Abstract
Regional integration in East Asia has been described as ‘market-led’ integration driven by the activities of multinational corporations creating vertical specialisation. This paper investigates the effect of free trade agreements (FTAs) on vertical specialisation-based trade by employing a gravity estimation for a sample of nine East Asian countries plus the US. We find that FTAs promote international trade based on vertical specialisation and enhances deep integration between countries. The FTA effect on vertical specialisation-based trade increases with pre-agreement vertical linkage level, that is, the deeper the real integration between countries the larger the FTA impact. The results of this paper also suggest that deeper economic integrations, such as currency unions, will enhance trade based on vertical production by reducing the risk of exchange rate volatility.
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Notes
For more information see Chapter 4 of the Asia and Pacific Regional Economic Outlook, published by the International Monetary Fund, October, 2007.
Hanson (1996) investigates the vertical trade on the production network in a two-country model and illustrate with the apparel industry in Mexico and the US.
World Trade Organisation 2008, page 112
Hummels et al. 1998, page 82
Hummels et al. (2001)
The Leontief inverse is fundamental to input-output analysis because it shows the full impact of an exogenous shock in net final demand on all industries in the economy.
In his case study of Mexican apparel industry, he finds that there has been a substantial relocation of Mexican apparel production since its opening to trade, and NAFTA reinforces this production relocation. Border producers in Mexico have easier access to the US market which reduces the importance of distance from its industry centre to Mexico City.
A gravity model is a handy tool when one is interested in looking into the determinants for any bilateral relationship. It tries to explain the interdependence between two objects in the space.
In technical terms one can include a ‘dummy variable’ for the FTA which is equal to one when there is a FTA between a particular pair of countries, and is equal to zero otherwise. An instrumental variable for the RTA dummy is needed in order to correct this endogenous problem and yield a more accurate estimate of RTA effect upon bilateral trade.
In our sample, ASEAN+3 means ASEAN5 (Indonesia, Malaysia, the Philippines, Singapore and Thailand) plus China, Japan and Korea.
Their gravity estimation shows there is a clear East Asia trading bloc, and a possible US dollar bloc rather than an East Asian currency bloc.
Baldwin (2007, page 11) briefly explains this American strategy.
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Acknowledgements
The author is grateful to the valuable comments from Prof Yaoxing Yue at Shanghai University of Finance & Economics, Dr Camine Ornaghi at the University of Southampton, Dr Brigid Gavin at the UNU-CRIS, Dr Peter Holmes at the University of Sussex and many participants to the workshop on Deep Integration and North–South Free Trade Agreements EU Strategy for a Global Economy in Bruges, June 2008.
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Li, X. Free trade agreements and vertical-specialisation in East Asia. Asia Eur J 7, 145–160 (2009). https://doi.org/10.1007/s10308-008-0215-x
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DOI: https://doi.org/10.1007/s10308-008-0215-x