Regional Business Cycles in East Asia: Synchronization and its Determinants

Abstract

I. IntroductionEconomic integration in East Asia has progressed with the aid of increasing international trade and financial flows. The size of ASEAN+31 economy has been taking an ever-greater share of the world economy, as shown in Table 1. China has emerged as a major economic partner of both East Asian countries and the rest of the world. This tendency of increasing economic integration is likely to lead regional business cycle synchronization in East Asia.Trade integration in East Asia has actively proceeded over the last two decades through the ASEAN Free Trade Area and the ASEAN Investment Area. These efforts contributed to lowering transaction costs of regional trade. Moreover, strong tendency of regional trade integration is supported by bilateral and plurilateral free trade agreements. For example, ASEAN+3 countries have concluded 131 FTAs and are currently negotiating 53 FTAs, as of 2012.Regional financial cooperation has been developed in East Asia under the ASEAN+3 initiatives since the Asian currency crisis. It has manifested in various aspects, including gradual financial liberalization, increasing cross-border capital flows, establishing regional financial safety nets, and developing local currency bond markets.2 The issue of regional business cycle synchronization is also relevant to the regional monetary cooperation in East Asia. This is, in particular, important for the optimum currency area because the degree of regional business cycle synchronization is understood as one of the economic convergence criteria. In this regard, recent studies have examined the business cycle comovement between countries in Asia in order to assess the desirability of a regional currency union.Empirical literature provides a general tendency of regional business cycle synchronization in East Asia. Selover (1999) uses principal component analysis to find evidence for a shared business cycle among ASEAN countries. However VAR estimations reveal weak evidence of business cycle transmission among ASEAN countries. Selover (2004) examines the economic links between Korea and Japan and finds evidence of moderate synchronization in economic activity. Rana (2007) extends Shin and Wang (2003) to find that intra-industry trade is the major factor explaining business cycle comovement in East Asia.For emerging and developing economies as in Calderon et al. (2007), the empirical evidence of business cycle synchronization appears to be more negligible with mixed results. Moneta and Ruffer (2009) examine business cycle synchronization in East Asia by estimating a factor model through Kalman filtering. Their finding is that Asian countries, except China and Japan, share a common factor of business cycle that appears to reflect export synchronization. The existing studies generally find a positive relationship between trade linkages and synchronization for the Asian region, in line with the relatively high share of intra-industry trade within the region (e.g. Choe, 2001; Shin and Sohn, 2006; and Rana, 2007). In contrast, Kumakura (2006) finds that similarities in the production structure are much more important explanatory variable for bilateral growth synchronization than bilateral trade links. Imbs (2011) examines bilateral business cycle correlations within emerging East Asia. He finds evident business cycle synchronization after the global financial crisis of 2008:Q3, but it is substantially more pronounced amongst developed countries than in emerging East Asia. Nguyen (2007) investigates the determinants of East Asian business cycle synchronization, covering the period 1970-2000, by using an OLS-based extreme bound analysis, and finds that trade openness, intra-industry trade, and the similarity of monetary policy are major channels of business cycle synchronization. Allegret and Essaadi (2011) analyze the feasibility of a monetary union in East Asia focusing on business cycles synchronization. They find that the increase in bilateral trade in East Asia improves long-run business cycle synchronization. …