Despite being a relatively latecomer to free trade agreements (FTAs), for the last 25 years, Indonesia has engaged in a significant number of multilateral, regional, and bilateral agreements. In 2018, Indonesia was engaged in FTAs with 19 countries, and it currently has 23 other regional and bilateral agreements either proposed or under consultation or negotiation. The liberalization trade is conducted through lowering tariffs, reducing export taxes and subsidies, removing non-tariff barriers (NTBs), and applying trade facilitation measures. As a result, the average tariffs in Indonesia decreased from 27% in 1986 to 2.0% in 2020.
The signing of trade agreement is accompanied by trade creation and trade diversion effects. Trade creation involves substituting goods that sourced from non-free trade partners with products sourced from regional members. On the other hand, FTAs may lead to trade diversion in which goods from outside the region substitute products from intra-bloc members. Generally, both trade creation and diversion effects follow the realization of a free trade agreement. The question is: which effect is larger and are free trade regions beneficial for Indonesia?
It is an interesting case of Indonesia for different reasons. First, Indonesia is the largest country by population, economy, and territory among ASEAN members. Second, the previous studies pointed that increasing trade liberalization in Indonesia is accompanied by increasing competition in regional (ASEAN and Asia) partners, i.e., Thailand, Vietnam, China, and India. The question rose as to whether developing agreements results in larger trade and easier access to markets for Indonesia or whether it drives the competition even tighter. Third, Indonesia produces plenty of natural resourced goods and has a lot of labor-intensive manufacturing. However, it lacks in advanced manufacturing export. Therefore, it is worth exploring whether integration leads to trade creation or trade diversion that impacts Indonesia’s regional value chains.
In the paper published in Economies, the study conducted using two approaches to evaluate the trade liberalization effect and regional trade partners. First, gravity model was applied to estimate the progress of trade agreement in accelerating the intra-regional trade. Second, we estimate the revealed comparative advantage (RCA) and the trade balance index (TBI) to identify trends in exports among trading partners. Based on the two, we can conclude the best selling export product, the least selling ones, and identify the new released products as the result of the trade agreement. Interestingly, the study maps the movement of products across countries allowing it to see who benefits and who is negatively affected.
The result shows that manufactured goods, medium tech goods, low tech goods, and primary products experienced trade creation effects derived from the implementation of regional FTA agreements. In other words, the signing of free trade agreement supported the rapid expansion of regional trade. The regional trade develops faster than the ones with no free trade agreement. On the contrary, the high tech goods and natural sourced goods face trade diversion. The trade diversion shows that the signing of a free trade agreement results in the replacement of goods which initially produced by trading partners into imported goods from other regions.
The study also found that the transportation cost highly impacted on the medium-tech products, natural resources, and the primary commodities. Logistics are an important determinant for trades in ASEAN Plus Six countries. The ASEAN Plus Six countries should create more efficient transportation systems to improve the regional trade. This finding is significant for Indonesia as some of the export products are included in the category. This finding shows a very good prospect of export expansion of ASEAN as all members may increase their purchasing power.
Secondly, this study mapped more than 5,100 goods based on RCA and TBI to find patterns of competition and advanced opportunities to expand trade with strategic partners. Several conclusions were drawn as follow.
First, the large number of trade agreements signed by Indonesia might have supported the rapid expansion of trade, as most of the gains from trade obtained from the regional partners. Second, trade partners also underwent large economic trade expansion, offering opportunities to expand trade and benefit from the large and growing market in Indonesia. Third, Indonesia export growth was strongly supported within the naturally sourced and primary product sectors that brought the most significant gains. Fourth, the opening of markets might have contributed to a healthier competition for Indonesia’s traditional industries (textile, footwear, and wood, among others). Countries with similar export patterns to Indonesia benefited from opening markets (China, Vietnam, and Thailand). Fifth, the Indonesian primary sector (the most competitive sector) generates for nearly 65% of total exports.
However, approximately 394 commodities lost competitiveness, while 248 new ones gained more. Sixth, Indonesia developed capabilities within new sectors (i.e., transportation) but lost in rapidly growing sectors in Asia (machinery and electrical), missing a decade of large expansion in production networks in Asia. Seventh, despite the aggressive competition landscape is aggressive, there are many possibilities for trade expansion, as more than 50% of Indonesian goods excel in some fields other countries do not provide.
Author: Miguel Angel Esquivias Padilla
Lecturer of Faculty of Economics and Business, Universitas Airlangga
Paper Link: Purwono, Rudi, Lilik Sugiharti, Rossanto D. Handoyo, and Miguel A. Esquivias. 2022. “Trade Liberalization and Comparative Advantage: Evidence from Indonesia and Asian Trade Partners” Economies 10, no. 4: 80. https://doi.org/10.3390/economies10040080
