short supply and steel in excess, although that relationship was soon to be reversed with the advent of oil as a major source of energy (Swann 1996, p. 2; George 1996, p. 3). The ECSC, however, went beyond the simple economics of a free trade area as the member states had to give up some of their formal powers to the supranational institutions that were set up, such as the High Authority and Court of Justice. This approach of sectoral integration was based on the neo-functionalist theory, where limited economic integration in a few key sectors would create positive spillovers into other sectors. The ECSC was generally considered to be a success. Between 1952 and 1960 iron and steel production rose by 75 per cent in the ECSC nations, and industrial production rose by 58 per cent. The GNP in the six countries combined increased at a rate of 5.6 per cent during the period 1950–55 (Lister 1960, pp. 75–76). The ECSC was important as it was the first successful integration exercise in the early post-war period. It was also instrumental in setting up several key institutions which helped to underpin a unique institutional structure with both supranational and intergovernmental elements. Following the ECSC, “the Six” moved on to create a common market for all the products, through the establishment of the European Economic Community (EEC) in 1957. As reported in The Economist in 1956, functional spillover seemed to have secured the transition from the ECSC to the EEC (George 1996, p. 40). The Economist reported:

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In the last four years, the Coal and Steel Community has proved that the common market is not only feasible but on balance, advantageous for all concerned. But it has also shown that “integration by sector” raises its own problems of distortion and discrimination. The Six have therefore chosen to create a common market for all products rather than continuing to experiment with the sector approach. (The Economist, 11 August 1956)

The main objectives of the EEC were as follows: • • • • • • • • •

A common market and progressive approximation of economic policies of member states; Promotion of harmonious economic development and higher living standards; Closer relations among member states; Removal of all tariffs and quantitative restrictions on imports and exports among member states; A common external tariff and a common commercial policy towards third countries; Free movement of goods, services, capital and labour; Common policies for agriculture and transport; A European Social Fund; and A European Investment to finance investment projects in the signatory states.

The EEC proved to be a success as “the Six” were natural trading partners, and they were able to benefit from the static and dynamic gains of economic integration. Between 1958 and 1970, trade within the EEC increased significantly by a factor of six, while trade between the EEC and the rest of the world increased by more than 70 per cent (Thody 1997). The high volume of trade was fuelled by the post-war economic boom in Western Europe, and factors such as high investment rates, U.S. capital, and low labour costs contributed to the high level of economic prosperity in the 1950s and 1960s. Since the early post-war era, the European integration project has come a long way, having successfully achieved deeper economic and monetary co-operation, which culminated in the creation of the common currency, the euro, in 1999. A chronology of the important events of the European integration from 1946 to 2002 is shown in Appendix Table 2.

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Appendix Table 2 European Integration: A Chronology of Important Events, 1946–2002 Year

Events

1946 1947

Winston Churchill advocates a kind of United States of Europe. The Benelux economic union, comprising Belgium, the Netherlands, and Luxembourg, is created. Treaty of Paris, establishing the European Coal and Steel Community (ECSC) is signed by West Germany, France, Belgium, the Netherlands, Luxembourg, and Italy. Treaty of Rome is signed by the six states, establishing the European Economic Community and the European Atomic Energy Community (Euratom). European Free Trade Association (EFTA) convention is signed by Austria, Denmark, Sweden, Norway, Portugal, Switzerland, and the United Kingdom. The ECSC, Euratom, and EEC merge to become the European Community (EC). Customs union is completed. After having been denied EC membership by French President Charles de Gaulle in the 1960s, Britain finally joins the EC, along with Ireland and Denmark. Greece joins the EC. Spain and Portugal join the EC. The Single European Act is signed (enters into force on 1 July 1987). In Maastricht, the twelve members sign the Treaty on European Union (TEU), turning the EC into the European Union (EU) and laying the groundwork for a common currency. The EU becomes a single market. Austria, Finland, and Sweden join the EU, bringing the membership to fifteen. Treaty of Amsterdam is signed (enters into force on 1 May 1999). The euro is adopted by eleven of the fifteen EU nations (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal and Spain). Treaty of Nice is signed. The euro becomes the sole currency within the twelve participating member states, as the period of dual circulation comes to an end. The treaty establishing the ECSC expires after fifty years in force.

1951 1957 1959 1967 1968 1973 1981 1986 1992 1993 1995 1997 1999 2001 2002

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NOTES 1.

2.

3.

4.

5.

6. 7.

Member countries of NAFTA are the United States, Canada, and Mexico. NAFTA does not have a formal policy on the free mobility of labour but has included provisions for the movements of skilled labour. One possible reason for the exclusion is to prevent this issue from slowing down the liberalization process in trade and investments, especially between the United States and Mexico. The European Coal and Steel Community, the European Atomic Energy Community, and the European Economic Community (EEC) merged to become the European Community (EC) in 1967. GATS is the service element of the WTO. The agreement, which came into force in 1995, was negotiated by the ASEAN governments themselves and relates to multilateral rules covering international trade in services. This sort of preferential treatment in services trade among regional groupings is permitted under WTO rules, provided that the agreement covers “substantially all” sectors, and eliminates discrimination among members to a substantial extent as well. The theme of the ASEAN Customs Vision 2020 is: “An ASEAN Customs Partnership for World Class Standards and Excellence in efficiency, professionalism and service and uniformity through harmonized procedures, to promote trade and investment and to protect the health and well-being of the ASEAN Community.” See Joint Press Statement on the Fifth ASEAN Director-Generals Meeting of Customs Meeting, Brunei Darussalam, 22–23 May 1997 . Britain declined the invitation to join the ECSC. In the 1950s, 70 per cent of the energy needs of Western Europe were met by coal, and steel was required to have an effective army. If the coal mines and steel mills of France and Germany were brought under international control, this would make it physically impossible for the two countries to go to war with each other again (Thody 1997, p. 3).

REFERENCES ASEAN Secretariat. ASEAN into the Next Millennium: ASEAN Vision 2020, Hanoi Plan of Action. Jakarta: ASEAN Secretariat, 1999. ———. “Protocol to Implement the Fourth Package of Commitments under the ASEAN Framework Agreement on Services, 3 September 2004. Avila, John Lawrence V., ed. Beyond AFTA. Manila: Center for Research and Communication, 2000. Balaam, D. and M. Veseth. Introduction to International Political Economy. Upper Saddle River, N.J.: Prentice Hall, 2001. Davidson, P.J. ASEAN: The Evolving Legal Framework for Economic Cooperation. Singapore: Times Media Private Limited, 2002. The Economist, 11 August 1956.

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George, S. Politics and Policy in the European Union. New York: Oxford University Press, 1996. Hans H. Glismann. “EC 1992: Strategic and Policy Issues for the 1990s — With Special Reference to Developing Countries and Yugoslavia”. Working Paper no. 387. Kiel Institute of World Economics, Germany, August 1989. Jones, R.A. The Politics and Economics of the European Union — An Introductory Text. Cheltenham, U.K. and Brookfield, U.S.: Edward Elgar, 1996. Lister, L. Europe’s Coal and Steel Community — An Experiment in Economic Union. New York: Twentieth Century Fund, 1960. Low, L. “Perspectives and Issues in ASEAN Framework Agreement on Services”. In Beyond AFTA, edited by John Lawrence V. Avila. Manila: Center for Research and Communication, 2000. Martinez, A. “The European Union and the Andean Community: Two Integration Systems”. . 2002. Neal, L. and Barbezat. The Economics of the European Union and the Economies of Europe. New York, Oxford: Oxford University Press, 1998. Nesadurai, H. “Is AFTA Still Relevant?”. IDSS Commentaries, Institute of Defence and Strategic Studies, Singapore, April 2003. ———. “Cooperation and Institutional Transformation in ASEAN: Insights from the AFTA Project”. In Non-Traditional Security Issues in Southeast Asia, edited by Andrew T.H. Tan and J.D. Kenneth Boutin. Singapore: Select Publishing for Institute of Defence and Strategic Studies, 2001. Nikomborirak, D. and S. Stephenson. “Liberalization of Trade in Services: East Asia and the Western Hemisphere”. Paper prepared for the Pacific Economic Cooperation Council (PECC) Trade Policy Forum on Regional Trading Agreements, 12–13 June 2001, in Bangkok. Park Sung-Hoon. “East Asia Economic Integration — Finding a Balance between Regionalism and Multilateralism”. EIAS Briefing Paper, February 2002. Rajan, R. and R. Sen. “International Trade in Services in Selected ASEAN Countries: Telecommunications and Finance”. ISEAS Working Papers in Economics and Finance no. 3, 2002. Swann, D. European Economic Integration: The Common Market, European Union and Beyond. Cheltenham, U.K. and Brookfield, U.S.: Edward Elgar, 1996. Teh R.R. “Completing the CEPT Scheme for AFTA”. In Beyond AFTA, edited by John Lawrence V. Avila. Manila: Center for Research and Communication, 2000. Thody, P. Historical Introduction to the European Union. London, New York: Routledge, 1997. Valdepeñas, Vincente B., Jr. “EC Single Market and ASEAN Countries”. Staff Paper no. 36, Research and Training Centre, South East Asian Central Banks (SEACEN), Kuala Lumpur, Malaysia, September 1990. United Nations Conference on Trade and Development (UNCTAD). Website: .

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Index Abu Bakar Bashyir, 90 AFTA-Plus programmes, 168 agro-based products, 2 AIA Ministerial Council, 151 air travel, 2 Agreement on Information Exchange and Establishment of Communication Procedures, 89 Al-Qaeda, 88 Amrozi, 90 Anwar Ibrahim, 86 apparel, see textile and apparel arbitrage measures summary, 259, 260 ASEAN capacity for change, 95, 96 centralization, need for, 70, 71 direct investment flow, 165 diversity, 41 economic environment, 41 expansion, perils of, 95 government budgets, smaller, 41 growth rates, 247 institutional environment, 40 integration, 164, 167, 168 investment inflows, 162, 163 investment measures, liberal, 153 national sovereignty valued, 64 non-intervention, policy of, 64

open economies, 42 political and security co-operation, 81–93 reforms, institutional, 168 regional reconciliation tool, 91 social indicators, 225 strengthening, 167–70 well-defined regulations, lack of, 66 ASEAN Business Summit, 152 ASEAN-China Comprehensive Economic Co-operation Framework Agreement, 22 ASEAN–China Free Trade Agreement (ACFTA), 247 ASEAN Committee on the Poverty Implications of Integration (ACPII), 10, 239 co-operative arrangements, 241 safety nets, 240 ASEAN Competitiveness Study, 15 ASEAN Compliance Monitoring Body, 3, 71, 72 ASEAN Consultation to Solve Trade and Investment Issues (ACT), 3, 71 ASEAN Court establishment, 67 need for, 72 ASEAN Declaration on Joint Action to Counter Terrorism, 88 319

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320

ASEAN Economic Community (AEC) AFTA, role of, 127–45 agreement to create, 32 capacity building, 184 challenges, 134–43 costs and benefits, assessment of, 14 declaration as common market, 7 economic integration, towards, 22–29 envisaged in ISEAS Concept Paper, 4, 5 European Union, taking cue from, 229 financial considerations, 52–55 labour, issues concerning, 210 labour mobility, implications of, 196–214 perspective from transitional economies, 105–23 political and security implications, 80–99 poverty reduction, implications for, 218–42 priorities, sectoral, 185 real-side roadmap, 46–52 regional fixed income market, 55–57 road ahead, 94–97 sectoral categories, 190, 191 time frame, 184, 185 ASEAN Economic Ministers Meeting (AEM), 28, 29 ASEAN Economic Ministers’ HighLevel task Force (HLTF), 1, 15, 71, 72 recommendation, 2, 3, 190, 191 ASEAN Foreign Ministers (AMM), 84 ASEAN Framework Agreement on Services (AFAS), 4, 50, 51, 58, 63, 105, 172 ASEAN-X rule, 187, 188 capacity building, 184 domestic regulation, 185, 186

lack in progress, 183 negative list, switch to, 186, 187 priorities, sectoral, 185 safeguards, application of, 188 trade liberalization under, 9 ASEAN Free Trade Area (AFTA), 2, 4, 13, 16, 18, 31, 58, 63, 87, 93, 105 challenges, 134–43 Council, role of, 68 implementation, 128–34 institutional barriers, 138 intra-ASEAN trade, 139–43 policies and strategies, recommended, 143–45 preferential rates, 14 role in AEC, 127–45 tariff liberalization, 151 tariff lines, 132–34 tariff reduction commitments, 129 trade and investment liberalization, 25 ASEAN Heads of Government Meeting (AHGM), 305 ASEAN Institute of Strategic and International Studies (ASEANISIS), 15, 16 report, 23 ASEAN Investment Area (AIA), 4, 13, 31, 63, 64, 67, 149–52 achievements, 151, 152 Council, see AIA Council features, main, 149–51 objective, 113 progress made, 9, 169 regional approach, 49 trade and investment liberalization, 25 ASEAN Investment Fair, 152 ASEAN Investment Networking and Outreach Programme, 152 ASEAN Ministerial Meeting (AMM), 28

320

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320

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Index

321

ASEAN Minus X formula, 3, 26, 108, 295 ASEAN–Plus Three arrangement, 166, 250 Bilateral Swap Arrangements, 279 ASEAN Regional Bond Market (ARBM), 55 guiding principles, 56, 57 ASEAN Regional Forum (ARF), 88 ASEAN Roundtable 2003, 4 ASEAN Secretariat, 7, 69, 70, 305 guardian of integration objective, 28 legal advice on trade disputes, 3, 71, 72 staff, 51 strengthening, 97 study, 23 ASEAN Security Community, 1, 81, 96 ASEAN-Six, 128–31 ASEAN Socio-cultural Community, 1 ASEAN Supporting Industry Database ASEAN Surveillance Process (ASP), 278 ASEAN Swap Arrangement (ASA), 114 ASEAN Treaty of Amity and Cooperation (TAC), 83 ASEAN Troika, 86, 92 ASEAN Vision 2020, 10, 241, 295, 307 Asian Bond Corporation, 10, 275 Asian Bond Fund, 10 Asian Development Bank, 41, 87 Asian financial crisis, 127 repercussions, 85–88 Asia-Pacific Economic Cooperation (APEC), 24, 53, 166 Australia–New Zealand Closer Economic Relations Trade Agreement (ANCERTA), 66 automotives, 2

Bangkok Declaration, 82 bank lending financing private investments, 53 bilateral agreements CLMV, 112 Singapore, 27 Bilateral Free Trade Areas, 166, 167 Bilateral Swap Agreements, 87 Bilateral Swaps and Repurchase Agreements (BSAs), 114 Board of Investment of Thailand, 151 Bolkestein Directive, 51 bond financing, 275 bond market ASEAN, for, 54 Bretton Woods System, 52 Brunei-Singapore Currency Interchangeability Arrangement, 312 Cambodia, see also CLMV loans, 115 capital controls, 268, 269, 270 Cecchini Report, 35 Chiang Mai Initiative (CMI), 278 China challenge posed to ASEAN, 228, 229 emergence, 107 WTO, accession, 118, 187 “China plus One” formula CLMV (Cambodia, Laos, Myanmar, Vietnam) AFTA commitments, 138, 139 ASEAN’s assistance, 115–21 best practices, adopting, 49 CEPT commitments, 131–34 challenges facing, 8 co-operation amongst, 118 GDP growth rates, 248 institutional weaknesses, 111 legal framework, weak, 119 net capital importers, 113 321

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322

reform process, accelerating, 122 perspective on AEC, 105–23 CLMV-China economic relations, 121 Common Agricultural Policy (CAP), 33, 52 Common Effective Preferential Tariffs (CEPT) Scheme, 2, 65, 130, 167, 302 concessions, 9 rates, 168 Temporary Exclusion List (TEL), 65, 130 utilization of concessions, 135, 136 common market, 311 “common market minus” approach, 23, 145 Confrontation, 82 counter-terrorism ASEAN Security Community, 98 covered interest parity (CIP), 249, 251 currency denomination co-operation, 57 custom procedures simplification, 1 “Customs Union plus”, 7, 33, 58 Database for ASEAN Supporting Industries ASEAN Technology Suppliers dispute settlement mechanism (DSM), 2, 7, 65, 67, 68, 73–77, 96, 97, 304 depoliticization of process, 12 protocol, 27 Double Taxation Avoidance Agreements, 149 drug trafficking countering, 98 e-ASEAN, 301 East Asia trade dependence on, 17

Economic and Monetary Union (EMU), 35 economic growth, 219, 220 economic integration, 230–32 forms, 311, 312 key issues, 297–303 sequencing, 269–74 economic trends, 16–22 economic union, 312 electronic equipment MRAs, 2 electronics, 2 Enterprise of ASEAN Initiative, 166 European Coal and Steel Community, 33 European Central Bank (ECB), 50 European Community (EC), 33 European Court of Justice (ECJ), 67 European Economic Committee, 294 main objectives, 314 European integration chronology of events, 315 learning from experience, 313 European Free Trade Area (EFTA), 33 European Monetary System (EMS), 35, 58 European Parliament, 36 European Payments Union, 33, 52 European Union (EU) binary variables, 36, 37 integration, statistical analysis, 36–40 lessons from, 3–59 regressions, 37 trade and investment determinants, 38, 39 export products, 20, 21 FDI Statistical System, 152 financial integration, 246–83 arbitrage measures, 250–60 capital controls, 268, 269 categorizing measures, 250 measuring, 249, 267–69

322

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Index

323

monetary integration, as against, 269–74 “firm congestion”, 282 fisheries, 2 foreign direct investment (FDI), 32 challenges affecting movement, 163–68 contribution to poverty reduction, 233, 234 correlation with foreign worker numbers, 202 ASEAN-Five economies, in, 148 ASEAN, in, 157–59 engaging high-skilled labour, 37 inflows, 4, 36, 155, 309 instrumentality in effecting changes, 45 manufacturing sectors, 160, 161 pattern and trend, 152–63 foreign investment ceiling, 271 free trade reducing intra-regional transactions, 42 free trade agreements (FTAs), 22 free trade areas, 311 diversion effects, 107 “FTA plus” arrangement, 23, 47, 49, 109, 145, 169 GATS minus arrangement, 182 GDP changes, 232, 233 per capita growth, 219, 220 sectoral shares, 228 General Agreement on Tariffs and Trade (GATT), 34, 112, 307 General Agreement on Trade in Services (GATS), 180, 189 general exclusion list (GEL), 130 Gini coefficients, 221 globalization, 226 Global Outbreak Alert and Response Network, 91 Goh Chok Tong, 248

Granger Causality stock exchange returns, 265–67 Greater Mekong Sub-region, 118 Hanoi Plan of Action, 31, 55 healthcare, 2 human trafficking countering, 98 income disparity between countries, 234–36 growth, effect of, 233 inequality, 224 per capita, 219 Indonesia lifting restrictions on foreign investments, 269 infrastructure access to, 227 institutional, development of, 303 preferential liberalization, 191 Initiative for ASEAN Integration (IAI), 28, 93, 116 current performance, 117 input-output analysis DFI-export link, 44 institutional reforms AEC integration, towards, 63–77 institutional strengthening, 238, 239 integrated market, 6 Integrated Sourcing Initiative (ISI), 27 International Labour Organization (ILO), 210 International Monetary Fund (IMF), 87, 268 international trade theory, 235 intra-ASEAN trade, 16 intra-regional trade, 231 investments effects of integration, 300, 301 private, financing of, 53 ISEAS ASEAN Community Roundtable, 5, 6 323

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Index

324

ISEAS Concept Paper, 4, 5, 47, 49, 50, 51, 59, 293–316 key policy recommendations, 308 scope, 295, 296 Jakarta Stock Exchange, 265 Japan International Co-operation Agency (JICA), 116 Jemaah Islamiyah, 88 Korean Stock Exchange Composite Index (KOSPI), 262 Kuala Lumpur Stock Exchange (KLSE), 265 labour countries importing, 197 migration, patterns of, 204–9 mobility, adverse effects with, 212 mobility within ASEAN, 196–214 policy measures under AEC, 211–13 problems arising from mobility, 209–11 Laos, see also CLMV bilateral trade agreement, 48, 49 non-performing loans, 115 literacy progress, 222, 223 “low cost labour trap”, 120, 122 “Lucas Critique”, 282 Maastricht Treaty, 35 Malaysia agricultural-export base, 44 automotive industry, 65 expatriates, number of, 203 foreign workers, composition of, 200, 201, 202 tariff preferences, 141 trade dispute with Thailand, 65 McKinsey Study, 25, 109, 294

Megawati Soekarnoputri, 29 merchandise trade, 297, 298 MERCOSUR, 47, 53, 154 Mexican peso crisis, 53 migrant workers data, quality of, 198 Indonesian, 206 limiting future flows, 10 Thailand, 208 types, 199 work, types of, 206 Mode 4, 189, 190 monetary integration case for, 272 monetary union, 312 most favoured nation (MFN), 9 rates, 14 multinational corporations ASEAN-Five economies, in, 148 attraction to ASEAN, 3 mutual recognition arrangements (MRAs), 2, 25 Myanmar, see also CLMV negative list, 109 network of co-operation, 310 non-debt price measures, 260–67 non-performing loans (NPLs), 54 non-tariff barriers (NTBs), 14, 34, 58, 66, 136, 137 elimination, 25 non-tariff measures (NTMs) ASEAN database, 2 North American Free Trade Agreement (NAFTA), 15, 53, 66, 295 intra trade, 16 official development assistance (ODA), 116 open customs union, 48 optimum currency area (OCA), 272–74, 276

324

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Index

325

Organization for Economic Cooperation and Development (OECD) defining modes of service, 50 Development Committee on Competition law Policy, 68 Overseas Migrant Workers Fund, 213 “peso problem”, 257 Philippines Overseas Migrant Workers Fund, 213 tariff preferences, 140 priority sectors, 2, 26 poor, the vulnerability, 237 post-September 11 regional security, 88–90 poverty co-operative arrangements, 241 incidence in ASEAN, 221, 222, 223 incomes, effect of growth in, 233 measures of well-being, 222, 223 negative impact of AEC, possible, 234 reduction, 233–41 reforms, sequencing of, 238 professional participating in implementing AEC, 6 Protocol on Dispute Settlement Mechanism, 27, 28 Protocol on Special Arrangement for Sensitive and Highly Sensitive Products, 130 public–private partnerships services, better, 234 real interest parity (RIP), 258 Real Time Gross Settlements (RGS), 57 reforms institutional, see institutional reforms

regional bond market, 7 regional economic integration forms, 109 Regional Haze Action Plan (RHAP), 87, 92 regional integration CLMV in ASEAN, 106–8 growth, effects on, 231, 232 reducing differences in factor prices, 235 welfare effects, 230 regional integration agreements (RIAs), 218 regionalism effect, 41 regional monetary integration, 246–83 regional trade agreements (RTAs) services, in, 181, 182 regional units creation, 7 rice import quota, 65 Rules of Origin (ROO) application, lack of, 14 ASEAN cumulative, 27 CEPT scheme, 2 elimination, 24 services, application to, 189 US-Singapore FTA, 27 Senior Economic Officials Meeting (SEOM), 29 Senior Officials Meeting (SOM), 28 services, see services trade services trade ASEAN’s exports of goods, in , 175 ASEAN’s imports of goods, in, 176 background, 173–77 barriers, substantial, 177, 178, 179 effects of integration, 298–300 exports, ranking in, 174 liberalization, 172–93 325

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Index

326

market access, developing economies, 179–80 modes of supply, 192, 193 net export ratios, 173, 176 policy goals, specifying, 180, 181 reform agenda, 177–84 regional trade agreements (RTAs), 181, 182 scorecarding, 188 share in employment, 175 workers, types of, 189 Severe Acute Respiratory Syndrome (SARS), 90, 91, 229 Singapore bilateral agreements, 27 intra-ASEAN imports, 142 migrants, large number of, 199 no tariffs, 46 Single European Act (SEA), 34, 35, 46, 50, 52, 53 Single Market Programme, 232 Soeharto, 86 “spaghetti bowl” effect, 110, 112, 120 Spearman Rank Correlation Coefficient technique, 44 special and differential treatment (SDT), 115, 116 Standard & Poor’s data, 269 standards and technical regulations harmonization, 2 state-owned enterprises (SOEs), 111 stock market integration, 54 movements, 260–67 returns, Granger Causality on, 265 returns, correlations, 261, 263, 264 returns, pre-crisis, 260 sugar tariff rate, 65

Tay, Simon, 70 telecommunication equipment MRAs, 2 “Ten-X” formula, 96 textile and apparel, 2 Thailand agricultural-export base, 44 labour outflow, 208 tariff preferences, 141 trade dispute with Malaysia, 65 tourism, 2 trade intra-ASEAN, 16, 110 trade barriers elimination, 1 trade facilitation economic integration, 302 trade intensity indices, 19 trade liberalization AFAS, under, 9 beneficial for poor, 236 benefits, 119 effect on employment and wages, 236 trade policy common, adoption of, 27 Treaty of Rome, 33 amended by SEA, 34 uncovered interest differentials, 255–57 uncovered interest parity (UIP), 249, 252–54 United Nations International Force for East Timor (INTERFET), 88 United Nations Conference on Trade and Development (UNCTAD), 293 Vietnam, see also CLMV non-performing loans, 115 progress, 48 Vientiane Action Programme (VAP), 10

tariff harmonization, 48 rates, 137 reduction, 129 326

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327

wood-based products, 2 world trade ASEAN, importance of, 176 World Trade Organization (WTO), 34 China’s accession, 118 dispute settlement mechanism, 67

WTO agreements liberalization efforts, 294 Technical Barriers to Trade, Sanitary and Phyto-Sanitary and Import Licensing Procedures, 2 Zambia purchase of maize, 237

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