An FTA is an arrangement among countries whereby tariffs and non-tariff barriers. for instance. quotas. Licensing requirements. and product-safety regulations. are abolished among members. Completed to customs unions and common markets. a free trade area is the least institutionalized form of economic integration. where each member of the FTA retains its own external tariffs and other regulations for trade with non-member countries. From the standpoint of economic theory. an FTA offers advantages to all member countries. Theoretically. an FTA increases intra-regional trade and enhances competitiveness, productivity. and efficiency. ln the case of ASEAN and China. the markets combined would permit the exploitation of economies of scale brought about by an expansion of market size. Firms producing below optimum capacity before integration would be able to reap efficiency gains from lower unit costs as they would now produce for a bigger mass market. The formation of the FTA is also expected to improve productivity of firms. As the abolition of intra-regional barriers would force firms from Southeast Asia and China into closer competition with one an- other and possibly induce them to be more competitive and innovative. Theoretically. the reduction of tariffs and removal of non-tariff barriers would likely facilitate trade and investment flows among member countries by allowing for improved market access to goods and services sectors. Other measures such as streamlining of customs procedures. liberalization of trading rights. or the mutual acceptance and adoption of common standards and practices, would further facilitate trade and investment flows by encouraging more tourist traffic and industrial cooperation. There by lowering trade friction among the countries concerned. An integrated market brought about by an FTA is also likely to attract foreign investment. creating employment and increasing economic welfare of the member states. However. it should be noted that the establishment of an FTA will not in itself lead to a massive inflow of foreign investment. because foreign capital seems to be attracted to growing markets. not just large ones. lf economic integration can stimulate growth. one can expect foreign capital to flow in. An FTA that shows no sign of growth. but perpetuates stagnation. cannot hope to attract private capital from abroad.
While the economic benefits that integration brings are desirable. there are adjustment costs for countries in the short term if they wish to enter into an FFA with potential trading partners. The FTA scheme inevitably entails an uneven distribution of costs and benefits among different sectors and among different industries. When intra-regional barriers are dismantled. industries will expand in some countries and contract in others. as industries relocate in response to differences in factor endowments. The adjustment costs resulting from such relocation of economic activity can be asymmetrical. since some economies may incur higher costs. in the short run. than others. ln the case of the ASEAN countries, it is probable that during rationalization of firms and industries. some firms might be attracted to move to China to benefit from agglomeration economies of nearby suppliers and business services. Compared to ASEAN_ which generally lacks an adequate base of supporting industries, China has a huge integrated industrial base and is strongly capable of providing auxiliary items like processing equipment. intermediate pans. and electronic components needed for manufacturing. Given its moderately well-developed basic technology industries such as machinery, China has the potential to develop an extensive network. or clusters. of supporting industries." Foreign companies could find it conducive to locate in China and benefit from agglomeration economies generated from being close to these supporting industries?
ln the short run. China (not merely ASEAN) would also suffer some adjustment costs if it entered into an PTA with its Southeast Asian neighbors. Within China. there would be an asymmetrical imbalance of costs and benefits. since some provinces might gain at the expense of others that are relatively backward. This might arise because manufacturing as a whole tends to cluster in relatively few locations. deindustrializing the less favored regions Manufacturing activities tend to concentrate in those geographic areas that have locational advantages and can provide well-developed infra- structure and a critical mass of supporting industries. not just low labor costs.
Overall, there are a number of a priori reasons to believe that an FTA would bring intrinsic benefits in the long term despite member countries experiencing transitional economic disequilibrium and other social costs such as drug trafficking and illegal migration as a result of freer cross-border trade. As the FTA scheme is gradually phased in over the years, multinational companies in the region will restructure their supply chains and rationalize their production networks by taking China and ASEAN as a single integrated market. In the long run. both ASEAN and China are expected to become more competitive internally and externally. since FTA membership should stimulate the governments to introduce domestic reforms and spur industrial up- grading. For this reason. it is in the interest of prospective member countries to carefully implement the preferential trading arrangement so that maximum benefits can be derived from the scheme. ln view of the complexity of issues involved, negotiations are expected to be protracted and, in some instances. filled with ambiguity. since it is not clear if China‘s negotiations would be with ASEAN as a regional organization or with each of the individual ASEAN states. Some academics have alluded to the possibility that the pro- posed FTA between China and ASEAN might preclude certain sectors and might not go beyond the agenda of liberalizing services." Finally. there is the question of whether the China-ASEAN FFA could be modeled on the Com- mon Effective Preferential Tariff (CEPT) scheme that allows members to re- duce their tariff rates at differential paces and intensities") Regardless of how the economic partnership between China and ASEAN evolves in future. it is imperative first to analyze the industrial structure and trade relations of the Chinese and ASEAN economies, before making any other specific assess- ments.