ASEAN Economic Integration: Glass Half Empty or Half Full?

Ramkishen S. Rajan and Sunil Rongala

When one thinks about economic integration among countries in a particular region, the first thing that comes to mind is the European Union (EU). The 1957 Treaty of Rome marked the start of the economic integration of Europe – beginning with Western Europe but gradually extending eastwards. Like the EU, the Association of South-East Asian Nations (ASEAN), has also had the aspect of economic integration and co-operation embedded in their founding declaration. ASEAN was founded in 1967 with Indonesia, Malaysia, Philippines, Singapore, and Thailand as its founding members.

Though the Bangkok ASEAN Declaration of 1967 laid out the case as well as the need for increased economic integration, not much was done in this area for a while. This lull in further negotiations resulted, perhaps, because of the war that took place in the region from the latter part of the 1960s to the mid 1970s. In 1976, the ‘Asean Concord’ was signed in Bali and that declaration provides that “Member States shall cooperate in the field of trade in order to promote development and growth of now production and trade”. In 1977, there was an agreement signed in Manila where members agreed to adopt various instruments on trade liberalization on a preferential basis. After the third summit meeting of the ASEAN heads of government in Manila in December of 1987, ASEAN declared that “Member States shall strengthen intra-ASEAN economic cooperation to maximize the realization of the region’s potential in trade and development.”

However, most of these agreements and declarations really did not amount to much action on the ground. The real breakthrough came in January of 1992 when, in Singapore, six ASEAN member countries signed the Common Effective Preferential Tariff (CEPT) scheme for an ASEAN Free Trade Area (AFTA). Under the AFTA, the bulk of intra-ASEAN trade enjoys tariff rates between 0 and 5 percent (the newer members, Cambodia, Lao PDR, Myanmar and Vietnam, have been granted longer timetables to implement AFTA). While AFTA came into force earlier than originally planned (January 1, 2002 for the original ASEAN members) and a target zero-tariff rate will be achieved by 2010 (2018 for the transition members), its impact has thus far proven to be rather disappointing.

Costs of complying with the Rules of Origin (ROOs) to satisfy the criteria for preferential treatment are perceived to be quite high by the businessmen. A recent study estimates that current utilization rate of tariff concessions under the CEPT scheme is as low as 5 percent. This is largely due to lack of clear and transparent procedures as well as absence of credibility and mutual trust between the countries that provide and receive preferential tariff treatment under AFTA. Further, the margins of preference between the ASEAN-wide tariff rate (CEPT) and those applied by ASEAN countries to imports from the rest of the world are rather low. Further, AFTA is narrowly focused on reducing and eventually eliminating intra-ASEAN tariff barriers on merchandise trade. Non-tariff and other trade hindering barriers have not been adequately addressed by AFTA.

The data bears out the limited effectiveness of AFTA. First, intra-ASEAN trade has accounted for only about one-fifth of ASEAN’s total trade, this share remained stagnant over the last decade (and much of the intra-ASEAN trade is due to Singapore), at the expense of its increasing trade linkages with the two Asian giants China and India. Intra-ASEAN trade is also far lower than other regional economic alliances such as the European Union (two-thirds) or the North American Free Trade Area (one half). Second, only a small proportion of intra-ASEAN trade is conducted under the CEPT (45 percent of intra-ASEAN trade is in electrical and electronic parts and components broadly defined).

In addition, little to no progress has been made in facilitating intra-ASEAN services trade (the ASEAN Framework on Services or AFAS has been largely ineffective). One of the prime reasons behind this has been political constraints, associated with the protectionist interests of those who might lose from reforms in AFAS.

Besides the AFTA and AFAS initiatives that provide a limited de facto building blocks for economic integration, there is also the ASEAN Investment Area (AIA) initiative that is force for the founding members of ASEAN and Brunei Darussalam and accords ASEAN investors preferential treatment with regards to market access and the granting of national treatment, for all sectors except for those deemed to be sensitive. The newer members of ASEAN, Cambodia, Laos and Viet Nam have until 1 January 2010 to implement AIA. However, as in case with other schemes for ASEAN economic integration, implementation of this scheme has been uneven among ASEAN members. Indeed, the framework of agreement of the AIA lacks substantive details, although being legally binding, as the implementation is left to the individual members.

A McKinsey study estimate that manufacturing costs as well as logistics costs will decline as a result of full economic integration. Their logic is that because there is a bigger consumer market, it reduces per-unit cost because of economies of scale. Then because of reduced customs duties, the manufacturers will benefit if they export goods to another country. All in all, they estimate that the costs of the electronic industry will reduce by some 10 – 20 percent. While the potential gains from integration within ASEAN are significant, another McKinsey Consulting report on ASEAN Competitiveness highlighted three significant concerns that investors have expressed about ASEAN: (a) subscale and fragmented markets; (b) unnecessary costs due to different product standards and customs procedures; and (c) unpredictable policy implementation by ASEAN members, including the recent back-tracking by some countries on their respective liberalization commitments (e.g. Malaysia in the case of motor vehicles and parts, Indonesia in agricultural products and the Philippines in the case of petrochemical products).

In recognition of these concerns, at the Bali summit in 2003, the ten ASEAN leaders agreed to the goal of creating an ASEAN Economic Community (AEC) by 2020 (so-called “Bali Concord II”). The AEC, which was initially mooted by then Singapore Prime Minister Goh Chok Tong, is one pillar of the “ASEAN Community”, the other two being political and security cooperation and socio-cultural cooperation. The primary objective of the AEC is to deepen and accelerate intraregional economic integration by liberalizing trade, investment and skilled labor flows and addressing behind-the-border barriers thus creating a single production base and single market.

While ASEAN needs to focus specifically on making the region a seamless and enlarged production base, there remain a number of skeptics about the effectiveness of ASEAN as an economic entity (as opposed to a political one), For instance, the vast and growing income gaps and heterogeneity among the various members may well act as a road-block to deeper economic intra-ASEAN integration in the near term. They could also limit the ability of the association to develop a common strategy to deal with extra-regional countries. Indeed, while ASEAN as a group is engaged in negotiations with China and India, Thailand and Singapore — which are the two most enthusiastic liberalizers in ASEAN — are negotiating separate comprehensive agreements with these two countries as they are concerned about the slow pace of negotiations and implementation of ASEAN-wide agreements.

Apart from establishing trade pacts with third countries, Singapore and Thailand have recently formed a “Singapore-Thailand Enhanced Economic Relationship” (STEER). Among other things, the aim of the STEER is to act as a high level forum to intensify bilateral economic cooperation across various sectors (Agriculture and Food, Life Sciences, Automotive Parts and Components and Financial Services). Other areas of cooperation include development of SMEs, customs cooperation, healthcare, spa services, tourism, transport logistics, financial services, ICT (Information and Communication Technology) and Mutual Recognition Arrangements (MRAs). In another substantive step in bilateral cooperation, Singapore has joined in the early harvest program initiated between Thailand and China in their bilateral FTA. The Agreement will involve the three countries eliminating tariffs on all fruits and vegetables and came into effect on 1 January 2005.

Clearly, just as some ASEAN countries prefer to take a more graduated approach to liberalization (as they aim to balance domestic economic priorities and promote their external economic interests), Singapore and Thailand are fully justified to “go-it-alone” in pursuit of their respective national interests. Recognizing this reality of multi-speed integration among member countries, ASEAN leaders implicitly endorsed the “2 plus X” approach, whereby any two member countries can choose to integrate certain sectors faster bilaterally if they so desire. (The “plus X” presumably refers to either other ASEAN members or Dialogue partners like China and India).

Nonetheless, there are valid concerns that this multi-speed approach taken towards integration will further stratify ASEAN and undermine its ability to act as a unified hub as they outreach to the rest of the world. Indeed, ASEAN’s first mover advantage in the FTA game may in fact be eroding. For instance, China and India are both now much more focused on opportunities for mutual rather than zero sum gains. There are signs of intensified business and economic interactions between these two Asian giants, as there are bilateral cultural and political ties.

One Response to "ASEAN Economic Integration: Glass Half Empty or Half Full?"

  1. Guest   May 27, 2008 at 11:55 am

    Given your conclusion – that china and India are engaged in more direct integration – what is the role for Asean? Given divergent interests of Asean countries are we just seeing the persistence of the noodle bowl of Asian integration?