Asia-Pacific Regional Integration: a Global Challenge

1. Asia-Pacific Regional Integration: a Global Challenge David Vines University of Oxford and ANU

2. 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

3. 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

4. 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.

5. 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.

6. 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.

7. 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 world’s 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.

8. 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.

9. 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.

10. 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

11. 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 region’s rapid economic growth.

12. 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.

13. 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

14. Dissatisfaction with the IMF’s practice in crisis management continues to cast a long shadow over the Fund’s 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.

15. 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…

16. Taking this step would require difficult decisions by these countries, in order to make surveillance between the pool’s 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.

17. 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