The Singapore Economic Review

A salient feature of the East Asian region is the persistent discrepancy between the progress in de facto and de jure economic integration. East Asia has long been said to be the champion of loose regional economic integration, with deepening intra-regional trade and investment linkages in the absence of any formal cooperative scheme. However, an oft-heard claim is that East Asia has been shifting recently towards an institution-based form of regional economic cooperation, primarily as a result of the 1997–98 financial crisis. Next to post-crisis financial cooperative schemes under the ASEAN+3, the surge of Regional Trade Agreements (RTAs) involving East Asian countries is thought by some to further substantiate this claim. The objective of the paper is twofold; first, to assess the validity of the aforementioned claim; and second, to examine the links between de facto and de jure economic integration in East Asia compared to other regions of the world. In the process, the sequencing between trade and monetary cooperation is also addressed. The paper starts by providing a candid assessment of the current state of play of economic cooperation in East Asia (de jure integration), both from the trade and the financial/monetary perspective, and highlights the limitations of the formal regional integration movement in East Asia to date. As a next step, it explores the changing nature of intra-regional trade and investment linkages, contrasts it to the situation in other parts of the world such as Europe and examines to what extent this new form of interdependence may be instrumental in making formal regional economic schemes more attractive. A major conclusion is that de facto trade integration may not automatically lead to deeper regional trade cooperation de jure and that its impact is likely to be stronger on monetary cooperation projects.

This paper compares Michael Spence's Growth Theory with Professor Lim Chong Yah's Trinity Growth Theory. The similarities and the differences in the two approaches are brought out in explaining the superlative growth rates of economies in the world. The writer maintains that the Trinity Growth Theory also explains why growth levels (income levels) differ, and why growth rates of mature as well as very poor economies display slow growth rates, and not superlative growth rates. The two theories are multi-causal and multidimensional, not uni-causal.

The paper explores the nature of macroeconomic interdependence in post-crisis Asia. Empirical evidence suggests that, relative to the pre-crisis period, output and price correlations in Asia have increased and the output and price impacts of shocks originating within the region have risen. This greater interdependence, however, did not come at the expense of a weaker economic tie with the rest of the world (as clearly demonstrated in the recent global economic crisis). Asian policymakers must better manage the region's growing macroeconomic linkages through greater cooperation — both to mitigate the impact of negative policy spillovers and to foster an environment in which regional and global links can continue to deepen.

This paper considers the form of monetary policy coordination and regional exchange rate arrangement that would best support economic and financial integration in East Asia. In view of the region's economic diversity, we propose a graduated program of informal policy cooperation from weak forms of cooperation to more intensive modes of cooperation such as the adoption of common monetary policy objectives. An array of informal monetary arrangements rooted to the degree of institutional development can improve the effectiveness of both sovereign and regional institutions, and promote integration in East Asia. Drawing upon the European experience with the Exchange Rate Mechanism (ERM), we conclude that East Asia should first embark on other forms of integration to aid in the development of a high degree of real and nominal convergence amongst the regional countries. Only then would an ERM-type system that employs a regional monetary unit become more sustainable and less susceptible to speculative currency attacks in the region.

We argue that a number of recent studies have overstated the economic case for the creation of a common Asian currency by focusing on only a few of the relevant criteria. We also conclude that endogenous forces are unlikely to be sufficiently strong that adopting a common currency would quickly turn Asia into an optimum currency area (OCA) as some have suggested. We argue that more attention needs to be devoted to issues of monetary, fiscal, and exchange rate coordination under a fairly flexible exchange rate system and that OCA analysis is a valuable framework for analyzing such issues.

We develop indicators to measure the degree of economic integration and cooperation among East Asian economies and compare these with similar measures for other regions. Our indicators cover regional integration in trade, investment, financial assets, and people-to-people exchange. We also analyze measures of regional cooperation such as the density of free trade agreements and official policy dialogues. We find that in various Asian groupings, and especially in a group of 16 integrating Asian economies, interdependence in trade, direct investment, financial flows, and other forms of economic and social exchange has increased significantly over time, and now approaches that in the European Union. Nonetheless, Asia's official cooperation remains weak and formal regional institutions remain relatively underdeveloped. To provide insight into the causes of this discrepancy, we also develop quantitative measures of political and cultural similarity of nations, and find that Asian countries have relatively low levels of political and cultural proximity compared to regions such as Europe. The diversity of political interests and cultural values may have hindered more intense cooperation among Asian economies in the past. But if regional economic and social interactions continue to grow, requirements for joint decision-making are also likely to expand, leading to stronger frameworks of official cooperation.

This paper compares the economic integration processes of the European Union and the East Asian nations and comments on the possible reciprocal lessons, if any, that can be drawn to smooth the future paths of the two groups. The most relevant lessons on the EU side rely on strong institutionalization, structural policies, and the monetary union. Lessons from East Asia can be found in regional production networks, trade patterns, and the recent developments in financial cooperation. Both entities are presently facing difficult challenges to progress and growth.

Though SAARC has the stated goal of an economic union and a common currency, after a quarter of a century, these remain distant goals as political tensions between India and Pakistan have hindered any real progress on a regional scale. Barriers to trade and factor mobility are high in the region as a whole, though considerable liberalisation has been achieved through various bilateral agreements involving India and some of its neighbours. The conventional economic conditions for a common currency are also currently absent as patterns of shocks are non-synchronised, trade links are weak and factor mobility much constrained. Deeper intraregional economic integration requires much more comprehensive trade and investment liberalisation among member nations. While the political conditions for a single currency are unlikely to emerge in the foreseeable future, steps towards closer monetary cooperation through a South Asian Monetary System — building on the existing SAARCFINANCE network — may provide an institutional framework for enhancing regional integration. However, such cooperation will have to be conceived as a component of a sustainable transitional strategy which commits to a serious programme of deeper trade liberalisation to facilitate greater integration with the rest of the world, and most importantly, with East Asia.

This is a substantially revised version of the paper presented to the Symposium on Asian Economic Integration organized by Nanyang Technology University in Singapore, 4–5 September 2008. The author is grateful to Teresa Carpenter for providing comments on an earlier version and to Pradumna B. Rana for encouraging him to update the paper with the discussion of recent international financial architecture reforms in response to the global financial crisis of 2007–2009. He also acknowledges competent editorial assistance by Barnard Helman. The findings, interpretations, and conclusions expressed in the paper are entirely those of the author alone and do not necessarily represent the views of the Asian Development Bank, its Institute, its executive directors, or the countries they represent.