Asian economy and finance : a post-crisis perspective

Asian Economy and Finance

Innovations in Financial Markets

and Institutions

Editor:

Mark Flannery

University of Florida

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Cottrell, A.F., Lawlor, M.S., Wood, J.H.:

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Initial Public Offerings: Findings and Theories

Anderson, S., and Born, J.:

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Banking Structures in Major Countries

England, C.:

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Hancock, D.:

A Theory of Production for the Financial Firm

Gup, B.:

Bank Mergers: Current Issues and Perspectives

Asian Economy and Finance

A Post-Crisis Perspective

Dilip K. Das

Dilip K. Das

2869 Battleford Road

Mississauga

Ontario L5N 2S6

Canada

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To Vasanti,

my true north.

There is a time for being ahead,

a time for being behind;

a time for being in motion,

a time for being in rest;

a time for being vigorous,

a time for being exhausted;

a time for being safe,

a time for taking risk.

The Master sees things as they are,

without trying to control them.

She lets them go their own way,

and resides at the center of the circle.

— from Tao Te Ching

CONTENTS

Preface xiii

Acknowledgments xxi

About the Author xxiii

1. ASIAN ECONOMY: THE HERITAGE 1

1.1 Past is Prelude to the Future 1

1.2 Alternative Historical Perspective on Asian Economy 2

1.3 Economic Linkages and Interactions in the Second Millennium 4

1.3.1 First Half 4

1.3.2 Second Half 7

1.4 Quantitative Dimensions of Growth 8

1.5 Past Trends in Trade 12

1.5.1 Intra-Regional Trade 13

1.5.2 Global Trade 16

1.6 Industrial Revolution and Its Aftermath 18

1.7 Asian Economic “Miracle” of the Post-War II Era 21

1.8 Summary and Conclusion 23

2. ECONOMIC DIVERSITY IN ASIA 27

2.1 Heterogeneity 27

2.2 High-Performing Economic Sub-Groups 28

2.3 Regional Economies and Economic Groupings 33

2.4 Japan—the Domineering Regional Economy 36

2.5 Contrasting the Two Populous Giants 43

2.5.1 China 44

2.5.2 India 52

2.5.3 Why India Lagged Behind China? 59

2.6 Newly Industrialized Asian Economies 60

2.7 Southeast Asian Economies 65

2.8 Post-Crisis Performance 68

2.9 Summary and Conclusions 71

x Contents

3. MARKET-DRIVEN REGIONALIZATION IN ASIA 77

3.1 Introduction 77

3.2 Trends in Intra-Regional Trade and Investment 79

3.2.1 Market-Driven Regionalization 80

3.2.2 Intra-Regional Trade 82

3.2.3 Is Trade Growing More Intra-Regional? 84

3.2.4 Intra-Regional Production Networks 86

3.3 Impact of Other RIAs on the Asia-Pacific Economies 89

3.4 Need for Regional Co-operation in the Aftermath of the Crisis 93

3.5 Impediments to Regionalization 94

3.6 Conclusions and Summary 95

4. CONTEMPORARY INITIATIVES IN INSTITUTIONALIZED

REGIONAL INTEGRATION 101

4.1 Regional Integration and the Global Economy 101

4.2 Agglomeration or Clustering Effect 105

4.2.1 Industrial and Sectoral Specialization in an RIA 107

4.2.2 Foreign Direct Investment and RIAs 108

4.2.3 Welfare Implications 110

4.3 Institutionalized Regional Economic Integration 116

4.3.1 Formation of ASEAN 117

4.3.2 Formation of ASEAN Free Trade Area 119

4.3.3 Common Effective Preferential Tariff Framework 121

4.3.4 Impact of Common Effective Preferential Tariff 123

4.3.5 ASEAN’s Contribution to Regional Integration 124

4.3.6 ASEAN Economic Community 2020 126

4.4 ASEAN-Plus-Three Grouping 127

4.4.1 Exploring the Future Potential 130

4.5 Asia-Pacific Economic Co-operation Forum 131

4.5.1 Consequences of Trade and Investment Liberalization 134

4.5.2 Economic and Technical Co-operation 136

4.5.3 APEC’s Contribution to Regional Integration 137

4.6 Bilateral Trade Agreements 139

4.7 Summary and Conclusion 141

5. TRADE, COMPETITIVENESS AND FOREIGN INVESTMENT

AND THE LINKAGES AMONG THEM 147

5.1 Outer-Orientation: The Strategic Stance 147

5.1.1 Adopting Outer-Orientation 148

5.1.2 Global Capital Flows 150

5.1.3 Role Played by TNCs 153

5.1.4 Interaction between Trade and FDI 154

Contents xi

5.2 Trade Performance 155

5.2.1 Trade and Economic Growth Nexus 156

5.2.2 Export Deceleration and the Asian Crisis 158

5.2.3 Emerging Trade Triangle 160

5.3 Growing Cohesion in Trading Pattern 162

5.4 Competitiveness in Global Market Place 165

5.4.1 Quantifying Competitiveness 166

5.4.2 Strengthening Competitiveness 168

5.4.3 Liberalized Policy Stance and Competitiveness 170

5.5 Regional Trends in FDI 172

5.5.1 Medium-Term Prospects 175

5.5.2 Outward FDI Flows 176

5.5.3 Centripetal Forces in China 178

5.5.4 Is China Eating ASEAN’s Lunch? 180

5.6 Integrated Production Networks and Refinement of

Comparative Advantage 182

5.6.1 Need for Integrated Production Networks 183

5.6.2 Splitting the Value Chain 184

5.6.3 Expanding Opportunities 184

5.7 Outsourcing in ICT and Business-Process Services 186

5.7.1 Igniting Protectionism: Squaring the Circle 188

5.8 China’s WTO Accession and its Regional Ramifications 189

5.9 Summary and Conclusion 192

6. FINANCIAL SECTOR DEVELOPMENT: STRUCTURE,

INSTITUTIONS AND MARKETS 201

6.1 Financial Sector: Chink in the Asian Armor 201

6.2 The Quality Continuum 203

6.3 Financial Market Structure and Country Classification 205

6.4 Carrying out Financial Market Development 207

6.5 Banking Sector 208

6.5.1 Ascertaining the Dominance 210

6.5.2 Foreign Banks 211

6.5.3 Non-Performing Loans 212

6.6 Intermediate Financial Structure 214

6.7 Bond Markets 215

6.7.1 Bond Market Developments in the Pre-Crisis Period 216

6.7.2 Bond Market Developments in the Post-Crisis Period 218

6.7.3 Market Limitations 220

6.7.4 Market and Institutional Upgrading 221

6.8 Regional Bond Market 223

6.8.1 Facilitating Market Growth 225

xii Contents

6.8.2 Managing Foreign Exchange Reserves to Support

Bond Markets 226

6.9 Equity Markets 227

6.9.1 Origin of Equity Markets in China 230

6.10 Risk Management 231

6.10.1 Credit Risk Management 234

6.10.2 Market Risk Management 235

6.10.3 Operational Risk Management 235

6.11 Conclusions and Summary 236

7. POST-CRISIS REGIONAL ECONOMIC CO-OPERATION

AND THE EMERGING FINANCIAL ARCHITECTURE 241

7.1 Realistic Dimension of the Asian Crisis 241

7.1.1 Manila Framework Group 244

7.1.2 ASEAN Surveillance Process 245

7.1.3 New Miyazawa Initiative 245

7.1.4 Asian Growth and Recovery Initiative 246

7.1.5 Asian Monetary Fund 247

7.1.6 Other Smaller Proposals and Initiatives 249

7.2 Launching the Chiang Mai Initiative 250

7.2.1 Belated Multilateral Acceptance 252

7.3 Multilateral and Bilateral Swap Arrangements 253

7.4 Future Challenges for the Chiang Mai Initiative 256

7.5 Pros and Cons of Institutionalized Regional Co-operation 259

7.6 Predilection for a Regional Financial and Monetary Institution 261

7.7 Augmenting Foreign Exchange Reserves Holdings 263

7.7.1 Adequacy of Foreign Exchange Reserve Holdings 264

7.8 Monetary and Central Banking Co-operation 266

7.9 Evolution of Exchange Rate Regimes 268

7.9.1 Synchronizing Exchange Rate Regimes 270

7.9.2 Post-Crisis Correction in Exchange Rate Regimes 271

7.10 Lessons from the EU Experience 273

7.11 Monitoring and Surveillance 276

7.12 Summary and Conclusions 280

Bibliography 287

Index 307

PREFACE

“When westerners think of Asia, they mostly think of dollar signs. And with good reason.

Call them tigers or dragons, write of thunder in the east or a shining India, whichever

imagery you prefer, the Asian economic miracle is exactly that. Across half the world, in a

few short decades, hundred of millions of people have been lifted out of abject poverty by

a combination of hard work, good policies and benefits of open trade. Yes, there have been

problems—remember the Asian financial crisis?—but the truly remarkable thing is how

quickly most of the Asian economies have bounced back from them. This year, yet again,

it is in Asia that the world’s fastest growing economies are to be found.”

The Economist. 24 April 2004

“That Other Miracle” p. 10.

Topicality of Asian economy has refused to fade for almost four decades; if any￾thing it has been levitating. The Asian economy has changed markedly since

the economic and financial crisis of 1997–98 and is continuing to evolve. As

a scholarly subject matter, Asian economy has not stopped attracting academi￾cians, policy mandarins and decision makers in the arena of business. Although

Asia includes all the economies in the arch stretching between Afghanistan and

North Korea, Asia in this book is defined to include the ten dynamic Asian

economies, namely, China, Hong Kong SAR, Indonesia, Japan, Republic of

Korea, Malaysia, the Philippines, Singapore, Taiwan and Thailand. Majority

of these economies are widely acknowledged to be the high-performers of the

post-war era. Although these dynamic Asian economies do not form a formal

regional or sub-regional group, all of them except Taiwan are included in the

ASEAN-Plus-Three (APT) grouping. The APT concept was born in the latter

half of the 1990s.

References and comparisons to other economies like India and those in

Indochina have been made wherever necessary and relevant. The reason for ex￾cluding the South Asian economies is that over the preceding four decades, they

never became a part of the vibrant and high-performing Asian economic sce￾nario. For starters, they attempted a wrong route to economic growth and indus￾trialization, namely import substitution. This group of Asian economies did not

seem highly committed to the objective of economic growth and consequently

xiv Preface

remained mired in low and uninspiring growth and poverty. Although there

have been some improvements, their large, inefficient and corrupt government

systems kept them at a low-level economic equilibrium.

To be sure, a country-by-country approach for examining the Asian economy

has its convenience and advantages, but such disaggregation misses out on the

basic unity and integrity of the regional economic entity. Therefore, without

decrying or ignoring the former analytical approach, this book takes the regional

approach, in both temporal and spatial terms. Asia has been conceptualized as

a region, which comprises contiguous countries, which in turn are remarkably

interdependent over a range of dimensions. These dimensions have evolved, and

would continue to evolve, over time. Indubitably, we discover that the whole is

greater than the sum of its parts. This is the principal benefit of following this

approach. Pursuing this approach of analysis presents a new perspective on the

regional dynamics across time and space.

Unprecedented growth rates in Asia during the post-war era have been the

focal point of enormous scholarly analysis. Economists from the academia and

professional worlds delved into the hows and whys at length and produced a

small library of literature on these and related issues. Asian economies were

fondly referred to as the “miracle” economies, which epitomized virtues of

the capitalist system, although this capitalism was different from the capital￾ism of the Western world in several ways. Well-known strengths of the Asian

economies were their macroeconomic and political stability, openness to trade

and investment, high domestic savings and investment rates, emphasis on hu￾man capital development and disciplined work force, and lastly pragmatism,

expediency and goal-orientedness in general economic policy structure. Asian

economies need to preserve and build on these strengths of the past. This is not

to imply that they were free of blemishes and imperfections.

The Asian crisis was a cataclysmic event for the region and brought to

the surface several systemic limitations, like those in the financial sector, cor￾porate governance, regulatory oversight, legal framework, and exchange rate

management. Managers of Asian economy need to get to the bottom of these

acutely problematical systemic issues. Additionally, in keeping with the Latin

maxim tempora mutanture, nos et mutamur in illis, Asian economies need

to change with the demands of time and devise their post-crisis development

strategy.

Asia’s growth model that served it so well for four decades is overdue for

renewal so that it can re-strengthen its bonds with the ever-evolving regional

and global economic reality. Well-known total factor productivity (TFP) studies

illustrated that economic growth in Asia was driven by input growth or factor

accumulation, not by productivity or efficiency growth (Kim and Lau, 1994;

Young, 1994, 1995). Asia’s growth model was castigated for being factor input￾based. No matter how you sliced it, the charge seemed correct, although its

Preface xv

consequence in terms of welfare growth was nothing but favorable for the Asian

economies. In a short time span, the dynamic Asian economies developed into

world’s most resilient ones as well as highly successful traders.

The old growth model is likely to be less relevant and effective in the post￾crisis future of the Asian economies. It is sure to run into the wall of diminish￾ing returns. As globalization progresses, freer trade, financial and technology

flows would make the global economy more competitive than ever. Asia would

face numerous regional and global challenges in a globally integrating world

economy, which would call for a different growth strategy from the past. At

the regional level, the economic performance and relationship of Japan with

neighboring Asia, China’s economic emergence as a regional economic pow￾erhouse and keen and robust competitor as well as a promising market, brisk

growth in the four East Asian economies and a changing and challenging re￾gional economic environment for the Southeast Asian economies are among the

important factors that would shape the economic landscape of the immediate

future in Asia.

The Asian currency and financial crisis of 1997–98 gave a rude jolt not only

to the so-called “miracle” economies but also to the region. These dynamic

economies were hit by the crisis and prompted the largest financial bail out

in history. However, after experiencing a sharp contraction in GDP growth,

the five crisis-affected economies and the region moved on to a recovery tra￾jectory rapidly. The Asian crisis brought to the fore copious shortcomings in

the areas of financial structure and markets, corporate governance, regulatory

institutions, legal framework, exchange rate management, policies related to

financial inflows and exchange rate management and social protection. Pal￾pably, these systemic weaknesses were needed to be overcome without delay.

Some progress has been made in this direction, although this work is far from

complete.

For the purpose of evolving a new, post-crisis, growth strategy, Asian

economies need to make concerted endeavors in the policy areas of finan￾cial sector and other institutional reforms, technological innovation, and with it

investment in knowledge-intensive sectors and R&D. While rapid growth in the

past was based on resource accumulation and input-based, the future growth

calls for the creation of an environment of innovation and intensive R&D.

That is, the factor-intensity-based growth model needs to be replaced with a

technology-based and productivity-driven paradigm of growth. The competi￾tiveness issue needs to be addressed both at macro- and microeconomic levels

(Chapter 5). Asian economies need to move up the product value-chain and

extend their reach into the services sector. This could not only put Asia back on

its high perch as the most dynamic region in the world, but also speed the tran￾sition of many Asian economies into the ranks of mature industrial economies.

Korea was accepted into the eminent membership of the Organization for

xvi Preface

Economic Co-operation and Development (OECD). Several more dynamic

Asian economies would be candidates for joining OECD in the foreseeable

future. To this end, they need to change their strategic gear, which would not be

difficult for the open and competitive Asian economies. They can devise and

launch into the new strategy from a position of strength, with adequate supply of

resources, and manufacturing skills, albeit in the post-crisis period they have to

be aware of their macroeconomic errors, financial missteps and the shortcom￾ings of their educational, financial and research infrastructures and business

services.

Various facets of Chinese economy have been provided a special niche in this

book. The reasons are, for one, the course that the Chinese economy took after it

adopted the “open door policy” in December 1978 is of enormous significance

to China, Asia and the global economy. The economy has been on a monotonic

ascent since that point in time in the Chinese economic history and has been

evolving into a world-class economy. Second, in the late nineteenth century the

United States emerged as a major industrial and economic power. A century

later, it was China’s turn to do the same. This period of China’s economic history

can be compared to Japan in the 1960s and 1970s, when it emerged as a major

economic power and the second largest global economy. Third, China has come

to acquire a singular place in the regional economy. Intra-regional trade and

investment as well as creation of integrated production networks made China an

important economy for the other dynamic Asian economies. Fourth, considered

with Hong Kong SAR and Taiwan, the greater China is an economic presence

to reckon with. Fifth, although China is not a member of the exalted Group-of￾Seven (G-7) or the significant OECD group of economies, in a short span of

time it has joined the small number of economies that have global significance.

With Japan suffering from recessions and a prolonged deflation, China played

the “locomotive” role in Asia. In Chapter 5, I try to establish that vertiginous

expansion of Chinese economy should be a boon to the neighboring Asian

economies, not a bane. In the newly emerging county grouping like the APT,

endeavors like Chiang Mai Initiative or creation of any other similar regional

public good, China’s role has far-reaching ramifications.

Perpetuating the folklore of Asian economic growth is not the objective

of this book. It takes an objective and dispassionate view and delves into the

constructive and favorable side as well as adverse and unfavorable side of the

Asian economy. The deficiencies and imperfections have not been overlooked.

As few analyses of the post-crisis economic scenario in the Asian economy with

a forward-looking emphasis are available, this book intends to provide that.

Although for covering the post-crisis scenario it does deal with the overture

to the crisis and the principal developments leading up to it in the pre-crisis

period.