MINISTRY OF EDUCATION AND TRANING
NATIONAL ECONOMICS UNIVERSITY
VIETNAM

MINISTRY OF EDUCATION AND SPORT
NATIONAL UNIVERSITY OF LAOS
LAOS

ATHSAPHANGTHONG SIPHANDONE
IMPACTS OF AFTA ON GOVERNMENT REVENUE,
EXTERNAL TRADE, AND FDI OF LAO PDR

A dissertation Submitted to the National Economics University, Vietnam and
National University of Laos in fulfillment of requirements for the degree of
Doctor of Philosophy in Economics
Supervisor: Prof. Dr. TRAN THO DAT

ABBREVIATIONS AND ACRONYMS vi

CHAPTER 1: INTRODUCTION 1

1.1 Background 1
1.2 Problem Statement 6
1.3 Objective 8
1.4 Expected Outcomes 8
1.5 Significance of Study 8
1.6 Scope of Study 9
1.7 Organization of the Dissertation 9

CHAPTER 2: LITERATURE REVIEW 11

2.1 Theoretical Literature Review 11
2.1.1 Definition and Levels of Economic Integration 11
2.1.2 Advantages and Disadvantages of Regional Economic Integration 13
2.1.3 ASEAN and AFTA 17
2.1.4 Challenges and Opportunity for Lao PDR after Joining ASEAN 28
2.2 Empirical Literature Review 30

CHAPTER 3: ANALYTICAL METHODOLOGY AND DATA
COLLECTION 43

3.1 Analytical Methodology 43
3.1.1 Descriptive Approach 43
iv

v
LIST OF TABLES

Table 2.1: Schedule for Tariff Reduction under CEPT Agreements 21
Table 2.2: Timetable for Accelerating AFTA for the Regional Six ASEAN
Countries. 26
Table 3.1: Framework on Analyzing the Impacts of AFTA on Economic
Performance, Government Revenue, Trade, FDI. 43
Table 3.2: Summary of Expected Signs of Independent Variables 50
Table 3.3: Data Sources Used in Analysis 51
Table 4.1: Directions of Exports, 1900-2012 77
Table 4.2: Merchandise Exports of Lao PDR (% of Total Merchandise
Exports) 78
Table 4.3: Directions of Imports, 1990-2012 79
Table 4.4: Merchandise Imports 80
Table 4.5: The World‘s most Opened and most Closed Economies in 1996 82
Table 4.6: Degree of Openness of ASEAN Member Countries, 1995-2012 83
Table 4.7: Intra-ASEAN Trade 2009 & 2010 85
Table 4.8: FDI Net Flows to ASEAN 87
Table 4.9: Percent Share of FDI in ASEAN 87
Table 4.10: FDI as Percent of GDP 88
Table 4.11: FDI by Countries, 2001-2010 89
Table 4.12: Results of Regressions by Using Lao Data 91
Table 4.13: Results of Regressions by Using the Weighted-Average Data
(WAD) 95
Table 4.14: Comparing the regression results by using the Lao data and WAD 99
Table 4.15: Regression Results by Excluding INFR in the EXP, IMP, and FDI
Equations and EXR in the GOVR Equation. 101
Table 4.16: Regression Results by Excluding INF and EXR in All Equations. 101


Fig. 4.20: Exports Shared by Countries, 1990-2012. 78
Fig. 4.21: Imports Shared by Counties, 1990-2012 80
Fig. 4.22: Degree of Trade Openness, 1990-2011 81
Fig. 4.23: Trends of Openness Degree of ASEAN Members, 1995-2012 84
Fig. 4.24: Foreign Direct Investment in Lao PDR, 1990-2012 86
Fig. 4.25: FDI Project Numbers by Sectors, 2002-2010 90
Fig. 4.26: Values of FDI by Sectors, 2002-2010 90
vii
ABBREVIATIONS AND ACRONYMS

ADB
AEC
AFC
AFTA
ASEAN
ASEAN-4
ASEAN-6
BOL
CEPT
EXP
EXR
FDI
FTA
FY
GDP
GDPF
GOL

INFR
Lao PDR
LIB
MPI
NSEDP
NTRs
ODA
RTAs
TAXA
TAXL
VAT
WAD
WB

Imports
Inflation Rate
Lao People‘s Democratic Republic
Liberalization
Ministry of Planning and Investment
National Socio-Economic Development Plan
Normal Trade Relations
Official Development Assistance
Regional Trade Agreements
Tariff Rate of ASEAN Member Countries
Value Added Taxes
Tariff Rate of Lao PDR
Weighted-Averaged Data
World Bank
2
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. This is true of China and India since they
embraced trade liberalization and other market-oriented reforms, and also of higher-
income countries in Asia—like Korea and Singapore—that were themselves poor
up to the 1970s (IMF, 2001).
It has been realized since Viner (1950) that the formation of a free trade
agreement (FTA) can lead to trade creation and/or trade diversion. The former
arises when the FTA promotes trade among the members without disrupting trade
with nonmembers, and tends to be efficiency-enhancing. By contrast, trade
diversion arises when the FTA promotes trade among members at the expense of
trade with bloc outsiders, and tends to be efficiency-reducing.
There have been attempts to pin down theoretically the characteristics that
make FTAs more trade creating or more trade diverting. Frankel (1997) develops
the ―natural trading partners‖ hypothesis, which states broadly that agreements
between countries that already trade significantly (in particular geographically close
countries and those that share cultural characteristics that reduce transaction costs,
such as language) are the ones most likely to be trade creating. Although
theoretically this does not need to always hold, as Bhagwati and Panagariya (1999)
point out, Frankel (1997) finds evidence consistent with the natural trade partners
hypothesis in a number of regression analyses based on the gravity equation with
country-level trade flows.
Lee and Shin (2006) extend the approach of Frankel (1997) and estimate a
gravity model with year dummies and with both random and fixed effects to assess

tariff revenue and improve economic efficiency.
When political-economy motives are incorporated, the results are
ambiguous. For example, Richardson (1993) and Ornelas (2005) find that, upon the
formation of a free trade area, lobbying will decline and external tariffs fall, as the
4
import-competing sector contracts and becomes weaker politically. This force will
be more important, the greater the share imports stemming from the bloc partners.
However, in a different model, Panagariya and Findlay (1996) find that countries in
a free trade area will raise protection against outsiders because lobbying in favor of
tariffs against the partner will be diverted to lobbying for a greater external tariff.
Furthermore, it is not just existing trade blocs that matter. As Bagwell and Staiger
(2004) show, the mere potential for a future trade agreement may affect the extent
of current tariff reduction that can be negotiated multilaterally. The threat of
―bilateral opportunism‖ reduces the extent of multilateral tariff reduction because
current global trade agreements can be later diluted by bilateral preferences.
By contrast, the empirical literature on the effect of RTA formation on
external tariffs is still in its infancy. Bohara, Gawande and Sanguinetti (2004)
examine tariff adjustments in Argentina following the formation of Mercosur,
finding some support for the hypothesis that the decline of industries driven by the
formation of a trading bloc leads to lower external tariffs. Similarly, Estevadeordal
et al. (2008) examine the direct impact of changes in preferential tariffs on changes
in MFN tariffs in ten Latin American countries and one hundred industries over 12
years. Using a number of empirical techniques to extract causality, they find that
preferences in free trade areas lead to a decline in external tariffs, whereas the
effects are negligible in customs unions. In contrast, Limão (2006) finds that the
United States was more reluctant to lower tariffs in the Uruguay Round for products
where preferences were granted. His results imply that trade preferences lead to less

revenue from trade taxes is likely to be low, particularly in light of the high share of
informal trade and only low levels of trade diversion; and (iii) foreign direct
investment (FDI) flows are likely to grow sharply in the future, as the legal,
administrative and institutional framework in Lao develops to meet the ASEAN
standard. Araya (2002) also analyzed the ways how new ASEAN member countries
(CLMV) cope with revenue loss due to AFTA tariff reduction.
Another recent studies of the impact of trade blocs have found that trade
diversion has been less apparent than was previously assumed to be the case. A
1995 study by the OECD concluded that there was no evidence that these
agreements had created trade diversion. While conceding that it was in some cases
6
difficult to assess diversion, the anecdotal evidence suggested that these agreements
had probably served to stimulate trade liberalisation elsewhere, including through
multilateral liberalisation.
A study by the Department of Foreign Affairs and Trade of the impact of
NAFTA concluded that there was no evidence that the trade agreement has had
diversionary effects. According to Krueger (1999), the NAFTA experience lends
weight to the conclusion that Free Trade Agreements between countries with low
trade barriers.
There are also 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

age 15+ in 2010, low life expectancy, high fertility, crude birth and death rates –
due to a lack of contraception and health care accession, and massive poverty.
To solve the above-specified development difficulties and attain the long-
term development goals, a sound national socio-economic development plan
(NSEDP) needs to be identified and implemented. The government of Lao PDR has
continued to set a five-year NSEDP in response to the development process
requirement. During implementing the 6
th
NSEDP (2006-2010), the average annual
GDP growth was 7.9 per cent, budget deficit accounted for 4.7 per cent of GDP,
FDI accumulation amounted to US$ 8 billion, exports accounted for 20.72 per cent,
imports covered 26.1 per cent and trade deficit represented 5.3 per cent of GDP,
respectively.
With respect to the economic integration with the regional and international
counterparts, after having become a member of Association of Southeast Asian
Nations (ASEAN) in 1997, Lao PDR has attempted through the implementation of a
8
policy of open foreign economic cooperation, on the basis of independence and
mutual benefit. As a result, there has been expansion in cooperation in the fields of
economy and commerce. International trade negotiations at the bilateral, regional,
sub-regional and global levels have increased and strengthened. International
integration includes multi-party trade cooperation, ASEAN and Regional Economic
Cooperation, Trade Negotiation within ASEAN and related countries, and Asia-
Pacific Trade Agreement (MPI, 2011).
1.3 Objective
The main objectives of this dissertation are twofold as follows:
 To review the economic performance of Lao PDR before and after

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.
1.7 Organization of the Dissertation
For a scientific approach and systemic and chronological flows, this thesis is
divided into five chapters, which will be further subdivided into sections, and they
are organized in the following manner.
The introductory part briefly presented problem statement, objective,
anticipated outcome and significance, scope of study, and thesis organization,
respectively as shown in Chapter 1.
Chapter 2 will review both theoretical and empirical literature on regional
economic integration. In the theoretical section, it firstly defines the levels of
economic integration, followed by the pros and cons of such integration. Next, it
will briefly review the background and objective of establishing ASEAN and
10
AFTA. After that, it will also describe the implementation of CEPT, especially the
CEPT production list and products covered under the CEPT agreement. Finally, it
will discuss the positive and negative impacts of AFTA that ASEAN member
countries have experienced. In the empirical section, some of the previous
researches on AFTA impacts in different countries‘ case studies will be
summarized. Additionally, it will discuss the differences between the previous and
this study in terms of the analytical methodology, models, and scope of study.
Chapter 3 is concerned with the analytical methodology and data sources. In
the section of analytical methodology, it will describe the method and model

more integrated the economies become, the fewer trade barriers exist and the more
economic and political coordination there is between the member countries.
There are six additive levels of economic integration: preferential trade
agreement, free trade area, custom union, common market, economic union, and
political union.
 Preferential Trade Agreement (PTA) is the simplest form of economic
integration which offers member countries tariff reductions in certain product
categories. Discrimination or preferential treatment for some countries is not
allowed as it is against the principle of Most Favored Nation (MFN) under
the World Trade Organization (WTO).
 Free Trade Area (FTA) is the second level of economic integration which
tariffs (a tax imposed on imported goods) between member countries are
abolished or significantly reduced. Each member country keeps its own tariffs in
regard to the third countries. The general goal is to develop economies of scale
and comparative advantages, which promotes economic efficiency.
 Custom Union (CU) sets common external tariffs among member countries,
implying that the same tariffs are applied to third countries. Custom unions
are particularly useful to level the competitiveness playing field and address
the problem of re-exports (using preferential tariffs in one country to enter
another country).
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 Common Market (CM) is an advanced level of economic integration that
factors of production, such a labor and capital, are free to move within
member countries, expanding economies of scale and comparative
advantages. Thus, a worker in a member country is able to move and work in
another member country.
 Economic Union (EC). In this level, monetary and fiscal policies between

Free trade improves the efficiency of resource allocation. The more efficient
use of resources leads to higher productivity and increasing total domestic output of
goods and services.
Increased competition promotes innovative production methods, the use of
new technology, marketing and distribution methods.
 Benefits to consumers
Consumers benefit in the domestic economy as they can now obtain a greater
variety of goods and services.
The increased competitions ensure goods and services, as well as inputs, are
supplied at the lowest prices. For example in Australia imported motor vehicles
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would cost 35 per cent more if the 1998 tariff levels still applied. Clothing and
footwear would also cost around 24 per cent more.
 Foreign exchange gains
When Australia sells exports overseas it receives hard currency from the
countries that buy the goods. This money is then used to pay for imports such as
electrical equipment and cars that are produced more cheaply overseas.
 Employment
Trade liberalization creates losers and winners as resources move to more
productive areas of the economy. Employment will increase in exporting industries
and workers will be displaced as import competing industries fold (close down) in
the competitive environment. With free trade many jobs have been created in
Australia, especially in manufacturing and service industries, which can absorb the
unemployment created through restructuring as firms close down or downsize their
workforce. When tariffs were increased substantially in the period 1974–1984 for
textiles and footwear - employment in the sector actually fell by 50 000, adding to
overall unemployment.

high value added imports, leading to large current account deficits and
subsequently large foreign debt levels.
 Developing or new industries may find it difficult to become established in a
competitive environment with no short-term protection policies by
governments, according to the infant industries argument. It is difficult to
develop economies of scale in the face of competition from large foreign
Transitional Corporations. This can be applied to infant industries or infant
economies (developing economies).
 Free trade can lead to pollution and other environmental problems as
companies fail to include these costs in the price of goods in trying to
compete with companies operating under weaker environmental legislation
in some countries.

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 Pressure to increase protection during the GFC. During the global financial
crisis and recession of 2008-2009, the impact of falling employment meant
that protection pressures started to rise in many countries. In New South
Wales, for example, the state government was criticised for purchasing
imported uniforms for police and firefighters at cheaper prices rather than
purchasing Australian made uniforms from Australian companies. Similar
pressures were faced by governments in the United States, Britain and other
European countries.
For the advantages of ASEAN Free Trade Area can be summarized as
follows:
 Rural Development and Poverty Eradication
Certain ASEAN member states, such as Laos, Cambodia and Myanmar are
defined by the United Nations as "least developed nations," while others, such as

on the Elimination of Violence against Women (2006-2010).
2.1.3 ASEAN and AFTA
1. Establishment and Objective
ASEAN was established on 8 August 1967 in Bangkok, Thailand, with the
signing of the ASEAN Declaration (Bangkok Declaration) by the Founding Fathers
of ASEAN, namely Indonesia, Malaysia, Philippines, Singapore and Thailand.
Brunei Darussalam then joined on 7 January 1984, Viet Nam on 28 July
1995, Lao PDR and Myanmar on 23 July 1997, and Cambodia on 30 April 1999,
making up what is today the ten Member States of ASEAN.
As set out in the ASEAN Declaration, the aims and purposes of ASEAN are:
1. To accelerate the economic growth, social progress and cultural development
in the region through joint endeavours in the spirit of equality and
partnership in order to strengthen the foundation for a prosperous and
peaceful community of Southeast Asian Nations;