ASEANi plus six and Successful FTAs: Can India propel intra-industry trade flows?

Abstract

Recent trends suggest that countries have turned away from the multilateral process in favor of free trade agreements (FTAs). However, whether FTAs increase trade among their members or result in efficiencies through trade diversion to more inefficient trading partners has remained a debatable issue. This paper sheds fresh light on FTAs by incorporating new trade theories that explain Intra-Industry Trade (IIT) flows that have hitherto not received adequate attention in the current literature on FTAs. Further, regional trade integration among ASEAN+6 nations in goods through IIT has special significance in the context of regional production chains. A lack of emphasis on these issues has perpetuated ambiguities in the policy-making and negotiating processes. The paper analyzes the relationship between Revealed Comparative Advantage (RCA) and IIT, which is further divided into Horizontal IIT and Vertical IIT. Under Vertical IIT, trade can be explained through the traditional trade models of absolute or comparative advantage, as the creation of high quality products can be factor-specific. Considering that RCA can represent and capture the traditional theories of trade, RCA should be positively correlated with IIT, especially vertical IIT. On the other hand, horizontal IIT includes goods that are close to each other in terms of quality and price and can be explained by Krugman’s model. This brings up our hypothesis - Does India, as a source of IIT, impel higher trade among the ASEAN+6 region through an FTA? We investigate this by means of an augmented gravity model, tested through panel Tobit methodology. The findings suggest that an ASEAN+6 FTA in goods IIT can be sustained via the impact of such an FTA on trade-FDI nexus, efficiency-seeking economic restructuring, horizontal and vertical integration, economies of scale, competition, technological improvements, and product differentiation, all of which facilitate regional value chains. The paper also demonstrates—both theoretically and empirically—that combining an FTA in goods among ASEAN+6 countries under the Regional Comprehensive Economic Partnership (RCEP) with greater trade integration, especially with India’s active role in the RCEP, both propels Intra-Industry type trade flows in the region as well as helps to sustain trade flows. These findings have important policy implications for India’s participation in RCEP negotiations with adept handling of Modalities of Tariff Reduction under RCEP; IIT-enhancing Trade in Services and Investment Negotiations; and Cooperation in Appropriate Technology.