A Study On The Economic Feasibility Of A Common Currency Area In East Asia

The growth of regional integration agreements has been one of the major developments in international relations in the past few decades; the European Union in Europe, the Common Market of the South in Latin America, the North American Free Trade Agreement, the Western African Economic and Monetary Union, and the Economic and Monetary Community of Central Africa are just a few examples of this trend. These regional integration agreements range in breadth and depth, covering both developed and developing countries and ranging from loosely connected, trade-centered groups to highly coordinated economic and monetary unions.In East Asia, regional integration began with the establishment of the Association of Southeast Asian Nations (ASEAN) in1967, consisting of only five countries. Forty-five-year after its establishment, ASEAN has expanded to ten countries and has developed partnerships and entered into dialogue with a number of other countries. The process of ASEAN Plus Three (APT) cooperation was initiated in1997. Since then, they have made concerted efforts to promote financial cooperation, trade facilitation, labor movement, and environmental and sustainable development. The pursuit of economic integration in East Asia is due to a variety of factors, including growing economic interdependence, slow progress in multilateral talks under the WTO framework, the popularity and success of regional groupings elsewhere, and the lessons learned from the1997-98Asian financial crisis. With the broadening and deepening of regional cooperation, the proposal for an East Asian common currency area has received much attention from economists around the world.This paper explores the feasibility of an East Asian common currency area and achieves three objectives.First, the paper reviews both the traditional principles of Optimum Currency Area and its recent developments, including the "endogeneity hypothesis" and the specialization theory. While traditional theory focuses on the criteria for cost-versus-benefit analysis, including degree of openness, labor mobility, and symmetry of shocks, before countries join a common currency bloc, recent developments in Optimum Currency Area theory emphasize the aftereffects of integration. The "endogeneity hypothesis" argues that increased trade after adopting a common currency could induce greater synchronization of business cycles, while the specialization theory argues the opposite, that convergence may be reduced due to the specialization effects of integration.Second, the paper incorporates all three arguments and applies them to East Asia. Using recent data from1981to2010, the paper argues that an East Asian common currency area is feasible. From the lens of traditional Optimum Currency Area theory, it is evident that East Asia experienced rising trends in intra-regional trade, FDI flows and labor movements, a great part of which has been market-driven as a result of intra-regional production chains. In return, these trends contributed to greater output and price co-movements among economies. In comparison with the Eurozone of the1980s, East Asia has demonstrated a similar level of intra-trade and output correlations, both of which are positive signs for deepening monetary cooperation in East Asia.In our tests of the "endogeneity hypothesis" and the specialization theory, the results demonstrate a positive link between intra-trade and business cycles synchronization in ten East Asian economies. The increased intra-trade is also accompanied by a rising degree of intra-industry trade. Due to the emergence of a production chain, with advanced countries in the upstream and less-developed ones downstream, we can expect a larger effect of trade creation than diversion as the regional integration intensifies.Third, the paper gives recommendations on transitional arrangements. It explores the options for a common currency in East Asia and suggests the use of a common internal currency basket-the Asian Currency Unit (ACU)-as a parallel currency for transaction and exchange rates coordination. Based on the current progress on regional Free Trade Agreements (FTAs), Currency Swap Agreements, and monitoring systems, we suggest that East Asian countries1) accelerate the development of FTAs and Asian Bond Market Initiative (ABMI) among APT,2) improve the effectiveness and independence of the Chiang Mai Initiative Multilateralization (CMIM) framework,3) set up surveillance mechanisms for exchange rates coordination and fiscal discipline, and4) carry out domestic financial reforms with the aid of cooperative projects.Ultimately, this paper argues that an East Asian common currency bloc is economically feasible, but it is only half of the story. Regional integration is as much a political process as it is an economic one, and it often results from many different and interactive forces. While economic obstacles could be overcome through market-driven forces and institutional efforts, political and socio-cultural differences are not as easy to bridge. While the paper believes that a common currency area is the ultimate goal, it calls for gradualism and a step-by-step multi-track approach. Deepening economic integration should be accompanied by equal efforts on the political and socio-cultural fronts. A common currency bloc in East Asia may take a long time to achieve, but this paper hopes to shed some light on the process as it moves forward.