Understanding ASEAN’s Free Trade Agreements

February 13, 2014 Posted by ASEAN Briefing Reading Time: 6 minutes

Op-Ed Commentary: Chris Devonshire-Ellis

ASEAN, the Association of South-East Asian Nations, is gaining considerably in importance as a trade bloc and is now the third largest in the world after the European Union and the North American Free Trade Agreement. Comprising the Asia Tigers of Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam (the ASEAN 6) with the smaller players such as Brunei, Cambodia, Laos and Myanmar, it has a combined GDP of US$2.31 trillion (2012) and is home to some 600 million people.

The ASEAN bloc have largely cancelled all import and export duty taxes on items traded between them, with the exception of Cambodia, Laos, Myanmar and Vietnam, who continue to impose nominal duties on certain items. However, these too will be completely lifted as of December 31st, 2015, meaning that the entire region will be duty free from this date.

ASEAN has entered into a number of free trade agreements with other Asian nations that are now radically altering the global sourcing and manufacturing landscape. It has a treaty with China, for example, that has effectively done away with reduced tariffs on nearly 8,000 product categories, or 90 percent of imported goods, to zero. These favourable terms have taken effect in China and in the original ASEAN members, including Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand.

Cambodia, Laos, Myanmar and Vietnam will also implement these terms by December 2015.

This has specific impact upon where manufacturing capacity is heading in the future. At the heart of this is China, which for the past twenty years has been enjoying a ‘worker dividend’ of cheap, young labour and has become, as a result, the world’s manufacturing hub. However, China is also growing old – and fast, as that same workforce is now greying and becoming more wealthy. This means that cheap Chinese labour is a thing of the past, yet this is compensated for by China now emerging as a vast consumer market. With an estimated 250 million Chinese of middle class standards in 2013, this number is set to explode to 600 million by 2020.

The manufacturing trend therefore is to continue to develop products destined for this huge consumer market, yet place the manufacturing capacity required to do so in a cheaper location. ASEAN’s free trade agreement with China allows regional companies and MNC’s involved in Asia to do just that. It is a trend already in process – as we note with Foxconn, manufacturer of many of the components that end up in Apple’s products, which is looking to shift its 1.3 million strong workforce out of China and to Indonesia where wages are lower and a large and available workforce exists. It is a sound strategy and one that is being increasingly adopted by many manufacturers.

When Vietnam comes into full play with the ASEAN treaty in just under a years’ time, this development of manufacturing capacity servicing the Chinese market to that country in particular will increase. Vietnam has also deliberately positioned itself to take advantage of the treaty with China by reducing its corporate income tax rate to 22 percent – 3 percent lower than in China.

Vietnam, Indonesia and other ASEAN countries are benefiting from the China FTA by being able to offer lower wages, and as such are attracting foreign investment both for the Chinese market, but also from global destinations such as the EU and United States. There has been some resistance to this, not least where the subject of China’s superior infrastructure is raised. However, countries across ASEAN have been upgrading, and especially the ASEAN 6. As a general rule of thumb, despite the production capability being reduced in some ASEAN nations when compared to China, it makes economic sense to place manufacturing capacity into the ASEAN 6 if production levels can reach 70 percent of that achievable in China. Details of the ASEAN-China FTA can be downloaded here.

ASEAN has a similar FTA with India, which is being phased in and is in the process of reducing tariffs on 90 percent of all traded goods between ASEAN and India. Come 2016, import-export duties on over 4,000 products will be abolished. This will have a similar effect to the China FTA in that it opens up the Indian consumer market to ASEAN manufactured goods. India, in fact, has a sizeable middle class consumer market in its own right of some 250 million, although it is not expected to grow as fast as China’s in the short term. The ASEAN-India FTA is also being expanded to include services, discussions are already at an advanced stage and a conclusion is expected to be reached later this year. Details of the ASEAN-India FTA can be found here.

These two agreements have the collective impact of making ASEAN the strategic hub for global sourcing and manufacturing. With ASEAN’s own middle class consumer base of 150 million, this market alone, then coupled with China and India’s 250 million each represent a total middle class consumer market with complete free trade of some 650 million people – today. By 2030, given Asia’s increasing wealth and dynamics, some 64 percent of the global middle class population will be based in Asia, accounting for 40 percent of all global middle class consumption.

In addition to the China and India FTA, ASEAN also has a combined FTA with Australia and New Zealand, known as the AANZFTA. The deal, also being phased in, has eliminated tariffs on 67 percent of all traded products between the regions, and will expand to 96 percent of all products by 2020. It is the first time ASEAN has embarked on FTA negotiations which covers all sectors, including goods, services, investment and intellectual property rights, making it the most comprehensive trade agreement that ASEAN has ever negotiated. Details of this agreement may be found here.

Further ASEAN treaties are in the process of being negotiated, not least with Japan, who already has a series of Comprehensive Economic Partnerships, while South Korea already has an FTA. Both of these are along similar lines to those identified above – the reduction of over 90 percent of all traded goods between ASEAN and these countries.

For international businesses, the ability to take advantage of ASEAN status and the FTA benefits the region has is simple: all that is required is for the foreign investor to establish a subsidiary in one of the ASEAN nations. It is a geographical qualification only. To this end, and as the region – plus the countries of China and India – is huge, it is Singapore that has developed as a regional Asian hub to reach out across ASEAN and beyond and provide management, financial and other support services to subsidiaries throughout the area.

Incorporation in Singapore is quick and easy – it is regularly positioned as first in the World Bank Global Ease of Doing Business Rankings, while the city state employs a high degree of international standards in its laws and compliance. Singapore also offers a low tax base of 17 percent corporate income tax and provides tax incentives for all SME’s – including foreign investors. As a result, some 7,0000 MNC corporations have already established operations in Singapore – for the sole purpose of looking at what ASEAN has to offer, the suitability of its various member states for establishing subsidiary manufacturing facilities, and the emergence of ASEAN as a production base from which to reach out to the domestic markets of China, India and beyond.

Chris Devonshire-Ellis is the Founding Partner of Dezan Shira & Associates – a specialist foreign direct investment practice providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.

For further details or to contact the firm, please email asia@dezshira.com, visit www.dezshira.com, or download the company brochure.

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