Samarth Kumar

BA LLB 8

03219103817 Assignment

Make a comparative study between the SAFTA Agreement and SAPTA Agreement.

Regional trade agreements (RTAs) have been proliferating since the mid-90 s. As of May 2016, some
629 notifications of RTAs (including goods, services, and accessions separately) have been received
by the WTO (World Trade Organization). Of these, 423 are in force. These WTO figures correspond to
458 physical RTAs (including goods, services, and accessions together), of which 270 are currently in
force (WTO website). In the meantime, the share of world trade occurring within RTAs has been
growing steadily, overreaching 30% even when intra-EU trade is excluded (Bureau et al. 2015). It is
more likely that RTAs can affect the order of international trade flows as they are signed to pave the
way for trade between member countries, but their actual impact on trade flows remains
controversial. Estimates in studies are highly variable, demonstrating a lack of robustness (Cipollina
and Salvatici 2010; Ghosh and Yamarik 2004; Head and Mayer 2014). Several studies talked about
trade diversion, i.e., when two countries gain from their bilateral trade agreement, third country will
be affected negatively due to losing market share in member countries. For example, some authors
find that RTAs generate large trade flows between members, albeit often at the expense of third
countries (e.g., Caliendo and Parro 2015; Egger and Larch 2011; Egger and Wamser 2013; Fugazza
and Nicita 2013; Grant and Lambert 2008). The impact of RTAs on trade flows tends to be lower than
often expected due to large number of goods subject to low duties (Carpenter and Lendle 2011)

On the other hand, many recent studies (e.g., February et al. 2015; Larch and Yotov 2016) found that
trade creation effect can be significantly higher than the trade diversion effect and even trade
diversion effect can be controlled through taking some potential steps for third countries when two
countries sign a trade agreement. Larch and Yotov (2016) argued that the trade creation and trade
diversion effects are first- and secondorder GE effects, respectively; hence, trade creation effect is
higher than trade diversion effect. In my paper, I use two regional trade agreements to show that
the welfare effect of RTAs is higher than the risk they have. the role of WTO (World Trade
Organization) in economic integration has been questioned since it came into force. Several studies
(e.g., Rose 2004; Subramanian and Wei 2007) found that the WTO promotes trade strongly but
unevenly. the WTO provides asymmetric treatment effects to different trade flows. More developed
countries are gaining more; on the other hand, less developed countries are on the losing side.
Taking this limitation of WTOs into account, and in a bid to pave the path of trade among member
countries, SAARC (South Asian Association for Regional Cooperation) member (Bangladesh, Bhutan,
India, Maldives, Nepal, Pakistan, and Sri Lanka) countries formed their own RTA (SAFTA—South
Asian Free Trade Area) in 2006 and ASEAN (Association of Southeast Asian Nation) member (Brunei
Darussalam, Indonesia, Malaysia, Philippines, Singapore and Thailand, Cambodia, Laos, Myanmar,
and Viet Nam) countries established AFTA (ASEAN Free Trade Area) in 1992 to boost trade among
the member countries of these two Asian associations.1 SAPTA (SAARC Preferential Trade
Agreement) was the first step to transition to a TLP (Trade Liberalization Program) among SAARC
member countries. By recognizing that it is necessary to progress beyond a Preferential Trading
Arrangement to move toward higher levels of trade and economic cooperation in the region by
removing barriers (tariff, para-tariff, and non-tariff measures) to cross-border flow of good, in 1995,
the Sixteenth session of the Council of Ministers (New Delhi, December 18–19, 1995) agreed on the
need to strive for the realization of SAFTA. the SAFTA Agreement was signed on January 6, 2004,
during Twelfth SAARC Summit held in Islamabad, Pakistan. the agreement entered into force on
January 1, 2006, and the Trade Liberalization Program commenced from July 1, 2006. Tere are very
few studies which use empirical approach to evaluate the welfare effects of SAFTA. Sengupta and
Banik (1997), Srinivasan and Canonero (1995) predict that SAFTA will have significant welfare effect
on other member countries but very small impact on India. This prediction supports my GE
equilibrium counterfactual welfare effect of SAFTA. Kemal (2004) conclude that the SAFTA has the
possibility of providing long-run benefits at the expense of short-term costs and there exist great
potential for free trade among the SAARC member countries. Using natural trading partner
hypothesis, Pitigala (2005) argued that SAFTA can influence the trade flows among member
countries positively. Hirantha (2003) use gravity model with panel trade data from 1996 to 2002 for
SAPTA to find out the ex-ante welfare effect of SAFTA. For SAPTA, he found that SAPTA has
significant trade creation effect on member countries; on the other hand, trade diversion effect is
negligible. Hence, this supports the proposition that further trade integration (SAPTA toward SAFTA)
may bring significant welfare gains for member countries. Raihan (2012) argued that there is trade
creation effect among member countries but infrastructure development could do more than trade
liberalization. the ASEAN heads of the government and state decided to sign a trade agreement
(ASEAN Free Trade Area—AFTA) in 1992 to increase the ASEAN region’s competitive advantage as a
production base geared toward the world market. AFTA was formed in 1993 by Brunei Darussalam,
Indonesia, Malaysia, the Philippines, Singapore, and Tailand, and in the second half of the 1990s it
expanded to incorporate Vietnam, Laos, Myanmar, and Cambodia. the main step was the
liberalization of trade among member countries through the elimination of tariff and non-tariff
barriers. In addition, economic integration of ASEAN gives consumers wider choice and better-
quality consumer products. the trade liberalization under AFTA is a Common Effective Preferential
Tarif scheme, which has been in force since January 1993. the Common Effective Preferential Tarif
(CEPT) Agreement for AFTA requires that tariff rates levied on a wide range of products traded
within the region are reduced to 0–5% (ASEAN website). the tariff reduction consisted of a schedule,
to be implemented progressively until 2008. Quantitative restrictions and other non-tariff barriers
are to be eliminated. Using gravity model, Okabe and Urata (2013) find that AFTA has a significant
and positive effect on the member countries through tariff elimination for a wide range of products.
David (2008) finds significant positive welfare effect of AFTA among member countries using gravity
model with PQML (Poisson quasi-maximum likelihood) estimator. On the other hand, the welfare
effect Baldwin (2006) finds is very low. Previously, it seems, no study finds out the general
equilibrium comparative (including partial effect, conditional GE effect, and full GE effect) analysis of
SAFTA and AFTA, which is one of the most important features of structural gravity model to find out
the potential effect of RTAs. As well as, this paper is the first, which find out potential exante welfare
effect of joint SAFTA and AFTA as still, discussion on forming several RTAs among the member
countries of these two RTAs are on the table, e.g., BIMSTEC2 (Bay of Bengal Initiative for Multi-
Sectoral Technical and Economic Cooperation). Accounting for endogeneity of partial RTA estimate
and using GEPPML estimator of Anderson et al. (2015), I find that the trade creation effect of SAFTA
and AFTA among member countries is positive and significant; on the other hand, the trade
diversion effect on non-members is negligible. the joint agreement of SAFTA and AFTA will bring
more welfare for small economy countries of these two regional trade agreements.