The Way Forward

Measures to Increase Private Investment

The first set of policy recommendations should deal with stimulating private investment in the Philippines. This problem has been the subject of many studies. The recent ADB study gives a succinct description of the main issues:¹⁴

“For Indonesia and the Philippines, where improvements have already taken place in the macroeconomic policy environment, the key to sustaining growth is likely to lie in improving the quality and performance of key institutions that influence investor perceptions about uncertainties, risks, and the costs of doing business…In the Philippines (too), governance issues are to the fore. Contract enforcement, corruption, and crime and security are of particular concern…Poor infrastructure, particularly in power and transportation, add most to costs. Generally, the institutions of government are weak and this has slowed the pace of progress. Complex rules and regulations do not adequately address competition issues and continue to create fertile ground for rent seeking. In a variety of dimensions, prospects for raising investment and accelerated growth will depend on the capacity of institutions to move ahead and implement the changes that are required to reduce uncertainty and risk.”

A more direct mechanism to ease pressure on the current account would be to channel workers’ remittances to more productive investment projects. The econometric evidence clearly shows a link between remittances and investment but the latter should go beyond housing and small-scale transportation which are the more popular options at present. To facilitate more productive investment, the BSP has adopted measures to encourage overseas Filipinos to remit through the financial system, such as enhancing transparency and promoting competition in the remittance market; improving the country’s payment and settlement systems and the access to financial services; encouraging overseas Filipinos and their families to increase savings and investments; and cultivating financial literacy among overseas Filipinos and their families.

The Heart of the Matter

Earlier it was mentioned that the progress in reforming the IFA has been uneven and asymmetric. This can gleaned from the Philippine case wherein emphasis has been on reforming the domestic financial system. Despite the substantial progress that has been made, the economy is still having difficulty coping with a rapidly appreciating peso. The latter is argued to be largely a result of the weak US dollar, the volatility of which over the past four years is a manifestation of problems in the IFA.

The uneven and asymmetric progress in the reform of the IFA—particularly the inability “to guarantee a more coherent macroeconomic policy approach at the global level”— is a manifestation of the unipolar world of finance which has been characterized as unjust and unsustainable.¹⁵ This is an extension of Triffin’s dilemma. In the present global financial system most of the international trade is denominated in US dollars, most of the international reserves are held in US dollars, and the US can pay for its external deficits by printing dollars which it does not expect to be redeemed in the foreseeable future. The US-led private financial institutions intermediate a major part of international savings and investments and the US-led international financial institutions now play a decisive role in determining the macroeconomic policies of many developing countries.

Under the unipolar financial system, the US has been appropriating seigniorage that is created by expanding world trade and cross-border capital flows. Because the US gets tremendous benefits in terms of financial gain and ideological hegemony, it cannot be expected to surrender these gains voluntarily through a meaningful reform of the IFA. In the unipolar world of finance, the US has had a soft budget constraint in terms of its external deficit. The US has been able to combine a widening current account deficit with an appreciation in the real effective exchange rate—or at least one that is relatively stable—because of huge capital inflows. This has led to what has been referred to as the trans-Pacific macroeconomic imbalance.

However, the US current account deficit reached $857 billion in 2006, equivalent to a historical high of 6.5% of GDP. As a point of comparison, the combined GDP of the ASEAN member countries was $884 billion in 2005 and approximately $1 trillion in 2006. Largely because of its soft budget constraint, the US has become the world’s largest debtor nation with a net foreign debt of $2.7 trillion as of 2005. Another major cause for concern is that the annual balance of net income on domestic and foreign investments in the US was –$1 billion in 2006, making it the first year on record with a negative net income flow. If “net investment income” continues to deteriorate, it will add to the current account deficit and increase the risk of a major reduction or reversal in the capital inflows into the US.

In this context, fixed investment in East Asia may actually be constrained by the need to support the trans-Pacific macroeconomic imbalance and prevent the sharp fall of the dollar. The sustainability of the trans-Pacific macroeconomic imbalance has been a subject of debate and there is still no consensus.¹⁶ However, the sharp depreciation of the US dollar, particularly since March 2006 and a pending US economic recession may be an indication of a difficult adjustment process.

In order to partly address the inequity caused by a unipolar financial system, the expanded use of Special Drawing Rights (SDRs) was recommended. The introduction of SDRs in 1969 created a truly global money to be used exclusively as a reserve asset, thus generating a more balanced distribution of seigniorage powers. Unfortunately, this proposal has not been implemented. A recommendation for a third allocation of SDRs, though approved by 77% voting majority of the IMF in 1997, did not come into effect because of opposition by the US Congress.

Other recommendations include an international currency (Mundell, 2003) and an international clearing agency (ICA) (D’Arista, 2006). This ICA could be based on a proposal by John Maynard Keynes revised to serve as the institutional platform for a new global payments system that would foster egalitarian interactions and more balanced outcomes. The new ICA would clear transactions denominated in members’ accounts. These clearing accounts would, in fact, constitute the international reserves of the system, held for the member countries by the ICA and valued using a trade-weighted basket of all members’ currencies.

Regional Monetary and Financial Cooperation

Regional financial and monetary cooperation in East Asia is at a critical juncture. The way forward has tremendous implications for the IFA. The “easy” phase of the reform process in East Asia is at its tail end. Policymakers in the region now have to agree to a blueprint for financial sector development in the foreseeable future, the long-term objective of which Kuroda (2004) succinctly identified as the establishment of a single currency in East Asia. This would cover the need to channel more East Asian savings to infrastructure and investment projects in the region.

The main elements of the blueprint are: (i) the structure of regional financial cooperation in terms of reserve pooling and exchange rate coordination; (ii) the relationship between regional cooperation and the domestic financial system, including required domestic economic reforms; (iii) the institutional set-up in the region that will underpin implementation of the blueprint; and (iv) the non-economic objectives of regional financial cooperation.

The last two elements have important political economy considerations. More specifically, they involve establishing a political consensus which is difficult in East Asia due to differences in political systems, “history” issues and the lack of mutual trust Kawai, 2005). No single economic power plays a dominant role in East Asia similar to that of the US in the Western Hemisphere, nor does any bipolar relationship exist similar to the Franco-German alliance in Western Europe. Japan has been mired in economic stagnation over the last decade and the People’s Republic of China, while recently emerging as an economic power, has yet to achieve full transition to a market economy and, more fundamentally, political transition.

Promoting non-economic objectives highlights the political economy issues that are involved. In light of the European experience, an important consideration in evaluating the trade-off between the potential benefits to be reaped from exchange rate coordination and the potential costs associated with the loss of macroeconomic policy independence arising from the implied need for broader macroeconomic cooperation, is whether the ultimate goals of financial cooperation in East Asia are wholly economic or also partly political. The goal could ultimately be political if the objective of fostering increased regional economic integration is paramount, and that objective is itself an instrumental one designed to achieve political goals. These could include, as in the European case:

1. The desire to defuse potential regional political conflicts. An important assumption driving European integration was that enhanced economic interdependence would induce European countries to focus on common interests.
2. Allowing the region to speak more effectively with one voice in international affairs. This was also an important motive in Europe, and has played a role in other regional integration initiatives. As the world economy becomes increasingly globalized and international negotiations on financial and commercial issues intensify, its importance may be increasing over time.

Grenville (2003) similarly points out that:

“Regional groupings are the principal way of addressing this ‘democratic deficit’. There seems little room for debate that this region is inadequately represented in many of the forums which determine the important issues of globalization. There seems little doubt, also, that the region pays a price for this. East Asia, with an IMF quota of less than 15 percent, accounts for more than 20 percent of world GDP, almost a quarter of world trade, and almost half of world foreign exchange reserves.”

In other words, the process of institutionalizing East Asian regional cooperation should be a venue where common interests of the countries can be articulated. Subsequently, it can be a vehicle by which these interests are pushed in the global setting.

The inability of East Asia to effectively speak with one voice, particularly with regard to the IFA, is one major reason why reform of the latter has become uneven, asymmetric, and patchy. A case in point is the proposed measures to address the trans-Pacific macroeconomic imbalance. Currently, policy proposals that are played up in the media are focused on revaluing East Asian currencies, particularly the yuan. However, the People’s Republic of China is not large enough an economy to be responsible for the US deficits or to be able to correct them. Between 1997 and 2004, the US current account deficit deteriorated by $529 billion, and, over the same period, the People’s Republic of China’s current account position improved by only $35.6 billion (Genberg et al., 2005). A united East Asian front could throw its weight towards a solution that emphasizes fiscal consolidation by the US, which makes more economic sense.

Another important issue is that of capital controls, which have proven be effective in several economies (see for example Epstein et al., 2004). This is evident with the behavior of the Malaysian ringgit compared to other currencies in the region (Figure 1 [ PDF 223.2KB | 3 page ] and Table 7 [ PDF 40KB | 1 page ]). However, with the advent of greater financial integration, capital controls, particularly on inflows, have to be endorsed at the international level in order to be effective (Grenville, 2007). Given that this would require IMF endorsement, international backing of any form of capital controls is unlikely. Hence, endorsement at the regional level would be a second best solution. A united East Asian front could subsequently advocate for fundamental reform of the IFA, particularly with regard to its current unipolar structure.

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