Regional Economic Integration in East Asia: Challenges and Responses

1. Before Answering “What is to be Done?” Let Us Determine Where We Are Josef T. Yap Philippine Institute for Development Studies (PIDS) 22 July 2005

2. Existing Global System Capital U.S. ASIA Demand for goods Investment

3. Core Issue: “The dollar is our currency but your problem.” Richard Nixon At the time the dollar was taken off the gold standard, 1971

4. External Risks • US has many structural problems: CA deficit reached record high 5.7% of GDP in 2004, large fiscal deficit, extremely low national saving rate, rapid household debt growth • While the fluctuations in the dollar have so far been fairly orderly, the US current account deficit remains very high, and a more abrupt and disruptive adjustment cannot be ruled out, particularly with a ballooning US net foreign liability position. 4

5. External Risks • Exchange rate debate is misplaced • East Asia accounts for about 39% of US trade, therefore 10% revaluation of currencies will contribute to only 4% change in REER and the latter has already fluctuated in a 20% range. • Large but reasonable changes in the value of the US dollar have very little impact on US current account deficit • China is wary of what happened to Japan after the 1985 Plaza Accord • US has to reduce excessive aggregate demand, especially through fiscal consolidation 5

6. Response to Uncertainties surrounding International Financial System: Acceleration of Regionalism in East Asia ASIA

7. Transformation Process • Greater regional economic integration, especially trade and investment • North Asia will absorb more imports from Southeast Asia, including skilled labor • Resources generated from high savings will be used to narrow development gap in the region. • Political détente between Japan and China: Japan acknowledges leadership role of China 7

8. Transformation Process: Concerns • Equitable • Peaceful 8

9. Concerns about Peaceful Process • In early June 2005, US Secretary of Defense Donald Rumsfeld asserted that China’s military spending is a threat to regional security • On July 14, Zhu Chenghu, a major general in the People's Liberation Army, warned the US: “If the Americans draw their missiles and position-guided ammunition onto the target zone on China's territory, I think we will have to respond with nuclear weapons…We Chinese will prepare ourselves for the destruction of all of the cities east of Xian. Of course the Americans will have to be prepared that hundreds ... of cities will be destroyed by the Chinese” 9

10. Concerns about Peaceful Process • On July 21, CNN reported that the Chinese Foreign Ministry said it filed a protest with the U.S. Embassy in Beijing over the Pentagon report. The Pentagon report said Chinese military planners are looking at expanding beyond their immediate goal of dominating Taiwan, the self-ruled island claimed by Beijing as its own territory. • At least three analysts have commented that apart from oil, the Iraq war was about China. 10

11. What does this have to do with the Philippines? • Manila Standard, June 3, 2005: Helle Dale, the director of the Heritage Foundation’s foreign policy center and international studies institutes, said they are keeping a close watch on the movements of China in the region, especially in its dealings with the Philippines which is considered to be the number one ally of the US in Asia. “You have had strong ties with us for a long time but we do wonder about your relations with China... and there are questions that we here in Washington think about.” (Dinner tendered for Secretary Romulo 18 May 2005) 11

12. What does this have to do with the Philippines? • Manila Standard, June 4-5, 2005: (Secretary) Romulo said the Heritage Foundation is free to express its views with China, considered to be the country’s “Big Brother” in the region, but it does not mean the government will act on such remarks… the foundation does not represent the US government and that in his bilateral talks with Washington officials, including State Secretary Condoleezza Rice, the China issue was never mentioned. 12

13. What is to be Done? • The Philippines should prepare well to maximize the benefits of closer regional economic integration and regional cooperation in East Asia • Human Resource Development • Improving technological capability through leverage and not necessarily innovation • Catch-up in infrastructure (this area will benefit the most from the establishment of a social cohesion fund a la the European Union)

14. What is to be Done? • Understand history in order to avoid “slaying the devil but at the same time sparing or even strengthening Satan.”

15. Financial Cooperation in East Asia • Chiang Mai Initiative • Bilateral swap arrangement wherein countries agree to help each other during episodes of currency crises. This is in the form of foreign exchange reserves. • There is progress towards ‘multilateralizing’ the swap arrangement, initially under IMF conditionalities, with the vision of establishing the Asian Monetary Fund. • Asian Bond Market Initiative: • One aim is to develop efficient and liquid bond markets in Asia, enabling better utilization of Asian savings for Asian investments. It would contribute to the mitigation of currency and maturity mismatches in financing