Economic interdependence as a driver of Regional integration in east asia

Regional integration has become the focus globally, and East Asia features prominently with its efforts to formalize cooperation in the region into a workable arrangement for the promotion of trade, investment and security. This cooperation is gaining much attention as the world shifts from a U.S-centered system to a new system in which China is emerging as a power. This paper focuses on regionalism in East Asia driven by economic interdependence among constituent countries.

East Asia is a heterogeneous region comprising several tiers of member countries; developed countries such as Japan and Singapore, developing countries like China, Korea and ASEAN, and less-developed countries including Cambodia, Laos, Myanmar and Vietnam. This region has diverse ethnic, religious and political aspects, in addition to wide variations in country size, size of population and levels of economic development among constituent countries.

The East Asian economies have historically been closely linked through events such as; the establishment of treaty ports by colonial governments that laid foundation for trade within the region, Japanese imperialism in the 20th century that brought about economic integration in northern East Asian (Korea and Taiwan), and the rapid development in East Asian generating linkages that have bias for the region (Beeson 2007).

With such early interdependence, however, East Asia is a significant economic area in the world lacking formal institutions that oversee and coordinate regional activities. There are many requirements in the endeavor towards regional institutionalization including enhanced intra-regional trade and investment and market dynamics in favor of the region; Preferential Trade Agreements; intra-regional political focus; rapid economic growth in the region with associated economic liberalization; and the democratization of many countries in the region. (Vision Group Report 2001). All these are contributory factors to the establishment of an East Asia community comparable to leading regional institutions like EU and NAFTA. There are several regional communities with an overlap of roles that could make for a future East Asia community including; Asia-Pacific Economic Cooperation Forum (APEC), ASEAN Regional Forum, ASEAN +3, and East Asia Summit.

Economic interdependence in East Asia is considered to be a market-led process due to minimal success in regional institutionalization so far. This process implies various shapes of intensified economic relations and, in this regard, focus is on cooperation in trade, financial and monetary aspects of economies. East Asian economies follow a trend towards intensified ties among them, significantly driven by economic factors rather than institutional arrangements. This trend is evident when we consider intra-regional trade and foreign direct investment among countries constituting East Asia.

Integration in trade is a foundation for regional economic cooperation. The major features in East Asia’s trade, as pointed out by Kawai and Motonishi (2004), are a rapid expansion of overall regional trade; a rapid expansion of trade among industries; and a rapid expansion of trade between large corporations and intermediaries in the production process. Such trade patterns supported by the FDI activity of multinational corporations, focus on Asia as a production hub (“the factory of the world”). As a result, regional integration through trade has deepened with member countries coming together in a variety of informal, intra-industry trade arrangements to exploit the inflow of international trade opportunities. A calculation made by Kwack (2004) on East Asian trade shows that the share of intra-regional trade to total trade rose from 31% in 1980 to 46% in 2003 while the import share rose to 53% from 31%.

Intra-regional trade in East Asia was 40 percent in 2009 majorly backed by the Chinese economy whose size provides it with enormous advantage in its new central role in the region. Due to globalization, and the entry of Japanese, Korean and Taiwanese investments into China, trade has increased between companies in these countries and their subsidiaries located in China, forming networks of production. These regional labor and capital-intensive firms have turned to China to evade rising levels of wage and costs at home, which makes it a comparative advantage for them to move their capacity to China.

China’s capacity in export gives further incentive as the country’s liberal policy has attracted huge foreign investments. Hong Kong has moved its manufacturing industries to mainland China while focusing on its specialization as a financial and service center. Taiwan and China have, also, developed similar economic relations in recent times though political challenges abound (ADB 2009). Trade through production fragmentation has been the driver of such increased trade integration and is prominent in various sectors including machinery, electronics, textiles and apparel, toys and furniture.

The central role of China is enhanced further by the trade and production relationships between it, the other Asian nations and the U.S, with China importing intermediate goods from Japan, Korea, and Taiwan, processing them into finished products and exporting them to the US and to the East Asia region (Xu, 2006). From 1990 to 2005, China-ASEAN trade volumes have risen at 22% average year-on-year and in 2006 it reached 160.8 billion dollars, an increase of 23.4% when compared to 2005 figures.

At country level, import trade in the region is concentrated among mainland China, Japan, Korea and Taipei, China. Import-share from the other East Asia nations is small, although it is expanding fast. In 2006/7 China accounted for 21.2% of total manufacturing exports from the rest of the region (ADB 2009).

East Asia lacks an institutional driving force for the promotion and integration trade as at present even as trade globally is conducted under regional agreements, majorly the EU and NAFTA. Counter to these, there exist customs union and free-trade areas such as ASEAN Free Trade Area (AFTA) which are, however, not as large and potent as to be a challenge to EU and NAFTA. East Asia is concerned over investment diversion especially in its markets in Europe and North America which is exacerbated by the financial crisis in 1997. This has forced its policymakers to rethink economic linkages connecting regional economies (Ba 2009).

Policies to support the market-driven economic forces and trade liberalization are entrenching institutional arrangements. This strategy is evidenced by the launch of ASEAN-China Agreement, and a move towards ASEA-Japan among several ongoing negotiations creating new alliances in favor of liberalization within the region.

Foreign direct investment flowing into the region has been a key driver of intra-regional trade. In particular, Japanese multi-national corporations, have an extended presence in the region through FDI, and are playing a pivotal role thereby enhancing integration. The major portions of FDI within ASEAN are characterized by net flow from Japan and Korea to the other ASEAN economies, with Japan taking up 69 percent in the FDI outflow (Frost 2008). In addition to such linkages through FDI, business processes with affiliates supplying intermediate goods creates more points for cooperation. Japan is a prominent center of process fragmentation operations in East Asia, with about a third of all regional exports of components for assembly sourced therein (Ng and Yeats, 2003). Indonesia imports over 70 percent of components for assembly from Japan, while Korea and the Philippines’ regional imports exceed 50 percent.

China has come in strongly recently to play this role as a specialist in assembly trade and is a key driver of East Asia’s regional integration process bringing about a shift from the “flying geese” hierarchical model led by Japan, to the new horizontal intra-regional economic integration commonly referred to as “galloping dragons”.

Other factors have facilitated the operation of a regional production network in East Asia including the easing of trade barriers, stable economic and political environments, access to a skilled labor force, and robust infrastructure. Moreover, the emergence of a middle class in Asia is encouraging the deepening of domestic markets for both intermediate and final products, key in reducing the region’s excessive reliance on the global export market as its engine for growth which open it up to global risks and vulnerabilities. These characterize the economic integration in East Asia which unlike other regions is market-led for lack of formal policy.

Enhanced trade often requires better financial services and instruments and it, therefore, is a catalyst for greater liberalization. East Asian countries have been keen to liberalize their financial markets to benefit from foreign investment, bank loans across Asian countries and regional investments in equity. However, the pattern of financial integration in East Asia is a global one, not a regional one with countries in the region having deeper financial links with Europe and the United states than with one another.

Financial integration in East Asia has, however, been underway driven by deregulation of financial systems, offers of financial services beyond the region, and opening up of capital. Bank loans and investment flow link the regional economies financially and strengthen macroeconomic interdependence (Ba 2009).

The financial crisis of 1997-98 taught East Asia the need for monetary and financial cooperation necessary for regional financial stability. The general sentiment is that the region needs to establish “self-help” mechanisms to prevent and manage possible crises. Such cooperation involves information transfer and policy discussions, setup of mechanisms to support liquidity, financial sector improvement both nationally and in the region to achieve balance, and collective coordination.

ASEAN plus 3 members have initiated regional cooperation in finance based on three pillars: the Chiang Mai Initiative creating a regional liquidity support facility; policy dialogue and surveillance; and development of bond markets. The Chiang Mai Initiative aims to reduce shortage in liquidity and, hence, limit crises (Frost 2008). It has created currency swap arrangements totaling 52.5 billion dollars among central banks. Dialogue on policy and regional surveillance on the economy involves assessment of macroeconomic and financial standing of member economies. The ASEAN+3 finance ministers perform this, focusing on global and regional entities, risk assessment, and policy with the development of a financial early-warning system for possible vulnerabilities.

Bond markets denominated in local-currency are essential in reducing the temptation to rely on external borrowing and bank-financing for capital requirement. These mitigate currency and maturity mismatches, a common problem of international capital markets. An Asian Bond Fund has been established by the finance minister process, as well, in a bid to stimulate demand in the local bond market, while the Asian Bond Market Initiative (ABMI) stimulates the supply side.. There, also, is enhanced effort in infrastructure development for the bond market including systems for clearing and settlement, bond guarantee, and rating to encourage regional bond issues (Ba 2009).

Monetary cooperation in coordination of exchange-rate or as a regional monetary union helps in stabilizing prices and lowering risk related to intra-regional trade. Before the Asian financial crisis, most countries in the region had their exchange rate pegged to the US dollar. Since then, most individual East Asia countries have allowed local currency to float against the US dollar though the move is not a common regional strategy. Despite potential benefits of stability in exchange-rate and an often-discussed single currency, progress is limited on policy coordination (Beeson 2007). The creation of a single currency is viewed by the regional think tank as a long-term agenda, and the region needs to establish a loose arrangement to ensure exchange-rate stability without much policy coordination, a precursor of future developments (Vision Group Report 2001).

With the achievement of financial openness in line with convertibility of local currency and regional economic convergence, East Asia would then need comprehensive policy aimed at stabilizing exchange-rates. Such attempts are projected to lead to a single currency in the future or the adoption of a strong currency in the region such as the Yen or the Yuan for its foreign exchange market. This would seem plausible in light of developments.

The East Asian region has realized considerable integration largely contributed by economic interdependence between countries in the region. This integration is market-driven as institutional support and political endeavor towards cooperation have until recently been limited and still needs further engagement. Several negotiations and agreements are ongoing, focused on better intra-regional ties, a proactive move to spur growth and a response to crises and threats from other blocs. Regional integration in East Asia is, therefore, built primarily upon economic cooperation.

NAFTA –North America Free Trade Agreement.

EU- European Union.

ASEAN – Association of Southeast Asia Nations.

ASEAN+3 – original ASEAN with the addition of three countries, China, Japan and Korea

WTO – World Trade Organization.

Asian Development Bank (ADB), 2009. Asian Development Outlook 2009. Oxford, Oxford University Press.

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East Asia Vision Group Report, 2001. Towards an East Asian Community: Region of Peace, Prosperity and Progress. [Viewed from http://www.mofa.go.jp/region/asia-paci/report2001.pdf on 17th March 2012].

Frost, E.,2008. Asia’s New Regionalism. London, Lynne Rienner Publishers.

Ng and Yeats (2003), Major Trade Trends in East Asia. In: World Bank Policy Research Paper 3084. Washington, World Bank.

Kawai, M. and T. Motonishi, 2004. Is East Asia an optimum currency areaIn: Masahiro Kawai (ed), Financial interdependence and exchange rate regimes in East Asia. Japan. Policy Research Institute, Ministry of Finance, pp. 157-203

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