Tariff Liberalization and the Intensive and Extensive Margins of Trade: The Case for the ASEAN Free Trade Agreement

This paper is the first in its attempt to analyse the effect of tariff liberalization on the intensive- and extensive margins of trade for the ASEAN Free Trade Agreement (AFTA). The extensive margin is examined by investigating to what extent preferential tariff changes between 1996 and 2008 contribute to the probability of importing a new HS 6-digit product category. For the intensive margin, the paper analyses to what extent these tariff changes impact the import value of already imported product categories. To alleviate the endogeneity problem encountered when analysing tariff changes in relation to import status and import value, the paper estimates the relationship using an instrumental variable approach. As such, implemented preferential tariffs are instrumented with the scheduled preferential tariffs, which member countries negotiated on before the agreement went into force in 1993. This paper finds robust evidence that tariff reductions significantly increase both the intensive- and extensive margins of trade. In addition, the paper finds that for the extensive margin this effect is smaller when the elasticity of substitution between varieties is high. For the intensive margin, the reverse is found, as a higher elasticity of substitution between varieties leads to a larger effect.