Thạc Sĩ Impacts of AFTA on Government revenue, external trade, and FDI of Lao PDR

TABLE OF CONTENTS

ACKNOWLEDGEMENT . ii
TABLE OF CONTENTS iii
LIST OF TABLES v
LIST OF FIGURES vi
ABBREVIATIONS AND ACRONYMS . vi

CHAPTER 1: INTRODUCTION 1

1.1 Background 1
1.2 Problem Statement 6
1.3 Objective . 8
1.4 Expected Outcomes . 8
1.5 Significance of Study . 8
1.6 Scope of Study 9
1.7 Organization of the Dissertation 9

CHAPTER 2: LITERATURE REVIEW 11

2.1 Theoretical Literature Review . 11
2.1.1 Definition and Levels of Economic Integration 11
2.1.2 Advantages and Disadvantages of Regional Economic Integration . 13
2.1.3 ASEAN and AFTA . 17
2.1.4 Challenges and Opportunity for Lao PDR after Joining ASEAN 28
2.2 Empirical Literature Review 30

CHAPTER 3: ANALYTICAL METHODOLOGY AND DATA
COLLECTION 43

3.1 Analytical Methodology 43
3.1.1 Descriptive Approach 43


iv
3.1.2 Econometric Approach 44
3.2 Data Collection 51
CHAPTER 4: IMPACTS OF AFTA ON ECONOMIC PERFORMANCE,
GOVERNMENT REVENUE, EXTERNAL TRADE AND FDI 53

4.1 Lao PDR Economic Performance During 1990-2012 53
4.1.1 Growth Rate 53
4.1.2 Output Structure 58
4.1.3 GDP per Capita . 61
4.2 Impacts on Government Revenue 63
4.2.1. Total Revenue . 63
4.2.2. Tax and Non-Tax Revenue . 66
4.3 Impacts on External Trade . 71
4.3.1. Exports, Imports and Trade Balance, 1990-2012 71
4.3.2. Direction of Exports and Imports 77
4.3.3. Degree of Trade Openness 80
4.4 Impacts on Foreign Direct Investment 85
4.5 Empirical Evidence of Impacts of AFTA on Government Revenue,
External Trade, and Foreign Direct Investment 91

CHAPTER 5: CONCLUSION AND RECOMMENDATION . 103

5.1 Conclusion 103
5.2 Recommendation . 106






1
CHAPTER 1
INTRODUCTION

1.1 Background
Regional integration has become the main form of trade liberalization since
the early 1990s. After the conclusion of the Uruguay Round in 1994, no
significant progress has been made at multilateral liberalization. By contrast, a
new regional trade agreement (RTAs) is announced almost every month.
According to the World Trade Organization, more than 300 regional trade
agreements (RTAs) are currently in force and all but one (Mongolia) of its 153
members participate in at least one of those arrangements. Given the rising
prominence of bilateral and regional trade liberalization, it is important to
understand the implications for world trade.
This is even more important because, unlike multilateral liberalization, which
most economists believe to be largely beneficial for both liberalizing countries and
by standers, preferential liberalization is controversial. The reason comes from its
inherent discriminatory nature: when forming an RTA, members agree to lower
trade barriers to each other but their tariffs on imports from outsiders remain
unconstrained. This can induce members to substitute inefficiently produced
imports from bloc members for imports previously sourced efficiently from
nonmember countries. Such trade diversion harms the nonmembers through lost
markets, as well as the members through reduced tariff revenue. However, like
broader trade liberalization, the RTA is also likely to enhance trade of the goods
that are efficiently sourced within the bloc. This trade creation will enhance welfare.
These two forces suggest that preferential liberalization can in principle be either
welfare-enhancing or welfare-reducing. Ultimately, the result must be empirical,
and may be different for different trading blocs. Trade creation forces may prevail
over trade diverting ones in some cases, but the reverse could be true in other cases.


2
Progress of the integration has been very impressive in recent decades for a
number of developing countries in Asia and, to a lesser extent, in Latin America.
These countries have become successful because they chose to participate in
regional and global trade, helping them to attract the bulk of foreign direct
investment in developing countries. This is true of China and India since they
embraced trade liberalization and other market-oriented reforms, and also of higher-
income countries in Asia—like Korea and Singapore—that were themselves poor
up to the 1970s (IMF, 2001).
It has been realized since Viner (1950) that the formation of a free trade
agreement (FTA) can lead to trade creation and/or trade diversion. The former
arises when the FTA promotes trade among the members without disrupting trade
with nonmembers, and tends to be efficiency-enhancing. By contrast, trade
diversion arises when the FTA promotes trade among members at the expense of
trade with bloc outsiders, and tends to be efficiency-reducing.
There have been attempts to pin down theoretically the characteristics that
make FTAs more trade creating or more trade diverting. Frankel (1997) develops
the ―natural trading partners‖ hypothesis, which states broadly that agreements
between countries that already trade significantly (in particular geographically close
countries and those that share cultural characteristics that reduce transaction costs,
such as language) are the ones most likely to be trade creating. Although
theoretically this does not need to always hold, as Bhagwati and Panagariya (1999)
point out, Frankel (1997) finds evidence consistent with the natural trade partners
hypothesis in a number of regression analyses based on the gravity equation with
country-level trade flows.
Lee and Shin (2006) extend the approach of Frankel (1997) and estimate a
gravity model with year dummies and with both random and fixed effects to assess
trade creation and trade diversion in 175 countries using data from 1948 to 1999.
The key trade creation variable is a dummy that is one if both countries are


3
members of a common RTA; the key trade diversion variable is a dummy that is
one if one country belongs to an RTA and the other does not belong to that RTA.
Lee and Shin interact these variables with geographical and common language
variables to identify whether trade creation and trade diversion are different for
―natural‖ trade patterns.
In most specifications, Lee and Shin (2006) confirm that RTAs increase
bilateral trade between members. The magnitudes are around 50 percent, but if the
countries share a common border this effect increases to up to 200 percent.
Similarly, the closer the countries are from each other, the larger is trade creation.
On the other hand, RTAs are never found to reduce trade between members and
nonmembers significantly. In fact, in most specifications RTAs are estimated to
increase trade between members and nonmembers, from 6 to 15 percent. Trade
with nonmembers grows more for RTAs with a smaller average distance between
their members and when more members of the RTA have common borders or
share a common language. Having the trade creation and trade diversion estimates
in hand, Lee and Shin then predict the average trade impact of several proposed
RTAs in Asia. They find in particular that the trade effects of AFTA are
significantly positive.
There is a sizeable theoretical literature that explores the optimal external
tariff response of countries following the formation of FTAs. In a standard model,
with a welfare-maximizing government, optimal external tariffs are likely to fall in
a free trade area precisely to limit the welfare costs of trade diversion [Bagwell and
Staiger (1999), Freund (2000), Bond et al. (2004)]. The intuition is that the welfare
cost of trade diversion induces governments to lower external tariffs to recapture
tariff revenue and improve economic efficiency.
When political-economy motives are incorporated, the results are
ambiguous. For example, Richardson (1993) and Ornelas (2005) find that, upon the
formation of a free trade area, lobbying will decline and external tariffs fall, as the


4
import-competing sector contracts and becomes weaker politically. This force will
be more important, the greater the share imports stemming from the bloc partners.
However, in a different model, Panagariya and Findlay (1996) find that countries in
a free trade area will raise protection against outsiders because lobbying in favor of
tariffs against the partner will be diverted to lobbying for a greater external tariff.
Furthermore, it is not just existing trade blocs that matter. As Bagwell and Staiger
(2004) show, the mere potential for a future trade agreement may affect the extent
of current tariff reduction that can be negotiated multilaterally. The threat of
―bilateral opportunism‖ reduces the extent of multilateral tariff reduction because
current global trade agreements can be later diluted by bilateral preferences.
By contrast, the empirical literature on the effect of RTA formation on
external tariffs is still in its infancy. Bohara, Gawande and Sanguinetti (2004)
examine tariff adjustments in Argentina following the formation of Mercosur,
finding some support for the hypothesis that the decline of industries driven by the
formation of a trading bloc leads to lower external tariffs. Similarly, Estevadeordal
et al. (2008) examine the direct impact of changes in preferential tariffs on changes
in MFN tariffs in ten Latin American countries and one hundred industries over 12
years. Using a number of empirical techniques to extract causality, they find that
preferences in free trade areas lead to a decline in external tariffs, whereas the
effects are negligible in customs unions. In contrast, Limão (2006) finds that the
United States was more reluctant to lower tariffs in the Uruguay Round for products
where preferences were granted. His results imply that trade preferences lead to less
multilateral tariff reduction. Limão and Karacaovali (2008) find similar results for
the European Union.
Recently, Lendle (2007) has developed the first analysis of the trade policy
reactions to regionalism in Asia. Specifically, Lendle evaluates whether products
receiving preferential treatment in Indonesia, Malaysia, Philippines and Thailand
under the ASEAN Free Trade Agreement underwent greater reduction in MFN
tariffs during the late 1990s and early 2000s than goods that did not receive







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