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Economic integration in Northeast Asia preconditions and possible trajectories PDF Print E-mail
Tuesday, 29 July 2008

by Bernhard Seliger*

Hanns Seidel Foundation in Seoul, Korea

When in November 2001, the leaders of the Southeast Asian and Northeast Asian states met for the ‘ASEAN (Association of South East Asian Nations) plus three (China, Japan and Korea)’, President Kim Dae-Jung of South Korea proposed the exploration for an East Asian Free Trade Area (EAFTA) and thereby opened a new chapter of East Asian integration. The special Northeast Asian perspective on regional co-operation became clear by the simultaneous decision to hold annual meetings of finance and trade ministers of China, Japan and Korea. At the same time, bilateral agreements like a free trade area between Japan and Singapore, the tentative large free trade area between ASEAN and China and the work-in-progress on a Korean-Japanese Free Trade Area show the devotion and sometimes even obsession of current policy-making with reaching regional trade agreements. Regional integration, it seems, is finally on the Northeast Asian agenda. In this paper the preconditions and perspectives of economic integration in Northeast Asia will be explored. Since economic integration is in various ways linked to political factors, the second section discusses the geo-political situation of Northeast Asia today. The third section deals with the economic perspectives of different forms of trade integration, followed by an analysis of various attempts for greater macro-economic and financial co-operation and a short conclusion.

1. Introduction


When in November 2001, the leaders of the Southeast Asian and Northeast Asian states met for the ‘ASEAN plus three (China, Japan and Korea)’ meeting in Bandar Seri Begawan in Brunei, President Kim Dae-Jung of South Korea proposed the exploration for an East Asian Free Trade Area (EAFTA) and thereby opened a new chapter of East Asian integration. The special Northeast Asian perspective on regional co-operation became clear by the simultaneous agreement with the Japanese Prime Minister Junichiro Koizumi and the Chinese Prime Minister Zhu Rongji to hold annual meetings among their finance and trade ministers. At the same time, bilateral agreements like a free trade area between Japan and Singapore, the tentative large free trade area between ASEAN and China and the work-in-progress on a Korean-Japanese Free Trade Area show the devotion and sometimes even obsession of current policy-making with reaching regional trade agreements. It seems regional integration is finally on the Northeast Asian agenda.


After researchers as well as politicians maintained throughout the 1990s that economic integration in East Asia was something apart from integration processes in Europe or America, namely “open regionalism” or a search for “de facto” instead of “de jure” integration, now it seems that the race for integration based on free trade treaties is unstoppable.1 This is another change in the process of East Asian integration, which in the last decade saw already two major changes. In the early 1990s, East Asian regionalism, which before only existed rudimentarily, was discussed as a collective answer to growing regionalism elsewhere. Existing organizations like ASEAN focused more on economic issues. The Asia Pacific Economic Co-operation (APEC) emerged as the leading, trans-Pacific organization for economic integration, but also inter-regional co-operation in the form of the Asia-Europe Meeting (ASEM) was explored. Today, this trans-Pacific approach in the wake of serious trade conflicts and difficulties with an ever-growing membership of APEC lost much of its appeal.


When the Asian crisis broke out in 1997 and the national responses to the crisis were quite heterogeneous, many observers predicted an end of East Asian regional integration. While this did not happen, nevertheless the crisis was a turning point.  While before the crisis the flows of goods and factors had been the focus of economic integration, afterwards increasing macro-economic co-operation and a common framework for financial stability were sought after. The results of that discussion were until now limited, namely an extension of a network of regional currency swap and repurchase agreements. But in the long run, especially the aspect of monetary co-operation could change the previous direction of integration.


Nevertheless, the Northeast Asia integration can only be called nascent, since until now, no exclusive regional trade agreement binds China, Japan, and Korea together. South Korea is geo-politically in an exposed position between Japan and China. Until now, the trilateral political problems made economic integration, comparable to Southeast Asia’s AFTA (Asian Free Trade Area) impossible. The division of the Korean peninsula and the precarious situation of the Russian Far East add to the unresolved problems in Northeast Asia. Economically and politically, the dependence on the United States and the fear of Japanese dominance are factors determining South Korea’s interest in regional economic integration. China and Japan again watch each other, potential hegemons in the East Asian region, with a mixture of interest and mistrust. And, other countries’ free trade agreements have also a strong domestic policy impact, since popular support for free trade is limited, as the difficulties to conclude even minor bilateral negotiations like a Korean-Chilean FTA (Free Trade Agreement) show.


In this paper the preconditions and perspectives of economic integration in Northeast Asia will be explored. Since economic integration is in various ways linked to political factors, the second section discusses the geo-political situation of Northeast Asia today. The third section deals with the economic perspectives of different forms of trade integration, followed by an analysis of various attempts for greater macro-economic and financial co-operation in section four and a short conclusion.

 

2. The geo-political situation of Northeast Asia and East Asian economic integration


Economic integration is not only an economic phenomenon, but closely related to political developments. Therefore, the geo-political situation in East Asia is a determining factor for economic integration. East Asia has been a latecomer in economic regionalism and it developed its specific form of ‘open regionalism’, based on voluntary integration and non-intervention in domestic affairs. Political factors led first to co-operation in Southeast Asia. The South East Asia Treaty Organization (SEATO) of 1954 as well as the ASEAN of 1967 were motivated not by common features of the political systems of these countries, but by common external threat. Domestically, the countries were autocracies of different degree. The common threat was the existence of communist movements and the possibility of a spill-over of the Vietnam War. The possible ‘domino effect’ from Vietnam was more important than the goals first mentioned by ASEAN, namely wealth, growth, and the peaceful development of the region. Economic development and the development of a Southeast Asian identity (‘think ASEAN’) were instrumental in stabilizing the ruling regimes in ASEAN states.


Two additional factors were catalysts of ASEAN integration, namely the importance of the Japanese economy for all ASEAN states and the existence of ethnic Chinese trading networks. The role of Japan is founded in its size as the by far biggest economy in the region with a weight of around 80 percent in East Asia until the mid-1990s. Since the 1980s, Japanese capital flows and Japanese technology played a growing role in economic development of the region. Rising labor cost in Japan and the yen appreciation made Southeast Asia a main target for Japanese Foreign Direct Investment (FDI). Not only did Japanese multinationals invested in Southeast Asia, but they were followed by a number of smaller enterprises producing intermediate products for the multinationals (Yamashita 1991; Tokunaga 1992; Doner 1993). Investment led to a transfer of Japanese technology and Japanese management know-how. The ‘look East' policy of Southeast Asian states furthered the transfer of Japanese management style, seeing it as a role model of non-Western economic development.2 Besides Japanese FDI flows, Japanese lending made Japan the biggest investor in the region, for example, accounting for around 40 percent of all Indonesian debts in 1998, compared to 8 percent for the United States (Asia Wall Street Journal 1998: 1). Investment and lending often targeted state companies and Chinese trading companies, which increased its influence in the region.


The trading networks of ethnic Chinese in Southeast Asia are a second factor leading to ‘de facto’ integration in the region. While the share of ethnic Chinese in the population is often tiny, between two percent in the Philippines and thirty percent in Malaysia, their share in private business is much higher, between forty percent in the Philippines and eighty-five percent in Thailand. Networking between their companies also leads to increased demand for regional institutional integration. However, in times of crisis like the Asian Crisis, the situation of the Chinese minority is endangered. In Indonesia, the alleged co-operation of Chinese companies with the Soeharto regime led to ethnic tensions. Despite of these, overall, the role of ethnic Chinese has been important for economic integration in Southeast Asia.


In Northeast Asia, the political situation has been much less conducive to integration3. In Southeast Asia communist threat and civil war in some peripheral states like Vietnam, Laos and Cambodia led to closer integration of the rest of the region. In Northeast Asia, tensions existed directly in the center, namely in China, and on the Korean peninsula. Political confrontation among the People’s Republic of China, and Taiwan and the United States as well as Maoist central planning made economic integration impossible. Even after the economic ‘open policy’ in China, increasing economic ties, and FDI, the political problems remained where institutional integration giving the same political status to Mainland China and Taiwan was inacceptable to the former.  Only semi-official contacts in the APEC were tolerable. At the same time, the People’s Republic until the mid-1990s was sceptical about economic imperialism of Japan and the United States in form of their dominance in regional organizations. On the Korean peninsula, China’s role is important as the only important partner for North Korea. For South Korea’s economic relations with China, increasing ties with China in the Yellow Sea region are the positive side, while increasing competition especially after the WTO accession of China in 2001 is the negative side.


From an economic point of view, China until very recently seemed content with secured domestic economic growth and record FDI. However, the sheer size does not guarantee continued growth and, indeed, it seems that the Chinese transformation process until now left out problems, which one day painfully have to been solved. The most important of these problems is the dual economy problem with the thriving private sector, and the large, bankrupt state-owned sector whose transformation will bring mass unemployment and unresolved debt problems, and the end of current pump priming measures (Jha 2002). Therefore, the recent shift in policy to a free trade agreement with ASEAN can be explained. However, integration with rivalling Japan and Korea will be much more difficult, not so much for economic but as for political reasons. Also, embracing regionalism would open the possibility for China to become a regional hegemon, in sharing its power with Japan.


The role of Japan in Northeast Asian integration is still hampered by the historical legacy of the Japanese concept of a “Greater East Asia Co-Prosperity Sphere” (Daitoa Kyoeiken) under Japanese leadership from World War II.4 The colonial experience of South Korea, Taiwan, and parts of Mainland China add to the problem, making a ‘look East’ policy impossible. Japanese economic engagement suffers from still lingering suspicion. So Japan’s relation to the neighbouring countries is extremely complex.  Since it is by far the largest economy in the region and the most successful and first Asian modernizer instead of Westernizer among the countries in the region, Japan could play a more important role, even a leading role in economic integration in the area. But as well ancient fears as the recent decade of economic stagnation seem to prohibit such a role for Japan.


In terms of culture, while in many ways related to China and Korea (which has been a cultural bridge to the mainland)5, nevertheless Japan qualifies in the terms of Huntington as a “lonely” state, not part of any larger cultural area.6 This also means a lesser amount of trust into Japan by the neighbours. While a role as regional hegemon becomes improbable for this reason, Japan has according to Huntington has four different strategic possibilities: to become the “United Kingdom of East Asia”, to take the role of France, Switzerland, or Germany in East Asia. The first option would mean a close alliance with the U.S. and would in the regional context mainly be interpreted as an anti-Chinese solution. Indeed, after some relaxation of relations in the 1990s, now the alliance between Japan and the US became strengthened (Green et al. 1999). The second option would be a close alliance with China (like the French alliance with Germany) and a common strategy for the future of East Asia. This option is regarded not only sceptically by Japan, which according to Professor Yukiko Fukagawa is reluctant and cautious about closer economic ties with China (Korea Herald 2002). Even more, it is also viewed extremely sceptical by the Chinese, which after a phase of admiration for Japanese modernization in the early 1990s and a willingness to accept Japanese capital and development aid by now more and more fears the possibility of regional hegemony, also through regional institutions (Moore et al. 1999; Rozman 2002).


The third strategic possibility is the role of a neutral, benevolent state like Switzerland, outside the quest for regional integration, but eager to keep good relations with all neighbours. The last role is that of Germany in Europe, namely to develop an active diplomacy – with the help of considerable funding as an incentive for more reluctant partners – to achieve a form of integration acceptable to all partners. While until now, the close alliance with the US was the cornerstone of Japan’s foreign policy in East Asia, Japan recently becomes “reluctantly realist” (Green 2001) about its role in East Asia.7


The geopolitical role of South Korea did not become easier in the last years. China is no longer a political enemy, but now a potential rival in many markets, including its rise as a shipbuilding nation in the next decade. After the end of the Cold War, Japan has greater political ambitions, for example, the recent changes of the defence policy shows. For South Korea, the situation between two economically and politically far bigger countries poses a historical trauma. Occasional nervous reactions, like in the textbook conflict or in a trade conflict about garlic with China, show the growing South Korean uneasiness. However, this could also lead to a greater South Korean desire for regional economic integration.


Despite its Far Eastern provinces with huge raw material potential, Russia plays no role in East Asian integration. The political relations with Japan and South Korea improved dramatically after the end of the cold war, but the hope for economic integration did not yet materialize (Seliger 1999). This is partly due to the unresolved problem of North Korea, partly due to the internal instability in Russia. De facto, there has been a desintegration between the European part of Russia, which dominates the Federation, and the Far Eastern provinces, leading to a sometimes chaotic situation concerning the administration of the Far Eastern provinces. This was a major problem in attracting Korean and Japanese FDI, even in highly profitable business like the oil and gas exploitation at Sachalin Island. Territorial dispute about the Kuril Islands also affecting South Korea’s fishery industry adds to the problem. APEC membership and the improved economic and administrative situation under the Putin government did not change the prospects for the Russian Far East so far.


The United States is an indirect political and economic factor in Northeast Asian integration. Politically, as a guarantee power for Taiwan and South Korea they are indispensable for these states but pose a problem to greater integration. Economically, still most states of the regions are concentrated on the United States as the single most important market for exports. This common interest in East Asian states can lead to closer co-operation, but also puts the East Asian states in a competitive situation. Also, the importance of the American market shapes the form of regional economic integration, making more protectionist forms of integration impossible. ‘Open regionalism’ therefore is partly a result of trade dependence.


Overall, the geopolitical situation in Northeast Asia is much less conducive to the economic integration than the situation in Southeast Asia. Political and territorial conflicts are unresolved, regional factors facilitating integration do not exist and the increasing political role of Japan as well as the increasing economic power of China pose a challenge. Both states can either attempt to lead economic integration in the region or to prevent it, while South Korea, who is in the middle, can only try to take an active role as a catalyst for regional integration. In the next section, the possibilities for trade integration and factor market integration will be reviewed.

 

3. Perspectives of trade integration and factor market integration in East Asia


The possibilities of economic integration in East Asia can be analyzed from a normative and positive point of view. The normative question is the size and depth of the optimal integration area, i.e. the question of advantages in multilateral, regional, and subregional integration. The positive analysis focuses on the interests of the actors in the ‘market for politics’ with the actors in the region.8 Here, especially the first question is of interest. While by now the original concept of APEC’s open regionalism lost much of its appeal, it is nevertheless a good starting point for discussion. Therefore, first the existing integration in the APEC framework is discussed, afterward, the policy of free trade agreements and then the possibility of a greater East Asian free trade area in form of ASEAN plus three (China, Japan, South Korea).


The intensity of regional economic integration can be measured by the importance of intra-regional trade and relative minor importance of intra-regional trade is an indicator for a low level of regional integration. According to this indicator, South Korea as well as Japan and Taiwan are characterized by a relatively low level of regional integration, compared to their Southeast Asian and Chinese neighbours. In 1998, the share of East Asia in Korean exports was 39.1 percent, compared to 34.9 percent in 1980.9 The share of East Asia in Korea’s imports was 37.3 percent, compared to 29.9 percent in 1980. For Southeast Asian states, the share of exports in the region was more than fifty percent and for China 46.6 percent and a similar situation existed for the imports. South Korea in its trade structure can be compared to Japan, while China’s trade structure is mostly complementary. However, the WTO accession of China and China’s modernization will expect a more similar trade structure in the medium term, due to increased foreign investment in China, leading to an upgrading in technology and production facilities. In fact, already now China emerges as a bigger competitor than Japan in many industries.10


Since APECs inauguration in 1989, at first, it was informal, later fostering more and more of an institutionalized framework for economic integration in the Asia Pacific Region (Ahn 1999; Pascha et al. 1999). Originally, it was born out of the Australian and New Zealandian desire for leaving the periphery of the world economy and the desire of the United States and the East Asian states to counteract the increased economic integration in Western Europe, and, more specifically, the Western European role in the Uruguay Round of world trade negotiations. In the first years, APEC states tried out the possibilities of increased co-operation. In 1994, the Bogor Declaration formulated the goal of free trade between developed countries in 2010 and all other states in 2020. This was a major step towards serious economic integration. It became more precise with the Osaka Action Agenda of 1995 and the Manila Action Plan of 1996, both defining the steps towards liberalization and their implementation. Since 1997, the member states decided ‘Individual Action Plans’ (IAP) to guarantee national implementation of the APEC liberalization plans. A characteristic of this phase of APEC was the low level of institutionalization, the dominance of national sovereignty, and consequently, the voluntary characterization of liberalization instead of fixed time-tables and goals, and the openess for non-member states in the form of most favoured nation rules.


However, since the Asian Crisis, APEC lost its dynamics and some analysts today even speak of the death of the APEC process. The first problem of APEC was the growing heterogeneity of its member states. Today, membership ranges from the original founding states in the Asia Pacific region to some states of Latin America (Chile and Peru) and Russia, effectively including parts of North- and South America, most of East Asia, and because of Russian membership parts of Central Asia and even Europe. In that sense, APEC became victim of its attractiveness. The goals of member states today are much more diverse than the original focus on trade liberalization and integration (Lee et al. 2001). Second, the process of fast track liberalization for advanced member states and slower integration of the rest of APEC did not lead to sufficient ‘peer pressure’. This became clear on the last summit meetings of APEC, where the programmes of Early Voluntary Sectoral Liberalization (EVSL) found no majority and where support for additional liberalization steps was lukewarm at best, as the slow progress of IAP implementation shows. In South Korea, where liberalization was rapid after the economic crisis, the catalyst was rather the IMF conditionality and the crisis situation, not the APEC process (Ahn et al. 1999).


While the goal of an Asia Pacific wide free trade still nominally exists, APEC lost its role as a leading organization in regional integration. In world trade negotiations, as well in the failed Seattle Round as in the Doha Ministerial Meeting, South Korea together with Japan and the European Union took a hostile stance towards inclusion of agriculture into trade liberalization negotiations. Therefore, the future role of APEC seems to be limited. It is important insofar, as it links East Asia with the Pacific region and insofar, as it allows a geographically wide integration area as well as semi-official contacts between Mainland China and Taiwan. The option for a common APEC market, however, seems impossible.


The decreasing dynamics of APEC as well as the proceeding economic integration in other parts of the world, including Southeast Asia, were AFTA was inaugurated, were probably the most important reasons to look for substitutes in the form of bilateral integration. According to their proponents, Free Trade Agreements (FTAs) are not thought to be substitutes for open regionalism, but rather complements (Cheong 1999a). FTAs in East Asia could enhance the process of greater East Asian integration, while FTAs in other continents could overcome the problem of regionalism that regional integration can pose increasing trade barriers to outsiders. However, much of the validity of this reasoning depends on the kind and the number of bilateral trade agreements.


Regional trade agreements (RTAs) always have been seen as analogous to potential stepping stones or stumbling stones on the way to free trade (Lawrence 1991 and 1995; Anderson et al. 1993). Taking the reality of increasing RTAs into account, and hoping for a “domino process”, where regional agreements would attract more and more members ultimately creating a worldwide free trade (Baldwin 1995).  The view of RTAs in the mid-1990s became more positive (Frankel 1997), as well as international organizations (OECD 1995). Among the Northeast Asian states, first Japan and Korea took steps for integration, but not between each other, but rather with remote and from the point of view of bilateral trade with relatively unimportant states, namely Singapore and Chile. These RTAs, according to the Singapore’s Trade Minister, George Yeo, are driven by “fear and insecurity” (De Jonquires 2001), were more or less “test balloons” on the way to more important RTAs, like a possible free trade area between Japan and Korea. Also, especially Korea’s RTA with Chile tried to minimize possible conflict areas by chosing a country with an economic structure which to the largest extent is complementary, not competitive. However, it is questionable, if this form of RTA shows the road for the future, given that increased intra-industrial trade in an RTA with two or more similar partners, while in the beginning painful in terms of economic adjustment processes, might in the long run through increased competition, innovation, and product quality allow any such benefits.


Given the geographic closeness and the mutual economic interdependence, a FTA with Japan is an important option for South Korea.11 The economic benefits of such an agreement in the long run, taking into account dynamic effects like increased rates of innovation through competition, can be considerable.12 It is discussed because for a long time, it was officially proposed by the then Japanese Prime Minister Obuchi in 1999. Korea’s businesses are Janus-headed about such a proposal: The Federation of Korean Industry and the representation of Korean business groups (chaebol) in the 18th Annual Conference of the Korea-Japan Business Council in November 2001 in Seoul endorsed a FTA and even invited China to join such an undertaking. However, an opinion polled by the Korea Economic Research Institute (KERI) in October 2001 showed that among 154 Korean corporations asked approximately 40 percent favoured as an option of a FTA with the United States, around thirty percent a FTA with China, but only eight percent picked Japan. Besides, political suspicion about the big trade deficit with Japan is a concern. Japan, on the other hand, has concerns about agricultural and fishery imports to its strongly protected domestic market.


For Korea, bilateral trade agreements can have various reasons: to secure export markets through overcoming trade barriers, to counter economic regionalism in other parts of the world by enhanced negotiation power of a regional trading bloc, to enforce economic restructuring in the domestic industry, to curb regional overinvestment in competitive industries, and to achieve cooperation in wide range of topics related to the economy, but needing political coordination, like pollution issues (Sohn 2001: 4-5). Only the first of these arguments points in the direction of RTAs with remote countries.13 All other reasons rather support RTAs with competitive, regional partners, where Japan is a strong candidate. The important question of bilateral trade deficits could lead to a gradual liberalization strategy, but it is not a general argument against such an RTA (Cheong 1999b: 33).  Also, for Japan, the reasons for closer regional integration point in the direction of an RTA to enhance dynamism and competitiveness: This could help overcome the Japanese “Asia-sclerosis” (Seliger 2001a) and paralysis of the political-economic system (Cheow 2002: 149-50), characterized by deflation, financial and political crisis as well as social transformation.


A bilateral free trade agreement, while possibly beneficial to the concluding partners, need not be beneficial at the same time to world trade. Both the Japan-Singapore FTA and the Korea-Chile FTA have considerable areas excluded from free trade, like financial services and agriculture. If a cobweb of more and more FTAs is woven in East Asia, this might be difficult to entangle, if region-wide free trade is the goal. Barfield (2002: 7) demands a number of preconditions for FTAs compatible with the goal of region-wide and international free trade: The baseline for tariffs should always be the lowest of the two countries’ tariffs (so that no other trading partner is worse of in terms of tariffs after the FTA)14, the agreement should be monitored by the WTO, the agreement after some time should be opened to all other participants willing to enter it (a form of open regionalism). However, such a form of bilateral free trade compatible with international free trade would meet severe opposition from special interest groups lobbying for protection. Another way, in which even a bilateral arrangement with exceptions could become beneficial in the long run, would be the “peer pressure” which is created by an agreement: Other states in the region would be attracted to the FTA so that the bilateral agreement would multilateralize.


But in the moment, even the political will for integration of Japan and Korea in a way allowing for some form of protection seems not to be enough for overcoming the cited difficulties. One problem in bilateral trade negotiations is the strong and concentrated position of possible losers of integration.15 The case-by-case removal of trade barriers is rarely successful, since the costs of protection are dispersed among consumers or taxpayers, while the gains of protection are concentrated to industries, giving them a much greater interest in lobbying efforts to secure protection.


The Western European experience of the 1970s shows the same experience, but also a possible way out of it. In the 1970s, Western Europe tried a case-by-case discussion of trade barriers which failed, and the European Community slipped into ‘euro-sclerosis’ (Seliger 2001b). However, in the 1980s, a programme to create a common market at the same time attacked 279 different main barriers to trade, including non-tariff barriers, and national protection and controls. Thereby, in a bargaining process, where all nations had to give and take, the obstacles of trade barriers could be overcome. A similar situation exists in East Asia today. Here, the barriers to integration are partly political, as discussed above, and partly economic. The integration project should be big enough to overcome concentrated opposition of small groups, but small enough that it does not fail due to heterogeneity like APEC.


The already cited invitation by the Japanese-Korean business forum to its Chinese counterparts to lobby for a triangular free trade area is such a zone. Even more promising is the approach of ASEAN plus three (China, Japan, South Korea). Since 1997, this group meets until now without a formal institutional framework. The ASEAN plus three groups includes more than one third of the world population (around 2 billion) and around 21 percent of world domestic product (around US$ 7 trillion). The group has two political advantages compared to APEC: First, since Taiwan is not a member of the group, the problems of Taiwanese-Chinese relations is no stumbling block for integration. Second, the inclusion of many smaller states as well as both big states from Northeast Asia (China and Japan) is important to counteract the possible tensions over either Chinese or Japanese domination of their neighbours.


South Korea’s President Kim Dae-Jung first proposed the study of closer economic, political, and cultural ties on the ASEAN plus three Summit in November 2000 in Singapore. Afterwards, a study group discussed plans for integration. In November 2001, it was again Kim Dae-Jung who in the summit meeting in Bandar Seri Begawan in Brunei proposed a regional free trade area. The response from Kim’s counterparts was generally cautiously optimistic. While calling it a ‘bold yet feasible’ plan (so did Brunei’s Sultan Hassanal Bolkiah), they voiced fears of a too fast pace of ASEAN plus three free trade negotiations. The ASEAN states are reluctant to give up the lead in integration, which they now have with the opening of the ASEAN FTA in 2002 as well as the initial agreement on an FTA with China. Kim Dae-Jung additionally proposed regular ministerial meetings between China, Japan, and South Korea. This shows that South Korea itself considers, as well the greater ASEAN plus three option, the Northeast Asian option. The success of both integration processes is dependent on the development of a true regional identity. This was stressed by the Asian crisis, which on the one hand was perceived as a collective threat to the economic position of East Asia, but on the other hand, resulted in divergent national responses instead of greater East Asian co-operation.


For South Korea, the options of multilateral trade liberalization through WTO and APEC, regional integration of ASEAN plus three and bilateral FTAs are the various options for mutual reinforcement. Bilateral FTAs can be used as promotors of regional integration. ASEAN plus three and APEC can be a fora for trade negotiations overcoming bilateral political or economic problems.


For the success of regional economic integration, the domestic acceptance of liberalization is very important. The strong position of concentrated business and of farming lobbies in South Korea can counteract the intentions of liberalization. The willingness to assume the political risk to be in favour of liberalization and possibly hurting domestic producers is low. However, in South Korea some factors also favour free trade acceptance. First, the strong position of the ministerial bureaucracy compared to the relatively weak position of political decision-makers is a factor contributing to free trade. Bureaucrats are less dependent on interest groups and have a strong position vis-à-vis political leaders due to the frequent changes in office of the political leadership. Also, the relatively low intensity of ideological conflict about free trade is important for the Korean political acceptance of free trade. Due to ideological opposition, no important political group is principally rejecting free trade.


A second important political factor conducive to free trade is the strong position of the export sector in South Korea. Together with the bureaucracy, export industries are generally favouring trade liberalization. Therefore, in South Korea, there is an all-encompassing interest group in favour of free trade. This makes South Korea a possible promotor of regional integration even in times, when worldwide protests against globalizaton and free trade are increasing. However, South Korea’s interest in regional integration also has a second source, namely the possibility of greater economic policy co-ordination. This became very clear after the Asian crisis and will be discussed in the next section.

 

4. Perspectives of monetary and macro-economic co-ordination in East Asia


The East Asian Economic and Financial Crisis of 1997 and 1998 have been widely discussed from two different points of view: One group of economists stressed the role of structural weaknesses in the national economies as fundamental factors for the Crisis. In South Korea, especially the system of corporate governance, including high concentration of chaebols, intransparent management, overcapacities, and low profitability have been identified as structural weak points. However, other economists discussed the Asian crisis mainly as a problem of international and regional financial stability. The question of monetary co-operation as a possible remedy was raised and this discussion was increased by the Western European movement towards a single currency and the discussion of the dollarization in Latin American economies.


Besides Malaysia, all East Asian states in the crisis decided against the imposition of unilateral capital restrictions and indeed, South Korea proceeded with capital flow liberalization. However, monetary co-operation is perceived as a possibility to achieve better regional control of capital flows, prevent competitive devaluation, and ultimately, come even to a moneatry system in East Asia. In the following paragraphs, the possibility of an Asian Monetary Fund (AMF), a common Asian Monetary System (AMS), and the greater co-ordination of fiscal policy will be discussed.


The introduction of an AMF was first proposed by the Japanese Finance Minister, Hiroshi Mitsuzuka, in September 1997 in Bangkok, at the most dramatic moment of the Asian financial crisis. This fund should fulfill the role of a regional lender of last resort and complement the IMF, whose role was widely perceived to be insufficient among the East Asian finance ministers. Japan was willing to contribute half of the necessary funds. Implicitly, the fund was designed to circumvent the conditionality of IMF structural adjustment programmes, which were deemed to be unacceptable. The lack of structural adjustment programmes in the AMF design and the weakening of the IMF were exactly the reasons, why the United States as well as representatives of the IMF strongly rejected the possibility of supporting an AMF. This would increase the danger of ‘moral hazard’ which is the irresponsible behaviour of creditors and debtors in the region. If creditors and debtors could implicitly count on a bail out by the states through the AMF, there would be no incentives to introduce the urgently needed better rules for corporate and financial management, especially prudential rules in relation to borrowing and lending.


When the AMF was rejected, the representatives from East Asian states, the World Bank, and the Asian Development Bank (ADB) in November 1997 in Manila installed the ‘Manila Framework Group’ to discuss the stability of an international and regional financial architecture.  APEC, on the other hand, where monetary co-operation in the crisis years of 1997 and 1998 also became a debated topic, stressed the importance of domestic structural reform, for example, financial sector reform and prudential regulation.  They introduced a programme to improve the education of financial regulation authorities in states facing a crisis.


In October 1998, when the financial crisis was overcome, the region was still in a grave recession, Japan funded the so-called new ‘Miyazawa Initiative’ with US$ 30 billion. Half of the money was used to finance East Asian trade and half of the money was used as medium or long-term credit. Trade in East Asia, especially in Southeast Asia, had suffered from underfinancing due to a lack of pre-financing possibilities. Occasionally, states had even resorted to a highly inefficient barter system. The idea of AMF was not revived. Opposition to it not only came from the United States and the IMF, but after the worst of the crisis was over. Also the East Asian states saw the proposal of an AMF as strengthening the role of Japan. In May 2000, the finance ministers of ASEAN plus three in Chiang Mai, Thailand decided on the ‘Chiang Mai Initiative’, a system of regional bilateral currency swap-and-repurchase agreements. These agreements widened the scope of the ASEAN swap arrangement by the inclusion of the three regional states with the strongest reserve positions.


The ‘Chiang Mai Initiative’ could become the seminal decision for an East Asian monetary system. In the 1970s, when the Bretton Woods system collapsed, one answer was the introduction of a European Monetary System (EMS). Similarly, the Asian crisis led to a collapse of the dollar pegging of most East Asian states before the crisis and the search for a new, more stable exchange rate system began. East Asian states prefer exchange rate stability due to their trade dependence and alleged positive effects on trade and growth through the reduction of currency risk the alleged better defence of currencies against speculative attacks, once currency reserves are pooled and also the prevention of competitive devaluation rounds (Fukasaku et al. 1998: 134-6; Kim et al. 2000: 49-51). An AMS can take on a similar form of quasi-fixed exchange rates, like the EMS or even the form of an Asian Monetary Union with one currency.


The AMS’ first decision is to decide about an anchor currency or a currency basket, for example, an Asian Currency Unit. Empirical analyses showed that until now in East Asia, despite of the greater internationalization of the yen since the 1980s, the US dollar is by far the most important currency (as a transaction currency, a vehicle currency, and a reserve currency) and the United States is the most important trading partner.  Therefore, East Asia is more a dollar-bloc than a yen-bloc.  An important question faced by the AMS is the decision of central parities (bilaterally between the participating currencies or in relation to the ACU), the allowed margins of deviation from the central parity and the conditions of interventions by central banks to defend central parities. The experience of the EMS is not very encouraging: Independent central banks cannot always at the same time achieve internal stability and exchange rate stability without policy conflicts. If interventions by the central banks to defend parities following agreed upon candidates are not accompanied by reforms, they are ineffective in the medium term. This was the lesson of the crisis faced by the EMS in 1992 and 1993. Structural reform, however, are very difficult to enforce in the absence of a hegemonic power, like the IMF, with the strong political backing of the United States. A credible committment or strict conditions, however, would lead to the question, what additional value an AMS would have compared to the IMF with the same characteristics.


Even more problematic seems to be the introduction of a common Asian currency or Asian Monetary Union. According to the Theory of Optimum Currency Areas (OCA) is characterized either by the absence of asymmetric economic shocks or by sufficient shock absorption capacity of factor markets, especially labour markets. Asymmetric shocks (i.e. supply or demand side shocks either occuring in only a part of the participating countries of an AMU or shocks affecting some countries positively while others, negatively) are less probable between the more advanced countries of the region, like Japan, Taiwan, South Korea, and Singapore. These countries are characterized by a higher amount of intra-industrial trade, i.e. trade between the same industries, which makes asymmetric shocks less probable (Kwan 1998). However, such a monetary union would clearly miss the goal to strengthen regional financial stability. A larger union, including most Southeast Asian states, however would be more prone to asymmetric shocks.


The shock absorbtion capacity of the labour market seems to be decreasing in the last decade, especially in Japan. Other possible shock absorption mechanisms like migration or fiscal federalism are largely absent in the region and can hardly be introduced due to a lack of political will (Sakong et al. 1999: 44). This leads to the main problem in achieving AMU, namely the lack of political will to give up a part of sovereignty to a supranational monetary institution and the lack of political will to come to greater fiscal co-ordination. Therefore, despite convergence of some macro-economic indicators (like inflation rates), AMU does not seem to be feasible.


Finally, macro-economic co-ordination became another topic of policy initiatives after the Asian crisis. In 1998, Kim Dae-Jung proposed to his colleagues in ASEAN plus three, a concerted lowering of interest rates and programmes to stimulate consumption through the easing of credit (Korea Times 1998). The same idea, namely that the Asian crisis was mainly an issue of trust which could be solved by deficit spending, was also prevailing in the new ‘Miyazawa Initiative’. However, the experience of Japan with deficit spending was not very successful: As long as structural reforms are lacking, especially the cleaning of the banking sector haunted by bad debts, even giant consumption programmes leading to record levels of debt to GDP in Japan did not pull Japan out of the crisis. Also, it allows for considerably limited the room for additional fiscal action by the state with every new programme.


For these reasons, monetary and macro-economic co-ordination or integration in East Asia only promises success, if at the same time necessary structural reforms in the financial and corporate sector are enforced. But then, the political attractiveness of co-ordination is greatly reduced, since structural reforms means adjustment costs, for example, when insolvent companies are forced into bankruptcy. In the long run, co-ordination used to delay structural adjustment will fail. Especially South Korea, that besides its own restructuring process, eventually might be forced to finance the North Korean transformation process, should therefore prefer the liberalization of trade, leading to more competitive economic structure, to the possibilities of monetary and macro-economic co-operation.16

 

5. Conclusion


Economic integration in East Asia is finally on the agenda. As the discussion above showed, those parts of the agenda focusing on trade and investment seem to be most successful. While trade and investment opportunities are the basis for economic integration, all forms of integration needing stronger regional, supranational or intergovernmental institutions are only possible after the development of a strong, regional identity. Such an identity, however, cannot be constructed by state action, but rather has to develop spontaneously. The Asian crisis was a possible catalyst for the development of a common identity. Until now, the evolution of East Asian integration followed the model of ‘open regionalism’. Politically, other forms of integration were not feasible. From the point of view of institutional development, this allowed for institutional flexibility and competition.


However, without a minimum of institutionalization, ‘market-driven’ integration will come to an end. This does not mean that strong supranational institutions are necessary, but that at least common competition rules for competition in the markets of goods and services and also for regulatory competition are necessary. This poses two challenges to future research of East Asian economic integration: First, the forms and size of integration areas should be understood not exclusively as an economic problem, but the explanation must be interdisciplinary, including the cultural as well as political factors shaping integration. Second, the dichotomic discussion of ‘open versus closed regionalism’ is no longer appropriate for the discussion of East Asian regionalism. Instead, the role of clear and enforcable competition rules (institutionalization) without supra-nationalization must be clarified.


The current attempts to achieve a network of bilateral RTAs seem less conducive to such a market-preserving integration process.  Rather, it is a more encompassing, ASEAN plus three approach. This would be able to overcome the stumbling blocs of bilateral free trade, namely concentrated losses and dispersed gains, by giving countries enough incentives to design a bolder approach of region-wide free trade. South Korea is a relatively small country in Northeast Asia and can due to the historical position have a key role in East Asian economic integration, if it overcomes the obsession with historical “rectification” and convincingly solves its own economic problems. The more South Korea can implement the domestic reform agenda, the stronger its role in regional integration will be. If South Korea fails to restructure the domestic economy, it not only cannot have a leadership role in East Asian integration, but also becomes a factor of dangerous instability in among a bankrupt North Korea and the two Northeast Asian giants, China and Japan.


Japan again can achieve a leading role in economic integration, which from an economic point of view seems clearly feasible, when it makes more serious efforts to understand the historical trauma of its neighbours. A large-scale cultural exchange programme could be the beginning of such an effort.17  While money cannot buy trust automatically, a compensation fund for war atrocities might help these efforts. China, until now the most uncertain factor in East Asia’s economic integration process, preoccupied with the unresolved domestic reform process, has the chance to use closer regional cooperation for a more rapid modernization process and to overcome a looming crisis as mentioned above.


For the three Northeast Asian countries, China, Japan, and Korea, a future without economic integration is at worst antagonistic and full of conflict, at best a future in “splendid isolation”. The sharing of power necessary in an economic integration process, again, does not really diminish the power of individual countries, but rather bundles their power, allowing the three countries a common and harmonious future. A bilateral free trade agreement between Japan and South Korea, which is designed as an “open” form allowing for the accession of other states, and with a minimum of exceptional areas, could be a first step to that future.

 
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