Study on Regional Economic integration in Asia and Europe

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1 EUROPEAN COMMISSION DIRECTORATE GENERAL ECONOMIC AND FINANCIAL AFFAIRS International questions Economic affairs within the Asian and Latin-American countries and within Russia and the new independent states Preliminary conclusions «Regional economic financial and monetary cooperation in Europe and Asia» Study on Regional Economic integration in Asia and Europe 1. EUROPE: Three Key Economic Achievements The creation of a single market in which capital, goods, services and people move (almost) freely without the hindrance of cumbersome barriers at the border and other non-tariffs barriers. Progress with deepening integration has been remarkable over the recent years, as market liberalisation and the adoption of a common regulatory framework have progressed broadly hand-in-hand. It allows firms and investors to develop Europe wide strategies and has led to an intense development of trade and financial flows, resulting in economies of scale and higher efficiency. The creation of an economic and monetary union and the adoption of a single currency, which has accelerated and consolidated the single market. It has also acted in its own right as a powerful catalyst for further structural change in the EU, especially in the financial sector. The introduction of the euro has accelerated the advent of deeper and more unified European financial markets. The euro has rapidly become an attractive alternative to the dollar for international bond issuance, especially in the corporate sector, where eurodenominated issuance increased more than three-fold in 1999 compared to Equity markets are also evolving rapidly. The last two years have seen a significant increase in the capitalisation of euro area stock markets and in the number of enterprises coming to the market. The development of an efficient system for policy co-ordination. In the run-up to the adoption of the euro, there was a remarkable convergence of views on the need to follow prudent macroeconomic policies and implement structural reforms in the markets for goods, labour and financial products. Building on this, the Member States have progressively put in place a comprehensive set of procedures for policy co-ordination. The procedures vary substantially between policy areas. At one extreme, monetary policy has been completely pooled and a new institution created. Public finances and especially deficits are subject to strict rules and in extreme cases sanctioning mechanisms. However, in other areas, such as employment policy and structural reform, co-ordination is largely based on a consensus, and on best practices, while enforcement relies on peer pressure.

2 2. ASIA AND EUROPE COMPARED Asia and Europe share some important similarities. Economically, as regions not endowed with many natural resources, they are open to foreign trade and investment, and therefore have a strong common interest in an open international economic and financial system. Both regions have been hit in the nineties by serious economic, currency and banking crises, they share the same ambition to better control the forces of economic and financial globalisation, in order to create a stability-oriented economic and financial system that promote high and sustainable growth and improve welfare. Both regions have complex models of society, which put a high price on the need to control the forces of globalisation. They are seeking to preserve the positive features of complex economic and social models, while retaining the capacity to change in the face of rapidly evolving circumstances. The two regions are also very different. Economic diversity is more pronounced in Asia, ranging from countries with highly modern economies to others that are still poor and with traditional, mostly rural, economic structures. In contrast, the European Union has become a much more homogenous economic grouping. That will of course change in the near future as the EU enlarges towards the east. According to World Bank data, on a purchasing power parity basis, the difference of per capita GNP between the richest (Luxembourg, 38,247$ PPP) and poorest (Greece, 14,595$ PPP) members of the EU amounted to 162% in The difference is 680% if one takes the poorest of the candidate countries (Bulgaria, 4,914$ PPP). In Asia, the difference amounts to about 2000% between the richest (Singapore, 27,024$ PPP) and the poorest (Cambodia, 1,286$ PPP). A more fundamental difference is the degree and timing of efforts made towards deeper regional integration. Since 1945 Europe has been more ambitious than Asia in making explicit a political goal of building an ever-closer union among its peoples. European efforts stem directly from the sheer extent of material devastation and moral exhaustion brought by the two World Wars. This has led Europeans to accept a significant pooling of sovereignty over a whole range of political as well as economic issues. It is fair to say that Asia, at this stage, does not have the same political ambitions. This should make us even more cautious about drawing conclusions from Europe s experiences for Asia. In any case it would be naïve to think that lessons from one area can simply be transplanted to another area in any circumstances. 3. HOW RELEVANT IS THE EU EXPERIENCE TO ASIAN POLICY MAKERS? There is much discussion in Asia today about how to take better advantage of globalisation while avoiding the recurrence of crisis similar to that of One solution that is being 2

3 debated is to deepen regional integration, notably in the areas of trade, macroeconomic surveillance, balance of payments support and strengthening of financial sectors. Although the European Union has a natural predisposition to be in favour of regional integration, it is not in favour under all circumstances. It is vital that moves towards regional integration are fully compatible with international and multilateral agreements. They should be building blocks towards a more open, rules-based international economic and financial system. This is why one of the EU's top policy priorities is to continue to press for an ambitious agenda for stronger international rules, both in the trade, monetary and financial fields. In this context, we have to pay attention to the design of new regional integration initiatives. Recent research by the European Commission on regional trading arrangements shows that the gains of trade from these agreements are maximised if two criteria are met: Proximity between partners: this does not mean only geographical proximity but also economic, regulatory and cultural proximity. Willingness to tackle areas beyond the elimination of tariffs barriers. This means that measures must be taken in areas including, inter alia, non-tariff barriers, regulatory cooperation, capital movements and freedom of providing services. In addition, as our experience shows, improving macroeconomic stability and accelerating structural reforms through stable exchange rates, regional macroeconomic surveillance and coordination mechanisms enhance dramatically the gains of trade. In this context, ASEAN's efforts to move beyond tariff measures and to tackle such issues as harmonisation of tariff nomenclatures, streamlining customs procedures and mutual recognition arrangements are very welcome. Our own experience with trade agreements between the EU and other regions suggests that economic results are often disappointing if only border measures are tackled. Most interesting is the growing debate in Asia on macroeconomic and financial issues, including how to prevent crises, and how to stabilise exchange rates. This has been initiated and pushed forward in earnest in the ASEAN context but has been broadened recently as Korea, China and Japan have also taken part in the discussions. Much of what is being done and discussed in Asia, including the ASEAN surveillance process, financial support arrangements and regulatory co-operation in the banking system forms part of our experiences in the lead up to full economic and monetary union in Europe. In the early seventies, long before we had adopted the goal of a single currency, we put in place various arrangements for closer monetary cooperation. These included short-term swap arrangements, long-term balance of payments support and a new institution, the European Monetary Cooperation Fund. With the creation of the European Monetary System in 1979, co-operation was strengthened significantly, and financial assistance instruments were reinforced. However, as was demonstrated during the ERM crisis, the monetary arrangements, in a context of an ever-increasing degree of liberalisation of capital movements, were not effective, essentially because they were not sufficiently backed by co-ordinated macroeconomic policy and sufficient structural reforms. This has been the main lesson of European economic 3

4 and monetary history since the end of the Bretton Woods System and until the entry into force of the Maastricht Treaty. The drive to adopt the single currency, with its ensuing focus on improving both nominal and real convergence of the European economies provided the real impetus for strong policy coordination and ensuring lasting macro-financial stability in the EU. An ASEAN macroeconomic surveillance procedure, backed by regular dialogue of Finance Ministers on the basis of assessments provided by the ASEAN secretariat, could be an important policy instrument. Peer group pressure, based on a commonly agreed analysis has certainly been a very useful tool in the EU. Co-operation in Europe has been most effective when it is backed by strong, independent and respected institutions, and when conclusions and recommendations made by Member States to one another are made public, thereby reinforcing peer pressure. The design and development of an autonomous ASEAN financial support mechanism, based on swaps arrangements and repurchase agreements, must be made carefully, especially given the still large disparities between members of ASEAN+3 for at least three reasons: First, it is important that this exercise complements the surveillance of international institutions, most particularly that of the IMF. Second, there is a danger that regional financial support could inadvertently defend exchange rate pegs and/or weak financial systems. In this context, caution is required when considering pegging Asian currencies to an external anchor. Focusing on the nominal exchange rate without setting up a process of policy co-ordination, structural reforms and a commitment to financial sector consolidation will not be a magic solution. This is true whatever the choice of peg, although it would obviously be unwise to return to the pre-1997 situation, when many Asian currencies pegged to the US dollar. Third, and as a consequence, it is important to be very transparent about the purpose and conditions of use of such financial arrangements. The decision to create such an instrument in ASEAN+3 countries should be accompanied by a strong commitment of all the countries concerned that they intend to include policy actions over a broad range of policy areas, including not only basic macro policy, but also financial sector and other structural policies in their overall peer group reviews. There should also be procedures to help ensure the adoption of policy measures in these areas, especially to accompany any use of the regional financing facility. Reaching lasting macroeconomic and financial sector stability in a group of countries as diverse as ASEAN+3 implies by necessity to focus on real convergence. In the European Union, the Single Market programme was an ambitious programme of far-reaching structural reforms in almost all sectors of the economy. Coupled with the positive impetus provided by world trade liberalisation (Uruguay Round), this provided a key support for the eventual success of full Economic and Monetary Union and the introduction of the Single Currency; and this was possible while pursuing both nominal and real convergence. That is why common action plans should develop in addition to the trade liberalisation agenda, in particular in the financial sector and capital movements. Much will be achieved to reduce 4

5 financial vulnerability by broadening the existing co-operation on strengthening prudential regulations and increasing competition in the financial sector. Dirk Verbeken- ECFIN D