Bilateral Cooperation Dilemma for ASEAN Economic Integration

Arranged by:
Dwi Maharatun Faikoh (1606862620)
Mohammad Akmal A (1606862583)
Novia Febriyanti H (1606830625)
Redi Sunarta (1606888216)
Yasmin Fitriana I (1606831905)

Paper for Final Assignment

Course: Introduction of Game Theory
Instructor: Chaikal Nuryakin S.E., M.S.E., M.A., Ph.D.

Fakultas Ekonomi dan Bisnis

Universitas Indonesia
Depok
2019
 Statement of Authorship

“We declare that the final project attached is purely the result of our work. There is no other person's
work that we use without mentioning the source. This material has never been presented / used as
material for papers / assignments in other subjects unless we state clearly that we declare to use it. We
understand that the assignments that we collect can be reproduced and or communicated for the
purpose of detecting plagiarism.”

Name NPM

Dwi Maharatun Faikoh 1606862620

Mohammad Akmal A 1606862583

Novia Febriyanti H 1606830625

Redi Sunarta 1606888216

Yasmin Fitriana I 1606831905

Course : Introduction to Game Theory

Title of the paper : Bilateral Cooperation Dilemma for ASEAN Economic Integration
Instructor : Chaikal Nuryakin S.E., M.S.E., M.A., Ph.D.
Date : April 6, 2019

1
 TABLE OF CONTENTS

Chapter 1 ................................................................................................................................................ 3
INTRODUCTION ................................................................................................................................. 3
1.1 Background .................................................................................................................................. 3
1.2 Problem Statement ....................................................................................................................... 4
1.3 Objective ...................................................................................................................................... 4
Chapter 2 ................................................................................................................................................ 5
LITERATURE OF RELATED REVIEW ............................................................................................. 5
2.1 Backward Induction ..................................................................................................................... 5
2.2 ASEAN as an Economic Cooperation’s: An Overview .............................................................. 5
2.3 Regional Level Analysis of ASEAN FTA ................................................................................... 6
2.4 Bilateral Level Analysis of ASEAN FTA .................................................................................... 7
2.5 Economic Impacts of Trade Liberalization: Case of Indonesia ................................................... 8
Chapter 3 .............................................................................................................................................. 11
RESEARCH METHODOLOGY......................................................................................................... 11
3.1 Choosing Player ......................................................................................................................... 11
3.2 Game Design .............................................................................................................................. 12
3.3 Statistical Payoff Verification .................................................................................................... 13
3.4 Data Collection ........................................................................................................................... 13
CHAPTER 4 ........................................................................................................................................ 14
ANALYSIS .......................................................................................................................................... 14
4.1. Trade Liberalization, Bilateral Cooperation and FDI Inflow .................................................... 14
4.2. Economic Effects of Singapore’s Bilateral Free Trade Agreement with Japan on Other
ASEAN Economies .......................................................................................................................... 16
4.3. The Game Tree of Bilateral Cooperation with Non-Member of ASEAN ................................ 20
4.3.1 Player’s of The Game .......................................................................................................... 20
4.3.2 Estimated results .................................................................................................................. 21
4.3.3 Solve The Game .................................................................................................................. 22
CHAPTER 5 ........................................................................................................................................ 25
CONCLUSION .................................................................................................................................... 25
REFERENCES .................................................................................................................................... 26

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 Chapter 1
INTRODUCTION

1.1 Background
Association of South East Asia Nations (ASEAN) was established by 5 leaders – the foreign
minister of Indonesia, Thailand, Singapore, Malaysia, and Philippines whose signed document on 8 th
August 1967 in Bangkok, Thailand. As the regional cooperation, ASEAN has several aims and
purposes, these aims and purposes were about cooperation in the economic, social, cultural, technical,
educational and other fields, and in the promotion of regional peace and stability through abiding
respect for justice and the rule of law and adherence to the principles of the United Nations Charter.
Nowadays, ASEAN consist of 10 member state, they are Indonesia, Malaysia, Singapore, Thailand,
Philippines, Vietnam, Cambodia, Laos, Myanmar, and Brunei Darussalam.
From economic point of view, as we know most of ASEAN member state are categorized as
developing countries, therefore ASEAN attempting to build strong regional economy cooperation to
escalating economic well-being for every member state of ASEAN and generate economy stability in
South East Asia. Moreover one of purpose of ASEAN cooperation is to decrease economic gap
between member state. Data from World Trade Organization (WTO) in 2006 shows that Asian regional
trade depends more on the Asian itself, than from any other region. This can be seen through Asia’s
intra export in which 50 percent of Asian total trade goes to Asian countries, while the remaining 50
percent goes to the rest of the world (Verico, 2017).
Table.1

Share of Regional Trade Flows (% of Merchandise Export) 2006

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 Inspired by European Union, strong economic cooperation was established by integrating trade,
while applying discriminative trade policy for non member state (known as custom union) to generate
capital inflow from non member and became common market. When capital accumulated, it would be
attracting people and services, and finally become closed and hard regional cooperation with single
currency. Slightly different with ASEAN case. The center point of this regional economic integration
process is intra-regional trade, which connects both trade and investment at the regional level. Intra-
regional trade is created by ASEAN Free Trade Agreement (AFTA) and in turn affects long-term
investment and free flow of people. The letter is part of the ASEAN Economic Community (AEC),
therefore ASEAN economic cooperation called as open and soft regional economic cooperation.
The open and soft principle of ASEAN economic cooperation allows each member state to
have direct Bilateral FTA (BFTAs) with non-member state. The openness, BFTA enable attracting
foreign direct investment inflows from non-member state such as custom union. The differences, CU
attract FDI inflow for regional level, while BFTA attract FDI inflow for a single country. The
possibility of doing bilateral FTA with non-member state will threatening one of the objective of
ASEAN economic cooperation to decreasing economic gap between member state of ASEAN.
Bilateral FTA (BFTA) stimulates “triggering action” or “snowballing effect” as it makes non-BFTA
members give more support for regional enlargement under FTA or ASEAN Umbrella (Verico, 2017).

1.2 Problem Statement

1.2.1 What is the best strategy for Indonesia as one of ASEAN member state when other member
state do bilateral cooperation with non-member state?

1.3 Objective
1.3.1 To analyzing Indonesia’s best strategy as one of ASEAN member state when other member
state do bilateral cooperation with non-member state.

4
 Chapter 2
LITERATURE OF RELATED REVIEW

2.1 Backward Induction

Backward induction first appeared in the von Neumann and Morgenstern’s founding book as a
general procedure for solving two-person zero-sum games of perfect information. It was used to prove
a precursor of Kuhn’s Theorem for chess and similar games (Kaminski, 2009). Perfect equilibrium
(Selten, 1975), sequential equilibrium (Kreps and Wilson, 1982) or procedures such as forward
induction (Kohlberg and Mertens, 1986) offered solutions oftentimes better comforting our intuition.
The arguments against backward induction began to multiply and sealed the doubts about its universal
validity (Basu, 1988, 1990; Bonanno, 1988; Binmore, 1987, 1988; Reny, 1986; Fudenberg, Kreps and
Levine, 1988; Bicchieri, 1989; Pettit and Sugden, 1989).
In game theory, backward induction is the most common solution to solve finite extensive form
and sequential (extensive) games. Backward induction is an iterative process of reasoning backward
in time, from the end of a problem or situation, and infer a sequence of optimal actions. The backward
induction (BI) algorithm for perfect information (PI) games is based on the following reasoning: The
last player, who must choose between outcomes of the game, chooses an action that maximizes his
payoff; taking this as given, the previous player maximizes his payoff; and soon, until the beginning
of the game is reached. Backward induction game determines the optimal strategy of the player who
makes the last move in the game at each stage of the game. Then, the optimal action of the next-to-last
moving player is determined, taking the last player's action as given. This process continues backward
until the best action for every point in time has been determined. Effectively, one is determining the
Nash equilibrium of each subgame of the original game. The backwards induction has an assumption
of common knowledge that each player will act rationally.
In finite games of perfect information, every backward induction equilibrium, i.e., a strategy
profile that survives backward pruning, is also a subgame perfect equilibrium (SPE), and all SPEs
result from backward pruning. Yet, game theorists consider it common knowledge that other games
can be solved backwards as well, and they routinely apply the procedure to such games (Kaminski,
2009).

2.2 ASEAN as an Economic Cooperation’s: An Overview

There are several sub-regional economic cooperation agreements in ASEAN. The first one is
the SIJORI (Singapore-Johor-Riau) Growth Triangle . Sijori was established with the main objective
of increasing the economic capacity of each of its member countries, in addition to strengthening

5
ASEAN regional economic cooperation (Arybowo, 2009). The basis is what is known as comparative
advantage, meaning that each country has advantages that are not the same. Singapore with adequate
supporting tools, capital, experts, and technology. Johor has a market and half-skilled personnel.
Whereas Riau (Batam-Bintan) has very cheap labor and land. Collaboration with differences in the
supporting tools possessed by each country is expected to create an efficient industrial environment
and can provide balanced benefits for each of the countries involved.
Besides the Sijori, another sub-regional economic cooperation is the IMT-GT (Indonesia
Malaysia Thailand Growth Triangle). IMT-GT is cooperation established in the context of accelerating
economic growth, cooperation and integrity, among the three member countries, especially the relevant
provinces. Then there is the BIMP-EAGA (Brunei Darussalam-Indonesia-Malaysia-Philippines East
ASEAN Growth Area). This cooperation aims to improve welfare and economic growth, through
infrastructure and investment, in the border areas of member countries. In 2001, Thailand, Indonesia
and Malaysia formed the International Tripartite Rubber Organization (ITRO), another sub-regional
economic cooperation. This organization controls certain products, natural rubber, with certain supply
management schemes (SMS) - supply side policies to control production quantities - and agreed export
tonnage schemes (AETS) to control the amount of trade (Verico, 2017).
In addition to sub-regional economic cooperation, there is a bilateral free trade agreement
(BFTA). BFTA was established to increase investment from non-member countries and developed
countries. Despite the advantages of BFTA, it has a negative effect on regional trade agreements
because of the substitution effect on regional trade arrangements. Nonetheless, ASEAN member
countries continue to do BFTA with non-member countries because there is one country that starts
BFTA with other countries, regardless of the risks involved. The country that first established BFTA
was Singapore, then followed by other countries.
AFTA (ASEAN Free Trade Area) was established in 1992 and implemented in 1999. AFTA is
an agreement made by ASEAN countries to create a free trade zone. The objective of establishing
AFTA is making the ASEAN region as a competitive production place so that ASEAN products have
strong competitiveness in the global market, increasing trade between ASEAN members (intra-
ASEAN Trade), and attract more foreign direct investment (FDI).

2.3 Regional Level Analysis of ASEAN FTA

Regional Trade Agreement (RTA) has been recognized that it could enhance welfare through
trade creation and reduce welfare through trade diversion (MacPhee, 2014). Trade creation takes place
when the imports and exports of members within a preferential arrangement expand due to the
elimination of internal trade barriers. Trade diversion occurs when trade shifts from outside trading

6
partners to members of preferential arrangement. Trade diversion has an impact that the product that
is available from more efficient country with a relatively low price is imported from an RTA partner
at a higher cost and sold at a higher price. In the other hand, trade diversion induces inefficient
production within the arrangement and prevents consumer surplus from rising to multilateral free trade
levels. The net welfare effects of RTAs determined by the balance of trade diversion and trade creation.
The size of the welfare effect itself affected by the market structure variables such as the elasticity of
the demand and supply, the geographical proximity of RTA members, and the relative number of
substitute products produced by RTA members.
ASEAN Free Trade Area (AFTA) is a form of Regional Trade Agreements with FTA model
in the South East Asia Region where in all trade barriers among members are removed, but each nation
retains its own barriers to trade with non-member states. Initially, AFTA is intended to increase intra-
regional trade by lowering tariff barriers and to attract investment through Foreign Direct Investment
(FDI) from non-members, even though RTA is basically aimed at trade integration. AFTA is expected
to generate trade creation through the increase of intra-regional trade in Southeast Asia (Verico, 2017).
ASEAN is currently attempting to enhance its regional trade liberalization in the AFTA by increasing
its attractiveness for long-term investment creation of FDI by deepening its CEPT implementation
tariff down to zero percent in 2010 for ASEAN-6 and in 2015 for ASEAN-4.

2.4 Bilateral Level Analysis of ASEAN FTA

According to the characteristics of ASEAN as soft and open regionalism principles, ASEAN
allows its member states to have direct Bilateral Free Trade Agreement (BFTA) with state outside
AFTA. BFTA itself is the best alternative for non-member states to avoid discrimination in the regional
trade policy. BFTA is expected to attract investment from advanced countries and non-member states.
BFTA creates a dilemma for its RTA. In the other hand, member states receive benefit from
establishing BFTAs that will differ between more advanced and less advanced member states.
Eventually will increase the economic gap within the member states. However, since no member state
of a RTA wants to be left behind when its fellow members establish a direct BFTA with non member
states from advanced economies, other member states will also make BFTAs, regardless the risk.
BFTA make trade arrangements very complicated as result of their substitution effect on regional trade
arrangements, which increase the economic gap between regional member state thus opposing the
main objective of the regional agreements. There are at least two negative impacts of BFTAs towards
regional economics arrangement:
a. BFTAs are capable to substitute regional economic arrangements in which will weaken the
function of the regional economic arrangement.

7
 b. BFTAs can increase the economic gap between developed and developing countries of the
member states. This impact will jeopardize the main objective of regional economic
integration, which is to reduce the economic gap within member states in order to establish
economic convergence.

2.5 Economic Impacts of Trade Liberalization: Case of Indonesia

In 1992, Indonesia signed her first ever major trade agreements under the AFTA (Asean Free
Trade Area). Under this agreement, the ASEAN members agreed to reduce intra-regional tariffs of
goods placed under a ‘Common Effective Preferential Tariff’ (CEPT). Then, in 2007, president of
Indonesia, Susilo Bambang Yudhoyono, and the prime minister of Japan, Shinzo Abe, signed the
Indonesia-Japan Economic Partnership Agreement (IJEPA). IJEPA effective since July 1, 2008 (entry
into force). IJEPA is the first bilateral agreement for Indonesia.
Overall AFTA has a greater impact on the Indonesian economy compared to IJEPA. Research
conducted by Gumilang, Mukhopadhyay, and Thomassin in 2011 aimed to analyze the impact of trade
liberalization of IJEPA and AFTA for Indonesian economy. In the study, researchers used the GTAP
6 database that covers 57 sectors and 87 regions. The trade data in this database was obtained from the
UN Comtrade while the sectoral/regional data are based on I-O data of each country economy.
Given that the main focus of that study is to study the possible impact of Indonesia's
participation in AFTA and IJEPA, the 87 regions in the original database were aggregated to nine
regions with an emphasis on countries in East Asia to facilitate and focus the scope of analysis. The 9
aggregated regions are ASEAN, China, Indonesia, Japan, Korea, NAFTA, Rest of Asia (ROA), Rest
of OECD (ROO) and Rest of the World (ROW). ASEAN is grouped as a region because the region
collectively is a major trading partner of Indonesia and has a much liberalized trade relationship with
Indonesia through AFTA. Similarly, China and Korea are listed as individual countries because they
play an important role in the region and are major trading partners of both Indonesia and Japan. In the
aggregation, ROO is separated from ROW because their distinct development stages may influence
their trade relationship and composition with Indonesia. The model that will be used in the study of
the objectives will include 9 regions and 57 sectors.
The research conducted by Gumilang, Mukhopadhyay, and Thomassin is consist of four
different scenarios. A total of four scenarios are considered in this study: a) Business as Usual (BAU),
without the presence of any additional trade policies, b) IJEPA, c) AFTA and d) AFTA and IJEPA.

Table 2.1
Percentage Changes in Output Level in BAU Scenario

8
Source: Gumilang, Mukhopadhyay, and Thomassin, 2011
In the BAU scenario, the world economy is projected to the future without implementing any
policy shocks in the form of tariff reductions. Table 1 shows the projected percentage changes in the
output level of the different economies up to the year 2022 (at constant price in 2001). The result
showed that China has the highest rate of output growth throughout the period, growing by 460.2%
over the year 2022. Among the three regions of interest, Indonesia has the highest output growth
followed by ASEAN and Japan. Overall, world output is expected to grow by 111.3% over the period

Table 2.2
Percentage changes in output compared to the BAU scenario in 2022.

Source: Gumilang, Mukhopadhyay, and Thomassin, 2011

Table 2 shows the percentage changes in total output that arises from the different trade
liberalization scenarios in 2022 compared to the BAU case (at constant price in 2001). The results in
Table 2 indicate that Indonesia stands to benefit from participating in both AFTA and IJEPA. . In the
case of the IJEPA scenario, Indonesia and Japan output is 0.11% and 0.01% higher over the BAU
output respectively while other countries saw a decline. Similarly, in the AFTA scenario, Indonesia
and ASEAN output increased by 0.47% and 0.11% respectively while other countries faced negative
output changes. The same pattern can be seen in the ‘AFTA+ IJEPA’.

9
 Table 2.3
Welfare gain arising from trade liberalization (US$ million).

Source: Gumilang, Mukhopadhyay, and Thomassin, 2011

Table 5 outlines the welfare changes that occur across the four scenarios together with the
decomposition of total welfare into three components: allocative efficiency, term of trade (ToT) and
investment goods–saving (I–S) effects. Welfare results indicate that trade liberalization leads to
welfare level improvement in agreement countries at the expense of non-agreement countries resulting
in a net loss in global welfare. The distributions of welfare increase among agreement countries
however are varied. Further analysis into the components of welfare changes showed that the source
of welfare gain for the agreement countries differed and positive ToT effect played an important role
in this gain. For Indonesia allocative efficiency also increased with greater trade integration.
So, the conclusion is AFTA appears to have a much greater impact on Indonesia compared to
IJEPA as AFTA resulted in 0.47% increase in Indonesia's output compared to 0.11% under IJEPA.
Combined, the agreements resulted in a 0.54% increase in output in Indonesia. Under all the scenarios,
Indonesia is the country that gained the largest relative increase in output. The results also showed that
in terms of output, member countries benefited from the agreements while non-member countries lose
out

10
 Chapter 3
RESEARCH METHODOLOGY

3.1 Choosing Player

Research methodology aims at explaining the research process, which is an organized and
methodical process involving data collection, data analysis, data interpretation and arriving at the
conclusions and recommendations at the end so as to help understand the underlying logic (Buring,
2007). First things first, we have to choose two ASEAN countries in this game simulation. the simplest
method to determine which country to play is by using Trade Similarity Index. This index can measure
the similarity of structures whether export or import in both countries or regions. The assumption that
we use is that the higher the level of similarity in the export structure between the two countries, the
more competitive the two countries will be outside the ASEAN market. Until the end, it will encourage
bilateral countries from third parties. Finger and Kreinin (1979) put forward the calculation formula
of product similarity index by the following formula:

𝑆𝐼(𝑎𝑏, 𝑐) = {∑ 𝑚𝑖𝑛 [𝑋𝑖 (𝑎𝑐), 𝑋𝑖 (𝑏𝑐)]} 100

𝑖

It assumes, there are two different countries a and b, this formula estimates export or import
similarity of a and b with c . 𝑋𝑖 (𝑎𝑐) is the share of commodity i in a’s trade to c. 𝑋𝑖 (𝑏𝑐) is the share
of commodity i in b’s trade to c. 𝑋𝑖 is used for the index because intened to compare only patterns of
export/import across product categories. Thus, it should not be influenced by the realtive size or scales
of total export/import. The number of S (0 ≤ SI ≤ 1) is bigger, the competition between two countries
is harsher in the third market. If the commodity distribution of a’s and b’s export is identical, the index
will take on a value of 100. If a’s and b’s export patterns are totally different, the index will take on a
value of zero (Finger and Kreinin).
We will prioritize export similarity because it has a more direct effect on the domestic economy. If the
product similarity index to rise over time, it shows that the export structure of the two countries is
converging. At the same time, it means that the two countries will become more competitive in the
third market (Pomfret, 1981; Pearson, 1979). If this convergence occurs between developing countries
and developed countries, then a rise index also reflects the rapid economic growth and industrialization
in developing countries (Finger and Kreinin, 1979).

11
3.2 Game Design
we use finite extensive games to describe the conditions between two countries that have been
chosen. In game theory, backward induction is the most common solution to solve finite extensive
form and sequential (extensive) games. Backward induction first appeared in the von Neumann and
Morgenstern’s founding book as a general procedure for solving two-person zero-sum games of perfect
information. It was used to prove a precursor of Kuhn’s Theorem for chess and similar games
(Kaminski, 2009). Perfect equilibrium (Selten, 1975), sequential equilibrium (Kreps and Wilson,
1982) or procedures such as forward induction (Kohlberg and Mertens, 1986) offered solutions
oftentimes better comforting our intuition

Backward induction is an iterative process of reasoning backward in time, from the end of a
problem or situation, and infer a sequence of optimal actions. The backward induction (BI) algorithm
for perfect information (PI) games is based on the following reasoning: The last player, who must
choose between outcomes of the game, chooses an action that maximizes his payoff; taking this as
given, the previous player maximizes his payoff; and soon, until the beginning of the game is reached.
Backward induction game determines the optimal strategy of the player who makes the last move in
the game at each stage of the game. Then, the optimal action of the next-to-last moving player is
determined, taking the last player's action as given. This process continues backward until the best
action for every point in time has been determined. Effectively, one is determining the Nash
equilibrium of each subgame of the original game. The backwards induction has an assumption of
common knowledge that each player will act rationally.

12
3.3 Statistical Payoff Verification
Last one, we have to prove that countries that do bilaterally with countries outside ASEAN will
get higher benefits. we assume that only one country has succeeded in conducting bilateral and means
that the country has a higher level of competitiveness than the other countries. Therefore, we will then
use one of the econometric models to measure this. we will use the one that best matches the estimated
goal is the fixed effect model. FEM allows us to see the difference in the impact of an interest variable
between individuals. with model specifications as follows:

𝑙𝑛 𝐺𝐷𝑃𝑝𝑒𝑟𝐶𝑎𝑝 = 𝛽0 + 𝛽1 𝑙𝑛𝑋𝑖𝑡 + 𝛽2 𝑙𝑛𝐼𝑀𝑖𝑡 + 𝛽3 𝑙𝑛𝐼𝑖𝑡 + 𝛽4 𝑙𝑛𝐻𝑢𝑖𝑡 + 𝜀𝑖𝑡

Where the dependent variable is the logarithm of real GDP of country i for the year t, with
GDP corresponding to gross domestic product per capita. Explanatory variables that derive from
neoclassical growth theory, where I and Hu correspond respectively to the investment, and the level
of human capital rate, of country i for the year t. Our variables of particular interest are aggregates
exports and imports are denominated X and IM. Finally, the estimation results of this model will be
the basis of this essay in determining the payoff of each country.

3.4 Data Collection

We use annual data over the period 2011-2017 for a balanced panel of 10 ASEAN countries. Most
required data are extracted from the Penn World Tabel (version 9.1) database. This is the case for the
following variables. The dependent variable is computed using the GDP based on Output-side real
GDP at chained purchasing power parity (expressed in constant mil. 2011US$). The annual population
is calculated based on total population figures (midyear estimates). The investment (I) is proxied
through the Real domestic absorption reduced by Real consumption of households and government, at
current PPPs (in mil. 2011US$) , while the human capita is used as a proxy for based on years of
schooling and returns to education; see Human capital in PWT9. Finally, the export (X) and import
(IM) is computed using values of exports and imports of goods and services in current USD dollars
from Atlas. Whereas X/M data was obtained from The Observatory of Economic Complexity (OEC)
edition of HS6 REV. 2007 (4 digit depth) with vulnerable in 2008 - 2017. Original data was obtained
from COMTRADE. Exploration data analysis is carried out with the help of Pandas as a data
cleaning/manipulating process tool.

13
 CHAPTER 4
ANALYSIS

4.1. Trade Liberalization, Bilateral Cooperation and FDI Inflow

Trade liberalization can drive economic growth through investment growth. Some literature
revealed that trade liberalization enables the creation of knowledge and technological spillover across
countries that can boost productivity of production factors in the country (Sheghezza & Baldwin,
2008). Research conducted by Elena and Richard in 2008 aimed to analyze the impact of trade
liberalization on growth through investment accumulation, where trade liberalization was able to
encourage the creation of investment and subsequently encourage economic growth. In the study,
researchers used data from manufacturing product exporters. The manufacturing sector allows
technological spillover and capital accumulation. The results of this study indicate that, domestic and
foreign barrier for trade is significant in reducing the level of investment, meaning that trade openness
is able to encourage the formation of investment in the country (Sheghezza & Baldwin, 2008).
Based on research conducted by Baldwin and Sheghezza in 2008 which states that the domestic
trade barrier has a significant negative effect on FDI inflow. Meanwhile, the conditions in Indonesia
for restrictions on imports in the form of reactive import tariffs are much higher among other countries
in Asia, especially in Southeast Asia. Data from the Global Trade Alert in 2017 published by World
Bank researchers; Massimilliano Cali shows that the import share of Indonesia's new import restriction
is around 50%, while Vietnam and Malaysia are in the range of 10%, Thailand is 5%, while Singapore
and the Philippines are under 5% (Cali, 2018).
Chart 4.1
Change in Tariff Impor for 2000-2017 in Average

14
 Based on chart 1 above, which explains the average change in import tariffs for intermediary
goods and overall goods and services, it can be analyzed that import restrictions on intermediate goods
on average from 2000-2016 show a positive trend, while member countries Other ASEAN such as
Vietnam, Thailand, Malaysia and the Philippines show a negative trend, thus the picture above shows
that Indonesia is relatively more closed compared to other ASEAN member countries. The current
global value chain era should be an opportunity for Indonesia to attract FDI Inflow through its
economic openness, in fact the opposite is the case, where Indonesia is relatively closed and its tariff
policies actually hamper Indonesia's participation in the global value chain.
Like the findings of Shegezza and Baldwin in a journal released in 2008, which stated that
domestic and non-domicidal barriers had a negative influence on FDI inflow, this was seen in the trend
of Indonesian FDI inflows and other ASEAN member countries. In addition, restrictions for
Indonesia's FDI inflow are also relatively high compared to other ASEAN member countries.

Chart 4.2
Degree of FDI Restriction 2018

Source: OECD, 2018

The degree of restriction shows the level of resistance of FDI inflow of a country, getting closer
to the value of 1, indicating the higher barriers for FDI inflow. Based on the graph above, the degree of
Indonesian FDI restriction is relatively high compared to Malaysia, Vietnam, Korea, China and Japan,
even above the world average (OECD average). The degree of Indonesian restriction is at the value of
0.31. In line with the high barriers to Indonesian imports and FDI, the Indonesian FDI inflow rate is
relatively small compared to Vietnam, Malaysia, the Philippines, China and Thailand. Based on data
from the World Bank, the average percentage of FDI inflow to Indonesia's GDP in 2016-2017 was only

15
1%, while Vietnam, Malaysia, the Philippines, China and Thailand averaged the percentage of FDI to
GDP in 2016-2017 amounting to 6%, 4%, 3% and 2% (World Bank, 2018).
On the other side, Regional Trade Agreement (RTA) is a collaboration that aims to create
regional trade by reducing barriers in the form of tariffs and ultimately can encourage FDI Inflow. In
the context of ASEAN cooperation, ASEAN regional trade cooperation is known as AFTA (ASEAN
Free Trade Area). At present through AFTA, it is expected to create a solid trade collaboration between
ASEAN member countries, and indirectly AFTA is expected to be able to attract FDI inflow.
In his book entitled "The Future of the ASEAN Economic Integration" an Indonesian economist,
Kiki Verico in 2017 sought to analyze the direct impact of AFTA cooperation on FDI inflow, the impact
of intra-regional trade cooperation on FDI inflows as an indirect impact of AFTA towards FDI inflow,
analyzing the impact of AFTA on the intra-regional trade trade collaboration itself, as well as the impact
of the Bilateral Free Trade Area (BFTA) on the Asian-Noodle Bowl Phenomenon.
The method used in the study was divided into two scenarios. The first scenario is to analyze
the impact of AFTA on FDI inflows using the PLS (Pooled Least Square) method where AFTA is used
as an independent variable to analyze its impact on FDI inflows as an independent variable. The second
scenario is used to analyze the indirect impact of AFTA on FDI inflows by using both non-systems that
separate equations from FDI inflows and intra-regional trade equations and systems of equality models
that make FDI inflows and intra-regional trade as endogenous variables and the remainder as exogenous
variable.
The results of the model estimation show that for the FDI inflows model, the two systems (non-
system and equation systems) show that the variables are economic size (log GDP), degree of openness
(DOO), consumption (log consumption), population, and total power employment has a significant
effect on FDI inflows and shows a positive correlation with FDI inflows. Meanwhile, for intra-regional
trade models, worker productivity variables, exchange rates, economic size, and electrical capacity are
significant for trade creation in the context of intra-regional trade, and have a positive correlation.

4.2. Economic Effects of Singapore’s Bilateral Free Trade Agreement with Japan on Other
ASEAN Economies
BFTA enable attracting foreign direct investment inflows from non-member state. According
to Ni (2003), bilateral trade liberalization has become an crucial part of Singapore’s trade policy.
Singapore has already concluded BFTA with a lot of ASEAN non member states. Singapore becomes
a “hub” of a hub-and-spoke system, and it is well believed by policymakers and theorists that
Singapore will enjoy “first-mover advantages” in forming free trade areas with a large number of
different countries (Wonnacott and Lutz, 1989; Rajan et al., 2002).

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 Table 4.1
BFTA of five ASEAN founding members and ASEAN+3 members 2010

Source: Verico, 2017

The possibility of doing bilateral FTA with non-member state will threatening one of the
objective of ASEAN economic cooperation to decreasing economic gap between member state of
ASEAN. Some of ASEAN member states feared Singapore’s BFTA with ASEAN non member states
will make their country worse off. BFTAs between ASEAN member states and non-member states are
considered a deviation from the regional commitments. Singapore is considered the first member state
to engage in such an arrangement. Singapore has developed bilateral agreements with non-member
states since 2001. In 2002, Singapore concluded a bilateral agreement with Japan (JSEPA).
Research conducted by Houmin Ni in 2003 concerns about the impact of Singapore’s BFTA
(SBFTA) on other ASEAN-5 member states (Malaysia, Thailand, Indonesia, Philippines, and
Vietnam) in terms of GDP, external trade and sectoral outputs. This research also explore the impacts
of other optional bilateral free trade agreements between Japan and ASEAN members after JSEPA
comes into force. However, for the purpose of this research, we will only focusing on the impact on
Indonesia.
Before this research, there are several studies on the impact of SBFTA on other ASEAN
member states. The optimistic side of the studies, SBFTA with Japan mentioned the JSEPA would
strengthen Japan’s involvement in and commitment to Southeast Asia in a long term, which is

17
beneficial to both Japan and the ASEAN countries. On the other hand, the pessimistic side of the
studies believe that SBFTA would result in the diversion of investment from other ASEAN countries
to Singapore (Ni, 2003).
The research conducted by Houmin Ni is consist of six different scenarios.
All the scenarios are:
Scenario 1, Japan-Singapore FTA (short-run effects are analyzed);
Scenario 2, Japan-Singapore FTA (long-run effects are analyzed);
Scenario 3, Post-JSEPA Japan-Thailand FTA with long-run effect impact analyzed;
Scenario 4, Post-JSEPA Japan-Philippine FTA with long-run effect impact analyzed;
Scenario 5, Post-JSEPA Japan-Indonesia FTA with long-run effect impact analyzed;
Scenario 6, Post-JSEPA Japan-ASEAN FTA with long-run effect impact analyzed.
The first subsection result from the research is looking at the changes in GDP and trade.
Table 4.2
Changes in Real GDP by Regions and Scenarios

Source: Ni, 2003

Comparing the scenario 1 and scenario 2, we can see that the long-run effects of JSEPA are
much greater than those of short-run. In the long-run period, the increased return attract more
investments in the Japan and Singapore. In the short run, Singapore will benefit from the JSEPA and
Indonesia suffer losses. In the long run, Indonesia suffer higher losses. These results means that in the
long run other ASEAN countries will be adversely but insignificantly affected in their GDPs.
In the case of a Japan-Indonesia FTA, Indonesia’s GDP will increase 2.2% while other ASEAN
countries bear losses in GDP. In this scenario the whole world bear a high costs in terms of GDP
changes. When integration takes the form of a Japan-ASEAN FTA, ASEAN countries and Japan will
all gain large increases in GDP while the GDPs of other regions will decrease.

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 Table 4.3
Changes in Exports by Regions and Scenarios

Source: Ni, 2003

Table 4.4
Changes in Imports by Regions and Scenarios

Source: Ni, 2003

Table 3 and 4 show the trade effects of SBFTA with Japan. In the short run, SBFTA with Japan
will make Indonesia’s exports and imports decrease, this also happens in the long run. In the case of a
Japan-Indonesia FTA, Indonesia will have higher increase in imports than exports. In scenario 6, which
is Japan-ASEAN FTA, there is a great increase in trade in Japan and ASEAN-5 countries. Singapore
continues to increase its trade revenue in scenario 6, whereas other regions in the world will bear
somewhat loss in trade due to trade-diversion (Ni, 2003).
Table 4.5
Changes of International Trade Flow by origins and destination in scenario 6

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Source: Ni, 2003

If a post-JSEPA Japan-ASEAN FTA comes into force, regional trade directions will be
changed. Table 5 prefigures three remarkable trends: most of ASEAN’s exports to non-ASEAN
regions increased, which indicates that the economic competence of ASEAN economies is
strengthened; the increased trade revenues between Japan and ASEAN countries indicate that the
economic relation of Japan and ASEAN is enhanced; most of intra-ASEAN trade will decrease, which
indicates that the intensity of the intra-ASEAN trade will be weakened and the extra-ASEAN trades
will play more important role in ASEAN economies.
As shown by my simulation results, other ASEAN countries will be adversely but
insignificantly affected in the long term; if more FTAs between Japan and other individual ASEAN
countries come into force, ASEAN countries that is not doing bilateral FTAs with Japan will suffer
much higher loss although the countries inside new FTAs earn benefits. However, these adverse effects
can be reversed if a Japan-ASEAN FTA comes into force.

4.3. The Game Tree of Bilateral Cooperation with Non-Member of ASEAN

4.3.1 Player’s of The Game

20
We measure the SI for the traded commodities for 2011 of 10 countries in ASEAN classified by the
HS6 Rev. 2007. The SI value is interpreted as a measure of the production competition level. On the
existence of international production chain, a high SI value can be interpreted as strong level of
competition. For instance, if the wages in one country sharply increase, the multinational firms will
certainly stop doing trade with this country and move their production in other countries. However,
the interpretation of a high value of SI should always be done with caution since the SI strongly
depends on the level of HS6 disaggregation. We carry out HS6 aggregation up to two digit level. It is
intended to make it easier to see the structure of the types of goods or services traded. In addition, in
2011 it was chosen because it was considered that the year was already in a normal after the financial
crisis.

The table above shows that there is a remarkable difference across countrie, implying that ASEAN
seems to be a heterogeneous economic zone in terms of export composition. The export structure of
Malaysia and Singapore has the highest similarity among combinations of other countries. It shows
that the two countries have the highest level of competition for their export commodities on the world
market. Nguyen, Pham, & Vallée ( 2017) find that the similar export structure among ASEAN
members has a positive effect on their bilateral exports. Meanwhile, out of 45 combinations of
competition between two ASEAN countries, there are ten combinations which show a high level of
competition, indicated by red numbers. The players in this game can be chosen among the ten
combinations. Therefore, we decided to choose the relationship between Singapore and Indonesia as a
case in this game. Besides because Singapore is the most competitive country in ASEAN, but also at
that time Indonesia was in the transition of the commodity boom

4.3.2 Estimated results

Our model estimation results show that both exports and imports statistically affect changes in
GDP per capita. deeper analysis, we found that there were differences in effects between intra-regional.
The figure below shows results similar to previous studies. where increasing export volume is more
profitable for developed countries than developing countries. It is clear, that Singapore is more
benefited by the existence of BFTA than Indonesia. besides because Singapore is the first party to do
BFTA (first movers advantage), but also supported by a more advanced economic structure. Therefore,
in the game design, Singapore will act as the first movers.

21
4.3.3 Solve The Game
We consider a bargaining game with game tree of Bilateral Cooperation between ASEAN and
other countries outside ASEAN. The game described in partition form which analyze the equilibrium
of the game into two scenario. The first game explain the best strategy between Singapore and
Indonesia’s bilateral free trade area as individual and the second game explain the best strategy of
Singapore and the ASEAN member states taking into account the bilateral agreement towards other
countries outside ASEAN. We set the bilateral free trade area (BFTA) in which assumed that member
countries trade at zero tariffs.
For every partition of the game includes a coalition and the coalition define as the bilateral free
trade area. Every coalition will result a value function that assigns a payoff given the adopted strategy.
In this section we treat the value functions as given and the payoff functions have to be constructed
from the objective functions that countries use to evaluate trade agreements.
The game is played as follow: One country is the leader and get the first-mover advantage,
which mean that is the agenda setter. Without loss of generality we assign this role to Singapore which
actually has an experience with the bilateral agreement. In the first stage of the game Singapore as the
leader country decides whether to enter bilateral free trade agreement or non-bilateral free trade area,
as shown in Fig 5.1 which depicted the Singapore and Indonesia BFTA Strategy as Individual.
If the leader country chooses bilateral bargaining, it makes a simultaneous take-it-or-leave-it
offer to the follower country. The follower country in this first game is Indonesia. If Singapore take
the bilateral free trade area, it is better for Indonesia to choose bilateral free trade area. As Indonesia’s
best strategy is to choose bilateral free trade area the resulting payoffs is {10, 8} and the game ends.
Next consider the sub-game in which Singapore chooses non-bilateral free trade area. In this
event, if Indonesia also chooses non-bilateral free trade area then will result in {3,3} or the same
payoffs among this two countries. In the other hand, if Indonesia chooses bilateral free trade area, the
resulting payoff is {3,7} which give higher payoff from Indonesia compared with the strategy for

22
choosing non-bilateral free trade area. Therefore, if Singapore chooses non-bilateral free trade area
then the best strategy for Indonesia is to choose bilateral free trade area and the game ends.
Figure 5.1
Singapore and Indonesia’s Bargaining Game

The second game played as follow: Singapore still act as the leader country and take a first-
mover in doing bilateral free trade area and the follower countries is the members of ASEAN
integration. As the leader country, Singapore has two strategy whether to make bilateral or non-
bilateral free trade area. If Singapore chooses bilateral free trade, then ASEAN’s member best strategy
is to choose non-bilateral free trade area that yields greater payoff. The resulting payoff for Singapore
and ASEAN’s members when both countries choose bilateral free trade area is {1,1}. In the other side,
if Singapore chooses non-bilateral free trade area, then the best strategy for ASEAN’s members is to
choose non-bilateral free trade area that yields {-1,1} as the payoff instead of choosing non-bilateral
free trade area that yields lower payoff for both Singapore and ASEAN’s members. The game of BFTA
when Singapore take a first-mover of BFTA, and consideration of another ASEAN’s members and the
integration of ASEAN is depicted below in the Fig 5.2.

Figure 5.2
Singapore and ASEAN’s members Bargaining Game

23
 In the second stage of the game, ASEAN’s members strategy of doing bilateral free trade area
is always make the ASEAN integration worse-off. This is reasonable since when the ASEAN’s
members also have bilateral free trade agreement will result in ASEAN Noodle effect phenomenon.
This phenomenon will trigger a stumbling block towards the intra-regional economic integration of
ASEAN’s member states and also will make a larger gap between the ASEAN’s member states in the
contexts of ASEAN Economic Integration. However, in contrast this the ASEAN condition, Singapore
has an advantage as the first-mover. Thus, the best strategy for Singapore is doing bilateral free trade
area.

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 CHAPTER 5
CONCLUSION

ASEAN attempting to build strong regional economy cooperation to escalating economic well-
being for every member state of ASEAN and generate economy stability in South East Asia. Moreover
one of purpose of ASEAN cooperation is to decrease economic gap between member state. ASEAN
Free Trade Area (AFTA) is a form of Regional Trade Agreements with FTA model in the South East
Asia Region where in all trade barriers among members are removed, but each nation retains its own
barriers to trade with non-member states. Initially, AFTA is intended to increase intra-regional trade
by lowering tariff barriers and to attract investment through Foreign Direct Investment (FDI) from
non-members, even though RTA is basically aimed at trade integration.
ASEAN allows its member states to have direct Bilateral Free Trade Agreement (BFTA) with
state outside AFTA. BFTA itself is the best alternative for non-member states to avoid discrimination
in the regional trade policy. BFTA is expected to attract investment from advanced countries and non-
member states. BFTA creates a dilemma for its RTA. In the other hand, member states receive benefit
from establishing BFTAs that will differ between more advanced and less advanced member states.
Eventually will increase the economic gap within the member states.
The first game explain the best strategy between Singapore and Indonesia’s bilateral free trade
area as individual and the second game explain the best strategy of Singapore and the ASEAN member
states taking into account the bilateral agreement towards other countries outside ASEAN. In the first
game, if Singapore take the bilateral free trade area, it is better for Indonesia to choose bilateral free
trade area. As Indonesia’s best strategy is to choose bilateral free trade area the resulting payoffs is
{10, 8} and the game ends. Next consider the sub-game in which Singapore chooses non-bilateral free
trade area then the best strategy for Indonesia is to choose bilateral free trade area and the game ends.
In the end of the second game, Singapore always chooses bilateral since Singapore was the
first-mover, and ASEAN must chooses non-bilateral because bilateral has a negative pay-off. The
negative pay-off of ASEAN’s bilateral action shows ASEAN’s members strategy of doing bilateral
free trade area is always make the ASEAN integration worse-off. This is reasonable since when the
ASEAN’s members also have bilateral free trade agreement will result in ASEAN Noodle effect
phenomenon. This phenomenon will trigger a stumbling block towards the intra-regional economic
integration of ASEAN’s member states and also will make a larger gap between the ASEAN’s member
states in the contexts of ASEAN Economic Integration. However, in contrast this the ASEAN
condition, Singapore has an advantage as the firs-mover. Thus, the best strategy for Singapore is doing
bilateral free trade area.

25
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