ASEAN Free Trade Area

8 August 2016

Regional economic integration is an agreement among countries in a geographic region to reduce and ultimately remove tariff and non-tariff barriers to the free flow of goods or services and factors of production among each other (Ghani et al. , 2008). It can be also refers as any type of arrangement in which countries agree to coordinate their trade, fiscal, and/or monetary policies are referred to as economic integration.

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Obviously, there are many different levels of integration as listed below: Free Trade Area: A free trade area occurs when a group of countries agree to eliminate tariffs between themselves, but maintain their own external tariff on imports from the rest of the world. The North American Free Trade Area is an example of a FTA. When the NAFTA is fully implemented, tariffs of automobile imports between the US and Mexico will be zero.

However, Mexico may continue to set a different tariff than the US on auto imports from non-NAFTA countries. Customs Union: A customs union occurs when a group of countries agree to eliminate tariffs between themselves and set a common external tariff on imports from the rest of the world. Common Market: A common market establishes free trade in goods and services, sets common external tariffs among members and also allows for the free mobility of capital and labor across countries.

Economic Union: An economic union typically will maintain free trade in goods and services, set common external tariffs among members, allow the free mobility of capital and labor, and will also relegate some fiscal spending responsibilities to a supra-national agency. Political Union:  Separate nations are essentially combined to form a single nation. The establishment of the European Parliament suggests that Europe is moving towards political union. Giving up this last bit of sovereignty, however, is a big step psychologically and philosophically. 2. Objectives for the formation of AFTA

AFTA stands for ASEAN Free Trade Area which involves the removal of obstacles to freer trade among member states. This includes the abolition of high tariffs or taxes on traded goods and the scrapping of quantitative restrictions (QR’s) and other non-tariff barriers (NTB’s) that limit the entry of imports. The ultimate objective of AFTA is to increase ASEAN’s competitive edge as a production base geared for the world market. A critical step in this direction is the liberalization of trade in the region through the elimination of intra-regional tariffs and non-tariff barriers.

This will have the effect of making ASEAN’s manufacturing sectors more efficient and competitive in the global market. At the same time, consumers will source goods from the more efficient producers in ASEAN thus expanding intra-ASEAN trade. As the cost competitiveness of manufacturing industries in ASEAN is enhanced and with the larger size of the market, investors can enjoy economies of scale in production. In this manner, ASEAN hopes to attract more direct foreign investments into the region. This will, in turn, stimulate the growth of support industries in the region for many direct foreign investments.

Overall the objectives are to strengthening and augmenting trade investment and cooperation among the members, to streamline the investment process within the community while providing guidelines to clarify these investment programs, to investigate possible new areas of cooperation, to facilitate economic integration and to bridge the gap in development levels among member nations. 3. Impact of AFTA on the Malaysian economy AFTA has a potential to produce a wealth of benefits, but faces a rocky road ahead.

It was signed to benefits the Malaysian consumers and local companies in the domestics market but the real situation is somewhat different (Ghani, 2008). There is a low rate of tax imposed on the raw material of the products, to encourage the free flow of products and make them cheaper, but due to the enforcement of taxes on the consumers, products prices are indirectly increasing. Prices supposed to be decreased as it was predicted, but consumer products are still expensive. There is also an increase in intra-ASEAN competition from lower cost producers.

Turning ASEAN region into single market will damage these producers in terms of competition and giving benefit to larger organization. In this assay, the impact of AFTA on four different sectors will be discussed. A. Agricultural sector Implementation of AFTA has stringent competition. Paddy Globalization affects the rural economy of the country. Cheaper imports have a severe impact on our paddy farmers. Major concerns are tumbling prices and lower demands for rice as most rice is imported or smuggled into the country. As a result farmers are ruined to excessive paddy supply and low prices.

The rice industry is heavily subsidized by the government for food security reasons via various price and fertilizer subsidies. As a result our farmers unable to compete in the open market without the subsidies provided by the government, as the production cost in neighboring countries are much lower. Though the government could ban rice imports as part of the measures to reduce the surplus, this measure is unsustainable once trade liberalization set in. B. Automotive sector Malaysia has two national carmakers in Proton and Perodua and the Government wants to protect their interests.

However, even this development could prove to be a temporary reprieve. Given the high selling prices of Malaysia’s national cars (due partly to the high production costs and lack of vendor efficiency), the future may see imported cars gaining market share. Frost & Sullivan expects that imported CKD vehicles of Honda, Nissan, and Toyota are expected to become 30 to 50 percent cheaper. All these developments will mean an increase in the number of vehicles on the road. The impact will be felt in the region’s infrastructure. There will also be a glut of used cars in the market, as people trade in their cars for cheaper, imported ones.

This development could see motorcycle users shifting to using second hand cars, thus, affecting the prospect of the two-wheeler industry in the region (Chu, 2001). C. Auto Component sector With local content regulations gone, local vehicle manufacturers will look out for cheaper and good quality foreign manufacturers for their component requirements. This will hurt the local component industry in the region, especially in countries like Malaysia. In 2005, AFTA will also come into effect, permitting the import of parts within the ASEAN region with a maximum of 5 percent tariff.

Moreover, an increase in CBU imports in the post-AFTA regime will have a negative impact on component sales in the region. An intensely competitive scenario will emerge for parts producers in this region. Vehicle manufacturers are likely to import parts from the network of parts manufacturers in the ASEAN region post-AFTA. This will increase competition in the OE segment. The aftermarket will also witness severe competition in the aftermarket as a number of imported brands compete with the new entrants. Already, the aftermarket is burdened with imported parts from China. D. Impact On The Retail Sector

In Malaysia, the supervision of the wholesale and retail sector falls under the supervision of the Ministry of Domestic Trade and Consumer Affairs (MDTCA) through the Committee on Wholesale and Retail Trade. ASEAN Free Trade Area (AFTA) allows local retailers to source for merchandises from countries such as Thailand and Indonesia. They do not have to rely on local distributors who have been imposing strict credit terms and trading conditions on them since the Asian financial crisis. On the other hand, regional trade liberalization poses great threats to small and medium-size retailers in Malaysia.

They include provision shops, sundry shops and mini-markets. Without the resources and bargaining power to source for cheaper food products in the region, these retailers will not be able to withstand the full impact of AFTA. They may be forced to close down eventually. 4. Application of Comparative Advantage Theory of International Trade In 1817, David Ricardo, an English political economist, contributed theory of comparative advantage in his book ‘Principles of Political Economy and Taxation’. This theory of comparative advantage, also called comparative cost theory, is regarded as the classical theory of international trade.

According to the classical theory of international trade, every country will produce their commodities for the production of which it is most suited in terms of its natural endowments climate quality of soil, means of transport, capital, etc. Ricardo’s Theory of Comparative Advantage implied that “good fit” is translated into relatively high labor productivity vis-a-vis other countries (Ricardo, 1971). It will produce these commodities in excess of its own requirement and will exchange the surplus with the imports of goods from other countries for the production of which it is not well suited or which it cannot produce at all.

Thus all countries produce and export these commodities in which they have cost advantages and import those commodities in which they have cost disadvantages. David Ricardo agreed that absolute difference in cost gives a clear reason for trade to take place. He, however, went further to argue that even that the country has absolute advantage in the production of both commodities it is beneficial for that country to specialize in the production of that commodity in which it has a greater comparative advantage. The other country can be left to specialize in the production of that commodity in which it has less comparative advantage.

According to Ricardo the essence for international trade is not the absolute difference in cost but comparative difference in cost. David Ricardo stated a theory that other things being equal a country tends to specialize in and exports those commodities in the production of which it has maximum comparative cost advantage or minimum comparative disadvantage. Similarly the country’s imports will be of goods having relatively less comparative cost advantage or greater disadvantage. Ricardo explains his theory with the help of following assumptions: a. There are two countries and two commodities.

There is a perfect competition both in commodity and factor market. c. Cost of production is expressed in terms of labor i. e. value of a commodity is measured in terms of labor hours/days required to produce it. Commodities are also exchanged on the basis of labor content of each good. d. Labor is the only factor of production other than natural resources. e. Labor is homogeneous i. e. identical in efficiency, in a particular country. f. Labor is perfectly mobile within a country but perfectly immobile between countries. g.

There is free trade i. e. the movement of goods between countries is not hindered by any restrictions. h. Production is subject to constant returns to scale. i. There is no technological change. j. Trade between two countries takes place on barter system. k. Full employment exists in both countries. l. There is no transport cost. On the basis of above assumptions, Ricardo explained his comparative cost difference theory, by taking an example of Singapore and Thailand as two countries & Wine and Cloth as two commodities. As pointed out in the assumptions, the cost is measured in terms of labor hour.

The principle of comparative advantage expressed in labor hours by the following table. 1 unit of Wine 1 unit of clothes England Singapore 120 100 Portugal Thailand 80 90 Thailand requires less hours of labor for both wine and cloth. One unit of wine in Thailand is produced with the help of 80 labor hours as above 120 labor hours required in Singapore. In the case of cloth too, Thailand requires less labor hours than England. From this it could be argued that there is no need for trade as Thailand produces both commodities at a lower cost.

Ricardo however tried to prove that Thailand stands to gain by specializing in the commodity in which it has a greater comparative advantage. Comparative cost advantage of Thailand can be expressed in terms of cost ratio. Thailand Singapore Wine Cloth Wine Cloth 80/120 > 90/100 120/80 > 100/90 0. 66 < 0. 9 1. 5 > 1. 11 Thailand has advantage of lower cost of production both in wine and cloth. However the difference in cost, that is the comparative advantage is greater in the production of wine (1. 5 -0. 66 = 0. 84) than in cloth (1. 11 – 0. 9 = 0. 21).

Even in the terms of absolute number of days of labor Thailand has a large comparative advantage in wine, that is, 40 laborers less than Singapore as compared to cloth where the difference is only 10, (40 > 10). Accordingly, Thailand specializes in the production of wine where its comparative advantage is larger. Singapore specializes in the production of cloth where its comparative disadvantage is lesser than in wine. Wine Cloth Domestic Exchange Rate W: C England 120 100 1: 1. 2 Portugal 80 90 1:0. 89 Let assume these 2 countries enter into trade at an international exchange rate (Terms of Trade) 1 : 1.

At this rate, Singapore specializing in cloth and exporting one unit of cloth gets one unit of wine. At home it is required to give 1. 2 units of cloth for one unit of wine. Singapore thus gains 0. 2 of cloth i. e. wine is cheaper from Thailand by 0. 2 unit of cloth. Similarly Thailand gets one unit of cloth from Singapore for its one unit of wine as against 0. 89 of cloth at home thus gaining extra cloth of 0. 11. Here both Singapore and Thailand gain from the trade i. e. Singapore gives 0. 2 less of cloth to get one unit of wine and Thailand gets 0. 11 more of cloth for one unit of wine.

In this example, Thailand specializes in wine where it has greater comparative advantage leaving cloth for Singapore in which it has less comparative disadvantage. Thus comparative cost theory states that each country produces & exports those goods in which they enjoy cost advantage & imports those goods suffering cost disadvantage. 5. Summary In summary, regional economic integration helps countries within a geographic region form an alliance aimed at reducing barriers to trade and investment. There are many different levels of integration such as free trade area, custom unions, common market, economic union and political union.

Overall the objectives are to strengthening and augmenting trade investment and cooperation among the members, to streamline the investment process within the community while providing guidelines to clarify these investment programs, to investigate possible new areas of cooperation, to facilitate economic integration and to bridge the gap in development levels among member nations. Malaysia has benefited generally from AFTA as Intra ASEAN and Foreign Direct Investment (FDI) from ASEAN into Malaysia have increased tremendously. However, it depends on the types of industrial sectors.

From the view of small farmers and fisher folks, they believe that in order to survive in the era of globalization, they need continuous support from the government and trade policies should favor them. Effective food and agricultural policies and institutions are needed to complement and guide globalization to achieve food security. An effective government is needed to facilitate privatization and guide the transformation of the agricultural sector in a direction beneficial to the poor. There will be both negative and positive impact happening when a local product needs to compete with foreign product.

In the automotive sector, competition between national car and foreign car is obvious. However, with the help of government increasing the import car tax will helps to protect the national car. At the other side, people from our country will work hard to improve the quality of the product to able to compete with the foreign product. This is same goes to other sectors such as component and retail sectors. For comparative advantage theory it can be conclude that all countries produce and export commodities in which they have cost advantages and import those commodities in which they have cost disadvantages.

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