Free Trade Agreements versus Customs Unions: An Examination of East Asia

Park, Innwon and Park, Soonchan (2008): Free Trade Agreements versus Customs Unions: An Examination of East Asia.

Abstract

The spaghetti bowl phenomenon expected from the proliferating East Asian regional trade agreements (RTAs) is worrisome. In particular, the complicated web of hub-and-spoke type of overlapping free trade agreements (FTAs) can result in high costs for verifying rules of origin (RoO). As an alternative policy option to avoid the negative effect of trade deflection, customs unions (CUs) should be examined. Most of the theoretical analyses on the formation of CUs highlight stronger positive welfare effects compared to FTAs. However, there is a lack of empirical evidence to support the second best theory of customs unions. This paper is an attempt to fill this gap by applying two methodologies, an ex-ante simulation approach and an ex-post econometric approach. We quantitatively estimate the trade effect of CUs and FTAs by adopting a Gravity regression analysis. In general, we find that a CU is a superior type of RTA to an FTA in terms of creating more intra-union trade. In addition to analyzing the trade effects of RTAs according to type, we quantitatively evaluate the welfare and output effects of CUs for East Asia (an ASEAN+3 CU and a China-Japan-Korea CU) compared to FTAs by applying a computable general equilibrium (CGE) model analysis. The East Asian CUs adopt a system of common external tariffs (CET) based on simple-averaged, import-weighted, consumption-weighted, and minimum rates. Overall, we find that the ASEAN+3 CU with the minimum CET is the most desirable type of RTA for both East Asian member countries and the world economy as a whole.

• Item Type: MPRA Paper
• Language: English
• Keywords: free trade agreements, customs unions, rules of origin, common external tariffs, Gravity, CGE, East Asia, ASEAN+3
• Subjects: F - International Economics > F1 - Trade > F15 - Economic Integration; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C68 - Computable General Equilibrium Models; F - International Economics > F1 - Trade > F13 - Trade Policy ; International Trade Organizations; O - Economic Development, Innovation, Technological Change, and Growth > O5 - Economywide Country Studies > O53 - Asia including Middle East

References

Aitken, N. D. 1973. The effect of the EEC and EFTA on European trade: a temporal cross-section analysis. American Economic Review 5: 881-892. Anderson, James and Eric Van Wincoop. 2003. Gravity with gravitas: a solution to the border puzzle. American Economic Review 93: 170-192. Andresen, Martin A. 2004. Is There a Case for an East Asian Customs Union? Mimeo. University of British Columbia. Asian Development Bank. 2008. Emerging Asian Regionalism: A Partnership for shared Prosperity. Asian Development Bank. Bair, S. L. and J. H. Bergstrand. 2007. Do free trade agreements actually increase members’ international trade? Journal of International Economics 71: 72-95. Baldwin, Richard. 1993. A Domino Theory of Regionalism. NBER Working Paper Series 4465. National Bureau of Economic Research (NBER). Baldwin, Richard. 2007. Managing the Noodle Bowl: The Fragility of East Asian Regionalism. ADB Working Paper Series on Regional Economic Integration No. 7. Asian Development Bank. Baldwin, R. and D. Taglioni. 2006. Gravity for Dummies and Dummies for Gravity Equations. NBER Working Paper Series 12516. NBER Bayoumi, T. and B. Eichengreen. 1997. Is regionalism simply a diversion? Evidence from the evolution of the EC and EFTA. edited by Ito, T. and Krueger, A. O., Regionalism vs. Multilateral Arrangements. The University of Chicago Press. Chicago. Bhagwati, J. 1991. The World Trading System at Risk. Princeton University Press. Princeton. Bhagwati, J. 1993. Regionalism and Multilateralism: an overview. Chapter 2 in New Dimensions in Regional Integration edited by Jaime De Melo and Arvind Panagariya, Centre for Economic Policy Research (CEPR). Cambridge University Press. pp. 22-51. Bhagwati, J., D. Greenaway, and A. Panagariya._1998. Trading Preferentially: Theory and Policy. The Economic Journal 108: 1128-1148. Brown, D. K., Alan V. Deardorff, and Robert M. Stern. 2001. Impacts on NAFTA Members of Multilateral and Regional Trading Arrangements and Initiatives and Harmonization of NAFTA’s External Tariffs. Discussion Paper No 471. Research Seminar in International Economics. School of Public Policy. The University of Michigan. Burfisher, M. E., S. Robinson, and K. Thierfelder. 2004. Regionalism: Old and New, Theory and Practice. MTID Discussion Paper No. 65. Markets. Trade and Institutions Division. International Food Policy Research Institute. Dimaranan, Betina V. and Robert A. McDougall, Editors. 2006. Global Trade, Assistance, and Production: The GTAP 6 Data Base. Center for Global Trade Analysis. Purdue University. Egger, P. 2000. A note on the proper econometric specification of the gravity equation. Economics Letters 66: 25-31. Feridhanusetyawan, Tubagus. 2005. Preferential Trade Agreements in the Asia-Pacific Region. IMF Working Paper WP/05/149. IMF. Frankel, J.A. 1997. Regional Trading Blocs. Institute for International Economics. Washington, DC. Ghosh, Sucharita and Steven Yamarik. 2004. Does Trade Creation Measure Up? A Reexamination of the Effects of Regional Trading Arrangements. Economic Letters 82: 213-219. Greenaway, D. and C. Milner. 2002. Regionalism and Gravity. Scottish Journal of Political Economy 49: 574-583 Hausman, J. 1978. Specification Tests in Econometrics. Econometrica 46: 1251-1271. Haveman, J. and Hummels, D. 1998. Trade Creation and Trade Diversion: New Empirical Results. Journal of Transnational Management Development 3: 47-72. Hertel, Thomas W. ed. 1996. Global Trade Analysis using the GTAP Model. Cambridge University Press. JETRO. 2003. Prospects for Free Trade Agreements in East Asia. Overseas Research Department. Japan External Trade Organization. Kawai, Masahiro. 2004. Regional Economic Integration and Cooperation in East Asia. paper prepared for the Experts’ Seminar on the Impact and Coherence of OECD Country Policies on Asian Developing Economies. Kawai, Masahiro. 2007. Evolving Economic Architecture in East Asia. ADB Institute Discussion Paper No. 84. ADB Institute. Kawai, Masahiro and Ganeshan Wignaraja. 2008. Regionalism as an Engine of Multilateralism: A Case for a Single East Asian FTA. Working Paper Series on Regional Economic Integration No. 14. Asian Development Bank. Kemp, M.C. and H.Y. Wan, Jr. 1976. An Elementary Proposition Concerning the Formation of Customs Unions. Journal of International Economics 6: 95-97. Krueger, Anne O. 1995. Free Trade Agreements versus Customs Unions. NBER Working Paper Series No. 5084. NBER. Kuroiwa, Ikuo. 2006. Economic Integration in East Asia and Changes in Production Networks. Chapter 1 in Regional Cooperation Toward the Establishment of an East Asian Community-with a View to Asia in 2020. Japan Center for Economic Research. Lee, Jong-Wha and Innwon Park. 2005. Free Trade Areas in East Asia: Discriminatory or Nondiscriminatory? The World Economy 28: 21-48. Lee, Jong-Wha, Innwon Park and Kwanho Shin. 2008. Proliferating Regional Trade Arrangements: Why and Whither? forthcoming in The World Economy. Lu, Feng. 2003. Free Trade Area: Awakening regionalism in East Asia. Working Paper Series E2003010. China Center for Economic Research. Magee, Christopher S. 2003. Endogenous preferential trade agreements: an empirical analysis. Contributions to Economic Analysis and Policy, vol. 2, no. 1. Berkeley Electronic Press. Magee, Christopher S. 2008. New Measures of Trade Creation and Trade Diversion. forthcoming in Journal of International Economics. Manchin, Miriam and Annette O. Pelkmans-Balaoing. 2007. Rules of Origin and the Web of East Asian Free Trade Agreements. World Bank Policy Research Working Paper 4273. The World Bank. Mirus, Rolf and Nataliya Rylska. 2001. Economic Integration: Free Trade Areas vs Customs Unions. Western Centre for Economic Research. Panagariya, Arvind. 1999. The Regionalism Debate: An Overview. The World Economy 22: 477-511. Panagariya, Arvind and Ronald Findlay. 1996. A Political-Economy Analysis of Free-Trade Areas and Customs Unions. Chapter 13 in The Political Economy of Trade Reform: Essays in Honor of Jagdish Bhagwati. MIT Press. Cambridge. pp. 265-287. Park, Innwon. 2006. East Asian Regional Trade Agreements: Do They Promote Global Free Trade? Pacific Economic Review 11: 547-568. Park, Innwon. 2008. Regional Trade Agreements in East Asia: Will They Be Sustainable? Mimeo. Plummer, Michael G. 2006. An ASEAN Customs Union? Journal of Asian Economics 17: 923-938. Rajapatirana, Sarath. 1994. The Evolution of Trade Treaties and Trade Creation: Lessons for Latin America. Policy Research Working Paper 1371. The World Bank. Richardson, Martin. 1994. Why a Free Trade Area? The Tariff Also Rises. Economics and Politics 6: 79-96. Rose, A. K. 2004. Do We Really Know That the WTO Increases Trade? American Economic Review 94: 98-114. Salvatore, Dominick. 2007. International Economics, 9th edition. John Wiley & Sons Inc. Srinivasan, T. N. 1997. The Common External Tariff of a Customs Union: Alternative Approaches. Japan and the World Economy 9: 447-465. Syropoulos, Constantinos. 2003. Rules for the Disposition of Tariff Revenues and the Determination of Common External Tariffs in Customs Unions. Journal of International Economics 60: 387-416. Trefler, D. 1993. Trade liberalization and the theory of endogenous protection: an econometric study of U.S. import policy. Journal of Political Economy 101: 138-160. Urata, Shujiro. 2006. A Shift from Market-driven to Institution-driven Regionalization in East Asia. Mimeo. Viner, J. 1950. The Customs Union Issues. Carnegie Endowment for International Peace.