1
Working Draft Only
Regional Economic Surveillance and Financial Governance in East Asia:
Knowledge, Interests and Policy Dialogue
By Helen E S Nesadurai
Institute of Defence and Strategic Studies
Nanyang Technological University, Singapore
Paper prepared for the
Conference on Regionalisation and the Taming of Globalisation,
26-28 October, Scarman House
University of Warwick, UK
Regional Economic Surveillance and Financial Governance in East Asia:
Knowledge, Interests and Policy Dialogue
Working Draft
By Helen E S Nesadurai
1. Introduction
Regional financial cooperation in East Asia has registered significant advances since the 1997-98 Asian financial crisis. Notable financial cooperation projects are the Chiang Mai Initiative (CMI), which is a regional liquidity facility aimed at supporting currencies in crises while the Asian Bond Market Initiative (ABMI) aims at putting in place the necessary infrastructure to support the development of national bond markets now seen as important in diversifying countries’ financial systems. Both projects were launched under the auspices of the ASEAN+3 regional grouping. The 13-member ASEAN+3 grouping is taken to be the institutional embodiment of the East Asian region.[1] A third initiative is the launch by the East Asian central bankers’ network, EMEAP,[2] of two regional bond funds, which have the potential to help channel the region’s considerable savings for use within the region.[3] These three initiatives are indicative of a greater desire within the East Asian region to embrace new capabilities in regional financial governance. They are viewed as key elements in an emerging regional financial architecture targeted at both crisis management (the CMI) and crisis prevention (bond market/funds), with the capacity to contribute significantly to regional financial stability (Henning, 2002: Kawai, 2004; Kuroda and Kawai, 2004).
What remains under-developed, however, is a credible regional economic surveillance mechanism. Regional surveillance mechanisms, like surveillance processes in general, aid in the maintenance of financial stability by helping governments to internalise the spillover effects of national policy decisions and internal economic developments through the exchange of information (Crockett, 1987), by issuing early warnings of impending crisis points within national economies (Manzano, 2001: 94) and by using peer pressure on policymakers from vulnerable countries to ‘pursue corrective policies’ (De Brouwer and Wang, 2004a: 4). This is especially important in settings characterised by macroeconomic and financial interdependence. According to recent research, macroeconomic interdependence and market-led financial integration have been growing in the East Asian region, thereby underscoring the importance of regional surveillance.[4] Economists also emphasise the importance of regional surveillance to the development of an effective regional liquidity facility like the CMI.[5] Effective surveillance can help reduce the risks posed to contributors to the funding pool by countries that follow questionable economic/financial policies, thereby alleviating disincentives to CMI expansion.
For advocates of regional surveillance mechanisms, their main advantage lies in being better able to monitor their regional neighbours, especially important in the presence of significant contagion effects (Chang and Rajan, 2001), and more importantly, ‘to exert mutual informal pressures to comply with external mandates’, especially through social sanctions (Girardin, 2004: 55-56). Regional surveillance mechanisms are also believed to be necessary given the existence of regional differences in analytical perspectives and diagnoses of each region’s problems (Montiel, 2004: 13). East Asia’s growing macroeconomic and financial interdependence reinforces, therefore, the adoption of an East Asian regional surveillance mechanism. Nevertheless, the region is home to more than one regional surveillance mechanism, each representing a different configuration of region. The Manila Framework Group (MFG) established in November 1997 (but dissolved in November 2004) has been closely associated with the Asia Pacific Economic Cooperation forum (APEC),[6] while the Association of Southeast Asian Nations (ASEAN)[7] established the ASEAN Surveillance Process (ASP) in October 1998. The surveillance mechanism of the ASEAN+3 grouping is officially named the Economic Review and Policy Dialogue (ERPD) process, and was established in May 2000. Of these three, regional governments have devoted considerable attention to the ASEAN+3 surveillance mechanism, which is also said to be the more advanced in terms of its technical content and in its policy dialogue or peer review process (Rana, 2005).[8]
Despite the advances made in ASEAN+3 regional surveillance, many scholars writing on East Asian regional financial cooperation are not optimistic that the ASEAN+3 governments will be able to develop a sufficiently robust regional surveillance mechanism (Park and Wang, 2005: 96). The problem area is said to be the peer review process, with governments lacking the ‘political will’ to engage in ‘frank discussions about domestic policy issues and problems’ (De Brouwer and Wang, 2004a: 7) and especially to discipline governments through peer review to adopt the necessary corrective policy measures once vulnerabilities have been identified and to adhere to sound macroeconomic and financial policies (Park and Wang, 2005: 96). To put differently, the primary stumbling block to effective regional surveillance is the absence of an enforcement mechanism.
While acknowledging the point that governments’ unwillingness to criticise their peers could undermine regional surveillance, this paper puts forward the argument that a ‘technical or knowledge gap’ also poses a barrier to regional surveillance. These knowledge gaps arise from the perceived ‘subjectivity’ of the economic or technical analysis that lies at the centre of surveillance processes. Drawing on insights from the IPE literature on money and finance, in particular, the notion of ‘ambiguous economics’ by Jonathan Kirschner (2003a & b), the paper suggests that within a rather broad grey area, it may be difficult to identify precisely the sources of economic vulnerabilities in countries participating in the surveillance exercise and the required corrective policies, particularly those that stem from microeconomic or sectoral policies. As I show in Section 3, this can prevent shared agreement among the participants in the surveillance process on what constitutes risky practices and the appropriate corrective policies to adopt.
The presence of ‘ambiguous economics’ further challenges what scholars have identified as a key component of an effective surveillance mechanism – a [peer] review process that requires the recalcitrant party to be persuaded or disciplined to adopt the necessary corrective measures identified by the surveillance process. This problem of the ‘knowledge gap’, thus, also undermines the prospects for adopting more stringent enforcement mechanisms able to ensure corrective measures are taken on identification of risky or defective policies. Even though participants in the surveillance process may be unwilling to embrace more intrusive peer review processes, even a limited peer review process offers the possibility for some form of social sanction to be applied in the event a country is guilty of imprudent domestic policies that risk regional financial and economic stability due to contagion effects. For instance, ‘shaming’ effects may be likely to operate when participants meet frequently in other regional forums and engage in other cooperative activities.[9] However, when the accuracy and objectivity of technical analyses and assessments is itself challenged, social sanctions through peer pressure have far less of a chance of asserting their effects.
These insights raise questions about what an effective surveillance mechanism should encompass. If these dynamics centred on the ‘ambiguous economics’ problem are prevalent, then we need to rethink the benefits of regional surveillance, and perhaps lower expectations about what such exercises can achieve. Section 4 examines the East Asian case, especially but not exclusively the ASEAN+3 surveillance process, against these theoretical insights for initial answers to these questions. Before engaging in this exercise, the paper first outlines the common features that many economists have suggested are vital in ensuring an effective East Asian surveillance mechanism.
2. What Constitutes an Effective Regional Surveillance Mechanism?
From the extensive writings on regional surveillance mechanisms, three elements are deemed crucial to their effectiveness. The surveillance process must be able to identify weaknesses and vulnerabilities in national economies, set appropriate policy targets and recommendations, and ensure implementation of the suggested policy advice (Girardin, 2004: 54). The three specific activities following from these three goals that are central to effective surveillance are: (a) information collection; (b) analysis and assessment with a view to identifying vulnerabilities and recommending corrective policies; and (c) policy dialogue and peer review to ensure corrective measures are indeed adopted.
The technical components: information collection, analysis and assessment
Accurate information on a range of economic and financial indicators is a crucial first task, with common data templates important for inter-country comparisons, facilitating the construction of regional models for assessing vulnerabilities, including early warning systems, and formulating the appropriate policy response. Information on broader sectoral, corporate, political and social indicators as well as on major institutional and legal changes is often recommended for deeper understanding of the overall resilience of individual countries (Girardin, 2004: 84-86). A key aspect of information sharing is, of course, transparency – the willingness of national authorities to provide the data and information needed for surveillance. Surveillance can, in fact, fail because countries are unwilling to disclose adequate, timely and so-called sensitive information to the surveillance process (Manzano, 2001: 97). Information sharing is, thus, deemed to be the first task when establishing a regional surveillance mechanism.
Economic surveillance cannot, however, be limited to the mere observation of economic indicators – it requires assessment of the economic, financial and sectoral policies of member countries (Wang and Woo, 2004: 431). While the peer review process is often held out to be crucial to effective surveillance, technical discussions and the quality of information collected has also been emphasised (Manzano, 2001: 97; Kuroda and Kawai, 2004: 157). In fact, this is a crucial task, as faulty analyses have in the past undermined the quality of the response to financial crisis (Goldstein and Calvo, 1996: 258). Numerous tools are available to support this process, including financial market stress indicators, macro-prudential indicators, and early warning models. Some economists suggest quantitative models, for instance, the early warning systems, as useful tools for assessing and predicting crises, although these models are not without their limitations (Manzano, 2001: 98-99; Wang and Woo, 2004: 434). In the end, most are agreed that having a range of indicators and analytical tools is useful to provide more comprehensive analyses of the economic and financial health of participating countries.
The political component: peer review
The third component of any effective [regional] surveillance mechanism is the review process. For many observers, this is where the political obstacles to surveillance lie. Although accurate information and timely warnings provided by a variety of analytical tools may be available, ‘surveillance can still fail because political considerations prevent the appropriate policy response from being exercised’ (Manzano, 2001: 98). This was, in fact, found to have been the experience of the IMF in its bilateral surveillance of member countries (Crow at al, 1999). Even in Asia, IMF advice to Thailand to review its exchange rate peg before the July 1997 collapse of the Thai baht failed to elicit a corrective policy response. In regional surveillance, peer review is an important mechanism through which governments of neighbouring countries are to be persuaded to alter risky policies and practices. Even though the technical components of surveillance may be of superior quality, surveillance is only as effective as its peer review process by which participating members are able to convince ‘offending’ governments of problem areas within their economies and persuade them to adopt corrective measures.
The peer review component of regional surveillance can range from the most simple – joint discussion of surveillance reports – to stronger mechanisms that employ carrots and sticks to influence behaviour. While simple information exchange is the weakest form of surveillance, discussion of surveillance reports in a joint forum provides greater opportunities for peer pressure to be exerted to persuade countries to adopt corrective measures or to dissuade them from a path that is perceived to be harmful to the region (Montiel, 2004: 7). Nonetheless, such processes are still considered by some to be a form of information coordination, albeit with the information flowing in two directions – countries provide information on their circumstances and future policies and receive feedback from other countries. Similar to the G-8 policy discussions, this type of coordination is said to be directly relevant to addressing the problem of regional contagion. A stronger mechanism is one that adopts carrots and sticks as a means through which participating countries collectively influence the behaviour of individual countries in the group (Montiel, 2004: 8). Such processes are said to be important in supporting reserve pooling activities since they allow the monitoring of borrowers as well as their disciplining by denying them the benefits of the reserve pool.
In fact, delegated or third party monitoring is advocated for surveillance associated with regional liquidity mechanisms, replacing the role of peer pressure through information exchange and policy dialogue in regional forums (Girardin, 2004: 87). Economists have proposed that the third party agent not only prepare the surveillance report (including early warnings), but also identify emerging issues and vulnerabilities affecting the region and offer policy advice on corrective measures (Kuroda and Kawai, 2004: 157). Some scholars even advocate making public these policy recommendations to reinforce through financial market monitoring and market discipline the pressure exerted by the third party surveillance agent (Girardin, 2004: 87; Wang and Woo, 2004: 437). In addition, a credible punishment mechanism has also been suggested as an integral part of regional surveillance (Wang and Woo, 2004: 438). In short, effective regional surveillance cannot be structured in ways that allow its participating members to ‘shop around and take decisions unilaterally without being subject to external pressure’ (Girardin, 2004: 58).
It is not surprising then that scholars point to the preoccupation of the ASEAN countries especially with the principle of non-interference in members’ internal affairs as the most likely barrier to the development of effective regional surveillance (Girardin, 2004: 74; Kuroda and Kawai, 2004; Amyx, 2004: 7-8). Collecting quality information and developing robust technical assessments of countries’ economies and identifying their vulnerabilities are generally regarded as ‘technical’ problems, not necessarily less important to the development of effective surveillance but considered to be more tractable than the political constraints that undermine the peer review process, and consequently, the effectiveness of regional surveillance. The paper suggests that this is a limited view of the constraints to regional surveillance. It misses the political economy of what may be termed ‘knowledge or technical gaps’ that could well pose an additional or possibly even the primary barrier to regional surveillance.
3. The View from IPE: Ambiguous Economics
The notion of ambiguous economics highlighted by Jonathan Kirshner (2003a: 651-57) offers us analytical leverage in identifying additional barriers to developing effective surveillance. Kirshner argues that there is a range of economic policy choices that a country can plausibly follow that should be sustainable when judged on the basis of economic theory. He cites a number of examples in support of this view. He points to the limited theoretical evidence that the pursuit of low inflation or the complete deregulation of capital flows are the most efficient practices. Moreover, empirical evidence that inflation undermines growth comes from episodes involving very high levels of inflation, while the costs of moderate inflation are apparently very difficult to establish. By drawing on a number of economic studies on inflation, he suggests that it is extremely difficult to uncover any real economic costs of inflation below 20 per cent, and certainly below 10 per cent.
Likewise, there are sound deductive reasons to accept that some form of capital controls might actually constitute efficient economic practice, a point that a number of economists including Jagdish Bhagwati (1998) have acknowledged. Another practice commonly regarded as sound policy – central bank independence – similarly leads to ambiguous economic outcomes. While central bank independence is associated with lower inflation rates, economists have apparently found little evidence that it is associated with enhanced economic performance. Moreover, financial crises can occur even when governments pursue ‘sound’ economic policies, due to the peculiar dynamics of present-day financial markets centred on hyper-mobility and herding behaviour (Blyth, 2003).
Kirshner’s discussion on ambiguous economics highlights three key points. First, economic theory is sometimes indeterminate with respect to the choice of policy as well as the target of certain economic indicators, inflation for instance. This does not suggest that authorities can do pretty much what they like – there are policy choices and policy outcomes that are inherently unsustainable economically as well as politically, and thus are not viable options. However, the notion of ambiguous economics suggests that there is likely to be a range of policy options and policy targets that should be sustainable, at least from the perspective of economic theory. A second point to note is that some policy choices are adopted simply because sufficient people believe them to be efficient, while other choices are rejected because of the common, though erroneous belief that they are unsustainable. The trend towards central bank independence and the embrace of complete capital mobility have been cited as examples. Third, markets often result in policy conformity across states through the beliefs that powerful market actors hold, which may not necessarily be suited to the diverse economic conditions of many countries.
These three points drawn from Kirshner’s discussion of ambiguous economics are important to understanding the political dynamics of regional surveillance. Given that a central task that economists have suggested for an effective surveillance mechanism is the identification of unviable policy choices and economic vulnerabilities as well as the formulation of corrective policy recommendations, the indeterminacy associated with economic theory suggests that such an exercise may run into problems. As already noted, countries may be able to operate within a fairly wide though not unbounded range of policy options. Interpretations of the correct economic policy may well differ amongst the different members of the surveillance process, including those undertaking the economic assessments.