Introduction

The purpose of this chapter is to examine the likely implications of the formation of AFTA on the volume and pattern of foreign direct investment (FDI) in the ASEAN region. There is avast and growing body of literature on ASEAN and AFTA. An important aspect that has not received adequate attention relates to the implications of AFTA for FDI in the region. This is a serious omission because FDI has acted as one of the most important sources of economic growth for all countries in the region, and therefore issues relating to the impact of AFTA on the relocation of industries in the region are likely to be important points of contention in the implementation of the proposed regional tariff preference scheme.

To assess the possible implications of AFTA for FDI in the region, we adopt the following two-step approach. In the first step, potential channels through which the formation of a free trade area (FTA) could affect FDI flows are identified by reviewing the relevant theoretical literature. This is done in order to provide an objective framework for evaluating such arrangements. In the second step, quantitative evidence relating to economic and political performance of AFTA is analysed in light of the criteria established in step one to make inferences about the subject at hand. Given the ex ante nature of the analysis, we are compelled to invoke the assumption that the proposal will be fully implemented (an assumption which does not seem unrealistic, for reasons discussed later in the chapter). The formation of a FTA has implications for both the members of the arrangement (insiders) and the countries excluded from the arrangement (outsiders). We focus on the former aspect only. Furthermore, we consider only the implications for the volume and composition of FDI; welfare implications of such changes are beyond the scope of the analysis.