Regional integration has become the main form of trade liberalization since the early 1990s. After the conclusion of the Uruguay Round in 1994, no significant progress has been made at multilateral liberalization. By contrast, a new regional trade agreement (RTAs) is announced almost every month. According to the World Trade Organization, more than 300 RTAs are currently in force and all but one (Mongolia) of its 153 members participate in at least one of those arrangements. Given the rising prominence of bilateral and regional trade liberalization, it is important that we understand their implications for world trade. This is even more important because, unlike multilateral liberalization, which most economists believe to be largely beneficial for both liberalizing countries and bystanders, preferential liberalization is controversial. The reason comes from its inherent discriminatory nature: when forming an RTA, members agree to lower trade barriers to each other but their tariffs on imports from outsiders remain unconstrained. This can induce members to substitute inefficiently produced imports from bloc members for imports previously sourced efficiently from nonmember countries. Such trade diversion harms the nonmembers through lost markets, as well as the members through reduced tariff revenue. However, like broader trade liberalization, the RTA is also likely to enhance trade of the goods that are efficiently sourced within the bloc. This trade creation will enhance welfare. These two forces suggest that preferential liberalization can in principle be either welfare-enhancing or welfare-reducing. Ultimately, the verdict must be empirical, and may be different for different trading blocs. Trade creation forces may prevail over trade diverting ones in some cases, but the reverse could be true in other cases. In this paper, we assess the consequences of the ASEAN Free Trade Agreement (AFTA) on trade and external tariffs. AFTA was formed in 1993 by Brunei Darussalam, Indonesia, Malaysia, the Philippines, Singapore and Thailand, and in the second half of the 1990s it expanded to incorporate Vietnam, Laos, Myanmar and Cambodia. Internal trade liberalization within the bloc has not been as abrupt as in some other trading blocs (e.g. NAFTA). Instead, liberalization has evolved gradually, though steadily. Furthermore, there are significant differences in 2 the speed and size of tariff reductions across countries and across products. This variation helps us to assess how preferential liberalization has affected trade and tariffs. We first examine trade effects. We find that the formation of the trade bloc has had a meaningful positive impact on the trade flows among members. Interestingly, this does not seem to have happened at the expense of trade with outsiders. Growth of imports from nonmembers did not falter after the formation and the enlargements of AFTA. Nor is growth in imports from nonmembers significantly different from growth in imports from members subsequent to AFTA. To examine the effect of AFTA on trade in more detail, we focus on the impact of preferential and multilateral tariff changes on intra-bloc import growth and import growth from excluded countries. For the analysis, we rely on detailed data on preferential and MFN applied tariffs at the product level for all ASEAN members, since the bloc was created in 1993 through 2007. This allows us to use a large set of fixed effects that control for a wide range of unobserved shocks. We find strong evidence that reductions in MFN tariffs have stimulated trade with nonmembers, but no evidence that preferential tariff reduction has reduced trade with nonmembers. Next, we examine the effect of preferential tariff reduction on external tariffs. It is possible that preferential and MFN tariffs are related to each other, and that governments respond to changes in the preferential tariffs by adjusting MFN tariffs. We therefore proceed to analyze the reaction of the bloc members’ trade policies vis- ‡-vis outsiders. Specifically, we ask: Has the reduction of tariffs on within-ASEAN trade led its members to change their barriers on imports form excluded countries? If so, have they gone up or down as a result of ASEAN, and by how much? Several theoretical forces have been advanced suggesting that the formation of a free trade agreement such as AFTA should induce changes in external tariffs. But just as in the trade creation/trade diversion debate, there are reasons supporting changes is either direction. Once again, the resolution of the debate must be empirical. 3 Our dataset provides enough variation to allow us to obtain very precise estimates on whether products with relatively large preferences have been liberalized or protected to the same extent as other products. It is also helpful that the ASEAN members generally set their applied MFN tariffs well below their bound rates at the World Trade Organization, so we do not need to worry with this potential institutional constraint. In line with recent analyses of regionalism in developing countries, our results imply that AFTA is a “building bloc” to free trade. There is strong evidence that preferences induce a faster decline in external tariffs than otherwise would occur. The results are both statistically and economically significant. For example, in a country where imports of a certain product from outsiders faced a 10% MFN tariff but were granted duty free access if stemming from other ASEAN members, the member would subsequently tend to reduce its MFN tariff on that product by between 2Ω and 4Ω percentage points. While the correlation between changes in external and preferential tariffs is unquestionable, determining causality is trickier. For example, it may be that some products are easier to liberalize than others, and trade in those products tends to be liberalized both regionally and multilaterally. We use three main distinct strategies to determine if this is a causal effect and find evidence that it is. First, evidence of “tariff complementarity” remains strong if we use lagged changes in preferential tariffs (or preferential margins) as our main regressor. Second, we look for and find differential effects precisely when either the theory or the practice tells us we should find them. Specifically, no tariff complementarity arises when the margin of preferences is too small to be meaningful for exporters. Furthermore, stronger tariff complementarity is obtained in sectors where the margin of preferences is meaningful and the share of intra-bloc imports is higher, as theory suggests. Third, we employ an instrumental variables approach that takes advantage of a unique feature of our dataset: the agreed speed and depth of internal liberalization of the six original members in their 1992 negotiations. As it turns out, observed changes in preferences have not corresponded to the planned ones in 1992. Numerous reasons may have caused this discrepancy. For us, this is especially valuable because the 4 planned internal liberalization can serve as an instrument for the actual one. While they are strongly correlated, the negotiated preferences should not have an independent effect on the incentives of countries to alter their external tariffs. To strengthen this rationale, in the IV regressions we restrict the sample to the post-Asian crisis period, during which trade policies were significantly affected. Interestingly, the qualitative results of our IV and OLS estimations are very similar (quantitatively, they are higher under the IV procedure). Replacing the actual with the planned preferential tariffs in the OLS estimation also delivers similar results. Taking all of our results together, we conclude that AFTA has promoted trade within the bloc without hurting trade with outsiders. An important reason for this is the unilateral reductions in external tariffs that ASEAN members implemented as a result of their liberalization vis-‡-vis each other. These reductions suggest that AFTA provides an important contribution to the global process of multilateral liberalization. The remainder of this paper is organized as follows. In the next section we discuss the related theoretical literature and the empirical findings. We provide a general view of ASEAN and discuss the data in Section III. In Section IV, we examine the impact of tariffs on trade. In Section V, we develop the empirical analysis on the effects of AFTA on external tariffs. Section VI concludes.