Cross-Border Production Sharing and Exchange Rates in East Asia

Abstract

Economic integration in East Asia is proceeding along two tracks. One involves discussions among governments and focuses on formal agreements covering bilateral and regional free trade areas, as well as cooperation at the level of macroeconomic stabilization. The other is informal and driven mainly by market forces, as part of the larger process of globalization and the growing integration of national economies into the world economy. A key feature of that process is the spread of cross-border production networks. The paper examines the implications of this development for official integration and concludes that its effects are negative for the suitability of traditional free trade areas and customs unions, but positive for single-market policies. De facto, market-oriented integration diminishes the sensitivity of trade flows to exchange-rate changes, which may be interpreted as reducing the case for floating rates and favoring (or facilitating) monetary cooperation.