The prospects for monetary integration in east asia

THE PROSPECTS FOR MONETARY INTEGRATION IN EAST ASIA HAZELYN YUEN LING (B.Soc.Sci.(Hons.), NUS; M.Soc.Sci.(Econs.), NUS) A THESIS SUBMITTED FOR THE DEGREE OF DOCTOR OF PHILOSOPHY DEPARTMENT OF ECONOMICS NATIONAL UNIVERSITY OF SINGAPORE 2003/2004 The Prospects for Monetary Integration in East Asia ii ACKNOWLEDGEMENTS Writing this PhD thesis is like running a marathon; it requires stamina and perseverance. It gives me great pleasure to thank the many people who made this thesis possible. First and foremost, I like to thank my beloved supervisors Associate Professor Peter Wilson and Associate Professor Tilak Abeysinghe. This thesis would not have been accomplished without their generous help and unwavering dedication. Associate Professor Peter Wilson has been steadfast and supportive. I thank him for starting my candidature and in faithfully seeing this thesis to fruition, and for being there throughout. Associate Professor Peter Wilson has also given me useful feedback and advice and the autonomy in writing this thesis. I am very encouraged to have Associate Professor Tilak Abeysinghe as a supervisor. He is kind, understanding and approachable. Associate Professor Tilak has also provided lots of wise words and immeasurable assistance when possible. I not also forget Associate Professor Ngiam Kee Jin, Dr Reza Siregar and Associate Professor Zhang Zhaoyong, for their enthusiasm and valuable insights on my thesis. My appreciation also goes to my Oral Examination Committee of Associate Professor Jose Tongzon and Dr Sarah Tong, as well as my Chairperson Professor Ake Blomqvist. In particular, a special word of thanks to Associate Professor Jose Tongzon for his contributions in overseeing this thesis to completion. Another source of strength is from my Husband Ee Chuan. I am appreciative for his understanding, endless patience and encouragement. Most of all, he has been instrumental in the proof-reading and formatting of this thesis as well as for the IT support. For friends like Angela, Andy, Jonathan, for the special moments especially when the going gets tough. And for all the inspirations, continued moral and spiritual support. Above all else, this thesis is not possible without the help of Omnipotent God, my unwavering source of strength and hope. The Prospects for Monetary Integration in East Asia iii TABLE OF CONTENTS ACKNOWLEDGEMENTS . ii TABLE OF CONTENTS iii SUMMARY vi LIST OF TABLES viii LIST OF FIGURES xi CHAPTER 1: INTRODUCTION pg - 1.1 1.2 1.3 1.4 MOTIVATION FOR STUDY .1 OBJECTIVES OF STUDY .2 SIGNIFICANCE OF STUDY… .3 STRUCTURE OF STUDY … .3 CHAPTER 2: THE THEORY OF MONETARY INTEGRATION .pg – 26 2.1 2.2 2.3 2.4 GENESIS ON THE LITERATURE OF MONETARY INTEGRATION .9 THEORY OF THE ‘OCA’ .11 ‘NEW’ THEORY OF THE OPTIMUM CURRENCY AREAS .16 ECONOMICS OF MONETARY INTEGRATION .22 CHAPTER 3: EMPIRICAL LITERATURE OF MONETARY INTEGRATION pg 27 – 48 3.1 3.2 3.3 3.4 3.5 3.6 SOURCES OF UNDERLYING DISTURBANCES .27 CROSS REGIONAL COMPARATIVE STUDIES 33 NON-MONETARY ADJUSTMENT 39 ‘OPERATIONALIZATION’ OF THE OCA CRITERIA(?) 42 ‘ENDOGENEITY’ OF THE OCA CRITERIA .43 BEYOND OCA EMPIRICAL RESEARCH 45 The Prospects for Monetary Integration in East Asia iv CHAPTER 4: STYLIZED FACTS OF THE EAST ASIAN ECONOMIES .pg 49 – 62 4.1 4.2 4.3 4.4 4.5 4.6 EAST ASIA’S DEVELOPMENT .49 COMPARATIVE OVERVIEW OF REGIONAL INDICATORS 50 EXTENT OF INTRA-REGIONAL TRADE FLOWS 53 FORMS OF EAST ASIAN MONETARY COOPERATION .58 EXTERNAL MONETARY POLICY PREFERENCES .60 SUMMARY .62 CHAPTER 5: EMPIRICAL STUDY – PART I: CONFLUENCE OF ECONOMIC OUTCOMES AND POLICIES .pg 63 – 119 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 MONETARY UNION AND ECONOMIC CONVERGENCE 64 CLUSTER ANALYSIS METHODOLOGY …………………… .…… 70 EMPIRICAL STUDY: DEGREE OF REGIONAL ECONOMIC CONFLUENCE .73 EAST ASIA’S CONVERGENCE .84 BEYOND THE EMU CONVERGENCE CRITERIA 88 TIME SENSITIVITY OF CLUSTER RESULTS .102 CLUSTER RESULTS AFTER ASIAN FINANCIAL CRISIS .106 CONVERGENCE IN ECONOMIC FREEDOM AND POLICIES .108 AN OVERALL EVALUATION – IMPLICATIONS FOR REGIONAL MONETARY INTEGRATION .117 CHAPTER 6: EMPIRICAL STUDY – PART II TESTS OF OCA CRITERIA .pg 120 – 149 6.1 6.2 6.3 6.4 IS EAST ASIA AN OPTIMUM CURRENCY AREA? .120 SIMILARITY IN ECONOMIC SHOCKS AND STRUCTURES 132 AVAILABILITY OF ADJUSTMENT MECHANISM .147 AN OVERALL ASSESSMENT OF THE OCA RESULTS FOR EAST ASIA 149 The Prospects for Monetary Integration in East Asia v CHAPTER 7: POLICY ISSUES AND IMPLICATIONS pg 150– 166 7.1 7.2 7.3 7.4 ‘ENDOGENEITY’ OF THE OCA CRITERIA? 150 THE ‘ENDOGENEITY’ ARGUMENT RE-EXAMINED .151 DOES CURRENCY UNION MAKE ECONOMIC SENSE? .151 IS AN EAST ASIAN CURRENCY AREA APPROPRIATE AT PRESENT?. .161 CHAPTER 8: MONETARY INTEGRATION IN EAST ASIA pg167 – 195 EXPLORING THE POSSIBILITIES 8.1 8.2 8.3 8.4 8.5 SEQUENCING OF MONETARY UNION: ‘GRADUAL’ OR ‘SHOCK’ APPROACH . 168 CHARTING AN EAST ASIAN MONETARY FRAMEWORK . 169 STAGE ONE: INCOMPLETE MONETARY INTEGRATION………………………………… 170 STAGE TWO: TRANSITION TO MONETARY UNION . 182 STAGE THREE: TOWARDS FULL MONETARY UNIFICATION . 192 CHAPTER 9: SUMMARY AND CONCLUSION .pg 196– 202 BIBLIOGRAPHY pg 203– 238 APPENDICES pg 239– 258 The Prospects for Monetary Integration in East Asia vi SUMMARY This thesis explores whether clusters of East Asian economies better suited for monetary union exist. To so, the thesis investigates the degree of similarity in economies and policies among East Asian economies, as a foundation towards a monetary union formation. The results in this study suggest that the prospects for forming a monetary union among any subsets of regional countries are not very promising at the current moment. This thesis is organized into three main parts. The first part provides the rationale for this study as well as the review of literature on monetary integration. The second part conducts the empirical tests in examining the suitability of regional economies for monetary union. The third part suggests policy implications arising from this study. Owing to the diversity of the East Asian economies, a practical approach towards monetary integration is to begin with smaller clusters. This thesis applies the Cluster Analysis technique to identify convergent groups of economies for Europe and the AsiaPacific based on the Maastricht convergence characteristics as a first premise for comparison. It then adds real and structural variables in clustering the heterogeneous economies of Asia-Pacific. The results suggest two consistent clusters of economies, including Malaysia and Thailand and to a lesser extent, Indonesia and Philippines, that are more convergent in their economic characteristics for the period under study. In the final analysis, no ‘champion’ cluster emerged that were consistently similar in their economic outcomes and policies as well as enjoy high trade intensity. A supplementary study employs the Structural Vector Autoregression approach to examine countries for monetary union based on the symmetry of shocks. The results indicated two sub-regional groupings of economies, namely Singapore and Malaysia, and Japan and South Korea, which had displayed greater symmetry of shocks, due perhaps to geographical proximity. However, the Variance Decomposition results indicated that underlying structural differences exist in the economies. Nevertheless, the symmetry of shocks is only a sufficient condition in the judgment towards monetary union. The Prospects for Monetary Integration in East Asia vii This thesis also clarifies the ‘endogeneity’ hypothesis, through the experience of a real world currency union in East Asia. There exists other important but less explicit preconditions that ensure the stability of currencies, which in turn lead to greater trade flows and a semblance of ‘endogeneity’. The thesis also completes the ‘endogeneity’ argument by discussing the balance of costs and benefits in joining a monetary union, especially among asymmetric members. Given that economic as well as political preconditions are currently lacking, this thesis suggests a gradual approach towards regional monetary integration in three broad stages. The first stage is to create a zone of external monetary stability due to increasing regional interdependence. The second stage is to harmonize clusters of convergent economies, and the third stage is to integrate these clusters towards a common currency area, once a sufficiently high degree of convergence and real economic integration is attained. The Prospects for Monetary Integration in East Asia viii LIST OF TABLES Table Title Page 4.1 Comparative Economic Indicators in main East Asian Economies over recent past (Ave, 1990-2000) 51 4.2 Direction of Trade within East Asia 54 4.3 Direction of Trade of East Asia (Imports plus Exports) 55 4.4 Exports by partner economy (Ave percent, 1990-2000) 56 4.5 Imports by partner economy (Ave percent, 1990-2000) 56 4.6 Total Trade by partner economy (Ave percent, 1990-2000) 56 4.7 Exchange rate arrangements in East Asia 61 5.1 Proximity Matrix for EU countries 75 5.2 Agglomeration Schedule for clustering of EU economies 76 5.3 Cluster membership of EU countries 79 5.4 Convergence Characteristics for Europe and East Asia 83 5.5 Proximity Matrix for Selected Asia-Pacific countries based on EMU characteristics 85 5.6 Agglomeration Schedule for Selected Asia-Pacific countries based on EMU characteristics 86 5.7 Cluster membership of Selected Asia-Pacific’s economies 86 5.8 Proximity Matrix on real and nominal indicators 92 5.9 Agglomeration Schedule on real and nominal indicators 92 5.10 Cluster membership based on real and nominal indicators 94 5.11 Group Statistics for Clustered Asia-Pacific Economies 97 5.12 Economic and Geographic Taxonomy of Asia Pacific Economies 101 5.13 Sensitivity Analysis: 1989-91, Agglomeration Schedule 102 5.14 Sub-period cluster membership (1989-91) 103 5.15 Sensitivity Analysis: 1992-94, Agglomeration Schedule 103 The Prospects for Monetary Integration in East Asia ix 5.16 Sub-period cluster membership (1992-94) 104 5.17 Sensitivity Analysis: 1995-97, Agglomeration Schedule 104 5.18 Sub- period cluster membership (1995-97) 105 5.19 Post-crisis Proximity Matrix (1998-2000) 106 5.20 Post-crisis Agglomeration Schedule (1998-2000) 107 5.21 Post-crisis period cluster membership (1998-2000) 108 5.22 Proximity Matrix in Economic Freedom, 1997 110 5.23 Agglomeration Schedule for similarity in 1997 Economic Freedom 111 5.24 Cluster membership for similarity in Economic Freedom, 1997 112 5.25 Proximity Matrix of Combined Variables 113 5.26 Agglomeration Schedule of Combined Variables 114 5.27 Cluster membership of Combined Variables 114 5.28 Proximity Matrix in Economic Freedom, 2001 115 5.29 Agglomeration Schedule in Economic Freedom Similarity, 2001 115 5.30 Cluster membership for similarity in Economic Freedom, 2001 116 6.1 Unemployment Dispersion in East Asia, 1992-1997 (percent) 121 6.2 Immigration Policy 122 6.3 Emigration Policy 123 6.4 Estimated Stocks of Foreign Workers in Some East Asian Economies 124 6.5 Labor Migration in East Asia, 1997 124 6.6 Openness of East Asian economies, Trade as percent of GDP 126 6.7 Exports Shares by SITIC Section (%) 127 6.8 Imports Shares by SITIC Section (%) 129 6.9 Production by broad industry, 1997 130 6.10 Similarity of Production and Industrial Structure 131 The Prospects for Monetary Integration in East Asia x 6.11 Correlations of supply disturbances 139 6.12 Correlations of real demand (IS) disturbances 140 6.13 Correlations of nominal demand (LM) disturbances 141 6.14 Variance Decomposition Results 142 6.15 Ranking of wage and price flexibility, 1996 148 7.1 Export Composition of Singapore and Brunei 154 7.2 Components generated by supply shocks & demand shocks 155 7.3 Brunei's Exports and Imports by Destinations 156 7.4 CPI Inflation rates (%) 157 7.5 Correlation of output and growth, 1974-1997 157 Chapter 3. Expression of vtgs Chapter 3. Expression of zebrafish vtg genes 85 Chapter 3. Expression of vtgs Abstract All seven zebrafish vitellogenin genes (vtg1-7) are predominantly expressed in female liver and can be induced in male liver by 17β-estradiol (E2). The level of vtg1 mRNA was about 100X and 1000X higher than those of vtg2 and vtg3 mRNAs, respectively, in the liver of female fish. vtg mRNAs were also detected in several non-liver tissues, but the expression level is generally [...]... objections for monetary integration The Prospects for Monetary Integration in East Asia 10 2.1.1 What is monetary integration? There is no generally accepted and standard definition of monetary integration in the literature The term monetary integration is broadly used to define a range of integration options, ranging from coordination to complete unification While incomplete forms of monetary integration. .. be explored going forward The Prospects for Monetary Integration in East Asia 9 CHAPTER 2 THE THEORY OF MONETARY INTEGRATION This chapter provides a review of the theory of monetary integration In so doing, the chapter identifies, defines, organizes and evaluates the literature Two popular perspectives have been used to assess the issue of monetary integration The first is based on the Theory of Optimum... an inspiration for monetary regionalism in other parts of the world, and especially for East Asia in our case It is indeed timely this thesis endeavors to investigate the prospects for East Asian monetary integration, given the significant developments in the international monetary scene This thesis seeks to provide a detailed study and analytical insight into some of the key issues concerning an East. .. content and direction of this thesis Chapter 2 reviews the theoretical literature of monetary integration, and deals predominantly with two approaches in examining this issue: the Theory of the Optimum Currency Areas, and 3 Pillay, S (1999) and Buenaventura (2001) The Prospects for Monetary Integration in East Asia 4 the Economics of monetary integration The theory of the Optimum Currency Areas (OCA)... economies for monetary union; Shed light on the existing preconditions and relevant state of affairs as well as; Suggest practical approaches towards prospective monetary integration in East Asia This study focuses mainly on the economic issues It seeks to answer the ‘what’, ‘why’ and ‘how’ of monetary integration in East Asia The ‘what’ refers to the varying forms of monetary integration, the ‘why’ includes... includes the background and evolving factors shaping the agenda, and the ‘how’ explores the practical possibilities towards achieving regional monetary integration, given the existing state of relevant affairs This thesis will also infer from the recent experiences of European monetary integration in drawing implications for policy issues of monetary integration in East Asia 2 See discussions in Bashar,... despite the shortcomings of the early theory of the OCA, the theory has however provided a simple checklist of criteria in assessing countries for monetary union Willett and Wihlborg (1999) also pointed out that in spite of the criticisms on the early OCA theory, the usefulness of this theory is not seriously undermined Therefore, intuitive insights from the theory of the OCA can still be drawn Finally, the. .. early theory of the OCA has provided important insights However, the framework for defining the ‘optimum’ currency area domain could be outdated and narrow The early theory of the OCA is incomplete in one important respect: the monetary criteria behind the motivation for the formation of currency areas The early OCA theory had dealt so intently with the ‘real’ criteria or the ‘real’ shocks affecting... requirements for a successful monetary union 7 Mongelli, F (2002) The Prospects for Monetary Integration in East Asia 25 According to this theory, if these conditions are satisfied, there is no need for a transition to monetary union (De Grauwe, 1997) However, in practice, the convergence of prospective members is important in the transition towards monetary union For instance, the lead-up to the European Monetary. .. regional monetary union could act as a deterrent against speculative attacks, due to the pooling of regional reserves 1 Dornbusch, R (1999) The Prospects for Monetary Integration in East Asia 2 The issue of an East Asian currency area would have been unthinkable a decade ago However, the Asian financial crisis in mid-1997 jolted the thinking of many policy makers and led some prominent figures (for e.g . for Monetary Integration in East Asia 9 CHAPTER 2 THE THEORY OF MONETARY INTEGRATION This chapter provides a review of the theory of monetary integration. In so doing, the. mainly on the economic issues. It seeks to answer the ‘what’, ‘why’ and ‘how’ of monetary integration in East Asia. The ‘what’ refers to the varying forms of monetary integration, the ‘why’ includes. Changes in demand factors 134 The Prospects for Monetary Integration in East Asia 1 CHAPTER 1 INTRODUCTION 1.1. MOTIVATION FOR STUDY Monetary integration in East Asia can