Shaping the New Economic Architecture in East Asia

(1) Early attempts

EAEG/EAEC proposal. Following the unsatisfactory progress of the GATT Uruguay Round Ministerial meeting in December 1990, Malaysian Prime Minister Mohamad Mahathir proposed the formation of a regional trade grouping, comprised of major ASEAN countries; PRC; Hong Kong, China; Japan; and Korea. This group of economies was called the East Asian Economic Group (EAEG). Mahathir’s objective was to establish a regional trade arrangement for the group, in response to the emergence of preferential regional trade arrangements elsewhere, including in North America, and to exercise a global impact on trade issues in the way, for example, the Cairns Group does. In October 1991, the ASEAN economic ministers considered Mahathir’s proposal useful, and renamed the grouping “East Asian Economic Caucus” (EAEC).

The US objected to the EAEG/EAEC proposal on the grounds that it could divide the Asia- Pacific, by excluding the US, and reduce the effectiveness of the trade and investment liberalization process within APEC. Japan hesitated to support the proposal not only out of consideration for the US opposition—wishing to calm the trade conflicts at the time with the US and keep their bilateral relationship in tact—but also because of the strategic priority it placed on the emerging APEC process. The PRC also took a cautious approach. Interest in the EAEG/EAEC proposal eventually waned in the absence of support from key countries in Northeast Asia. But when the leaders of PRC, Japan, and Korea were invited to the informal ASEAN leaders’ meeting in December 1997, in the midst of the Asian financial crisis, the de facto ASEAN+3 process began; it was formally launched in April 1999. Thus, the EAEG/EAEC proposal may be seen as a precursor to the ASEAN+3 process, as membership of the latter overlaps that of the former.

Asian Monetary Fund (AMF) proposal. Soon after the outbreak of the Thai baht devaluation in July 1997, the Japanese government hosted a meeting in August to generate an agreement among the “Friends of Thailand” on a much-needed financial support package for crisis-affected Thailand.²² Following this success, Japan, with support from Korea and many ASEAN countries that participated in the Thai package, proposed in September to establish an Asian Monetary Fund (AMF), which was designed to supplement IMF resources for crisis prevention, management, and resolution. The aim was to pool foreign exchange reserves held by the East Asian authorities, both to deter currency speculation, and to contain a currency crisis and contagion in a member economy. It was said then that as much as US$100 billion would be mobilized. The United States and the IMF opposed this proposition on the grounds of moral hazard and duplication. They argued that an East Asian country hit by a currency crisis would bypass the tough conditionality of the IMF and receive easy money from the AMF, thereby creating the potential for moral hazard; they also reasoned that an AMF would be redundant in terms of its expected businesses and operations in the presence of an effective global crisis manager, the IMF. Without the PRC’s clear support, the idea was eventually shelved.

New Miyazawa Initiative. A highly successful example was the so-called New Miyazawa Initiative, which contributed to the resolution of the Asian financial crisis. In October 1998, Japan pledged US$30 billion to support the economic recovery of the crisis-affected countries. Half of the pledged amount was dedicated to short-term financial needs during the process of implementing economic restructuring and reform, while the rest was earmarked for medium- and long-term reforms. Part of short-term financial support was dedicated to currency swap arrangements with Korea (US$5 billion) and Malaysia (US$2.5 billion). Longterm support was extended to assist the crisis-affected countries in restructuring corporate debt, reforming financial sectors, strengthening social safety nets, generating employment, and addressing the credit crunch. A commitment to provide substantial financial resources helped stabilize the regional markets and economies, thereby facilitating the recovery process. Noteworthy is the fact that the short-term financial support provided to Korea and Malaysia became a model for bilateral currency swap arrangements under the Chiang Mai Initiative.

(2) Multiple Groups: ASEAN, ASEAN+3, and EAS

Three key leaders’ processes in East Asia—that is, ASEAN, ASEAN+3, and the East Asia Summit (EAS, or ASEAN+6)—are likely to shape the future economic architecture in the region.

ASEAN Economic Community. Until recently, ASEAN, established in August 1967,²³ had been the only formal grouping that pursued regional economic integration in East Asia. The original five ASEAN central banks and monetary authorities—Indonesia, Malaysia, the Philippines, Singapore, and Thailand—introduced the ASA, with the total facility of US$100 million, in 1977. ASA has evolved since then in terms of both amount and membership and has eventually become one of the two elements of the CMI.

ASEAN has embarked on several economic integration initiatives, including AFTA, the ASEAN Framework Agreement on Services (AFAS), and the ASEAN Investment Area (AIA) (see Box 1 [ PDF 60.4KB | 1 pages ]). In 1997, the ASEAN leaders adopted the “ASEAN Vision 2020,” which envisioned ASEAN as outward looking, living in peace, stability, and prosperity, and bonded together in partnership in dynamic development and in a community of caring societies. To implement this long-term vision, the Hanoi Plan of Action (1999–2004) was drawn up as the first in a series of action plans. Following the launch of the “Initiative for ASEAN Integration” (IAI) in 2000, the ASEAN leaders in 2003 adopted the “Declaration of ASEAN Concord II” (Bali Concord II), whereby they agreed on the establishment by 2020 of an ASEAN Community comprising three pillars: an ASEAN Security Community, an ASEAN Economic Community, and an ASEAN Socio-Cultural Community. See the Appendix Table for major decisions made by leaders of ASEAN (as well as those of ASEAN+3 and the East Asia Summit [EAS]).

According to the “ASEAN Vision 2020” and “ASEAN Concord II,” by 2020 ASEAN was expected to become a competitive economic region with a single market and production base, where there is a free flow of goods, services, and investment, a freer flow of capital, equitable economic development, and reduced poverty and socio-economic disparities.²⁴ In moving in this direction, it was considered necessary to strengthen the implementation of its existing economic initiatives including the AFTA, AFAS, and AIA; accelerate regional integration in 11 priority sectors;²⁵ facilitate movement of business persons, skilled labor, and talents; and improve the existing Dispute Settlement Mechanism. ASEAN leaders also considered the idea of adopting a “2+x” approach to ASEAN economic integration in addition to the existing “ASEAN minus x” formula. In the “2+x” approach, two countries ready to cooperate on a specific sector could work together first.

The ASEAN leaders in 2004 adopted the “Vientiane Action Program” (VAP), a six-year plan (2005–10), as the successor of the “Hanoi Plan of Action” to realize the end goal of the “ASEAN Vision 2020” and “ASEAN Concord II.” The VAP focused on deepening regional integration and narrowing the development gap within ASEAN, particularly the least developed member countries of Cambodia, Lao PDR, Myanmar, and Viet Nam (called CLMV), and called for the establishment of an ASEAN Charter in order to make ASEAN mechanisms more effective. In 2005 they tasked an Eminent Persons Group (EPG) to provide practical recommendations on the future directions for ASEAN and the nature of the Charter. In January 2007, they endorsed the submitted EPG Report on the ASEAN Charter as one of the bases for drafting the Charter, and directed the High-level Task Force to complete the drafting of the ASEAN Charter. They also decided to advance the time frame of the ASEAN Community, including AEC, forward to 2015. In November 2007, the leaders signed the “ASEAN Charter” and adopted the “ASEAN Economic Community (AEC) Blueprint” for ASEAN economic integration.²⁶

ASEAN+3. Officially launched in 1999, the ASEAN+3 process contains many ministerial processes—for foreign affairs, economy, and trade; macroeconomic and finance; environment; energy; health; labor; science and technology; and social welfare, among others. The PRC regards ASEAN+3 as a natural grouping for East Asia’s trade and investment cooperation, and the ASEAN+3 economic ministers have focused on the feasibility of an East Asia Free Trade Area (EAFTA).²⁷ In addition, the group’s finance ministers have been particularly active for regional financial cooperation, including the launch of the regional liquidity support arrangement (Chiang Mai Initiative), the regional economic surveillance process (ERPD), and Asian bond market development (ABMI).

The ASEAN+3 leaders in 2004 agreed that the establishment of an “East Asian Community” was a long-term objective and affirmed the role of ASEAN+3 as the “main vehicle” for this eventual establishment. The idea of creating such a community had been proposed by the East Asia Vision Group (2001).²⁸ The Vision Group had envisioned the progressive integration of the East Asian economies, ultimately leading to an “East Asian economic community;” the group held that once a region-wide FTA is formed, covering both trade and investment, and once institutions for other types of regional cooperation are established, the basic foundation for an East Asian economic community will have been prepared. But the leaders apparently considered some of these recommendations bold.

An East Asia Study Group (EASG), composed of government officials, was set up in 2000 essentially to respond to the Vision Group’s recommendations. The ASEAN+3 leaders in 2002 received the EASG Final Report, which identified 17 concrete short-term measures and 9 medium- to long-term measures to move East Asian cooperation forward (see Box 2 [ PDF 59.5KB | 1 pages ]). The leaders endorsed in 2003 the implementation strategy of the short-term measures—to be implemented by 2007—and in 2004 encouraged a speedy implementation of the shortterm measures and medium- and long-term measures proposed by the EASG. Most of the medium- to long-term recommendations have begun to be addressed, with a few exceptions—such as the pursuit of a more closely coordinated regional exchange rate mechanism.

East Asia Summit (ASEAN+6). One recent, significant development is the ASEAN leaders’ agreement in 2004 agreement to convene an EAS. Creation of this new forum had been suggested by both the East Asia Vision Group and the EASG, but without a clear view of which countries should be included as its members. The first EAS meeting was held in Kuala Lumpur in 2005, with the participation of thirteen ASEAN+3 members as well as Australia, India, and New Zealand. In the second meeting in January 2007, this wider group decided to focus on five priority cooperation areas: energy, education, finance, avian influenza, and natural disaster mitigation. Japan regards the EAS (or ASEAN+6) as an appropriate grouping for East Asia’s trade and investment cooperation.

Future economic cooperation in East Asia, leading to an East Asian economic community, is likely to evolve around the multiple agreements under ASEAN, ASEAN+1, ASEAN+3, and EAS processes.²⁹ Given the political economy dynamics in East Asia,³⁰ it is likely that the “ASEAN Economic Community” to be created by 2015 will be the hub of East Asian economic cooperation. It is now understood that the core of East Asian cooperation lies in ASEAN as the major “driving force,” with ASEAN+3 as the “main vehicle” for the realization of an eventual East Asian economic community, with the EAS as “an integral part of the overall evolving regional architecture.” Nonetheless, how effective the EAS will become as a group remains to be seen.

APEC and ASEM as trans-regional forums. APEC, established in 1989, has played a useful role in encouraging trade and investment liberalization within the Asia-Pacific region, including the United States, Canada, and Australia as members. Australia played a major role in promoting APEC as a trans-regional forum with the basic principle of “open regionalism.” One of its most important achievements was to encourage unilateral, voluntary trade liberalization of non-WTO members such as the PRC and Taipei,China. In addition, the Bogor Declaration of 1994 set the goal of zero tariffs by 2010 for developed countries and by 2020 for developing countries. The modality of achieving the Bogor goals was clarified in the Osaka Action Agenda. Nonetheless, APEC’s prominence appears to have declined since the Asian financial crisis because of its inability to effectively respond to the crisis and the recent proliferation of bilateral and sub-regional FTAs pursued by the member economies. In addition, its excessive diversity is often mentioned as a cause for its increasing ineffectiveness. But the basic principle of “open regionalism,” set out by APEC, may remain important if APEC members take APEC—and WTO—principles as a liberalization infrastructure for their FTAs and attempt to go beyond such basic principles.³¹

One recent notable development is that based on the US proposal to create an FTA for members: APEC leaders in 2006 and 2007 decided to examine options and prospects for a Free Trade Area of the Asia-Pacific (FTAAP) through a range of practical and incremental steps.³² However, some members fear that this move can hamper APEC’s “open regionalism” principle.

ASEM, organized in 1996, is a forum for Asia-European Union economic cooperation. Its membership initially covered the five original ASEAN members, the PRC, Japan, Korea, and the EU members, but was later expanded to include all ASEAN members, and more recently key South Asian countries, like India and Pakistan. ASEM has not been so active a forum for trade and investment liberalization as in the case of APEC. There has been no official proposal to set up an ASEM FTA, at least for now.

(3) Consolidation of multiple FTAs into an EAFTA—ASEAN+3 or ASEAN+6?

If an East Asian economic community is to be created, the region must become a single market. A starting point for this would be the deepening of ASEAN economic integration and the creation of a single East Asian FTA, which could evolve into an East Asian customs union and/or a common market in the future.

Need for consolidation. Since the late 1990s, East Asia has seen the rapid emergence, and negotiations, of a number of FTAs/EPAs, including ASEAN+1 FTAs—such as ASEAN+PRC, ASEAN+Korea, ASEAN+Japan, ASEAN+India, and ASEAN+CER. One of the problems with FTA proliferation in the region is that various provisions, standards, and rules—including ROOs, services, investment and other “WTO-plus” elements—in overlapping FTAs can raise administrative costs and become burdensome to business firms, giving rise to the famous Asian “noodle bowl” effect. Consolidation of multiple, overlapping FTAs into a single East Asian FTA will ensure consistency across different trade arrangements through identical rules, standards, and procedures. A practical approach to consolidation would be to build on ASEAN+1 FTAs, and then merge them into an ASEAN+3 FTA (PRC’s proposal) or an ASEAN+6 FTA (or CEPEA, Japan’s proposal). This ASEANcentered approach requires deep integration of ASEAN, which is clearly a natural “hub” for an East Asian FTA as key production networks are rooted in ASEAN and all major economies in, or those trying to link with, East Asia are forming FTAs with ASEAN. As the timeline for creating the ASEAN Economic Community has been brought forward to 2015 and all ASEAN+1 FTAs are expected to be completed by 2018 (Table 7 [ PDF 48.4KB | 1 pages ]), it is reasonable to assume that a single East Asian FTA could emerge well before 2020.

Kawai and Wignaraja (2007) reported computable general equilibrium (CGE) results that demonstrate a large gain from an ASEAN+3 FTA and an even larger gain from an ASEAN+6 FTA. Hence, East Asia is advised to aim for ASEAN+6 as the region’s goal. However, sufficiently deep integration may not be achieved among the ASEAN+6 countries due to the diverse interests among the group, particularly given India’s high degree of protection in trade and FDI. Then a realistic approach could be to take a sequenced move by starting with an ASEAN+3 FTA and then expanding it to an ASEAN+6 FTA. Essentially, any FTA must be designed with a view toward consolidation. A useful step in this direction would be to allow cumulation of VA ROOs among countries that have completed bilateral or plurilateral FTAs.

Connecting East Asia with North America and Europe. The CGE computation also indicates a negative impact of an ASEAN+3 or ASEAN+6 FTA on several countries in North America and Europe. These impacts, though small, need to be addressed by maintaining openness. While consolidation of FTAs within East Asia is clearly important, the region’s eventual connection with North America and Europe will have to be the next agenda. For many East Asian economies, the US is the crucial ally from a security perspective, particularly given the geopolitical concerns in the Korean Peninsula. APEC remains important for East Asia and the US because it is the only multilateral economic forum that connects East Asia with the US. A natural approach for East Asia is to strengthen economic ties with the US through the formation of an FTA between the EAS (i.e., ASEAN+6) and NAFTA—or an expanded version of an FTAAP as APEC does not include all ASEAN members or India. While several East Asian countries have agreed on bilateral FTAs with the US and Mexico, some have reservations about a comprehensive agreement with the US.

The current political economy conditions in East Asia will require the key role of ASEAN intact in connecting East Asia with North America and/or Europe, that is, East Asian trade integration with the two major blocks in the world will need to proceed with ASEAN as its hub. Given that the EAS members are all signatories of the Treaty of Amity and Cooperation (TAC),³³ East Asia’s trade integration process involving North America and Europe will be facilitated relatively smoothly if the US and the EU also sign TAC. Then the likely scenario is for ASEAN to complete an ASEAN+US (or ASEAN+NAFTA) FTA and/or an ASEAN+EU FTA and merge these into an ASEAN+6 FTA to form a much wider FTA that connects East Asia with North America and/or Europe. Of course a question remains as to whether the US is ready to agree an FTA with East Asia—that includes the PRC—and whether the US trade promotion authority (which expired in June 2007) will be revived.

(4) Three steps toward monetary and financial integration

The deepening regional economic integration and rising business cycle synchronization within East Asia suggest that the region would be better off by maintaining intraregionally stable exchange rates. But, currently, there exists no coordination of exchange rate or monetary policies across East Asia as each country wishes to pursue its own domestic objectives. To pursue policy coordination, a gradual, step-by-step approach is appropriate. The first step is to coordinate informally on exchange rate regimes by moving toward greater exchange rate flexibility vis-à-vis the US dollar. The second step is to initiate exchange rate policy coordination to ensure some intraregional rate stability without rigid coordination of monetary policy. The third step is to adopt tightly agreed exchange rate and monetary policy coordination (see Table 8 [ PDF 49.2KB | 1 pages ]).

Informal coordination of exchange rate regimes. The first step is the introduction of informal policies that attempt to achieve both greater exchange rate flexibility vis-à-vis the US dollar and some exchange rate stability within East Asia by using a basket of G3-plus currencies (the US dollar, the euro, the yen and emerging East Asian currencies) as a loose reference. This can be done by those economies under US dollar pegs to increase exchange rate flexibility and by all emerging East Asian economies to adopt managed floating targeted at a G3-plus currency basket—as is currently practiced by Singapore. The currency weights in the basket could vary across countries, at least initially. How strictly countries stabilize currencies to this basket could depend in each case on country conditions and preferences. National monetary authorities can maintain most of their autonomous policymaking by combining an appropriately defined inflation targeting policy and basketbased managed floating. At this stage, an Asian Currency Unit (ACU) index—as a weighted average of the yen and emerging East Asian currencies—can also be introduced as a tool for measuring the degree of joint movements of East Asian currencies and the degree of divergence of each currency movement from the regional average set by the ACU.³⁴ Once the PRC moves to a more flexible exchange rate regime, ACU index movements and divergences of component currency movements can provide more meaningful information.

This informal currency coordination should be complemented by enhanced financial cooperation. This includes a multilateralized CMI and more effective regional economic surveillance (ERPD). ERPD should focus more intensively on frank discussions, with “peer review” elements, and on exchange rate issues by using an ACU index and divergence indicators.³⁵ ASEAN+3 finance ministers and central bank governors are encouraged to work closely to strengthen their policy dialogue. In addition, a regional forum for financial sector supervisors and capital market regulators may be established to facilitate information exchange, policy dialogue, and mutual cooperation among them.

Formal exchange rate policy coordination. The second step is the joint adoption of a formal policy of stabilizing intraregional exchange rates using a common basket of G3-plus currencies (i.e., the US dollar, the euro, and the ACU) as a reference. The basket stabilization policy will have to be clearly defined with transparent rules on exchange rate parity against the common basket, a relatively wide exchange rate band (like ±10%) around the central rate, and adjustment of both the central rate and the band—along the lines proposed by Williamson (2005). The authorities would allow greater exchange rate flexibility vis-à-vis the US dollar while enjoying a lesser degree of national monetary policy autonomy. The ACU index should continue to serve as an important indicator in measuring joint movements and divergences of East Asian currencies, and its use in the financial markets should be encouraged.

Supporting institutional arrangements should be developed to a much greater extent. An independent secretariat will have to be created to support a fully multilateralized, enlarged CMI that is more independent of IMF programs, and much more enhanced ERPD, with advanced “peer review” and “due diligence” elements, for ASEAN+3 finance ministers and central bank governors. Various regional entities—including for credit guarantees and enhancements, and regional settlements and clearance—will become fully operational to support the development of local currency bond markets. Coordination of financial supervisors and capital market regulators will have to be strengthened for regional harmonization starting with mutual recognition of supervisory and regulatory practices with minimum standards.

Tight, systematic coordination of exchange rate and monetary policies. The third step is the launch of more systematic exchange rate and monetary policy coordination to create a regional monetary anchor. Here, two approaches are possible—the “European” approach and the “parallel currency” approach (Eichengreen, 2006). Under the “European” approach, a common basket peg similar to the snake or exchange rate mechanism (ERM) could be introduced. All currencies will become freely flexible vis-à-vis external currencies, such as the US dollar and the euro, but maintain intraregional stability through joint stabilization of individual currencies to the ACU. The mechanism should include well-defined monetary policy and intervention rules so as to provide a credible monetary anchor within East Asia as well as a fully elaborated short-term liquidity support arrangement, which is large and speedy enough for frequent interventions in the region’s currency markets.³⁶ Fiscal policy rules may also be designed to lend credibility to the exchange rate stabilization scheme. The “parallel currency” approach could be considered in the absence of strong political will. This approach involves issuance of an ACU as a parallel legal tender together with national currencies, issuance of ACU-denominated bonds, and the establishment of a clearing and settlement system for ACU transactions. In the longer term, as the volume of ACU transactions increases, the ACU could develop into the sole legal tender within the region. The centralized reserve pool could then be converted into an Asian Central Bank.³⁷

A practical approach is to take a multi-track, multi-speed approach, whereby economies ready for deeper policy coordination begin the process while others prepare to join later. A group of economies that are sufficiently integrated—Japan and Korea; PRC and Hong Kong, China; or Singapore, Malaysia, and Brunei Darussalam—and with sufficient political commitment, may wish at this stage to initiate subregional currency stabilization schemes. Each subregional group could intensify exchange rate and monetary policy coordination while allowing the possibility for others to join them subsequently. Over time these groups may start negotiations to integrate into a larger monetary zone.

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