Question

In 1992, Association of Southeast Asian Nations Free Trade Area (AFTA) was applied by eliminating tariffs and non-tariff barriers between the member countries. The original members were Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand. knowing that:

• Brunei needs to import Cereal (Cereal is a homogenous good).
• The best exporter for Cereal that is United States (the price per ton is $8).
• Brunei can import Cereal from Indonesia (the price per ton is $12).
• Brunei imposed a specific tariff on its imports of Cereal accounts for $6 per ton.

Discuss the impacts of joining AFTA including Brunei and Indonesia on the foreign trade of both of Brunei, Indonesia and USA.     

Answer 1

A free trade area is an agreement between a group of countries such that they have no barriers of trade between them. This enables free trade among the nations who form a part of the agreement. It should however be remembered that these agreements can be trade creating or trade diverting.

In this case, it can be seen that it is trade diverting agreement. This is because since Brunei and Indonesia enter into the agreement, they will remove the tariffs on trade between them as they are members in the agreement. However, for Brunei to import from the USA was initially cheaper but now because of imposition of the tariff, the price of cereal when imported from the US is $13 whereas its only $12 when it is imported from Indonesia. So Brunei would want to import from Indonesia than the US. This diverts trade from more effcient producers in US to those in Indonesia.

Brunei would gain because they earn the tariff revenue which can be utilised for productive purposes by the government and Indonesia also gains because the agreement has made cereal cheaper in Indonesia which was not the case earlier. If the tariff was not imposed, the US would have exported to Brunei at a lower price than Indonesia. Since cereal is a homogenous product, Brunei can easily shift from the US to Indonesia. This suggests that the welfare of the US reduces as a result of this agreement. This is because their income from exports reduces as trade is now diverted to Brunei.