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Trade creation and the status of FTAs: empirical evidence from East Asia

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Abstract

East Asia has been considered a latecomer with respect to Free Trade Agreements (FTAs). Since the turn of the last century, however, FTAs with East Asian participation have seen an intra- and extra-regional expansion. Many trade initiatives have been proposed, negotiated or even implemented. This introduces interesting perspectives for the analysis of trade agreements regarding their anticipatory trade effects. This paper focuses on the trade impact of FTAs at different stages that East Asian economies participate in. The central part of this study is an econometric analysis that applies panel data to the gravity model of international trade flows. We augment the traditional model with variables to estimate trade effects of bilateral and multilateral agreements and year-to-year changes in the stages of their implementation. Our results reveal that there exist anticipatory effects preceding the actual implementation of bilateral FTAs with East Asian participation. Further, anticipation effects are larger for bilateral than for multilateral agreements, possibly because the realisation of bilateral agreements is considered more realistic.

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Notes

  1. Throughout this paper, we will use the terms implemented (under implementation) and in effect interchangeably.

  2. These are: Brunei Darussalam (hereafter Brunei), Cambodia, People’s Republic of China (hereafter China), Hong Kong SAR (hereafter Hong Kong), Indonesia, Japan, Republic of Korea (hereafter Korea), Lao People’s Democratic Republic (hereafter Laos), Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam.

  3. In the subsequent analysis, we use the term FTA to describe various forms of trade enhancing initiatives such as preferential trade agreements, customs unions and of course FTAs. According to Vicard (2009), the trade creation effect of different categories of trade agreements does not vary significantly.

  4. Developing East Asia refers to the ten ASEAN members and the NIE (Newly Industrialised Economies), namely Hong Kong, Korea and Taiwan.

  5. For a comprehensive overview on the effects of regional integration agreements on FDI see Blomström and Kokko (1997).

  6. Regional initiatives have been initiated that are supposed to cushion negative shocks that could result in overlapping effects for the region. The Chiang Mai Initiative (launched in 2000) and Asian Bond Market Initiative (launched in 2003) are the most prominent ones.

  7. Baldwin’s (1993) domino theory helps to comprehend East Asia’s fear of discrimination: the costs of non-membership increase when trading partners (e.g. USA, Europe) enter existing trade agreements as members’ trade within an agreement is treated preferentially. For reference on this issue in the context of East Asia, see Dent (2006).

  8. Medvedev (2010) shows that between 2000 and 2002, only 12% of total trade in East Asia was conducted under preferential trade agreements.

  9. See Table 1 for the definitions of the respective stages.

  10. It is worth mentioning that there are outliers in the data on bilateral FTAs. Agreements with the United States e.g. tend to be stuck in one stage for a considerable amount of time which distorts the average number of years upwards. The United States-Indonesia FTA, which stands at the proposed stage since 1997, is an example.

  11. In another empirical analysis on NAFTA, Krueger (1999) finds that trade relations between Canada, the United States and Mexico were affected even before the FTA became effective. According to Krueger, this was not entirely attributable to the anticipation of NAFTA but also to the liberalisation process prior to 1994 (when NAFTA was implemented) that took place in Mexico.

  12. Dent (2006: 18) provides the example of the Japan-Mexico Economic Partnership Agreement whose negotiations took 14 rounds.

  13. A considerable number of authors contributed to the further development and justification of the gravity model. Further inputs include Pöyhönen (1963) and Helpman (1987). For a comprehensive summary on the theory of the gravity model, see Deardorff (1995) or Feenstra (2004) who review the relevant contributions in this field. Anderson and van Wincoop (2003) criticise the existing setup of the gravity equation on the grounds of missing multilateral resistance terms which shall reflect a country pairs’ relative position to the rest of the world economy in addition to the bilateral resistances, such as the distance between its trading partners.

  14. We concentrate on nominal trade flows instead of real flows due to data availability. There are no export or import deflators on hand for the respective countries. Only a few authors record whether they use real or nominal data. Among those who do, some follow Rose (2004) and obtain real values by deflating the nominal trade flows by the US CPI. This is criticised by Baldwin and Taglioni (2006), who state that this method is biased, as export/import deflators are needed. Following Frankel (1997), we include time dummies in each regression to account for effects of global inflation and growth that are common to all country pairs in any year.

  15. We use distance according to the great distance formula which makes use of the countries’ most populous agglomerations.

  16. For a comprehensive overview on possible variables in the gravity model and further references see Ghosh and Yamarik (2004).

  17. Melitz (2008) recently emphasised the positive influence of a common language on the volume of bilateral trade.

  18. Consider the examples of China and Vietnam. Vietnam’s accession to the WTO in the beginning of 2007 was expected to boost FDI (Hau and Dickie 2006) similar to the boost that occurred with China’s 2001 accession.

  19. http://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm.

  20. In order to address the concerns raised by Haveman and Hummels (1998), who argue that gravity model estimates are sensitive to the sample of countries included, we have run robustness checks with different sample selections, such as adding more countries according to the total average trade volume with East Asia or by GDP, without significantly altering our results.

  21. This number has been calculated as follows: For each of the 14 East Asian countries, we include 78 extra-regional trading partners over the period of 13 years (78 × 13 × 14 = 14,196 observations). There are 13 intra-regional trading partners for the first East Asian economy, 12 for the second, etc., resulting in 1,183 observations ((13 + 12 + 11 + 10 + 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1) × 13). This adds up to 15,379 observations for East Asia’s intra- and extra-regional trade relations.

  22. A single dummy variable prevents the differentiation between the different types of FTAs. Trade agreements may include different kinds of trade facilitation measures, or even promote FDI or monetary cooperation among the signatories. A more sophisticated analysis should incorporate and reflect trade effects coming from different types of trade agreements in order to assign the effects to certain measures. Magee (2008), for example, distinguishes between FTAs, customs unions, and preferential trade agreements.

  23. This method directly reflected the natural ordering of the degrees of implementation; from the proposed until the concluded stage. The five stages have been ordered in an ascending manner from 1 (proposed) to 5 (in effect). For overlapping, multilateral FTAs, we summed the numbers to incorporate scale effects coming through multiple trade agreements. The results are available from the authors upon request.

  24. Their results show that differences in capital/labour ratios (making use of comparative advantages), proximity of the respective trading partners and similarity of the countries’ GDP (exploiting economies of scale) among others are significant determinants of FTAs. The authors correctly predicted 97.29% of trade agreements.

  25. Political factors as a driving force for FTAs has been examined by Mansfield et al. (2002) and Rosendorff (2005) and their findings suggest that democratic country pairs favour bilateral trade liberalisation, as do dyads of autocracies.

  26. The results are not reported here but are available from the authors upon request.

  27. Caporale et al. (2009) refer to the fixed effect vector decomposition method if estimation is based on a small sample.

  28. For further justification of the Poisson model in non-count models, see Winkelmann (2008) and Wooldridge (2002) who recommend Poisson due to its properties under the existence of heteroskedasticity.

  29. An empirical application of the Poisson method for gravity models can be found in Magee (2008).

  30. Y denotes the dependent variable (in our case, trade flows between i and j). X refers to the explanatory variables.

  31. This would violate the equidispersion condition in the Poisson model.

  32. In our case, a likelihood-ratio test rejects the hypothesis that the Poisson and negative-binomial distributions are equivalent, pointing towards overdispersion.

  33. Overdisperion is characterised by an increasing ratio of the variance to the conditional mean (Wooldridge 2002).

  34. For empirical analyses employing a negative-binomial distribution, we refer to Soloaga et al. (2006) and Fratianni and Marchionne (2009).

  35. The 33.64% result from calculating e 0.29 = 1.3364.

  36. The fixed effects approach was favoured over the random effects model by a Hausman test.

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Acknowledgments

The authors would like to thank Birgit Schmitz, Jürgen von Hagen, Ansgar Belke, Jörg Breitung, James Reade and an anonymous referee for helpful comments. The usual disclaimer applies.

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Authors and Affiliations

  1. DIW Berlin, Mohrenstraße 58, 10117, Berlin, Germany

    Florian Mölders

  2. German Development Institute, Tulpenfeld 6, 53113, Bonn, Germany

    Ulrich Volz

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  1. Florian Mölders
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  2. Ulrich Volz
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Correspondence to Florian Mölders.

Appendix

Appendix

See Tables 3 and 4.

Table 3 FTAs including East Asian countries
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Table 4 Countries included in the data set
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Mölders, F., Volz, U. Trade creation and the status of FTAs: empirical evidence from East Asia. Rev World Econ 147, 429–456 (2011). https://doi.org/10.1007/s10290-011-0095-9

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