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The effect of ASEAN-korea free trade agreement (AKFTA) on Indonesia trade:

a gravity model approach

Article  in  Jurnal Ekonomi Pembangunan · July 2019

DOI: 10.29259/jep.v17i1.8916

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 Jurnal Ekonomi Pembangunan, Vol. 17 (1): 1-7, June 2019
Received: 2019-07-06; Accepted: 2019-07-09
p-ISSN: 1829-5843; e-ISSN: 2685-0788

The effect of ASEAN-Korea Free Trade Agreement (AKFTA)

on Indonesia Trade: A Gravity model approach
Arjun Saka Agung1, Zulkarnain Ishak2, Imam Asngari2 and Abdul Bashir2*
1
Student of Department of Development Economics, Faculty of Economics, Universitas Sriwijaya
2
Department of Development Economics, Faculty of Economics, Universitas Sriwijaya
* Correspondence author email: [email protected]

Abstract: This study investigates the effect of the ASEAN-Korea Free Trade Agreement (AKFTA) on Indonesia
Trade with a gravity model approach using panel data. Data collected during 2007-2016 as a result of AKFTA
and trading data mostly obtained from UN Comtrade. The test result shows that REM is the best model
chosen to analyze the effect from GDP per capita, exchange rate, distance and AKFTA Policy to the import
from 14 AKFTA members country to Indonesia. The result from the determination coefficient indicated that
the variation of independent variables (GDP per capita, exchange rate, distance, and AKFTA policies) affected
the variation of the dependent variable (Import) as 54 percent. Meanwhile, from the gravity theory, the
trade among AKFTA economies to Indonesia has brought positive impact as the distance has a positive sign
and lead to form trade creation. While the variable of dummy policy has negative and significantly affected
the import.

Keywords: Trade; gravity model; AKFTA, ASEAN

JEL Classification: F12, F14, F17

1. INTRODUCTION
Economic integration is an international trade policy undertaken by reducing or eliminating
trade barriers discriminatively for the countries involved (Salvatore, 2014). Economic integration
through Regional Trade Agreements (RTAs) has continued to grow significantly since the 1990s.
Based on the report of the World Trade Organization (WTO), up to April 7, 2015, 612 RTAs have
been registered in the form of Free Trade Agreement (FTA) and Customs Union (CU) and 406 of
them have been implemented (Bacchetta et al., 2015) .
ASEAN Free Trade Area Agreement (AFTA) has a goal to improve the welfares of people in
Southeast Asia. The ASEAN economic region is legalized in October 2002 in Cambodia with the aims
of establishing a single market and production base by 2020. The three main pillars of ASEAN
formation are the ASEAN Economic Community, the ASEAN Socio-Culture Community and the
ASEAN Security Community (ASEAN, 2015).
In addition to China, ASEAN conducts economic and trade cooperation with South Korea, the
ASEAN-Korea Free Trade Area (AKFTA). AKFTA was established through the Joint Declaration on
Comprehensive Cooperation Partnership and endorsed in Vientiane, Laos in 2004. Preferential
Treatment of AKFTA in the form of goods, services and investment sectors. The total trade of ASEAN-
Korea FTA reached 134.9 million USD. This shows that trade in the ASEAN region with South Korea
has a positive impact of increasing the volume of trade and public welfare. In addition to these
impacts, AKFTA cooperation will provide positive contribution in the form of increased direct
investment (FDI) and improve the quality of domestic products in the ASEAN region as well as
national competitiveness.

https://ejournal.unsri.ac.id/index.php/jep/index DOI: https://doi.org/10.29259/jep.v17i1.8916

Jurnal Ekonomi Pembangunan, Vol. 17 (1): 1-7, June 2019

Table 1.The Competitiveness Ranking ASEAN Trade Partner 2016

Countries World Rank
Singapore 2
USA 3
Japan 8
Hongkong 9
Malaysia 25
Australia 22
Rep.Korea 26
Thailand 34
Indonesia 41
Philippina 57
Cambodia 89
Laos 93
Vietnam 60
Source: World Economic Forum, 2016-2017.
Table 1 shows that the Indonesia's competitiveness on ranked 41 st of 138countries. While in
ASEAN is in the order of 4 after Singapore, Malaysia, and Thailand. The AKFTA agreement aims to
increase the volume of trade in goods in Indonesia, ASEAN, and South Korea. The agreement is used
to reduce trade barriers and spur productivity. AKFTA goods agreement to increase trading volume
divided into Normal Track (NT) and Sensitive Track (ST) categories. Normal Track is a product that
accelerated the reduction of import tariffs in order to increase trading volume. Sensitive Track is a
product that is considered sensitive and lowered import tariffs with a slower pattern of normal track
products such as fisheries, rice, sugar, textiles and so on.

Table 2. Indonesian - South Korea Trade Balance Year 2013-2016 (Thousand US$)
Component trade 2013 2014 2015 2016
Total trade 23.015.109,6 22.468.592,00 16.091.652,2 13.682.201
Export 11.422.476,2 10.621.193,30 7.664.446,245 7.007.623,660
Import 11.592.633,4 11.847.398,70 8.427.205,940 6.674.577,343
Trade Balance -170.157,20 -1.226.205,50 -762.759,695 333.046,317
Source: UNCOMTRADE, 2016

Indonesia’s total trade growth rate with South Korea in 2013 was 44.93 percent while in 2014
the growth rate of total Indonesian trade with South Korea decreased. The decline reached 8.06
percent. The highest decrease in total trade growth in 2015 reached 14.82 percent. In general, total
trade between Indonesia and South Korea has decreased.
The empirical results of Ritaningsih (2014) shows that overall the trade sector of Indonesia
suffered losses due to trade diversion and there’s no trade creation. Indonesia's import trade flows
with non-member countries ASEAN-Korea is 68 percent less than the level of trade which has been
done. The government needs to lower the real exchange rate, negotiating the price of free trade
offer to non-member countries to lower and approach the offer price of free trade member
countries in anticipating the occurrence of trade diversion, and opening up market access to new
products in order to trade creation with the country member.
The Heckscher-Ohlin model is a theory in economics explaining that countries export what can
be most efficiently and plentifully produced. This model is used to evaluate trade and, more
specifically, the equilibrium of trade between two countries that have varying specialties. Emphasis
is placed on the exportation of goods requiring factors of production that a country has in
abundance and the importation of goods that the country cannot produce as effectively.

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2. LITERATURE REVIEW
The Heckscher-Ohlin model is a theory in economics explaining that countries export what can
be most efficiently and plentifully produced. This model is used to evaluate trade and, more
specifically, the equilibrium of trade between two countries that have varying specialties. Emphasis
is placed on the exportation of goods requiring factors of production that a country has in
abundance and the importation of goods that the country cannot produce as effectively (Silitonga
et al., 2017).
The Modern International Trade Theory begins when the Swedish economist is Eli Hecskher
and Bertil Ohlin put forward an explanation of International trade that has not been able to be
explained in the theory of Absolute comparative. Before entering into the discussion of H-O theory,
this little writing will poses the weakness of the classical theory that led to the emergence of H-O
theory. The Classical Comparative advantage theory explains that international trade can Occurs
because of differences in the productivity of labor explicitly stated) interstate (Salvatore, 2014). But
this theory is not Provide an explanation of the causes of the difference in productivity. Economic
integration in general is the removal (obliteration) of economic barriers between two or more
economies (countries). Operationally, defined as the deprivation of discrimination and political
unite (wisdom) such as norms, rules, procedures. The instruments include import duties, taxes,
currencies, laws, institutions, standardization, and economic policy
According to Salvatore (2014), there are also several stages or sequences before the influence
that occurs, are: (1) Free Trade Area, (2) customs union, (3) general market, and (4) monetary union.
FTA is one form of response from the presence of globalization, the failure of the multilateral trading
system and the liberalization that it implies Reduction and elimination of various barriers to good
trade barriers Tariff or non-tariff barriers. In other words, "internal tariff" between countries
Members become 0 percent, while each country has an "external Tariff "is different. For example
AFTA (ASEAN Free Trade Area) that begins With CEPT (Common Effective Preferential Tariff) which
came into force Since January 1, 1993 and the ASEAN-China Free Trade Area (ACFTA) has been in
effect January 1, 2010.
Following the specification of Newton’s universal law of gravitation in physics, the gravity
model utilizes the gravitational force concept as a research instrument to address various
investigation purposes in economics and political sciences (Yang & Martínez-Zarzoso, 2013). It has
been applied to study the determinants of bilateral trade volumes and performs well in assessing
other bilateral flows, namely capital flows, aid flows or migration flows. It has been used to assess
the effects of market access, trade resistance and the impacts of regional trade agreements on
bilateral trade. In a basic gravity model, trade between country i and country j is proportional to the
size of the economies and inversely relates to the distance, a proxy for transportation costs,
between them.
According to Anderson (2011) Taking a step toward structure, an intuitively appealing starting
point is the description of a completely smooth homogeneous world in which all frictions disappear.
Developing the implications of this structure yields a number of useful insights about the pattern of
world trade. A frictionless world implies that each good has the same price everywhere. In a
homogeneous world, economic agents everywhere might be predicted to purchase goods in the
same proportions when faced with the same prices. In the next section the assumptions on
preferences and/or technology that justify this plausible prediction are the focus, but here the focus
is on the implications for trade patterns. In a completely frictionless and homogeneous world, the
natural benchmark prediction is that Xij/Ej = Yi/Y, the proportion of spending by j on goods from i is
equal to the global proportion of spending on goods from i, where Y denotes world spending.

3. MATERIALS AND METHODS

This study there are 5 main variables; Import, Distance, Tariff, Exchange rate and GDP per
capita. There are one dependent variable is Import and 4 independent variables for the result of
AKFTA effect done with approach of gravity model. This research employs the secondary data type
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for the quantitative method. Data has been downloaded and collected from legal authorities such
as UN Comtrade, WTO, and ASEAN.
Data collected in 10 years range from 2007-2016 as a result of AKFTA. Trading data mostly
downloaded from UN Comtrade and will be analyzed by panel data regression. The data collected
for this problem is through documentation methods which means collecting data in categories and
written clarified data related to problem research rather than legal documents, whether
newspapers or other media and etc.
Quantitative analysis refers to economic, business or financial analysis that aims to understand
or predict behavior or events through the use of mathematical measurements and calculations,
statistical modeling and research. Quantitative analysts aim to represent a given reality in terms of
a numerical value. Quantitative analysis is employed for a number of reasons, including
measurement, performance evaluation or valuation of a financial instrument, and predicting real
world events such as changes in a country's gross domestic product (GDP) growth rate. The model
can be showed:
𝑀𝑖𝑡 = 𝑎0 + 𝑎1 𝐺𝐷𝑃𝐶𝑖𝑡 + 𝑎2 𝐷𝐼𝑇𝑆𝑖𝑡 + 𝑎3 𝐸𝑋𝐶𝑖𝑡 + 𝑎4 𝐷𝑢𝑃𝑜𝑙𝑖𝑡 + 𝑒𝑖,𝑡

where: M is import country i and y in Million US$; GDPC is GDP per capita country i and y in million
US$; DITS is Economic distance country i to y; t is year 2007-2016; EXC is exchange rate in US$; DuPol
is AKFTA policy tariff reduction (dummy), AKFTA economies and Top 4 trade partners; 𝑎0 is
constanta; 𝑎1 , 𝑎2 , 𝑎3 , 𝑎4 is parameters coefficient and e is error term.

4. RESULTS AND DISCUSSION

Import from AKFTA economies to Indonesia increasing from 2009 to 2014. Indonesia's import
trade from ASEAN-Korea is dominated by Singapore, South Korea, and Malaysia. The value of
imports from Singapore continues to increase from year by year. Because, Singapore is a center of
trade and finance as well as a transit point of entry of goods circulating for Southeast Asia. This
indicates that the establishment and enforcement of the ASEAN-Korea FTA affects the increase in
the value of Indonesian imports.
4.1. AKFTA Policy in Tariff
The inclusion of dummy variable is to determine the effect of the AKFTA Policy. Dummy
variables represent qualitative value in 1 and 0. In this case, dummy variables represent AKFTA
policies on tariff reduction scheduled from 2007-2016. Value determine for this dummy is 1 if the
policies applied, and 0 otherwise. The test uses Gretl application to regress the panel data. Chow
test and Hausman test is done to choose the best model. Whether the fixed effect model or random
effect model are chosen.

Table 3. The result of model estimation (Fixed Effect)

Variable Description Coefficient
C Constants 4.04786*
Ln GDPC GDP per capita 1.90134***
Ln EXC Exchange rate 0.00599
DuPol AKFTA policy tariff reduction −0.41209**
2
LSDV R 0,963076
LSDV F 200.5115
Chow Test 1.16342
Source: Processed, 2018
Note: * = 10%; ** = 5%; ***= 1%

To choose between common effect and fixed effect model is through Chow test. If the
probability value is significant toward alpha (ɑ), it can be conclude that to choose fixed effect for
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Jurnal Ekonomi Pembangunan, Vol. 17 (1): 1-7, June 2019

the model. The result showed from chow test probability value 1.16342.

Table 4. The result of model estimation (Random Effect)

Variable Description Coefficient t-test
Constant Constants 4.01062 0,630
Ln GDPC GDP per capita 1.72069*** 8,405
Ln EXC Exchange rate −0.01420 -1,566
Ln DITS Distance country 0.20002 0,928
DuPol AKFTA policy tariff reduction −0.34605** -2,142
R2 0,548653
f-test 41,02611
Schwarz criterion 657,0063
HQ 648,2751
Hausman test 0.07212
Source: Processed, 2018
Note: * = 10%; ** = 5%; ***= 1%

To choose between fixed effect and Random effect model can be resulted through Hausman
test. If the probability value significant toward alpha (ɑ), so the option is Random effect model. The
hypothesis, H0 is Random Effect Model; H1 is Fixed Effect Model. The result estimation showed that
cross section probability value from Hausman test as 0.0721225.The result of the test is to choose
the best model from both test Chow test and Hausman test. Based on Chow test result as the
hypothesis, H0 rejected if p-value < 0.05 or ɑ otherwise. The result is probability value 1.16342e-
030 < 0.05 H0 is rejected, and the chosen model is Fixed Effect. Based on Hausman test result H0
rejected if p-value < 0.05. The result probability value is 0.0721225 > 0.05 so H0 is accepted. The best
model which use for this research is Random Effect Model.
4.2. Statistics test
4.2.1. Determinant Coefficient
The goodness of fit for the model is showed by the determinant coefficient of R 2. Where the R-
squared result from regression is 0,548653. This is describe that the variation of independent
variables (GDP per capita, Exchange rate, distance and AKFTA Policies) affected the variation of
dependent variable (Import) as 54 percent. Thus other 46 percent are explaining by other variables
in term of error (e).
4.2.2. Statistics of F-test
Based on the result of test F-statistic is 41.02611 is greater than f-table in ɑ = 5 % which is
2,289851. Probability value of f-statistic is significant. Therefore It is shows that the independent
variables GDP per capita, Exchange rate, distance and AKFTA Policy affect significantly toward
Indonesia Import from AKFTA.
4.2.3. Statistics of t-test
The hypothesis for t-test for the result if p-value of the t-statistic smaller than t table of alpha
(ɑ) 0,05 the variable is significantly effect on dependent variable, and vice versa. Minimum 1
dependent variable significantly affect to independent variable. Where p-value of the t-statistic
result from each variables:
(1) GDP per Capita: the effect of GDP per capita variable is can be determine from T-test result
value. P-value of GDP Per capita is 0,000; this result is smaller than alpha significance level ɑ =
0.05. Therefore the GDP per capita is affect significantly towards Indonesia Import from AKFTA.
(2) Exchange rate: whether the Exchange rate is affected Indonesia import or not, it is can be find
from T-test result. P-value of Exchange rate is 0.8364; this result is higher than alpha
significance level ɑ = 0.05. Thus the exchange rate is not affect significantly towards Indonesia
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Import from AKFTA.

(3) Distance: the effect of distance as independent variable from Indonesia to AKFTA economies
can be found from the P-value of it. Then the P-value of Distance is 0.8015; this result is higher
than alpha significance level ɑ = 0.05. However, the conclusion is the variable of distance has
not affect significantly towards Indonesia Import from AKFTA. How far or near the distance is
Indonesia still can become the good partner on trade in AKFTA member.
(4) Policy (AKFTA): the t-test is to find the effect of AKFTA policy as dummy variable to Indonesia
import. P-value of Policy is 0.0386; this result is smaller than alpha significance level ɑ = 0.05.
Therefore the AKFTA policy is affect significantly towards Indonesia import from AKFTA.
4.2.4. Dummy of Policy
The policy dummy variables in this study are used to capture the difference between the years
before and after the ASEAN-Korea FTA are applied for each year. The estimation results show that
the policy dummy has a significant and negative effect on the Indonesia Import with the value of
coefficient 0.34. The elimination of tariff from AKFTA agreement will increase Indonesia Import as
34 percent. According to integration economic theory AKFTA is the first level of the integration. The
Agreement on trade in goods provides the reduction or elimination of tariffs and other barriers of
AKFTA. All tariff Lines under the agreement are categorized as Normal Track and Sensitive Track.
Korea has progressively eliminate tariff by 2010 for ASEAN-6, Vietnam by 2018, Cambodia, Lao PDR,
and Myanmar by 2020.

5. CONCLUSION
Indonesia's import trade flows have increased when the trade agreement of goods in ASEAN-
Korea FTA is applied as an impact of regional integration. The Import significantly increasing from
2010-2014 and fall down on 2015. Then back to normal on 2016. GDP per capita positively significant
affect to import. The GDP per capita is increasing in stable condition each year. GDP per capita shows
the country's ability in trading with countries trading partner. Thus the impact is increasing income
per capita and the purchasing power that lead to the consumption.
The exchange rate of national currency to US Dollar from AKFTA and other 4 partners is show
negative effect. It means the depreciation in the real exchange rate lead to increase domestic import
prices in order to reduce domestic demand for imports. On the other hand the variable of
distance has positive value and significantly affected the import. However not become the best
consideration because the extra-ASEAN partner also joining the same FTA as same as Indonesia. The
AKFTA Policy for progressively eliminate tariff level is still ongoing and its effect is negatively
significant. ASEAN 6 have experienced the zero level started on 2010. However, other member
Vietnam by 2018, Myanmar, Lao PDR and Cambodia by 2020. The liberalization on trade will happen
on 2020.

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