OSIPP Discussion Paper: DP-2011-E-002

Assessing the Impact of the ASEAN Economic Community
March 23, 2011
Hiro Lee †Osaka School of International Public Policy, Osaka University

Michael G. Plummer
OECD and Johns Hopkins University, SAIS-Bologna

Keywords: ASEAN, AEC, CGE model
JEL codes: F15, F17
Abstract: Consequences of the ASEAN Economic Community (AEC) are investigatedusing a dynamic computable general equilibrium (CGE) model. Quantitative
assessments of the effects on economic welfare, trade flows and sectoral output are
offered. When the removal of trade barriers are combined with reductions in
administrative and technical barriers and lowering the trade and transport margins under
the assumption of endogenously determined productivity, the estimated welfare gains forthe year 2015 range from 1.1% in Indonesia to 9.4% in Thailand. The results suggestthat streamlining customs procedures and other reductions in administrative andtechnical barriers, as well as increased competition and improvements in infrastructure,are significant in enlarging the benefits of the AEC.

† Corresponding author. Osaka School of International Public Policy, Osaka University, 1-31

Machikaneyama-cho, Toyonaka, Osaka 560-0043, Japan. Email: hlee@osipp.osaka-u.ac.jp. We
are grateful to Mordechai E. Kreinin and Dominique van der Mensbrugghe for their helpfulcomments.

1. Introduction
Founded in 1967 with the Bangkok Declaration, the Association of Southeast Asian
Nations (ASEAN) is the most advanced institution of regional cooperation in Asia and oneof the oldest. At first, its goals were mainly political in nature. In particular, it sought topromote peace in what was at that time a volatile region. ASEAN did not attempt any
significant economic cooperation initiatives until the new international political environment emerged at the end of the 1980s. Its first major initiative was ASEAN Free Trade
Area (AFTA), which was established in 1992 and originally only covered trade in
manufactured goods to be liberalized over a 15-year period. 1 However, ASEAN subsequently broadened the scope and shortened the implementation period of AFTA so that it
was technically in full effect at the beginning of 2004 for the original ASEAN countries 2
and Brunei Darussalam (“ASEAN-6”), although there are transitional periods for productson the temporary exclusion lists, including some agricultural and food products andautomobiles.
At the 2002 ASEAN Summit in Phnom Penh, it was proposed that the region
should consider the possibility of creating an ASEAN Economic Community (AEC) by
2020. In the 2007 “Cebu Declaration” the ASEAN leaders not only formalized thiscommitment but actually pushed up the deadline to 2015. The action plan for the
implementation of the AEC was published in the form of the “ASEAN Blueprint” inNovember 2007. As part of the AEC process, ASEAN developed the ASEAN Charter,
which was ratified by each ASEAN member state and went into effect in December 2008.
Specifically, the AEC has the following four goals:
1. A single market and production base, characterized by a free flow of goods,
services, investment and skilled labor, as well as a freer flow of capital.
2. A competitive economic region, characterized by sound competition policy, consumer protection, intellectual property rights protection, infrastructure development,
sectoral competition in energy and mining, rationalized taxation and e-commerce.
1 Liberalization was somewhat loosely defined, as it left tariffs in the 0–5% range rather than the

traditional 0%.
2 Indonesia, Malaysia, the Philippines, Singapore and Thailand.

23. Equitable economic development, characterized by small and medium enterprisedevelopment and enhancement of initiatives geared to help the least-developed
ASEAN member states.
4. Integration into the global economy, with ASEAN centrality and participation in
global supply networks.
In sum, the primary goal of economic integration in ASEAN, as articulated by its
leaders, is to reduce transactions costs associated with economic interchange and to makethe region more attractive to multinational corporations wishing to take advantage of its
diversity and openness in rationalizing production networks. In this sense, it is both
determining and determined by the new wave of outward-oriented regionalism in Asia.
The objective of this paper is to evaluate the potential effects of the AEC on
economic welfare, trade flows and sectoral output of the member states using a dynamic
computable general equilibrium (CGE) model. The model incorporates endogenously
determined sectoral productivity and reductions in transactions costs, including the trade
and transport margins and frictional trade costs (i.e. trade-related risks and administrative
and technical barriers to trade). The next section gives an overview of the model. Section 3
provides a brief description of the baseline and policy scenarios, followed by assessmentsof computational results in section 4. The final section offers conclusions and possible
extensions of the paper.
2. Overview of the CGE Modeling Framework
The model used in this study is a modified version of the LINKAGE model
developed by van der Mensbrugghe (2005). This model has been extensively used for thecomparative analysis of alternative trade integration scenarios, including an assessment ofvarious Doha Round proposals by Anderson et al. (2006) and the evaluation of various
free-trade agreement scenarios in East Asia by Lee and van der Mensbrugghe (2008). In
many respects the structure of the LINKAGE model is similar to two other widely used andcited global trade models, specifically, the Purdue-based GTAP, as elaborated in Hertel3

(1997) and MIRAGE, sponsored by CEPII in Paris and discussed by Bchir et al. (2002). 3
The core of all three frameworks is a comparative static CGE model, although all threeincorporate specific variations. For example, LINKAGE and MIRAGE are typically used forundertaking a recursive dynamic analysis, where specific assumptions regarding population and labor growth, capital accumulation and productivity are invoked in order todevelop a baseline scenario from which different policy shocks are then examined. 4
The LINKAGE model entails a standard CGE paradigm, built around the circularflow of the economy, where on the supply side, goods and services are produced by
combining intermediate inputs and factors (e.g., labor, capital and land). A nested constantelasticity of substitution (CES) structure captures the substitution and complementary
effects across intermediate goods and factors. In most sectors, the degree of substitution
between capital and labor constitutes the core relation, while intermediate goods are taken
to be a fixed proportion of output. 5 A second node of the circular flow, relating toeconomic agents’ supply of the needed factors of production and their factor earnings, is
specified in the LINKAGE framework by a single representative household that receives all
factor income. Finally, a third node, characterizing agents’ demand for final goods andservices, uses the extended linear expenditure system (ELES) whereby purchases of goods
and services are simultaneously determined with savings (Lluch, 1973). As in theconventional CGE model, such as those developed by Dervis et al. (1982) and Löfgren etal. (2002), constant returns to scale and perfect competition are assumed in the goods andservices market, and product and factor prices are determined by equilibrium in theirrespective markets.
An open-economy CGE model entails a somewhat more complicated structure,since domestic production needs to be allocated between domestic and multiple foreign
3 van der Mensbrugghe (2006) offers a discussion of representative numerical results based on the
LINKAGE model, along with a summary comparison to those using GTAP.
4 Although a dynamic version of GTAP has been developed by Ianchovichina and McDougall (2000), a
majority of GTAP applications involve a static version of that model.
5 One strength of the LINKAGE model is a rather detailed formulation for agricultural production, in

which land use plays a key role, as, for example, in the choice between intensive versus extensive crop
production, or range-fed, as compared to other smaller livestock undertakings. The energy sector also
constitutes a separate activity, which is assumed to be a near-complement to capital in the short run, but
a substitute for capital in the long run.

4

markets, while domestic demand can be met by goods produced either domestically orfrom abroad. In this regard, the standard LINKAGE model assumes that domestic output is
supplied homogeneously from all markets, with the law of one price holding, so that
producers can switch their sales across market destinations costlessly. 6 On the demandside, products are differentiated for both producers and final consumers on the basis of
their origin, in keeping with the so-called Armington assumption. 7 More specifically, the
LINKAGE framework relies on a nested CES structure, where at the top nested level, eachagent chooses to allocate aggregate demand between locally produced goods and an
aggregate import bundle, while minimizing the overall cost of the aggregate demandbundle. At the second level, aggregate import demand is allocated across different trading
partners, again using a CES specification, wherein the aggregate costs of imports areminimized. This open-economy formulation generates a much broader set of market
equilibria, whereby the supply and demand for each traded good is required to be equal.
Hence, if the closed economy model had n equilibria for n goods, the global model has
r x n equilibria for domestic goods and r x r x n equilibria for traded goods, where r is thenumber of modeled countries/regions.
The model distinguishes between four interrelated price categories for traded
goods, which entail four separate instruments. The initial price producers receive for theirexported goods is designated as PE, while the FOB price, denoted as WPE, reflects
domestic export taxes or subsidies. The CIF price, WPM, includes the trade and transport
margins, represented by the ad valorem wedge ζ, as well as frictional trade costs,
corresponding to an iceberg parameter λ. 8 Thus, the relationship between the FOB and CIF
prices is given by

6 The model also allows for a finite constant elasticity of transformation (CET) function, which applies

across market destinations, and uses a two-level nested CET specification. At the top nested level,
production is allocated between the domestic market and aggregate exports, so as to maximize revenue.
At the second level, a CET function is used to allocate aggregate exports across foreign markets, while
maximizing total export revenue.
7 See Armington (1969).
8 Such an iceberg specification for transportation costs was formulated by Samuelson (1952), based ona concept developed earlier by von Thünen.

5

WPM r ,r ',i = (1 + ζ r ,r ',i ) WPE r ,r ',i λ r ,r ',i(1)

for the different r and r' combinations of exporting and importing regions/countries and icommodities. Finally, the domestic price of imports, PM, equals the CIF price, WPM, plus
tariffs and/or the tariff-equivalent effects of a range of possible commercial policies. In thesubsequent analysis, an increase in λr ,r ',i corresponds to a reduction in trade-related risks,
lower administrative barriers to trade (e.g., customs procedures), and/or a fall in technicalbarriers (e.g., mutual recognition of product standards). In sum, trade facilitating policy
initiatives imply an increase in the value of λr ,r ',i .
Final demand in the model is split into three categories, involving a representative
household, the public sector and the investment account. Public expenditure is specified as
fixed as a share of GDP and investment is determined by the total savings of the economy,
thereby leading to a different pattern of demand expenditures relative to that of households.
There are three closure rules relating to final goods expenditures in each country. First, thegovernment deficit is assumed to be fixed, while a lump sum tax borne by the
representative household is endogenously determined, so as to meet the public deficit
target. Thus, trade reform can generate an increase in the direct taxation of consumers, as aresult of reduced tariff revenues. Second, investment equals the sum of private, public andforeign savings. Third, the level of foreign saving is fixed; i.e., the current account balanceis taken as exogenously given. The latter implies that an ex ante change in import demand
generates an offsetting adjustment in the real exchange rate.
The model was calibrated to a 2004 base year using version 7 of the GTAP
database. 9 Although the LINKAGE model can be analyzed for 113 countries/regions and 57
sectors, this more detailed database has been aggregated in the current analysis, and relates
to 14 countries/regions and 20 sectors as shown in Table 1. More specifically, thecountry/region breakdown includes five individual ASEAN economies (Singapore,
Indonesia, Malaysia, the Philippines and Thailand), an aggregation of other ASEAN
economies (Brunei, Cambodia, Laos, Myanmar and Vietnam), four East Asian economies

9 A detailed description of version 7 of the GTAP database is offered by Narayanan and Walmsley(2008).

6

(China, Japan, Korea and Taiwan), as well as regional country groupings forAustralia/New Zealand, North America, Europe (EU and EAFTA) and the rest of theworld. The values of key parameters, such as demand, supply and substitution elasticities,
are based upon the previous empirical estimates. The model calibration primarily consistsof calculating share and shift parameters to fit the model specifications to the observed
data, so as to be able to reproduce a solution for the base year. 10 The Appendix provides
the values of the key elasticities used in the model.

3. The Baseline and Policy Scenarios
3.1 The Baseline Scenario
In order to evaluate the effects of the ASEAN Economic Community, the baseline
scenario is first established, showing the path of each of the 14 economies/regions in theabsence of ASEAN economic integration over the period 2004-2020. Population and labor
force growth are assumed exogenous, in line with assumptions made by the UN, such thatthe growth of the labor force growth equals the growth of the working age population (ages15-64). Real GDP growth rates are also exogenous in the baseline in order to be consistent
with the actual growth rates for 2004-2008 and the World Bank’s growth forecast for
2009-2020. The basic capital accumulation function equates the current capital stock to thedepreciated stock inherited from the previous period plus gross investment. In the baseline
the trade and transport margins are assumed to decline by 1 percent per annum in every
country/region, which is consistent with the recent trends.
Sectoral productivity is determined by three components: a uniform economy-wide
factor that is calibrated to achieve the given GDP target, a sector-specific factor related tothe degree of openness, and a shift term that permits constant deviations across sectors
beyond the differences in openness. More specifically, the sector-specific factor intended
to capture the sensitivity of changes in productivity to an economy’s openness, χi,t, is givenby the formula:

10 Some of the calibrated parameters are adjusted in the dynamic scenario, as explained by van der

Mensbrugghe (2006).

7

η⎛ Ei ,t ⎞ i⎟
χ i ,t = φ i ,t ⎜⎜⎟X⎝ i ,t ⎠(2)

where Ei,t is exports of commodity i, Xi,t is the output of commodity i, φi,t is a shiftparameter, and ηi is the elasticity of productivity with respect to openness. The parameter

φi,t is calibrated in the baseline scenario so that the trade-sensitive portion of sectoral
productivity is a constant share of total productivity. 11
The four types of taxes included in the model consist of commodity, production,
income and trade taxes, where the latter include both tariffs and export taxes. Whereas
commodity and production taxes are held constant throughout the simulation period, themarginal income tax rate adjusts to maintain a given government budget surplus or deficit.
The sectoral tariff rates for five ASEAN countries and the aggregated other
ASEAN region on imports from the ASEAN members in 2004 are summarized in Table 2.
There are striking differences in the tariff structures across the member states. Singapore is
duty free and has low barriers to services trade. The ASEAN-4 countries’ tariff rates on
intra-ASEAN trade are relatively low except some agricultural products, processed foodand services. Other ASEAN (mainly CLMV)’s average tariff rate is significantly higher
than the other five members. In particular, the tariff rates on transportation equipment andpetroleum products are substantially higher.

3.2 Policy Scenarios
The economic implications of the creation of an ASEAN Economic Community are
to be examined here. Specifically, the following four interrelated scenarios are considered:

11 Openness has been linked to increased productivity via three main channels. These consist of theimports of technology-intensive intermediate inputs (for example fertilizers in agriculture), imports ofcapital goods, and export market penetration. The latter effect can arise because of the higher standards
required to access and penetrate foreign markets, relative to those prevailing at home. The expansion ofsales to foreign markets can also create scale economies. There is considerable empirical work aimed at
ascertaining the extent to which each one of these different channels operates. For example, Das et al.
(2007) have explored some firm-level characteristics of export supply responses. The link between trade
openness and productivity formulated by de Melo and Robinson (1992) and Dessus et al. (1999) issimilar to that proposed here.

8

Scenario 1: The ASEAN members remove bilateral trade barriers by 2015. The sectorspecific productivity factors capturing the impact of openness, χi,t, are fixed at
the baseline levels.
Scenario 2: A 2.5% reduction in frictional trade costs among the ASEAN members overthe period 2010-2015 is introduced under Scenario 1, while the sector-specificproductivity factors related to the degree of openness, χi,t, are, again, fixed at
the baseline levels.
Scenario 3: The sector-specific productivity factors related to the degree of openness (χi,t)
are now endogenously determined, in keeping with equation (2), while
maintaining the other assumptions of scenario 2.
Scenario 4: A 10% reduction in the trade and transport margins among the ASEAN
countries relative to the baseline over the period 2010-2015 is incorporated in
scenario 3.
Bilateral tariffs, nontariff barriers and export taxes/subsidies in all the sectors aregradually removed among the ASEAN members over the 2010-2015 period. It is assumed
that frictional intra-ASEAN trade costs, such as costs arising from trade-related risks andadministrative and technical barriers, would be reduced by 2.5%. 12 In scenarios 3 and 4,
the elasticities of productivity in relation to the degree of openness, ηi, are set equal tovalues of 0.5 and 1.0 in agriculture and all other sectors, respectively. Finally,
improvements in transport infrastructure and increases in competition within the region are
assumed to reduce the trade and transport margins among the ASEAN members by 10%
over the period 2010-2015 relative to the baseline. 13

12 Keuschnigg and Kohler (2002) and Madsen and Sorensen (2002) consider a 5% reduction in realcosts of trade between the EU-15 and Central and East European countries. However, a smaller
reduction in these costs is invoked here, since the extent of reductions in technical barriers is expected
to be smaller for the AEC compared with EU enlargement.
13 Stone and Strutt (2009) use a 45% reduction in transportation costs in the Greater Mekong Subregion(GMS) to quantify the potential benefits of a reduction in transport costs within the GMS in a generalequilibrium framework. Thus, the assumption of a 10% reduction in the trade and transport margins
over the 2010-2015 period might be rather conservative.

9

4. Empirical Findings
4.1 Effects on Welfare
The welfare results for the four policy scenarios, as deviations in equivalentvariations (EV) from the baseline in 2015, are summarized in Table 3. When bilateral tradebarriers among the member states are removed under scenario 1, economic welfare ofSingapore is expected to increase most substantially. In terms of percentage deviations
from the baseline, Thailand, Malaysia and the Philippines are also expected to realize
welfare gains of more than 1%, while ‘Other ASEAN’ region would incur a welfare loss.
This finding may initially appear surprising since consumers in countries with higher
initial tariff rates are generally expected to benefit more from regional integration.
Nonetheless, this result is clearly driven by the Armington assumption of nationallydifferentiated products, which implies that each country has a monopoly in the market for
its exports. 14 Thus, the terms of trade of countries with zero or low initial tariff rates (e.g.,
Singapore and Malaysia) improve, while those of countries with high initial tariff rates(Other ASEAN) deteriorate, often dominating other welfare effects. Although non-ASEAN
countries incur some welfare losses, they are extremely small in percentage terms.
When the reduction in trade costs among the ASEAN countries is added in scenario
2, the magnitudes of welfare gains for the members are amplified considerably.
Principally, this is a trade-creating policy initiative, since lower administrative andtechnical barriers facilitate trade by generating greater intra-ASEAN market access. OtherASEAN’s economic welfare is predicted to become positive under this scenario. Overall,
ASEAN-10’s welfare gain would double from 1.06% under scenario 1 to 2.10% underscenario 2.
In the next two scenarios, the sector-specific productivity levels actually respond tochanges in the sectoral export-output ratios. A comparison of the results in scenario 3 withthose in scenario 2 shows that endogenizing χi,t leads to an increase in welfare gains for all
ASEAN members, but the increases are relatively small.

14 Brown (1987) shows that monopoly power implicit in national product differentiation is the source ofstrong terms-of-trade effects resulting from tariff changes in Armington-type models.

10

Under scenario 4, it is hypothesized that improved infrastructure and increased
competition within the region lead to a significant reduction in the trade and transport
margins, ζ r,r',i. Specifically, it is assumed that ζ r,r',i will be reduced by 10% over the period
2010-2015 compared with the baseline. The associated increases in welfare gains for the
ASEAN countries are striking, ranging from a 37% increase in Singapore to a sixfold
increase in Other ASEAN. The substantial variations in the extents of additional welfare
gains across members result from large disparities in the initial trade and transport margins
both among countries and across commodities, as well as from substantial differences inthe trade structures among the ASEAN members. For example, Singapore, Malaysia andthe Philippines have the highest export share in electronic equipment, which has the lowest

ζ r,r',i among all products except services. In contrast, Other ASEAN’s main export items
are apparel, coal, oil and gas, agricultural products, processed food and other manufacturing, but ζ r,r',i for these products except apparel are relatively high. Thus, an improvement
in infrastructure is expected to benefit the CLMV countries by a much greater extent thanthe other ASEAN members. 15
4.2 Effects on Intra- and Extra-regional Trade Flows
In this sub-section, the effects of ASEAN integration on intra- and extra-regional
trade flows are examined under the assumptions invoked under scenario 4. Accordingly,
sectoral productivity levels are endogenously determined, while it is assumed that there areremovals of trade barriers, a 2.5% fall in administrative and technical barriers to trade, and a
10% reduction in the trade and transport margins among the member states over the period
2010-2015. Table 4 summarizes the results, where the trade flow effects are expressed aspercent deviations from the baseline for the year 2015.
Not surprisingly, intra-ASEAN trade is predicted to increase drastically. The
percent increase in a member’s intra-ASEAN imports is positively correlated with its
initial tariff rates. For example, intra-ASEAN imports of Other ASEAN are estimated to

15 Stone and Struttt (2009) find that trade and transport cost reductions in the Greater Mekong

Subregion (GMS) would greatly expand intraregional trade and increase economic welfare of the GMS
countries.

11

increase by 111%, whereas those of Singapore increase by only 26%. On average, intraASEAN trade would expand 54% while ASEAN-10’s imports from non-ASEAN countries
would contract by 6.1%. Since world trade flows increase by 0.4%, the extent of tradecreation effects is greater than that of trade diversion.
While Other ASEAN’s imports from all the member states increase significantly,
increases in the Philippines’ imports from Other ASEAN, Indonesia’s imports fromThailand and Malaysia’s imports from the Philippines stand out. Although changes in tradeflows by sector are not presented in Table 4, these dramatic increases mostly stem fromextraordinarily large increases in bilateral imports of particular products. For example, thePhilippines’ imports of rice, fossil fuel and apparel from Other ASEAN are predicted toincrease by 970%, 163% and 134%, respectively, compared with the baseline in 2015.
However, the enormous increase in rice imports is the main reason for a 264% increase in
the Philippines’ imports from Other ASEAN because rice constitutes about one-fifth of theformer’s imports from the latter. Similarly, a 556% increase in Indonesia’s imports ofprocessed food from Thailand and over a 1,000% rise in Malaysia’s imports of other crops
from the Philippines are major causes of the drastic increases in Indonesia-Thailand andMalaysia-Philippines trade, respectively.
4.3 Effects on Sectoral Output
Estimates of the impact of ASEAN integration are provided for the 20 sectors
under scenario 4. The expected changes are again expressed in percent deviations from thebaseline in 2015. Evidently, the differences in the initial tariff rates across sectors play a
critical role in determining the direction of the adjustments in sectoral output. Other factorsthat affect the magnitude and direction of output adjustments for each product category
include the import-demand ratio, the export-output ratio, the share of each imported
intermediate input in total costs, and the elasticity of substitution between domestic andimported products. 16

16 A sector with a larger import-demand ratio generally suffers from proportionately larger output

contraction through greater import penetration when initial tariff levels are relatively high. In contrast, a
sector with a higher export-output ratio typically experiences a larger extent of output expansion, as aresult of the removal of tariffs in the member countries. The share of imported intermediate inputs in the12Among agricultural sectors, output of rice in Thailand and Other ASEAN(particularly Vietnam) and that of other crops in the Philippines expand through large
increases in intra-ASEAN exports. By contrast, output of rice in the Philippines andIndonesia, as well as that of other crops in Malaysia, Thailand and Other ASEAN, contract
mainly because of large import penetrations resulting from the removal of relatively hightariffs. Finally, since the share of Singapore’s agricultural sectors in total output is only
0.3%, the results for Singapore are unimportant. Overall, changes in output of agricultural
sectors among the ASEAN members are consistent with a priori expectations.
Sectoral output results for manufacturing and services sectors need to be interpretedwith caution. Output expansions of processed food in Thailand, textiles and apparel in
Other ASEAN, machinery in Singapore and Malaysia, electronic equipment in Singapore,transportation equipment (mainly motor vehicles) in Thailand and financial services in
Singapore and Malaysia are consistent with comparative advantage of these countries.
However, output expansions of processed food, textiles and apparel in Singapore andMalaysia and machinery and electronic equipment in Other ASEAN, as well as an output
contraction of electronic equipment in Malaysia, seem to be counter-intuitive and needsome explanations.
The tariff rates on processed food are among the highest in the region except in
Singapore and the Philippines. Thus, a significant increase in Singapore and Malaysia’s
intraregional exports appears to be a major cause for their output expansion of processed
food, including palm oil in Malaysia. Expansions of output in textiles and apparel in thetwo countries also results from the elimination of relatively high tariffs in these products,
but absolute increases are very small because textiles and apparel account for less than 1%
and 2%, respectively, of Singapore and Malaysia’s total output. The predicted contractionof Malaysia’s electronic industry might be explained by a small percent increase in theexports relative to other industries. Almost 70% of Malaysia’s intra-ASEAN exports ofelectronic equipment are shipped to Singapore, while about 60% of its intra-ASEAN
total cost of a downstream industry (e.g., the share of imported textiles in the cost of the apparelindustry) would evidently affect the magnitude and direction of output adjustments in the latter sector.
Finally, the greater the values of substitution elasticities between domestic and imported products, thegreater the sensitivity of the import-domestic demand ratio to changes in the relative price of imports,
thereby magnifying the effects of regional integration.

13

imports of this product originate from Singapore. Malaysia’s exports of electronicequipment to Singapore are predicted to increase by only 9.7%, whereas its imports fromSingapore are estimated to increase by 13.6%, which eventually results in a reduction indemand for domestic electronic equipment in Malaysia.
In the machinery and electronic equipment sectors, international fragmentation has
dramatically developed in East Asia since the 1990s (Ando and Kimura, 2005a; Kimura,2006). Paralleling this development is a significant rise in the shares of parts andcomponents in both exports and imports of machinery and electronic equipment in theregion. More specifically, over the 1990-2003 period, intra-East Asian exports of parts andcomponents of these products increased by 452%, which accounted for about a half of
intraregional export growth (Ando and Kimura, 2005b). Thus, it is quite plausible for
Other ASEAN to expand exports of low-quality machinery and electronic equipment(including parts and components), imports of high-quality products and output of theseproducts simultaneously. It should be noted that absolute changes in Other ASEAN’s
output of machinery and electronic equipment are rather small since these products areprojected to constitute only 7% of Other ASEAN’s total output for 2015 in the baseline,
compared with 27% in Singapore, 34% in Malaysia, 20% in the Philippines and 26% in
Thailand.

5. Conclusion
In this paper, we have used a dynamic CGE model to examine the effects of theASEAN Economic Community on economic welfare, trade flows and sectoral output of
the member states. The simulation experiments are conducted for four different nested
scenarios, starting with the removal of bilateral tariffs and export taxes/subsidies.
Subsequently, a reduction in frictional trade costs (e.g. administrative and technicalbarriers) is examined. In two final scenarios, productivity levels are assumed to bepositively correlated with economic openness, while the incremental effects of lowering
the trade and transport margins are also assessed.
Large disparities in the initial tariff rates across members and the incorporation of
the Armington assumption result in large terms-of-trade effects, particularly for Singapore

14(positive) and Other ASEAN (negative), which might dominate other welfare effects under
the first scenario. It is found that reductions in frictional trade costs and the trade andtransport margins have large effects on economic welfare while allowing for endogenously
determined productivity levels has a small impact. When these factors are incorporated, theestimated welfare gains for the year 2015 range from 1.1% in Indonesia to 9.4% in
Thailand. The results suggest that reductions in administrative and technical barriers (e.g.
streamlining customs procedures and mutual recognition of product standards) andlowering the trade and transport margins (e.g. through increased competition andimprovements in infrastructure) are significant in enlarging the benefits of the AEC.
A challenging extension of the paper would be to endogenize FDI flows to consider
attraction of these flows to ASEAN countries, which may have greater effects than theremoval of trade barriers, as in the cases of Mexico joining NAFTA and Spain andPortugal joining the EU. Changes in FDI flows deriving from the AEC in the Plummer andChia’s (2009) study are estimated to result in an increase in ASEAN’s FDI stocks to thetune of 28-63 percent ($117-$264 billion relative to 2006 inward FDI stocks).
Endogenizing an FDI effect would require the construction of a world investment matrix
by industry, but the data on bilateral FDI flows by source and host countries and industry
are currently available only in a few developed countries. Nevertheless, such an extension
will allow us to shed new light on the trade-FDI nexus and international production anddistribution networks in the region.

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Appendix: Values of the Key Elasticities
Most of the elasticities in the LINKAGE model have a long vintage, in some cases
going back to the late 1980s. Many have been gleaned from the literature using
econometric estimates when available. Others can be attributed to guess-estimates.
Production is based on a series of nested CES functions. Production elasticities,
summarized in Table A.1, are differentiated between installed or old capital and capitalinstalled at the beginning of the year, which is called new capital. New capital has more
flexibility in general than old capital. The aggregate sectoral substitution patterns will be afunction of the share of new capital in total sectoral capital with that share higher incountries with higher savings rate.

Table A.1: Production elasticities

Elasticity across inputs (excl. sector-specific and energy inputs)
Elasticity between value added (including energy) and other inputs
Elasticity between capital & energy bundle and labor
Elasticity across labor inputs
Elasticity between capital and energy
Elasticity between capital and sector-specific factors
Elasticity across fuel inputs

Old

New

0.0
0.0
0.1
0.5
0.0
0.0
0.3

0.0
1.0
0.5
0.8
0.0
2.0

The trade elasticities are presented in Table A.2 and are divided into four sets.
There are two sets of import elasticities, or the so-called Armington elasticities. The toplevel Armington elasticity reflects the degree of substitution between domestically
produced goods and aggregate imports. The second-level Armington elasticity describes
the degree of substitution of imports across region of origin. The next two set of tradeelasticities reflect the degree of transformation of domestic production across domestic andexport markets. Similar to imports, this transformation is implemented in a two-nested
structure.

16

Table A.2: Trade elasticities
Top-level Armington elasticity
Rice
Other crops
Other agriculture
Coal, oil and gas
Other natural resources
Processed foodTextilesApparelPetroleum products
Chemical products
Metal and products
Machinery
Electronic equipment
Transportation equipment
Other manufacturing
Construction and utilities
Trade and transport
Financial services
Other private services
Government services

4.45
4.36
3.94
4.93
2.80
4.01
3.94
4.27
4.93
3.94
3.94
3.94
3.94
4.71
3.94
1.76
2.09
2.09
2.09
2.09

Elasticity of substitution across imports byregion of origin

Twice the value of top-level
Armington elasticity

Elasticity of transformation between output
supplied domestically and exported

Infinity

Elasticity of transformation across exports byregion of destination

Infinity17

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20

Table 1: Regional and sectoral aggregation
A. Regional aggregation
Country/region

Corresponding economies/regions in the GTAP database

Singapore
Indonesia
Malaysia
Philippines
Thailand
Other ASEAN
China
Japan
Korea
TaiwanAustralia/New Zealand
North America
EU and EAFTA
Rest of world

Singapore
Indonesia
Malaysia
Philippines
Thailand
Brunei, Cambodia, Laos, Myanmar, Vietnam
China, Hong Kong
Japan
Korea
TaiwanAustralia, New ZealandUnited States, Canada
EU-27, Iceland, Liechtenstein, Norway, Switzerland
All the other economies/regions

B. Sectoral aggregation
SectorCorresponding commodities/sectors in the GTAP database

Rice
Other crops

Paddy rice, processed rice
Wheat, cereal grains nec, vegetables and fruits, oil seeds, sugar cane andsugar beet, plant-based fibers, crops nec
Livestock, fishing
Coal, oil, gas
forestry, minerals
meat products, dairy products, other food products, beverages andtobacco products
TextilesWearing apparel and leather
Petroleum and coal products
Chemical, rubber and plastic products
Iron and steel, nonferrous metal, fabricated metal products
Machinery and equipment
Electronic equipment
Motor vehicles and parts, other transportation equipment
Wood products, paper products, publishing, mineral products,
manufactures nec
Construction, public utilities
Trade, sea transport, air transport, transport nec
Insurance, financial services nec
Communication, business services, recreation and other services
Public administration and defense, education, health services

Other agriculture
Coal, oil and gas
Natural resources
Food products
TextilesApparelPetroleum products
Chemical products
Metal and products
Machinery
Electronic equipment
Transportation equipment
Other manufactures
Construction and utilities
Trade and transport
Financial services
Other private services
Government services

Source: GTAP database, version 7.
Note: nec = not elsewhere classified.

21

Table 2: ASEAN countries’ tariff rates on imports from ASEAN members, 2004
(percent)
Sector
1 Rice2 Other crops
3 Other agriculture
4 Coal, oil and gas
5 Other natural resources
6 Processed food7 Textiles
8 Apparel
9 Petroleum products
10 Chemical products
11 Metal and products
12 Machinery
13 Electronic equipment
14 Transportation equipment
15 Other manufacturing
16 Construction and utilities
17 Trade and transport
18 Financial services
19 Other private services
20 Government services
Weighted average

Singapore

Indonesia

0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
2.5
5.6
3.0
5.5
0.0

18.7
3.3
2.7
0.0
1.5
18.5
2.5
2.2
1.3
2.2
2.1
1.5
0.6
2.8
2.9
6.0
12.0
10.3
21.5
10.5
3.2

Malaysia Philippines
0.0
11.8
0.4
1.2
0.0
19.8
4.4
2.8
0.3
1.4
2.2
1.8
0.1
5.8
2.0
4.0
4.5
11.6
3.5
5.5
2.4

50.0
4.6
2.3
3.0
2.9
3.6
2.6
4.5
1.5
2.8
1.5
0.9
0.2
3.8
2.8
15.0
17.0
13.8
17.5
10.5
3.3

Thailand

Other
ASEAN

0.0
20.6
4.1
0.0
0.2
34.7
12.5
6.4
0.7
6.3
3.7
2.6
0.9
4.5
10.1
13.5
17.0
12.5
17.0
13.0
4.4

2.4
7.3
7.2
0.2
1.2
21.8
8.9
7.4
13.9
3.9
3.4
5.5
5.1
22.8
7.3
6.0
7.5
17.7
9.5
10.5
9.4

Sources: Sectors 1-15: GTAP database, version 7. Sectors 16-20: Authors’ calculation based on ad
valorem equivalents of nontariff barriers in Hoekman (2000), Kiyota and Stern (2008), andVerikos and Zhang (2001).

22

Table 3: The welfare effects of the AEC(Deviations in equivalent variations from the baseline in 2015)
RegionScenario 1

Scenario 3

Scenario 4

A. Absolute deviations (US$ billion in 2004 prices)
Singapore
5.25
8.09
Indonesia
0.48
1.76
Malaysia
2.73
5.37
Philippines
1.15
1.80
Thailand
1.80
3.50
Other ASEAN
-1.00
0.10
China
-0.91
-1.59
Japan
-0.30
-0.84
Korea
0.04
-0.29
Taiwan-0.11-0.31
Australia/New Zealand
-0.45
-0.51
North America
-0.42
-0.79
EU and EFTA
-0.37
-1.43
Rest of world
-1.13
-1.59
ASEAN-10
10.41
20.61
World
6.76
13.26

8.13
2.06
5.47
1.91
3.88
0.42
-0.99
-0.65
-0.21
-0.27
-0.46
-0.50
-1.08
-1.12
21.88
16.60

11.16
4.37
8.99
2.69
7.47
2.50
-1.62
-1.07
-0.54
-0.39
-0.60
-0.89
-1.99
-1.55
37.19
28.54

B. Percent deviations
Singapore
Indonesia
Malaysia
Philippines
Thailand
Other ASEAN
China
Japan
Korea
TaiwanAustralia/New Zealand
North America
EU and EFTA
Rest of world
ASEAN-10
World

5.93
0.53
3.45
1.67
4.87
0.39
-0.03
-0.02
-0.02
-0.07
-0.06
0.00
-0.01
-0.01
2.23
0.04

8.14
1.13
5.66
2.35
9.38
2.33
-0.05
-0.03
-0.06
-0.10
-0.08
-0.01
-0.02
-0.02
3.78
0.07

3.83
0.12
1.72
1.01
2.26
-0.94
-0.03
-0.01
0.00
-0.03
-0.06
0.00
0.00
-0.01
1.06
0.02

Scenario 2

5.90
0.46
3.38
1.58
4.39
0.09
-0.05
-0.02
-0.03
-0.08
-0.07
-0.01
-0.01
-0.02
2.10
0.03

Definitions of scenarios:
Scenario 1: The ASEAN members remove bilateral tariffs and export taxes/subsidies by 2015. The sectorspecific productivity factors related to openness (χi,t) are fixed at the baseline levels.
Scenario 2: Scenario 1 plus a 2.5% reduction in administrative and technical barriers among the ASEAN
members over the period 2010-2015. χi,t are fixed at the baseline levels.
Scenario 3: Same as scenario 2 except that χi,t are endogenous and determined by equation (2).
Scenario 4: Scenario 3 plus a 10% reduction in the trade and transport margins among the ASEAN
countries over the period 2010-2015.
Source: Model simulations.

23

Table 4: Intra- and extra-regional trade flow adjustments resulting from the AEC under scenario 4(Percent deviations from the baseline for the year 2015)
Importing countries/regions
Exportingcountries/regions

Singapore

Indonesia

Malaysia

Philippines

Thailand

Other
ASEAN

ASEAN-10

NonASEAN

World

26.6

35.4
85.3

27.8
61.5
52.8

50.3
99.4
69.3
83.2

40.1
61.9
45.3
70.9
71.5
69.3

-9.5
-4.9
-5.0
-7.0
-5.7
1.4

3.7
8.3
5.6
6.7
7.9
13.7

54.0
-6.1
7.7

-5.8
0.2
-0.1

6.8
-0.1
0.4

Singapore
Indonesia
Malaysia
Philippines
Thailand
Other ASEAN

31.1
25.6
17.0
29.5
15.8

55.1
27.0
159.0
49.7

124.5
38.9
58.8

61.2
263.9

80.9

83.4
106.6
106.1
144.3
138.8
120.7

ASEAN-10
Non-ASEAN
World

26.2
-2.6
3.9

53.8
-4.6
9.6

49.8
-9.2
7.7

56.5
-4.7
7.2

70.6
-4.2
8.9

111.4
-20.3
15.0

Source: Model simulations.

24

Table 5: Sectoral output adjustments resulting from the AEC under scenario 4(Percent deviations from the baseline for the year 2015)
SectorRice
Other crops
Other agriculture
Coal, oil and gas
Other natural resources
Processed foodTextilesApparelPetroleum products
Chemical products
Metal and products
Machinery
Electronic equipment
Transportation equipment
Other manufacturing
Construction and utilities
Trade and transport
Financial services
Other private services
Government services

Singapore

Indonesia

Malaysia

Philippines

Thailand

Other
ASEAN

6.7
0.7
-0.1
-2.6
6.0
11.3
30.5
7.5
-19.1
-0.2
9.7
2.4
3.4
-4.6
7.3
4.9
-2.6
3.4
2.2
0.5

-2.6
0.2
0.2
-2.0
0.9
-3.7
2.8
-2.3
1.1
-1.0
2.0
6.1
6.4
9.3
1.7
0.1
0.3
-0.8
-1.3
0.0

2.6
-7.4
9.9
-4.3
-5.9
18.8
24.1
13.0
4.6
10.3
3.0
2.9
-6.2
-1.0
-2.9
3.4
-2.3
2.6
-3.4
-0.2

-30.0
23.8
-2.2
-1.4
-7.1
-0.8
-4.3
-4.3
3.8
-3.1
0.3
-2.2
-1.6
20.1
-2.4
1.2
0.9
1.0
0.7
0.9

6.3
-6.6
10.0
-0.6
-6.2
13.0
-2.9
0.4
7.5
5.6
3.7
3.0
-3.2
17.8
-4.5
1.5
-1.2
0.0
1.9
-2.2

10.5
-4.7
-7.6
-0.2
-3.2
-18.1
7.2
5.1
-19.7
5.3
12.9
16.3
9.8
-1.3
-0.6
1.5
2.8
-1.6
-1.6
-0.2

Source: Model simulations.

25