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ECONOMICS TRADE CREATION AND DIVERSION UNDER THE THAILAND-AUSTRALIA FREE TRADE AGREEMENT (TAFTA) by Sally Milton Business School University of Western Australia and M A B Siddique Business School University of Western Australia DISCUSSION PAPER 14.26

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Page 1: ECONOMICS TRADE CREATION AND DIVERSION …...trade creation, exporter diversion and importer diversion) allows for the correct identification of these Vinerian trade effects [see (Egger,

ECONOMICS

TRADE CREATION AND DIVERSION UNDER THE

THAILAND-AUSTRALIA FREE TRADE AGREEMENT (TAFTA)

by

Sally Milton Business School

University of Western Australia

and

M A B Siddique Business School

University of Western Australia

DISCUSSION PAPER 14.26

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TRADE CREATION AND DIVERSION UNDER THE THAILAND-AUSTRALIA FREE

TRADE AGREEMENT (TAFTA)*

Sally Milton** and M A B Siddique**

Please address correspondence to:

Dr. M. A. B. Siddique, Associate Professor, Economics

M251, UWA Business School, The University of Western Australia

35 Stirling Highway, Crawley, WA. 6009

Phone: +61 (0)8 6488 2941

Fax: +61 (0)8 6488 1016

E-Mail: [email protected]

DISCUSSION PAPER 14.26

*The authors acknowledge the generous grant that they have received from the UWA Business School in order to facilitate the preparation of this paper. ** University of Western Australia (UWA) Business School

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ABSTRACT

This paper examines the impact of the Thailand-Australia Free Trade Agreement (TAFTA)

on bilateral merchandise trade flows between Australia and Thailand. Using aggregated data,

an augmented gravity model is estimated in an attempt to quantify the trade creation and/or

diversion effects of the agreement. The model includes 178 countries and is estimated using

panel data over the period 1998 to 2012. The inclusion of three variables describing TAFTA

membership (i.e. intra-TAFFTA trade creation, exporter diversion and importer diversion)

allows for the correct identification of Vinerian trade creation and trade diversion effects. The

estimation method accounts for country heterogeneity, endogeneity and potential selection

bias through the use of time-invariant, time-varying, country-specific and country-pair

effects. Diagnostic checks indicate the presence of heteroscedasticity and serial correlation,

which are controlled for in a fixed effects model with robust standard errors. The results

indicate that the Thailand-Australia Free Trade Agreement has had modest trade creation

effects, with little evidence to suggest that this is at the expense of trade diversion. The

findings of the study have obvious policy implications.

Keywords: Free Trade Agreement; Thailand; Australia; FTA; Trade and Growth; Trade

Flow Effects; Gravity Model; Trade Policy

JEL Classification: F13, F14, F15, O24

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1 Introduction

One of the emerging trends in international economics in recent years has been the

proliferation of Regional Trading Agreements (RTAs), including Free Trade Agreements

(FTAs), Preferential Trading Agreements (PTAs) and Customs Unions (CUs)1. According to

the World Trade Organisation2, as of 31 July 2013, 379 RTAs were in force with a total of

575 notified3. This global acceleration in trading agreement activity has led to debate among

international economists about the merits of entering into such agreements. While some see

bilateral liberalisation as trade creating and progression towards free world trade4 , others fear

that preferential and regional trading agreements will be a hindrance and act to divert trade

towards those with preferential treatment. Despite this, the reality is that practically all WTO

members are parties to FTAs and/or are actively involved in FTA negotiations (DFAT,

2010).

After the East Asian Financial Crisis of 1997-98, there has been a notable increase in policy

efforts aimed to hasten progress of economic integration in the region (DFAT, 2010). As a

result of this, around half of the FTAs notified to the WTO are between countries in the Asia-

Pacific region (Kohpaiboon, 2008), with Australia being an active player. Since 2003,

Australia has successfully negotiated and implemented six FTAs with: Singapore, the United

States, Chile, the Association of South East Asian Nations (ASEAN), Malaysia and Thailand

which, when considered with the Australia-New Zealand Closer Economic Relations Trade

Agreement (implemented in 1983), account for 28 per cent of Australia’s total trade 5 .

Negotiations for a further nine FTAs 6 (including five bilateral and four plurilateral

agreements) are also being undertaken by the Australian government, which account for a

further 45 per cent of Australia’s trade.

1 The cause of the expansion of FTAs in the global trading system is not so clear. The stalemate in the WTO’s Doha Round is seen by many authors as a potential explanation for the increased interest in FTAs. Given this, it is reasonable to consider that countries interested in trade liberalisation, when faced with these stalled multilateral negotiations, have sought bilateral and plurilateral liberalisation through FTAs. 2 Data includes trade in goods and services and are taken from the WTO website: http://www.wto.org/english/tratop_e/region_e/region_e.htm. Accessed 17 September 2013. 3 Since the establishment of the WTO in 1995, over 400 notifications of RTAs have been received compared to only 124 from 1948-1994. 4 The WTO Secretariat has argued that FTAs have facilitated negotiation of rules and commitments that go beyond what was possible at the time multilaterally; and that some of these rules have developed into agreements in the WTO. 5 Figure represents two way trade in goods and services from 2008-2009, taken from Department of Foreign Affairs and Trade website http://www.dfat.gov.au/fta/. Accessed 17 September 2013. 6 Bilateral: China, Japan, Korea, India and Indonesia. Plurilateral: Trans-Pacific Partnership Agreement (TPP), the Gulf Cooperation Council (GCC), the Pacific Trade and Economic Agreement (PACER plus) and the Comprehensive Economic Partnership Agreement (RCEP).

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As trade makes such a crucial contribution to Australia’s economic performance, maintaining

access to existing open markets and liberalising access to other markets through FTAs are

key trade policy objectives for the Australian government (DFAT, 2010). Mortimer and

Edwards (2008) reflect this view and state that “[t]he increasing number of global and

regional FTAs has important implications for Australia: as more FTAs are negotiated,

Australian goods and services exports face the prospect of loss of market share. Australia

needs an active FTA agenda for the future to deal with these risks but also to expand export

and investment opportunities” (pg 92).

2 Aims and Objectives

In light of this growing interest in FTAs in Australia and abroad, this paper examines the

conflicting effects of trade liberalisation, trade creation and trade diversion (hereafter referred

to as “trade flow effects”), in the context of one of Australia’s recently signed FTAs, the

Thailand- Australia Free Trade Agreement (TAFTA).

The study specifically addresses two research questions. First, has the TAFTA had a trade

creation effect and led to an increase in bilateral trade between Australia and Thailand?

Second, to the extent that the TAFTA has increased trade, how much was a result of trade

diversion? The inclusion of three dummies describing TAFTA membership (intra-TAFFTA

trade creation, exporter diversion and importer diversion) allows for the correct identification

of these Vinerian trade effects [see (Egger, 2002); (Carrère, 2006); (Martínez-Zarzoso et al.,

2009) and (Yang and Martínez-Zarzoso, 2013)]. The study of the TAFTA at this time is of

particular interest as it is Thailand’s first comprehensive FTA signed with a developed

country and as it is in its ninth year of operation, sufficient time has now passed to discern the

Agreement’s preliminary effect on bilateral trade flows between Australia and Thailand.

3 Motivation

A few studies have provided ex-ante assessments of the TAFTA, including the Centre for

International Economics (CIE, 2004), Hoa (2004) ,Siriwardana (2006) and Sally (2007).The

most comprehensive study was commissioned by the Department of Foreign Affairs and

Trade and conducted by the Centre for International Economics (CIE, 2004). They examined

the economic gains likely to arise from trade liberalisation under the TAFTA and concluded

that the TAFTA will be economically beneficial for both Australia and Thailand; however,

2

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the gains for Thailand will be larger due to higher initial barriers to trade and greater relative

importance of trade with Australia to Thailand.

Hoa (2004) explores the impact of bilateral trade between Thailand and Australia on Thai

growth and draws conclusions as to the potential challenges and benefits that may arise from

the TAFTA. The results indicate that trade activities between Australia and Thailand do

affect Thailand’s growth and therefore the TAFTA can be expected to enhance bilateral trade

and improve both countries welfare.

Siriwardana (2006) provides an overview of the effects of various FTAs, including the

TAFTA, on the Australian economy using a computable general equilibrium (CGE) model.

The results predict both Australia and Thailand are to gain from the TAFTA in terms of

welfare. Additionally, Australia’s trade balance is projected to improve and Thailand’s to

deteriorate.

However, literature examining the ex-post assessment of the TAFTA is very scant. From a

policy-making perspective it is very important to ‘take stock’ of the effects of an FTA after it

is established as there are widespread policy implications (domestic and foreign) along with

implications for ongoing FTA negotiations. Comparing the expected effect and the effect

that eventuates from the FTA can also help policy makers improve pre-FTA assessment

methods. Siddique (2013) emphasises this point with reference to the TAFTA and states that

“(e)xperience from the TAFTA could be used by Australian policy makers to design and

establish future FTAs with Southeast nations which have similar economic characteristics to

Thailand” (pg 15).

The specific contributions of this paper are as follows. First, to emphasise the importance of

using proper econometric techniques in the modelling of trade flows effects of FTAs and to

use caution when making inferences from trade data. Second, to fill a gap in the literature on

trade flow effects of FTAs and provide a broad assessment of the impact of the TAFTA on

trade flows. Given the mixed predictions of these ex-ante assessments, the results of this

paper will provide useful information about the accuracy of ex-ante FTA impact studies that

go on to assist policy makers to make better informed inferences about the effects of future

FTAs.

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4 Australia- Thailand Bilateral Trade

In 2012, Australia and Thailand celebrated 60 years of bilateral relations, of which trade is an

important factor. During 2012, Thailand was ranked as Australia’s 10th largest export partner

and Australia as Thailand’s 8th largest7, highlighting the importance of bilateral trade between

the two countries. Australia’s main exports to Thailand are primary products and

manufactured metals while manufactures dominate Thailand’s exports to Australia. In 2011-

2012, bilateral merchandise trade between Australia and Thailand was valued at around

AU$15 billion comprising of roughly AU$5 billion worth of Australian exports to Thailand,

and AU$10 billion worth of imports from Thailand.

Table 4.1 below summarises Australia’s merchandise Trade with Thailand in the years

leading up to and following the implementation of the TAFTA, disaggregated into exports

and imports.

Table 4.1: Australia's Merchandise Trade with Thailand

Year Exports (A$m)

Growth (yoy, %)

Share of Total

Exports (%)

Imports (A$m)

Growth (yoy, %)

Share of Total

Imports (%)

Total trade (A$m)

Growth (yoy, %)

1995 1737 27.0 2.4 1014 15.6 1.3 2751 22.5 2000 1959 40.0 1.8 2816 27.9 2.4 4775 31.1 2004 3059 35.9 2.6 3772 4.7 2.7 6831 16.7 2005 4131 35.0 3.0 4812 27.6 3.1 8943 31.0 2006 4281 3.6 2.6 6258 30.0 3.6 10539 17.8 2010 5855 38.0 2.5 11005 -5.4 5.2 16860 6.3 2011 6766 15.6 2.6 8441 -23.3 3.7 15207 -0.98 2012 4873 -28.0 2.0 10175 20.5 4.2 15048 -1.1

Source: Table created by authors using data from ABS Cat. 5368.0 July 2013. Notes: (i) Exports refer to Australian exports to Thailand and imports refer to Australia’s imports from Thailand (ii) Shaded cells indicated figures collected after the implementation of the TAFTA

It is apparent that bilateral trade between Thailand and Australia has grown significantly

since the early 1990s, from $AU 2.7 billion (bn) in 1995 to just over $AU 15 bn in 2012. This

growth has occurred primarily on the import side, from just over $AU 1 bn in 1995 to over

$10 bn in 2012, which is intuitive as Australia has historically been a net importer. It can be

seen from this table that there has been a marked increase in total bilateral trade between

Australia and Thailand since the TAFTA came into effect in 2005 (see Table 1). The increase

in trade has occurred primarily on the import side, with Thai imports increasing in

7 Source: Direction of Trade Statistics (DOTS)

4

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importance in Australia’s trade portfolio. This conclusion is supported by Athukorala and

Kohpaiboon (2011). The seemingly inconsistent trade patterns post-TAFTA implementation

may be able to be explained by external factors, such as the 2008 global financial crisis and

flooding in Thailand during 2009 causing disruptions to trade. The following empirical

analysis hopes to disentangle these factors from the effects of the TAFTA.

Figure 4.1: Relative Share of Trade Between Australia and Thailand

Source: created by authors using data from WITS, UN COMTRADE.

It is apparent that bilateral trade between Thailand and Australia has grown significantly since the early 1990s, from $AU 2.7 billion (bn) in 1995 to just over $AU 15 bn in 2012. This growth has occurred primarily on the import side, from just over $AU 1 bn in 1995 to over $10 bn in 2012, which is intuitive as Australia has historically been a net importer. It can be seen from this table that there has been a marked increase in total bilateral trade between Australia and Thailand since the TAFTA came into effect in 2005 (see Table 1). The increase in trade has occurred primarily on the import side, with Thai imports increasing in importance in Australia’s trade portfolio. This conclusion is supported by Athukorala and Kohpaiboon (2011). The seemingly inconsistent trade patterns post-TAFTA implementation may be able to be explained by external factors, such as the 2008 global financial crisis and flooding in Thailand during 2009 causing disruptions to trade. The following empirical analysis hopes to disentangle these factors from the effects of the TAFTA.

Figure 4.1 above compares the relative importance of Australia (Thailand) in Thai (Australian) trade from 1990 to 2012 through each country’s relative trade share. It is expected that bilateral trade between Australia and Thailand has become relatively more important for each country post-TAFTA implementation. Prior to the implementation of the TAFTA (to 2004) it appears as though the relative trade shares for both Thailand and Australia were fairly similar. After the implementation of the TAFTA (2005 onwards) there is a clear divergence, with bilateral trade between Australia and Thailand becoming relatively much more important for Thailand. Interestingly it appears that, since 2005, Australia-Thailand bilateral trade has become relatively less important for Australia. As mentioned above, these trends

0

1

2

3

4

5

6

1990 1994 1998 2002 2006 2010

Rela

tive

trad

e sh

are

Relative share of trade

Aus Share of Thai Exports Thai Share of Aus Exports

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likely incorporate external macroeconomic shocks and therefore may not be reflective of the TAFTA’s actual impact.

An annual trade intensity index (TII) for Australia and Thailand from 1990 to 2012 is shown in Error! Not a valid bookmark self-reference., which measures the importance of bilateral trade between the two countries based upon their importance in world trade or the intensification of the trade between Australia and Thailand relative to the rest of the world. It is defined as the share of one country’s exports to a partner divided by its share of world exports. An index of 1 indicates that the bilateral trade flow is as expected, given the country’s importance in world trade. It is expected that this index will increase post-TAFTA implementation as the trade between Australia and Thailand becomes relatively more important for each country relative to the rest of the world. Trade is more intensive than normal if the TII is greater than one. It is evident from the figure that this appears to be true for both Thailand and Australia; however again it appears that trade has intensified more for Thailand post TAFTA implementation and has become less intense for Australia

Figure 4.2: Trade Intensity Index for Australia and Thailand

Source: created by authors using data from WITS, UN COMTRADE.

A number of studies have examined the historical trading relationship between Australia and

Thailand, including DFAT (2010) and Siddique (2013). DFAT (2010) finds that Australian

export growth to Thailand is about 50 per cent higher on average per annum in the four years

since the implementation of the TAFTA than was the case four years prior, with growth in

the exports of manufactured products, Australia’s primary export to Thailand, notably

increasing. Siddique (2013) notes the stark increase in trade between Australia and Thailand

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since the early 1990s, but cautions the conclusion that the TAFTA has had a large part to play

in this increase.

5 Theoretical Background

A consensus has emerged out of recent empirical work by Carrère (2006), Baier and

Bergstrand (2007), Magee (2008) and Eicher et al. (2012) that, in general, the trade creating

effects of FTAs outweighs the trade diversion effects8. This consensus forms the premise for

the development of the hypotheses examined in this paper (outlined in section 6.1).

5.1 Modelling of the Impact of FTAs on Trade Flows

As the theoretical papers on preferential trade theory suggest that FTAs may be beneficial or

harmful depending on the relative magnitudes of trade creation and diversion, empirical

studies attempting to estimate these effects are particularly relevant. Existing studies

exploring changes in trade patterns can be divided into two groups: ex-ante analyses using

historical trade patterns to calculate the predicted effect of a reduction or elimination of trade

barriers, as in CIE (2004); and ex-post analyses that examine trade flows after an FTA has

come into force, as in Carrère (2006). As the focus of this study is an ex-post assessment of

the TAFTA, ex-post studies will be the focus of the following review of the empirical

literature.

There has been little concurrence among international economists on the appropriate

methodology for examining the impact of FTAs on trade flows. Despite this, the gravity

model has gained widespread popularity and is used in this paper to estimate the magnitude

and direction of trade flow effects of the TAFTA.

5.1.1 The Gravity Model

The most successful and extensively used model in international trade research for the last 50

years has been the gravity model. This model was first applied to international trade flows by

Tinbergen (1962) and Pöyhönen (1963) and has been used for analysing the effects of FTAs

on bilateral trade flows ever since. It is based upon Newton’s Law of Gravitation and when

applied to international trade, predicts that the volume of trade between two countries in time

t, 𝑋𝑖𝑗𝑡 should increase with their incomes, 𝑌𝑖𝑡 , 𝑌𝑗𝑡 (used as proxies for market size) and

8 Ghosh and Yamarik (2004) disagree with this consensus and suggest that the trade creation effect found in the literature is overstated and does not reflect the sample information but rather the prior beliefs of the researcher.

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decrease with the geographical distance between them, 𝐷𝐼𝑆𝑇𝑖𝑗 (used as a proxy for

transportation costs) 9,10:

𝑋𝑖𝑗𝑡 = 𝛽0𝑌𝑖𝑡𝛽1𝑌𝑗𝑡

𝛽2𝐷𝐼𝑆𝑇𝑖𝑗𝛽3𝐹𝑖𝑗𝑡

𝛽4𝑢𝑖𝑗𝑡 (1)

where 𝐹𝑖𝑗𝑡 represents any other factors influencing trade flows between countries and 𝑢𝑖𝑗𝑡 is

the error term. The multiplicative form as specified above in Equation 1 can be estimated

using generalised linear modelling (GLM)11, however it is more common to express the

gravity equation using the following log-linear specification and estimate it using ordinary

least squares (OLS):

𝐿𝑋𝑖𝑗𝑡 = 𝛼0 + 𝛽1𝐿𝑌𝑖𝑡 + 𝛽2𝐿𝑌𝑗𝑡 + 𝛽3𝐿𝐷𝐼𝑆𝑇𝑖𝑗+𝛽4𝐹𝑖𝑗𝑡 + 𝑢𝑖𝑗𝑡 (2)

where L denotes variables in natural logs, 𝑋𝑖𝑗𝑡 are the exports from country i and j in year

t, 𝑌𝑖𝑡(𝑌𝑗𝑡) indicate the nominal gross domestic product (GDP)of country i (j) in year t, 𝐷𝐼𝑆𝑇𝑖𝑗

denotes the geographical distance between the capital cities of countries i and j, 𝐹𝑖𝑗𝑡 are a set

of dummy variables that represent any other factors that influence trade between countries i

and j , and 𝑢𝑖𝑗𝑡 is a normally-distributed error term.

To explore the effects of trade policy and other cultural and political factors, it is common

practice to include various variables and indicators within the model, such as colonial links,

adjacency, common language and dummy variables denoting FTA membership. Numerous

papers [see (Baier and Bergstrand, 2004); (Baxter and Kouparitsas, 2006); (Eicher et al.,

2012)] have found these cultural and political factors to be significant determinants of the

volume of bilateral trade and therefore they are included in the gravity model estimated

within this paper.

The gravity model is particularly well defined for ex-post assessments of trade agreements

for two main reasons. Firstly, the model seems to represent a relevant counterfactual to

isolate the effects of a FTA , that is, the model suggests a normal level of bilateral trade for

the sample so dummy variables are able to capture the effects of a FTA (Carrère, 2006).

9 Specification as found in Martínez-Zarzoso (2013), pg 318. 10 These relationships are demonstrated in Appendices A1 and A2 for the data used in the empirical section of this paper. 11 “GLM assumes that there is a function that explains the relationship between the variance and the mean and does not assume constant variance” (Martínez-Zarzoso ,2013, pg 318).

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Secondly, one is able to isolate the trade flow effects of a FTA by controlling for the effects

of other trade determinants.

In light of the recent expansion of FTAs, an increasing number of studies have attempted to

analyse the impacts of trade policy, such as FTAs, using the gravity model; some of the more

prominent being McCallum (1995), Rose (2000), Baier and Bergstrand (2004) and Helpman

et al. (2008); with mixed results. The majority of studies have found FTAs and RTAs to be

trade creating, however a number of high profile studies, such as Ghosh and Yamarik (2004),

suggest that these conclusions may be misleading.

In addition to being well defined for assessments of trade policy, trade gravity model is also

able to consistently explain the variation in trade flows across a wide range of time periods

and countries which makes it, according to De Benedictis and Taglioni (2011) one of the

most stable empirical relationships in economics.

5.1.2 Theoretical Foundations for the Gravity Equation

The preceding discussion outlined the historical background of the gravity model, the key

studies using it for ex-post analysis of FTAs and presented some explanations as to why it is

used so frequently. A number of recent papers have provided comprehensive outlines of the

historical background, theoretical foundations and estimation issues of the gravity model [See

(Helpman et al., 2008); (De Benedictis and Taglioni, 2011); and (Head and Mayer, 2013)].

This section will explore the gravity model’s theoretical foundations in more depth.

Although the gravity model has been used extensively in the empirical literature since

Tinbergen (1962) and Pöyhönen (1963), the theoretical foundations have been built up over

many years through the contributions of many authors (Evenett and Keller, 1998).

Early trade theorists [see (Linnemann, 1966); (Leamer and Stern, 1970); (Leamer, 1974)]

provided further motivations for a gravity model analysis of trade flows. It was, however,

Anderson (1979) who was the first to present a more comprehensive theoretical foundation

for the gravity model. He concluded that the gravity equation could be derived from the

properties of expenditure systems based on goods differentiated by country of origin12, Cobb-

Douglas preferences and, in an appendix, constant elasticity of substitution (CES)

preferences.

12 The assumption that products are differentiated by country of origin is commonly referred to as the Armington assumption.

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Theoretical work subsequent to Anderson (1979) has shown that gravity models can arise

from a range of trade theories13. Bergstrand (1985 and 1989) and Helpman and Krugman

(1985) show that a gravity model can be developed from a model of trade based on

monopolistic competition. This model is based on assumptions similar to those of Anderson:

CES preferences and product differentiation by country of origin. Deardorff (1998)

demonstrates a traditional factor-proportions explanation of trade can give rise to a gravity

model. Later work by Eaton and Kortum (2002) and Helpman et al. (2008) has shown that the

gravity model can also arise from Ricardian and Heckscher-Ohlin (HO) type models.

The contribution of recent studies regarding the theoretical foundations of the gravity model

has emphasised the importance of determining the specifications and variables used from

economic theory (UN and WTO, 2012). This allows appropriate inferences to be drawn from

estimations using the gravity model. One of the most important contributions in this regard

has been made by Anderson and Van Wincoop (2003).

Anderson and Van Wincoop (2003) show that for a gravity model to be correctly specified it

must control for relative trade costs14. The results from their study demonstrate that relative

trade costs [“Multilateral trade-resistance terms (MTRTs)”] are an important determinant of

bilateral trade and are typically not included in the standard gravity model, leading to biased

estimation. The gravity model specifications used in this paper includes country fixed effects

as a proxy for MTRTs, as in Rose and Van Wincoop (2001), Baldwin and Taglioni (2006)

and Martínez-Zarzoso (2013).

With the publication of Eaton and Kortum (2002) and Anderson and Van Wincoop (2003) ,

the traditional view of gravity equations lacking theoretical foundations was dismissed (Head

and Mayer, 2013)15. These models paved the way for estimation methods that take into

account the structure of the models. The fixed effect models used in this paper are consistent

with theory and an example of an estimation method that does not involve strong structural

assumptions on the underlying gravity model (Head and Mayer, 2013).

13 See Deardorff (1998 ), Evenett and Keller (1998) and Feenstra et al. (2001) for useful summaries of the theoretical foundations 14 The propensity of country j to import from country i is determined by country j’s trade cost towards i relative to its weighted average trade costs and to the weighted average trade costs facing exporters in country i. from Anderson and Van Wincoop (2003). 15 Head and Mayer (2013) state that “ [s]ince neither model relie[s] on imperfect competition or increasing returns, there [is] no longer a reason to believe that gravity equations should only apply to a subset of countries…”

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Despite this, much of the gravity literature has been highly critical of the estimation methods

used for gravity equations and has hence identified many important limitations and common

modelling mistakes. These issues are discussed briefly in the following section.

5.1.3 Existing ex-post Assessments of Trade under TAFTA

Since the TAFTA came into effect in 2005, several studies have examined aspects of the

agreement, including, Chiasakul et al. (2010), DFAT (2010), Athukorala and Kohpaiboon

(2001) and Siddique (2013). The hypotheses addressed in this paper have not been

systematically examined in these existing papers; however, the existing studies do provide

some useful insights.

Chiasakul et al. (2010) studied the sector specific effects of the TAFTA on the Thai economy

with a focus on the liberalisation of services. The study uses a CGE model and finds that the

TAFTA benefits Thailand regardless of the level of liberalisation of services. This result

provides further motivation for the focus on merchandise trade as found in this paper.

DFAT (2010) provides an overview of Australia’s existing bilateral and regional trade

agreements. The report examines a number of areas including but not limited to: the

reduction of trade and investment barriers; safeguards against new barriers; FTAs role in

lending support to the WTO; global economic developments and the promotion of regional

integration and the impact of FTAs on Australia’s trade and economic performance. With

regards to the TAFTA, DFAT (2010) find that growth in two-way trade (both imports and

exports) between Australia and Thailand has increased faster post-implementation . It is

found that average Australian export growth to Thailand (12.2 per cent a year) is greater than

that to the rest of the world (11.6 per cent a year).

Athukorala and Kohpaiboon (2011) provide the most comprehensive assessment of the

TAFTA to date. They examine the impact of the TAFTA on bilateral trade between Australia

and Thailand, paying particular attention to rules of origin (RoO), sector specific effects and

the utilisation of tariff preferences. Their findings suggest that the TAFTA has contributed to

an expansion of trade between Australia and Thailand, but that this can be accounted for by

an expansion in automotive imports to Australia from Thailand.

Finally, Siddique (2013) explores the trade relationship between Australia and Thailand

between 1990 and 2011 and finds that the composition of trade has changed significantly. He

suggests that the changes in trade patterns are part of long term structural changes and not

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necessarily related to the implementation of the TAFTA. This paper aims to add to this

existing literature by providing estimates of the trade flow effects of the TAFTA.

6 Trade Creation and Trade Diversion under the TAFTA: An Empirical Analysis

Overview

This section provides the empirical analysis of trade creation and trade diversion under the

TAFTA. Section 6.1 outlines the development of the hypotheses. Section 6.2 describes the

data, the research method and variables employed in the study. Section 6.3 presents some

initial diagnostics of the data, whilst Section 6.4 describes the model in detail. The results are

presented in Section 6.5 followed by a robustness analysis in Section 6.6.

6.1 Development of Hypotheses

The simple concepts of trade diversion and trade creation highlight two essential areas of

interest to consider as we examine the ex-post effects of TAFTA16. First, to what extent did

trade between Australia and Thailand increase as a result of trade liberalisation under the

TAFTA? Second, was any of the increase in trade between Australia and Thailand at the

expense of other trading partners, that is, a result of trade diversion?

The preliminary analysis of the bilateral trade relationship between Thailand and Australia as

presented in section 4 suggested an expansion of trade between Thailand and Australia since

the TAFTA came into force. This naturally leads to the first hypothesis, which states that:

H1: The TAFTA has led to increased bilateral merchandise trade between Australia and

Thailand

To make any inferences about the welfare effects of the TAFTA on member countries or its

impact on the global trading system one must also determine whether there has been any

significant trade diversion. As bilateral trade between Australia and Thailand accounts for a

small share of world trade and according to Athukorala and Kohpaiboon (2011), and is

confined to a limited number of sectors, it is not expected that the TAFTA has significantly

diverted trade away from non-member countries. This leads to the development of the second

hypothesis, which states that:

16 Closely modelled on research questions presented in Clausing (2001)

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H2: The increase in merchandise trade between Australia Thailand due to TAFTA cannot be

accounted for by a reduction in TAFTA member trade with non-member countries.

Both of these hypotheses will be addressed through the addition of three dummy variables

(BOTHin, IMPORTERin and EXPORTERin), which allow us to isolate the trade creation and

trade diversion effects of TAFTA. A summary of these effects can be found in Appendix A 4.

6.2 Analysis of Data

Data Sources

This paper uses a strongly balanced panel data set consisting of annual observations for a

sample of 178 countries17 over the period 1998 to 2012 to evaluate the hypotheses outlined in

Section 6.1 (see Appendix A1 for a complete list of countries used). This length of period is

chosen to provide enough data to obtain consistent estimates while still remaining

computationally feasible, given the limited scope of this paper. The sample consists of 23891

country pairs, 285922 observations18, and is constructed by merging data aggregated at the

country level from a wide variety of sources

Following criticisms made by Baldwin and Taglioni (2006) on the use of incorrectly deflated

data, only nominal data is used in this study. Merchandise export data is taken from the

International Monetary Fund’s (IMF) Direction of Trade Statistics (DOTS) and used as a

measure of the volume of bilateral trade. Countries’ GDP and total population, obtained from

the World Bank’s World Development Indicators (WDI), are used as proxies for market size.

Data on distance, common language, adjacency and common colonial links are from Centre

d'Etudes Prospectives et d'Informations Internationales (CEPII)19. These dummy variables

are set constant during the sample period. Finally the TAFTA and AFTA dummies are

created by the authors using information obtained from the WTO’s RTA Database20. A full

list of variables can be found in Table 6.2 below. Descriptive statistics are reported in

Appendix A 5 and do not show any particularly noteworthy results.

17 As Australia and Thailand are both global traders and FTAs are part of a multilateral trading system, it is important to estimate the impact of TAFTA on all countries and not just member countries (DFAT, 2010). 18 Missing values are dropped from the sample. It is assumed, as in,Helpman et al (2008), that all non-reported information is zero. Missing values represent 39.50 % of total data. This implies there may be a selection bias. 19 Information sourced from: http://www.cepii.fr/anglaisgraph/bdd/distances.htm 20 Information sourced from : http://rtais.wto.org/UI/PublicMaintainRTAHome.aspx

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6.3 Initial Diagnostics

Some initial diagnostics were conducted to identify problems with the dataset before

conducting further analysis.

As the gravity model deals with observations that are potentially heterogeneous, the

assumption of homoscedasticity of the error term is likely violated. This assumption was

tested using a Wald test for group-wise heteroscedasticity in fixed effects models. The results

suggest that heteroscedasticity is present and it is for this reason that robust standard errors

have been used for all fixed effects regressions in this paper21.

As serial correlation is a common problem in macro panels (Wooldridge, 2002) a test for

autocorrelation in panel data is conducted that indicated the presence of significant serial

correlation22.

Leamer (1994) argued that it is important to look at the simple correlation matrix between

dependent and independent variables. Therefore, the bivariate relationship between the

explanatory variables is shown in Table 6.1, which displays the pair-wise correlations for all

of the explanatory variables used in the study.

There is a strong positive correlation between the level of exports and GDP with a stronger

correlation evident for GDP of the exporting country. See Appendix A 1 for a visualisation of

this relationship. There is also a positive correlation between the level of export and

population, with the relationship again being stronger on the export side. As expected, a

negative relationship exists between the level of exports and distance. See Appendix A 2 for a

visualisation of this relationship.

With respect to the variables of interest, it appears as though they are all significantly

correlated with the level of exports. It is interesting to note that the dummy for TAFTA trade

creation is not significantly correlated with the historical and cultural dummies. This is

intuitive as Thailand and Australia do not share a common language, are not contiguous and

have not shared a common coloniser.

21 H0: homoscedasticity , χ2(23891)= 5.6e+09 22 H0: no first order autocorrelation, F(1, 20665)=1686.864

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Table 6.1: Variable Correlation Matrix

lexports lgdp_exporter lgdp_importer lpop_exporter lpop_importer ldistcap colony contig comlang_off bothin exporterin importerin afta

lexports 1

lgdp_exporter 0.5491*** 1

lgdp_importer 0.3501*** 0.0305*** 1

lpop_exporter 0.3816*** 0.7239*** 0.0021 1

lpop_importer 0.2639*** 0.0021 0.7239*** -0.0046*** 1

ldistcap -0.2279*** -0.0547*** -0.0547*** -0.0478*** -0.0478*** 1

colony 0.1411*** 0.0854 *** 0.0854*** 0.0492** 0.0492*** -0.0610

*** 1

contig 0.1586*** 0.0370*** 0.0370*** 0.0669*** 0.0669*** -0.3558

*** 0.0944 *** 1

comlang_off 0.0100*** -0.0908 *** -0.0908*** -0.0707*** -0.0707*** -0.1158

*** 0.1402 ***

0.1077*** 1

bothin 0.0142*** 0.0082*** 0.0082*** 0.0051*** 0.0051*** 0.0014 -0.0006 -0.0008 -0.0024 1

exporterin 0.0647*** 0.1805*** 0.0114*** 0.0684*** 0.0013 0.0460 ***

-0.0041 ***

-0.0035 ** -0.0012 -0.0005 1

imrporterin 0.0338*** 0.0114*** 0.1085*** 0.0013 0.0684*** 0.0460 ***

-0.0041 ***

-0.0035

** -0.0012 -0.0005 -0.0006 1

afta 0.0564*** 0.0187*** 0.0187*** 0.0316*** 0.0316*** -0.1008

*** -0.0057

*** 0.0926*** -0.0113*** -0.0003 0.0332*** 0.0332*** 1

Source: Created by Authors Notes: (i) The symbols *, ** and *** denote statistical significance at the 10%, 5% and 1% levels respectively for a two tailed t-test. (ii) Shaded squares are indicative of a relationship with no significant correlation. (iii) Refer Table 4.2 for definitions of the variables.

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6.4 The Model

Following the methodology proposed by recent literature providing ex-post assessments of

trade agreements [(Clausing, 2001);(Martínez-Zarzoso and Nowak-Lehmann, 2003); and

(Carrère, 2006)] and using panel data this paper estimates a series of gravity equations using

several different models. Data is aggregated at the country level and the gravity equation is

augmented with three dummy variables denoting TAFTA membership. The three TAFTA

dummy variables follow the Vinerian specification of trade flow effects and represent trade

creation, export diversion and import diversion effects. The inclusion of these dummies

allows us to test the hypotheses outlined in section 6.1.

Unbiased and consistent estimates are obtained by including country-specific fixed effects

[see (Rose and Van Wincoop, 2001) and (Baldwin and Taglioni, 2006)] which are used as

proxies for the multilateral resistance terms (MRTs) proposed by Anderson and Van

Wincoop (2003). Time effects and country-pair effects are also included to control for

macroeconomic shocks to the global trading system and bias caused by country

heterogeneity, respectively. Further to this, the analysis considers differing impacts of time-

invariant and time-varying individual characteristics, as used by Baier and Bergstrand (2007).

Fixed effects models are used as they do not impose strong structural assumptions and are

consistent with general gravity theory (Head and Mayer, 2013).

6.4.1 Baseline Model Specification

The baseline augmented gravity equation used in this analysis is specified as follows:

𝑙𝑛𝑋𝑖𝑗𝑡 = 𝛼0 + 𝛽1𝑙𝑛𝑌𝑖𝑡 + 𝛽2𝑙𝑛𝑌𝑗𝑡 + 𝛽3𝑙𝑛𝑃𝑂𝑃𝑖𝑡 + 𝛽4𝑙𝑛𝑃𝑂𝑃𝑗𝑡 + 𝛽5ln (𝐷𝐼𝑆𝑇𝑐𝑎𝑝𝑖𝑗) +

𝜃1𝐵𝑂𝑇𝐻𝑖𝑛𝑖𝑗𝑡 + 𝜃2𝐸𝑥𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝜃3𝐼𝑚𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝛽6𝐴𝐹𝑇𝐴𝑖𝑗𝑡 + 𝛽7𝐶𝑜𝑛𝑡𝑖𝑔𝑖𝑗 +

𝛽8𝐶𝑜𝑚𝑐𝑜𝑙𝑖𝑗 + 𝛽9𝐶𝑜𝑚𝑙𝑎𝑛𝑔_𝑜𝑓𝑓𝑖𝑗 + 𝑢𝑖𝑗𝑡 (3)

where 𝑙𝑛 denotes variables in natural logs, all variables are defined as in Table 6.2 below and

𝑢𝑖𝑗𝑡 is assumed to be a log-normally distributed error term.

In line with the literature and the intuition that with a high level of income the exporting

(importing) country will attract a high level of exports (imports), 𝛽1 and 𝛽2 are expected to be

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positive. The impact of population on bilateral trade is ambiguous 23 .The coefficient for

distance, 𝛽5, is expected to be negative as it is being used as a proxy for trade costs. If both

countries i and j are members of the ASEAN-FTA they are expected to trade more with each

other, it is for this reason that 𝛽6, the coefficient for AFTA, is expected to be positive.

The dummy variables Contig, Comcol and Commlang_off represent factors that may explain

the volume of bilateral trade between two countries. Intuitively, one would expect countries

that share a common border and have common colonial links and official language to have

higher volumes of trade and it is for this reason that 𝛽7, 𝛽8 and 𝛽9 are expected to be positive.

Under this specification BOTHin, EXPORTERin and IMPORTERin are dummy variables that

measure the trade flow effects of TAFTA. A positive and statistically significant 𝜃1 is

suggestive of trade creation and indicates that bilateral trade between Australia and Thailand

is higher than normal trade levels. 𝜃2 (𝜃3) captures TAFTA member imports (exports) from

(to) the rest of the world and, depending on its sign and magnitude, may indicate trade

diversion. A summary of the effects can be found in Appendix A 4.

23 Larger populations may imply large domestic markets with less reliance on international trade, see Yang and Martínez-Zarzoso (2013) page 17, but also may be used as a proxy for the capital endowment ratio, see Carrère (2006) page 226

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Table 6.2: Reference Table for all Variables

Variable Name Exp. Description Data Source Xijt Value of Merchandise Exports NA Value of merchandise exports from country i to j at time t: Current USD, F.O.B IMF, DOTS GDPi(j)t Nominal Gross Domestic Product + Nominal gross domestic product of country i (j) at time t: Current USD World Bank, WDI 2012 Distcapij Geodesic Distance - Great circle distance24 between capital cities of countries i and j: Kilometres CEPII POPi(j)t Population +/- Total population of country i (j) at time t World Bank, WDI 2012 Contigij Contiguity + Dummy variable, 1 if countries share a common border, 0 otherwise CEPII Commlang_offij Official Common Language + Dummy variable, 1 if countries have a an official language in common, 0 otherwise CEPII Colonyij Common Coloniser + Dummy variable, 1 if countries have ever shared a colonial link25, zero otherwise CEPII IMPORTERinijt Importer in TAFTA + Dummy variable, 1 if only importing country is a member of 0 otherwise Created by authors EXPORTERinijt Exporter in TAFTA + Dummy variable, 1 if only exporting country is a member of TAFTA, 0 otherwise Created by authors BOTHinijt Both in TAFTA + Dummy variable, 1 if both countries are members of TAFTA, 0 otherwise. Created by authors AFTAij Both in ASEAN-FTA +/- Dummy variable, 1 if both countries are members of the ASEAN-FTA, 0 otherwise Created by authors

𝐼𝑖𝑗 Country Pair Effects NA Dummy variable, 1 for all observations of trade between i and j, 0 otherwise Fixed effects estimator 𝐼𝑖(𝑗) Time Invariant Country Effects NA Dummy variable, 1 if country is i (j), 0 otherwise Created by authors 𝐼𝑡 Time Effects NA Dummy variable, 1 if year is t, 0 otherwise Created by authors 𝐼𝑖𝑡(𝑗𝑡) Time Varying Country Effects NA Dummy variable, 1 if country is i(j) at time t, 0 otherwise Created by authors Source: Created by authors Notes: (i) The Variable column displays the syntax used to represent the variables, the Name column displays the name of the variables, the Description column describes the variables, the Expected Sign column (Exp.) displays the expected sign of the associated coefficient, and the Data Source column displays the source of the data. (ii) Note: CEPII variable definitions obtained from: http://www.cepii.fr/anglaisgraph/workpap/pdf/2011/wp2011-25.pdf

24 Great circle distance defined as the shortest distance measured on the earth’s surface. 25 Colonial link is defined as a relationship between two countries in which one has governed the other for some period of time and has contributed to the current state of its institutions.

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6.4.2 Analytical Specifications and Method

The baseline gravity model, Equation (3), is first estimated using pooled OLS to provide a

benchmark for the following analytical specifications. It is expected that the signs of the

explanatory variable coefficients will match the expectations as described above in 6.4.1. As

this specification does not consider heterogeneity caused by country and time-specific effects

the coefficients will be biased and inconsistent.

To partially correct for the bias caused by these individual differences, Equation (3) is

augmented to include time and country-specific effects [as in (Baldwin and Taglioni, 2006)]

as proxies for time-invariant MRTs , Equation (4) and is then estimated using pooled OLS.

𝑙𝑛𝑋𝑖𝑗𝑡 = 𝛼0 + 𝛽1𝑙𝑛𝑌𝑖𝑡 + 𝛽2𝑙𝑛𝑌𝑗𝑡 + 𝛽3𝑙𝑛𝑃𝑂𝑃𝑖𝑡 + 𝛽4𝑙𝑛𝑃𝑂𝑃𝑗𝑡 + 𝛽5ln (𝐷𝐼𝑆𝑇𝑐𝑎𝑝𝑖𝑗

+ 𝜃1𝐵𝑂𝑇𝐻𝑖𝑛𝑖𝑗𝑡 + 𝜃2𝐸𝑥𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝜃3𝐼𝑚𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝛽6𝐴𝐹𝑇𝐴𝑖𝑗𝑡

+ 𝛽7𝐶𝑜𝑛𝑡𝑖𝑔𝑖𝑗 + 𝛽8𝐶𝑜𝑚𝑐𝑜𝑙𝑖𝑗 + 𝛽9𝐶𝑜𝑚𝑙𝑎𝑛𝑔_𝑜𝑓𝑓𝑖𝑗 + 𝐼𝑖(𝑗) + 𝑢𝑖𝑗𝑡 (4)

where 𝐼𝑖(𝑗) is a time invariant dummy variable used to capture all country-specific

characteristics and control for a country’s overall level of exports. The coefficient estimates

from this regression are expected to be more accurate than those obtained from Equation (3).

As the use of panel data allows us to control for country-pair heterogeneity through country-

pair fixed effects, subsequent specifications use fixed effect models (FEM)26 to obtain more

accurate estimations.

The third model estimated, Equation (5), is a FEM with only country-pair fixed effects27.

(Kepaptsoglou et al., 2010)

𝑙𝑛𝑋𝑖𝑗𝑡 = 𝛼0 + 𝛽1𝑙𝑛𝑌𝑖𝑡 + 𝛽2𝑙𝑛𝑌𝑗𝑡 + 𝛽3𝑙𝑛𝑃𝑂𝑃𝑖𝑡 + 𝛽4𝑙𝑛𝑃𝑂𝑃𝑗𝑡 + 𝜃1𝐵𝑂𝑇𝐻𝑖𝑛𝑖𝑗𝑡

+ 𝜃2𝐸𝑥𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝜃3𝐼𝑚𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝛽6𝐴𝐹𝑇𝐴𝑖𝑗𝑡 + 𝐼𝑖𝑗 + 𝑢𝑖𝑗𝑡 (5)

where 𝐼𝑖𝑗 denotes country-pair fixed effects. These fixed effects are used to control for

country-pair heterogeneity. Note that the impact of time-invariant bilateral determinants, such

as distance, colony, common language and adjacency, are unable to be estimated using a

FEM due to perfect collinearity and they are therefore left out of the equation.

26 According to Kepaptsoglou et al. (2010), the FEM tends to provide more stable results and has been preferred in most studies. 27 Note: the country-pair fixed effect is equivalent to the classic fixed effects model estimator.

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According to Anderson and Van Wincoop (2003), Equation (5) is incorrectly specified due to

the omission of multilateral trade-resistance terms (MRTs). In order to incorporate MRTs

into this analysis, country specific importer and exporter effects are used, as in (Baldwin and

Taglioni, 2006). The fourth model to be estimated, Equation (6), builds upon the previous

specification and includes a time dummy variable and exporter and importer effects.

𝑙𝑛𝑋𝑖𝑗𝑡 = 𝛼0 + 𝛽1𝑙𝑛𝑌𝑖𝑡 + 𝛽2𝑙𝑛𝑌𝑗𝑡 + 𝛽3𝑙𝑛𝑃𝑂𝑃𝑖𝑡 + 𝛽4𝑙𝑛𝑃𝑂𝑃𝑗𝑡 + 𝜃1𝐵𝑂𝑇𝐻𝑖𝑛𝑖𝑗𝑡

+ 𝜃2𝐸𝑥𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝜃3𝐼𝑚𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝛽6𝐴𝐹𝑇𝐴𝑖𝑗𝑡 + 𝐼𝑖𝑗 + 𝐼𝑡

+ 𝐼𝑖(𝑗) + 𝑢𝑖𝑗𝑡 (6)

where 𝐼𝑡 is a time dummy variable used to eliminate bias caused by aggregate shocks to

world trade, eg. 2008 global financial crisis, and the time-invariant country specific effects,

as used in Equation (4) ,are used to control for all time invariant country characteristics.

A joint F test was conducted to determine whether time fixed effects were needed when

running further FEM. The results indicated that time fixed effects should be included in any

further analysis28.

Baier and Bergstrand (2007) note, however, that multilateral resistance is likely to be time-

varying. The fifth model to be estimated, Equation (7), therefore includes time-varying

country specific fixed effects to control for the time-varying MRTs.

𝑙𝑛𝑋𝑖𝑗𝑡 = 𝛼0 + 𝛽1𝑙𝑛𝑌𝑖𝑡 + 𝛽2𝑙𝑛𝑌𝑗𝑡 + 𝛽3𝑙𝑛𝑃𝑂𝑃𝑖𝑡 + 𝛽4𝑙𝑛𝑃𝑂𝑃𝑗𝑡 + 𝜃1𝐵𝑂𝑇𝐻𝑖𝑛𝑖𝑗𝑡

+ 𝜃2𝐸𝑥𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝜃3𝐼𝑚𝑝𝑜𝑟𝑡𝑒𝑟𝑖𝑛𝑖𝑗𝑡 + 𝛽6𝐴𝐹𝑇𝐴𝑖𝑗𝑡 + 𝐼𝑖𝑗 + 𝐼𝑡

+ 𝐼𝑖𝑡 + 𝐼𝑗𝑡 + 𝑢𝑖𝑗𝑡 (7)

where 𝐼𝑖𝑡 and 𝐼𝑗𝑡 are importer and exporter time varying individual effects. Note that these

effects make the estimation of country-specific variables, such as GDP, impossible due to

perfect collinearity (UN and WTO, 2012).

Equation (7) follows a specification outlined in UN and WTO (2012) which pairs time-

varying country specific effects, country-pair effects and time dummies. Interestingly, some

of the empirical literature seems to favour specifications omitting the time dummies.

To discern the impact of macroeconomic shocks on the magnitude of TAFTA’s dummy

variables, a final model is estimated, Equation (7), with the time dummy omitted.

28 H0: all year dummies jointly =0, F(14, 23890)=18.40

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6.5 Empirical Results

The gravity equations specified above in Section 6.5 are estimated to ascertain the trade flow

effects of the TAFTA. The variables of interest are BOTHin, IMPORTERin and

EXPORTERin. The regression results are presented below in Table 6.3 which displays the

regression results with the log value of exports as the dependent variable .The variables of

interest are EXPORTERin, IMPORTERin and BOTHin..

Columns (I) and (II) of Table 6.3 show the regression results using pooled OLS to estimate

Equation (3) and Equation (4), respectively. The R-squared improves with the inclusion of

fixed effects in Column (II), suggesting that this specification describes the data more

accurately. The signs of the estimated coefficients match prior expectations and the

coefficients of our variables of interest are all positive and significant at the one-percent

level, with the exception of IMPORTERin in Column (II). These results are suggestive of

significant pure trade creation in terms of both exports and imports.

From the previous discussion, we know, however, that the coefficients of both of these

regressions are biased due to the omission of country-pair fixed effects. This bias will more

severe in column (I) where no effort is made to control for unobserved country specific

effects. The coefficients presented in column (II), although less severely biased, will still not

account for the time-invariant nature of multilateral resistance terms. The difference between

the coefficients in Column (I) and (II) indicates the severity of bias caused by exclusion of

country fixed effects and emphasises the importance of including multilateral resistance

terms in gravity analysis. It is interesting to also note that the coefficients for AFTA and

lpop_exporter switch signs.

Column (III) displays the results for a model including country-pair fixed effects, as in

Equation (5). This specification used country-pair fixed effects to mitigate the bias generated

by heterogeneity. The coefficient for intra-TAFTA trade (BOTHin) remains positive and

statistically significant; however, the coefficients for the exporter and importer effects of

TAFTA are no longer significant. This suggests that TAFTA has created trade between

Australia and Thailand and had no significant effects on both countries’ trade with the rest of

the world. Note that the AFTA coefficient is no longer significant.

As discussed in section 6.4.2 above, the use of a fixed effects model prevents the estimation

of coefficient of time-invariant variables (eg. lDistcap) due to perfect collinearity. A

21

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Hausman Chi-Squared test was conducted to determine whether fixed or random effects are

more suitable. The results suggest that a fixed effect model is most suitable and rejects the

use of a random effect model 29. The results for the random effect model are shown in

Appendix A 6.

Column (IV) displays the results from a FEM with time, country-specific and country- pair

fixed effects, Equation (6). These effects are used to control for macroeconomic shocks,

country-pair heterogeneity and endogeneity caused by time-invariant MRTs. Compared with

Column (III), the coefficients of our variables of interest remain positive, decrease in

magnitude slightly and in the case of BOTHin., remain statistically significant. The value of

R-squared increases slightly from 14.1% to 14.2 %. The similar results suggest that there is

not much bias caused by time-invariant MRTs.

The results for the model, Equation (7), including time-varying fixed effects for the exporter

and importer, are presented in Column (V). As defined in Table 6.2 above, the variables of

interest vary in three dimensions: importer; exporter; and time. Baier and Bergstrand (2007)

recommend that models include exporter and importer time-varying effects to control for all

determinants of trade that vary in those dimensions. The results, presented in Column (V),

provide unbiased estimates for BOTHin, IMPORTERin and EXPORTERin. The coefficient

for BOTHin remains positive and statistically significant (at the 10% level), which suggests

that the TAFTA has caused bilateral trade between Australia and Thailand to increase. The

average treatment effect is 30.6% 30 higher than expected from normal levels of trade. The

coefficients for IMPORTERin and EXPORTERin are not found to be statistically significant,

which suggests that TAFTA has had no significant effects on Australia and Thailand’s trade

with the rest of the world. Additionally, the R-squared is improved from the preceding FEMs

estimated.

Finally, Column (VI) displays the regression results for the modified Equation (7) with the

time dummy omitted. The results when compared with the previous column are quite

shocking. The coefficients of the variables of interest are now all statistically significant (at

the 1% level) and the magnitudes of each effect are notably larger with comparable standard

errors. These results support the findings of a test conducted earlier, which determined that

time effects should be included in our analysis. As our panel data set covers a period in which

29 H0: RE model preferred, Hausman’s χ2(8)= 7042.21 30 Calculated: Average treatment effect= (exp(0.267)-1)*100)

22

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there have been significant macroeconomic shocks, e.g. the 2008 global financial crisis, the

disparate results are not surprising.

In conclusion, using annual data over a 14 year period extending from 1998 to 2012, the

results suggest that trade liberalisation under TAFTA has resulted in modest trade creation

with no evidence found to support the view that this is at the expense of trade diversion.

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Table 6.3: Gravity Model Regression Results

(I)

Pooled OLS (II)

OLS with FE (III)

FE (1) (IV)

FE (2) (V)

FE (3) (VI)

FE (4) Variable Exp Coeff. R.S.E Coeff. R.S.E.

Coeff. R.S.E. Coeff. R.S.E. Coeff. R.S.E. Coeff. R.S.E.

Constant +/- -24.26*** -0.0946 1.634 -1.161 -16.33*** -1.36 -14.29*** -1.838 14.39 - 14.30*** -0.0392 lgdp_importer + 0.817*** -0.00291 0.580*** -0.0207 0.719*** -0.0188 0.675*** -0.0221 lgdp_exporter + 1.190*** -0.003 0.331*** -0.0239 0.464*** -0.0211 0.418*** -0.028 lpop_importer +/- 0.0599*** -0.00356 0.369*** -0.0635 0.376*** -0.0717 0.384*** -0.0738 lpop_exporter +/- 0.00815** -0.00376 -0.406*** -0.0725 -0.234*** -0.0809 -0.228*** -0.0836

ldistcap - -1.326*** -0.00586 -1.706*** -0.00689 colony + 1.109*** -0.0262 1.065*** -0.0273

comlang_off + 0.976*** -0.0135 0.833*** -0.0142

contig + 0.970*** -0.0273 0.727*** -0.0284

afta +/- 1.381*** -0.0699 -0.698*** -0.0615 -0.386 -0.273 -0.351 -0.273

BOTHin + 3.178*** -0.142 1.118*** -0.0741 0.394*** -0.0517 0.387*** -0.0517 0.267* 0.145 0.693*** -0.144

EXPORTERin + 0.843*** -0.0388 0.128*** -0.0411 0.039 -0.0413 0.0314 -0.0415 0.0377 -

0.0361 0.272*** -0.0345

IMPORTERin + 0.472*** -0.0494 0.123* -0.066 0.121 -0.0753 0.114 -0.0756 0.0765 -

0.0777 0.311*** -0.0769 Observations 271,109 271,109 271,109 271,109 285,922 285,922

Number of pairid - - 23,891 23,891 24, 663 24,663 R-squared 0.623 0.724 0.141 0.142 0.189 0.185

𝐼𝑡 NO YES NO YES YES NO 𝐼𝑖𝑡(𝑗𝑡) NO NO NO NO YES YES 𝐼𝑖(𝑗) NO YES NO YES NO NO 𝐼𝑖𝑗 NO NO YES YES YES YES

Source: Created by Authors Notes: (i)‘Exp.’ refers to the expected sign of the coefficient, FE stands for fixed effect(s) and R.S.E. stands for robust standard error (ii) The estimates for the fixed effects are omitted due to space considerations; however it is indicated where they are included. (iii) The symbols *, ** and *** denote statistical significance at the 10%, 5% and 1% levels respectively. (iv). Variable definitions are provided in Table 4.2

24

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6.6 Robustness and Sensitivity Analysis

Sensitivity

As Ghosh and Yamarik (2004) suggest that coefficient estimates from gravity equations are

highly sensitive to model specification, a sensitivity analysis was conducted to determine

how the results are affected when one or more of the variables are omitted from the

regression. Using existing extreme bounds analysis literature as a guide, a systematic series

of fixed effects regressions are run to assess the sensitivity of the estimated coefficients of all

non-core (testing) variables. The results from this analysis are shown below in Table 6.5.The

core variables are those required to specify the baseline gravity model and the testing

variables are all other variables used in the study.

As expected, both exporter and importer GDP are highly robust in a basic fixed effects

model. It is also found that both exporter and importer population are significant in all

possible iterations. Of our variables of interest, BOTHin is significant in all iterations and

IMPORTERin and EXPORTERin are not. Due to the parsimonious nature of the

specifications examined these results come as no surprise.

Econometric Concerns

An additional econometric concern not dealt with in earlier chapters is the presence of zero

trade flows in the data. The sample had a potential of 472590 observations, however missing

values are reported are for 39.5% of observations resulting in 285922 useable observations. If

these missing values truly indicate zero trade flows, dropping them from the sample will

result in a loss of information and estimations will produce inconsistent results (UN and

WTO, 2012)31. As in (Brun et al., 2005), zeroes are replaced with Xijt=1 and the total number

of observations is increased by 65.3%. The results are reported below in Table 6.4 which

displays the regression results with the log value of exports as the dependent variable. The

variables of interest are EXPORTERin, IMPORTERin and BOTHin.

31 See section Error! Reference source not found. for a more in depth discussion on the issue of zero trade flows.

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When compared to the regression results in Table 6.3, it is evident that dropping zero trade

values from the data may have caused the results to be biased. The results are fairly similar

when comparing the core gravity variables; however, the TAFTA variables are significantly

different, with changes in signs. A test for selection bias would ideally be performed at this

stage; however this is outside the limited scope of this paper.

Based on the robustness results discussed in this chapter, it is evident that strong conclusions

are not able to be drawn from this analysis and the findings of trade creation under TAFTA

should be taken with a grain of salt.

Table 6.4:Regression Results for Robustness Study Addressing Zero Trade Flows

(I)

FE(1) (II)

FE(2) (III)

FE (3) Variable Exp Coeff. R.S.E Coeff. R.S.E Coeff. R.S.E Constant +/- -35.95*** -2.654 -6.034* 3.597 8.989*** -0.14

lgdp_importer + 1.186*** -0.0359 0.921*** 0.0436 lgdp_exporter + 0.583*** -0.0361 0.321*** 0.0455 lpop_importer +/- 0.294* -0.158 -0.278* 0.166 lpop_exporter +/- -0.0478 -0.152 -0.619*** 0.156

Afta +/- 1.126 -0.968 0.830 0.975 BOTHin + -0.0764* -0.0463 -0.171*** 0.0469 -0.267 -0.207

EXPORTERin + -0.276*** -0.0744 -0.345*** 0.0741 -0.119* -0.0646 IMPORTERin + 0.571*** -0.152 0.501*** 0.151 0.222 -0.162

Observations 389,297 389, 297 415,726 Number of pairid 26,998 26,998 27,878

R-squared 0.072 0.075 0.136 𝐼𝑡 NO YES YES

𝐼𝑖𝑡(𝑗𝑡) NO NO YES 𝐼𝑖(𝑗) NO YES NO 𝐼𝑖𝑗 YES YES YES

Source: Created by Authors Notes: (i) ‘Exp.’ refers to the expected sign of the coefficient, FE stands for fixed effect(s) and R.S.E. stands for robust standard error (ii) The estimates for the fixed effects are omitted due to space considerations; however it is indicated where they are included. (iii) The small constant is added to trade flows before taking logarithms. (iv) The symbols *, ** and *** denote statistical significance at the 10%, 5% and 1% levels respectively. (v) Variable definitions are provided in Table 6.2

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Table 6.5: Summary Statistics from Sensitivity Analysis

Core variables Max Min Mean

AvgSTD PercSig Perc+ Perc- AvgT Obs

lgdp_importer

0.757873058

0.713912904

0.735769602

0.01911323 1 1 0

38.56126297 512

lgdp_exporter

0.473798782

0.441425771

0.45814902

0.021531766 1 1 0

21.27982676 512

Testing –variables Max Min Mean

AvgSTD PercSig Perc+ Perc- AvgT Obs

Bothin 0.398996

651 0.382327

408 0.390581

174 0.05953

8736 1 1 0 6.58994

9086 256 Importerin

0.12117976

0.106226355

0.113541038

0.078915569 0 1 0

1.438778721 256

Exporterin

0.048461806

0.037254144

0.043057884

0.043350366 0 1 0

0.993155321 256

lpop_exporter

-0.207481

399

-0.235163

51

-0.221228

751 0.08430

7993 1 0 1 2.62348

4716 256 lpop_importer

0.376438707

0.356366873

0.36633356

0.074836333 1 1 0

4.894833118 256

Afta

-0.370708

168

-0.393347

561

-0.381827

43 0.28462

7472 0 0 1 1.34150

9711 256 Source: Created by Authors Notes: (i) Max, Min and Mean are respectively the maximum, minimum and mean value of the coefficients over all regressions. AvgSTD and AvgT are averages of the standard deviations and t-values, respectively. PercSig gives share of regressions where the coefficient was significant. Perc+ indicates the number of times the coefficient had a positive sign and analogously for Perc-. (ii) The statistics are obtained using robust standard errors in a model with fixed country-pair effects and time-invariant effects have been omitted.

7 Summary and Policy Implications

The aim of this study was to determine whether the TAFTA has had an impact on bilateral

merchandise trade between Australia and Thailand, through trade creation, and to examine

what extent of this was a result of trade diversion. It is a widely held view that FTAs are trade

creating, yet model uncertainty and econometric issues surrounding the gravity model have

led to mixed results in studies examining the ex-post trade flow effects of FTAs

This paper assesses two hypotheses. Firstly, that the TAFTA has led to an increase in

bilateral merchandise trade between Australia and Thailand. Secondly, that this increase in

bilateral trade has not been the result of trade diversion away from TAFTA non-member

countries. To assess these hypotheses, data aggregated at the country level, including 178

countries and covering the period from 1998 to 2012, was used to estimate a series of

augmented gravity equations.

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The endogeneity problem commonly found in gravity analyses is addressed through the use

of time-invariant and time-varying country-specific effects as suggested by Baldwin and

Taglioni (2006), Baier and Bergstrand (2007) and Martínez-Zarzoso et al. (2009). The

inclusion of these fixed effects means that unbiased estimates of the trade flow effects of the

TAFTA could be obtained. Additionally, the use of panel data allows for the mitigation of

bias generated by heterogeneity across countries through the inclusion of country-pair fixed

effects (UN and WTO, 2012).

According to the estimated results, the TAFTA has resulted in modest trade creation (at the

10% level) with no significant trade diversion effects detected. These results come as no great

surprise. As trade liberalisation under TAFTA is still occurring, it is unlikely that the full

extent of the trade flow effects of TAFTA will be realised until this process is complete32.

DFAT (2010) indicate that there is likely to be a lag between the entry into force of the

TAFTA and the realisation of its larger economic impacts. The robustness analysis conducted

suggested that these results should be viewed with caution due to potential selection bias

caused by dropping zero trade flows from the data.

These results have several implications. Firstly, the findings reiterate the importance of

controlling for bias caused by heterogeneity and endogeneity in gravity models. The analysis

shows that the use of standard OLS estimation of gravity equations likely leads to severe bias

and misleading results. Time-invariant and time-varying country effects should be included to

capture all country-specific characteristics and provide a proxy for the multilateral resistance

terms proposed by Anderson and Van Wincoop (2003). Fixed time effects should also be

included to capture any macroeconomic shocks to the global economic environment that may

influence international trade.

Based on the finding that TAFTA has created trade, the results add to the existing literature

and widespread belief suggesting that FTAs are, in general, trade creating. In light of this,

trade liberalisation under TAFTA can be considered an effective addition to the growing

number of bilateral and plurilateral agreements in the South East Asian region.

32According to CIE (2004) , TAFTA is predicted to have a larger economic impact in Thailand due to their higher initial trade barriers.

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7.1 Limitations and suggestions for future research

There are several limitations to the findings presented in this study. Firstly, the study only

examined the impact of the TAFTA on merchandise trade and did not consider the impact on

services trade. It is important to note that the amount of bilateral trade in services between

Australia and Thailand is not insignificant and therefore further assessments of the TAFTA’s

impact on trade should attempt to incorporate services trade in the analysis.

A second limitation of this study emanates from the use of aggregated trade data. As the

removal of trade barriers is often not equal between sectors, it is feasible to presume that

trade liberalisation under the TAFTA will have had a differing impact on different sectors.

Clausing (2001) notes that the use of aggregate data may mask changes that are occurring at a

disaggregate level and several existing studies [See Chiasakul et al. (2010); Kohpaiboon

(2008); Athukorala and Kohpaiboon (2011); and Siddique (2013)] of TAFTA have suggested

that this may be the case with increases in trade confined to a limited number of sectors.

A third limitation of this study stems from the use of the gravity model. As the gravity model

has been applied in such a large number of empirical studies, the model’s limitations and

econometric modelling issues have been well documented and explored in depth by many

authors33. These issues include endogeneity bias34, selection bias due to model uncertainty35

omitted variable bias36, bias caused by heterogenous trading relationships37, the prevalence of

zero values in trade flow data38, incorrect deflation of trade flows39, the use of averaged trade

flows40, and the omission of non-tariff barrier variables41. This paper takes these issues into

consideration and uses panel data, includes time-invariant country specific effects as proxies

for MRTs, country-pair effects to control for bilateral heterogeneity and assumes that all non-

reported information reflects zero trade flows.

33 Baldwin and Taglioni (2006), De Benedictis and Taglioni (2011), UN an WTO (2012) and Head and Mayer (2013) provide useful summaries of the gravity equation’s estimation issues. 34 See Ghosh and Yamarik (2004); UN and WTO (2012); Hausman and Taylor (1981); and Baier and Bergstrand (2004, 2007, 2009) 35 See Ghosh and Yamarik (2004) 36 See Anderson and Van Wincoop (2003); and UN and WTO (2012) 37 See Cheng and Wall (1999); Egger (2000); Egger and Pfaffermayr (2003); and Baier and Bergstrand (2004) 38 See UN and WTO (2012) 39 Nominal trade flows are used in this paper. See Baldwin and Taglioni (2006) or Benedictis and Taglioni (2011) for a discussion about conversion issues. 40 Unidirectional export flows are used as the dependent variable in this paper. See Baldwin and Taglioni (2006) or Benedictis and Taglioni (2011) for a discussion about typology issues. 41 Novy (2013) raises the problem that traditional gravity analysis omit many trade cost components, such as non-tariff barriers, as it is difficult to find empirical proxies for them

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A fourth limitation of this study is that trade liberalisation under the TAFTA is still being

implemented. The longer phase in period for Thailand means that the full extent of the

TAFTA’s impact on trade flows will not be able to be estimated until 2025 at the earliest,

when Thailand’s tariffs on Australian imports are scheduled to be eliminated. DFAT (2010)

note this in a review of Australia’s bilateral and regional trade agreements and state that due

to the staged implementation of trade liberalisation under TAFTA too few years may have

passed to effectively assess the effects of the agreement. It would be beneficial for a similar

analysis to this paper to be conducted at a later date to capture more completely the impact of

the TAFTA.

Finally, it is important to note that FTAs have effects beyond trade creation and diversion,

that is they are not just about improving market access but also aim to deal with non-tariff

barriers beyond the border. It is evident that the TAFTA goes beyond the removal of tariffs

on merchandise trade and aims to deal with non-tariff barriers such as customs procedures,

electronic commerce, competition policy, intellectual property and government procurement.

Future studies should, hence, attempt to incorporate the liberalisation of non-tariff barriers.

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WTO 2013. Regional Trading Agreements Database. http://rtais.wto.org/UI/PublicMaintainRTAHome.aspx: World Trade Organisation

YANG, S. & MARTÍNEZ-ZARZOSO, I. 2013. A Panel Data Analysis of Trade Creation and Trade Diversion Effects: The case of ASEAN-China Free Trade Area (ACFTA). Ibero-America Institute for Economic Research.

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Appendix A 1: Scatter Plot and Line of Best Fit for Exports vs Combined GDP(Exporter*Importer)

Source: Created by authors

A 2 Scatter Plot and Line of Best Fit for Exports vs Distance

Source: Created by authors

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A 3: List of Countries and Corresponding Country Codes

Country code

Country Name

ABW Aruba AFG Afghanistan, Islamic Republic of AGO Angola ALB Albania ARE United Arab Emirates ARG Argentina ARM Armenia, Republic of AUS Australia AUT Austria AZE Azerbaijan, Republic of BDI Burundi BEN Benin BFA Burkina Faso BGD Bangladesh BGR Bulgaria BHR Bahrain, Kingdom of BHS Bahamas, The BIH Bosnia and Herzegovina BLR Belarus BLX Belgium-Luxembourg BLZ Belize BMU Bermuda BOL Bolivia BRA Brazil BRB Barbados BRN Brunei Darussalam CAF Central African Republic CAN Canada CHE Switzerland CHL Chile CHN China, P.R.: Mainland CIV Cote d'Ivoire CMR Cameroon COG Congo, Republic of COL Colombia COM Comoros CPV Cape Verde CRI Costa Rica CUB Cuba CYP Cyprus CZE Czech Republic DEU Germany DJI Djibouti DMA Dominica DNK Denmark DOM Dominican Republic DZA Algeria ECU Ecuador EGY Egypt ESP Spain EST Estonia ETH Ethiopia FIN Finland FJI Fiji

FRA France FRO Faroe Islands GAB Gabon GBR United Kingdom GEO Georgia GHA Ghana GIN Guinea GMB Gambia, The GNB Guinea-Bissau GNQ Equatorial Guinea GRC Greece GRD Grenada GRL Greenland GTM Guatemala GUY Guyana HKG China, P.R.: Hong Kong HND Honduras HRV Croatia HTI Haiti HUN Hungary IDN Indonesia IND India IRL Ireland IRN Iran, Islamic Republic of IRQ Iraq ISL Iceland ISR Israel ITA Italy JAM Jamaica JOR Jordan JPN Japan KAZ Kazakhstan KEN Kenya KGZ Kyrgyz Republic KHM Cambodia KNA St. Kitts and Nevis KOR Korea, Republic of KWT Kuwait LAO Lao People's Democratic Republic LBN Lebanon LBR Liberia LBY Libya LCA St. Lucia LKA Sri Lanka LTU Lithuania LVA Latvia MAC China, P.R.: Macao MAR Morocco MDA Moldova MDG Madagascar MDV Maldives MEX Mexico MKD Macedonia, FYR MLI Mali MLT Malta MMR Myanmar

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MNG Mongolia MOZ Mozambique MRT Mauritania MUS Mauritius MWI Malawi MYS Malaysia NCL French Territories: New Caledonia NER Niger NGA Nigeria NIC Nicaragua NLD Netherlands NOR Norway NPL Nepal NZL New Zealand OMN Oman PAK Pakistan PAN Panama PER Peru PHL Philippines PNG Papua New Guinea POL Poland PRK Korea, Democratic People's Rep. of PRT Portugal PRY Paraguay QAT Qatar ROM Romania RUS Russian Federation RWA Rwanda SAU Saudi Arabia SDN Sudan SEN Senegal SGP Singapore SLB Solomon Islands SLE Sierra Leone SLV El Salvador

SOM Somalia STP Sao Tome and Principe SUR Suriname SVK Slovak Republic SVN Slovenia SWE Sweden SYC Seychelles SYR Syrian Arab Republic TCD Chad TGO Togo THA Thailand TJK Tajikistan TKM Turkmenistan TON Tonga TTO Trinidad and Tobago TUN Tunisia TUR Turkey TZA Tanzania UGA Uganda UKR Ukraine URY Uruguay USA United States UZB Uzbekistan VCT St. Vincent and the Grenadines VEN Venezuela, Republica Bolivariana de VNM Vietnam VUT Vanuatu WSM Samoa YEM Yemen, Republic of ZAF South Africa ZAR Congo, Democratic Republic of ZMB Zambia ZWE Zimbabwe

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A 4 :Possible Trade Flow Effects of TAFTA

Exporter effects Importer effects 𝜃2>0 𝜃2<0 𝜃3>0 𝜃3<0

Intra TAFTA trade

𝜃1>0 Pure TC(X) TC+XD(𝜃1>𝜃2) or XD (𝜃1<𝜃2)

Pure TC(M) TC+MD(𝜃1>𝜃3) or MD(𝜃1<𝜃3)

𝜃1<0 XE XD + XC ME MD+MC Source: Table 1, Yang and Martínez-Zarzoso (2013) Notes: (i) θ_1 is the coefficient of BOTHin which denotes intra-TAFTA trade. θ_2 is the coefficient of EXPORTERin which denotes exports from member countries to non-member countries. θ_3 is the coefficient of IMPORTERin which denotes imports from member countries to non-member countries. (ii) TC(X) and TC(M) denote trade creation in terms of exports and imports, respectively. XD and MD denote trade diversion in terms of exports and imports, respectively. XE and ME denote expansion of extra-TAFTA exports and imports, respectively. XC and MC denote contraction of intra-FTA exports and imports, respectively.

A 5: Descriptive Statistics for Explanatory Variables

This table reports descriptive statistics for the explanatory variables. Refer to Table 6.2 for variable definitions.

Variable Obs.

Mean

S. D.

Min.

Max. lGDP 472590 23.7757 2.321659 18.15228 30.38371 lDISTCAP 472590 8.734909 0.7745998 2.349362 9.898699 lPOP 472590 15.66363 2.017288 10.70079 21.02389 CONTIG 472590 0.0171713 0.1298485 0 1 COMLANG_OFF 472590 0.141973 0.3489546 0 1 COLONY 472590 0.0111725 0.1048055 0 1 BOTHin 472590 0.0000339 0.0058185 0 1 EXPORTERin 472590 0.0059587 0.0769621 0 1 IMPORTERin 472590 0.0059587 0.0769621 0 1 AFTA 472590 .0028185 .0530148 0 1 Source: Created by Authors Notes: (i) ’Obs.’ refers to the number of observations and ‘S.D.’ refers to the standard deviation. (ii) As the descriptive statistics for both lGDP(lPOP)_exporter and lGDP(lPOP)_importer are identical, only one is reported, lGDP (lPOP)

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A 6: Regression Results for Random Effects Model

This table shows the regression results for the random effects model as used in the Hausman Chi squared test in section 6.5. The log value of exports as the dependent variable and variable definitions are provided in Table 6.2

Variable Exp Coeff. R.S.E. Constant +/- -23.03*** -0.326

lgdp_importer + 0.804*** -0.00975 lgdp_exporter + 1.033*** -0.0111 lpop_importer +/- 0.0796*** -0.0111 lpop_exporter +/- 0.146*** -0.012

ldistcap - -1.361*** -0.0191 colony + 1.476*** -0.0921

comlang_off + 1.004*** -0.0428 contig + 1.015*** -0.0961 afta +/- 0.933*** -0.236

BOTHin + 0.576*** -0.0915 EXPORTERin + 0.127*** -0.0425 IMPORTERin + 0.147** -0.0744 Observations 271,109

Number of pairid 23,891 R-squared

Source: Created by Authors Notes: (i) ‘Exp.’ refers to the expected sign of the coefficient, FE stands for fixed effect(s) and R.S.E. stands for robust standard error. (ii). The symbols *, ** and *** denote statistical significance at the 10%, 5% and 1% levels respectively.

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Editor, UWA Economics Discussion Papers: Ernst Juerg Weber Business School – Economics University of Western Australia 35 Sterling Hwy Crawley WA 6009 Australia Email: [email protected] The Economics Discussion Papers are available at: 1980 – 2002: http://ecompapers.biz.uwa.edu.au/paper/PDF%20of%20Discussion%20Papers/ Since 2001: http://ideas.repec.org/s/uwa/wpaper1.html Since 2004: http://www.business.uwa.edu.au/school/disciplines/economics

ECONOMICS DISCUSSION PAPERS 2012

DP NUMBER AUTHORS TITLE

12.01 Clements, K.W., Gao, G., and Simpson, T.

DISPARITIES IN INCOMES AND PRICES INTERNATIONALLY

12.02 Tyers, R. THE RISE AND ROBUSTNESS OF ECONOMIC FREEDOM IN CHINA

12.03 Golley, J. and Tyers, R. DEMOGRAPHIC DIVIDENDS, DEPENDENCIES AND ECONOMIC GROWTH IN CHINA AND INDIA

12.04 Tyers, R. LOOKING INWARD FOR GROWTH

12.05 Knight, K. and McLure, M. THE ELUSIVE ARTHUR PIGOU

12.06 McLure, M. ONE HUNDRED YEARS FROM TODAY: A. C. PIGOU’S WEALTH AND WELFARE

12.07 Khuu, A. and Weber, E.J. HOW AUSTRALIAN FARMERS DEAL WITH RISK

12.08 Chen, M. and Clements, K.W. PATTERNS IN WORLD METALS PRICES

12.09 Clements, K.W. UWA ECONOMICS HONOURS

12.10 Golley, J. and Tyers, R. CHINA’S GENDER IMBALANCE AND ITS ECONOMIC PERFORMANCE

12.11 Weber, E.J. AUSTRALIAN FISCAL POLICY IN THE AFTERMATH OF THE GLOBAL FINANCIAL CRISIS

12.12 Hartley, P.R. and Medlock III, K.B. CHANGES IN THE OPERATIONAL EFFICIENCY OF NATIONAL OIL COMPANIES

12.13 Li, L. HOW MUCH ARE RESOURCE PROJECTS WORTH? A CAPITAL MARKET PERSPECTIVE

12.14 Chen, A. and Groenewold, N. THE REGIONAL ECONOMIC EFFECTS OF A REDUCTION IN CARBON EMISSIONS AND AN EVALUATION OF OFFSETTING POLICIES IN CHINA

12.15 Collins, J., Baer, B. and Weber, E.J. SEXUAL SELECTION, CONSPICUOUS CONSUMPTION AND ECONOMIC GROWTH

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ECONOMICS DISCUSSION PAPERS 2012

DP NUMBER AUTHORS TITLE

12.16 Wu, Y. TRENDS AND PROSPECTS IN CHINA’S R&D SECTOR

12.17 Cheong, T.S. and Wu, Y. INTRA-PROVINCIAL INEQUALITY IN CHINA: AN ANALYSIS OF COUNTY-LEVEL DATA

12.18 Cheong, T.S. THE PATTERNS OF REGIONAL INEQUALITY IN CHINA

12.19 Wu, Y. ELECTRICITY MARKET INTEGRATION: GLOBAL TRENDS AND IMPLICATIONS FOR THE EAS REGION

12.20 Knight, K. EXEGESIS OF DIGITAL TEXT FROM THE HISTORY OF ECONOMIC THOUGHT: A COMPARATIVE EXPLORATORY TEST

12.21 Chatterjee, I. COSTLY REPORTING, EX-POST MONITORING, AND COMMERCIAL PIRACY: A GAME THEORETIC ANALYSIS

12.22 Pen, S.E. QUALITY-CONSTANT ILLICIT DRUG PRICES

12.23 Cheong, T.S. and Wu, Y. REGIONAL DISPARITY, TRANSITIONAL DYNAMICS AND CONVERGENCE IN CHINA

12.24 Ezzati, P. FINANCIAL MARKETS INTEGRATION OF IRAN WITHIN THE MIDDLE EAST AND WITH THE REST OF THE WORLD

12.25 Kwan, F., Wu, Y. and Zhuo, S. RE-EXAMINATION OF THE SURPLUS AGRICULTURAL LABOUR IN CHINA

12.26 Wu, Y. R&D BEHAVIOUR IN CHINESE FIRMS

12.27 Tang, S.H.K. and Yung, L.C.W. MAIDS OR MENTORS? THE EFFECTS OF LIVE-IN FOREIGN DOMESTIC WORKERS ON SCHOOL CHILDREN’S EDUCATIONAL ACHIEVEMENT IN HONG KONG

12.28 Groenewold, N. AUSTRALIA AND THE GFC: SAVED BY ASTUTE FISCAL POLICY?

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ECONOMICS DISCUSSION PAPERS 2013

DP NUMBER AUTHORS TITLE

13.01 Chen, M., Clements, K.W. and Gao, G.

THREE FACTS ABOUT WORLD METAL PRICES

13.02 Collins, J. and Richards, O. EVOLUTION, FERTILITY AND THE AGEING POPULATION

13.03 Clements, K., Genberg, H., Harberger, A., Lothian, J., Mundell, R., Sonnenschein, H. and Tolley, G.

LARRY SJAASTAD, 1934-2012

13.04 Robitaille, M.C. and Chatterjee, I. MOTHERS-IN-LAW AND SON PREFERENCE IN INDIA

13.05 Clements, K.W. and Izan, I.H.Y. REPORT ON THE 25TH PHD CONFERENCE IN ECONOMICS AND BUSINESS

13.06 Walker, A. and Tyers, R. QUANTIFYING AUSTRALIA’S “THREE SPEED” BOOM

13.07 Yu, F. and Wu, Y. PATENT EXAMINATION AND DISGUISED PROTECTION

13.08 Yu, F. and Wu, Y. PATENT CITATIONS AND KNOWLEDGE SPILLOVERS: AN ANALYSIS OF CHINESE PATENTS REGISTER IN THE US

13.09 Chatterjee, I. and Saha, B. BARGAINING DELEGATION IN MONOPOLY

13.10 Cheong, T.S. and Wu, Y. GLOBALIZATION AND REGIONAL INEQUALITY IN CHINA

13.11 Cheong, T.S. and Wu, Y. INEQUALITY AND CRIME RATES IN CHINA

13.12 Robertson, P.E. and Ye, L. ON THE EXISTENCE OF A MIDDLE INCOME TRAP

13.13 Robertson, P.E. THE GLOBAL IMPACT OF CHINA’S GROWTH

13.14 Hanaki, N., Jacquemet, N., Luchini, S., and Zylbersztejn, A.

BOUNDED RATIONALITY AND STRATEGIC UNCERTAINTY IN A SIMPLE DOMINANCE SOLVABLE GAME

13.15 Okatch, Z., Siddique, A. and Rammohan, A.

DETERMINANTS OF INCOME INEQUALITY IN BOTSWANA

13.16 Clements, K.W. and Gao, G. A MULTI-MARKET APPROACH TO MEASURING THE CYCLE

13.17 Chatterjee, I. and Ray, R. THE ROLE OF INSTITUTIONS IN THE INCIDENCE OF CRIME AND CORRUPTION

13.18 Fu, D. and Wu, Y. EXPORT SURVIVAL PATTERN AND DETERMINANTS OF CHINESE MANUFACTURING FIRMS

13.19 Shi, X., Wu, Y. and Zhao, D. KNOWLEDGE INTENSIVE BUSINESS SERVICES AND THEIR IMPACT ON INNOVATION IN CHINA

13.20 Tyers, R., Zhang, Y. and Cheong, T.S.

CHINA’S SAVING AND GLOBAL ECONOMIC PERFORMANCE

13.21 Collins, J., Baer, B. and Weber, E.J. POPULATION, TECHNOLOGICAL PROGRESS AND THE EVOLUTION OF INNOVATIVE POTENTIAL

13.22 Hartley, P.R. THE FUTURE OF LONG-TERM LNG CONTRACTS

13.23 Tyers, R. A SIMPLE MODEL TO STUDY GLOBAL MACROECONOMIC INTERDEPENDENCE

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ECONOMICS DISCUSSION PAPERS 2013

DP NUMBER AUTHORS TITLE

13.24 McLure, M. REFLECTIONS ON THE QUANTITY THEORY: PIGOU IN 1917 AND PARETO IN 1920-21

13.25 Chen, A. and Groenewold, N. REGIONAL EFFECTS OF AN EMISSIONS-REDUCTION POLICY IN CHINA: THE IMPORTANCE OF THE GOVERNMENT FINANCING METHOD

13.26 Siddique, M.A.B. TRADE RELATIONS BETWEEN AUSTRALIA AND THAILAND: 1990 TO 2011

13.27 Li, B. and Zhang, J. GOVERNMENT DEBT IN AN INTERGENERATIONAL MODEL OF ECONOMIC GROWTH, ENDOGENOUS FERTILITY, AND ELASTIC LABOR WITH AN APPLICATION TO JAPAN

13.28 Robitaille, M. and Chatterjee, I. SEX-SELECTIVE ABORTIONS AND INFANT MORTALITY IN INDIA: THE ROLE OF PARENTS’ STATED SON PREFERENCE

13.29 Ezzati, P. ANALYSIS OF VOLATILITY SPILLOVER EFFECTS: TWO-STAGE PROCEDURE BASED ON A MODIFIED GARCH-M

13.30 Robertson, P. E. DOES A FREE MARKET ECONOMY MAKE AUSTRALIA MORE OR LESS SECURE IN A GLOBALISED WORLD?

13.31 Das, S., Ghate, C. and Robertson, P. E.

REMOTENESS AND UNBALANCED GROWTH: UNDERSTANDING DIVERGENCE ACROSS INDIAN DISTRICTS

13.32 Robertson, P.E. and Sin, A. MEASURING HARD POWER: CHINA’S ECONOMIC GROWTH AND MILITARY CAPACITY

13.33 Wu, Y. TRENDS AND PROSPECTS FOR THE RENEWABLE ENERGY SECTOR IN THE EAS REGION

13.34 Yang, S., Zhao, D., Wu, Y. and Fan, J.

REGIONAL VARIATION IN CARBON EMISSION AND ITS DRIVING FORCES IN CHINA: AN INDEX DECOMPOSITION ANALYSIS

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ECONOMICS DISCUSSION PAPERS 2014

DP NUMBER AUTHORS TITLE

14.01 Boediono, Vice President of the Republic of Indonesia

THE CHALLENGES OF POLICY MAKING IN A YOUNG DEMOCRACY: THE CASE OF INDONESIA (52ND SHANN MEMORIAL LECTURE, 2013)

14.02 Metaxas, P.E. and Weber, E.J. AN AUSTRALIAN CONTRIBUTION TO INTERNATIONAL TRADE THEORY: THE DEPENDENT ECONOMY MODEL

14.03 Fan, J., Zhao, D., Wu, Y. and Wei, J. CARBON PRICING AND ELECTRICITY MARKET REFORMS IN CHINA

14.04 McLure, M. A.C. PIGOU’S MEMBERSHIP OF THE ‘CHAMBERLAIN-BRADBURY’ COMMITTEE. PART I: THE HISTORICAL CONTEXT

14.05 McLure, M. A.C. PIGOU’S MEMBERSHIP OF THE ‘CHAMBERLAIN-BRADBURY’ COMMITTEE. PART II: ‘TRANSITIONAL’ AND ‘ONGOING’ ISSUES

14.06 King, J.E. and McLure, M. HISTORY OF THE CONCEPT OF VALUE

14.07 Williams, A. A GLOBAL INDEX OF INFORMATION AND POLITICAL TRANSPARENCY

14.08 Knight, K. A.C. PIGOU’S THE THEORY OF UNEMPLOYMENT AND ITS CORRIGENDA: THE LETTERS OF MAURICE ALLEN, ARTHUR L. BOWLEY, RICHARD KAHN AND DENNIS ROBERTSON

14.09

Cheong, T.S. and Wu, Y. THE IMPACTS OF STRUCTURAL RANSFORMATION AND INDUSTRIAL UPGRADING ON REGIONAL INEQUALITY IN CHINA

14.10 Chowdhury, M.H., Dewan, M.N.A., Quaddus, M., Naude, M. and Siddique, A.

GENDER EQUALITY AND SUSTAINABLE DEVELOPMENT WITH A FOCUS ON THE COASTAL FISHING COMMUNITY OF BANGLADESH

14.11 Bon, J. UWA DISCUSSION PAPERS IN ECONOMICS: THE FIRST 750

14.12 Finlay, K. and Magnusson, L.M. BOOTSTRAP METHODS FOR INFERENCE WITH CLUSTER-SAMPLE IV MODELS

14.13 Chen, A. and Groenewold, N. THE EFFECTS OF MACROECONOMIC SHOCKS ON THE DISTRIBUTION OF PROVINCIAL OUTPUT IN CHINA: ESTIMATES FROM A RESTRICTED VAR MODEL

14.14 Hartley, P.R. and Medlock III, K.B. THE VALLEY OF DEATH FOR NEW ENERGY TECHNOLOGIES

14.15 Hartley, P.R., Medlock III, K.B., Temzelides, T. and Zhang, X.

LOCAL EMPLOYMENT IMPACT FROM COMPETING ENERGY SOURCES: SHALE GAS VERSUS WIND GENERATION IN TEXAS

14.16 Tyers, R. and Zhang, Y. SHORT RUN EFFECTS OF THE ECONOMIC REFORM AGENDA

14.17 Clements, K.W., Si, J. and Simpson, T. UNDERSTANDING NEW RESOURCE PROJECTS

14.18 Tyers, R. SERVICE OLIGOPOLIES AND AUSTRALIA’S ECONOMY-WIDE PERFORMANCE

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ECONOMICS DISCUSSION PAPERS 2014

DP NUMBER AUTHORS TITLE

14.19 Tyers, R. and Zhang, Y. REAL EXCHANGE RATE DETERMINATION AND THE CHINA PUZZLE

14.20 Ingram, S.R. COMMODITY PRICE CHANGES ARE CONCENTRATED AT THE END OF THE CYCLE

14.21 Cheong, T.S. and Wu, Y. CHINA'S INDUSTRIAL OUTPUT: A COUNTY-LEVEL STUDY USING A NEW FRAMEWORK OF DISTRIBUTION DYNAMICS ANALYSIS

14.22 Siddique, M.A.B., Wibowo, H. and Wu, Y.

FISCAL DECENTRALISATION AND INEQUALITY IN INDONESIA: 1999-2008

14.23 Tyers, R. ASYMMETRY IN BOOM-BUST SHOCKS: AUSTRALIAN PERFORMANCE WITH OLIGOPOLY

14.24 Arora, V., Tyers, R. and Zhang, Y. RECONSTRUCTING THE SAVINGS GLUT: THE GLOBAL IMPLICATIONS OF ASIAN EXCESS SAVING

14.25 Tyers, R. INTERNATIONAL EFFECTS OF CHINA’S RISE AND TRANSITION: NEOCLASSICAL AND KEYNESIAN PERSPECTIVES

14.26 Milton, S. and Siddique, M.A.B. TRADE CREATION AND DIVERSION UNDER THE THAILAND-AUSTRALIA FREE TRADE AGREEMENT (TAFTA)

14.27 Clements, K.W. and Li, L. VALUING RESOURCE INVESTMENTS

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