Determinants of trade and investment in Southeast Asia : an application of the gravity trade model

This study is an analysis of the determinants of bilateral trade and foreign direct investment in ASEAN at the time of the establishment of ASEAN Free Trade Area and its enlargement. Beginning with an economic perspective on ASEAN and a review of the literature, the theoretical underpinning of the model is then demonstrated. This confirms that the gravity trade model can be derived from several trade theories. The model is then used to assess ASEAN’s trade pattern in both aggregate and disaggregate level. The results show that, although there is trade diversion regarding its importing activities, the positive effect of ASEAN’s trade creation is higher than the negative effect of its trade diversion. Moreover, the impact of distance is not diminishing over time. The disaggregate model shows that the products that are not convenient to transport have high distant effect. The results from FDI model confirm that the gravity variables are significant determinants of FDI. The negative effect of proximity suggests that there is Vertical-FDI in this region and FDI is complementary to trade. ASEAN should continue to facilitate trade and capital movement among members in order to increase aggregate economic activities and bring economic prosperity to the region in a whole.