monetary economics

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Asian Monetary Cooperation：：：：Theory and Possibility
ZHAO Xijun , SONG Xiaoling
School of Finance Renmin university of China, Beijing, PR.China,100872
sxlhfr@sina.com
Abstract In this paper we attempt to make a comprehensive analysis of Asian monetary cooperation.
The intra-regional trade and investment, the degree of economic openness, the flexibility of wages and
prices in East Asian is high, meeting with the basic conditions to construct optimal currency area. When
considering the factor mobility, the interdependence of financial market, the level of economic
development, the economic structure and the likelihood of economic policy, we could find that there is
still a long way to regional monetary cooperation in East Asia. However, it is possible to establish some
sub-regional monetary cooperation.
Key words Asian Monetary Cooperation, Optimal Currency Area, Possibility
1 Introduction
After the 1997 Asian financial crisis, with their higher and higher degree of economic integration,
the Asian countries realized the importance of regional monetary cooperation and began to promote
Asian monetary cooperation. Study on the theory and Possibility of Asian monetary cooperation mainly
focused on exploring the cost of the Asian currency earnings, the most appropriate monetary areas,
operational mechanism, and so on. Foreign scholars, including Eiehengreen and Bayoumi (1996, 1999),
Lee, Park and Shin (2002), apply the optimum currency areas (OCA) theory to study on the possibility
of Asian Monetary Cooperation. Chinese scholars, Huang Meipo(2001) and Bai Dangwei(2002) use the
theory of Optimum Currency Areas to research the possibility of Asian monetary cooperation.Using
Bayoumi and Eichengreen’s OCAI approach for referrence, Wan Zhihong and Dai Jinping (2005)
constitute the regional OCAI model. These researches indicate that: On the whole, Asia doesn’t have the
conditions to construct optimal currency area, but it’s feasible to establish a Monetary Union in some
regions. However, up to now, a systematical summarize in the theory of monetary cooperation is in lack,
and the factors considered to promote Asian monetary cooperation are not comprehensive enough.
2. Theory and Possibility of Asian Money Cooperation1
The theory of monetary cooperation consists primarily of “the theory of Optimum Currency Area”,
“the theory of One Market One Money”, “the theory of ‘GG-LL’” and “the theory of some positive
methods”. According to all these theories, the demand for regional monetary cooperation is based on
economic conditions including the level of economic interdependence, regional trade and capital flow,
economic openness, factor mobility and the level of economic development.
2.1 The degree of Economic integration
Generally speaking, the degree of economic integration can be measured by the intra-regional trade
and investment, external economic openness, the factor mobility, financial market integration, and so
on.
2.1.1 The intra-regional trade and investment
As a whole, Asian economies are strongly complementary. The intra-regional trade and investment
is highly developed. At present, three regional trade areas have been formed within the East Asian
1
The Asian countries differ enormously in economy, politics, the culture, the religious, making it very difficult to
realize the entire Asian currency integration. The realistic consideration is first to impel East Asia (including
Southeast Asia) integration process. Based on such understanding, the study object of this paper is East Asia
(including Southeast Asia).

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region in the rough, namely, China area (including mainland China, Hong Kong, Macao and Taiwan),
Japan and South Korea area (including Japan, South Korea, North Korea), ASEAN (including the
six-nation ASEAN).From the trade structure of the three specific trade areas, it can be seen that, in the
China region and the ASEAN region, the proportions of their intra-regional trade to their total trade are
much higher (47.22%and 44.70%). However, in the Japan and South Korea area, the proportion of
intra-regional trade (17.07%) to its total trade is lower than those of China area and ASEAN area, but
has developed rapidly in recent years and with a tremendous growth potential. According to the
"ASEAN Statistical Yearbook 2004" data, the ratio of the trade within ASEAN area to the GDP has
grown from 11.1% (1980) to 43.5% (2003), an increase of nearly three times. With the data in ASEAN
plus that in Japan, the ratio reaches 71.6 %, even higher than EU level in the same period.
Compared with trade flows, the capital flows in Asia have shown a higher level of integration. The
proportion of intra-regional direct investment to its total direct investment is even higher than that of EU
and NAFTA area (Andreas, 2002). In such circumstances, if the direct investment in the Asian area
increase continually, to choose a common currency pegged exchange rate policy among countries will
be more propitious to attract foreign investment (Dobson, 2001). The continually strengthen of Asian’s
intra-regional trade and investment indicates that the degree of economic integration in Asia has
deepened. It demands a more stable exchange rate environment and creates basic conditions for
monetary and exchange rate cooperation.
2.1.2 Economic openness
Traditional method to Measure the economic openness degree is calculating the proportion of a
country's foreign trade volume to its GDP. However, with an increasingly growing of a country's
cross-border investment and financing, to weigh the economic openness degree of one country, it should
give full consideration to its integration degree of the trade, investment, finance, and other fields with
the world economy. In this paper, we use a comprehensive openness degree indicator to measure the
openness degree. The formula is: the Comprehensive openness degree = 1 / 3 × (international trade ratio
+ external and foreign direct investment ratio + external financial assets and liabilities ratio). In
accordance with the formula, the comprehensive openness degree of the European and East Asian
countries in 2000 is shown in table 1.
Table 1 The Comprehensive Openness Degree of Europe and East Asia (2000) (100 million US$, %)2
Countries (areas) GDP
International
Trade
External financial
assets and
liabilities
external and
foreign direct
investment
Comprehensive
Openness Degree
European 60.87%
Belgium 2 266 3 915.61 2 170.86 1 688.41 114.35%
UK 14 174 7 983.18 3 988.70 3 893.10 37.31%
France 12 948 7 249.86 2 297.60 2 126.50 30.05%
Holland 3 691 4 759.54 1 367.73 1 263.12 66.75%
Italy 10 740 5 970.15 1 372.81 252.50 23.57%
Ireland 953 1 673.57 1 590.72 267.61 123.50%
Germany 18 724 12 428.60 2 339.80 2 412.30 30.59%
East Asian 56.78%
China 10 800 5 302.49 186.24 393.15 18.15%
Japan 47 493 9 575.58 1 307.50 397.60 7.92%
Hong Kong 1 626 4 802.85 682.62 1 274.47 138.56%
Singapore 923 3 149.10 138.57 106.66 122.65%
Thailand 1 222 1 519.94 3.96 30.15 42.40%
South Korea 4 572 3 987.64 91.90 135.31 30.73%
Philippines 747 795.69 13.88 21.24 37.06%
Source: “International Financial Statistics Yearbook，2001”．
2
Note: When the data in Table converted to dollars, the annual average exchange rate is used.

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From Table 1, it can be seen that the average level of the comprehensive openness degree in the
East Asian areas is much higher, being closed to the European’s, but with a larger difference among the
country within the area. Among them, as a regional trade and financial center, Hong Kong and
Singapore have a much higher degree of openness. China and Japan have a lower degree of openness.
Basically belonging to open economy, Asian "Four Little Dragons" and the ASEAN countries have a
higher level of openness, which indicates that these countries are sensitive to economic fluctuations in
the exchange rate, so it is necessary to promote regional monetary cooperation, and maintain exchange
rate stability.
2.1.3 Factor mobility
East Asian countries are in an economic take-off and developing stage, and a lot of rural labor is
transferring to the city. With weak trade unions and high wages price elasticity, in view of keeping the
stability of the country and community, more often than not, these countries make more restrict with the
flow of labor factor. In addition, more restrictions on the flow of labor factor have been made from the
language, legal, cultural, political, and other aspects. In the role of these factors, the labor mobility in the
entire East Asian region is very low.
2.2 Similarity of economic development level and adaptability to external shocks
2.2.1 Similarity of economic development level
The level of economic development is the foundation of regional monetary cooperation. Although
the differences in level of economic development among Asian countries, especially East Asian
countries, are gradually narrowing, but in key economic indicators, there are still significant differences
(Table 2).
Table 2 major economic indicators of East Asian countries (regions) (2004)3
Countries (regions)
GDP (1
billion US$)
Per capita GNP
(US$)
*Deposit
rate (%)
Exchange rate
(against us$)
Inflation rate
(%)
China 1 591 1 230 2.0 8.28 4.00
* Hong Kong 157 25 860 0.1 7.77 -10.0
Singapore * 91 21 230 0.5 1.63 1.00
Malaysia 115 3 880 3.1 3.80 5.00
Philippines 83 1 060 5.2 56.27 13.00
Indonesia * 208 1 360 10.6 9 290.00 28.00
Thailand * 143 2 190 1.3 39.06 7.00
Japan * 4 301 34 180 — 104.12 -2.00
South Korea * 605 12 030 4.3 1 035.10 15.00
2.2.2 The similarity of policy objective
The inflation rate is an important indicator to assess the similarity of policy objective in various
countries. Through comparing the average inflation rate of the East Asian countries (regions) in two
consecutive decades (1984-1993, 1994-2003), it can be found that, there is a clear difference in the
control of inflation of the East Asian countries (regions), which has brought more difficult for the
establishment of the unified currency policy coordination.
2.2.3 The flexibility of Wages and prices
Generally speaking, the higher the price elasticity of wages, the stronger the ability to adjust to
external shocks, thus it will be more easy to implement regional monetary cooperation. The social and
economic situation in the region has decided its higher wages price elasticity. First of all, being a
developing area with a higher growth rate, East Asian area's process of industrialization is going with a
great labor transfer from rural to urban. The transfer not only meets the huge demand for labor in the
process of industrialization, but also ensures the sufficient flexibility of the labor market. Secondly, in
East Asian countries and regions, the minimum wage law, employment protection law and other
regulations are usually not been set, thus the basic wage level is determined by the relationship between
3
Notes: * For Data in 2003.

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supply and demand of the labor market. Lastly, compared with European and American countries, the
strength of trade unions in Asia countries is weak, and the unemployment insurance system is not sound,
resulting in the not so strong wage rigidity.
2.3 Optimal Currency Area index
Referring the OCA index approach of Bayoumi and Eichengreen , Wan Zhihong, Dai Jinping
(2005) calculate the OCA index in East Asia area in 1996 and 2000, conclude that: after the Asian
financial crisis, the East Asian region has undergone significant changes in the OCA index and the cost
of the East Asian monetary cooperation has increased. The small regional open economies generally
show a lower OCA index, demonstrating a lower cost in and thus relatively optimal to promote
monetary cooperation. As a whole, the East Asian members have great differences in the conditions of
monetary cooperation. The possibility of currency cooperation among small open economies is higher,
and among big size countries is quite difficult.
3．．．．Conclusion
The intra-regional trade and investment, the economic openness degree, the flexibility of wages
and prices in East Asian is higher, meeting with the basic conditions of constructing optimal currency
area. When considering factor mobility, similarity of economic development, policy targets and other
aspects, we could find East Asia doesn’t possess the conditions of constructing optimal currency area,
and such a conclusion is also supported by the OCAI test. Therefore, in sum, there is still a long way to
regional monetary cooperation in East Asia, and it will need even more time to introduce the single
currency. But, it is possible to establish some sub-regional monetary cooperation including China
monetary region, ASEA monetary region and Japan-Korea monetary region. At last, East Asia would be
able to establish a Monetary Union like the EMU after a long-term hard working.
References
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currency area index perspective. Guangdong social sciences, 2005(3)
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region.the social sciences Literature Publishing House, 2003:20-23
[3]Bayoumi, T, B. Eichengreen. Ever closer to heaven? An optimum currency area index for European
countries. European Economic Review, 1997: 761-770
[4]Mckinnon, Ronald I.Optimum currency areas and the European experience.Economics of Transition,
2002: 343-364.
[5]Mundell, Robert A. A theory of optimum currency areas.American Economic Review, 1961 657-665