TOWARDS AN ASEAN ECONOMIC COMMUNITY: THE CHALLENGES AHEAD

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1 TOWARDS AN ECONOMIC COMMUNITY: THE CHALLENGES AHEAD Dr. Poppy S. WINANTI Universitas Gadjah Mada, Indonesia Abstract s ambition to accelerate regional trade liberalisation has been strengthened by the commitment to establish Economic Community (AEC). AEC is intended to create a single market and production base with a freer movement of goods, services, investment, workers, and capitals in Southeast Asia. Furthermore, AEC is also expected to encourage a more equal economic development and to reduce poverty, as well as economic gap in the region. This paper intends to identify the challenges faced by members in the effort to establish AEC, particularly in achieving one of its main goals to create a single market in the region. By analysing both intra and extra regional trade relations of members, this paper argues that one of the biggest challenges in establishing a single market in Southeast Asian region is the characteristic of members economic external relations which was mostly still extra-regional trade oriented. Introduction Considering the history of its birth, the establishment of was intended to achieve mainly political goals. was established to attain peace, security, and stability in the region. During s early development, economic cooperation, however, was not seen as urgent needs. The effort to build economic cooperation started to emerge in the late 1970s through the establishment of Preferential Trading Agreement (PTA) in Nevertheless, the implication of the PTA was also still limited. Most members during that period implemented relatively closed economy and Import Substitution Industrialisation (ISI) policies. By implementing those policies, most members were able to achieve a relatively high economic growth. This is why they did not have sufficient incentive to push for trade liberalisation at the regional level (Cuyvers et.al, 2005). Trade liberalisation efforts have started to be taken more seriously in the mid of 1980s. During that period, most members were quite confident not only with their economic achievement but also in dealing with external challenges. International institutions including IMF and the World Bank pressurised members to accelerate their trade liberalisation efforts. In addition, there had been the needs to strengthen themselves in facing the emergence of trade blocs. These needs were necessary especially considering that countries joining trade blocs, such as NAFTA and

2 EU, were the main destination countries for s exports and imports (Cuyvers et.al, 2005). As part of the effort to accelerate trade liberalisation, in January 1992, Free Trade Area (AFTA) was established. The establishment of AFTA exhibited a significant leap especially compared to the establishment of PTA in This ambition has been strengthened by the commitment to achieve Economic Community (AEC) during the 9 th summit in Bali on 7 October AEC which is one of the Community pillars 1 is intended to create a single market and production base with a freer movement of goods, services, investment, workers, and capitals in Southeast Asia. Furthermore, AEC is also expected to encourage a more equal economic development and to reduce poverty, as well as economic gap in the region. This paper, therefore, intends to identify the challenges faced by members in their effort to establish AEC, particularly in achieving one of its main goals to create a single market in Southeast Asia. In doing so, the next part of this paper provides a conceptual framework in understanding economic regionalism. This paper then continues by briefly explaining the history of AEC establishment, its principles, its goals and the mechanism to achieve them. The following part discusses the development to this day. This part also assesses the achievement and also identifies the challenges faced by members in achieving their aim to establish an Economic Community. The last part of this paper summaries previous explanations by highlighting main findings and concludes the discussion. Understanding Regional Economic Integration: Conceptual Framework There are several terms related to regional economic integration, such as Preferential Trade Area (PTA), Regional Trade Agreement (RTA), and Free Trade Area (FTA). Each term, however, has its own meaning depending on the depth of its integration and the arrangement of its institutional framework. Balaam and Veseth (2005) refer regionalism as a process by a group of nation-states which usually are in the same geographical area to agree to cooperate and share responsibilities in order to achieve common goals. Hurrell (1995) defines regionalism in a broader meaning as a level of social cohesiveness (ethnicity, race, language, cultural, historical), economic cohesiveness (trade partner, complementary economic relations), political cohesiveness (regime type, ideology), and organisational cohesiveness (the existence of formal regional institution). Based on the depth of its integration and institutional framework, economic regionalism can be divided into several levels: Preferential Trade Area (PTA), Free Trade Area (FTA), Customs Union (CU), Common Market, Economic Union (Panagariya, 1999; Cleaver, 1997; Balaam and Veseth, 2005): 1 The other two pillars are Security Community (ASC) and Socio-cultural Community (ASCC).

3 (1) Preferential Trade Area (PTA): can be understood as the lowest level of economic integration. PTA can be defined as the agreement between two or more states to reduce trade barriers for products that domestically produced in the region compared to products that are not produced in the region. (2) Free Trade Area (FTA): the states in the area agree to eliminate any trade barriers, including tariffs, quota, for goods and services that they produce. However, the elimination of these trade barriers does not apply to goods and services that are not produced in the region. Within this scheme, each member has its right to have an independent economic policy especially concerning trade relations with non-member states. (3) Customs Union (CU): the member states agree to reduce trade barriers and to implement common regulation for external tariffs through the implementation of Common External Tariff (CET). For different goods can be applied different CET. However, it is not allowed to implement different CET for different state members. In this regard, a deeper economic relation is required under this scheme. In addition, to some extent, member states have to give away their sovereignty and their national policy especially considering that they are unable to have tariff without consulting with other member states. (4) Common Market: this includes free trade agreement which is not only covering goods and services but also free movement for workers and capitals. This scheme is also combined by a broader common policy aiming at policy harmonisation in the region. (5) Economic Union: this is the last stage of economic and political integration. It is not only intended to eliminate tariff barriers but also to achieve full economic integration with formal institutional arrangement. Member states agree to have a broader and deeper common policy to maintain a free movement of goods, services, persons, capitals, including common currency and monetary policy. It also includes common central bank at regional level and other regional economic institutions dealing with tax, financial policy oversight, competitions, and others. This scheme, as a consequence, represents the limitation of member states sovereignty. Based on previous explanations, it can be argued that based on the depth of its integration and institutional framework, economic regionalism can be divided into several levels, ranging from Preferential Trade Area to Economic Union. This theoretical framework is useful to comprehend the development of s effort to establish a single market in Southeast Asian region. Understanding Economic Community: the history and its characteristics Prior to the agreement to establish Economic Community (AEC) in 2003, had several initial agreements concerning its effort to achieve regional economic integration: the Free Trade Area (AFTA) in 1992, the Framework Agreement on Services (AFAS) in 1995, the Agreement on Customs (AAC)/ Customs Vision 2020 in 1997, and the Framework Agreement on the Investment

4 Area (AIA) in These agreements provided cooperation framework for almost all sectors (goods, services, investment, capitals) except workers. The main purpose of AFTA is to reduce both tariff (up to 5% within 15 years) and nontariff barriers, covering a wide range of products. Through the reduction of trade barriers among its members, AFTA is intended to change economic to become a single union production base which is then expected to become a regional market for around 500 millions consumers (Cuyvers et.al, 2005). Based on the initial agreement, this objective should have been achieved by However, in 1994, it was agreed to accelerate AFTA by In 1995, members agreed to accelerate further tariff reduction to 0 5% to be achieved by 2002 for -6 and within 10 years for - CLMV. 2 In the same year, it was also agreed to implement zero tariff for -6 by 2010 and 2018 for -CLMV. Figure 1 Acceleration in Tariff Reduction Such acceleration owes to several factors: first, the increase in confidence of members regarding the process of economic integration which then drives to the need to move even faster. The acceleration also shows that members regional commitment for liberalisation and open policy amid the financial crisis. Another reason is also to enhance regional competitiveness facing China s competition (Soesastro, 2005). Interestingly, despite the effort to accelerate economic integration in Southeast Asian region, the level of flexibility is considerably high. This means that even though 2-6 refers to the original 5 members of (Indonesia, Malaysia, Philippines, Singapore, Thailand) and Brunei Darussalam. -CLMV refers to the newest members and less-developed members of (Cambodia, Laos, Myanmar, and Vietnam) (Cuyvers, et.al, 2005).

5 every member has to commit to achieve common target, they are still given a freedom to find the most realistic way in implementing their commitments (Cuyvers, et.al, 2005). Another mechanism introduced to achieve tariff reduction is the Common Effective Preferential Tariff (CEPT) scheme. CEPT covers manufactured and semi-manufactured products including processed agricultural products. Liberalisation is implemented with different level of acceleration for different product. Liberalisation is differentiated based on two schemes: fast track and normal track. Products under the Inclusion List (IL) must be liberalised through the reduction of CEPT maximum 5% by 2002, even though -CLMV is given a longer transition period. Vietnam is given until 2006, Laos and Myanmar until 2008, and Cambodia is given until Under the AFTA framework, members are also allowed to include sensitive products in the list of tariff reduction both under the scheme of fast track or normal track. For this purpose, AFTA has different types of the list, including Temporary Exclusion Lists (TEL), Sensitive Lists (SL), and General Exception Lists (GE) (Cuyvers et.al, 2005). As briefly stated earlier, s ambition to create a single market in the region has been strengthened by the commitment to achieve Economic Community (AEC). As can be seen from the Declaration of Concord II (or Bali Concord II), the main purpose of AEC is...the realization of the end-goal of economic integration...in which there is a free flow of goods, services, investment and a freer flow of capital, equitable economic development and reduced poverty and socio-economic disparities in year 2020 (see Figure 2). Figure 2 The Core Elements of AEC Source: AEC Blueprint, 2007

6 In this regard, through AEC, will achieve a single market and production base...making a more dynamic and stronger segment of the global supply chain... In other words, AEC aims to create (AEC Blueprint, 2007): A single market and production base A highly competitive economic region A region of equitable economic development A region fully integrated into the global economy As will be explained later, this commitment, however, has been accelerated during the Summit in January It was agreed that the Economic Community should be achieved by 2015 instead of by As can be seen from the Declaration of Concord II, it can be concluded, therefore, by establishing AEC, members intend to create a Common Market in Southeast Asian region. The acceleration effort towards AEC, nevertheless, poses several questions, including how effective the CEPT scheme to support the establishment of AEC and what challenges faced by members in achieving their goal to establish a single market in the region. The next part of this paper deals with these questions. The Challenges in Establishing a Single Market in Southeast Asia Despite its acceleration and high level of the confidence among members regarding the establishment of AEC, it can be found several problems that need to be addressed. First, due to its embedded flexibilities under the CEPT scheme, many members use these flexibilities to protect their industry and sensitive products. For example, until 2004, Malaysia still applied import tariff for automotive products in order to protect its national automotive industry, Proton (Cuyvers, et.al, 2005). The inclusion of automotive industry as part of Malaysia s inclusion list just happened recently. Nevertheless, in general as can be seen from figure 3 the progress of CEPT Tariff Rate especially among -6 is quite good. Tariff reduction through CEPT scheme among -6 from 1996 to 2003 was reduced more than half. This figure, however, somehow different in -CLMV because tariff policy in some of these countries, are still considered as states revenue. The implementation of CEPT is, therefore, seen as revenue loss.

7 Figure 3 Average CEPT Tariff Rate in -6 Source: Secretariat In addition to the disparity in CEPT Scheme implementation between -6 and -CMLV, another important problem is the characteristic of members economic external relations which tends to be extra-regional trade oriented. It means that external trade relations of members were mostly characterised by extraregional trade than that of intra-regional trade. In 2010, for example, both the top 10 export markets and import origins of members were dominated by the European Union, China, Japan and the United States (see Figures 4 and 5).

8 Figure 4 Top 10 Export Markets 2010 Source: Statistics 2012 Figure 4 shows that extra- export is higher than its intra export, reaching 74.7% in 2005 and increased to 75% in As table 1 indicates, it can be seen that the percentage of intra- export at the individual member is also low. For example, in 2005, Cambodia s intra export was only 4.7%. The figure increased almost triple in 2010 to 12.6%. In addition, Singapore s intra export was 31.3% and the figure slightly declined in 2010 to 30%. The highest percentage was Myanmar s intra export which reached to around 49% both in 2005 and 2010 (see table 1).

9 Table 1 Intra and Extra Export 2005 and Intra- Exports (%) Extra- Exports (%) Intra- Exports (%) Extra- Exports Brunei Darussalam Cambodia Indonesia Lao, PDR Malaysia Myanmar Philippines Singapore Thailand Viet Nam Source: Statistics 2012 Even though in general, intra- import occupies only 24.5% in 2005 and slightly increased to 25.8% in 2010, table 2 shows that intra- import at the individual level is higher that intra- export. Most members intra- imports also slightly increased between 2005 and For example, in 2005 Lao s intra- import reached up to 51.6% and increased to 68.7% in The lowest percentage in 2005 was Philippines intra- import which was 18.7%. In 2010, this figure increased to 27.9%. The striking decrease can be found in Vietnam s intra- imports from 27.4% in 2005 to 19.3% in 2010.

10 Figure 5 Top 10 Import Origins 2010 Source: Statistics 2012 Table 2 Intra and Extra Import 2005 and Intra- Imports Extra- Imports Intra- Imports Extra- Imports Brunei Darussalam Cambodia Indonesia Lao, PDR Malaysia Myanmar The Philippines Singapore Thailand Viet Nam

11 Source: Statistics 2012 Based on previous explanations, it can be argued the disparity in CEPT Scheme implementation between -6 and -CMLV is one of the challenges faced by members in creating a single market. In addition to that, previous discussion also showed that one of the biggest challenges in establishing a single market in Southeast Asian region is the characteristic of members economic external relations which was mostly still extra-regional oriented. By analysing both intra and extra regional trade relations of members, intra-regional trade among members is lower than their extra-regional trade relations. In this regard, it can be argued that AEC through AFTA framework has not achieved a meaningful progress especially in promoting export-import activities among members. Nevertheless, it should be noted that focusing only at export-import activities is insufficient to assess AEC comprehensively. In this regard, therefore, in order to have a more comprehensive assessment, in addition to analysing intra and extra trade relations, it should also be assessed how the reduction in trade-barriers as well as technological and innovation activities in the region may also contribute to s global competitiveness. Conclusion Previous explanations illustrate that one of the biggest challenges for members to establish a single market is the fact that most members economic external relations is still highly characterised by extra-regional trade orientation policy. In this context, based on the depth of its integration and institutional framework, s economic regionalism has already passed Free Trade Area and achieved Custom Union levels. However, s economic regionalism has not been able to achieve Common Market as intended. Since one of the problems in establishing a single market is its low level of intra- trade, expanding AEC to include Japan, China, and South Korea through the framework of +3 seems to be a more realistic approach. This is especially because these countries are among the top 10 of both export markets and import origins. Nevertheless, members also need to improve their collective bargaining power in dealing with these three neighbouring countries to ensure that achieving a single market through +3 can bring more benefit to members.

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