Chapter 1: Introduction

Economic development is the object of all nations in the world especially in developing countries. Although the level and the rate of economic development depend primarily on internal conditions in developing nations, most economists today believe that international trade can contribute significantly to the development process (Salvatore, 1995, p. 329). In the context of joining in international trade, each country can not import as many as it want because it must concern to the balance of trade or in general is the balance of payment. Since the balance of payments adjustment process is traditionally cast in terms of demand functions, it is necessary to measure the value of demand elasticities. However, it is proved that in international trade, the measurement of demand elasticities for imports is difficult, so investigators have attempted to derive demand elasticities from the measured substitution elasticities.  In addition, there are situations, in which it may be useful to set hypotheses in terms of elasticity of substitution, in particular when interest may not center entirely on elasticity but on other influences that affect import volume. One such situation when we want to explain price competitiveness between exporting countries Kotan and Sayan (2001), existing trade patterns of particular exporting countries vis-à-vis one another (Leamer and Stern, 1970, p.68). In addition, elasticity of import substitution also is used in models to estimate the trade effect of liberalizing trade agreements (Koomsup & Kawanabe, 1981). Such knowledge could be useful in formulating government policies affecting on import in particular and foreign trade in general.

Vietnam is in the process of economic renovation with a strategy of industrialization and mordenization. Thanks to this process, Vietnam has increased its exports rapidly, which earns much money for the economy, however it also must import more to meet the needs of process. In the context of joining in international trade, each country can not import as many as it want because it must concern to the balance of trade or in general is the balance of payment. Since the balance of payments adjustment process is traditionally cast in terms of demand functions, it is necessary to measure the value of demand elasticities. However, it is proved that in international trade, the measurement of demand elasticities for imports is difficult, so investigators have attempted to derive demand elasticities from the measured substitution elasticities. Besides that, in the open condition like now, Vietnam has many trade partners, which is good for Vietnam but it also makes it difficult for Vietnam when choosing the partners, and having a good import strategy especially in the context of continuously changing in global economic situation. In additions, Vietnam has entered the ASEAN and APEC and is on the way to complete the commitment for the realization of ASEAN Free Trade Area (AFTA) and at the process for accession to WTO (Institute of Economics, 2001a). Aware of the advantages and disadvantages of these processes will help Vietnam to actively participate in regional and international organizations. The analysis of entering the free trade area must be both in terms of qualitative and quantitative aspects in order to have a comprehensive analysis. The models used to calculate these effects in quantitative terms have elasticity of import substitution as one of its important parameters. However, up to now, Vietnam still not has officially estimated elasticities of substitution for imports. When economists need to use those elasticities, they usually use the results of a quite similar country like China. According to this situation of Vietnam, I intend to do this thesis in order to estimate the substitution elasticities for the import goods of Vietnam based on the central question:

What are the elasticities of substitution of Vietnam's imports?

  This study firstly focus on reviewing theoretical approaches in order to get the model used to estimate import substitution elasticity, then estimates the elasticity of substitution for 3 import products of Vietnam based on data from General Custom Office. Finally, the thesis will analyze trade diversion effects on Vietnam's two import commodities when there is a change in trade policy, and some ideas for import policies and strategy of Vietnam in the coming years are provided.  

Besides the introduction, conclusion and policy implications, appendices, the main part of the thesis consists of three chapters

Chapter 2 represents a theoretical framework. Chapter 3 provides some main ideas about the situation of Vietnam' s steel, fertilizer and automobiles markets and estimated elasticities of import substitution in Vietnam's market for those products. Chapter 4: The application of those elasticities in calculating trade effect when Vietnam entering AFTA. 

Chapter 2: Theoretical Framework

2.1. Definition of elasticity of substitution for imports:

Elasticity of substitution, which is defined simply as the percentage change in relative quantities demanded, divided by the percentage change in relative prices.

                                                   0< s <

Where q₁ and q₂ are imported from two competing supply sources (1 and 2) and must be imperfect substitution, and p₁ and p₂ are their respective prices. Thus, according to the definition, elasticity of substitution measures the percentage change in relative quantities of exporting countries 1 and 2 in the commodity imports resulting from a one percent increase in the price charged by country 1 exporters relative to the price charged by country 2 exporters.

2.2. Theoretical approaches to estimate the elasticity of substitution for imports.

In order to estimate the elasticity of substitution, Leamer and Stern (1970) have given a model which is log-linear regression:

                                   Ln (q₁/q₂) = a +b ln (p₂/p₁)     (*)

Where the coefficient b is the elasticity of substitution.

In order to get the final form of the model given above, Leamer and Stern (1970) have approached from the conventional demand analysis. Deriving the import- demand functions of the two products to the model, Leamer and Stern (1970) based on two main assumptions: (i.) The algebraic sum of cross and direct elasticities of demand for the two products must be equal.

(ii.) The income and any price elasticities of demand for the two products must be equal. This implies that the two products be alike in all economic respects except that they are not perfect substitutes.   

 The model with the form above is only the functional relationship between q₁/q₂ and p₁/p₂ while eliminate the role of income or other prices. It makes the measurement of the elasticity of substitution more easily because it does not need collect data on income y and other price p_r. However, this approach had some disadvantages when using the model (*) to estimate elasticity of substitution for example, we must test assumptions by sub- model to ensure that the estimate from the model is consistent with the structural relationships suggested by consumer demand theory.

 Applying the approach of Paul Armington can solve out all disadvantages of the Leamer and Stern's approach to the model.  The Armington's approach (Armington, 1969) bases on four assumptions for the purpose of simplifying the product demand functions to the point where they relevant to the practical purposes of estimation:

-                   The assumption of independence

-                   The quantity index functions are linear and homogenous

-                   The elasticity of substitution between any two products competing in any size of the market are constant

-                   The elasticity of substitution between any two products competing in a market is the same as that between any other pair of products competing in the same market.

It is commonly known that international trade flows are identified and classified on the basic of three characteristics: the kind of commodity involved, the country or region of the seller, and the country or region of the buyer. Accordingly, in his paper, Armington (1969) presented a general theory of demand for products that are distinguished not only by their kind, for example: motorbike, chemicals, but also by their place of production. Thus, Thai motorbike, Japanese motorbike, might be two different products distinguished in the model of demand. The difference between goods and products (or in other word is commodities) is that goods are distinguished only by kind whereas products are distinguished both by kind and by place of production.                      

 Theory of demand states that demand functions are the relationships among variables if buyers are to be satisfied. Demand functions may thus be considered as situations of conditions under which an index of buyers' satisfaction is high as limited incomes and given prices that permitted (Armington, 1969, p.163). Given an index U- utility index, these conditions or demand functions can be derived by maximizing U subject to a budget constraint.

 Because we want to treat the imports coming from different countries as imperfect substitutes, commodities must be distinguished by type as well as the country of origin. The particular product on which we wish to focus, for example: motorbike, is to be denoted Q_i with subscript j indicating the source country. Thus, Q_ij denotes the quantity of product Q_i imported from country j. The key point to remember is that the Q_ij are differentiated by j and, therefore, command different prices. Quantities of all other products consumed are lumped together into a single row vector denoted X. The utility function is then written:

                          U = U ((Q_i1, Q_i2,…… Q_im); h(X))   

Letting D be the total expenditure. P, the row vector of prices associated with X. Pi is a function of prices of products in the ith market, just as Q_i is a function of quantities of these products. But Pi can not be just any function of products prices, the prices of goods must be such that the demand for the ith goods which they explain, in consistent with the optimum selection of products in the ith market. In order to ensure that P_i is independent of Q_i, that is, P_i is only a function of P_i1, P_i2,……, P_im, the first assumption must be used. The second assumption which leads the quantity index functions () are linear and homogenous, assumed that each country 's market share is unaffected by changes in the size of the market, as long as the relative prices in that market remain unchanged.

The utility maximization problem can be written as:

Max. U= ((Q_i1, Q_i2,…… Q_im); h(X)) + l [ D -( + PX' )]        

Note that X' is the column vector of all commodities other than the Q_ij.

The first-order conditions for optimum mix of products of i^th goods are:

                     (9)

Thus, the demand functions for any Q_ij are, with the implication that they are obtained by minimizing the cost of purchasing the quantity of given Q_i.

                             (10)

If many countries or areas were identified in the model, equation (10), in the above form would probably be too complicated to be of practical use. A way to simplify them is to apply the next two assumptions that (iii.) the elasticities of substitution between any two products competing in any size of the market are constant- that is they do not depend on market shares, and (iv.) the elasticity of substitution between any two products competing in a market is the same as that between any other pair of products competing in the same market. These assumptions are equivalent to the specification that the 's are constant elasticity of substitution (CES) functions, having the general form. This general form was first developed and introduced by Arrow, et. al. (Arrow et al., 1961, p. 230) .

       (12)

                      Where , and r_i is a constant greater than -1

With the two first assumptions, this function is linear and homogenous as required. If any given quantity of the i^th goods is to be obtained at least money cost, then the following conditions are needed:           '               j,k=1,2,…..m          

From the above equation, let = s_i, where s_i is the elasticity of substitution in the ith market and bij, b_ik are constant. We have:

                      Ln  = s_i ln+ s_i ln      (**)

The model (**) resulting from the approach of Armington (Armington, 1969) is similar to the model (*) of Leamer and Stern (Leamer and Stern, 1970) given above. However, with the Armington' s approach, the sources of imports and import products are clearly identified. Armington  (1969) also derived his study base on product demand function and, in order to get this equation, there are also needed some assumptions, but all those assumptions are qualitative so they do not need to test. Besides that, the Armington's approach not only gives out the demand function of import goods but also the demand function of import products which are distinguished above.

2.3. Applications of elasticities of substitution for imports.  

The most important applications of the elaticities of substitution for imports in the current context is used to estimate the impact of trade agreement, joining free trade areas or custom unions (Koomsup and Kawanabe, 1981), also indirectly used to estimate the cost of protection.

 Giving the elasticity of substitution, we can derive the demand of import product from particular country through the total import demand of such goods, thus, can be used to explain existing trade patterns between importing country and particular exporting country (Leamer and Stern, 1970, p. 68).

Using the elasticity of import substitution, we can forecast the growth of import product from particular country in imported market (Armington, 1969).

 Kotan and Sayan (2001) suggested one application of elasticity of substitution for imports. According to them, the elasticities of substitution can be used to interpret the price competitiveness of two competing export countries in the import market, thus can help import country having the best choice when there are some changes in trade policies of export countries.

Chapter 3:Estimate elasticity of import substitution for selected commodities.

3.1. Overview about Vietnam's trade situation in the recent years

Vietnam has come long way since the doimoi reform process was implemented in 1986. With the process, Vietnam has gained many good achievements both in economic growth and poverty reduction. The most important progresses have made over past 15 years is that the government of Vietnam has been managing the transition from a relatively closed, centrally planned economy towards one which is open to trade and where market forces direct resource flows within the economy. Trade liberalization has played a key role in this transition. Exports and imports have experienced double-digit growth, while the number and range of agents able to participate in trade has expanded (Riedel, 1999). Vietnam’s leading imports in the recent years consist of electronics and machinery equipment followed by chemical and rubber products, and basic manufacturing. A large percentage of Vietnam’s imports in these categories are likely to be intermediate inputs and capital goods (Fukase and Martin, 1999). Together with the renovation process, Vietnam is in the road of trade liberalization with entering some regional associations like ASEAN, APEC. Vietnam now has trade relations with most countries in the world, those relations makes good condition for both producers and consumers. The leading import suppliers of Vietnam are ASEAN countries (27% of Vietnam’s imports in 1996) while Singapore accounts for large percentage (19% in 1996, 2000), Japan, China, Taiwan, Europe, Korea especially we are having trade relation with USA (2% of total imports in 1996,2000). 

     Because Vietnam has trade relationship with many countries in the world so each imported good can import from many sources. This situation creates opportunities for competing between exporters and also between exporters and domestic producers of each commodity.

    3.2. Elasticities of import substitution for some commodities in Vietnam

In this section, the elasticities of import substitution for fertilizer, steel and iron, and automobiles will be calculated. There are two reasons for why I choose those commodities to calculate. The first is the economic meaning of those commodities. The second reason is related to data.

3.2.1. Overview the market situation of selected commodities in Vietnam

      As we know, Vietnam is an agricultural country with about 80% of population living in rural area who living mainly by planting. However, time passes, cultivated land becomes exhausted so it needs to be improved by putting down fertilizer. In addition, with intensive cultivating method instead of extensive ones, the farmers must use fertilizer to get high productivity crop. Thus, fertilizer is a key input of agricultural production. The demand of fertilizer is large while the domestic producers still can not meet the demand so import demand is existed. For example, in the case of urea, there is relatively small domestic production sector with the capacity 170,000 tons yearly when the demand is more than 1 million tons (Tran, and Pham, 1999) so an import is necessary in order to ensure a sufficient supply. According to Tran Truc Son and Pham Quang Ha (Tran, and Pham, 1999), almost 80% nitrogen requirement, 50% phosphorus requirement and 100% potassium needs for agriculture production should be imported yearly. And the facts have shown out that import of fertilizer in the recent years (1995-2000) was still increased although many domestic fertilizer plans were invested technology to produce fertilizers. There are about 19 fertilizer exporters to Vietnam while the key exporters are China, Singapore, Indonesia, Korea and Japan (base on statistic of general custom office). Thus if those key import suppliers have any changes in their export policy, Vietnamese domestic market will face difficulty especially the farmers - consumers of this product.

Also like fertilizer, steel and iron is a key input in the economy. A key industry is one, which provides inputs widely used in other industries. Steel and iron is used as intermediate material in some industries such as engineering work, use in construction plans especially infrastructure sector which are continuously growth in the time of industrialization and modernization in Vietnam nowadays. In the 1990-1995 period, thanks to the policy of renovation, the steel industry was financed and developed and the rolling steel reached 450,000 tonnes in 1995, a fourth-times increase over 1990. And, in the year 2000, the production capacity of the steel industry has increased ten-fold over 1990 with the steel rolling capacity of 2.3 million tonnes (Do, 2001). Nevertheless, facilities of the industry are of small scale and commonly belong to the old outdated generation, the technological level is low and less uniform, leading to the limited product quality (CIE, 1999a). The top five largest steel and iron companies in Vietnam still using out off date technology with low productivity (CIE, 1999a) hence, the industry can not supply enough for the demand of this commodity in domestic market. For example, Vietnamese companies produce virtually no high-grade steel certified for complex construction purposes, shipbuilding, bridge construction or domestic water supply, so, such special purpose steels are imported. With fertilizer, steel is also in the group of leading imported items of Vietnam. The share of steel in total import value increases rapidly in period 1990 -1999 (from 0.9% of total import value in 1990 to 5.08% in 1999) (GSO). Until the early 1990s, Vietnam imported most of its steel from the former Soviet Union. With the collapsing of this country and the renovation in trade policies of Vietnam, import steel partners of Vietnam nowadays are about 26 countries with the top suppliers are China, Russia, Hong Kong, Korea and Taiwan. Inheriting the market share of former Soviet Union, Russia is the biggest supplier (Base on statistic data of General Custom Office - 1997).

 Car is consumer good. With the average income per capita of Vietnam now, car is expensive good that many people can not afford it. However, thank to the renovation process, the living standard is improved day by day, so like many countries in the world, in the future people will use car as means of transport instead of motorbike. Thus, it is obviously that the demand for car has increased in the recent year and will be continuously increased in the coming day (demand for vehicles is expected to be around 60,000 per year by the year 2000 and around 80,000 in 2005 (Vietnam Economic Times, May 1997). While car industry in Vietnam still is infant industry, import is dispensable. In 2000, Vietnam imported 26700 ones compare with 11200 ones in 1999. This import quantity is imported from about 23 countries all over the world while the top suppliers are Korea, Japan, Singapore, United States and Russia (General Custom Office, 1997). The name of top suppliers also suggests the kind and price of import goods. Most of import goods are not very expensive and suitable with the condition of developing countries especially for Vietnam.

In short, three commodities chosen are necessary goods and have potential large demand but domestic suppliers still can not meet the demand so it is needed to import. Having import demand, the elasticity of import substitution is useful to analysis import activities.

          3.2.2. Data and methodology

* Data:  The data is collected according to the raw data of General Custom Office (GCO). The data is in quarterly form. For the case of fertilizer, the data includes 40 observations for the period from the year of 1991 to the year of 2000. The two rest commodities: automobile and steel, data includes 24 observations from the year of 1995 to the year of 2000.

Obviously we can see that both fertilizer and steel have seasonal factor.  So, to avoid bias in estimation, before running the regression, the seasonal factor of these products was adjusted.

* Methodology

In order to estimate the elasticity of import substitution for those commodities, the model given bellow is used:

Ln  = a_o + s_i ln + a₁ ln (J)

Where: J is an industrial production index of Vietnam

 a₀, s_i , a₁ are a constant term, substitution elasticity and activity coefficient

That addition of the domestic production index here since a country imports one commodity, it is not mean that there are not existing domestic production of such that goods. When there are having domestic production, there are existing a pair of competitive suppliers of such that commodity in domestic market, thus consider the industrial production index variable in the model used to estimate the elasticity of substitution is reasonable.  

In the case of fertilizer:

Q₁, P₁ is the quantity and price of fertilizer imported from Indonesia respectively,

 Q₂, P₂ is the quantity and price of fertilizer imported from China respectively

In the case of steel:

Q₁, P₁ is the quantity and price of steel imported from Korea respectively,

 Q₂, P₂ is the quantity and price of steel imported from Russia respectively,

In the case of automobile:

Q₁, P₁ is the quantity and price of car imported from Japan respectively,

 Q₂, P₂ is the quantity and price of car imported Korea respectively,

All import prices of chosen commodities are in CIF prices. So, the price of such those import products in domestic market, which used in the model, is equal CIF price plus import tax.

Base on the form model, OLS method will be used to get the result of elasticities of import substitution for those commodities.

Choosing what pair of competitive country is not influenced the result, according to the assumption of Armington. However, those pairs of countries were chosen based on import composition by trading partner of Vietnam for those commodities. Both of those countries are in the top five of Vietnam's import suppliers of those commodities. All the pair of these products is satisfied condition of imperfect substitution based on the approach of Armington (Armington, 1969)

3.2.3. The results

Using Stata software to run those regression, and test the defect of the model using to estimate. All the tests showed that the model is good at the 5% level of significant

Table 3: Estimation of import substitution elasticity for fertilizer, steel and car

Source: Own calculates

According to the table, the Vietnam's elasticity of import substitution for fertilizer is about 2.2. It means that when there is having one percent decrease in the price charged by one fertilizer exporter country to Vietnam (for example Indonesia) relative to the price charge by another country exporter to Vietnam (e.g. China), there will be 2.2 percent increase in relative quantities of fertilizer import from Indonesia and from China and via versa. Base on the elasticity, we can know that when there is an increase in the export price of fertilizer by a country for example China, Vietnam's importers will shift their demand to a possible substitute of that commodity which has a relative lower price - e.g. Indonesia. The country who are able to charge relatively lower price due to a number of reasons such as lower transportation and/or insurance costs, lower tariff rate advantages, or some other cost advantages. The meaning of this Vietnam's elasticity of substitution for fertilizer is the same with any pair of competitive fertilizer supplier countries in fertilizer market of Vietnam, and this is the constant elasticity.

For the case of steel, the elasticity of substitution for Vietnam's import is quite high. The elasticity equal to 4.6 means that any change one percent in relative price of competitive pair exporter countries of Vietnam, the example in this case are Russia and Korea, will lead to change in opposite way 4.6 percent in relative quantity of that pair. Thus, elasticity of substitution can be a basic for price competition between exporters, if the price of steel imported from Russia decrease one percent relative to price of steel from Korea, Vietnam's consumers will shift away about 4.6% from steel of Korea to steel of Russia. Because the elasticity of substitution of steel in Vietnam is quite high, so the reaction of Vietnam steel market to the change in price of any exporters is quite clear.

The case of Vietnam' automobile elasticity of substitution is a little different with the case of steel. The elasticity of substitution for imported car in Vietnam is only 0.42, that is quite small so the sensitivity of import demand to the change in import price from one supplier is not high. There is only 0.42 percent change in relative quantity of car from exporting countries 1 and 2, like Japan and Korea in the context use to calculate the elasticity, resulted from a one percentage change in price charged by country 1 - Japan relative to price charged by country 2 - Korea. In other word, we can say that the price competition between car exporters in Vietnam market is not high.

Comparing the elasticities of import substitution for three commodity- fertilizer, steel and car in Vietnam market, we can see that the sensitivity in import demand reaction of steel is high, while it is average for fertilizer and low for car. It is easy to understand, because car is a consumer good especially we can say that it is a luxury goods in context of Vietnam today when the GDP per capita is only $311 in 1998 (World Bank, 1998), so the low elasticity of import substitution which can be representative to import demand elasticity is reasonable. However, the quite high of elasticity of import substitution for steel put steel importers of Vietnam before challenge, they need to follow closely with the change of steel price in world market in order to shift their demand to exporter who give more potential benefit for them. The elasticity of import substitution for fertilizer is at average level, we can know that there is having price competition between exporters to Vietnam's market and this competition will be able bring opportunities for consumer of Vietnam to have lower price product. Elasticity of substitution is not only to present the sensitivity to price of imports, but also to show out the degree of product differentiation. A low elasticity means a high degree of product differentiation while a high elasticity for products which are rather homogenous (Koomsup & Kanawabe, 1981, p 60,62). Thus, according to this suggestion, we can see that the car products here has high level of product differentiation resulted from collecting data. The product differential levels of fertilizer and steel are gradually lower.

The meaning of elasticity of import substitution is obvious. Base on the meaning of this elasticity, there are many applications of elasticity of import substitution where the most useful is to analysis the impact of free trade process to trade in particular and to the economy as a whole in general. This application is used for the case of Vietnam in the next chapter in order to analysis the changing in direction of trade after Vietnam joining in regional free trade area - AFTA.

Chapter 4: Application of elasticity of import substitution in the case of Vietnam

 This chapter will estimate in the trade effect of Vietnam when the country integrates to regional free trade area (AFTA).

4.1. Asean Free Trade Area ( AFTA) in brief

The ASEAN Free Trade Area (AFTA) was formally established in 1992 due to some reasons such as the slow progress in trade liberalization by ASEAN or the completion of the European Single Market and preparations for the North American Free Trade Agreement (NAFTA). According to its name, AFTA is a free trade area, which means that each member country abolishes tariff among the participating members while maintain individual tariff regimes towards non-member countries. The key vehicle of AFTA is the Common Effective Preferential Tariff (CEPT). The CEPT scheme is applied to goods originating in ASEAN and requires member states to lower their tariff rates on most goods to between 0 and 5% by the year 2003 for the realization of the AFTA (by 2006 for Vietnam and 2008 for the Lao PDR and Myanmar) (Zimmermann, 2000). The CEPT scheme is based on the reciprocal, product by product basis. Another feature of the CEPT is that members have to eliminate all quantitative restrictions on products on which they receive CEPT concessions and to eliminate other NTBs within a period of five years after receiving concessions. The CEPT also requires the commitments to harmonize customs, investment and standard regulations and procedures (IOE, 2001a).

 4.2. Analysis effect of integration in to AFTA of Vietnam

In order to estimate these effects, we use the model that used by Koomsup and Kawanabe (1981).

4.2.1. Theoretical model

Analysis of the effect of trade agreement on one country's export to imported country has the following general features. Firstly, the scope of the analysis is confined to examination of short run and partial equilibrium impact effect of joining in free trade area. For example, cheaper price of industrial materials imports from intra - area country may reduce the price of the domestic substitutes of the manufactured imports from that country, and thus intra area country's exports may get the negative effects. Secondly, in this analysis, we ignore all these indirect effects but concentrate on the impact effects assuming things other than rates of tariffs and other trade restrictions (import quotas) to be constant.

According to Koomsup and Kawanabe (1981), the world economy also includes two groups of countries: group A-countries in free trade area including country J-importer and country T- exporter, and group B- countries from rest of the world. The model was set out under the following assumptions:

-                   The commodity exported from group A and group B are imperfect but close substitutes

-                   The price elasticity of export supply both from group A and group B is infinite.

As the commodity from group A is consider to be different in its quality, deliver period… from that exported by group B, the first assumption is realistic, but the second one might bring about overvaluation in the results.

Denoting country J's total import value of a commodity, the value of import from country T, the share of country T's export value in the total import value of country J before and after trade agreement as M, M_t, a, a' respectively. The change in the country T's export value is expressed as follows:

Let M_b and M_n stands for the import value of the commodity from group A and that from group B, and let define the following ratios.

Since the domestic prices of the imports are the import prices plus tariffs, and let t and g, t' and g' stand for the tariff rate for group A and group B before and after trade agreement respectively, we get the model for estimate the trade diversion effect of a commodity when country J entering free trade area presented below:                             

Where s is elasticity of import substitution.

The magnitude of  is expected to positive due to the trade diversion effect

4.2.2. An application for Vietnam

When Vietnam join in AFTA, the world economy may be divided in to two groups of countries. Group 1 includes countries in ASEAN (group A) and group B consists of countries outside ASEAN (group B). Under the AFTA's principle, Vietnam will reduce tariff rate to exports from ASEAN - discriminatory in foreign trade, thus the relative domestic price of the ASEAN's commodities in Vietnamese market to that of countries outside the bloc (we consider as rest of the world- ROW) changes. Then the ASEAN export changes through substitution between it and the exports from ROW. In the case of Vietnam, because of difficulties in collection data, we only calculate the trade effect of two commodities: fertilizer and steel. The base year is 1998 with the average import tariff rate of those commodities are 3.1% and 9.2% respectively (IOE, 2001b). We assume that when Vietnam will reduce these tariff rates to 0% applied for group A countries' exports in the step to compete the process joining AFTA while the tariff rates will be still unchanged for countries in group B. Data used in this analysis extracts from GSO's book: "International Merchandise Trade of Vietnam1998"

Applying to the model of Koomsup and Kawanabe (1981), we have the trade diversion effect in the case of fertilizer and steel when Vietnam reduce the import tariff rates of those commodities to 0% due to the commitment to joint in AFTA. According to the assumption of Armington (1969), the elasticity of import substitution is constant by time and equal to any pair of competing suppliers. Thus, the elasticity of import substitution for fertilizer and steel, which has estimated in the pervious chapter, are 2.1984 and 4.6087 respectively.

 The detail results are in table 6 and table 7:

Table 6: Trade diversion effect of fertilizer

(US $)