Speech

Mitsuhiro Furusawa, Deputy Managing Director, IMF

Tokyo, March 3^rd, 2016

As Prepared for Delivery

Good morning, ladies and gentlemen, and let me welcome you to this conference, co-hosted by Hitotsubashi University and the IMF. I would like to first thank our friends at Hitotsubashi, who together with our regional Office of Asia and the Pacific, have made this event possible.

Seminars like this, where we share cutting-edge ideas and policy perspectives, is an important part of what the IMF does. Our main presence in Asia, the OAP manages and organizes several capacity-building events, including a scholarship program for junior officers from Asia, seminars, and high-level conferences like this one to foster policy dialogue. Over the years, all these events have been generously financed by the government of Japan, for whose continued assistance we remain grateful.

We are here today to discuss economic integration in the region—where we stand, where we are headed, and what we should do to make the most of it. This remains an important issue, as multilateral economic integration has been a backbone of Asia’s growth, with efforts ongoing to promote further trade as well as financial integration. It is imperative to design these measures such that benefits are maximized, while keeping potential vulnerabilities as low as possible.

Integration: Where Does Asia Stand?

The region has come a long way in terms of economic integration, helped by many successful rounds of multilateral trade agreements that have reduced barriers.

Within the region itself, we have seen much progress, with many countries in Asia participating in complex trade networks—what we call the global value chains (GVCs). While the rise of GVCs is a global phenomenon, we have seen them really flourish among Asian emerging market economies, particularly within the Association of Southeast Asian Nations (ASEAN) and, of course, China.

GVCs comprise fragmented production processes, with components crossing numerous international borders before being finalized. Over the last two decades, the region’s trade in intermediate goods has grown by a factor of six, while trade in final goods grew by about four times. This compares to fourfold and threefold increases, respectively, in the rest of the world.

Participation in the GVCs—this new pattern of production—has not only increased trade in these Asian economies, but has also improved the quality of their production technologies. Indeed, many countries in the region now produce highly sophisticated goods that could not have been produced earlier. Korea and Singapore provide good examples of this “moving up the value chain” phenomenon in electronic goods. More recently, China has been expanding its market share in numerous sophisticated products. And trade has certainly helped these countries grow faster, with populations benefiting in turn.

Such integration brings not only benefits, but also increased exposure to external shocks. Recently, trade has slowed, with this decline particularly pronounced in the last year. Many Asian countries have been hit hard. One reason for this is the slowdown in import demand from China, due to slower investment growth. And given these GVCs, the decline in import demand in China has been reflected in weaker exports among participants in this process, many of which are Asian countries. Anticipated economic slowdown in China, coupled with expected internal rebalancing away from investment to consumption, can also be expected to affect these countries.

In addition to the GVCs, Asia has also seen rapid growth in the number of regional trade agreements. Late last year, the ASEAN Economic Community (AEC) launched its Blueprint 2025, building on achievements of its earlier Blueprint 2015, which was finalized in 2007. These, and other more recent initiatives, have tried to go beyond tariff reduction. New trade agreements, such as the recently concluded Trans-Pacific Partnership that involves many Asian countries, have focused on new areas, including regulatory convergence and reforms in product and labor markets.

Can we have too many regional trade agreements? Overlapping sets of trade agreements—each comprising different subsets of members—could give rise to a ‘noodle bowl’ of regulations and rules of origin. Beyond the usual considerations of trade creation and diversion, these overlaps could generate additional costs, which risk undermining benefits of trade integration. In this seminar, I look forward to hearing your perspectives on how the undeniable benefits from trade can be balanced against these potential costs. Perhaps you have useful country experiences to share.

In addition to trade, Asia has made important strides in the area of financial integration as well. A move in large measure motivated by the Asian financial crisis of 1997-98, significant steps have been taken since then—regional liquidity support arrangements through the Chiang Mai Initiative Multilateralization, the Asian Bond Fund, and the Asian Bond Market Initiative. Additionally, ASEAN has outlined plans to foster capital market integration, including by building capital market infrastructure and harmonizing regulations. Regional authorities continue to have discussions at other financial forums as well.

Underlying these developments is a belief that, if managed well, financial integration will bring important benefits, including higher productivity and living standards, not the least by improving the allocation of savings and investment. In particular, it could help direct the large savings of aging populations in some countries toward high-return projects in dynamic economies with significant investment needs.

However, despite its rapid growth, the degree of financial integration within Asia remains relatively low. While about 60 percent of Asia’s exports and imports occur within the region, only 20 to 30 percent of cross-border portfolio investment and bank claims are intraregional.

What has financial integration in Asia not been even deeper? For one, home bias is particularly strong in Asia, limiting cross-border financial transactions within the region. Also, the size and sophistication of financial systems in many countries seem to matter for financial integration. Restrictions on foreign asset holdings, informational asymmetries, barriers to foreign bank entry, and differences in regulatory and institutional quality create obstacles to financial integration.

Where Does Asia Go From Here?

Asian economies have long been held as examples of facilitating growth via trade. Specialization and allocations based on comparative advantage, arising from trade liberalization and integration, have lifted many boats in this region. The GVCs are an interesting example of the continued importance of the idea of comparative advantage, with countries specializing in producing different stages of the same good.
Further integration could come via additional reforms in traditional trade policy measures, such as tariff and non-tariff barriers. But, in many cases, these are now already very low. Promoting integration in new areas—electronic commerce, trade in services, and regulatory coordination—could be the new frontier. When product markets are already well-integrated, turning to integrating factor markets—labor via migration, and capital via cross-border investments—could generate further benefits.

What form should this integration take—multilateral or regional? Can regionalism be a building block or a stumbling block to a globally welfare-enhancing multilateral liberalization. An argument could be made that comprehensive, well-designed regional trade agreements could be useful, particularly when progress at the multilateral level is slow. On the other hand, while regionalism could lead to a multi-speed approach to trade integration, proliferation of regional trade agreements could also risk fragmenting the multilateral trading system.

Turning to financial integration, initiatives to advance Asian policymakers’ agenda toward deeper regional integration could include steps to further promote financial market development and trade linkages, while reducing informational asymmetries through increased financial disclosure and reporting requirements. Lowering regulatory barriers to capital movements and foreign bank entry, as well as harmonizing regulation, especially for investor protection, contract enforcement, and bankruptcy procedures, appear particularly important.

These are indeed big issues, and policies undertaken could have big impacts. Over the next two days, I look forward to hearing your perspectives—what works, what doesn’t; what considerations are important. And what lessons from your own experiences are worthwhile for others. This will be a good learning experience for us all.

Thank you very much.