The current European crisis has highlighted the policy mistakes that were made in the process of European financial and monetary integration. It has exposed major deficits in the eurozone’s institutional framework, including insufficient macroeconomic policy coordination and the lack of a crisis response mechanism (which then had to be negotiated in the midst of crisis). One of the major failures that led to the current European predicament was that national and European policymakers allowed the build-up of huge macroeconomic imbalances within the eurozone. Wages and prices in southern “periphery” countries (with Ireland being an honorary member of the south) rose much more quickly than in the northern “core” countries such as Germany. The resulting loss of economic competitiveness of the periphery countries has led to a growth crisis that fed into a sovereign debt crisis after government finances were severely strained during the global financial crisis.
There is no question that the (political) decision to allow Greece—a country with grave governance problems (Faust and Volz 2012)—to join the euro was a serious and very costly mistake. It is also questionable whether Portugal should have entered the eurozone. Yet the current crisis was avoidable: had Ireland regulated its financial sector more prudently and hence avoided the bubble of its banking sector it would not be in trouble today. Had Spain applied macroprudential regulation to contain the property bubble that destabilized the banking system after it burst in 2008, its problems today would be less dire. Had today’s crisis countries carried out structural reforms and adjusted internally in time, they would not face severe competitiveness problems today. If only…
The crisis in Europe provides important lessons for East Asian countries. In a recent paper (Volz 2012), I highlight five lessons for regional financial and monetary cooperation and integration in East Asia.
The first relates to monetary integration in East Asia. While the arguments in favor of regional monetary and exchange rate cooperation in East Asia—as made for example by Kawai (2010)—remain valid and strong, the European crisis has illustrated once again that any fixed exchange rate arrangement (including monetary union) is prone to crisis if countries do not adjust their economies internally and imbalances are allowed to grow too large. East Asian countries should therefore steer clear of overambitious monetary and exchange rate integration schemes, since these are likely to backfire and lead to crisis. Instead, they should pursue a very gradual approach to monetary integration that will allow for much flexibility and room for adjustment. Managed floating regimes guided by currency baskets are one way of keeping relative intra-regional exchange rate stability while avoiding the dangers of fixed, rigid arrangements.
Second, the European crisis has highlighted once again that international financial integration will not automatically lead to an efficient allocation of capital, as predicted by neoclassical theory. East Asian countries, many of which still maintain partial capital controls, should consider carefully which types of capital flows may be beneficial for their long-term development, and which may not be. Given that financial institutions engaging in cross-border activities increase systemic risk and pose a serious regulatory challenge, financial markets should not be liberalized too quickly. For instance, the countries of the Association of Southeast Asian Nations (ASEAN) should proceed very carefully when working toward their declared goal of allowing a “freer flow of capital” (ASEAN 2008: 6) as part of building a single market and production base across ASEAN by 2015.
Third, East Asian countries should work on developing and strengthening a regional crisis prevention and resolution mechanism before the next crisis hits the region. Although considerable progress has been made with the Chiang Mai Initiative Multilateralization (CMIM), which has been complemented by regional surveillance agency, the ASEAN+3 Macroeconomic Research Office (AMRO) in April 2011, further efforts are needed to make the CMIM fully functional. The agreement by ASEAN+3 deputy finance ministers at the end of March 2012 to double the CMIM from US$120 billion to US$240 billion was a move into the right direction. The so-called IMF link, which allows member countries to draw only 20% of the agreed amounts without an IMF program, and which has thus far prevented the CMIM from becoming fully effective, also needs to be reviewed.
Fourth, the European crisis has shown again that crises can spread quickly among closely integrated economies, either through trade, finance, or both. A regional approach (to complement global efforts) to volatile capital flows is needed, with better surveillance of East Asian financial markets. East Asian countries should first strengthen the newly created AMRO, which needs much larger resources to allow it to carry out meaningful macroeconomic and financial market surveillance. A further step would be to establish an Asian Financial Stability Dialogue as proposed by ADB President Haruhiko Kuroda (ADB 2010).
Last but not least, financial authorities must respond swiftly and decisively to banking crises with rapid recapitalization of banks. Europe has set a negative example in this respect, allowing the banking crisis of 2008 to feed into a sovereign debt crisis, which in turn has further increased the fragility of the banking system. To avoid making the same mistake, East Asian countries should put in place adequate resolution procedures and recapitalize banks swiftly once the banking system is in trouble.
Sooner or later a crisis will hit East Asia again. With a stronger regional financial architecture, it will be much easier to cope with.
ADB. 2010. Institutions for Regional Integration: Toward an Asian Economic Community. Manila: Asian Development Bank (http://www.adb.org/documents/books/institutions-regional-integration/institutions-regional-integration.pdf ).
ASEAN. 2008. ASEAN Economic Community Blueprint. Jakarta: ASEAN Secretariat (http://www.aseansec.org/5187-10.pdf ).
Faust, J. and U. Volz. 2012. Greece—A Crisis of Governance. Europe’s World, 6 February (http://www.europesworld.org/NewEnglish/Home_old/PartnerPosts/tabid/671/PostID/2890/TheCurrentColumnGreeceACrisisofGovernance.aspx ).
Kawai, M. 2010. An Asian Currency Unit for Asian Monetary Integration. In The Future Global Reserve System— An Asian Perspective, edited by J.D. Sachs, M. Kawai, J.-W. Lee and W.T. Woo. Manila: ADB (http://aric.adb.org/grs/papers/Future_Global_Reserve_System.pdf ).
Volz, U. 2012. Lessons of the European Crisis for Regional Monetary and Financial Integration in East Asia. ADBI Working Paper No. 346, Tokyo: ADBI (http://adbi.org/files/2012.02.21.wp347.lessons.european.crisis.east.asia.pdf ).