Is the ASEAN-Korea Free Trade Area (AKFTA) an Optimal Free Trade Area?

Park, Donghyun; Park, Innwon; Estrada, Gemma Esther B. Working Paper Is the ASEAN-Korea Free Trade Area (AKFTA) an Optimal Free Trade Area? ADB Working Paper Series on Regional Economic Integration, No. 21 Provided in Cooperation with: Asian Development Bank (ADB), Manila Suggested Citation: Park, Donghyun; Park, Innwon; Estrada, Gemma Esther B. (2008) : Is the ASEANKorea Free Trade Area (AKFTA) an Optimal Free Trade Area?, ADB Working Paper Series on Regional Economic Integration, No. 21, Asian Development Bank (ADB), Manila, https://hdl.handle.net/11540/1788 This Version is available at: https://hdl.handle.net/10419/109538 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Estrada November 2008 Donghyun Park+, Innwon Park++, and Gemma Esther B. Estrada+++ Is the ASEAN-Korea Free Trade Area (AKFTA) an Optimal Free Trade Area? + Donghyun Park is a senior economist in the Economics and Research Department, Asian Development Bank, Manila, Philippines. Tel: 632 632 5825, Fax: 632 636 2342, E-mail: [email protected]. ++ Innwon Park is a professor of international economics in the Division of International Studies, Korea University, Anam-Dong, SeongbukGu, Seoul Korea. 136 701. Tel: 82 2 3290 2406, Fax: 82 2 929 0402, Email: [email protected]. +++ Gemma Esther B. Estrada is an economics officer in the Economics and Research Department, Asian Development Bank, Manila, Philippines. Tel: 632 632 6397, Fax: 632 636 2342, E-mail: [email protected]. November 2008 The ADB Working Paper Series on Regional Economic Integration focuses on topics relating to regional cooperation and integration in the areas of infrastructure and software, trade and investment, money and finance, and regional public goods. The Series is a quick-disseminating, informal publication that seeks to provide information, generate discussion, and elicit comments. Working papers published under this Series may subsequently be published elsewhere. Disclaimer: The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank or its Board of Governors or the governments they represent. The Asian Development Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. Use of the term “country” does not imply any judgment by the authors or the Asian Development Bank as to the legal or other status of any territorial entity. Unless otherwise noted, $ refers to US dollars. © 2008 by Asian Development Bank November 2008 Publication Stock No. Contents Abstract 1 I. Introduction 2 II. Theory of Economic Integration 3 A. Theory of Customs Union 4 B. Static Factors 4 C. Dynamic Factors 5 D. Non-Economic Factors 5 III. Prospects of AKFTA 5 A. Static Economic Factors 5 1. Size of FTA 6 2. Pre-FTA Tariff Structure 6 3. Intra-FTA Trade Prior to AKFTA 6 4. Substitutability of Products 6 5. Disparity in Pre-FTA Level of Development 7 6. Geographical Proximity and Transportation Infrastructure 7 7. Complementary or Competitive Economic Structures 7 B. Dynamic Economic Factors 8 C. Non-Economic Factors 8 IV. Quantitative Analysis Using the CGE Model 9 A. Model and Data 9 B. Empirical Results 10 C. Trade Effects 11 D. Welfare and Output Effects 12 V. Concluding Remarks 15 References 17 ADB Working Paper Series on Regional Economic Integration 19 Tables 1. Sectoral Aggregation of the CGE Model (7 Sectors) 10 2. Sectoral Real Output Impacts of AKFTA (% Deviations from the Base) 14 Figures 1. Trade Creation and Diversion Effects of AKFTA 11 2. Bilateral Trade with Republic of Korea ($ billion) 12 3. Welfare and Output Effects of AKFTA on Member-Countries 13 4. Effects of AKFTA on Trade of Member-Countries 13 5. Growth in Bilateral Trade with Korea 15 Abstract The 1997/98 Asian currency crisis has led a once high-flying East Asia to realize its vulnerability to external shocks. This realization has given strong impetus to greater economic integration among East Asian economies, with the ASEAN-Korea Free Trade Area (AKFTA) a case in point. This paper qualitatively and quantitatively examines the economic feasibility of AKFTA: qualitatively using the theory of economic integration, and quantitatively by applying a CGE model. Our two-dimensional analysis provides some, but not overwhelming, support for AKFTA’s prospects as an effective means of promoting trade between ASEAN and the Republic of Korea. Keywords: ASEAN, Korea, trade, free trade area, economic integration. JEL Classifications: F10, F14, F15 2 I. Introduction The Republic of Korea (Korea) and the countries of the Association of Southeast Asian Nations (ASEAN) have been integral to the miracle that has transformed East Asia from a group of typically poor third world countries into the world’s most dynamic economies. More precisely, Korea and ASEAN’s Indonesia, Malaysia, Singapore, and Thailand have sustained rapid growth in the postwar era, alongside Hong Kong, China; Japan, and Taipei,China to put East Asia on the world map as an economic powerhouse. Hong Kong, China; Korea; Singapore; and Taipei,China are newly industrialized economies, while Indonesia, Malaysia, and Thailand have transformed themselves from stagnant agricultural economies into dynamic manufacturers. These eight “miracle” economies share a number of elements, including sound macroeconomic policies, high savings and investment rates, and heavy investment in education. Above all, the remarkable success of these countries has been based on export-oriented industrialization and is a powerful tribute to the potential benefits of globalization. But that same globalization turned against these countries with a vengeance in the 1997/98 Asian financial crisis. The massive capital inflows that had helped fuel rapid economic growth wreaked financial havoc as foreign investors suddenly lost confidence, beginning with Thailand’s forced baht devaluation in May 1997. Turmoil in the financial markets soon spread to the real economy and saw output contract sharply. Passionate debate rages about the causes of the crisis, but it is likely that a combination of external and internal factors played a role. What is beyond doubt is that the crisis was a painfully clear reminder that globalization holds opportunities as well as risks. Furthermore, there has been an unmistakable loss of momentum and self-confidence among many of these once high-flying economies. There is a widespread perception throughout the region that external forces, such as investors from the United States (US) and Europe, were largely responsible for the Asian crisis. Regardless of their accuracy, such perceptions gave rise to a region-wide sense of vulnerability to and suspicion of external forces, which, in turn, fostered a greater sense of regional identity and gave a strong impetus to regional economic integration.1 In the immediate aftermath of the Asian crisis, the focus of economic regionalism lay in promoting regional financial cooperation, best exemplified by the Chiang Mai Initiative (CMI) among the ten ASEAN countries, the People’s Republic of China (PRC), Japan, and Korea. The focus of regionalism has more recently been shifting toward the expansion of intra-regional trade. The region’s governments increasingly view intra-regional trade and domestic demand as a means of reducing their heavy dependence on extra-regional trade. The ASEAN-Korea Free Trade Area (AKFTA)2 is a concrete example of the active promotion of intra-regional trade. In May 2006 the two sides signed a free trade agreement that would lead to a free trade area by 2016. (Thailand did not sign due to the exclusion of rice from the agreement.) Greater economic cooperation between the two—with Korea the world’s eleventh largest economy and ASEAN collectively a substantial economic presence—can yield 1 Asian Development Bank (2005, 2008), Ahn, Baldwin and Cheong (2005), Moon and Andreosso-O’Callaghan (2005), Harvie, Kimura and Lee (2005), Lee and Park (2005), Park (2006), and Lincoln (2004) provide overviews of East Asian economic regionalism in the post-crisis period. 2 For more detailed information about the “Framework Agreement on Comprehensive Economic Cooperation Among the Governments of the Member Countries of the Association of Southeast Asian Nations (ASEAN) and the Republic of Korea,” visit http://www.aseansec.org/18063.htm (ASEAN site) and http://www.mofat.go.kr/english/econtrade/fta/issues/ index.jsp (Korea site). For recent developments related to the ASEAN-Korea FTA, visit http://www.bilaterals.org/rubrique. php3?id_rubrique=142. 9 flexibility in light of intensifying global competition. The formation of AKFTA may also increase the foreign direct investment (FDI) into the ASEAN economies and Korea by creating a larger common market from the perspective of outside investors. Foreign multinational companies (MNCs) locating in ASEAN will find it easier to export to Korea, and MNCs in Korea to export to ASEAN. C. Non-Economic Factors While economic factors are clearly a powerful rationale for economic integration, we cannot ignore the importance of non-economic factors. The political commitment, will, and leadership of governments, by facilitating close cooperation among governments, are critical pre-conditions for a successful FTA. While many outside observers have often criticized ASEAN for being excessively consensual and hence largely ineffective, the group has in fact been remarkably successful in promoting political cooperation among member governments. Therefore, to a large extent, ASEAN countries have been able to speak with a single voice in negotiations with Korea over the formation of AKFTA. As noted earlier, Thailand is a significant exception in this regard due to its objections to the exclusion of rice from the agreement. In addition, there seems to be an ASEAN-wide consensus about the desirability and feasibility of AKFTA. The political commitment of ASEAN and Korean governments to AKFTA is further reinforced by fundamental economic considerations. For ASEAN, AKFTA is a mechanism for benefiting from closer economic interaction with the world’s eleventh biggest economy, a significantly richer and technologically more advanced country. This includes not only the opportunity to expand exports into a big market but also to attract capital and technology from Korean companies. For Korea, AKFTA is a means to expand trade with an economically significant region which is already a major trading partner. As such, AKFTA can help diversify both export and import markets, and reduce the country’s reliance on trade with the PRC and the US. IV. Quantitative Analysis Using the CGE Model In our qualitative analysis of static factors, we have noted that several factors, such as pre-FTA size, initial trade, and tariff barriers appear to bode well for the economic integration of ASEAN and Korea. At the same time, other factors such as pre-FTA level of development and limited substitutability of products between what ASEAN exports (imports) and what Korea imports (exports) may work against the success of AKFTA. This means that, depending on the importance of each factor, it is not clear whether a free trade area between Korea and ASEAN will be beneficial for its member-countries. Several studies have investigated the impact of AKFTA using CGE models. These have mostly relied on the model and data base of the Global Trade Analysis Project (GTAP) and differ mainly in their assumptions. For the most part, these studies look at all the proliferating proposals for free trade agreements in East Asia rather than only AKFTA, and compare the welfare implications of various alternative scenarios of FTAs. While these studies tend to show AKFTA’s impact on Korea, they do not always show its effect on individual ASEAN countries. A common finding across several CGE-based studies is that AKFTA can benefit the ASEAN region as a whole. However, they are divided in terms of (1) the impact on Korea, (2) which countries are likely to benefit the most, or (3) whether Korea or ASEAN is likely to gain more from AKFTA. A study by Choi, Park, and Lee (2003) indicates that both Korea and ASEAN will experience welfare gains, but Korea will gain more than ASEAN. In contrast, simulations by 10 Cheong (2003) show that ASEAN will benefit but Korea is likely to suffer welfare and output losses. Ando and Urata (2006) incorporate trade liberalization, capital accumulation, and trade facilitation into their model, and found that individual ASEAN countries, in particular Thailand and Singapore, will benefit from AKFTA. More recent studies based on CGE modeling takes into account countries’ commitments to trade agreements as well as expected trade liberalizations over several years. Kawai and Wignaraja (2008) found that AKFTA generated positive income effects for Korea and individual ASEAN countries relative to their baseline scenario. Based on deviations in equivalent variations, the highest gains accrued to Viet Nam, Korea and Thailand while the lowest gains accrued to the CLM countries. Lee and van der Mensbrugghe (2007) examined AKFTA’s welfare effects relative to a baseline scenario of no FTAs over the period 2001-2015. They found that AKFTA raised the welfare of Korea and ASEAN as a whole, but did not analyze the welfare effects for individual ASEAN countries. Having reviewed the existing quantitative studies of AKFTA, we are now ready to perform our own quantitative analysis of AKFTA. More precisely, we apply the CGE model to quantify the gains and losses for the entire free trade area as well as individual countries. Information on individual country impact is particularly relevant for AKFTA, since the free trade area encompasses a great deal of heterogeneity in income and development levels. A. Model and Data The CGE model used in this section is the “GTAP6inGAMS” model developed by Rutherford (2005). The model has three economic agents: producer, representative consumer consisting of both private household and government, and trading partners. The GTAP6inGAMS model is a traditional static Arrow-Debreu type of general equilibrium model in which the zero profit condition and market clearance define the equilibrium. The GTAP6inGAMS is a modified version of the GTAP model version 6 developed for GAMS users.4 We use the GTAP 6 database, which provides global production and trade data for 89 countries/regions and 55 sectors. For simplicity, we aggregate sectors into 7 general industries (See Table 1). We measure trade, output and welfare effects for (1) the free trade area as a whole and (2) individual member countries, except Cambodia, Lao PDR, and Myanmar, which we aggregate into a single economy and refer to as CLM.5 Our simulations assume 2001 to be the base year using the GTAP Version 6. 6 The model is implemented using the GAMS MPSGE.7 In order to quantitatively measure the effects of the AKFTA on welfare, output production, and trade flows for member economies, we assume that both import tariffs and export taxes between members are eliminated, but trade barriers between members and nonmembers remain. 4 The GTAP (Global Trade Analysis Project) is providing both a multi-region and multi-sector CGE model and a global economic dataset for use in the quantitative analyses of international economic issues. For the GTAP, visit https://www.gtap.agecon.purdue.edu. For the GAMS (Generalized Algebraic Modeling System), visit http://www.gams.com. 5 Owing to data limitations, we also exclude Brunei Darussalam. 6 See Dimaranan and McDougall (2006). 7 MPSGE (Mathematical Programming System for General Equilibrium analysis) is a subsystem within GAMS. See http://www.gams.com/solvers/mpsge/index.htm. 11 Table 1: Sectoral Aggregation of the CGE Model (7 Sectors) Sector Commodities Agricultural Products Paddy rice, wheat, cereal grains not elsewhere classified (nec), vegetables, fruit, nuts, oil seeds, sugar cane, sugar beet, plant-based fibers, crops nec, cattle, sheep and goats, horses, animal products, raw milk, wool, silk-worm cocoons, Food Products Meat products nec, vegetable oils and fats, dairy products, processed rice, sugar, food products nec, beverages and tobacco products Extractive Industry Forestry, fishing, coal, oil, gas, minerals nec, petroleum, coal products Light Manufacturing Textiles, wearing apparel, leather products, wood products Heavy Manufacturing Paper products, publishing, chemical, rubber, plastic products, mineral products nec, ferrous metals, metals nec Technology-intensive Manufacturing Metal products, motor vehicles and parts, transport equipment nec, electronic equipment, machinery and equipment nec, manufactures nec Services Electricity, gas manufacture, distribution, water, construction trade, transport, financial, business, recreational services, public admin and defense, education, health, dwellings & services B. Empirical Results Results of the simulations indicate that for the free trade area and most member-countries, the creation of an AKFTA will bring about welfare and output gains, that is, the benefits from integration will outweigh the losses. In addition, since trade diversion is smaller than trade creation, net trade creation is positive. However, gains are unevenly distributed, with a few countries gaining more than the others. In addition, while some economic sectors are likely to grow, other sectors are likely to contract. While it is important that net welfare effects for the whole region be positive, it is also crucial to consider the distribution of net benefits across countries, in particular whether richer economies benefit more than poorer economies. On the other hand, for an individual country, an important issue is the distribution of net benefits across industries. It matters whether or not the FTA’s impact falls primarily on industries of high significance for the national economy. C. Trade Effects Figure 1 illustrates trade creation and diversion effects, which are computed as percentage deviations from the base value of trade volumes with members and nonmembers, respectively. Positive trade creation means expansion of trade within the free trade area, while negative trade diversion means reduction of trade with nonmembers. For the free trade area as a whole, trade among member-economies will rise by 18.1% while trade with non-members will fall by only 2.2%. 12 Figure 1: Trade Creation and Diversion Effects of AKFTA Malaysia Philippines Singapore Thailand Viet Nam Cambodia, Lao PDR, and Myanmar ASEAN AKFTA Indonesia Korea, Rep. of -6 -4 -2 0 2 Trade diversion (%) 020 40 60 80 Trade creation (%) As expected, AKFTA will accelerate trade between ASEAN and Korea. Indonesia and Malaysia will account for about half of the growth in trade between ASEAN and Korea. AKFTA will shift the trade balance in favor of ASEAN, whose exports to Korea will rise by 20% and imports from Korea will fall by 3%. ASEAN countries’ bilateral trade balance with Korea will improve. More specifically; (i) Indonesia, Malaysia and, to a lesser extent, the CLM countries will see an increase in the trade surplus; (ii) Thailand will see a shift from a negative to a positive trade balance; and (iii) Philippines, Singapore, and Viet Nam will see a decrease in the trade deficit (see Figure 2). As a result, ASEAN’s total trade balance with Korea will shift from negative prior to AKFTA to positive after its implementation. 13 Figure 2: Bilateral Trade with Republic of Korea ($ billion) Philippines Thailand Viet Nam ASEAN Indonesia Singapore Malaysia Cambodia, Lao PDR and Myanmar -2 -1 0 1 2 Before AKFTA -2 -1 0 1 2 3 After AKFTA We now explore the impact of AKFTA on the trade of less developed ASEAN member-countries. Four points are worth noting: first, Viet Nam and CLM will account for less than 10% of ASEAN’s growth in trade with Korea. Second, while Korea’s trade with Viet Nam will expand by only 2%, its trade with CLM will grow by no less than 18%. CLM-Korea trade will thus become the fastest-growing component of ASEAN-Korea trade. Third, CLM’s trade surplus with Korea will increase and Viet Nam’s trade deficit with Korea will decrease. Finally, along with Thailand, CLM and Viet Nam will experience the highest net trade creation among all member-countries. This is because they benefit from relatively high trade creation and suffer little trade diversion. Overall, AKFTA seems to have a favorable impact on the trade of ASEAN’s poorer countries. D. Welfare and Output Effects The formation of AKFTA will increase aggregate welfare (0.4%) and raise real GDP (0.9%). ASEAN as a group will experience positive welfare and output gains. We can divide AKFTA into three groups based on welfare effects: (i) Malaysia and Singapore will enjoy relatively high welfare gains of 2–5%; (ii) Indonesia, Philippines, Thailand, and Viet Nam will experience modest gains of less than 2%, and (iii) CLM and Korea will suffer welfare losses (see Figure 3). Broadly speaking, real output effects more or less correspond to welfare effects so that countries which gain the most in welfare also tend to gain the most in real output. What is interesting and troubling is that the CLM countries will suffer net welfare and output losses despite net trade gains. Output losses can be partly traced to total imports rising faster than total exports. Although CLM’s exports will rise by 11.2% under AKFTA, this will be more than offset by an 11.8% rise in imports (see Figure 4). 14 Figure 3: Welfare and Output Effects of AKFTA on Member-Countries Malaysia Thailand Viet Nam Cambodia, Lao PDR, and Myanmar ASEAN Korea, Rep. of AKFTA Indonesia Philippines Singapore -2 0 2 4 6 Welfare (%) -3 0 3 6 9 Output (%) Figure 4: Effects of AKFTA on Trade of Member-Countries Indonesia Singapore Thailand Viet Nam Korea, Rep. of ASEAN AKFTA Malaysia Philippines Cambodia, Lao PDR, and Myanmar 0 4 8 12 16 Exports (%) 0 3 6 9 12 Imports (%) 15 Unlike CLM, Viet Nam will enjoy welfare and output gains under AKFTA. In fact, Viet Nam’s output gains will be greater than those of higher income countries such as Indonesia, Thailand, or Philippines. This is mainly because Viet Nam’s total exports will grow rapidly, by 15.4%, the fastest among member-economies. Viet Nam’s total export growth will be much higher than its total import growth. Looking at the sectoral impacts in Table 2, the real output of all sectors listed in Table 1 will contract in CLM countries, except in two sectors: the extractive industry and light manufacturing. The real output of agricultural products and food products will contract by 2.7% and 4.1%, respectively. Since agriculture is a key sector in these countries in both output and employment, a marked decline in real agricultural output would have large repercussions for their fragile economies. This helps explain why CLM countries are likely to suffer a decline in real welfare and output under AKFTA. Viet Nam, however, will not suffer a similar fate, despite the contraction of its agricultural and food products sectors, as high growth in its manufacturing sector more than compensates those losses. While we have not quantified the dynamic gains here, a source of optimism for CLM is that dynamic gains may exceed static losses. This is not unlikely since growing trade with advanced member-countries within the region can deliver potentially large productivity gains for poorer countries over time. Table 2: Sectoral Real Output Impacts of AKFTA (% Deviations from the Base) Total Output Agricultural Products Food Products Extractive Industry Light Mfg. Heavy Mfg. Technologyintensive Mfg. Services Indonesia 0.14 1.73 3.54 0.26 -0.06 0.21 1.24 0.94 Malaysia 3.72 -10.16 19.63 0.49 7.29 -0.05 -0.94 0.00 Philippines -0.12 3.96 0.20 0.87 -1.25 1.34 1.10 1.01 Singapore 8.43 0.34 51.87 7.13 4.05 4.94 -0.82 0.93 Thailand 0.36 7.49 -1.77 0.21 -0.20 3.88 2.99 0.77 Viet Nam 2.88 -0.43 -0.09 -0.97 7.64 0.85 10.99 -0.38 CLM -0.06 -2.69 -4.06 1.04 1.41 -1.62 -3.25 -1.30 Korea, Rep. of -0.01 -0.66 -1.07 -0.09 -0.19 0.19 0.11 -0.14 CLM = Cambodia, Lao People’s Democratic Republic, Myanmar. Korea will suffer net welfare and output losses from a free trade area with ASEAN. Out of the seven sectors considered in this paper, all but two manufacturing sectors will contract. However, being left out of the general trend toward ASEAN+1 free trade agreements may bring about substantial dynamic losses for Korea, which competes against China and Japan. Since our analysis suggests that Korea is unlikely to experience positive static trade, welfare or output net gains, dynamic gains or non-economic factors are likely to be Korea’s main underlying motivation for pursuing AKFTA. This reinforces the point made in Section 3 that dynamic economic considerations appeared to be a key impetus behind the AKFTA, especially from the point of view of Korea. More specifically, Korea is expecting the relatively fast-growing ASEAN region to grow in importance as an export market over time. Securing a stable and 16 geographically close supply of mineral and energy resources would be another important longrun motive for Korea. Finally, ASEAN will continue to be a major destination for Korea’s large and growing FDI outflows, especially for firms which seek geographical diversification of their production. Dynamic considerations are likewise important for ASEAN. In addition to productivity gains from greater competition, transfer of technology through trade – e.g. imports of capital goods – can benefit ASEAN, which lags substantially behind Korea in terms of technological capabilities. This is especially true for the CLM countries since not only will they experience the fastest growth in trade with Korea (see Figure 5) but their low technology levels imply a larger scope for improvement. Measures to promote technology diffusion will facilitate the transfer of technology from Korea to ASEAN. Figure 5: Growth in Bilateral Trade with Korea V. Concluding Remarks Korea and ASEAN, through sustained, rapid growth, have been part of the East Asian miracle that has transformed this group of once poor developing countries into the world’s most economically dynamic region. This miracle was based on export-oriented industrialization and provides compelling evidence of the enormous potential benefits of globalization. However, the Asian financial crisis which devastated the economies of ASEAN and Korea in 1997/1998 gave equally compelling evidence of the potential risks of globalization. The crisis gave rise to a newfound sense of vulnerability to external forces and, in turn, to economic regionalism. Although the initial focus of post-crisis East Asian economic regionalism lay in promoting financial cooperation through the Chiang Mai Initiative, this has gradually shifted to expanding intraregional trade. 0 5 10 15 20 Viet Nam Singapore Philippines Malaysia Thailand Indonesia Cambodia, Lao PDR, and Myanmar % 17 The subject of our paper is the ASEAN-Korea Free Trade Area (AKFTA) initiative, a concrete example of East Asia’s effort to boost intra-regional trade in the post-crisis period. The two sides signed a free trade agreement in May 2006 to create a free trade area by 2016. Our central objective was to perform a qualitative and quantitative analysis to assess the feasibility and desirability of AKFTA. Our qualitative analysis, which used the theory of economic integration to critically examine whether purely economic static considerations are conducive for AKFTA, suggested that there are grounds for both optimism and pessimism. For example, the large and growing level of pre-FTA trade between ASEAN and Korea is a conducive factor, whereas the large income gap between Korea and ASEAN as a whole is an impediment. Our quantitative analysis, which is based on application of a CGE model, also suggests that AKFTA will entail both costs and benefits. The costs include AKFTA’s negative welfare and output effects on poorer member countries, especially CLM, while the benefits include positive net trade creation for the AKFTA region as a whole and for each member-country. Since AKFTA entails potential welfare losses, the creation of structural funds such as those implemented by the EU may be necessary. The case for structural funds is all the stronger for AKFTA since our analysis indicates that welfare losses will fall disproportionately on poor CLM. Structural funds can help to narrow the gap between poor and rich countries by providing support for infrastructure, technological improvement, and human capital development. They can also enhance transportation and communication linkages between member countries, and provide structural adjustment assistance for adversely affected industries. The EU experience offers useful lessons in terms of how the costs and benefits of structural funds can be shared without disrupting cohesion among member countries. Taking into account dynamic economic factors and non-economic factors provides grounds for optimism. ASEAN and Korea share the challenge of growing competition from the PRC and India, and, more generally, competing in an increasingly competitive global economy. As such, improving economic efficiency by exposing their firms and industries to greater foreign competition can bring significant benefits. AKFTA will thus improve the international competitiveness of ASEAN and Korea by promoting competition and efficiency. In addition, ASEAN and Korea share a desire for a multi-polar East Asia not dominated by Japan and the PRC, and this shared geopolitical objective provides a solid cornerstone for economic cooperation between the two sides, in particular through AKFTA. 18 References Ahn, C., R. Baldwin and I. Cheong, eds. 2005. East Asian Economic Regionalism: Feasibilities and Challenges. Dordrecht, Netherlands: Springer. Ando, M. and S. Urata. 2006. Emerging Developments in East Asia FTA/EPAs. Paper presented at the JSPS (Kyoto University)-NRCT (Thammasat University) Core University Program Conference. October 27-28. Asian Development Bank. 2005. Asian Economic Cooperation and Integration: Progress. Prospects and Challenges. Manila ________. 2008. Emerging Asian Regionalism: A Partnership for Shared Prosperity. Manila Baldwin, R. and C. Wyplosz, 2006. 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