http://exed.maxwell.syr.

edu/exed/sites/policy/ June 2008

Knitting Together Asia: East Asian Economic Integration and its Implications
By George Abonyi
Abstract
George Abonyi is Visiting [Type sidebar content. A sidebar Professor at the Department of is a standalone supplement to the Public Administration and main document. It is often Executive the left or right of the aligned onEducation Program, Maxwell School, at the top page, or located Syracuse or University; and Text Box Tools bottom. Use theSenior Advisor, Fiscal change the formatting of tab to Policy Research Institute, Ministry of text box. the sidebar Finance, Thailand. Type sidebar content. A sidebar is a standalone supplement to the main document. It is often aligned on the left or right of the page, or located at the top or bottom. Use the Text Box Tools tab to change the formatting of the sidebar text box.] The performance and growing global importance of East Asia is well documented. Yet the story of East Asias re-emergence in the 10 years since the Asian Crisis is one of increasing regional integration and cooperation that is driving the regions growth and development. The challenge that goes beyond East Asia is one of building cooperative regionalism, consistent with an open and expanding global economy. From this perspective, East Asian regional cooperation and integration is still a work in progress. regional integration and cooperation and its impact on East Asias growth and development. Financial and monetary cooperation has accelerated in the past 10 years, driven to an important extent by the experience of the Asian Crisis. Its focus is on regional economic surveillance; liquidity support facility; and development of an Asian bond market. Regional trade initiatives involve a wide range of bilateral and plurilateral3 Free Trade Agreements (FTA), spurred by a stalled multilateral trade system, and a desire on the part of East Asian economies for more extensive economic linkages. However, it is production-related integration the emergence of regional production networks that is responsible to a large extent for the regions growth, development and restructuring. Multinational enterprises from outside the region are key participants in this production-related integration process; and final products that are the output of regional production networks continue to go primarily to international markets, particularly the US and EU. Therefore there is a close and mutually supportive relationship between de facto intraregional economic integration in East Asia, and the evolution and growth of the global economy. It is in the interest of Asia and the West to ensure that East Asian integration unfolds in a globally cooperative manner. The issue is not one of exclusive or inclusive East Asia (with or without the US or EU), any more

I. Introduction
In 1997-98 many of the star economies of the East Asian Miracle were in the midst of a devastating Asian Crisis. There were strong suggestions that the Crisis laid bare structural weaknesses such as corruption and cronyism that would condemn the countries of the region to years of lost growth. What a difference 10 years make. Today the performance and growing importance of a recovered East Asia1 is well documented; its dynamism reflected in its economic growth, international trade and investment, and financial resources.2 East Asia is playing an increasingly central role as a growth pole in the global economy. It is East Asia with a difference. Although China is an important part of the story, the on-going transformation of the region goes deeper. It is a story of increasing

(T)here is a close and mutually supportive relationship between intra-regional economic integration in East Asia, and the evolution and growth of the global economy

The challenge that goes beyond East Asia is one of building cooperative regionalism, consistent with an open and expanding global economy

than it is a question of an exclusive or inclusive NAFTA or EU (with or without East Asia). The challenge that goes beyond East Asia is one of building cooperative regionalism, consistent with an open and expanding global economy. From this perspective, East Asian regional cooperation and integration is still a work in progress. II. Drivers of East Asian Cooperation and Integration 1. Legacy of the Asian Crisis The 1997 Asian Crisis marked the end of a historically unprecedented three decades of sustained economic growth in East Asia, driven to a large extent by increasing integration with global product markets through expanding exports and imports. For example 1986-1996 the crisis economies of Indonesia, South Korea, Thailand and Malaysia grew at close to 7% GDP per annum, with manageable inflation, stable exchange rates, high savings and investment rates, sound fiscal and monetary positions. The Asian Crisis, cascading through the region, abruptly halted decades of growth, devastating economies in its wake. The Asian Crisis also had wider repercussions. There was strong criticism, warranted or not, of how International Financial Institutions (IFIs) led by the IMF responded to the Crisis. It seemed, and not only in Asia, that the IMF did not understand the challenges of rapidly changing global monetary and capital markets. The Asian Crisis was not a standard example of a financial crisis resulting from loose macroeconomic policies, where the conventional remedy is mainly macroeconomic tightening to restore economic discipline and investor confidence; and the IFIs led by the IMF -- were seen as misreading the basic nature of the capital account crisis facing Asia. The sobering experience of the Asian Crisis led to a rethinking of key tenets of (Western) economic theory and policy, particularly with respect to capital market liberalization and exchange rate management. For example, capital controls anathema in the pre-Crisis world of the mid 1990s began to be seen as respectable under certain circumstances. A renewed debate about

the global financial architecture and the Breton Woods institutions also followed. Economic devastation on the scale of the Asian Crisis has deep effects beyond debates of economic policies and institutions. It led to a soul searching within Asia on the extent to which the Asian values and ways of managing businesses and economies contributed to the Crisis, and therefore needed fundamental change. Yet, it also generated deep skepticism about the received doctrine of free markets, private enterprise, and international openness as the path to economic prosperity. After all, this was the path East Asian economies generally followed prior to the Crisis on the advice of Western-dominated Breton Woods institutions. As a consequence, there was also a loss of confidence in the institutions that were the source of such advice. At the time of the Asian crisis Japan proposed the establishment of an Asian Monetary Fund -- a kind of Asian version of the IMF. However, strong opposition from the IMF and the U.S. government, and lack of support from China, effectively blocked this concept. This was also a lesson learned by some in the region. The East Asian countries concluded that while the international financial institutions might come to their assistance, this may not be as effective as it should be, and there would be stringent strings attached. As a consequence, they decided to take certain steps in their own interest. First, the regions economies decided to insure themselves against future speculative attacks by building up large foreign currency reserves. Second, the countries of the region felt that the Crisis demonstrated their vulnerability within the existing international financial architecture. They saw the region as a whole as having very limited voice in influencing IFI (e.g. IMF) policies and operations, including conditionality requirements. Dissatisfaction with IFI performance in the Asian Crisis, coupled with underrepresentation of the region in the global financial architecture left the East Asian countries with two general options. They could push for substantial reforms of 2

The East Asian Crisis countries concluded that while the international financial institutions might come to their assistance, this may not be as effective as it should be with stringent strings attached. Hence, they decided to take certain steps in their own interest

Asia Policy Briefs June 11, 2008

the Asian Crisis spurred East Asian countries to pursue a risk-management strategy aimed at reducing future overdependence on G7-dominated IFIs, given the continuing uncertainty of the evolving global financial and monetary system.

international financial institutions aimed at strengthening the regions voice in these forums; and/or they could create alternative self-help institutions for and of the region. At the global level there are continuing discussions about reforming the G7-centred international financial architecture. However, these have not yet been translated into significant and timely changes that meet the expectations of East Asian countries. For example at the IMF whose basic structure was set 60 years ago-- there has been limited reform in areas such as representation in decision making bodies like the Executive Board, quotas, and voting power.4 At the regional level, there has also been a general uncertainty, as well as differences in perspective, about the feasibility and even desirability of region-wide more formal institutional arrangements. There had been discussions of regional cooperation and integration prior to the Asian Crisis, but arrangements had been more symbolic than real. However, a perceived key lesson of the Asian Crisis was that East Asia needs to strengthen economic cooperation in order to sustain the regions dynamic growth and stability. International financial institutions were seen as not fully satisfactory in supporting the regions development and reform process; while national initiatives were not sufficient. Hence the general sentiment emerged that East Asia must establish its own self-help mechanisms for economic management. In summary, the Asian Crisis spurred East Asian countries to pursue a riskmanagement strategy aimed at reducing future overdependence on G7-dominated IFIs, given the continuing uncertainty of the evolving global financial and monetary system. This has involved creating new financial and monetary arrangements that are region-based supplements and perhaps potential alternatives to global institutions. These are also intended to better position the region in the reform of IFIs. Yet the strategy pursued for regional financial and monetary cooperation has also enabled East Asia to maintain its critical relations with G7-centred global financial institutions, without antagonizing key players outside the region. In effect, East Asia for now is hedging its economic bets about the uncertain prospects of

both the reform of global financial system, and the creation of formal region-wide economic institutions. Therefore East Asia is following a kind of pragmatic middle path in regional economic cooperation and integration; but with the potential to adjust direction both within the region, and with respect to external players and institutions -- depending on which way global and regional winds blow. 2. Globalization of Production In the 10 years since the height of the Asian Crisis the global economy has changed in important ways. The evolution of the global economy and the resulting growth, development, restructuring and integration of East Asia-- is largely a story of the transformation of international business and multinational enterprises, and in particular, the globalization of production.5 The proportion of goods and (tradable) services conceived, produced, and consumed entirely within one countryor within one firm--is rapidly shrinking. Technological and managerial innovations and the removal of constraints on the cross-border flow of resources, goods, services and capital have led to the emergence of global value chains (GVC) driven by the twin dynamics of outsourcing and offshoring. Global value chains and associated production networks involve the fragmentation, dispersal, coordination, and re-integration of production-related activities among firms in geographically dispersed locations. They are emerging as the organizing framework for production, investment, and trade in an expanding range of product groups such as garments, agro-industry, automobiles/auto-parts, consumer electronics, telecommunications, IT, as well as business and health services. Multinational enterprises, including more and more from emerging markets, purchase inputs and components from (smaller) firms in widely dispersed locations that serve particular industry niches. Global trade increasingly involves flows of parts, components, subassemblies, and services within the framework of GVCs and associated production networks. This has resulted in growing task-related specialization by

Technological and managerial innovations and removal of constraints on the cross-border flow of resources, goods, services and capital have led to the emergence of global value chains driven by the twin dynamics of outsourcing and offshoring.

Asia Policy Briefs June 11, 2008

East Asias regional growth and economic restructuring is largely driven by increasing regional trade integration, involving primarily the expansion of intra-industry flows of parts and components.

firms in the production of goods and services, and the corresponding acceleration of growth in intra-industry and intra-product trade, as compared with traditional trade in final goods. The fundamental transformation of international business and the global economy is reflected in East Asias shifting economic geography. The regions growth and economic restructuring is largely driven by increasing regional trade integration, involving primarily the expansion of intraindustry flows of parts and components.6 At the same time, the regions growing trade with the rest of the world particularly with US and EU markets -- is dominated by final goods. As will be discussed, China occupies a special place in this triangular pattern of global trade and regional integration. This pattern, where expanding intra-regional trade is dominated by parts and components and growing inter-regional trade by final goods, is complementing global trade. III. East Asian Economic Cooperation and Integration: Key Elements 1. Asian Financial and Monetary Cooperation Important strides have been taken in East Asian financial and monetary cooperation in three general areas: (i) regional economic surveillance; (ii) liquidity support facility; and (iii) development of an Asian bond market. Regional economic surveillance: As East Asia was recovering from the Crisis, the ASEAN + 3 finance ministers established in May 2000 the Economic Review and Policy Dialogue (ERPD) process. Its purpose is to help prevent future financial crises through the early detection of problems leading to timely coordinated response. Cooperation to date has involved information sharing; exchange of views; assessment of economic conditions and policies; and exploring collaboration on financial, monetary, and fiscal issues of common interest. Specific areas of focus have included: identifying macroeconomic and financial risks, and policies to reduce such risks; strengthening banking and financial systems; cooperation in monitoring shortterm capital flows through exchange of data and information; establishment of

national surveillance units for economic and financial monitoring; and developing regional early-warning system to assess financial vulnerabilities. In addition to ERPD, other regional forums focusing on economic surveillance-related issues have included: ASEAN finance ministers Surveillance Process; ASEAN Central Bank Governors Meeting and related EMEAP (Executives Meeting of East Asia Pacific Central Banks); and trans-regional dialogue under APEC and ASEM. Liquidity support facility - Chiang Mai Initiative and regional reserve pooling: The Chiang Mai Initiative (CMI), adopted by the ASEAN + 3 in May 2000, is intended to respond to short-term liquidity needs in the case of future financial crises. It is composed of 2 parts: an expanded ASEAN Swap Arrangement (ASA) of around $2 billion in 2007; and a set of bilateral swap arrangements (BSAs) among 8 ASEAN + 3 members, of around $83 billion in 2007. This mechanism is linked to the IMF and associated conditionalities --in order to leverage additional funds, as needed. The IMF link is viewed by participating countries as a necessary cautionary step at this stage, but one that is likely to be reduced over time. Consistent with this, the drawdown under the CMI swap arrangement was initially set at 10%, but was then expanded to 20% in May 2005, with the IMFs contribution correspondingly reduced from 90% to 80% -- with more reductions in the role of the IMF expected to come. Since its initiation the CMI has been reinforced and expanded. For example, the ASEAN + 3 Economic Review and Policy Dialogue (ERPD) has been strengthened and integrated into the CMI framework in May 2005; a collective decision-making procedure to replace bilateral swaps has been adopted as an important step toward making CMI mechanism multilateral and therefore more efficient to activate in the case of a crisis; and there is an agreement in principle on a self-managed pooling arrangement under the CMI, with key elements presently under discussion, including surveillance, reserve eligibility, commitment size, borrowing quota, and activation mechanism. Asian bond market development: The Asian Crisis focused attention on the shortcomings of the regions bankdominated financial systems, and dependence on external savings, 4

Asia Policy Briefs June 11, 2008

Expanding trade between East Asia and the rest of the world has reflected the regions growing importance in the global trading system. East Asias share of world trade has increased from about 10 percent in the 1970s to more than 25 percent in 2006

particularly short-term capital flows.7 The basic objective of the development of local currency-denominated bonds is to mobilize the regions extensive savings to be intermediated directly within the region for (long-term) investment. This would reduce dependence on external financial centres and currencies, and diversify the regions financing mechanisms. To implement this, the Asian Bond Fund (ABF) initiative was established within the framework of the EMEAP (Executives Meeting of East Asia Pacific Central Banks) in June 2003. This is aimed at expanding demand for local bonds through purchases by central banks of bonds issued by the 8 EMEAP countries including PRC; Hong Kong, China; Indonesia; Korea; Malaysia; Philippines; Singapore; and Thailand. The Asian Bond Markets Initiative (ABMI) launched in August 2003 under the auspices of the ASEAN + 3 finance ministers (Executives Meeting of East Asia Pacific Central Banks) aims at creating robust primary and secondary bond markets in the region for example through easier access for diverse issuers and investors. It also includes exploring new debt instruments for infrastructure financing, and developing and strengthening bond market mechanisms. Partly as a consequence of these initiatives, local currency bond markets in ASEAN + 3, excluding Japan and Hong Kong, have grown 6.8 fold between 1997 and June 2006.8 2. Regional production integration East Asias increasing share of world trade: Expanding trade between East Asia and the rest of the world has reflected the regions growing importance in the global trading system. East Asias share of world trade has increased from about 10 percent in the 1970s to more than 25 percent in 2006, overtaking the NAFTAs share of about 20 percent, (though still lagging the EUs share of a third of world trade). This inter-regional trade is dominated by final goods, primarily for key markets such as the US and EU. However, the regions demand for its final products is a growing share, expected to expand in the future. Intra-regional trade and investment: Market-driven trade and investment integration has moved forward in East Asia without formal intergovernmental or region-wide agreements; though

facilitated by (mostly ad hoc) policy liberalization. Intra-regional trade has expanded as share of the regions total trade from around 35% in 1980 to over 55% by 2006.9 This is driven by the growth of intra-industry trade in parts and components, whose share of total regional trade is estimated to have increased from 55% in 1990 to 78% by 2005. Export profiles of countries increasingly match import profiles of other economies in the region, reflecting growing production complementarity and integration. Supporting trade expansion and integration, FDI to East Asia has expanded even faster, from 7% of total world FDI inflows in 1980 to 13% in 2006; with outflows also increasing from 5% to 12% of world total outflows over this same period. Much of the FDI flows are intra-regional-- e.g. from Japan and NIEs to ASEAN and China; as well as intra-ASEAN; and from ASEAN to China--further strengthening the regional economic integration. The result is an increasingly integrated regional economy of expanding intra-regional trade dominated by parts and components, feeding growing inter-regional trade of final goods. Role of China: China plays a central role in global triangular trade and related regional integration. It imports intermediate products mostly from other East Asian economies, assembles then exports final goods to global markets. To date, Chinas domestic value added in manufactured exports has been a relatively modest share, estimated as averaging around 20%10 -- though expected to change over time. As a result, China runs a trade deficit with East Asia and a surplus with the US. This reflects complementarity between Chinas globally-oriented assembly industries, and its East Asian suppliers of intermediate products. Therefore labels on many of Chinas manufactured exports should read as Made in East Asia, in order to reflect more accurately their true origins and the related regional production integration process. There are indications of increasing sophistication of Chinas domestic manufacturing and a corresponding slowing of imported components, but the extent and implications of this trend are not yet clear.11

[L]abels on many of Chinas manufactured exports should read as Made in East Asia, in order to reflect more accurately their true origins and the related regional production integration process.

Asia Policy Briefs June 11, 2008

East Asia is now following a 3-track approach to trade: (i) multilateral liberalization under WTO; (ii) regional cooperation and integration; and (iii) bilateral arrangements between countries in the region and with outside economies.

Market-driven open regionalism at work: Multinational enterprises (MNEs) from outside the region such as Apple, Cisco, Dell, Hewlett-Packard, Levi -- have been key participants (direct/indirect) and beneficiaries from the regional production integration process. For example, MNEs accounted for close to 60% of Chinas total exports in 2005; thus playing a central role in connecting East Asias increasingly integrated production system to global markets. However, there have been limited linkages to date between market-driven regional production integration, and the large number of Free Trade Agreements under discussion in the region in recent years. 3. Trade cooperation and integration: Free Trade Agreements (FTAs) The Asian Crisis caused the regions economies to focus more closely on trade and investment cooperation to help sustain economic growth. This has been partly a reflection of the demonstrated vulnerabilities of individual national economies, as well as of perceptions of shortcomings of the international economic system and institutions. Since the late 1990s there has been a proliferation of bilateral and plurilateral FTAs in (East) Asia, building in part on the dynamic of the 1993 ASEAN Free Trade Area (AFTA). This reflects a shift away from the regions earlier longstanding strategy of pursuing trade liberalization within a multilateral framework based on WTO, and through the inter-regional structure of APEC. As a consequence, East Asia is now, in effect, following a 3-track approach to trade: (i) multilateral liberalization under WTO; (ii) regional cooperation and integration (e.g. ASEAN + 3; ASEAN + 6, which includes India, Australia, and New Zealand); and (iii) bilateral arrangements between countries in the region and with outside economies. Some of the FTAs, such as the ASEAN-Japan Comprehensive Economic Partnership Agreement (AJCEP), go beyond the WTO framework WTOplus -- addressing issues such as trade and investment facilitation, government procurement, dispute settlement, and labour mobility. As of the end of 2007 there were over 100 FTA-type initiatives at various stages of preparation.12 Example of European and North American economic integration: At one

level, the experience of the EU and NAFTA suggests to the regions economies potential trade and investment gains from more formal and expanded regional economic cooperation and integration. At another level, governments in East Asia increasing feel that unless they coordinate their own trade and investment policies at the regional level, they will be at a disadvantage in global competition and multilateral negotiations vis-a-vis other more integrated regions that are following a more coordinated strategy at both the government and enterprise level. They see such cooperation and integration therefore as important in strengthening their place at the table in defining the rules of the game for an emerging international economic system where Asia is playing an increasingly key role. This is spurred on by the slow progress of the WTO/Doha round and a perceived loss of steam of the APEC process. Against this background, regional FTAs bilateral and plurilateral are therefore seen as an insurance policy or/and potential building blocks, within the framework of an uncertain multilateral trade liberalization system. FTAs and increasing regional production integration: At this stage, the marketdriven production integration process could benefit from focused policy measures to deepen and sustain such integration. Measures could include the elimination of formal and informal crossborder impediments; trade and investment facilitation measures; harmonization of rules, procedures, standards and regulations, and so on, to facilitate deepening and widening the increasingly complex production linkages aimed at both regional and global markets. Given the role of global markets and multinational enterprises in regional economic integration, the expansion of FTAs within the region is best seen within the broader context of the globalization of production, implemented through expanding regional production networks. This is illustrated by expectations from the ASEAN-Japan Comprehensive Economic Cooperation Agreement.13

Asia Policy Briefs June 11, 2008

[I]t is in the interest of all parties to manage effectively East Asian integration within a wider international setting, in order to ensure that the global economy does not become fractured into regional economic blocs.

4. Subregional Cooperation14 Economic cooperation and integration in Asia has evolved differently from other regions, partly as a reflection of its size and diversity. While Europe and North America have been characterized by formal, region-wide arrangements, Asia has taken a more varied, informal, and open approach to regional integration and cooperation. In addition to more formal rule-based subregional cooperation such as the Association of Southeast Asian Nations (ASEAN), cooperation has also involved a variety of more informal arrangements aimed at responding to local circumstances, and expanding the specific development options of particular groups of countries. The Asian Development Bank (ADB) has been particularly active in facilitating this form of cooperation.15 This more informal activity-based regional cooperation has involved identifying a set of specific activities as the basis for cooperation, e.g. roads, power, environmental issues, customs procedures. Therefore such cooperation is more limited in scope, targeted at specific well-defined activities or relatively well-bounded issues of priority interest to a particular set of countries. As subregions in Asia differ in character and needs, so the scope and speed of such activity-based cooperation will also differ. The general idea is that this approach allows, in principle, any group of countries or parts of countries to cooperate and integrate at a pace and level consistent with their specific constraints and opportunities, deepening and expanding such cooperation over time both with the original participants, and beyond. In practice, the experience with this type of subregional cooperation has been mixed to date. Examples of activity-based subregional cooperation: The best known example of such cooperation is the Greater Mekong Subregion (GMS) Program, initiated with support from ADB in 1992. It includes Cambodia, Lao PDR, China (first Yunnan Province, then Guangxi Zhuang Autonomous Region added in 2004), Thailand, and Viet Nam. The GMS Program involves initiatives in transport, energy, telecommunications, human resource development, tourism, environment, trade facilitation, investment, and agriculture. The Central Asia Regional Economic Cooperation

(CAREC) Program, begun in 1997, focuses on cooperation in transport, energy, trade facilitation, and trade policy; and includes Afghanistan, Azerbaijan, PRC (Xinjiang Uygur Autonomous Region), Kazakhstan, Kyrgyz Republic, Mongolia, Tajikistan, and Uzbekistan. CAREC, initially supported by ADB, is now also supported by an alliance of multilateral institutions, including European Bank for Reconstruction and Development (EBRD), International Monetary Fund (IMF), Islamic Development Bank (IsDB), United Nations Development Programme (UNDP), and World Bank. Other examples include the South Asia Subregional Economic Cooperation (SASEC) Program launched in 2001; the Brunei Darussalam, Indonesia, Malaysia, and PhilippinesEast ASEAN Growth Area (BIMPEAGA) launched in 1994; and the Indonesia-Malaysia-Thailand Growth Triangle (IMT-GT), made up of two Indonesian provinces on Sumatra, four northern Malaysian states, and five provinces of southern Thailand started in 1993; and the Greater Tumen Initiative (GTI) launched in 1995 with support from the United Nations Development Programme (UNDP) and including China, the Democratic Peoples Republic of Korea, Mongolia, Republic of Korea, and Russian Federation. IV. Policy Implications of Asian Integration: issues for consideration Rationalizing and strengthening regional financial and monetary cooperation: An important challenge is to ensure continuing consistency, coordination, and harmonization among the various regional initiatives for financial and monetary cooperation and integration as they move forward. These initiatives address different if complementary needs, and are at various stages of progress. They include reserve pooling arrangements (Chiang Mai Initiative, CMI), regional economic surveillance (Economic Review and Policy Dialogue, ERPD), and Asian Bond Markets Initiative (ABMI) under ASEAN + 3. Taken together, what may be ultimately emerging is a de facto East Asian Monetary Fund with monitoring and financing roles to forestall and respond to financial crises in the region; and for helping to deepen, strengthen and

Asia Policy Briefs June 11, 2008

Formal East Asian cooperation and integration focused initially on financial cooperation before significant attention was given to trade-related integration

diversify regional institutions and instruments for financial intermediation. In this process, in addition to ensuring a coherent framework for effective East Asian financial and monetary cooperation, a key challenge is to ensure a consistency between regional and international financial institutions and mechanisms in order to contribute to both regional and global financial stability. In this context, it should be noted that a strong push to greatly reduce the CMI swap-IMF link could be an increasingly contentious issue in East Asia - US relations, given indications that the US would like to see CMI lending continue to be closely linked to IMF programs and conditionality. Consolidating regional trade agreements: An important challenge to regional cooperation is to rationalize the noodle bowl of extensive, multiple, and overlapping FTAs into a coherent regionwide East Asian agreement that enhances deep integration, complementing ongoing market-driven production integration. This implies approaching individual FTAs not as independent bilateral agreements, but within the broader framework production-related multi-country linkages. In this context, ASEAN may provide a possible base for working toward a region-wide East Asian framework (and perhaps beyond, e.g. India). This is because ASEAN, as the only formal regional cooperation institution, has a number of integration initiatives well underway with varying degrees of success, including the ASEAN Free Trade Area (AFTA), ASEAN Framework Agreement on Services (AFAS), ASEAN Investment Area (AIA). It is also the basis for enlarged participation through ASEAN + 3 (and a push by some for ASEAN + 6) in a range of wider regional economic cooperation and integration initiatives, as noted. In addition, ASEAN as a group has concluded or is negotiating a wide range of economic partnerships, both within East Asia (e.g. China, Korea, Japan) and outside (e.g. India, EU, Australia and New Zealand). More generally, the ASEAN + 3 leaders agreed in 2004 to the long-term objective of establishing an East Asian Community with this grouping as its main vehicle. Ensuring continuing open regionalism in East Asia: Rationalizing the variety of trade agreements toward a region-wide

China has played an important and active role in regional cooperation and integration [and] plays a central role in the regional production integration process. The emerging challenge has sometimes been phrased as one of a potential clash over leadership of the global economy between a Chinaled Asia and a US-led West

East Asian agreement that is consistent with open regionalism may be a delicate line to walk, given the dynamics both within and outside the region. As noted, traditionally, East Asia has taken an ad hoc, market-driven approach of nonexclusionary open regionalism, and to date only ASEAN has constituted a formal cooperation arrangement. However, as also noted, the Asian Crisis has reshaped East Asian perceptions and attitudes in important ways toward regional cooperation and self-help arrangements in what is seen as an uncertain international environment. At the same time, production integration driving growth and diversification of the regional economy is closely linked to global markets, and involves as key participants multinational enterprises from outside the region. Therefore it is in the interest of all parties to ensure that progress toward more formal region-wide integration retains key elements of the traditional East Asian approach of open regionalism, consistent with basic principles of an open multilateral trading and investment system. It is in this way that more formal cooperation and integration can best support the marketdriven production integration essential to the regions continued growth and development. In this process, retaining and strengthening an increasingly integrated and self-confident East Asias smooth linkages with North America/NAFTA and Europe/EU is likely to present important challenges for all. For example, the US has proposed a Free Trade Area of the Asia and the Pacific (FAATP) within the framework of APEC as a way of expanding the boundaries of East Asian integration beyond the region - and in the eyes of some in order to blunt its Asian focus. Therefore it is essential to manage effectively East Asian integration within a wider international setting, in order to ensure that the global economy does not become fractured into regional economic blocs. Exchange rate coordination: Regional cooperation in finance, trade, investment, and production has not been accompanied by efforts at exchange rate coordination. Until the Asian Crisis many economies in the region maintained a de facto exchange rate peg to the US$. Since the Crisis, exchange rate regimes have varied: for

Asia Policy Briefs June 11, 2008

The international community has to address in a meaningful way the challenge of providing an appropriate voice and representation to an East Asia that is playing an increasingly central role in the global economy.

example, Japan has maintained a free float, while the PRC has a managed crawling peg regime linked to the US$. At the same time, with the US$ as the primary currency of the regions reserves, East Asia has become in effect the buyer of last resort of US$s, accumulating excess reserves16 generally in the form of short-term US treasury bills. Deep global imbalances involving large US deficits and East Asian surpluses, along with problems in the US financial sector, have all put downward pressure on the US$, along with upward pressure on many East Asian currencies. The economies of the region are faced with a complex mix of inflationary pressures, emerging asset price bubbles, and short-term capital inflows that suggest allowing currency appreciation. But appreciation could undercut price competitiveness of exports and stability in a region increasingly tied together through production-related linkages. The resulting challenges to exchange rate management are well illustrated in the case of a Thailand that imposed controls on capital inflows in December 2006 (since then significantly relaxed). In this context, orderly and cooperative exchange rate appreciation in East Asia could spread the adjustment costs across the regions increasingly integrated economies. A likely result is greater flexibility vis--vis the US$ and increasing adoption of a currency basket arrangement based on the US$, Euro, and a mix of Asian currencies. This, in turn, raises the wider challenges of effective and coordinated management of global exchange rate adjustments, including the issue of a hard vs. soft landing for the US$. From this perspective, Asian bond market initiatives aimed at developing the foundations for investing Asian savings directly in Asia, also have implications for regional and global exchange rate management. Increased coordination between financial and trade-related initiatives: There has been very limited coordination to date between the initiatives on financial and trade-related regional cooperation and integration. Formal East Asian cooperation and integration, unlike traditional regional integration processes such as the EU, focused initially on financial cooperation before significant attention was given to trade-related integration. This was in part a consequence of the Asian Crisis, where

attention was centered on the regions financial systems and financial contagion. At this stage it is increasingly important to bring together developments in the two spheres; particularly in the context of extensive production-related integration that has important implications for and linkages to financial, trade, and investment flows in the region. Future role of China: China is playing a central role in the evolution of Asia. Since not supporting the Japanese proposal in 1997 for an Asian Monetary Fund, China has played an important and active role in subsequent regional cooperation and integration. For example, it has been a key participant in various ASEAN + 3 initiatives, and commenced an FTA with ASEAN in 2005. Furthermore, it plays a central role, as discussed, in the regional production integration process. The emerging challenge has sometimes been phrased as one of a potential clash over leadership of the global economy between a China-led Asia and a US-led West.17 From the perspective of East Asian integration, the issues raised by Chinas role are broader, and include the following: (1) what is the likely pattern and implications, e.g. for its East Asian neighbours, of Chinas future movements down and up the value chain to produce intermediate goods in key industries where it has been importing parts and components from other economies in the region for final assembly for third markets; (ii) how will the complex and evolving relationship between China and Japan play out in shaping the political economic geography of the region; and (iii) in what direction will China influence the East Asian integration process with respect to key external players, in particular the US and the EU. How these issues develop has important implications for China, East Asia and the global political economy. Upgrading subregional cooperation: Subregional cooperation programs such as GMS and CAREC have focused to date primarily on strengthening physical connectivity through cross-border infrastructure and related software, particularly trade facilitation. Various programs have also included areas such as tourism, human resource development, and cooperation on public goods such as

Asia Policy Briefs June 11, 2008

environment and health.18 There has been limited focus to date on production integration, the key driver of East Asian economic growth and integration. The concept regional value chains and their central role in economic integration and development, as well as their implications for cooperation in areas such as crossborder logistics, standards and certification, and enterprise clusters, have been missing so far from subregional cooperation programs. Focusing on this dimension of subregional cooperation is particularly important at this stage, especially so for lagging economies that are not well connected to the regional production system and international markets.19 A further stage of cooperation within the framework of wider regional integration is likely to involve building bridges across subregional boundaries, as these cooperation programs evolve. An interesting example in this direction if with limited results to date -- is the BIMSTEC Bay of Bengal Community Initiative for Multisectoral, Technical and Economic Cooperation that cuts across the GMS and SASEC, involving countries from South Asia (India, Nepal, Bangladesh, Bhutan and Sri Lanka) and East Asia (Thailand, Myanmar). Giving voice to an emerging East Asia: An important motivation of East Asian cooperation and integration has been to strengthen the voice of the region in the evolving global governance process. The international community has to address in a meaningful way the challenge of providing an appropriate voice and representation to an East Asia that is playing an increasingly central role in the global economy. That is, a rapidly growing and integrating East Asia must have a fitting role in various global economic governance structures and arrangements, including in the evolving international financial, trade, and development-finance architecture. Although some steps are being taken in this direction in some IFIs, more is required.

Role of the Asian Development Bank (ADB): The ADB, located in Manila, is the only international financial institution with a region-specific mandate for fostering development in Asia. The ADB also provides an institutional link between the developing economies of Asia, and key countries outside the region who contribute to its financing and are represented on its Board (e.g. US, Canada, Europe). Supporting regional cooperation and integration has been an important part of ADBs activities since the early 1990s. This has included support to subregional cooperation programs such as the GMS and CAREC, and since the Asian Crisis, for ASEAN + 3 initiatives in financial and monetary cooperation. The ADB is in a unique position to further support Asian cooperation and integration, and to help bridge the intra-regional integration process with external/global interests and dynamics. For example, ADB can help deepen and extend the process of intraand inter-regional production integration, helping to link firms from both within and outside the region. Such a role could be particularly important to Asias balanced development by helping to integrate lagging economies into the regional and global growth dynamic, linking them to international markets. However, to be effective in this context, ADB has to reshape its role, strategy, and operations, for example with respect to subregional cooperation programs such as the GMS and CAREC, in order to ensure continuing relevance to the emerging challenges of a rapidly changing region. More fundamentally, it is in the interest of ADB member and donor countries from both inside and outside Asia to ensure the institutions continuing relevance and effectiveness as a region-based multilateral forum for continuing intraand inter-regional dialogue, cooperation, and development-related partnership.

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Endnotes
1

East Asia as used here includes the 10 ASEAN economies of Brunei Darusslaam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Viet Nam; as well as Hong Kong, China; Korea; Taiwan; Peoples Republic of China; and Japan. An important subset is the ASEAN + 3, a key group in the context of regional cooperation and integration that includes the 10 ASEAN countries, China, Japan, and Korea. 2 See for example, Asian Development Bank, 2007. Asian Development Outlook 2007. ADB, Manila; and Gill, Indermit and Homi Kharas, 2007. An East Asian Renaissance: Ideas for Economic Growth. The World Bank, Washington D.C.; 3 Plurilateral FTAs involve more than 2 parties. 4 There are, however, some important changes. For example, the newly appointed Chief Economist and Senior Vice President of the World Bank for the first time in the institutions history is East Asian, Dr. Justin Yifu Lin, an internationally widely respected economist from China. 5 See Abonyi, G., 2007. Linking Greater Mekong Subregion Enterprises to International Markets: The Role of Global Value Chains, International Production Networks, and Enteprise Clusters. United Nations Economic and Social Commission for Asia and the Pacific, Studies in Trade and Investment 59, New York. 6 See for example Gill, Indermit and Homi Kharas (2007) op cit. 7 This contributed to the double mismatch problem of the Asian Crisis. Banks and corporates borrowed short term foreign currency (i.e. US$), generally unhedged given pegged exchange rates against the dollar; these were used for long term investments denominated in l ocal currencies, for example to expand production capacity and real estate. Banks and corporates in the Crisis countries were subsequently devastated when foreign (US$) denominated loans were called in as local currencies plummeted, and interest rates soared. The development of an Asian bond market is intended to reduce the risks of such double mismatch problems in the future, while diversifying financing options in the region. 8 Asian Development Bank, Asian Bonds Online. 9 See for example IMF, 2007: Regional Economic Outlook: Asia and Pacific, October, Washington D.C.; and ADB (2007), op cit. 10 See for example Lau, L.J, Xikang Chen, Leonard K. Cheng, K.C. Fung, Jiansuo Pei, Yun-Wing Sung, Zhipeng Tang, Yanyan Xiong, Cuihong Yang, and Kunfu Zhu, 2006. Estimates of US-China Trade Balances in Terms of Domestic Value-Added. Working Paper No. 295, Stanford Centre for International Development, October. 11 See for example Li Cui and Murtaza Syed, 2007. The Shifting Structure of Chinas Trade and Production. IMF Working Paper, WP/07/214, Asia and Pacific Department, September. 12 See the Asian Development Banks Asian Regional Integration Centre (ARIC) FTA Database for details. 13 This is clearly the context within which Japan views the recently signed ASEAN-Japan Comprehensive Economic Partnership Agreement: "This agreement will provide legal support for the further development of the manufacturing network between Japan and ASEAN," Japanese Foreign Minister Masahiko Komura said in a separate press statement. "I hope it will take effect soon to further stimulate trade and investment between Japan and ASEAN and strengthen the region's economic attractiveness." (Associated Press, April 14, 2008. Japan ASEAN complete signing free trade accord) 14 For more detailed discussion of this type of regional cooperation and integration in Asia, see Abonyi, G., 2008. Activity-Based Subregional Cooperation in Asia: Example of the Greater Mekong Subregion (GMS). Maxwell Asia Policy Briefs (forthcoming). 15 See ADB, 2006. Regional Cooperation and Integration Strategy. Asian Development Bank, July. 16 Excess reserves, in light of the Asian Crisis, are seen as those reserves over and above what are needed to respond to a capital account crisis. 17 See for example Bergsten, C. Fred, 2007. China and Economic Integration in East Asia: Implications for the United States. Policy Briefs in International Economics. Peter G. Peterson Institute for International Economics, March. 18 For brief summary involving ADB-supported subregional cooperation programs see ADB (2006) op cit. 19 For a discussion of this aspect of subregional cooperation see Abonyi (2007); and Zola et al, 2008. Enhancing Upland Food Security and Crossborder Agricultural Production Supply Chains in the Greater Mekong Subregion. Maxwell Asia Policy Briefs, (forthcoming).

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