Asian Integration: What can be learnt from the European Union?

In today's talk I will ask, what can be learnt from European integration? Can Asian integration succeed? What is the best strategy for Japan?

I would like to start with a brief history of European integration. The starting point was the intention to prevent a repetition of the German-French war, which led Europeans to identify coal and steel as key sectors to liberalize. A common market was then launched and a slow process of industrial integration followed. The breakdown of the Bretton Woods system coincided with volatility in exchange rates, which hurt trade. Europeans became aware that they needed a European Monetary System, at a time of international financial deregulation and ensuing instabilities. The need for a single currency and a fiscal pact led to the embryo of a European State.

From the above story, three major elements emerge. The first was that there was interaction between the economy and polity. Second, a permanent guide was needed to promote and extend the single European market. Third, institution building was a key feature of European integration.

European integration was a spiral of trading, litigating, legislating, and lobbying. The foundation of European competence induced the adjustment of domestic actors. And trans-border conflicts from trade led to litigation at the European Court, and jurisprudence emerged. As a result, the European Commission's need for codification led to legislation in Brussels, and new private lobbying strategies and new trade conflicts emerged. This created a new wave of litigation at the European level. The deepening of jurisprudence and the need for new procedures resulted in new treaties.

We are now in what I would call the epoch of regionalism, rather than globalism. The most recent trends in the realm of internationalization during the 1990s included the following: exports have grown faster than GDP; foreign direct investment has grown faster than exports; financial flows have grown faster than FDI; and a new dynamism has emerged in industrializing countries in Asia. Financial globalization has been the key feature, and most global standards are actually American.

Another trend has been the importance and deepening of intra-regional trade. The nation state has become too small, but the world is too diverse to move toward an integrated world governance. Thus, regional trade agreements prosper. Conditions needed for successful regional integration include the following: shared political objectives, non-heterogeneous members, modest initial steps and a long term vision, a multilateral body in charge of defending integration, compensatory mechanisms for losers, new public goods, and the creation of a common jurisdiction.

Regional integration strategies have changed. NAFTA, Mercosur, and ASEAN are not a repeat of the European experience. The European Union developed a multinational entity in charge of defending economic integration, a mechanism for compensating the losers, and a common jurisdiction to solve conflicts, while ASEAN and APEC developed none of these.

I could picture the following scenario playing out in Asia following the 1997 financial crisis which inspired the Chiang Mai agreement. Those events lead to a series of meetings that in turn develops trust. And the need for an international entity leads to better currency management and deeper financial integration. Integration would benefit the member countries and create more incentives to integrate further. The removal of trade barriers and the creation of a single market would create positive integration, common regulations, and the call for political initiative.

What can we say specifically about Asian integration? There is a continuous rise in the share of Asian exports in world trade, and integration is easier when the region is booming. But the countries in Asia are heterogeneous in terms of population size, per capita GDP, human development indexes, and political regimes.

Asian pragmatism and flexibility will strengthen the drive toward integration. There is already de facto integration. Free trade negotiations and monetary initiatives between varying partners could be concluded in order to enhance the bargaining power of each state. Asian integration will continue to be a competition between inter and intra regional negotiations. This process is the opposite of what happened in Europe. European integrated through a process of institutionalization-a deepening of relations between core members and then progressive enlargement.

Regarding Japan's strategy, should the starting point be an agreement with Korea? Should there be an Asian Monetary Fund? How should Japan cope with China? The rise of China is changing the shape of integration. South Korea and Taiwan are exporting more to China, and China is exporting more to ASEAN, Taiwan, and Japan. China's unit labor costs are impressively low. And China is receiving an increasing share of FDI.

As a consequence, the Americans have become the consumers of last resort, the Japanese the savers of last resort, and the Chinese the manufacturers of the world. I can imagine two possible dynamics. One is that the US buys from China and borrows from Japan, creating tensions in global financial stability. Another is that Japan invests in China, which de-industrializes Japan, creating tensions in Asian integration.

In conclusion, the current epoch is one of regional integration. The objectives of regionalism include coordinating monetary policy and promoting regional financial stability. Asia and Europe's challenges are symmetric. In Asia, the challenge is to deepen multilateral negotiations and build institutions. In Europe, the challenge is to emulate innovation and entrepreneurship. My concerns for the international system are that Japanese and Chinese deflation may spread, there is an overcapacity in the manufacturing sector, and financial stability is not warranted.

Q: Many people say that countries fall back to regionalism when multilateralism is slowing down.

A: Regionalism is a two-sided strategy. Blocs can either vie with or act as stages for multilateralism. But I believe that regionalism is a good starting point because it allows you to change bargaining positions and you can go further from there.

Q: Could monetary union come before political union in Asia?

A: European integration took a long time. But financial and political union could take place simultaneously, helping to stabilize the economy and currency fluctuations.

Q: Some think that Asia can learn from the European experience; some think that Europe's experience was specific to that region. But I think we should learn from Europe. First of all, there is a need to institutionalize integration. Also Europe's approach was legalistic. In Asia, the political initiative (to achieve peace) is lacking. The Asian process is based on economic need only. You seem to underestimate the driving force of ASEAN plus three. And, by the way, an AMF could function without a currency arrangement.

A: At least some institutionalization would help. Europe has too few civil servants, actually, given their sizable role.

Q: To what extent are Asian countries ready to use the union to address domestic problems?

A: An institution would help in Asia, for example, to compensate the losers from integration.

Q: European integration can be based on security. Europe has a longer history of wars than does Asia. So maybe this is something we lack. Is China like France in the sense that it is a nation trying to differentiate itself from the US?

A: Trust is key. Geopolitically, France and China play similar roles. But China is skyrocketing while France is plateauing. It will be difficult for Japan to negotiate when its economy is weak.

Q: What are the differences between NAFTA and the EU? What can we learn?

A: NAFTA is a trilateral treaty with a lot of asymmetry. Asia could look at NAFTA as an example, but it is unclear which country would be the hub in Asia. NAFTA was more economically driven compared with EU, which was more political. Asia could learn from NAFTA in that it started as a bilateral agreement and was built from there.

Q: Does Asia have the necessary political leadership?

A: China may have the leadership, but it would be ideal for a small country to take the lead because it would be more palatable to the other members. I am thinking of Holland's role in Europe.