PROSPECTS FOR MONETARY
INTEGRATION IN ASEAN
Submitted by Carlos José Ferreira Cortinhas, to the University of Exeter as a thesis for the degree of Doctor of Philosophy in Economics, March 2007.
This thesis is available for Library use on the understanding that it is copyright material and that no quotation from the thesis may be published without proper acknowledgement.
I certify that all material in this thesis which is not my own work has been identified and that no material has previously been submitted and approved for the award of a degree by this or any other University.
Abstract
In the past two decades, a new resolve for both increased economic integration and monetary and exchange rate cooperation has started to emerge in ASEAN, most notably since the 1997-1998 Asian financial crisis. This thesis addresses the question of whether there are sufficient economic reasons to justify such a move.
The first chapter presents an historical overview of the integration process in ASEAN to date and the main motivations for the study. The following two chapters present a review of the main theory (Chapter II) and empirical works (Chapter III) on optimum currency areas and present the basis for the remainder of the study.
The fourth chapter investigates whether structural shocks among ASEAN countries are becoming more symmetrical over time, thus verifying whether this region is becoming better prepared to introduce a common currency.
The fifth chapter studies the degree of relative price adjustment in ASEAN by providing a study on the degree of exchange rate pass-through into domestic prices, using the distribution chain of pricing. This study includes, for the first time, all five founding members of ASEAN (ASEAN5) and draws inferences on their suitability for further monetary cooperation.
The sixth chapter researches whether the recorded increase in intra-ASEAN trade is moving ASEAN members towards closer economic integration by applying a new panel data methodology.
To Rebecca, whose love, support, help and encouragement have kept me going all this time.
Acknowledgements
I am greatly indebted to my supervisors John Maloney, Malcolm Macmillen and Nigar Hashimzade of The University of Exeter for their consistent support and encouragement and for always finding the time to give timely comments and useful suggestions along several versions of these chapters.
I would also like to thank Francisco Veiga and Miguel Ângelo of The University of Minho and Cherif Guermat of The University of Exeter for their valuable comments and suggestions on Chapter VI.
Table of Contents
Page List of Tables 8 List of Figures 10 Abbreviations 11 Chapter I - Introduction 131.1 The Genesis of ASEAN 13
1.2 ASEAN Free Trade Area (AFTA) 14
1.3 Cooperation or Integration for ASEAN? 17
1.4 ASEAN Monetary Cooperation? 19
1.5 Asian Financial Crisis 20
1.6 Final Remarks and Motivation for the Study 22 Chapter II - Overview of Exchange Rate Regimes 27
2.1 Introduction 27
2.2 The Exchange Rate Spectrum 27
2.3 Flexible Vs Rigid Exchange Rates: A Reminder 34 2.3.1 Flexible Exchange Rates Systems 34 2.3.1.1. Are Exchange Rates Excessively Volatile? 35 2.3.1.2. What is the Equilibrium Exchange Rate? 36
2.3.2 Rigid Exchange Rates Systems 38
2.4. A Brief Survey of OCA Theory 41
2.4.1 Mundell’s Contribution: Labour (and Capital) Mobility 42 2.4.2 Why Does the Size and Openness of an Economy Matter? 43 2.4.3. Professor Kenen’s Contribution: Production Diversity (and Economic Development), Symmetry of Shocks and Fiscal
Transfers 43
2.4.4 Price and Wage Flexibility 44
2.4.5 Financial Market Integration 45
2.4.6 Other Criteria 46
2.5 The OCA Theory: What Have We Learned? 47 Chapter III-Optimum Currency Areas: A Survey of Recent Empirical Works 49
3.1 Introduction 49
3.2 A Survey of Selected OCA Empirical Studies 49 3.2.2 Empirical Studies on Asymmetry of Shocks 51 3.2.2.1 Asymmetry of Output Movements 52
3.2.2.2 Regional/Industrial Specialisation 54 3.2.3 Empirical Studies on Mechanisms of Adjustment to
Asymmetric shocks 56
3.2.3.1 Empirical Studies on Labour Mobility 56 3.2.3.2 Empirical Studies on Fiscal Federalism 58 3.2.3.3 Regional and International Risk-Sharing and
Consumption Smoothing 60
3.2.3.4 Empirical Studies on Relative Prices 62 3.2.4 Empirical Studies using an “OCA index” 63 3.3 Empirical Studies on OCA: What Have We Learned? 66 Chapter IV - Asymmetry of Shocks and Convergence in Selected Asean
Countries: A Dynamic Analysis 68
4.1 Introduction 68
4.2 Empirical Methodology 70
4.3 Data and Results 71
4.3.1. Correlation of Shocks 72
4.3.2 Size and Speed of Adjustment of Shocks 74 4.3.3 Constant Parameter Estimation Results 76 4.3.4 Time-Varying Parameter Estimation Results 77
4.4 Concluding Remarks 80
Chapter V - Exchange Rate Pass-Through in ASEAN 81
5.1 Introduction 81
5.2 Data and Empirical Methodology 87
5.3 Results 88
5.4 Sensitivity Analysis 93
5.5 Final Remarks 94
Chapter VI - Intra-Industry Trade and Business Cycles in ASEAN 96
6.1 Introduction 96
6.2 Data, Empirical Methodology and Results 99
6.3 Final Remarks 106
Chapter VII - Conclusions 108
Appendix A: ASEAN Statistics 113
Appendix B: Description of the Clarida and Gali (1994) Methodology 117
Appendix C: Derivation of the Kalman Filter 120
Appendix E: Additional Data and Results 125 Appendix F: Description of the Industries Included in the Import Unit Value
Index 132
Appendix G: Impulse Response Functions 133
Appendix H: Unit Root Tests 140
Appendix I: Raw Data 141
List of Tables
Page Table 1: Alternative Exchange Rate Arrangement Classifications 28 Table 2: Exchange Rate Arrangements: Examples and Main Characteristics 32 Table 3: Exchange Rate Arrangements in ASEAN5 33 Table 4: Exchange Rate Arrangements in ASEAN10 33 Table 5: Fixed vs. Floating: Main Advantages and Costs 40 Table 6: Main Optimum Currency Area Criteria 47 Table 7: The Relationship between Some Selected (OCA) Variables and the
Probability of Adoption of Flexible Exchange Rates 50 Table 8: Correlation of Structural Shocks in ASEAN – 1968-2004 (excluding
1997 and 1998 73
Table 9: Size and Speed of Adjustment of Structural Shocks 75 Table 10: Convergence of ASEAN5 Countries with their Partners as opposed to
the USA 79
Table 11: Accumulated Responses after 2 periods in ASEAN5 90 Table 12: Accumulated Responses after 2 periods in ASEAN5 (variables in US
dollars) 91 Table 13: Intra-Industry Trade and Business Cycles in ASEAN – Model (4) 101
Table 14: Hansen Tests to the Validity of the Instruments of Model (4) 101 Table 15: Intra-Industry Trade and Business Cycles in ASEAN – Model (5) 104 Table 16: Estimations for Model (5) with Year Dummies as Instruments 104 Table 17: Estimations for (5) using Alternative Combinations of 4 of the
ASEAN5. 105 Table A-1: ASEAN Trade Flows (1990-2003): Average Growth Rates 114
Table A-2: ASEAN Trade Pattern: Percentage of Total (world) Trade 1990, 1997,
2003 115 Table E-1: Unit Root Test Results for the First Difference of the Log of Real
GDP, CPI and REER Time Series. Data Range: 1968-2004 125 Table E-2: Correlation of Structural Shocks in ASEAN – 1968-2004 125 Table E-3: Convergence of ASEAN5 countries with their Partners as Opposed
to the USA - Constant Parameter Estimation of β (OLS) – Period: 1968-2004 126 Table E-4: Convergence of ASEAN5 Countries with their Partners as Opposed to
the USA - Constant Parameter Estimation of β (OLS) – Period: 1968-2004
Table E-5: Convergence of ASEAN5 countries with their Partners as Opposed to the USA - Time Varying Parameter Estimation of β (OLS) – Monetary
Shocks - Period: 1968-2004 129
Table E-6: Convergence of ASEAN5 Countries with their Partners as Opposed to the USA- Time Varying Parameter Estimation of β (OLS) – Demand Shocks
- Period: 1968-2004 130
Table E-7: Convergence of ASEAN5 Countries with their Partners as Opposed to the USA - Time Varying Parameter Estimation of β (OLS) – Supply Shocks
- Period: 1968-2004 131
Table F-1: Description of the Industries included in the Import Unit Value Index
(imp) 132 Table G-1: Accumulated Responses after 2 periods in ASEAN5 – Annual and
Quarterly Data 139
Table H-1: Fisher Test for Panel Unit Root on Variable IIT in Levels 140 Table H-2: Unit Root Tests for all Individual IIT Series in First-Differences 140 Table H-3: Unit Root Tests for all Individual Series of Depended Variable of (5) 140 Table I-1: Annual Real Gross Domestic Product 141 Table I-2: Annual Consumer Price Index (1995=100) 142 Table I-3: Annual Real Effective Exchange Rates 143 Table I-4: Annual Nominal Effective Exchange Rates 144 Table I-5: Annual Consumer Price Index (2000=100) 145
Table I-6: Annual Import Unit Values Index 146
Table I-7: Quarterly Data used in Section 5.4 147 Table I-8: Grubel-Lloyd Intra-Industry Trade Indexes 150 Table I-9: Geodesic Distances between Asean Countries 152
List of Figures
Page Figure 1: The Exchange Rate Arrangement Spectrum 29 Figure 2: Correlation and Size of Structural Supply Shocks with Malaysia 76 Figure A-1: Total Trade (Exports plus Imports) of ASEAN countries 1990-2003 113 Figure A-2: Total Trade of ASEAN5 Versus ASEAN10 countries 1990-2003 113 Figure E-1: Convergence of Indonesia to ASEAN as Opposed to the USA: β
Coefficients: (1968-2004, excluding 1997-1998) 127 Figure E-2: Convergence of Malaysia to ASEAN4 as Opposed to the USA: β
Coefficients (1968-2004, excluding 1997-1998) 127 Figure E-3: Convergence of Philippines to ASEAN4 as Opposed to the USA: β
Coefficients (1968-2004, excluding 1997-1998) 127 Figure E-4: Convergence of Singapore to ASEAN4 as Opposed to the USA: β
Coefficients (1968-2004, excluding 1997-1998) 128 Figure E-5: Convergence of Thailand to ASEAN4 as Opposed to the USA: β
Coefficients (1968-2004, excluding 1997-1998) 128 Figure G-1: Accumulated Impulse Response of Import Prices to the Exchange
Rates Shock 133
Figure G-2: Accumulated Impulse Response of Relative CPI to the Exchange
Rate Shock 134
Figure G-3: Accumulated Impulse Response of Exchange Rates to the Import
Prices Shock 135
Figure G-4: Accumulated Impulse Response of Exchange Rates to the Relative
CPI Shock 136
Figure G-5: Accumulated Impulse Response of Import Prices to the Relative CPI
Shock 137 Figure G-6: Accumulated Impulse Response of Relative CPI to the Import Prices
Shock 138 Figure G-7: Accumulated IRFs using Different Choleski Orderings and Impulse
Definitions 139 Figure G-8: Accumulated IRFs using Different De-Trending Methods 139
Abbreviations
ADB Asia Development BankADF Augmented Dickey-Fuller AEC ASEAN Economic Community AFTA ASEAN Free Trade Area AMF Asian Monetary Fund
APEC Asia Pacific Economic Community APMF Asia Pacific Monetary Fund
ARIC Asia Regional Information Centre ASEAN Association of Southeast Asian Nations ASEM Asia Europe Meeting
CEPT Common Effective Preferential Tariff CPI Consumer Price Index
EIV Error in Variable
EMU Economic and Monetary Union ERM Exchange Rate Mechanism EU European Union
FEER Fundamental Equilibrium Exchange Rate FTAA Free Trade Area of the Americas
GDP Gross Domestic Product HP Hodrick-Prescott
HPA Hanoi Plan of Action
IAI Initiative for ASEAN Integration IFS International Financial Statistics IIT Intra-Industry Trade IL Inclusion List
IMF International Monetary Fund IMP Import Unit Value Index
IRF Impulse-Response Function
JSEPA Japan-Singapore Economic Partnership Agreement LCP Local Currency Pricing
MFG Manila Framework Group
NEER Nominal Effective Exchange Rate OCA Optimum Currency Area
OECD Organization for Economic Co-operation and Development OLS Ordinary Least Squares
PCP Producer Currency Pricing PP Phillips-Peron PPI Producer Price Index
PPP Purchasing Power Parity
PTA Preferential Trading Arrangements REER Real Effective Exchange Rate
RIA Roadmap for the Integration of ASEAN SITC Standard International Trade Commodity SVAR Structural VAR
TSLS Two-Stage Least Squares USD US dollar