MINISTRY OF EDUCATION AND TRAINING VIET NAM NATIONAL ECONOMICS UNIVERSITY ATHSAPHANGTHONG SIPHANDONE IMPACTS OF AFTA ON GOVERNMENT REVENUE, EXTERNAL TRADE AND FDI OF LAO PDR (Economics) Code : 62.34.03.01 A dissertation submitted to the National Economics University in fulfillment of requirements for the degree of Doctor of Philosophy in Economics Hanoi, March 2014 Summary This dissertation has been fulfilled at the National Economics University, Hanoi, Vietnam Supervisor: Prof. Dr. Tran Tho Dat First Commentator: Assoc.Prof.Dr Dao Van Hung Second Commentator: Assoc.Prof.Dr Phosy Chanhming Third Commentator: Assoc.Prof.Dr Nguyen Dinh Tho The oral defense will be undertaken at the National Economics University, Hanoi, Vietnam at date of …., 2014 The dissertation can be found at: - The National Library of Vietnam - The Library of National Economics University, Hanoi, Vietnam - The Library of National University of Laos, Vientiane, Lao PDR PUBLICATIONS 1. Athsaphangthong Siphandone (2011), “Vận dụng một số kinh nghiệm về thu hút đầu tư trực tiếp nước ngoài (FDI) của một số nước vào nước CHDCND Lào”, kỷ yếu hội thảo khoa học Quốc tế:, “Phát triển kinh tế xã hội Việt Nam và Lào giai đoạn 2011-20120”, Tập II, 7/VIÊNG CHĂN. 2. Athsaphangthong Siphandone (2014), “Impacts of AFTA on Lao External Trade”, in “Creating new growth momentum: strengthening FDI – local enterprises linkages” International Conference in Hanoi, 2014. 1 I. INTRODUCTION 1. Background Regional integration has become the main form of trade liberalization since the early 1990s.Progress of the integration has been very impressive in recent decades for a number of developing countries in Asia and, to a lesser extent, in Latin America. These countries have become successful because they chose to participate in regional and global trade, helping them to attract the bulk of foreign direct investment in developing countries (IMF, 2001). There are a number of arguments on free trade. It can bring about several advantages and disadvantages. The benefits can be indicated in trade creation, increased exports, economies of scale, increased competition, make use of surplus raw materials, increased production, production efficiencies, benefits to consumers, foreign exchange gain, employment opportunities, and economic growth. Although free trade has benefits, there are a number of disadvantages such as changes in structural unemployment in the short term, increased domestic economic instability from international trade cycles, as economies become dependent on global markets, developing or new industries may find it difficult to become established in a competitive environment with no short-term protection policies by governments, free trade can lead to pollution and other environmental problems, free trade may raise government revenue by import taxes, but this will only be a small amount of money. In Southeast Asian region, ASEAN Free Trade Area (AFTA) is a significant trade bloc. Having established in 1992, it is considered in the second level of economic integration. The primary goals of AFTA are to increase ASEAN’s competiveness through eliminating the tariffs and non-tariff barriers within member countries and to attract more foreign direct investment to the region. The impacts of free trade in general and AFTA in particular can be reviewed from different countries’ case studies. Within ASEAN member, a number of research papers focus on the consequences of AFTA on economy as a whole. These can be 2 found in the study case of Vietnam conducted by Fukase and Martin (1999), Loc (2001), Ba (2004), Harris et al (2007), and Thanh (2007). The main findings reveal that there is an increase in welfare and poverty reduction thanks to broader liberalization. In addition, many studies on economic impacts, particularly government’s revenue, intra-trade, and FDI flows of the entire and individual member countries have been conducted.Chaiwootet al (2006) analyze the economic impacts of AFTA on Thailand’s economy, whereas Piriya (2010) examines whether the AFTA creates trade for Thailand or actually diverts it away from the country by analyzing various trade indicators and Pupongsak (2009) investigates the impact of trade liberalization on taxation and government revenue of Thailand. Fukase and Martin (2001) explore implications for Cambodia of its entry into the AFTA through considering the trade regime, including the reliance on customs duties as a revenue source. Hartono et al (2007) investigate the impacts of AFTA on the Indonesian economy, namely economic growth, poverty, and income distribution. Participating in AFTA is challenging for newer ASEAN members (Cambodia, Lao PDR, Myanmar, and Vietnam) in terms of social and economic development. Therefore, there have been some studies related to the consequences of AFTA commitment execution on CLMV. The empirical evidence can be found in the work done by Tongzon, Khan, and Doanh (2004 and 2005) and Araya (2002) which focus on analyzing how CLMV deal with revenue lost and options for revenue management after participating in AFTA tariff reductions, as well as the challenges of economic integration for CLMV. Elsie (2005) examines whether the formation of AFTA leads to an increase in ASEAN intra-trade and how it brings trade benefits to economies with different stages of development from 1988 to 2003. Adams and Park (1995) evaluate the impact of AFTA with a link to Computable General Equilibrium (CGE) model to quantify the macroeconomic effects of external shock, domestic policy, and regional- grouping and market-opening efforts through tariff reduction policies among ASEAN 3 nations. Hapsari and Mangunsong (2006) analyze the determinants of AFTA members’ trade flows and potential for trade diversion, including the impacts of creation of AFTA on its intra- and extra-regional trade flow by comparing trade patterns of AFTA countries with AFTA members and non-members. David Cheong (2008) studies the effects of AFTA, using a gravity model to address changes in trade patterns of ASEAN during 2001-2003. Adams and Horridge (2000) estimate the AFTA trade liberalization on ASEAN member countries, with special reference to Thai economy in long term. Ho Sze Yin (2010) investigates the effects of AFTA whether it leads to trade creation or diversion among member countries during 1988- 2004. Gumilang (2011) studies the trade agreements with Japan (IJEPA) and AFTA with reference to Indonesia. Hector et al (2009) examine the impacts of AFTA on trade flows and external trade barriers during 1992-2007. In case of Lao PDR, one of the most directly related to the consequences of implementing AFTA can be found in the study conducted by Menon (1999), AusAid and UNDP (1996), and Phouphet (2004). In these papers, the main objective is to examine the impacts of AFTA on Lao economy by addressing the trade, government revenue and foreign investment flows. The key findings show that (i) trade diversion is likely to be low; (ii) the reduction in government revenue from trade taxes is likely to be low; and (iii) foreign direct investment (FDI) flows are likely to grow sharply in the future. However, Phouphet argues that AFTA will lower the general price, causing an increase in real consumption, investment, and macroeconomic variables, and therefore the GDP will also increase. Besides, Phongsavanh (2003) studies the Lao PDR’s integration in ASEAN. The main objective is to initially assess the potential impacts of joining ASEAN of the Lao PDR. By employing descriptive approach, the results reveal that through accessing to ASEAN and following the commitments of AFTA, the trade regime of the Lao PDR is negatively affected. However, the risk of trade diversion is considered to be minimal, it may occur in some imported products, namely automobiles. Simultaneously, the welfare of people will be improved through AFTA’s scheme as they can buy commodities at lower prices with more choices in a larger ASEAN market. 4 From the above-revised researches, the discrepancies between this study and the previous ones, particularly the one conducted by Phouphet (2004), can be distinguished in terms of analytical methodology, independent variables used in the models, and time periods. In building Lao macroeconomic model, Phouphet focuses on the effects of AFTA on the whole economy through changing general price. He also focuses on demand and supply sides which are adjusted by general price mechanism. Since Lao PDR is an agricultural country, he thus divides the supply side (GDP) into agricultural and non-agricultural GDP to analyze the agricultural structure change. To analyze the trade structure change, trade with Thailand and trade with non-Thailand are also divided.The model consists of 15 structural equations. The main policy variable is government investment, foreign direct investment, money supply, and exchange rate. The main target variables are GDP, general price, private consumption, domestic investment, export, and import. He uses ordinary least square method to estimate structural equations and Newton method to simulate the model.In the export and import equations, there is no tariff rate. Therefore, he assumes that the effects of AFTA by deduced tariff have the same effect by decreasing import price by 5 per cent. The data used covers during 1988-2000, which is a short-time period and the data per se is not well organized and less reliable since the economic structure had changed from centrally planned to market-oriented economy in 1986. In this paper, rather than using only the OLS method of econometric approach to estimate the impacts of AFTA on government revenue, external trade, and FDI, but descriptive approach is utilized to analyze the tendency and relationship among the specified variables. In the export and import equations, the tariff rate of both ASEAN member countries and Lao PDR are included. Concerned with the time period, it covers from 1990 to 2012 which is longer and more accurate. 2. Objective The main objectives of this dissertation are twofold as follows:  To review the economic performance of Lao PDR before and after participating AFTA;  To estimate the impacts in implementing the Common Effective Preferential 5 Tariff (CEPT) scheme under AFTA on the Lao PDR’s government revenue, external trade (exports and imports), and Foreign Direct Investment (FDI) flows. 3. Expected Outcomes Based on the above-specified objectives, the expected outcomes of this paper are as follows:  Be able to realize the current situation of AFTA’s CEPT scheme of Lao PDR; and  Be able to measure the changes in the magnitude of the Lao government revenue, expansion of external trade to the regional markets, and growth of FDI after joining ASEAN in 1997. 4. Significance of Study The findings of this paper are considered significant for the author since it deepens more understandings on economic development policies, strategies and growth in Lao PDR in the past and shades light on the future development directions. Moreover, the results will provide better knowledge on the repercussions of regional economic integration, particularly with ASEAN on the Lao government revenue, external trade directions, influx of FDI, and smuggling activities. In addition, this paper will be a useful reference for the scholars, researchers, and general interested groups who desire to analyze the similar issues in the different case studies, approaches, and time periods. 5. Scope of Study The scope of this study is to focus on the impacts of regional economic integration, namely AFTA on the Lao government revenue, external trade, and FDI. These indicators are selected as dependent variables to indicate the impacts during 1990-2012. These time periods cover several internal, regional, and international economic shocks, namely the implementation of NSEDP, membership of ASEAN and AFTA implementation of Lao PDR, Asian Financial Crisis in 1997, and global economic crisis in 2008. 6 II. METHODOLOGY In order to carry out the findings in accordance with the set objectives, this paper simply employs descriptive and econometric approaches. 2.1 Descriptive Approach The impacts of AFTA on economic performance, government revenue, FDI, and external trade (exports and imports) can be analyzed through the specified indicators of individual variable, which are displayed in Table 1. To clearly present the results or the relationship between the tariff reduction under AFTA’s CEPT scheme, tables and charts will be used. Also, to distinguish differences of economic development, changes in government revenue, FDI, and external trade, the duration of time will be divided into a five-year period: 1990- 1995, 1996-2000, 2001-2005, and 2006-2012, which are in accordance with the five- year NSEDP of the GOL. Table 1: Framework on Analyzing the Impacts of AFTA on Economic Performance, Government Revenue, Trade, FDI. Issues Indicators Economic Performance — Economic development measured by GDP growth rate during 1990-2012; — GDP per capita during 1990-2012; — Structure of Lao Economy; — Economic growth rate by sectors: Agriculture, Industry, and service, covering from the 3 rd to the 6 th five-year NSEDP. Government Revenue (Tax Revenue Reduction) — Structure of government’s revenue (tax and non-tax revenue); — Growth rate and percent share of tax and non-tax revenue to total revenue and GDP; 7 Issues Indicators — Relationship between government’s tax revenue and averaged-tax rates Trade — Volume, growth rate, and percent share of exports and imports; — Growth rate and percent share of trade balance to GDP; — Trade directions (main exporting and importing markets); — Compositions of exports and imports; — Percent share of total trade to intra-trade of ASEAN; — Degree of trade openness (terms of trade); FDI — FDI flows from ASEAN members (intra-FDI) and non- ASEAN countries (Extra-FDI); — Percent share of total FDI to intra-FDI of ASEAN; — FDI by home/original countries; — FDI by economic sectors. 2.2 Econometric Approach To obtain the empirical evidences of the consequences of the AFTA on government revenue, FDI, and external trade (dependent variables), the Ordinary Least Squares (OLS) method is applied. The functions of the above-mentioned dependent variables can be expressed as follows: [...]... exchange rate will lower the imports Thus, the expected sign of EXR is negative (-) It is expected that AFTA bring about better quality commodities and cheaper price to Lao market Consequently, the expected sign of LIB is also positive (+) With regard to the FDI function, it is important to observe that economic growth of host country is one of attracting factors for FDI So, the expected sign of 9 GDP... Independent Variables Dependent Variables Independent Variables EX IM FDI GOVR Constant + + + - + + + + + - GDP GDPF + TAXL TAXA + INFR - + - - EXR + - + - IM + LIB + + + - Sources: Author’s Expectation (2013) 2.3 Data Collection In analyzing economic development and impacts of AFTA accession on government revenue, external trade, and FDI flows to Lao PDR, the secondary data of time series during 1990-2013... services has grown up It is contended that the momentum of this growth is thanks to the regional liberalization and integration, namely AFTA participation The results of examining the impact of AFTA participation on Lao PDR’s government revenue, external trade, and FDI can be summarized as follows: First, the main revenue sources of the GOL are derived mainly from taxes, which account for 65 per cent... assumption FDI is also positively associated with GDP and EXR, which can be obviously observed by the computed parameters with the expected signs and significant levels at 5 per cent and 1 per cent, respectively An increase in GDP by 1 per cent will attract more FDI to invest in Lao PDR by 2.682 per cent A rise in or depreciation of 16 EXR by 1 per cent will also help create a conducive factor to attract FDI. .. trade liberalization In respect of the FDI equation, the estimated parameters of GDP, EXR, and LIB are also positive and statistically significant at 1 per cent, which confirm the set hypothesis An increase in GDP by 1 per cent will attract FDI flows to Lao PDR by 2.436 per cent A rise in or depreciation of the EXR by 1 per cent will also help create an incentive for FDI by 0.217 per cent.In addition,... and the rest of the world Third, FDI has made a positive contribution to the manufacture of goods, economic growth and the restructuring of the Lao economy It also helped develop the private sector These achievements are attributed to the incentives provided by the Government and other measures, including as the decentralization of foreign investment licensing Major FDI to Lao PDR in recent years comes... ASEAN member countries; TAXL : Tariff rate of Lao PDR; INFR : Inflation rate; EXR : Exchange rate; LIB : Trade Liberalization by implementing AFTA commitments commencing in 1998; Dummy Variable, LIB = 0 (1990-1998), LIB = 1 (otherwise); IMP : Imports; EXP : Exports; FDI : Foreign direct investment RP : Relative price : Error corrections 8 In export function (EXP), some of the most influential factors are... The EXP, IMP, FDI, and GOVR equations have high goodness fit as the Adjust R-squared are 0.934, 0.941, 0.817, and 0.961, respectively These suggest that the sample regression lines fit the data very well.Additionally, the Durbin Watson Statistics (D.W) of 1.574, 1.611, 1.684, and 1.532 illustrate non-autocorrelation or inexistence of the serial correlation of the error terms in the EX, IM, FDI, and GOVR... Variables Independent Variables ln(IMP) Ln (FDI) ln(GOVR) -11.079 -7.213 -2.898 -20.838 (-4.296)*** (-3.557)*** (-2.945)*** (-5.850)*** 2.068 2.436 1.928 (9.631)*** (23.378)*** (2.520)*** 1.147 0.213 2.296 (3.809)*** Constant ln(EXP) (1.456) (4.415)*** ln(GDP) ln(GDPF) 1.400 (8.956)*** ln(TAXL) ln(TAXA) 0.585 (2.819)*** 17 Dependent Variables Independent Variables Ln (FDI) ln(GOVR) -0.916 -0.189 -0.944 -1.288... function, which is associated positively with GOVR In this connection, it is expected that GOVR will reduce after joining AFTA (both TAXL and LIB are expected to have negative signs) From functions (1), (2), (3), and (4), the econometric models of imports, exports, government revenue, and FDI in the logarithm forms can be written as follows: …………………… ………… … (5) ……… ……… .……………………………………………….………… . trade); FDI — FDI flows from ASEAN members (intra -FDI) and non- ASEAN countries (Extra -FDI) ; — Percent share of total FDI to intra -FDI of ASEAN; — FDI by home/original countries; — FDI by. số kinh nghiệm về thu hút đầu tư trực tiếp nước ngoài (FDI) của một số nước vào nước CHDCND Lào , kỷ yếu hội thảo khoa học Quốc tế:, “Phát triển kinh tế xã hội Việt Nam và Lào giai đoạn 2011-20120”,. determinants of AFTA members’ trade flows and potential for trade diversion, including the impacts of creation of AFTA on its intra- and extra-regional trade flow by comparing trade patterns of AFTA