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Free Trade Agreements for Indonesia?

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Pacific Money

Free Trade Agreements for Indonesia?

Bilateral and regional agreements are not ideal, but they do offer some compelling benefits.

Free Trade Agreements for Indonesia?
Credit: Jakarta via

One might argue that regional integration can get in the way of international integration. However, no one can debate that if the member countries are geographically proximate and natural trading partners, then a union would be trade creating.

Indonesia is one country that has been quite active in concluding free trade agreements (FTAs). By July 2012, Indonesia had eight FTAs in effect, six regional and two bilateral (specifically, the ASEAN free trade area, AFTA; ASEAN-Australia and New Zealand, ASEAN-China, ASEAN-India, ASEAN-Japan and ASEAN-Korea FTAs, Indonesia-Japan EPA and Indonesia-Pakistan FTA). These agreements mean that Indonesia has FTAs with trading partners that account for of 67 percent of its total trade. For context, Chile, Peru, and Mexico have FTA coverage ratios of more than 80 percent, while Canada, Singapore and New Zealand are at more than 50 percent.

Asian economies in recent years have been driven by China’s impressive growth, especially since its ascension to the World Trade Organization in December 2001, and by Japan’s focus on Asia. Still, a number of countries with relatively low trade integration question their positions in the Asian factory and the benefits of FTAs for their economies. And it is true that the use of existing ASEAN FTAs has been limited, and predominately by large firms. An economy with relatively low trade integration like Indonesia may only enjoy a modest gain from free trade agreements.

For small economies, though, there at least two positive outcomes to be derived from regional trade agreements. The first is an expansion in investment. While the direct impact on trade might be debatable in the beginning, rising investment usually follows. As an illustration, after the ASEAN-Korea FTA and ASEAN-Japan Comprehensive Economic Partnership took effect in 2010, foreign direct investment (FDI) from Korea into ASEAN roughly doubled between 2011 and 2013, from $1.7 billion to #3.5 billion, while the Japanese figure increased from $9.7 billion to $22.9 billion over the same period. In planning their expansion, American businesses tend to see ASEAN as a single entity rather than as 10 separate countries, and 81 percent of 588 senior U.S. executives operating in Southeast Asia claim that ASEAN integration helped their expansion in the region (AmCham Business Outlook Survey for Southeast Asia, 2015).

Second, regional agreements can drive unilateral domestic reforms. New Zealand is a good example of how a small country has transformed from a highly protected market into one of the most open through parallel unilateral and regional tracks that headed towards a multilateral track (the WTO, 1996). Preferential tariff reductions for Australia did not lead to the collapse of the manufacturing sector in New Zealand, and this encouraged the country to become more open in most tariff lines, not only towards Australia but to the rest of the world.  In the case of Indonesia, InaTrade (an online system for obtaining trade-related licenses) and the negative investment list are two products of domestic reforms driven mainly by regional commitments.

The bottom line is that Indonesia and its ASEAN peers should advance regional integration as a vehicle for multilateral integration; and to keep regional integration viable, they should adopt an open regionalism (i.e. regional economic integration that does not discriminate against outside countries).

While I am not a big fan of bilateral and regional agreements, they can be an elegant sweetener to attract investments as well as a sophisticated driving force for unilateral domestic reforms, particularly when multilateral negotiations have stalled.

Still, it should be kept in mind that globalization in any form will inevitably be submissive to national domestic objectives, not the other way around.

Lili Yan Ing is an economist for Economics Research Institute for ASEAN and East Asia (ERIA) and a lecturer at University of Indonesia. The views expressed are her own.