International Business refers to that area of business which is focused around trades consisting of goods, technologies, services, capital, etc. beyond national borders and at a global level (Picciotto and Mayne, 2016). It undertakes cross border transactions of various commodities or services involving multiple countries. The following report is based on ASEAN Free Trade Agreement (AFTA) and its impacts on the Malaysian Economy. It covers Introduction to Regional Economic Integration (REI) and objectives for formulation of AFTA. It also discusses application of comparative advantage theory of international trade on the agreement.
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REI and Levels of Integration
Regional Economic Integration could be explained as agreements between various countries of a particular geographical location which focuses on reduction or removal of barriers to ensure free flow of commodities and production factors between one another. The agenda of such integration focuses on agreements which could be tariff or non-tariff barriers.
There are various levels of Regional Economic Integration which could are effectively discussed below:
- Free Trade:Under this, tariffs, which refer to imposed tax on various imported goods, are reduced by a substantial quantities among different member nations. In some cases these tariffs are completely abolished. Tariffs within trades are constrained only to third countries. Agenda of such agreements is to enhance comparative advantages and economies of scale. Free trade promotes and encourages economic efficiency, For instance, there is a partial reduction in tariffs seen in ASEAN Free Trade Agreement (AFTA) (Hamilton and Webster, 2018).
- Custom Union:Tariffs applied in this level is common between member nations as well as third countries. The objective of custom union is to achieve a similar trade regime. Usefulness of this level while addressing re-export problems and to match competitive fields.
- Common Market:Capital as well as services are free to flow within member nations which results in comparative advantages and expansion of scale economies. However, there are various personal regulations like product standards imposed by each country (Stahl and Tung, 2015).
- Economic Union:A uniform market is created in this level by removing all the tariffs during trade between the member nations. In addition, labours move freely too which enables the employees to offer their service in another member country. Fiscal as well as monitory policies are harmonised within member nations, implying a substantial state of political integration.
- Political Union:Such integration is quite advanced in nature where integrity is concerned and a common government comes into operation. Under this, sovereignty of member nations are limited.
Illustration 1: Levels of Economic Integration
(Levels of Economic Integration, 2018)
Objectives for formation of AFTA
ASEAN Free Trade Agreement refers to trade bloc agreements which happened among original six members of ASEAN, which stands for Association of South East Asian Nations. These nations are Malaysia, Thailand, Singapore, Philippines, Indonesia and Brunei. It was established in 1992 and was endorsed by six government heads (Vernon, 2017). At that time, it was imperative to form such a scheme which could effectively facilitate economic integration and enhances free trade within these mentioned countries. Thus, there are various objectives of formulation of AFTA which are mentioned below:
- Market Integration:
The biggest objective for the formation of AFTA was to develop an international production base and create a single market (Buckley, 2017). Market integration would have allowed these countries to create their own hub for producing various commodities and free the flow of these goods within the member countries. Having a single market would have allowed the businesses within these countries to facilitate trade and develop a uniform market to conduct all their activities effectively. Moreover, this objective is also backed by the point that it was required by these countries to share their resources among one another which reduces outside dependencies and create effective integration.
- Competitive Edge:
Another objective of ASEAN heads to create AFTA was to gain a competitive advantage in a global level. The most crucial aspect for which formulation of this agreement was necessary that it would induce liberalization of trade via complete eradication of all kinds of barriers to facilitate free and consistent trade between the member countries. Formation of AFTA was in response to other unions and agreements like NAFTA and EU. Thus, its free trade policies and market integration strategies aim at gaining a competitive edge in the market against these unions and integrations.
- Attraction of Foreign Direct Investment:
As per ASEAN heads, it was quite important to indulge Foreign Direct Investment which could contribute in enhancement of economies of region as well as of the member countries. AFTA, with a wide scale integrated market, free flow of goods and production capacity, would have attracted FDI in large quantities. This is because there is a direct linkage between FDI and free trade agreements. AFTA could have allowed businesses to integrate their efforts which also could have resulted in innovation and immense technological advancements (Buckley, P.J., 2016). Thus, various non-FTA countries would rather invest in region where they could acquire opportunities to grow.
- Expansion of intra-ASEAN investments and trades:
This objective emphasises on enhancing intra-ASEAN trades within the member nations. It could have given quite a great advantage to the firm to enhance its capacity to trade which would have given quite impressive benefits to the local businesses. With reduction in tariff rates, AFTA would have decreased product price within ASEAN. Thus, it would automatically be a positive and contributing factor for intra-ASEAN exports and thus, it was imperative to form a strategy which could have provided such a large scale benefit to the ASEAN regions. This was one major and one of the most important objectives for which AFTA was established(Cantwell, J., 2017).
Impact of AFTA on the Malaysian Economy
AFTA, since its inception, has produced quite significant and effective benefits to regions and to member countries. However the agreement was signed to provide appropriate advantages to local companies and Malaysian buyers, still the agreement has a bit shaky impacts on the region. For instance, it reduced taxes on raw materials to induce free flow. Yet, taxes have been imposed on customers which increased product prices substantially.
The various impacts of AFTA on Malaysian Economy sectors are briefly discussed below:
- Primary Sector:
This sector consists of mining, agriculture as well as natural resource industries. There have been an adverse effect which is witnessed on this sector of Malaysian Economy. One effect which AFTA had on the agricultural industry is that it would be facing greater competition with various other countries with excess production costs. In addition to this, AFTA caused a trade deficit in Malaysia in agriculture in 1996 and 1997 and thus, it had somewhat a negative impact on the primary sector of Malaysian Economy. In addition to this, due to dominance of corporate and estate on cocoa, rubber and palm oil, AFTA also affected various rice planters, fishermen as well as small families (The Effect of AFTA on Malaysian Agriculture,2019).
- Secondary Sector:
Another significant area which has witnessed the impact due to implementation of AFTA was the secondary sector which includes, manufacturing and engineering. With free flow of raw materials, this sector has quite few benefits reaped in terms of acquisition of equipments and technology for production. Within the Malaysian economy, this impact was witnessed on its automotive industry. For instance, after AFTA companies like Honda have invested quite a major amount in the country and other automotive industries which enhanced the production capacity within the industry. However, there are negative impacts of AFTA too. For instance, domestic companies like Proton had an advantage before AFTA came into action and were effectively dominating market. With implications of policies and strategies carried out by this agreement, AFTA threatened this dominance of domestic automotive companies of Malaysia (Folsom and et. al., 2016). There is an outside pressure imposed on domestic markets from various other component as well as finished commodity manufacturers which have posed a serious impact on this sector of Malaysian economy.
- Tertiary Sector:
This particular sector undertakes the service industry of a particular nation into account. AFTA has its impact on this sector in Malaysia. There have been quite new opportunities present within the country to effectively support businesses like hospitality and tourism. With market integration, the services have also aligned which have created a competitive advantage over other countries. Within Malaysia, there were substantial rise in the tourists and hospitality activities due to lower the cost of equipments and better working equipments and operations. However, this sector experienced a backdrop where employment and opportunities for workforce are concerned (Giovanni, Levchenko and Mejean, 2016). This is because domestic businesses were under market pressure and were continuing to lost their competitiveness due to integration with outside firms as a reason to which, companies started to shut down and people lost employment after AFTA. Thus, in this respect, the country faced disadvantages where employment within service sector is concerned.
- Quaternary Sector:
One of the most crucial sectors for any country is the quaternary sector which consists of effective activities in the knowledge sector. AFTA opened a whole new spectrum where effective equipments, knowledge and skills could be integrated within the country which enabled its inner human resources to effectively grow. Moreover, their productivity have also risen seeing such effective exchange of valuable resources. In addition, with reduction in tariffs, aspects like software, media equipments, school technologies, etc. have been effectively acquired which has enhanced the competence of individuals and broadened the scope of this sector.
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Application of Comparative Advantage Theory of International Trade on AFTA
Comparative advantage theory is given by David Ricardo in 18thcentury which state that a country will gain comparative advantage when it produce goods or services at relatively lower cost as compare to another country. According to David Ricardo a country can boosts up its economical growth by focusing over the industry which help it in providing sustainable comparative advantage. This approach was developed in order to combat with trade restriction practices that are usually faced by countries while importing of good or services. This theory work over an aim of providing mutual benefit to parties involve in trade agreement from voluntary and cooperation trade. It is also consider as foundational principle of international trade.
This theory is perfectly fit over the ASEAN Free Trade Agreement (AFTA) as this is formed to facilitate integration of economy among six countries and to make them enjoy the free flow of trade which also support in enhancing their economical growth. This agreement is usually formed to provide countries mutual benefit over their trade practices that support them in economical growth. On the other side, comparative theory focuses over principle that a country must product product or services in which it can earn more then another country and achieve comparative advantage. So, by implementation of this theory at international trade ASEAN countries can focuses over retaining products which have comparative advantage by enhancing their production capacity. This help in diverting the focus of ASEAN country toward specialization because as per comparative advantage theory a nation must try to exploit that in order to become specialized in that product. For instance, Malaysia is more technological advanced and it posses high comparative advantage in technologically advanced product but the future of this industry is based over the capability or resource availability of country to deal with future threats. On the other side China's bilateral AFTA trade agreement allow it to perform free flow of good or service in several different countries over an international market. China is also having specialisation in technology based products and because of which Malaysia is getting huge competition from China as they both are specialised in same industrial product. So in order to get comparative advantage in this Malaysia must focuses over exploit the technological based product and try to improve its quality. This will help them in gaining m,ore competitive advantage that contribute toward the achievement of comparative advantage by earning more over their trading of product as compare to China.
Apart from this Malaysia is also having comparative advantage within resource based industry which offer product that are made up of wood. Malaysia also get benefit in trading resource based industrial product with the entry of China into WTO in economical terms. The reason behind this is that Malaysia can produce furniture at relatively lower cost as compare to another country because of availability of natural resources. There are three main factors that support Malaysia in getting comparative advantage within this industry it includes labour productivity, unit labour cost and salary & wages per worker. This comparative advantage will help Malaysia in gaining more economical benefit at international trade with the help of AFTA free flow trade agreement in which it is involved.
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ASEAN Free Trade Agreement has been an effective integration of various economies which facilitated free flow of resources and market integration.
There have been important and quite effective aspects regarding AFTA which has been effectively reviewed in the report.
The first aspect effectively covered the concept of Regional Economic Integration, within which, five levels of integration has been showcased as well as analysed. All these levels are distinctive in nature and cover different types of integration which could happen between countries.
Another aspect which has been discussed in this report is the objectives for the formulation of AFTA. Four objectives as per the policy makers and ASEAN heads are examined which provided effective insight onto the reasons which were the main factors of formation of this agreement (Perri and Peruffo, 2016).
This report then defines impact of AFTA on Malaysian Economy. All the sectors within the economy are evaluated on the basis of impact bore by them and thus, it was determined that while AFTA had majority of positive impacts on the country, various sectors like agriculture and employment were subjected to negative impact as well.
Comparative advantage theory was also applied on international trade on AFTA. Various instances and intra-AFTA trades have been highlighted and comparative advantage is shown through appropriate application.
Thus, it is concluded that international business is a very important aspect which undertakes various wide aspects related to international commerce and trade. REI helps in determining various integrations that could be opted by countries as per their requirements. Economic integration, production capacity and FDI were vital aspects for formation of AFTA. This agreement had an impact on primary, secondary, tertiary and quaternary sectors of Malaysia in positive as well as negative ways. Lastly, comparative advantage theory is quite useful to determine effectiveness in international trade in AFTA.
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Books and Journals
- Buckley, P., 2017. International business. Routledge.
- Buckley, P.J., 2016. The contribution of internalisation theory to international business: New realities and unanswered questions. Journal of World Business. 51(1). pp.74-82.
- Cantwell, J., 2017. Innovation and international business. Industry and Innovation. 24(1). pp.41-60.
- Folsom, R.H., and et. al., 2016. International business transactions in a nutshell. West Academic.
- Giovanni, J.D., Levchenko, A.A. and Mejean, I., 2016. The micro origins of international business cycle comovement (No. w21885). National Bureau of Economic Research.
- Hamilton, L. and Webster, P., 2018. The international business environment. Oxford University Press.
- Perri, A. and Peruffo, E., 2016. Knowledge spillovers from FDI: a critical review from the international business perspective. International Journal of Management Reviews. 18(1). pp.3-27.
- Picciotto, S. and Mayne, R. eds., 2016. Regulating international business: beyond liberalization. Springer.
- Stahl, G.K. and Tung, R.L., 2015. Towards a more balanced treatment of culture in international business studies: The need for positive cross-cultural scholarship. Journal of International Business Studies. 46(4). pp.391-414.
- Vernon, R., 2017. International investment and international trade in the product cycle. In International Business (pp. 99-116). Routledge.