Regional Economic Integration, Mergers and FDI: Welfare and Policy Implications for ASEAN

As East Asia follows Europe and other regions by deepening regional economic integration, an important consideration is the likely effect on competition and ownership of production in the region. Traditional analysis of preferential trade agreements (PTAs) focuses on trade creation and trade diversion effects, with no consideration of changes in market structure. Panagariya (1999) argues that ASEAN members are unlikely to gain from these traditional effects, due to their relatively small market sizes and low levels of intra-regional trade. However, PTAs have also tended to be accompanied by increased production by firms from outside the region, attempting to take advantage of a larger internal market by avoiding tariffs on non-member countries, and any analysis of the welfare implications of a PTA should take such effects into account. This chapter draws on previous theoretical work by the authors and presents a theoretical framework for analysing the effects of a PTA on both greenfield FDI and mergers and acquisitions, and considers the implications for ASEAN members' welfare and competition policy. Increasingly governments are looking to regional trade agreements as a means of promoting domestic industry in the belief that bigger markets will enable domestic firms to grow and prosper. While some literature has studied the effects of such integration in monopolistic industries where economies of scale are prevalent, the impact of regional agreements in oligopolistic industries is less well understood.1 This chapter focuses on the strategic aspects of such trade agreements in the context of a Cournot model and considers the influence of regional integration on the incentives of foreign firms to export, to engage in greenfield FDI or to merge with domestic firms. We show that, contrary to government intentions, such agreements are likely to increase foreign participation in the customs union at the expense of domestic and union partner firms. This may take the form of increased greenfield investment or takeovers of domestic firms by foreign predators even in situations where a potential domestic predator has the superior technology. However, consumer welfare unambiguously rises as a result of the union formation.