ࡱ> 7 bjbjUU %:7|7| %lDDD@0  84 \ +&j  " """$Q qЂ """""Ђs+ s+s+s+" s+"s+ts+3F6|,T @ n ^ 0li )bTn<0+*ns+ Draft December 2008 Not to be Cited without Permission Optimal Sequencing Issues in Real and Monetary Cooperation Mordechai E. Kreinin, Michigan State University And Michael G. Plummer, The Johns Hopkins University, SAIS-Bologna Via Belmeloro, 11 40126 Bologna ITALY Email:  HYPERLINK "mailto:mplummer@johnshopkins.edu" mplummer@johnshopkins.edu Paper Presented to /ACAES Session, Financial Integration in Asia: New Wine in Old Wineskins? 10: 15am, January 3, 2009, San Francisco, CA Optimal Sequencing Issues in Real and Monetary Cooperation in Asia Mordechai E. Kreinin, Michigan State University Michael G. Plummer, The Johns Hopkins University, SAIS-Bologna I. Introduction Asian economic cooperation has been taking place on many fronts, e.g., subregional cooperation in the form of growth triangles, bilateral free-trade areas (FTAs), plurilateral FTAs, even a proposal to create an economic community in ASEAN (the ASEAN Economic Community, AEC), in which there would be free flows of trade in goods and services, foreign-direct investment (FDI), skilled labor, and a freer flow of capital by 2015. Initiatives in the financial sector are fewer in number but are receiving an increasing amount of attention in light of the on-going global financial crisis. In any event, real and financial cooperation are unfolding at the same time in Asia. To what extent is the sequencing of these approaches to formal integration optimal? A traditional approach to regional integration would suggest that focusing on deepening integration in the real sector, that is, from an FTA to a customs union to a common market, should precede financial cooperation. For the most part, this was the experience of the EU, which is in many ways has been a model for integration programs in the 2000s. Most FTAs in the world today are bilateral in nature and how little or no reference to financial and/or monetary cooperation. Should Asian cooperation focus first on the real sector before moving forward significantly in the financial realm? The objective of this paper is to review recent approaches to integration in the real and financial sectors, underscore their motivations, and gauge where these initiatives will take the region in the future. Our hypothesis is that, given the motivations for regional integration in Asia, the current strategy of moving forward on regional integration in the real and financial sectors simultaneously makes economic (as well as political) sense. The on-going global financial crisis should serve to enhance this result. The paper is organized as follow. Section II considers real integration in Asia. The main result from our analysis in this section is that the motivations behind deepening real-sector integration relate to the policy priorities being placed on enhancing competitiveness, encouraging the creation of value chains and the process of fragmented trade, and plugging the region into the global marketplace more effectively. We use the AEC as a case in point. Section III focuses on monetary and financial cooperation. We argue that the economics of closer macroeconomic and financial cooperation in Asia are actually quite strong and should support the process of increasing competitiveness of the real sector. Moreover, closer monetary cooperation will allow the region to reduce global imbalances, which were in part responsible for the on-going financial crisis. Section VI offers a brief conclusion. II. Real Cooperation Sequencing We might begin by making a clear distinction between economic integration and economic cooperation. In this paper, we specifically refer to the former as a market-led process, whereas the later refers to formal (i.e., government-induced) initiatives. Typically, economic integration follows economic cooperation. This certainly was true of the EU; beginning with the European Payments Union and continuing through Economic and Monetary Union, closer economic integration was promoted by official sponsorship of intra-regional economic activity. The opposite has been true in Asia, however: rising intra-regional trade and investment flows have preceded the current trend toward economic cooperation in Asia, which essentially began at the beginning of the 2000s. While there are many motivations driving the FTA movement in Asia (see, for example, ADB 2008 for a survey), a salient goal is to further this process of creating an integrated region in which local, regional, and global multinational corporations (MNCs) can operate more easily and connections among markets can be strengthened. These FTAs could be one means by which partner-countries could reduce barriers to economic interaction and, as such, profit from greater efficiency. The outward-oriented approach to economic reform in the region has manifested itself in the area of trade initiatives. The result of economic reform at the national level has been an increase in intra-industry trade (Rana 2006) and a rising importance of fragmented trade (ADB 2008); in fact, while intra-regional trade in Asia is approaching 60 percent, export markets are still driven by final good demand in OECD markets (especially the United States). Thus, anything but outward-oriented FTAs would be detrimental to the development strategies being pursued by the regions economies. There is a rancorous debate in economics over whether bilateral and regional FTAs in the global economy constitute a threat or an opportunity to the multilateral trading system and the cause of open international markets. In practice the response to this question is a function of the type of accord that is being developed. Discrimination inherent in these agreements has the potential to create inefficiencies and distort international markets; the trick is to minimize these negative effects (e.g., traditional trade and investment diversion, higher transactions costs through rules-of-origin-induced spaghetti bowl effects, and the like). Still, if these accords are outward-oriented and embrace best practices, the probability that the FTA movement will be salutary to the international trading system improves greatly. The demand for FTAs on the part of Asian economies relates to the need to reduce transactions costs associated with the creation of a regional productive base, which would have the effect of furthering regional integration and improving competitiveness. Fragmented trade relies on this type of facilitation; it can gain from economies of scale due to a larger, freer market. With greater FDI inflows, the potential for technology transfer improves. Moreover, FTAs tend to require harmonization of various microeconomic policies and present a strong case for adoption of best practices in terms of accounting standards, management techniques, harmonization of customs classification and procedures and other trade and investment facilitation measures, adoption of common product standards, and so on. These types of deep integration policies are exactly the type of measures that MNCs seek; by reducing transactions costs and forming a more cohesive environment in which to exploit a vertical division of labor, FTAs can create a common marketplace that transcends national borders. Still, FTAs are discriminatory and could potentially increase the costs of doing business in the region, for reasons that go well beyond mere trade diversion issues. In particular, in order to avoid trade deflection, FTAs require rules of origin (ROO) that ensure that a certain percentage of value-added or a substantial transformation of the product takes place within the partner-countries borders. As these ROOs are product specific, they can be costly in terms of their bureaucratic requirements and, in fact, can be used as a hidden form of protectionism. For example, the ROOs in NAFTA require 62.5 percent value added in North America, and textiles essentially require 100 percent (through the yarn forward rule). A country that has many FTAs could end up having different ROOs for trade in a certain product for each FTA, potentially creating confusion but also influencing the input-sourcing decisions of a representative firm in a way that could be detrimental to efficiency. Kawai and Wignaraja (2007) use the example of ROOs across Asian FTAs to compare similiarities and differences for major four-digit HS codes in autos and auto parts, i.e., 87.01, 87.03, 87.04, 87.08, 87.11, 87.14. Substantial differences exist. For instance, if we compare the Japan-Thailand, Japan-Singapore, and Japan-Malaysia FTAs, we find that ROOs are not consistent across FTAs in any product line, and are only generally the same in 87.01 and 87.14 for the Japan-Thailand and Japan-Malaysia agreements. In other words, even if FTAs have the best of intentions in terms of outward-orientation, the devil may well be in the details. None of these latter studies, however, quantifies the associated costs of ROO inconsistencies. Estevadeordal and Suominen (2003) estimate that compliance costs between 3-5 percent of the value of exports, but this paper is an exception to the rule: there are few studies that explicitly estimate the cost of ROO compliance in Asian FTAs. Indeed, it is strange that an area that has become so controversial has not led to a much greater interest in the empirical literature. But whatever the true cost of compliance, a strong advantage of the WTO framework is that it generally (but not totally) avoids this problem. FTAs have both positive and negative aspects to them. What has been the net effect of the current wave of bilateral and regional agreements in Asia? It is too early to tell; the regionalism movement is just too new to Asia: even the most advanced accords offer a very small time horizon within which to try to capture the effects ex-post. Ex-ante models (e.g., ADB 2006, Kawai and Wignaraja 2007) tend to show positive effects of bilateral FTAs, but these bilaterals tend to generate far smaller effects than region-wide accords, such as in the ASEAN+3 and APEC-wide contexts. It should be noted that these models tend to have a downward-bias in estimating the effects of FTAs, as they generally leave out the important dynamic effects of regionalism, e.g., economies of scale, increases in FDI, technology transfer, X-efficient, and so on. Moreover, since these models often rely on tariff liberalization and tariffs have come down significantly over the past two decades, one would not expect a very large effect on output. This would also explain the (reportedly) low utilization rates of preferences granted by Asian FTAs. From an FTA quality perspective, Plummer (2007) attempts to assess bilateral and subregional accords in Asia based on a series of best practice indicators. He finds that these accords generally are quite open and deserve high marks in most categories, with the exception of ROOs (in bilateral agreements with OECD countries) and product and service coverage (in the case of developing-economy accords). Which would be the optimal configuration of FTAs in the region? Currently, there is a strong revealed preference for bilateral FTAs for a variety of reasons, not the least of which would be the difficulty of negotiating plurilateral FTAs. However, while a system of bilateral FTAs might lead to positive welfare gains, economic studies have shown that wider arrangements, e.g., in the form of an ASEAN+3, ASEAN+6, or APEC wide arrangement, would tend to have far greater effects, as well as circumvent or mitigate problems associated with the Asian noodle bowl. In fact, the ADO (2006) uses the GEMAT CGE model to show that an Asia-wide FTA (including Japan) would increase developing Asias income by 1.1 percent, whereas a global free-trade deal would only increase it marginally higher (1.3 percent). Using the same GEMAT model, Plummer and Wignaraja (2006) show that the current fragmented scenario of the existing series of FTAs would yield relatively small gains in economic efficiency and welfare, whereas wider arrangements would have much larger effects. The summary results of this study are presented in Figure 1. As Harrigan et.al. (2008) conclude from their simulations of various FTA configurations, Regionalismor the creation of a wider, single FTA within Asiais likely to generate greater benefits for developing Asian economies than bilateralism or the creation of hub-and-spoke systems that fail to connect the spokes. Figure 1 Effects of Six FTA Scenarios Real Income (EV), US$billions  Source: Plummer and Wignaraja (2006). Kawai and Wiganaraja (2007) also focus on the issue of which configuration would be best for Asia. They stress the potential costs of the existing bilateral FTA approach and make a strong case for a single East Asian FTA that would reduce potential costs associated with overlapping ROOs and other inefficiencies. They conclude that an ASEAN+6 arrangement would generate the largest gains, while costs to non-members in terms of trade diversion would be small. Nevertheless, they stress that regionalism in Asia needs to take into account the regions relationship with major trade, investment, and diplomatic allies such as the United States and the EU. They support the formation of either an East Asia-North America FTA or an APEC FTA. A. The Case of ASEAN The ASEAN economic integration experience in many ways reflects the movement from market-led regional integration to regionalism in Asia. While economic deepening has been gradual, its pace has quickened and has been focused on the need to use regionalism as a means of supporting market-led integration. Founded in 1967 with the Bangkok Declaration, ASEAN is the most advanced institution of regional cooperation in Asia and one of its oldest. At first, its goals were mainly political in nature. In particular, it sought to promote peace in what was at that time a volatile region. While these diplomatic initiatives did not promote economic integration directly, the peace and security that followed paved the way for economic growth and development throughout Southeast Asia. It also allowed for a stable environment in which to promote economic reform. ASEAN did not attempt any significant economic cooperation initiatives until the new international political environment emerged at the end of the 1980s. Its first major initiative was AFTA, which was established in 1992 and originally only covered trade in manufactured goods to be liberalized over a 15-year period. But ASEAN subsequently broadened the scope and shortened the implementation period of AFTA so that it was technically in full effect at the beginning of 2004 for the original ASEAN countries and Brunei Darussalam (ASEAN-6), although there are transitional periods for products on the temporary exclusion lists. ASEAN has also made important strides in the area of investment cooperation, e.g., in the form of ASEAN one-stop investment centers, the ASEAN Investment Area (AIA), and most recently the ASEAN Comprehensive Investment Area (ACIA), which was approved by the ASEAN Economic Ministers in August 2008 and should be formalized at the next ASEAN Summit (currently scheduled for mid-February 2009). As part of the AEC process (discussed below), the ACIA will supercede other existing FDI-related agreements (including the AIA) and will: (1) offer benefits to ASEAN and (non-ASEAN) MNCs based in ASEAN along the same timeline (rather than giving an advantage to ASEAN investors), underscoring the open regionalism substance of the accord; (2) reduce costs associated with trans-border FDI in ASEAN; (3) solicit more input from the private sector and on a regular basis; and (4) provide for a dispute settlement process, Investor-to-State Dispute Settlement (ISDS). As most MNCs in ASEAN are from non-member countries and ASEAN countries are actively courting FDI, legislation is emerging or is in place in a number of member countries that would accord national treatment for all investors together. Singapore, for example, does not discriminate between ASEAN and non-ASEAN investors. In November 2002, the ASEAN Heads of Government meeting in Phnom Penh proposed that the region should consider the possibility of creating an AEC by 2020. In the 2007 Cebu Declaration the ASEAN leaders not only formalized this commitment but actually pushed up the deadline to 2015. The action plan for the implementation of the AEC was published in the form of the ASEAN Blueprint in November 2007. As part of the AEC process, ASEAN is developed the ASEAN Charter, which was ratified by each ASEAN Member State and went into effect in December 2008. It will significantly enhance the formal nature of ASEAN integration by making it an international legal entity. The Charter is arguably a necessary step in order to deepen integration as substantially as the AEC requires. The primary goal of economic integration in ASEAN, as articulated by its leaders, is to reduce transactions costs associated with economic interchange and to make the region more attractive to MNCs wishing to take advantage of its diversity and openness in rationalizing production networks. In this sense, it is both determining and determined by the new wave of outward-oriented regionalism in Asia. In short, the unfolding of economic integration in ASEAN is typical of the approach to regional integration in Asia noted above, that is, regionalism that is supporting regional integration, rather than vice versa (e.g., in the EU case). ASEAN continues to face many challenges, but its initiatives demonstrate a desire to use trade and investment liberalization through the AEC as a means to promote competitiveness and integration with the global economy and Asia. B. Real Sector and Financial/Monetary Cooperation We argue above that Asian regionalism should be an effective tool to enhance competitiveness in Asia. Formal agreements, such as in ASEAN, are generally outward-oriented and strive for the adoption of best practices, that is, greater efficiency at all levels, including behind the border. Still, although we would suggest that the conventional approach of trade following the flag has been happily reversed in Asia, we have not made the case as to why financial and monetary cooperation should take place simultaneously. There are several reasons for this: First, the two sectors are closely related; assuming that they can be separated has had highly problematiceven disastrouseffects on other regional groupings. Examples include the September 1992 Financial Crisis in Europe, in which regional integration in the real sector (The Single Market Programme) included the liberalization of capital flows, which in turn led to a currency crisis; the Mexican Peso Crisis of 1994, which threatened NAFTA only a year after it began implementation; MERCOSUR, in which on several occasions (e.g., Brazilian devaluation in 1999, Argentine devaluation in 2002) the financial crisis has lead to the slowing down of implementation of real-sector cooperation (i.e., its customs union, which was technically in place in December 2001 but is still far from including all goods). Second, the Asian Crisis of 1997-98 continues to influence the thinking of Asian leaders. The big push toward regional cooperation agreements began only a few years after this traumatic event. Given the obvious policy externalities that were revealed to exist in the region during the Crisis, financial and macroeconomic cooperation were deemed essential to ensuring stability in the real sector. As Asia becomes more inter-dependent, shocks originating in the region will have amplified effects. Third, real exchange-rate volatility has been shown frequently in the literature to reduce trade and investment. The success of Asian cooperation in the real sector will ultimately be measured by its effects on trade and investment, which in turn will be influenced by developments in the financial sector. Fourth, and related to point three, greater macroeconomic stability, exchange-rate volatility, improved financial structures through concerted action, and easier cross-issuances of financial transactions should reduce the cost of capital and doing business in the region. Finance, after all, lubricates the chains of the real-sector engine. In addition to making trade finance easier and cheapera major issue in the current crisisthese policies will render the region a safer, easier, and more efficient place for MNCs. As we have argued that improving the environment for MNCs and value chains is a primary motivation behind real-sector integration, financial and monetary cooperation will help achieve these goals. Fifth, with respect to the on-going global financial crisis, the Asian financial systems are far less exposed to the toxic assets that are decimating the OECD financial structures. However, they are indirectly exposed through the relationships that Asian financial markets have with the West. Moreover, the over-emphasis on net exports (rather than domestic demand, particularly investment) as a source of economic growth has rendered the region extremely vulnerable to the recessions that have now hit the OECD markets. In China, for example, exports fell by 2 percent in November 2008 (year on year), whereas over the 2000-2006 period they grew by an average annual rate of 26 percent. Stock markets in Asia have been hit as badly as those in the United States and Europe. We argue elsewhere (Kreinin and Plummer 2008) that the lack of closer financial cooperation in general, and exchange-rate cooperation in particular, helped perpetuate imbalances in the economic system and this reliance on external demand for growth. Closer cooperation in this regard could help reduce these problems. Thus, cooperation in financial and macroeconomic areas may not only be justifiable but actually necessary to the medium- and long-term success of real-sector initiatives. In addition to providing greater stability and internalizing policy externalities, concerted action to deepen financial structures, promote macroeconomic stability, and facilitate cross-border transactions will serve to reduce uncertainties and transaction costs to intra-regional trade and investment and, hence, will bolster the goals of real-sector integration. III. Financial and Monetary Cooperation As noted above, the literature has heretofore focused much more on trade cooperation than financial/monetary cooperation in Asia. However, since the Asian Crisis the need to move forward on financial and monetary matters has moved up the ladder of policy priorities. For example, in December 1999, the ASEAN heads-of-government focused on the need to move towards greater regional cohesion and economic integration, as expressed in the ASEAN Vision 2020 statement. In this document, they pledge, among other things, to maintain regional macroeconomic and financial stability through closer cooperation in terms of monetary and financial policies. The next year in Vietnam they agreed to the "Ha Noi Plan of Action," which calls for: (1) maintenance of financial and macroeconomic stability; (2) strengthening of the financial systems; (3) liberalization of financial services; (4) intensification of cooperative efforts in monetary, tax, and insurance matters; and (5) developing ASEAN capital markets. As ASEAN countries endeavor to deepen their national capital markets, they have been using both ASEAN-based and ASEAN+3 approaches. In effect, most significant financial initiatives have been thus far at the ASEAN+3 level. Hence, in what follows, we consider exchange-rate management and financial and monetary cooperation mainly from an ASEAN+3 perspective. A. Exchange-rate Management Exchange-rate regimes in Asia differ widely, from various degrees of managed floats (e.g., most ASEAN countries, Japan, and South Korea) to hard pegs (e.g., China and Hong Kong). There are many excellent reviews of exchange-rate regimes in the region (see, for example, ADB 2006). However, they all have one common characteristic: the US dollar as the (explicit or implicit) reference currency or anchor. In reviewing the evolution of the roles of the US dollar, yen, and euro in East Asia, Kawai (2002) notes that the US dollar was either the de facto or de jure anchor in the regions economies prior to the 1997-98 Asia Crisis. During the Crisis the role of the US dollar declined but in its aftermath the US dollar generally assumed its traditional role as anchor. Still, its importance diminished in certain countries (e.g., Indonesia) and there has been greater flexibility in exchange-rate management. As of end-2008, the role of the US dollar continues to be prevalent, but there have been indications over the past few yearsas the value of dollar plummeted--of certain strains and a desire to diversify is in evidence. Weakness in the US dollar appears to have led some countries (e.g., China) to announce explicit reserve diversification strategies. Thailand in December 2006 even (briefly) imposed capital controls in order to prevent further appreciation of the baht against the dollar, reflecting problems associated with continued sterilization of foreign exchange interventions over a long period of time (holdings of US dollars by the regions central banks are at historical highs). The current crisis will no doubt increase the motivation for diversification; while the dollar is seen as a safe haven for the time being, once the crisis begins to turn around, there will be a strong incentive in Asia to reduce reliance on the dollar (as well as the US market in general). Numerous studies in the literature evaluate alternative exchange-rate regimes in the ASEAN+3. Kwan (2001), for example, considers from an institutional/political-economy perspective the case for closer exchange-rate management in Asia, with a focus on the potential role of the Japanese yen in future arrangements. McKibbin (2004) evaluates the performance of several potential Asian exchange-rate arrangements with respect to their effects on output and inflation variability in the presence of various shocks, and finds that no regime dominates in the presence of all shocks but the regimes of floating and a basket peg to the US dollar, euro and yen generally perform better than an Asian currency union or yen-zone regime. There continues to be a strong appetite in the region for various proposals regarding future exchange-rate management and cooperation, even if there has been little or no concrete progress in this regard at the policy level (as will be discussed below, various forms of monetary union in Asia have been tabled by academics but these have not been considered seriously in policy discussion). Arguably, this desire relates to the problems associated with the Asia Crisis. This contagion effect of the Crisis, which began in Thailand on July 2, 1997 and quickly spread to Malaysia, Indonesia, the Philippines, and ultimately South Korea and even Hong Kong, took the region by surprise, particularly since the potential for real contagion was thought to be small given the relatively-low levels of trade integration between the affected economies at the time. However, the contagion effect was devastating. Kim, et. al. (2002) separate contagion into several separate categories, with bilateral real integration just being one (and a small part of it).  The others would include competition in third markets; financial contagion, which relates to international investors behavior during a crisis; and pure contagion, which could be herd behavior, informational cascades, and the like. Kim, et. al. (2002) argue that all these channels played a role in the Crisis and survey the relevant literature. For Asian policymakers, this contagion effect clearly underscored the policy externalities associated with macroeconomic and financial policies in an increasingly-integrated region, which in turn has given birth to a variety of approaches geared to endogenize at least in part these externalities. We discuss these initiatives below. Suffice it to note that the presence of contagion at higher levels of integration (see, for example, Candelon, Piplack and Straetmans 2006 and Dungey, et. al. 2004) reinforces arguments in favor of monetary union, a topic that we discuss elsewhere. B. Financial/Monetary Integration One might trace the first initiative in favor of monetary/financial cooperation in the ASEAN+3 to be the original Miyazawa Plan, which was initiated by Japan during the Asian Crisis to create an Asian Monetary Fund to supplement the IMF. It was opposed by the IMF and the United States, but eventually led to the establishment of currency swap arrangements among East Asian countries (basically bilateral swaps between Japan and individual countries) during the annual meeting of the Asian Development Bank in May 2000 (the Chiang Mai Agreement). These swaps have grown in terms of nominal values to approximately $85 billion in 2008. There have also been proposals to integrate capital markets in the region, from modest proposals to coordinate more closely existing national capital markets, to more ambitious proposals such as the creation of supranational regional bond and stock exchanges. The main issues relate to integration as opposed to capital market development more generally, although one motivation for integration is typically to foster development of the market. Interest in stock market integration arises primarily because financial theory suggests that an integrated regional stock market is more efficient than segmented national capital markets. Capital market efficiency in Southeast Asia has become even more important after the Asian financial crisis. Southeast Asian countries are specifically seeking to reduce the traditional dependence of firms on bank loans rather than bond and stock issuances, and at the same time are seeking new capital from outside the region. With an integrated regional stock market, investors from all member countries will be able to allocate capital to the locations in the region where it is the most productive. With more cross-border flows of funds, additional trading in individual securities will improve the liquidity of the stock markets, which will in turn lower the cost of capital for firms seeking capital and lower the transaction costs investors incur. These suggest a more efficient allocation of capital within the region. From the perspective of a portfolio investor outside the region, stock market integration suggests that separate markets move together and have high correlations, so there is less benefit from portfolio diversification across countries. However, an integrated regional stock exchange will be more appealing to investors from outside the region who would find investment in the region easier or more justifiable. As shares become more liquid and transaction costs fall, fund managers become increasingly willing to take positions in the stocks. In addition, outside investors may take notice of the regional stock exchange instead of dismissing a collection of small national exchanges: the whole (one regional stock exchange) might be greater than the sum of the parts (individual country exchanges). Click and Plummer (2005) find evidence of co-integration of the original ASEAN-5 stock markets, which would bode well for the creation of a regional market. Candelon, Piplack and Straetmans 2006 come to the same conclusion; they consider five different Asian economies (Malaysia, Thailand, Chinese Taipei, Singapore and South Korea) and find an increased co-movement of these stockmarkets during periods of boom and bust, with a common break in 1997 (which can only be interpreted as an Asian Flu effect). With respect to fixed-income markets, the need to finance emerging government deficits in the region, robust demand for infrastructural projects, and ambitious business plans of many private-sector companies make the development of bond markets a natural priority, though a major challenge. Fixed-income instruments are important not only as an additional financial vehicle but also as a complement to equity markets. Firms may wish to raise medium- and long-term financial capital without relinquishing more control of the firm, or possibly as a complement to equity issuances (or vice versa; major corporate bond issues are often accompanied by warrants). Moreover, ASEAN governments in particular have recognized that a stronger and more extensive local bond market can be strong protection against maturity and currency mismatches. While ASEAN launched a study on the possibility of creating an ASEAN bond market in 2002-2003, the idea was essentially put on a back-burner in favor of an ASEAN+3 framework, which would include the major financial players in Asia. For example, the December 2002 Asian Bond Markets Initiative established a (small but growing) bond pool under the auspices of the Bank for International Settlements. Until the current financial crisis, financial and monetary cooperation in Asia had nonetheless continued to be at a conceptual stage. Even the most successful cooperative effect, the Chiang Mai Initiative, relatively lacks ambition if one considers that its swaps totaling $85 billion will be drawn from reserves that are currently at about $3.5 trillion. But the economics seem to support such initiatives, and the outbreak of the financial crisis in September 2008 has prodded Asian leaders to move more gingerly in this area. On the sidelines of the Asia-Europe Meeting (ASEM) in October 2008, the Chiang Mai countries decided to move ahead quickly with the liquity-swap facility totaling $85 billion. The Asian Finance Ministers reportedly also want to create a multilateral stabilization fund, which could grow to $350 billion, or 10 percent of current regional reserves. This is far more than the IMF has at its disposal. Still, many questions remain, in terms of how such a fund would be technically managed, what type of conditionality would be involved, who would be the leaders, and how it would relate to the IMF. V. Concluding Remarks In this paper, we focus on the sequencing issues in terms of real and financial cooperation in Asia. We argue that proceeding simultaneously with real and financial cooperation programs in Asia makes a great deal of economic sense, given the over-riding goals of economic cooperation in the region, which relate to improving international competitiveness and plugging into the global marketplace more efficiently. Financial and monetary cooperation could be important inputs into this process and could determine in part the success of real-sector cooperation. Regarding the optimal unit of analysis for regional cooperation, the literature would suggest that more encompassing regional accords, e.g., at the Asian or Asia-Pacific levels, will generate the most economic benefits in both real and financial cooperation. However, behind the border integration is easier in smaller units; deep integration programs such as the AEC have a strong economic rationale, provided that they are outward-oriented (and in this study we have argued that they are). With respect to financial cooperation, the market seems to prefer larger Asian schemes to ASEAN-specific ones. The AEC itself does provide for closer cooperation in strengthening national financial markets but addresses only slightly the enhancement of regional integration of financial markets, such as cross-issuances of stocks and bonds. ASEAN leaders appear to anticipate greater benefits by including the Northeast Asian Giants in these sorts of financial cooperation programs. It will be interesting to witness what the net effect the on-going financial crisis will have on regional cooperation in Asia. Theoretically, it could go either way: the region could see the logic of deeper integration in order to internalize policy externalities and ensure larger markets or it could resist, given the need to concentrate on national emergency measures. We argue above that, in terms of financial cooperation, ultimately it should prove to be a positive force; it has already had an impact on pushing forward the multilateral Asian Fund. How much further it will go is another issue. For the real sector, so far it would appear that the region intends on continuing to move forward. For example, at the APEC meeting in Lima, Per in November 2008, the APEC leaders reiterated their interest in possibly creating a Free-trade Area of the Asia-Pacific. The Crisis may well serve as a protagonist to move forward on this front, and to avoid the protectionist impulses that often arise during deep global recessions. The AEC only has about six years to build its single market and production base; to be successful, ASEAN leaders will need to move forward during the Crisis (and, in fact, has been doing so). ASEAN also signed accords with New Zealand, Australia, and India in August 2008, and continues to negotiate with the EU regarding a possible FTA (though it has a long way to go). In short, thus far we would argue that the global financial crisis of 2008 is serving as a protagonist of real and financial integration. References Asian Development Bank, 2008, Emerging Asian Regionalism, Manila, Asia Development Bank. Asian Development Bank, 2006, Outlook 2006: Routes for Asias Trade, Manila: Asian Development Bank. Ballard and Cheong, 1997, The Effects of Economic Integration in the Pacific Rim: A Computational General Equilibrium Analysis, Journal of Asian Economics, 8(4). Bchir, Mohamed Hedi, and Michel Fouquin, 2006, Economic Integration in Asia: Bilateral Free Trade Agreements versus Asian Single Market, CEPII Working Paper No. 2006-15. Click, Reid, and Michael G. Plummer, 2005, Stock Market Integration in ASEAN, Journal of Asian Economics, 16.1, pp. 5-28. Candelon, B., J. Piplack, and S. Straetmans, 2006, On Measuring Synchronization of Bulls and Bears: The Case of East Asia, mimeo. Dungey, Mardi, Rene Fry, Brenda Gonzales-Hermosillo, and Vince Martin, 2004, Empirical Modeling of Contagion: A Review of Methodologies, IMF Working Paper WP/04/78, May. Francois, J.F., McQueen, M. and Wignaraja, G., 2005, European Union-Developing Country FTAs: Overview and Analysis, World Development, 33-10 Frankel, J. and A. K. Rose, 1998, "The Endogeneity of the Optimum Currency Area Criteria," Economic Journal, 108, July, pp. 1009-1025 Gilbert, J., Scollay, R. and Bora, B. (2004), New Regional Trading Developments in the Asia-Pacific Region in S.Yusuf, N. Altaf and K. Nabeshima (Ed.), Global Change and East Asian Policy Initiatives, Washington DC: World Bank Glick, R., and Rose, A.K., 1999, Contagion and Trade: Why Are Currency Crises Regional?, Journal of International Money and Finance, Vol. 18 (4), pp. 603-17. Kawai, Masahiro, 2002, Exchange Rate Arrangements in East Asia: Lessons from the 1997-98 Currency Crisis, Monetary and Economic Studies (Special Edition), December. M. Kawai and G. Wignaraja (2007), "ASEAN+3 or ASEAN+6: Which Way Forward?" ADBI Discussion Paper No 77 (Tokyo, Asian Development Bank Institute). Kim, Sunghyun, Ayhan Kose and Michael G. Plummer, 2002, Contagion or Simple Transmission of Business Cycles?, in Hooley, Richard and Jang-Hee Yoo (ed.s), The Post-Financial Crisis Challenges for Asian Industrialization, New York: Elsevier, pp. 43-93. Kochar, K., P. Loungani, and M. Stone, 1998. The East Asian Crisis: Macroeconomic Developments and Policy Lessons, IMF Working Paper No. 98/128. Kwan, C.H., 2001, Yen Bloc: Toward Economic Integration in Asia. Washington, D.C.: Brookings Institution Press. McKibbin, Warwick J., 2004, Which Exchange Rate Regime for Asia?, Brookings Discussion Papers in International Economics, No. 158, February. Plummer, Michael G., 2007, Best Practices in Regional Trading Agreements: An Application to Asia, The World Economy, Vol. 30, Issue 12, December, pp. 1771-1796. Plummer, Michael G., and Ganeshan Wignaraja, 2006, The Post Crisis Sequencing of Economic Integration in Asia: Trade as a Complement to a Monetary Future, Economie Intrnationale, 107, pp. 59-85. Rana, Pradumna B., 2006, "Economic Integration in East Asia: Trends, Prospects, and a Possible Roadmap" ADB Working Paper Series on Regional Economic Integration, No. 2. Urata, S. and Kyota, K., 2003, Impacts of an East Asian FTA on Foreign Trade in East Asia, NBER Working Paper Series, Working Paper 10173, Mass: National Bureau of Economic Research. Zhai, F. (2006), Preferential Trade Agreements in Asia: Alternative Scenarios of Hub and Spoke ERD Working Paper Series No. 83, Manila: Asian Development Bank Zhang, Y., et. al., 2006. Towards an East Asia FTA: Modality and Road Map, A Report by Joint Expert Group for Feasibility Study on EAFTA (Jakarta, ASEAN Secretariat).  The only exception was the ASEAN Free-trade Area (AFTA), which was signed in 1992. Still, AFTA has taken a long time to implement and, indeed, is not fully an FTA at the time of this writing, as intra-regional tariffs and non-tariff barriers (NTBs) continue to exist.  Table 10 in their paper.  For a summary of some of this work in the Asian Context, see ADB (2008).  The Economist, December 13, 2008, p. 9.  Parts of this section are drawn and updated from Plummer and Wignaraja (2007).  Glick and Rose (1999), for example, examine five currency crisis episodes and find that countries affected by crisis have strong trade relations with the country that was the first victim of the crisis episode. But this effect is not important relative to other channels. Moreover, in the case of the Asian Crisis, Thailand accounted for only between 1 percent and 4.5 percent of the exports of the affected Asian economies.  That is, if a crisis hits Thailand and Malaysia and Thailand compete significantly in the US market, a strong devaluation of the baht would impact the competitiveness of Malaysia, which would lead investors to sell short Malaysian ringgit. For analysis of this type of competitiveness effect in the Asian Crisis context, see Kochar, Loungani and Stone (1998), who find that this type of trade channel played an important role in the Crisis.  For example, Kreinin and Plummer (2008) and Plummer and Wignaraja (2006).  BBC News, 4 December, 2008, accessed December 29, 2008. http://news.bbc.co.uk/2/hi/business/economy/7754167.stm  The statement issues at the November 2008 G-20 Meeting in Washington, DC also stressed the importance of avoiding protectionism and instructed their economic ministers to work toward a successful conclusion to the Doha Development Agenda.     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