Speech

"Asia’s Economic Integration: A Driver of Global Growth in the 21st Century" by Naoyuki Shinohara, Deputy Managing Director, International Monetary Fund

November 20, 2012

As Prepared for Delivery

Thank you. It is a great pleasure and honor to be here in the presence of so many distinguished leaders.

Today, I would like to share our thoughts on Asia’s changing role in the world and how its economic integration can be a driver of global growth in the 21^st century.

Specifically, let me talk about three things:

• One, the opportunities and challenges that face Asia today.
• Two, the importance of trade integration.
• Three, the importance of financial integration.

Let me start with some basic observations. The sands of the global economy are shifting to the East. Asia has been, and will remain, a global growth leader. Because of the reform measures taken to strengthen policy frameworks and economic fundamentals in the aftermath of Asian financial crisis, Asia’s economy is now much more stable and resilient. For 2013 we project Asia’s growth to be close to 6 percent—2 percentage points more than the global average.

The long-term trends are clear. In less than two decades, Asia’s economy should be larger than that of the United States and the European Union combined.

So, we are optimistic about Asia’s future. But that does not mean that everything is fine for Asia. There are a number of potential roadblocks along the road:

• First, the hazardous “middle-income trap”—the risk that development can take you so far, but no further. Many Asian economies are reaching the tipping point at which many countries suffered sustained growth slowdowns.
• Second, pressures from rising income inequality and rapidly aging populations. If not managed properly, these pressures could strain the social fabric.
• Third, the need to rebalance growth. Asia has achieved phenomenal success with its outward-oriented growth model, relying on demand from advanced economies in the West. But that demand is no longer assured, which means Asia needs to rely more on its own people to fuel growth.

So today, I would like to focus on the following questions: How can further trade and financial integration strengthen Asia and make growth more inclusive and sustainable in the face of demographic change? And how can integration in Asia help the world by promoting global growth and economic rebalancing?

Let me start with the trade side. The degree of Asian trade integration is already very high. The most striking trend in Asia’s rise as the world’s leading source of exports has been the growth in intraregional trade. While global trade and Asia’s trade with economies outside the region have doubled since 2000, intra-Asian trade has tripled, and regional trade involving emerging Asia has increased even faster.

Asian economies increasingly have formed a supply network, with China taking the role of an assembly hub for final goods exports, notably consumer goods. For the rest of Asia, the share of intermediate goods exports to China in total exports has doubled over the last decade, and the share of direct consumer goods exports to the United States and Europe has steadily declined. In other words, direct exports to advanced economies have been replaced by indirect exports via China.

At the same time, China’s role as a regional trade hub is changing in important ways. China’s current account surplus has declined from a pre-crisis peak of over 10 percent of GDP in 2007 to around 3 percent of GDP in 2011. But this decline is coming from too much reliance on investment, not from the needed shift to consumption.

Still, we expect China to rebalance from investment to consumption. This will provide important opportunities and challenges for the rest of Asia. For a start, Asian trading partners that have benefitted from investment-led growth in China might face adverse consequences. By contrast, getting a foothold in the Chinese consumer goods markets could offer lasting benefits for Asian trading partners.

As the China example makes clear, reaping the rewards of further trade integration means promoting access to final goods markets. Harmonizing the investment regime further will also be important as rising wages in Mainland China are providing greater incentives to shifting production to ASEAN’s frontier developing economies. In this context, the formation of the ASEAN Economic Community in 2015 offers the opportunity of creating a larger common market.

But it cannot be just Asia. So regional arrangements must go hand-in-hand with multilateral trade liberalization and not just on trade in goods either. For example, plans for the Trans-Pacific Partnership also have a strong focus on liberalizing trade in services.

While trade integration has pushed ahead, financial integration has lagged behind—especially for ASEAN economies, which are typically less integrated with their peers than with global financial hubs in the United States, Europe, and Japan. Just look at ASEAN cross-border portfolio investment flows—more than 90 percent of transactions are with advanced economies outside Asia. Asia does not appear to be investing in itself.

Greater regional financial integration could offer significant benefits. First, it would give countries a wider range of instruments and financial assets to insure against shocks and smooth consumption. Second, it would strengthen domestic demand—say by reducing incentives for precautionary savings in China or removing credit constraints on small service sector firms in some of the ASEAN countries. And improved access to financial services, especially by small and medium-sized enterprises or rural households, can also help reduce income inequality.

However, as the global financial crisis has taught us, greater financial integration also comes with risks. This is especially true when financial regulations and supervision and international coordination of surveillance frameworks do not keep up with financial development and integration.

What about the issue of sizable and potentially volatile capital flows? While views on short-term capital flow and macroprudential measures are evolving, longer-term picture is clear: capital inflows into Asia can help growth and rebalancing. The issue is making sure they go to the right place—supporting long-term development rather than just short-term profits. For this to happen, long-term investment into Asia should be made more attractive—for example by lowering restrictions on foreign investment in the services sector, by harnessing private-public partnerships for infrastructure investment, and by promoting financial market development. In this regard, the integration of ASEAN stock markets would help, as would a large regional bond market as envisaged by the Asian Bond Market Initiative.

Lastly, allow me to conclude by saying that going forward, deeper economic cooperation and integration, if well managed, will not only help Asia strengthen its domestic engines of growth—it will also set the path for Asia’s economic leadership in the 21^st century and sustain growth across the world.