Asia-Pacific Regional Integration: a Global Challenge

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Asia-Pacific Regional Integration a Global
Challenge

• David Vines
• University of Oxford and ANU

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1 Introduction

• A world in which multilateralism is in difficulty
  
• There is much discussion in Asia of the extent to
  which the European example can be taken as a
  model for Asia. How far is this true?
• The EEC and the European model of regional
  integration was founded in very different
  economic conditions than those which exist in the
  Asia Pacfic Region today.
• Huge Growth Prospects
• The emergence of large scale flows of private
  sector capital across international frontiers
• Size, Complexity and the Absence of an EU-like
  political solution

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2 Features of European Regional Integration

• Initial reasons were political
• The fusing of the coal and steel industries of
  France and Germany in the wake of the Second
  World War as a bulwark against war.
• The Treaty of Rome set the goal of an ever
  closer union of the peoples of Europe
• Four Features of the Economic Model
• The creation of a Common Market, which led in
  the 1980s to the agenda for a Single Internal
  Market an agenda of deep integration of goods
  services and labour
• The Common Agricultural Policy
• a political agenda of the support of agriculture
  and an economic agenda of ensuring that the
  agricultural sector had a rising real income to
  stimulate demand for industrial goods.
• Monetary Union in the 1990s
• partly an outcome of an era in which there was
  much less confidence in the ability to use
  monetary policy to give good macroeconomic
  outcomes
• Financial Stability kept as a national concern,
  rather than being integrated with the tasks of
  the ECB in the monetary union

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3 Macroeconomic Projections the Asia Pacific
Region

• How might the world and the Asian region -
  might continue to grow in the next quarter of a
  century. Maddison (2002, 2006)
• Population will continue to grow fast in Asia
  (and Africa), but not at all in Europe. It will
  grow at an intermediate rate in the US, (partly
  driven by immigration).
• The proportion of workers engaged in
  non-agricultural activity will grow much faster
  in emerging market economies than the growth of
  their population. For example, in China alone,
  the urban workforce is growing by more than
  twenty million a year, rate of growth roughly
  four or five times the rate of growth of the
  Chinese population.
• The accumulation of physical capital has been
  fundamentally important in past growth, this will
  continue.
• Linked to the acceleration of technical progress,
  and to an increase in human capital, in a way
  which will continue.

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• Two striking consequences.
• First, we are likely to see both a very rapid
  increase in GDP in the period to 2030 according
  to Maddison world GDP is likely to be nearly 2.5
  times as large in 2030 as it was in 2001. This is
  accumulation a la both the Solow model and the
  Lewis model.
• Second we will see an extraordinary increase in
  the relative economic size of the periphery in
  the world.
• In 1990, at the end of the Cold War, GDP in
  Western Europe was about the same size as the US
  the US.
• Japan and China were each about a third as big as
  the US, India was tiny
• The rest of Asia was about half as big as the US.
  By 2030 there will again be two major powers,
  but they will be the US and China. The rest of
  Asia (other than India) will, together, be just
  as big, or bigger, than either of these big
  powers, and much bigger than Western Europe.
  India will be half as big as China and coming up
  fast. Japan will be tiny.

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• If well managed, this will be another golden age.
  
• This will, inevitably, produce a multi-polar and
  multi-lateral world, unlike that in the 1990s in
  which the hegemonic size, and thus power, of the
  US was so pronounced, and much more like that in
  the late 1940s, immediately after World War 2.
• But if it is to work out, significant adjustments
  to the changes in relative size will be
  necessary.

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4 Trade Aspects of Asia- Pacific Growth

• This Solow-Lewis miracle has strong trade
  implications
• Exporting commoditised goods into the
  international market place and importing high
  quality capital goods to enable countries to
  accumulate capital and develop. This process of
  integration into the worlds economy was underway
  long before the more recent and wider pattern of
  globalisation was in train.
• Companies (initially led by multinationals) to
  diversify and fragment production and build up
  marketing and supply chain networks to exploit
  economies of scale from division of labour and
  specialisation across international boundaries.
• Thirdly, increased globalisation itself,
  reflected particularly in the growth of private
  sector capital flows since the mid-1980 and the
  introduction of previously excluded countries
  (particularly China) to the framework of the
  international market economy. This has encouraged
  Asian economies to liberalise in order to take
  advantage of potential gains from FDI and capital
  flows.

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5 Implications for Regional Trade Integration

• 5.1 Asia Pacific Interests in an Open
  International System
• 5.2 There are advantages of Unilateral
  Liberalisation.
• Optimal tariff argument
• Political economy of using liberalisation
  elsewhere as argument to support liberalisation
  at home
• 5.3 Open Regionalism as an Alternative Strategy
• Concerted MFN liberalisation as a strategy
• Momentum of the 1990s and Bogor Declaration
  (1995)
• experience shows collective action
  difficulties resolvable
• Free rider problem outsiders hold out
• US always saw this problem strategically
• At APEC meetings it was agreed that an FTA this
  was not what APEC would do.
• As a result the US and its neighbours thus set
  off towards bilateral discriminatory
  arrangements.

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• 5.4 Western Pacific FTAs
• Singapore-Japan Singapore-New Zealand
  Singapore-Australia Singapore-United States
  Australia-Thailand Australia-US, and China-Hong
  Kong.
• None of these is of huge importance in itself,
  each adds new layers of complexity.
• More importantly, each adds credibility and
  momentum to the drift towards discriminatory
  trade in the western Pacific and globally.
• At recent ASEAN heads of government meetings and
  ministerial meetings involving China, Japan,
  Korea, and India, announcements have been made
  that ASEAN would negotiate separate FTAs with
  each of these partners. Negotiations are
  proceeding on Thai-US, Japan-Korea,
  Australia-China, New Zealand-China,
  Australia-NZ-ASEAN, from early 2006 Korea-United
  States, from early 2007 Japan-Australia and
  several other bilateral FTAs.
• Following much talk and some action on
  single-country and ASEAN bilateral free trade
  agreements, discussion of an East Asian FTA has
  risen in profile and credibility.

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• Evenett a self-reinforcing domino tendency.
• Typically, the new FTAs breach WTO rules in one
  way or another.
• Generally there are excessively long transition
  periods, or exclusion of significant areas of
  potential trade, or -- in the case of the
  China-ASEAN early harvest -- the beginnings of
  trade discrimination in particular areas before
  there is a plan and a schedule for movement to
  free trade in substantially all items..
• Different rules of origin from all other existing
  FTAs, and every one of the new FTAs still under
  negotiation is also to have different rules of
  origin from existing FTAs.
• These moves in the Asia Pacific region are
  creating obvious and major systemic risks for the
  international trading regime, risks which are
  perhaps especially large for developing,
  moderately sized and small economies. There are
  serious risks for all Asia Pacific economies. But
  there are also such risks for Europe, and, indeed
  for the US itself.
• 5.5 The US Strategy Competitive Discriminatory
  Liberalisation

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6 Macro and Financial Aspects of Asia Pacific
Growth

• The Solow Lewis miracle also has strong macro and
  financiaql implications
• During the 1990s the Asian miracle countries
  liberalised international capital flows and
  integrated with the international capital. Many
  emerging East Asian countries clearly benefited
  from the liberalisation and globalisation of
  financial markets.
• From the mid-1980s to the mid-1990s, large
  inflows of capital, particularly long term
  capital such as FDI helped finance the regions
  rapid economic growth.

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• An under-developed financial system and
  over-protected financial sector in some Asian
  economies meant that the private sector had to
  rely on borrowing, rather than equity issuance,
  to raise investment funds. As a result, firms
  became highly leveraged, but banks continued to
  lend because they were underpinned by implicit
  government guarantees.
• When growth slowed, as it first did in Thailand
  in 1996, these banks were exposed to the
  inability of borrowers to repay loans.
• In addition, countries had received large inflows
  of capital in the financial and corporate
  sectors, particularly in the form of un-hedged
  short-term capital due to relatively high
  domestic interest rates with de facto US
  dollar-pegged exchange rates. As a result, the
  ratio of short term external debt to foreign
  exchange reserves rose dramatically and the
  exposure to risk of double mismatch (maturity
  risk and currency risk) and when market
  perceptions changed in 1997 there was a sudden
  outflow of capital and consequent large downward
  pressures on currencies.

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• A further difficulty came, as so many times
  before, from the existence of fixed exchange-rate
  systems, but with a new twist. Banks financed
  much of their domestic corporate lending by
  borrowing in foreign exchange from abroad, often
  at shorter maturities than those employed when
  they lent onwards in domestic currency. Very
  little of this borrowing was hedged as a result
  of the implicit guarantee on the exchange rate.
• As noted the financial sector was already in
  difficulty after the initial slow down in growth
  in 1996. Currencies fell in mid-to-late 1997
  because of foreign investors concerns about
  these difficulties as a consequence, widespread
  bankruptcies and potential bank failures loomed
  because of the unhedged foreign-currency
  obligations. Fear grew that fiscal systems would
  be unable to bear the cost of large-scale bank
  rescues.
• Inadequacies of IMF Rescue

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• Dissatisfaction with the IMFs practice in crisis
  management continues to cast a long shadow over
  the Funds relations with many emerging-market
  economies, may have regional consequences
• The Fund has developed a detailed debt
  sustainability framework and complemented its
  traditional analysis of financial flows with a
  balance sheet approach to analysing stock
  imbalances, so as to enable it to understand the
  financial vulnerabilities of countries. This tool
  is designed to help Fund staff draw a clearer
  distinction between liquidity crises and solvency
  cases.
• The crises threw the problem of moral hazard
  arising from IMF lending into sharp relief. The
  need to better balance debtor moral hazard and
  creditor moral hazard is one of the key
  challenges now facing the Fund in the design of
  its lending facilities and its accompanying
  policy responses to crises.

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7 Macro and Financial Implications for Regional
Integration

• Low investment and slow growth since crisis
• A number of East Asian countries, over the ten
  years since the East Asian crisis, have
  accumulated in excess of a trillion US dollars of
  reserves. This massive reserve accumulation
  reflects a persistent excess of saving over
  investment across these economies, which may, at
  least in part, represent a conscious choice to
  amass reserves as a form of self-insurance
  against future crises.
• These countries have gone about a pooling of some
  of these reserves into a common fund, a process
  which began in 2000 when ASEAN, Japan, China and
  the Republic of Korea agreed to set up a
  bilateral currency swap scheme known as the
  Chiang Mai Initiative.
• This could help to deal with original sin. And

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• Taking this step would require difficult
  decisions by these countries, in order to make
  surveillance between the pools members effective
  and enforceable.
• Such a common pool of reserves might also
  create its own form of moral hazard, if it were
  to encourage countries to take excessive risks
  with foreign borrowing
• Could responsibility for international
  financial stability be internationalised when
  this has not proved possible in much more
  politically integrated Europe.

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8 Trade Macro and Finance Implications for
Regional Strategy

• Inexorable rise of China, importance of Chinese
  Japanese relationship, no obvious regional
  agenda, as there was in Europe
• Trade much more global than in the early days of
  the EU Asia-wide FTA hard to contemplate
  strong interest in progress in WTO and
  difficulties for regional FTAs
• No prospect of monetary union
• Difficult questions ahead for Chiang Mai
  initiative on financial cooperation