Trade Diversion and Creation Effect of Free Trade Agreements in ASEAN: Do Institutions Matter?

Abstract

There has been a proliferation of free trade agreements (FTAs) over the last three decades and the Association of Southeast Asian Nations (ASEAN) has since greatly embraced the development. However, research on the effect of trade agreements on trade in the Southeast Asia region has not received adequate attention. The few studies conducted on the issue fail to account for the heterogeneity of the FTA effects and the role of the quality of domestic economic and political institutions in shaping the effects. Therefore, this study evaluates the role of institutions vis-a-vis the trade diversion and creation effects of the FTAs on trade flow in ASEAN over the period 2000-2018. The study accounts for FTA endogeneity and multilateral resistance terms by estimating a structural gravity model using Poison pseudo-maximum likelihood with a high-dimensional fixed effect (PPMLHDFE). The findings reveal that the inclusion of the indicators of political and economic institutions into the specification significantly changed the magnitudes of the trade creation and diversion effects of FTA on international and intra-ASEAN trade. And, the effects of the quality of institutions are robust to the different trade flows (total trade, exports, and imports) of the ASEAN economies. Therefore, we conclude that the trade diversion and creation effects of the FTAs on trade flows in ASEAN largely depend on the quality of economic and political institutions in the region.