Why Has There Been Less Financial Integration in East Asia Than in Europe?

Announcing a collaborative project of the Institute of East Asian Studies and the Institute of European Studies, under the umbrella of the "New Geographies, New Pedagogies" initiative of the Institute of International Studies. An interdisciplinary project involving Berkeley graduate students, faculty, and international experts.

In Europe, one of the most striking aspects of regional integration has been the growth and integration of securities markets. European bond markets have grown explosively, especially since the advent of the euro in 1999. Cross border transactions in government bonds have risen sharply with the emergence of the German bund as a benchmark asset. Bid-ask spreads in the government bond market have fallen to U.S. levels. Corporate bond issues have doubled in less than two years, and the growth of subinvestment bond issues has risen even faster than the total. The story in the commercial paper and unsecured money markets is similar: the volume of outstanding commercial paper rose by a third in the 12 months ending in October 1999 alone, while international banks have been able to book very large money-market deals on a cross-border basis at very fine bid-ask spreads (Eichengreen 2000). Securities markets are consolidating around London and Frankfurt, which are competing for the status of Europe's dominant financial center. This rapid market integration has raised questions about the viability of Europe's traditional model of bank-based financial intermediation, causing commercial and investment banks to respond with a wave of mergers and acquisitions, so far mainly within national but, increasingly, across them (as with the acquisition by Spanish banks of the leading Portuguese banking groups and by Swedish intermediaries of some leading Danish institutions).

In Asia, in contrast, regional integration has not had analogous effects in promoting financial integration. As documented in Park (2002), while regional initiatives have produced a substantial increase in intra-regional trade and foreign direct investment in Asia, there is surprisingly little progress toward regional financial integration. Cross border bank credit flows within Asia remain becalmed at low levels. There is no sign of the development of an integrated market in government and corporate bonds. Equity markets have not yet begun to consolidate. If anything, the countries of East Asia have developed stronger financial ties with the advanced economies of Western Europe and the United States rather than developing stronger financial links with one another. This conclusion obtains whether one analyzes the distribution of lead manager by nationality, the source of cross-border bank credit flows, or any one of a number of other indicators of financial integration.

Regional integration in Europe differs notoriously from regional integration in Asia. In Europe regionalism is motivated in part by a desire for political integration that has no counterpart in East Asia. Where Europe has built institutions of transnational governance (the Commission, the Parliament, the Court, and now the European Central Bank), Asian integration is "weakly institutionalized" - it is predicated not on transnational institutions but on intergovernmental agreements that above all respect the sovereignty of the participating states. Integration in Asia is not driven by an alliance of key nations like France and Germany or by a single hegemonic power (the role played by the United States in the Western Hemisphere); it is a more multi-polar process.

All of these are reasons why regionalism in Europe and Asia might take different forms. But none of them obviously explains why both regions have been relatively successful at promoting the integration of trade and foreign-direct investment flows while, at the same time, their experiences with financial integration contrast so sharply.

This project analyzes the causes of these contrasting experiences and what they bode for the future financial development of the two regions. Is the contrast explicable in terms of the fact that Europe was earlier to begin the process of removing its controls on cross-border portfolio capital flows? Did Europe have better-developed regional financial markets at the start of its regional monetary and financial integration project? Is deeper trade and factor market integration due to the Single Market project in Europe, compared to the still more partial and tentative moves toward regional trade integration in Asia? Does Europe's single currency make the key difference through the elimination of exchange risk?

In addition to arranging a series of visits and seminars and a workshop on this topic, this project has commissioned systematic analysis of the direction of cross border financial flows. The results will have obvious implications for East Asian policies toward the development of financial markets going forward. If Asian policy makers wish to promote the integration of regional financial markets (as is their stated goal), it should be possible to say, on the basis of this research, whether domestic financial development, exchange rate stabilization, monetary unification, or the promotion of other product and factors flows within the region is likely to be the most effective stepping stone.