Harnessing the true power of ASEAN FTAs

MUTRAP III Team leader and professor at Italy’s Bocconi University Claudio Dordi and Federico Lupo Pasini, from MUTRAP and Berne’s World Trade Institute look at how Vietnam will be impacted on by ASEAN FTA deals.

Over the last few years Vietnam has undergone a massive period of economic reform that led to a deeper participation in the global economic system. Sure enough its World Trade Organization (WTO) accession three years ago represents the pinnacle of its journey towards complete integration into the world economy.

In addition to its WTO membership, Vietnam also participates, as a member of ASEAN, in a number of free trade agreements (FTA) with third countries. In this regard besides the ASEAN Free Trade Area, the FTA in force since 1993 among the 10 ASEAN countries that Vietnam joined in 1995, ASEAN concluded FTAs with China (2004), Korea (2005), Japan (2008), India (2009) and Australia and New Zealand (2009). Some of the above agreements (ASEAN-India, Japan and Australia New Zealand) are not in force, pending the ratification by each member states’ national competent authority.

The main objective of each FTA is to promote the elimination or, at least, the reduction of customs tariffs among members within a certain period of time at a deeper level compared to those applied towards all other WTO members. Besides the reduction in tariffs these agreements provide for a progressive liberalisation of trade and services, promote investment and lay down the basis for further negotiations to facilitate trade amongst members. For example, within ASEAN there are negotiations regarding the improvement of customs cooperation, the creation of the “single window” for customs purposes.

Each agreement has its own specific features and deadlines for liberalisation. For example, trade among ASEAN members will be completely free of duties for all the products since 2018, even if most of the liberalisation has already taken place. Indeed, since January 1, 2010, the first ASEAN members, namely Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand, the so-called ASEAN-6, applied 0 per cent customs duties for all products originating from other ASEAN members. Vietnam since 2006 has applied a maximum 5 per cent customs tariffs on most products originating from other ASEAN members.

In ASEAN FTA agreements each member has its own programme of liberalisation, which should conform to the general framework provided by the agreements. Even if the model of liberalisation provided by each agreement is different, some features are in common. For example, each FTA allows member states to group the products into different categories with different deadline of liberalisation, depending on the grade of sensitivity of the goods. For example, in all the commitments Vietnam included cars into the most sensitive group of products.

For this reason the import of cars in Vietnam will only be completely liberalised towards other ASEAN members in 2018, while the agreement with China obliges Vietnam to reduce customs duties for car imports to 50 per cent in 2018, without further commitments. Moreover, all the agreements provide shorter deadlines for ASEAN-6 and counterparts such as China, Korea, India, Japan, Australia and New Zealand compared to the deadlines applicable to Cambodia, Myanmar, Laos and Vietnam (CMLV countries).

All the above-mentioned features make the assessment of the agreements extremely complicated. Therefore, in this article we tried to answer only three of the most crucial questions usually raised in regards to FTAs. What are the domestic industries losing protection afforded by customs duties? Are there any advantages for the companies located in Vietnam to export to other countries and do the FTAs represent an incentive for foreigners to invest in Vietnam and re-export in other countries benefiting from trade liberalisation?

Tariff reductions in Vietnam

The analysis of the tariff reductions committed by Vietnam within the ASEAN FTAs has interesting implications. In this paper we take into consideration six sectors deemed to be particularly strategic for Vietnam pharmaceuticals, garment, footwear, electronics, mechanical and automotive.

With regard to pharmaceuticals it should be pointed out that Vietnam already applies relatively low customs duties. Indeed, the pick tariff is 10 per cent – tariffs for pharmaceuticals applied to other WTO members vary from 0 to 10 per cent. While Vietnam has already almost completely eliminated the customs duties applied towards other ASEAN members, 5 per cent is the maximum tariff applied at present, concrete liberalisation towards Chinese and Korean products will take place in 2011, the reduction of tariffs to 5 per cent.

The liberalisation with India will be delayed until 2019 and for some products to 2025 while with Australia and New Zealand all pharmaceuticals will be free of duties from 2015.

With the exception of the AFTA agreement, tariff liberalisation committed by Vietnam for garment products is limited. As the maximum tariff applied to the products originating from other WTO members is 20 per cent, Vietnam committed to maintain these tariffs towards China and Korea until 2015 – even if with China, since 2011, it is planned a reduction of 5 per cent for some specific products. Full liberalisation is quite far away, 2018 with Australia and New Zealand, 2020 with Japan, Korea and China and 2021 with India.

Vietnam committed to liberalise the footwear sector before 2015 with China and Korea, while the deadlines with India, Japan and Australia and New Zealand are, respectively, 2019, 2025 and 2018. In five years customs duties applied to imports of Chinese and Korean footwear will decrease, in some cases, from 25 to 0 per cent.

With regard to electronics and mechanical equipment, an assessment of the liberalisation should be conducted on a product-by-product basis, with the exception of imports from other ASEAN countries, completely liberalised since 2009. The situation is different for the automotive sector where, as already specified, Vietnam maintained the right to apply high tariff duties towards all countries even after 2018, with the exception of ASEAN states.

The advantages of Vietnamese companies exporting goods

The relatively high number of agreements concluded by ASEAN with third countries, combined with the asymmetries and differences in commitments between the various members, makes it quite complicated to assess the real advantages coming from the FTAs for all the Vietnamese enterprises engaged in exports.

Nonetheless, a comparative analysis between ASEAN members suggests that Vietnam would benefit in some sectors from the reduction in tariffs. In this respect, when the tariff advantages are particularly relevant and when the investment climate is particularly favourable in terms of efficiency and productive capacity, the preferential tariff liberalisation brought by the FTAs, together with the increased market size would act as a magnet to foreign investors.

In general, the tariff advantages are quite relevant where the importing country applies high tariff duties to WTO members.

This happens, for example, in the case of exporting automotive originating in Vietnam to a number of ASEAN members, and in particular to Indonesia, Thailand and Malaysia. Vietnam-originating automotive products exported to these countries have to pay a customs duty variable 0 to 5 per cent, while the same products originating in all the other countries, except ASEAN members, are subject to customs duties variables from 20 to 80 per cent.

For example, cars originating from the European Union, United States or Japan to Thailand face up to 80 per cent of customs duties, while they are tariff free if they originate in Vietnam and in other ASEAN members.

The combination of tariff liberalisation towards ASEAN countries, lower tariffs for car component imports and high customs duties on car imports even from other ASEAN members will have an interesting impact. It could make Vietnam an interesting platform for producing cars and exporting them in the ASEAN region.

Basically, even if China included cars for fast-track liberalisation, this would allow Vietnam to export cars to China with a tariff advantages up to 25 per cent towards cars originating in other non FTA members (e.g. Japan, EU and US). However, in the ASEAN-China FTA there is a provision allowing China to limit the liberalisation on a reciprocal basis, for example only if counterparts included the same products in the fast-track liberalisation list and this is not the case in Vietnam.

The garments sector is strategic in many ASEAN countries and tend to be quite protected. Indeed, if we look at the applied tariffs imposed by the so-called ASEAN-6 members to all the other WTO members, the duties at the border can reach up to 30 per cent. Conversely, in the context of the various ASEAN FTAs, Vietnam benefit from preferential tariffs that will be progressively reduced to 5 per cent or even eliminated within a 10-year period. This gives a clear competitive advantage to Vietnamese producers when exporting to Thailand and Malaysia, especially vis-à-vis their Indian competitors.

As is the case with garments, shoes constitute one of the other backbone industries in South East Asia whose importance is testified by the iron curtain of import duties imposed by most of the Asian nations. In this contest the Vietnamese industry has recently been subject of a huge inflow of foreign investment, mainly from European producers that moved here their production.

By far the footwear sector is the one that benefits the most from the regional liberalisation. In fact, a comparative analysis of the tariffs applied by other ASEAN states on European, Indian and Chinese shoes revealed that Vietnam exporters to ASEAN countries benefit from a consistent reduction of duties on their exports not available for other countries. In some cases such tariff advantages can reach up to 30 or 40 per cent as in the cases of Thailand and Malaysia. From a business perspective, in few years, Vietnam could become an export platform for footwear products in South East Asia.

Electronics originating in Vietnam have important tariff comparative advantages towards the same products exported from other developed countries to Thailand and Malaysia (up to 30 per cent) and to the Philippines and Indonesia (up to 15 per cent).

The most relevant comparative tariff advantages, taking into consideration the sectors analysed, are those benefited by exporting Vietnamese-originating motorcycles, the tariff advantages towards other developed countries are more than 40 per cent for the exports to Indonesia, more than 20 per cent for exporting in the Philippines and Malaysia and over 50 per cent, for exports to Thailand. As in the case of cars, Vietnam still protects this sector and, as a consequence, at least from the point of view of the comparative tariff advantages, it could be a right platform for the production of motorcycles.

When a product is “originating” in Vietnam?

An important issue for foreign investors is the possibility of import ed raw materials and components from third countries, to produce a final product in Vietnam and export it to other countries. Indeed, the tariffs preferences are granted only to products that can be considered “originating” in one of the members of the free trade area. For this reason all the FTA agreements provide “rules of origin” aimed at determining when a product can benefit from the preferences.

The more the rules of origin are “liberal”, i.e. they allow the finished products to contain a high percentage of non-originating value, the higher are the incentive for foreign producers, from a non-ASEAN FTA member state, to re-locate their production to Vietnam and benefit from the preferences.

The ASEAN FTAs rules of origin are really liberal. Indeed, a product manufactured in one of the FTAs’ members, which contains foreign values, is considered originating in the FTAs when “not less than 40 per cent of its content originates from any party, 35 per cent in the case of ASEAN-India FTAs.”

This means that a product will benefit from the preferential treatment when exported in other members’ states even when the “foreign value” is less than 60 per cent. Moreover, the full value of the raw materials and components originating from a member of the FTA, such as raw materials imported from Korea, when incorporated in the final products manufactured in one ASEAN country, can be counted in the value of “originating” materials for the calculation of the ASEAN regional content, even if they contain non-originating materials, this is the so-called “cumulation principle”.

This further lowers the minimum content requirement, as the imported component can be considered as fully originating in the FTA region. Furthermore, when the material imported from another member is not originating according to the rules of origin but it contains at least 20 per cent of regional value content, this regional value content can be added to the value of the finished products.

Although equipped with extreme liberal rules of origin, few companies in Vietnam would benefit from the preferential treatment provided by the FTAs, only 9 per cent of the products that could potentially benefit from the FTA. According to a survey promoted by Japan, this is due to many reasons, in particular administrative and bureaucratic requirements needed to obtain a certificate testifying that the products originate in the FTA.

In the Vietnamese trade scenario, FTAs are a relatively recent phenomenon that in most cases have yet to produce any consistent impacts on the economy. For this reason it is still premature to reach any conclusions on the costs and benefits brought by this set of preferential trade liberalisation. Nonetheless, in this article we tried to present an interim assessment of what are the legal and economic implications of the various ASEAN FTAs signed by Vietnam.

The reduction in trade tariffs between FTA members has the first effect of increasing the size of the market from the territory of Vietnam to the rest of ASEAN countries and to all the other FTAs signatories such as China and India. The market expansion can induce economies of scales at the industrial level, allowing Vietnamese exporters to extend their consumers base to a total of roughly three billion people.

If we look at the ASEAN-China FTA alone, which is by far the biggest FTA in force in terms of consumers involved (almost two million), and the third largest in terms of nominal gross domestic product (GDP), the market size is four times that of the EU. From a business perspective the reduction in tariffs would provide incentives to the export activities of those Vietnamese enterprises that wish to enlarge their production to reach a wider consumer base.

Of course, what is valid for Vietnamese producers in terms of increased business opportunities is also valid for other ASEAN producers that that would similarly benefit from the reduction in tariffs from the various FTAs. In this respect the toughest competition to Vietnamese exporters will be coming from their Thai, Indonesian or Malaysian counterparts, which will thus become the main Vietnamese challenger for the Asian market.

Another possible threat might come from producers located in countries where the big size of the market and cheap labour costs are already in favour of efficient production. In this regard it is still unclear the level of competition posed by for instance by Chinese and Indian manufacturers, which might endanger the business positions of their Vietnamese counterparts, especially when the structure of the business relies on similar factor of production, such as cheap labour or reduced production costs.

In this respect, a recent MUTRAP research on the ASEAN-China FTA showed that, even in case of complete and sudden liberalisation towards China (i.e. reduction of all the customs duty to 0 per cent), the impact would be limited, with a potential increase in imports to around $1.2 billion (1.67 per cent of Vietnam’s GDP). The liberalisation committed by Vietnam in the framework of ASEAN-China FTA is limited with 50 per cent of the tariff line to be liberalised from 2013 and for many products included in the sensitive and high sensitive list the liberalisation will take place only in 2018 and 2020. With some products completely excluded, the impacts on the import side of the Vietnamese economy will be limited.

Nonetheless, from a theoretical perspective the reduction on tariff barriers to foreign produced goods in competition with similar Vietnamese products would pose a threat to inefficient Vietnamese producers. They would likely be expelled from the market, substituted by cheaper and sometimes better foreign products. This possibility, which is at the core of the concept free trade, can nevertheless be considered an opportunity.

This is because it will induce a transformation towards a more efficient and higher quality industrial sector. In particular Vietnam should avoid direct competition with Chinese and Indian producers on low-quality products as the economies of scale from which India and Chinese producers benefit are too big to be challenged. Rather the Vietnamese industrial sector should focus on upgrading the quality of its products and in diversifying the offer from that of their rivals.

Another important feature of the Vietnamese FTAs is the increase in foreign investment. The economic theory has clearly demonstrated that in some cases FTAs can attract more foreign direct investments from third parties investors excluded by the FTAs. In particular, the combination of high tariffs for third party-produced goods and the market expansion due to the FTAs would induce foreign investors to relocate the production in Vietnam, in order to benefit from those advantages, especially in sectors that are more likely to rely on tariff policies such as textiles, automobiles and general manufacturing.

Clearly, the market size and the reduced tariffs cannot be the only policy tool to push foreign investors to relocate the production in Vietnam. Other economic variables such as technology, overall good productive efficiency together with a friendly investment climate would play a decisive role in this regard. None the less, from a trade perspective, as it was demonstrated above with the automotive sector or with electronics, Vietnam could definitely become an important investment cluster for quality manufacturing products to be exported in the region.

VietNamNet/VIR

Tags: Vietnam Asean ASEAN FTAs, Vietnam asean cooperation, Vietnam cooperation