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The Key Factors of Economic Integration in Southeast
Asia: Case of Indonesia, Malaysia, and Thailand
Kiki Verico University of Indonesia, Indonesia
Abstract
The major aim of economic integration in Southeast Asia is to shift economic integration
from intra-regional trade to intra-regional investment before it achieves the common
market. This article attempts to analyze the two essential factors in Southeast Asia’s
economic integration: intra-regional trade and an economic community. In the first
analysis, this article observes three selected countries: Indonesia, Malaysia, and Thailand;
while in the second analysis it focuses on Indonesia as a case study. Findings from this
article showed that free trade agreement is effective to increase intra-regional trade but not
effective to attract investment; therefore suggesting that Southeast Asia needs to amplify its
open-regionalism principle. This article also found that the private sector is ready for the
economic community; therefore the ASEAN Economic Community (AEC) is fit for
Southeast Asia’s economic integration exemplary.
Key words: economic integration, international investment (long-term capital-FDI
inflows), ASEAN Free Trade Area (AFTA), Bilateral Free Trade Agreements
(BFTA), Asian noodle bowl phenomenon
Introduction investment. Intra-regional trade is affected
The Association of Southeast Asian by its regional trade agreement known as
Nations (ASEAN) is committed to the ASEAN Free Trade Area (AFTA),
while its impact is expected to attract
transform Southeast Asia’s economic long-run investment inflows of Foreign
integration in trade, which allows free Direct Investment (FDI). As intra-regional
flows of goods to free flows of investment trade analysis is essential for Southeast
and services. The latter is known as an
economic community and has started Asia’s economic integration, this article
since the end of 2015. This agreement was attempts to observe both the impact of
implemented through the ASEAN free trade agreement to intra-regional
trade and the impact of intra-regional
1
Economic Community (AEC). trade to FDI inflows. It is followed by a
The key factor for this second observation on the economic
transformation process is in its intra- community as this is the next stage to
regional trade because it connects intra- intra-regional trade.
regional trade and intra-regional Previous studies show that intra-
regional trade is directly affected by the
1 implementation of AFTA through the
For further detail, refer to
http://www.aseansec.org/18757.htm.
Journal of ASEAN Studies, Vol. 4, No. 2 (2016), pp. 107-126
DOI: 10.21512/jas.v4i2.887.g1736
©2016 by CBDS Bina Nusantara University and Indonesian Association for International Relations
ISSN 2338-1361 print / ISSN 2338-1353 electronic
108 The Key Factors of Economic Integration in Southeast Asia
reduction of tariff barriers among its In addition, to analyze the impact
members (Braga and Bannister, 1994; of AFTA on FDI inflows, this article
Ravenhill, 1995; Menon, 1996; Bowles and adopts another type of agreements titled
MacLean, 1996). A high intra-regional the direct Bilateral Free Trade Agreement
trade indicates that the welfare-enhancing, (BFTA) as a factor to FDI inflows. BFTA
trade-creating effects outweigh its directly connects ASEAN member states
welfare-reducing, trade-diverting effects to non-member states. Some previous
(Viner, 1950). An increasing intra-regional studies show that BFTA has been
trade within members is expected to considered as a shortcut for member states
attract long-run investment creation of to attract FDI inflows from non-member
FDI inflows. states alongside regional trade agreements
Theoretically, intra-regional trade (Menon, 2006). BFTA is not prohibited in
affects FDI inflows in two ways: (1) an ASEAN; therefore there is a potential risk
increase in horizontal FDI inflows from that BFTA can infringe the objectives of
non-members which avoid trade AFTA. In Asia, this glitch is known as the
impediments as a result of discrimination ‘Asian noodle bowl phenomenon.’
from regional trade policies (Markusen, In order to complete a model
1984), and (2) an increase in vertical FDI analysis of the factors and impacts of the
inflows from members due to the Southeast Asia’s intra-regional trade, this
increasing benefits from intra-regional article observes the economic community
trade following the implementation of in Southeast Asia by finding the
regional discriminative trade policies perceptions of firms, from both the
(Helpman, 1984). manufacturing and service sectors, on the
Previous studies find that intra- AEC. The analysis uses primary data
regional trade increases FDI inflows. based on a field survey of the upper-
Applying Generalized Method of middle level firms in Indonesia. The
Moments analysis to European Union primary data is adopted from a survey
(EU) member states in 1989-2001, Baltagi, titled ‘Monitoring of Investment Climate,’
Egger, and Pfaffermayr (2005) find that of which one of its coverage in 2014 was
the increase of intra-regional trade the firms’ perceptions on the AEC 2015.
significantly increased FDI inflows. This method is necessary to evaluate the
Dunning (1990) finds that the acceleration perceptions of firms on the economic
of the United States’ FDI inflows in community, the next stage factor for
Europe, which occurred in the late 1950s, economic integration in Southeast Asia
was affected by the EU’s discriminative after the intra-regional trade.
trade policy towards non-member states. Objective
Using fixed effects panel data of gravity Based on the background, this
model on 55 Organisation for Economic article attempts to conduct three analyses.
Co-operation and Development (OECD) First, the factors that affect intra-regional
countries in 1982-1997, Mac Dermott trade. This is a proxy for trade creation
(2006) finds that intra-trade integration effect. This objective is achieved by
encourages total FDI inflows in North adopting and testing two time dummy
America (North American Free Trade variables: (1) the AFTA that is expected to
Area).
create positive impact on Southeast Asia’s
intra-regional trade and (2) the direct
Journal of ASEAN Studies 109
BFTA that is expected to do the opposite: Model, Variable, Hypothesis, and
create negative impact on ASEAN’s intra- Method
regional trade. This article uses BFTA as a Secondary Data Analysis: Case of
proxy to prove the existence of the ‘Asian Indonesia, Malaysia, and Thailand
noodle bowl’ in Southeast Asia. This
phenomenon is a major problem for This article chooses the time
enhancing intra-regional trade in 2
Southeast Asia. dummy of AFTA of year 1999 and, with
the purpose of sterilizing from global
Second, the impact of intra- economic crises in 2008, this article limits
regional trade on FDI inflows as a proxy the time series up to year 2008. In order to
of investment creation in Southeast Asia. have a balanced time series span, this
This article adopts two dummy variables article selects the first time dummy of year
of AFTA and BFTA as they are the factors 1988. Therefore, finally this article has 21
for intra-regional trade of trade creation years (1988-2008) of time series analysis.
and intra-regional trade is a factor of FDI In order to make a connection
inflows of investment creation. For these between the factors and impact of intra-
two objectives, given several regional trade, this article has formulated
considerations, the observed countries in two equations as a system. The first
this article are limited to the ASEAN’s equation uses intra-regional trade as a
founding members, in particular dependent variable while the second one
Indonesia, Malaysia, and Thailand. uses FDI inflows. This article has adopted
Third, the perceptions of firms on trade arrangements (AFTA and BFTA) as
the AEC 2015 from both the the factors affecting intra-regional trade of
manufacturing and service sector. These Southeast Asia that is complemented by
perceptions are obtained from the field other macroeconomic variables as control
survey conducted in the biggest ASEAN variables given that trade arrangements
member state in terms of Gross Domestic are not the sole factor affecting intra-
Product (GDP) and population size, regional trade. These trade agreements are
Indonesia. The field survey had been treated as time dummy variables. The
conducted in six big cities around time dummy for BFTA is its first time of
Indonesia in 2014. In order to achieve this agreement among the observed countries,
objective, this article designs questions which was 2004. (Indonesia signed its first
that are related to the theory of economic BFTA in 2006, Malaysia in 2005, and
community for respondents from upper- Thailand in 2004.)
middle level classification. This article assumes that AFTA
directly affects intra-regional trade and
intra-regional trade directly affects FDI
3
inflows. This assumption is also based on
2 According to Nesadurai (2003), the AFTA
processes have three stages of negotiations:
identification (1992-1995), expansion (1996-
1998), and implementation that began in 1999.
3 Indirect impact of AFTA to FDI inflows
follows the preposition by Ravenhill (1995)
and Bowles and MacLean (1996).
110 The Key Factors of Economic Integration in Southeast Asia
12
the empirical facts that AFTA was in home of developed countries to invest.
designed to boost Southeast Asia’s intra- Regarding that, this article uses nominal
regional trade while, for attracting FDI exchange rate as local home currency per
inflows, ASEAN offered ASEAN local host currency; therefore, the
Investment Area (AIA) policy. increasing ER generates disincentive for
As for the impact of intra-regional the investors to invest FDI inflows in host
trade to FDI inflows, this article adopts countries.
selected variables that hypothetically This article proposes a new
affect FDI inflows from previous studies exogenous variable: FDI profit. This
of nominal value of GDP, economic variable is adopted from the Global
4
growth and number of population, value Financial Development data of the World
5 6 13
of consumption, employment, electricity Bank. The data is part of Resource
7 8
capacity, degree of openness, Flows, at which the data set form is on
productivity of labors and their level of yearly basis. This article adopts this data
9 10 as a proxy for the profit for the home
education, as well as exchange rate.
Exchange Rate (ER) effects on FDI county of FDI.
inflows in Southeast Asia are essential to Variables such as corruption index,
be observed. During Southeast Asia’s political stability, distance, and English
economic crises, exchange rates incurred proficiency however are not observed due
unanticipated depreciation leading to to either limited data availability or
11
devaluation. Exchange rate also irrelevance to the article’s hypothesis.
represents the cost of service link. This The selected variables, their
means that countries with high exchange expected signs of hypothesis, and sources
rate volatility will be difficult to cooperate of data are described in Table 1. The
with other countries under a production methodology is built to find the most
network as their exchange rate volatility significant variables that explain the effect
endangers the entire network. of trade agreements at the regional and
According to the relative value of bilateral levels in Southeast Asia (AFTA
wealth approach, the more depreciated and BFTA) on investment creation (FDI).
the local currency of a developing country The trade agreements in question are
host, the more incentive for the investors accompanied by other macroeconomic
variables, because FDI flows are affected
4 For more details, see Sethi, Guisinger, not only by trade policies but also by
Phelan, and Berg (2003). macroeconomic variables.
5 For more details, see Walz (1997).
6 For more details, see Hejazi and Pauly (2003). 12 Previous study shows that exchange rate
7 For more details, see Foster (2000). volatility has significant negative impact to
8 For more details, see Park and Park (2008). FDI inflows in East Asian countries (Kiyota
9 For more details, see Hejazi and Safarian and Urata, 2004).
(1999). 13 The World Bank defines it as the form of
10 For more details, see Barrell and Pain (1996). value of Profit Remittance of FDI in US$ which
11 Hayakawa and Kimura (2008)’s study finds explained in details as ‚payments of direct
that exchange rate is the most important investment income (debit side) which consist
variable to describe economic uncertainty and of income on equity (dividends, branch
competitiveness within production blocks in profits, and reinvested earnings) and income
the regional production networks. on the intercompany debt (interest).‛
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