The Future of the ASEAN Economic Integration

Home , Economic power, Enlargement of ASEAN

The Future of the ASEAN Economic Integration Kiki Verico The Future of the ASEAN Economic Integration Kiki Verico Th e Institute for Economic and Social Research (LPEM), Faculty of Economics and Business , University of Indonesia , Jakarta , Indonesia

ISBN 978-1-137-59612-3 ISBN 978-1-137-59613-0 (eBook) DOI 10.1057/978-1-137-59613-0

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Th is Palgrave Macmillan imprint is published by Springer Nature Th e registered company is Macmillan Publishers Ltd. Th e registered company address is: Th e Campus, 4 Crinan Street, London, N1 9XW, United Kingdom In memory of my late father, Ma’as Sary (1943–1988) -- You have always been my inspiration

To my mother, Nahdiar Ma’as, -- Without you none of this would be possible Preface

Empirical experiences from the European Union’s (EU) economic integration, which has been adopted as theory in regional economic integration studies, show that neighboring countries within a region can achieve economic integration having undergone phases from trade (Free Trade Area/FTA) to investment (Custom Union and Common Market) before fi nally achieving fi nancial integration (Single Monetary Union and a Single Currency). Th is theory was fi rst proposed by Jacob Viner in 1950 and continued by Bela Balassa in 1961 who argues that this process requires formal institutionalization at the regional level. Southeast Asian countries have a similar formal institution at regional level, ASEAN (Association of Southeast Asian Nations) , established in 1967. Currently ASEAN’s commitment is to transform Southeast Asia ’s economic integration from free fl ows of goods (FTA) to that of investment, services, and capital at the end of 2015 and afterwards named the ASEAN Economic Community (AEC) . Th e center point of this regional economic integration process is intra-regional trade, which connects both trade and investment at the regional level. Intra-regional trade is created by ASEAN Free Trade Area (AFTA) and in turn aff ects long-term investment and free fl ows of people. Th e latter is part of the AEC. It is, therefore, essential to observe the impact of AFTA on intra-regional trade and further the impact of intra-regional trade on the long-term investment infl ows ( Foreign Direct Investments/FDI ). vii viii Preface

Historical perspectives prove that ASEAN’s economic integration process has been largely infl uenced by the international dynamic situ- ation, which includes, for example, the end of the Vietnam War, which led to the fi rst ASEAN summit taking place in 1976, almost ten years after ASEAN’s establishment in 1967. ASEAN commitments on AFTA in 1992 had been decided just after the end of the Cold War in 1989. Th e ASEAN enlargement to the APT was also aff ected by the dynamic changes aff ecting the ‘Greater East Asian’ (Bowles and MacLean 1996) region after China adopted a market economy, joined the WTO, and became one of the largest economic entities, in terms of nominal GDP, in the world. To some extent, ASEAN needs external factors to stimulate its internal reform and cooperation. Given its open regionalism, which contrasts with that of the EU’s closed regionalism, ASEAN has several other economic cooperations that involve its members, such as direct bilateral trade agreements between members and non-members of ASEAN; sub-regional economic cooperation which involves limited member states of ASEAN; then regional cooperation involving ASEAN members as well as regional-plus which incorporates all ASEAN members with non-members under the so called “ASEAN umbrella. ” Th is study attempts to analyze the impacts of bilateral, sub- regional, and regional economic cooperation to investment (FDI infl ows). Th is objective is essential for ASEAN if it is to shift its economic integration from trade to investment. As for the regional-plus framework, this study will analyze the impact on not only shifting ASEAN’s economic integration from trade to investment but also the impact from investment to fi nancial integration afterwards. In sum, this study will discuss all relevant arrangements of economic cooperation that could integrate trade, investment, and fi nancial aspects in Southeast Asia from various level of cooperations of bilateral, sub-regional, regional, and regional plus frameworks .

ASEAN in Descriptive Data View

Data of the World Trade Organization (WTO) in 2006 show that Asian regional trade depends more on the Asian region itself than from any other region. Th is can be seen through Asia’s intra export in which 50 percent Preface ix of Asian total trade goes to Asian countries while the remaining 50 percent goes to the rest of the world, as shown in Table P.1 (Appendix) Table P.1 shows Europe as the most prominent region for regional economic cooperation as their intra-regional merchandise trading achieves 73.6 percent in 2006. North America’s intra trade is around 53.9 percent. Africa depends more on Europe in which 40.8 percent of their export in 2006 went to Europe, while Latin America depends more on North America with 31.4 percent of their export going to North America. Meanwhile the Middle East depends more on the Asian market with 52.6 percent of their exports in 2006 going to Asia. Naturally, most of the region’s countries rely on their trade activities to their own region given the closer distance, lower cost in trade-related services such as export import insurance and transportation cost, as well as similarities in demand factors within countries in the region. In Asia, one of the regions with a potential bright future for strong regional economic integration is ASEAN with its ASEAN Free Trade Area (AFTA), which completed its 0 percent tariff rates among members in 2015 and will enter the economic community afterwards. Given this, it is essential to understand the potential capacity of AFTA in terms of enhancing trade liberalization and its connection to investment creation. According to Table P.1 in terms of trade Asia depends more on its region. Historically in Asia, Southeast Asian countries have good trade relations with East Asian countries. Th ey both are very close to each other and have had a long history of interdependent relations. Regional economic integration can promote FDI infl ows and economic development in individual countries of the region ( Aggarwal , 2008). Th erefore, the role of FDI infl ows becomes important to see the connectivity between ASEAN and East Asian countries. Th is is useful to assess potential interconnection between Southeast and East Asian countries. From a historical perspective, Japan, China, and South Korea have played an important role in promoting Southeast Asia economic networks. Japan established a Regional Production Network (RPN) in Southeast Asia to produce automotive and electronic products in several ASEAN countries in the 1930s ( Akamatsu 1944; Kojima 1978; Urata 1993). China had Guanxi , a traditional business network within ethnic Chinese in Southeast Asia ( Wang 2001). Th is network is also known as x Preface

ECBN ( Ethnic Chinese Business Network ) and works based on trust and usually avoids formal agreements between them. China holds a non-formal yet solid business network in Southeast Asia (Peng 2002). A regional production network producing fi nal goods has been established between South Korea and Southeast Asian countries. South Korea established production networks in Southeast Asia originally in Cambodia, Laos, Myanmar, Vietnam (also referred to as CLMV), and Th ailand, then to other Southeast Asian countries (Cheong 2011). Korea’s largest trading partners in Southeast Asia are the ASEAN-6, ASEAN’s founding members with the largest share starting from Singapore, Indonesia, Malaysia, Th ailand, and Philippines; while among the ASEAN-4, which are its CLMV members, the largest Korean trading partner is Vietnam. Korea’s exports to ASEAN are mostly of heavy industry, chemical products, and light industries while Korean’s dominant imports from ASEAN are primary products, raw materials, and energy sources. China, Japan, and South Korea play important roles in promoting and enhancing production networks between East Asia and other Asian countries especially Southeast Asian countries. Global production networks (GPN) in Asia have promoted more intermediate goods transaction than that of consumption and capital goods. China, Japan, and South Korea are among the largest FDI investors in Southeast Asia. Th is economic cooperation has been stimulated by market-driven factors that are crucial in helping ASEAN to move from intra-regional trade to investment integration and fi nally to fi nancial integration . Bowles and MacLean (1996) argue that East Asia shows increasing interest in Southeast Asia in particular on regional trade and investment. Th is makes the ASEAN+3 (APT of ASEAN and China, Japan, & South Korea) compose economic integration of advanced technol- ogy products from Japan and South Korea, skilled-labor intensive from China, and labor-intensive products from ASEAN. Enhanced relations between intra-regional trade and direct long-term investment infl ows are the key success factor for the establishment of further compact economic integration. ASEAN needs external countries that have the potential to become member states starting from its FTA such as the ASEAN+1 FTA then to become part of the economic community, common market, and fi nally, Preface xi

fi nancial integration . Why? Take for instance the indicator of the annual GNI/capita (US$) the convergence of which is one of the most important long-term issues in ASEAN. Unlike the EU, which has high-income countries in terms of GNP per capita, with a large size in terms of proportion of population and value added, ASEAN’s high-income country members such as Singapore and Brunei are small in terms of size (GDP and population) yet a large-population-sized country, Indonesia, is not a high-income country. Th erefore, ASEAN’s power is not at the center, but appears more like a “doughnut-shape” without a single country playing as the center of power. Details in GNI per capita of ASEAN members are described in Fig. P.1 (Appendix). Open and soft regionalism principles help ASEAN to enlarge its economic cooperation to other countries. Th is will be a very important factor for achieving economic convergence in Southeast Asia. ASEAN has member states with varying economic levels. Th ey come from diff erent GNI per capita levels. For instance, Singapore and Brunei are classifi ed as high income countries (above US$ 12,736 per capita per year), while Malaysia and Th ailand are upper-middle-income countries (between US$ 4,125 and US$ 12,736 per capita per year) and Indonesia, Philippines, Vietnam, Laos, and Myanmar are lower-middle-income countries (between US$ 1,045 and US$ 4,125) while Cambodia is classifi ed as a low-income country. ASEAN’s economic divergence is, therefore, higher than the EU-27, which consists of only two income groups with the majority in high income and only one country with upper- middle-income status. Th is high economic convergence explains why the EU has strong economic integration and fi t with legally binding and closed regional integration choice. Th e EU has a level playing fi eld within its members and this helps the EU to attain a high level of intra-regional trade share compared with other regions. Economic divergence in ASEAN is not only seen in the GNI per capita per year gap but also in the proportion of each member state’s economic size both in terms of value (GDP) and population to ASEAN’s total of these factors. Th is indicator shows that high income countries such as Singapore and Brunei are actually small in terms of size while a lower-middle-income country such as Indonesia is big in terms of size. Illustration of the size of GDP and population of ASEAN members can be seen in Fig. P.2 (Appendix). xii Preface

Th is fi gure shows that Indonesia is the biggest country in ASEAN in terms of size (GDP and population). It contributes up to 36 percent of ASEAN’s GDP and its population proportion of the total ASEAN population is also large at 41 percent. Th erefore, if we compare Indonesia’s contribution in the ASEAN economy to Indonesia’s contribution on ASEAN population, we can notice that Indonesia’s productivity is smaller (0.88) compared to Singapore (14.16). Each member state’s productivity rank is similar to that in the Human Development Index (HDI) rank. Take, for instance, 2014 where Singapore (world rank 9) and Brunei (rank 30) have very high HDI while Malaysia (rank 62) and Th ailand (rank 89) have high HDI. Indonesia (rank 108), Philippines (rank 117), Vietnam (rank 121) and Laos (rank 139) have medium HDI classifi cations. In terms of GNI per capita, interestingly Myanmar (lower-middle) is better than Cambodia (low) but in terms of HDI, Cambodia (medium level at rank 136) is ranked higher than Myanmar (low level at rank 150). For the case of Myanmar and Cambodia, a better HDI does not mean a better GNI per capita. But the improvement of HDI will improve the level of GNI per capita since it is connected to productivity and the increasing of value added. Figures P.1 and P.2 (Appendix) show that high and upper-middle income member states of ASEAN have a higher contribution proportion for GDP to total GDP than that of their population contribution. For example, in 2014, Singapore’s GDP to total ASEAN GDP was 12 percent while her population to total ASEAN population was only 1 percent. Brunei’s GDP to total ASEAN GDP was 1 percent while her population only contributes 0.5 percent. Upper-middle-income countries such as Malaysia and Th ailand also contribute higher percentage of GDP to total ASEAN GDP than their population percentage to total ASEAN population, while for lower-middle-income countries such as Indonesia, Philippines, Vietnam, Laos, Myanmar, and Cambodia contribute a higher proportion in population than in GDP. If ASEAN’s GDP and population data are compared to that of global level data, we can see that in 2014, ASEAN’s population and GDP share to the world are 9 percent and 3 percent respectively. If we were to take ASEAN+3 (ASEAN plus China, Japan, and South Korea) instead, these proportions (compared to total global fi gures) would be 30 percent and Preface xiii

24 percent respectively. While ASEAN+6 (ASEAN+3 plus Australia, New Zealand, and India) would represent 48 percent and 29 percent of the global GDP and population. Th is means that with the ASEAN+6 framework, the contribution towards population increases from 30 percent to 48 percent which is more than the increasing in its GDP share from 24 percent to 29 percent. Th is is indicating that ASEAN+3 is a ‘more productive’ framework than the ASEAN+6. In term of ASEAN+3, ASEAN’s integration index, based on author’s calculation, is signifi cantly aff ected by Japan then South Korea and recently by China. Japan established a regional production network that offi cially integrates the Southeast Asian market both in the production and trade as South Korea has with Th ailand and Cambodia, Laos, Myanmar, and Vietnam, and Chinese which are known as non-formal trading networks and recently are formal investment networks. Due to such gaps in macroeconomic performance and the mismatch between economic value and size, ASEAN’s economic cooperation is fragile. Unlike the EU, the macroeconomic gaps among the ASEAN member economies unfortunately create a ‘non-single dominant power’ within the region. Member states with strong economic performance are not large countries in terms of population size or area. Th e EU has Germany which is classifi ed as a rich country with a large population and geographic space. Th e richest ASEAN member state on the other hand is not its largest country whereas its largest country is not the richest member state, making some scholars, as mentioned earlier, liken ASEAN’s economic power to a doughnut, which has a hollow middle, as ASEAN has no single central power. In terms of GNI per capita (current US$), in ASEAN, only Singapore and Brunei have been classifi ed as high income countries while in term of GDP size (current US$) only Indonesia has become a member of the G20. In terms of economic growth, the author’s calculation using World Bank data, shows that the recent (2013–2014) economic growth of ASEAN was at 4.3 percent, with ASEAN+3 at 3.7 percent and ASEAN+6 at 4 percent, all of which are higher than the global economic growth at 2.5 percent. Data show that in terms of contribution to the world’s economic growth, the more countries involved in a grouping the greater their contribution regardless of whether positive (pulling up the world’s economic xiv Preface growth) or negative (pulling down the world’s economic growth). Th e highest contribution to the world economic growth is from the framework of the ASEAN+6 at 42 percent, the ASEAN+3 at 32 percent and ASEAN at 4 percent. Th is proportion order is similar to their contribution to the World’s GDP of which ASEAN+6 was 29 percent, ASEAN+3 was 24 percent and ASEAN was 3 percent respectively. Germany is the largest country in the EU in terms of economic size (GDP) and population and has a high income level while ASEAN does not have member states that are both large and rich. ASEAN still has the potential to achieve what the EU has completed in its comprehensive regional economic integration process . Following this enthusiasm, in the future ASEAN may achieve both real sector and monetary sector integration. Th e fi rst option is for Indonesia, with the highest size of GDP and population in ASEAN, to achieve high-income level, given that rich countries cannot increase their size to be big but it is possible for a big country to become rich in the future. Fulfi lling this condition could assist ASEAN to have strong leadership. Th e second option would be for ASEAN to utilize the ASEAN-PLUS frameworks such as the ASEAN+ FTA, ASEAN+3, ASEAN+6, and so on, as well as optimizing its sub- regional economic role. In line with the ASEAN-PLUS frameworks, ASEAN promotes an ‘open-regionalism’ principle to attract investment creation (FDI infl ows) in Southeast Asia from non ASEAN member states. Th is involves at least two stages: fi rst, to have trade liberalization among member states in order to increase intra-regional trade then to use it to attract FDI infl ows from non-member states to Southeast Asia. Horizontal FDI infl ows from non- member states will increase when trade costs of being excluded are high which then motivates the non-member state to change its trade preference into investing into a member state. Other reasons include the fact that the non-member state gains trade benefi ts from the region such as collecting trade account surplus and enlarging market access, which also motivates it to invest FDI and produce its products locally. Th is strategy will also reduce transportation costs. Th ese non-member state investors invest their surplus current account back into the region in order to fulfi ll the region’s domestic demand, to reduce service-link costs (shipping, insurance, custom clearance, other administrative and local Preface xv transportation cost), to avoid currency volatility costs, transaction costs of trade, and to increase benefi ts from the investment (FDI) itself. Th e enlargement of ASEAN’s economic integration to include East Asian countries such as Japan and China is important for at least two main reasons: (1) ASEAN had started enhancing her tight economic cooperation with East Asian countries (China, Japan, and South Korea) via trade, investment, and fi nance due to the Asian Financial Crises in late 1990s. (2) ASEAN has a very long history and strong trade relations with East Asian countries over centuries. (3) ASEAN depends on investments fl owing in (FDI) from Asian countries in particular the East Asian region. Th is is because some potential FDI source countries worry about “hollowing out” risks. Th is hollowing-out at fi rst comes from the con- cern of the EU that related to her plan on “the enlargement of EU from Western to the Eastern part of Europe.” Th e hollowing-out assumption made the EU concerned about the risk of investing outside the European region, therefore, the EU prefers to invest in Europe especially given the recent enlargement to Eastern Europe. Western European FDI investors believe if they invest (FDI) outside the region, for example, in Asia, that direct investment will remove their production network from Europe to Asia, which will generate unem- ployment in Europe. Regarding the EU’s plan to enlarge its membership towards the eastern part of Europe, which are basically countries that need FDI infl ows and off er low cost production process compared to producing in West Europe, the EU prefers to invest in Eastern Europe rather than in countries outside Europe, such as Asia including Southeast Asia, Africa, South or Latin America. Th is explains why Asia depends on its long-term investment (FDI) infl ows from advanced economic countries such as Japan, China, and South Korea. Last, but not least, the enlargement of ASEAN economic cooperation to East Asia countries was more reasonable because regional economic integration in East Asia is much better than that in Central Asia, South Asia and Pacifi c (ADB, 2010). Since both Japan and China invest in Southeast Asia in the manufacturing sector and considering that AFTA is applied in that sector, this chapter will focus on the manufacturing sector. Verico’s (2013a) study shows that, prior to Southeast Asia ’s economic crises that started at the end of 1997, average FDI infl ows in ASEAN was xvi Preface

7.7 percent of the World’s total FDI infl ows (1995–1997) yet this share dropped to 3.14 percent in 1998 and constantly decreased until 2000. Th e average FDI infl ows decreased to 2.5 percent (1998–2000). FDI infl ows in ASEAN started to increase in 2001 and constantly increased up to 2005. Average FDI infl ows in ASEAN reached 3.79 percent of the total World’s FDI infl ows. Even now average FDI infl ows in ASEAN are lower than that before the 1997 Asian economic crises, but the level has been increasing. Decreasing FDI infl ows due to Asian fi nancial crises in 1997–1998 not only reduced FDI infl ows in Southeast Asia but also in East Asia. Th is proves that both regions are interconnected. Detailed fi g- ures are shown in Table P.2 (Appendix). Since 2000, FDI infl ows in the developed countries of North America and the EU decreased while FDI infl ows in developing countries such as Southeast Asia and Latin America increased (see Table P.2). Th is refl ects the movement of production-based networks from developed to developing countries, including in Southeast Asia. Increasing FDI infl ows supports ASEAN’s objective of having an economic community since it needs long-term investment and the fi gures above shows that integration of East Asia and Southeast Asia gives signifi cant impact to both regions. Th ese regions receive around 22 percent of total world’s FDI infl ows. Data on FDI infl ows to ASEAN countries (from 1995 to 2014) shows that Singapore has been the largest host country of FDI infl ows in Southeast Asia followed by Indonesia. In addition to huge diff erences in terms of percentage of FDI infl ows to total FDI infl ows in ASEAN, the FDI infl ows trend has never become negative while FDI infl ows in Indonesia experienced a negative value due to capital outfl owing from non-residents between 1998 and 2002. Th ailand follows as the third largest receiver of FDI infl ows after Singapore and Indonesia. In 2014 the biggest FDI infl ows recipients in ASEAN are Singapore, Indonesia, Th ailand, Malaysia, Vietnam, and Philippines. Th e proportion of FDI infl ows between Singapore and other ASEAN members are enormous as Singapore for instance in 2014 received 51 percent of Total FDI infl ows while other 49 percent went to other member states. Detailed fi gures are presented in Table P.3 (Appendix). Verico’s (2013a) study found that the majority of FDI infl ows by source (home) country to ASEAN come from the EU, Japan, USA, and Preface xvii

ASEAN itself. Th e compositions vary in each host FDI infl ows country. For Indonesia (1995–2006) the highest FDI investors came from the EU, ASEAN, Japan, and the USA, for Singapore from the EU, the USA, Japan, and ASEAN, for Th ailand from Japan, the EU, ASEAN, and the USA, and for Malaysia from the USA, the EU, ASEAN, and Japan. Th is fi gure represents a long-term economic connection between ASEAN members and their long-term investors. In terms of proportion, ASEAN intra-investment is around a half of ASEAN intra-regional trade. In 2014 intra-ASEAN trade is estimated at around 24 percent with intra-ASEAN investment around 17.9 percent. On the other hand, ASEAN in terms of trade and investment still depends on external non-members or on inter-regional trade and inter- regional investment at around 76 percent and 82.1 percent. A detailed description is in Table P.4 (Appendix). Both intra-ASEAN investment and extra-ASEAN investment are still dominantly held by the ASEAN-6 (Brunei, Indonesia, Malaysia, Philippines, Singapore, and Th ailand) at around 88.8 percent of intra- investment and 91 percent of extra-investment than those obtained by ASEAN-4 (Cambodia, Laos, Myanmar, and Vietnam) at around 11.2 percent for intra-ASEAN investment and 9 percent for extra-ASEAN investment. At the country level, the largest proportion of intra- investment is obtained by Indonesia at around 55.2 percent while the largest proportion of extra-investment is received by Singapore at 60.4 percent. At the country level, in 2014, intra-ASEAN investment was dominated by Myanmar at 72.2 percent of total FDI infl ows and Indonesia at 60.4 percent. As for the extra-ASEAN investment, Philippines, Th ailand, and Singapore, all gain more than 93 percent of their FDI infl ows from ASEAN’s non-member states. As for disaggregation of FDI infl ows at sectoral level, Plummer and Cheong (2008) use specifi c data on FDI infl ows by sector based on source country. Th ese data show a diff erent pattern for each ASEAN and selected countries. Th e majority of FDI infl ows from Japan to ASEAN countries were in the manufacturing sector. Th e majority of FDI infl ows from USA to ASEAN were in the fi nancial sector (28.5 percent), followed by the manufacturing sector (23.11 percent) and commerce (10.24 percent). Th e majority of FDI infl ows from the EU to ASEAN were in xviii Preface the manufacturing sector (33.13 percent), followed by the fi nancial sector (26.28 percent) and mining/quarrying (13.01 percent). For ASEAN member states, such as Indonesia, its majority FDI infl ows in ASEAN were placed in the real estate sector (71 percent), while for Singapore the majority is in the manufacturing sector (52.97 percent), for Th ailand in the fi nancial sector (39.29 percent) and Malaysia in the real estate sector (41.14 percent). At the regional level with its ASEAN FTA, ASEAN has two objec- tives, one is to increase intra-regional trade. Th is is a direct objective of AFTA. Another is to attract FDI infl ows. Th is is seen as an indirect objective of AFTA. ASEAN has several agreements to attract FDI infl ows and these hold the direct objective of increasing FDI infl ows in Southeast Asia . Aside from the expected positive impact of intra-regional trade to FDI infl ows, there is a fi nding showing that intra-regional trade can have a negative impact on FDI infl ows due to the disincentive to have long- term investment to ASEAN by non-member states. Th e higher proportion of FDI infl ows from non-member states than from member states can generate signifi cant impact on ASEAN’s FDI infl ows. One of the factors is the existence of trade defl ection in typical FTA as it does not harmonize the external tariff rate from members to non-members. Th is weakens discriminative trade arrangements and provides less incentive for non-member FDI investors to change their strategy from doing trade to putting long-term investment in the member countries ( Verico , 2013a). Th e positive impact of AFTA on intra-regional trade indicates high trade creation while negative impact of intra-regional trade on FDI infl ows in the manufacturing sector indicates low trade diversion impact and the existence of trade defl ection in Southeast Asia. Th is circumstance will stimulate more FDI infl ows from ASEAN member states than non- ASEAN member states starting from comprehensive implementation of AFTA by the founding members in 1999. Th e share of ASEAN intra-regional trade by the observed countries of Indonesia, Malaysia, Philippines, and Th ailand can be seen in Fig. P.3 (Appendix). Th is fi gure shows that Indonesia has the highest proportion followed by Malaysia, Th ailand, and Philippines. Th is is the proportion of each observed member’s intra-ASEAN trade to total intra- ASEAN trade. Th e trend of intra-regional trade is increasing, but even at the current Preface xix

(2014) rate, Southeast Asia depends more on external trade at around 76 percent than internal trade within ASEAN members at around 24 percent. It is rather diffi cult to see the impact of AFTA on FDI infl ows in Southeast Asia, in particular to the four observed countries of Indonesia, Malaysia, Philippines, and Th ailand, empirically because the period of the formal implementation of comprehensive AFTA overlapped the economic crises period. Th erefore, there were mixed factors that created the negative impact of the Asian economic crises to the decrease of FDI infl ows in Southeast Asia between the economic crises (1998) and the comprehensive implementation of ASEAN FTA (1999). Th e crises signifi cantly aff ected FDI infl ows in Indonesia, the FDI infl ows had been negative due to capital outfl owing from non-residents during the crises. Verico’s (2013a) study found that average FDI infl ows in Southeast Asia from non-member states is higher than that from member states except in 1991 and 2002. Th is can be related to the regional economic progress by which 1991 was only one year before formal sign- ing of AFTA while 2002 was offi cial implementation of 5 percent tariff of CEPT (Common Eff ective Preferential Tariff ) for ASEAN-6 (Indonesia, Malaysia, Th ailand, Singapore, Philippines, and Brunei Darussalam). Th e percentage of FDI infl ows from ASEAN to ASEAN to total FDI infl ows in ASEAN has increased since year 2002. In general FDI infl ows in Southeast Asia were decreasing in the period 1998 to 2002 due to negative FDI infl ows (capital out fl ows from non-residents) due to the economic crises. Th is fi gure confi rmed the existence of the J-curve—it took about a 5-year period for the negative impact of the economic crises to change to a positive result in Southeast Asia. Figure P.4 (Appendix) describes the FDI infl ows (million US$) in Indonesia, Malaysia, Philippines, and Th ailand. Based on the latest data (2014), FDI infl ows to Indonesia hold the highest value followed by Th ailand, Malaysia, and Philippines. Th ailand experienced a slowing down of FDI infl ows due to a fl ooding natural disaster in the period 2010 to 2011. In the last fi ve years, Malaysia has shown relatively stable FDI infl ows and Philippines shows a persistent positive trend. Th is indicates Philippines is getting more attractive for FDI infl ows and this helps ASEAN to attain economic convergence in the region through the establishment of a solid network of investment. Acknowledgements

Th is book has benefi ted from academic wisdom, guidance, and support received throughout my early academic career in the fi eld of regional economic integration which I started more than ten years ago at the Asia- Europe Institute University of Malaya in collaboration with Universidad Autonoma de Madrid. Later I continued my academic journey in this same fi eld at the Graduate School of Asia-Pacifi c Studies at Waseda University. Th erefore, I am indebted to the late Professor D. Fernando Rodrigo Rodriguez and Professor Shujiro Urata for their priceless insights and also Professor Nobuhiko Fuwa for his valuable views. I would also like to thank the excellent editors, Amber Husain and Laura Pacey at Palgrave Macmillan, for their tireless work in seeing this book to publication. Finally, I owe a special thank you to my mother and in-laws, Ama, Bunda, and Abah, who have been a constant source of support and com- fort. In particular, I am eternally grateful to my beloved wife, Liza, for her unconditional love, great patience, and relentless support, in particular the extensive feedback she provided on an earlier draft of this book. Last but not least, to my son, Omar, who was enlisted without consent, to my academic journey. I couldn’t have asked for better company.

xxi Contents

1 General Introduction 1 1.1 Context 1 1.2 ASEAN Economic Cooperation’s Overview 3 1.3 Purpose 6 1.4 Proposition 7 1.5 Question 7 1.6 Th eoretical Framework 8 1.7 Th e Observed Countries 16 1.8 Original Contribution 20 1.9 Data Sources 22 Notes 23

2 Th e Impact of ASEAN FTA: Regional Level Analysis 25 2.1 Context 25 2.2 Purpose 27 2.3 References Review 27 2.3.1 Factors of FDI Flows 28 2.3.2 FDI Flows and ASEAN Economic Integration 42 2.3.3 Intra-regional Trade and Its Impact on FDI Inﬂ ows 46

xxiii xxiv Contents

2.3.4 ASEAN Free Trade Area (AFTA): Historical Approach 52 2.3.5 ASEAN Free Trade Area (AFTA): Political-Economy Approach 58 2.3.6 Th eory of Comprehensive Regional Integration 62 2.3.7 Overview: Comprehensive Regional Economic Integration in ASEAN 69 2.4 Proposition 84 2.4.1 Independent Variable 86 2.5 Method 94 2.5.1 Econometric Analysis: Non-system Analysis of Original TSLS 95 2.5.2 Econometric Analysis: System Analysis of Seemingly Unrelated Regressions Estimator (SURE) 96 2.5.3 Econometric Analysis: System Analysis of Simultaneous Equation Models Estimator (SEME) for AFTA 97 2.6 Analysis 97 2.6.1 Th e Impact of AFTA and Intra-regional Trade on Aggregate FDI Inﬂ ows (Investment Creation): Non-system Equations of Panel Data 97 2.6.2 Th e Impact of AFTA and Intra-regional Trade to Aggregate FDI Inﬂ ows (Investment Creation): System Equations of SURE and 3SLS (SEME) of Panel Data 100 2.7 Conclusion 106 Notes 108

3 Th e Impact of Bilateral FTA: Bilateral Level Analysis 113 3.1 Context 113 3.2 Purpose 115 3.3 References Review 116 3.4 Proposition 128 3.5 Method 128 Contents xxv

3.6 Analysis 130 3.7 Conclusion 139 Notes 141

4 Th e Impact of the International Tripartite Rubber Organization (ITRO): Sub-Regional Level Analysis 145 4.1 Context 145 4.2 Purpose 149 4.3 Literature Review 149 4.3.1 Overview: ASEAN’s Sub-Regional Economic Organizations 150 4.3.2 History of Natural Rubber and the International Tripartite Rubber Organization (ITRO) 151 4.3.3 Learning from European Economic Integration: From the ECSC to Now 153 4.3.4 Oligopoly (Duopoly) Market Power of Cournot: Nash 155 4.4 Proposition 159 4.5 Method: Macroeconomic Approach 161 4.6 Method: Microeconomic Approach 162 4.7 Analysis 166 4.7.1 Macroeconomic Approach 166 4.7.2 Microeconomic Approach 172 4.7.3 Input–Output Analysis on Rubber Production in Indonesia in 2000 and 2005 177 4.8 Conclusion 179 Notes 181

5 Th e ASEAN Economic Community of 2015 and Beyond 185 5.1 Context 185 5.2 Purpose 188 5.3 Proposition 188 5.4 Method 188 5.5 Analysis 189 xxvi Contents

5.5.1 Regional Production Network of ASEAN: Literature and Desk-Research 189 5.5.2 Th e Role of ASEAN+1 192 5.5.3 Unilateralism and Service-Sector Liberalization 194 5.5.4 Featuring: Indonesia’s 2015 Field Survey of the AEC 199 5.6 Conclusion 201 Notes 201

6 Th e Future of ASEAN’s Financial Integration 203 6.1 Context 203 6.2 Purpose 207 6.3 Literature Review 207 6.4 Proposition 212 6.5 Methodology 212 6.6 Result Analysis 214 6.7 Conclusion 218 Notes 220

7 General Conclusion 223 7.1 Executive Summary for the Future of ASEAN Economic Integration 229 Notes 232

Appendix 233

Bibliography 257

Index 269 List of Figures

Fig. P.1 GNI per capita per year (Current US$) of ASEAN countries 2014 245 Fig. P.2 Share to ASEAN’s GDP & population (%) ASEAN member states 2014 246 Fig. P.3 Patterns of intra-regional trade of observed ASEAN members, 1988–2014 246 Fig. P.4 Patterns of FDI inﬂ ows of observed ASEAN members, 1988–2014 247 Fig. 1.1 Prisoner’s dilemma of developed and developing country of ASEAN members 247 Fig. 1.2 Open regionalism in ASEAN in comparison to close regionalism in EU 248 Fig. 4.1 Share of ITRO to world natural rubber production volume (%) 1988–2008 248 Fig. 4.2 Country levels of world natural rubber’s main producers 1988–2008 249 Fig. 4.3 Trade relation between IMT and rest of the world (Non-IMT) 1988–2008 249 Fig. 4.4 Total quantity of trade between IMT and Non-IMT compared to its Cournot-Nash equilibrium line 1988–2008 250 Fig. 4.5 Rubber impact on Indonesia economy Input Output table analysis (value) 2000 and 2005 250

xxvii xxviii List of Figures

Fig. 4.6 Indonesia’s rubber market orientation 1988–2008 251 Fig. 4.7 Illustration for the connection between CNE (microeconomic analysis) and Indonesia’s I-O analysis (2000 and 2005) 251 List of Tables

Table P.1 Share of regional trade fl ows (% of Merchandise Export) 2006 233 Table P.2 World’s FDI infl ows (%) by host regions 1990–2014 234 Table P.3 FDI infl ows in ASEAN by host countries (%) 234 Table P.4 FDI infl ows to ASEAN countries by host country (%) 2014 235 Table 1.1 Weighted average MFN and CEPT manufactured goods in ASEAN (%) 2003 and 2007 235 Table 2.1 Selected variables, hypothesis, and sources of data model of AFTA analysis 236 Table 3.1 BFTAs of fi ve ASEAN founding members and ASEAN+3 members 2010 238 Table 3.2 Selected variables, hypothesis, and sources of data model of BFTA analysis 238 Table 3.3 Healthy test on BFTA models 240 Table 3.4 Quality rank of overall, infrastructure, and customs Global Competitiveness Report (2009–2010) logistics performance index and indicators 2010 ASEAN countries 241 Table 4.1 Selected variables, hypothesis, and sources of data model of ITRO analysis 241

xxix xxx List of Tables

Table 4.2 Market proportion founding members of ITRO (Indonesia, Malaysia, and Th ailand/IMT) and the rest of exporters (Non-IMT) in tonnes 1988–2008 242 Table 4.3 Rubber impact on Indonesia economy input output table analysis 2005 243 Table 6.1 Stationarity test on pair infl ation rate (CPI) of ASEAN-5 founding members and East Asian countries (China, Japan, and Korea) 1988–2008 243 Table 6.2 Error correction mechanism pair infl ation rate (CPI) of ASEAN-5 founding members and East Asian countries (China, Japan, and Korea) 1988–2008 244 Table 6.3 Cointegration test on infl ation rate (CPI) of ASEAN-5 founding members and East Asian countries (China, Japan, and Korea) 1988–2008 244 Table 6.4 Exchange rate and infl ation rate diff erence Yuan China and all observed countries 1988–2008 245 Table 6.5 Relationship characters on exchange rate and infl ation rate diff erence to trade relations 1988–2008 245 List of Models

Model 2.1 Indirect impact of intra-regional trade (trade creation) on FDI infl ows (investment creation) and direct impact of AFTA on FDI infl ows 252 Model 2.2 Th e impact of intra-regional trade and FDI infl ows in system equation models of Seemingly Unrelated Regression Estimator (SURE) and Simultaneous Equation Model Estimator (SEME/3 SLS) 252 Model 3.1 AFTA, BFTA, and macroeconomic factors on FDI infl ows at country level 253 Model 3.2 Reduced form estimation on BFTA and macroeconomic factors on FDI infl ows at country level 254 Model 4.1 Panel data (PLS) of the impact of ITRO on FDI infl ows in natural rubber: sub-regional economic agreement, case of IMT’s natural rubber (ITRO) 255

xxxi List of Abbreviations

ACFTA ASEAN China Free Trade Area ADB Asian Development Bank AEC ASEAN Economic Community AETS Agreed Export Tonnage Scheme AFAS ASEAN Framework Agreement on Services AFTA ASEAN Free Trade Area AIA ASEAN Investment Area AIC ASEAN Industrial Complementary AICO ASEAN Industrial Cooperation AIJV ASEAN Industrial Joint Ventures AIP ASEAN Industrial Project ANRPC Asian Natural Rubber Producer Country APEC Asia-Paciﬁ c Economic Cooperation APT ASEAN Plus Th ree APTA Asia-Paciﬁ c Trade Agreement ARBC ASEAN Rubber Business Council ARF ASEAN Regional Forum ASC ASEAN Security Community ASCC ASEAN Sociocultural Community ASEAN Association of South East Asian Nations ASEAN-4 ASEAN’s new members, Cambodia, Laos, Myanmar, and Vietnam

xxxiii xxxiv List of Abbreviations

ASEAN-6 ASEAN’s original members, Indonesia, Malaysia, Th ailand, Philippines, Singapore, and Brunei ASP ASEAN Surveillance Process BFTA Bilateral Free Trade Agreements BIMP-AEGA Brunei, Indonesia, Malaysia and Philippines—East ASEAN Growth Area CEPT Common Eﬀ ective Preferential Tariﬀ CLMV Cambodia, Laos, Myanmar and Vietnam CMSA Constant Market Share Analysis CNE Cournot-Nash Equilibrium COO Country of Origin CU Custom Union EC Economic Community ECBN Ethnic Chinese Business Network ECSC European Coal and Steel Community EEC European Economic Community EU European Union FAO Food and Agriculture Organization FDI Foreign Direct Investment GDF Global Development Finance IMF International Monetary Fund IMT-GT Indonesia, Malaysia, and Th ailand – Growth Triangle INRA International Natural Rubber Agreements IRCO International Rubber Cooperation IRSG International Rubber Study Group ITRO International Tripartite Rubber Organization JAFTA Japan ASEAN FTA KAFTA Korea ASEAN FTA LAIA Latin American Integration Association MFN Most Favored Nations NAFTA North American Free Trade Agreement PTA Preferential Trade Arrangement RCA Revealed Comparative Advantage ROO Rule of Origin RPN Regional Production Network RTA Rubber Trade Association SC Single Currency SGP Stability and Growth Pact List of Abbreviations xxxv

SIJORI Singapore – Johor, Malaysia – Riau, Indonesia SM Single Market SMS Supply Management Scheme SMU/PU Single Monetary Union or Political Union TAC Treaty of Amity and Cooperation WDI World Development Indicator WTO World Trade Organization