ABSTRACT
 
This paper is a study on the applicability of the optimum
currency area in the ASEAN region. The same theory has been
applied in the European Monetary Union (EMU). Several
comparisons were made with the European Monetary Union (EMU)
while carrying out the analysis. The history of the European
Monetary Union and the history of the United States as a
monetary union were discussed briefly to see the reasons for
forming a monetary union with the assistance of the optimum
currency area theory created by Robert Mundell (1961). The
analysis included in this paper consists of cyclical
convergence, investments (includes financial and banking
services), employment and growth. The pros and cons of the
optimum currency theory are also looked at to see the benefits
of forming a monetary union in the region if applicable. It is
of no doubt that this work can be further analysed and improved.
It would be interesting to carry out an econometric analysis
using the balance of payments or trades of countries in the
ASEAN region. More sophisticated econometric analysis will
further improve the study. One can also try to approach the
study at the micro level rather than just focusing on the macro
level of the economy. There are many references on how to
conduct this study, especially with the emergence of the
European Monetary Union.
 
INTRODUCTION
 
The ASEAN countries of Brunei Darussalam, Indonesia, Malaysia,
Philippines, Singapore, Thailand and Vietnam were once known as
the Asian "miracle". Economists throughout the world had spoken
of the economic growth of the countries in this region
positively. As a result of strong economic growth since 1970,
Singapore has now joined the ranks of rich industrial countries.
Indonesia, Malaysia, and Thailand have seen their GDP growth
rise over the period of 1990 to 1995 when the economy was at its
peak. Recession started in 1997 and the currencies of these
countries were devalued to historical lows. From Figure 1, we
can see that the recession had slowed down the economy in these
ASEAN countries. Starting from 1996 to 1999, most of these
countries' GDP was negative. Among the countries with the lowest
GDP rates were Malaysia, Indonesia and the Philippines.
 
Despite the downturn from 1996 to 1999, a good recovery was seen
from 2000 onwards (Figure 1). It may be a new millennium
resolution that each country worked on its economic policy and
it has been fruitful. However, defensive steps need to be
implemented should the same crisis happen again. Immediately
after the crisis, Thailand and Indonesia had taken the bailout
from the International Monetary Fund (IMF). Malaysia had taken
several measures of capital control. While each country is at
the edge of sustaining the economy, several economists came up
with the idea of forming the AMU (Asian Monetary Union), which
is similar to the EMU (European Monetary Union) as a measure of
improving the economy after the crisis.
 
The EMU is based on a theory of optimum currency areas
constructed by Robert Mundell (1961), the Nobel Prize winner in
Economics for this theory. Mundell (1961) takes the example of
North America. In what circumstances could it be of benefit for
Western Canada and the Western United States to join together to
create a Western currency, or for the Eastern parts of the two
countries to create a currency peculiar to the East of the
Continent?
 
This paper will examine the theory's validity and applicability
in the ASEAN region. The types of monetary union that have
emerged before the European Monetary Union would give us an idea
of what a monetary union is all about.
 
Monetary unions can be divided into four categories, according
to an article titled "History Shows EMU's Success may depend on
Political Union" by Dr Gerard Lyons
(www.euroknow.org/articles/rmu.html). The first category is
where political union has ensured the monetary union's success.
A recent example is the German Unification. Longer lasting is
the Italian Monetary Union from the last century, which followed
political union in 1861. Secondly, monetary unions of small
countries can survive without political union, provided there
has been economic convergence. Two examples are the 1923 Union
between Belgium and Luxemberg and the CFA Franc Zone in West
Africa, which has survived since 1948. The third category is
where the survival of the monetary union is dependent on the
political system. Once the political system binding it
collapses, the monetary union fails. One example is the collapse
of the Soviet system, another is the failure of the nineteenth
century German Monetary Union. The fourth category is a
temporary monetary union that survives for a long time without
political union but eventually collapses. The Latin and
Scandinavian Monetary Unions from the last century are examples.
The Latin Monetary Union was formed in 1865 between France and
the closely linked economies of Belgium, Italy and Switzerland.
Greece joined in 1868. It was a bimetallic union, initially
based on silver and then on gold.
 
WHAT IS OPTIMUM CURRENCY AREA?
 
This hypothesis was derived from the debate over fixed and
flexible exchange rates. Milton Friedman (1953) and Leland
Yeager (1959) had argued that a country could be better off by
allowing its currency to float, and reserving domestic monetary
policy for price or employment stability. It was Robert Mundell
(1961) who first used the term "Optimum Currency Area" in a
paper published in 1961. A monetary union or an optimum currency
is where all member states in the region or a continent adopt a
common currency (single currency) as their medium of exchange.
The monetary union will have a single currency and one exchange
rate towards the rest of the world.
 
DOES ASEAN MAKE AN IDEAL OPTIMUM CURRENCY AREA?
 
First and foremost, let's not forget that the formation of the
European Monetary was based on the theory of optimum currency
area, created by Robert Mundell (1961). Based on his theory, a
monetary union and a single currency were formed, i.e. the
European Monetary Union and the Euro. The analysis is based on
these four factors:
1) Cyclical convergence
2) Investments (include finance and banking industry)
3) Employment
4) Growth.
 
Earlier, the United Kingdom had done these assessments as stated
above (UK Membership of the Single Currency, 1997). I have tried
to apply these assessments in analysing the applicability of the
optimal currency area in the ASEAN region, and similarly to
study if a monetary union and a single currency is possible
within the ASEAN region. Some points were also taken from the
analysis as well. I have made an analysis of these six countries
in the ASEAN region: Malaysia, Indonesia, Thailand, Singapore,
Philippines and Vietnam. These six countries are some of the
strongest economies within the region. Several countries had
just joined ASEAN: Myanmar, Laos and Cambodia. The years that I
have applied in my analysis may not be applicable to them. We
want to see the effects on the economy after they joined ASEAN.
The analysis here is on the ASEAN region and not on any country
individually.
 
Cyclical Convergence (Co-movement of the economy cycle) The
analysis of cyclical convergence for each ASEAN country is
important because it gives us an overview of the economic
structure and the economic cycle of each country. Optimum
currency areas recognize that the decision of a country whether
to peg or float vis-à-vis its neighbours should depend on
country characteristics such as the extent of trade ties with
their neighbours and the extent of correlation of business cycle
shocks (Frankel and Rose, 1996). Based on the analysis carried
out below, it is seen that the business cycles of the ASEAN
countries are about the same; there wouldn't be so much problem
in applying the optimum currency area to this region. We have
seen from the past that during the financial crisis, most of the
ASEAN countries' currency depreciated greatly. At this time the
ASEAN countries exchange rate system is based on the flexible
exchange rate system. If we come up with a single currency and
exchange rate, the volatility and transaction costs will be
reduced.
 
Later on in this study, the GDP growth data are analysed using a
stepwise regression model to locate some variables that
contribute information to the prediction of the dependent
variable. Each country is tested as the dependent variable based
on the model as follows:
 
E(y)= B0 + B1x1 + B2x2 + ...... Bkxk (1)
B = vector of the coefficients
x = independent variable
 
Based on the test, there are two models of stepwise regression.
A stepwise regression analysis commences by fitting the model
 
E(y) = B0 + B1x1 (3)
 
for each of the "k" independent variables. The variable with the
largest t-values for beta will be included in the model. The
second step in the stepwise regression analysis is to fit all
possible two-variable models. Most computer programs retain x1
and fit only models of the type
 
E(y) = B0 + B1x1 + B2x2 (3)
 
The best-two variable model is the one with the largest value of
R-square. Full results of the test are shown in the Appendix
under Statistics and Tables.
 
Strong correlation and relationships can be seen between
Indonesia and Malaysia. The second model (model consisting of
more than one independent variable) shows a higher R-square
value in the case when Indonesia and Malaysia are used as the
dependent variable. This shows that Indonesia's economy cycle
converges with Malaysia and Thailand. Malaysia's economy, on the
other hand, converges with Indonesia and Singapore. In addition,
the F-significance and the t-significance also help to justify
that the model is good in showing the cyclical convergence
between these countries. R-square values and high beta can be
seen in the first model for Thailand and Indonesia, plus
Singapore and Malaysia. Thailand's economy is dependent on
Indonesia's in this case and Singapore's on Malaysia. The lowest
Rsquare and beta value is seen in the test when the Philippines
is tested as the dependent variable. The best variable to fit
into this model is Singapore, which means that there is slight
convergence between the economy of the Philippines and
Singapore. The analysis didn't work out at all when Vietnam is
used as the dependent variable, which shows that there is very
little convergence between Vietnam and the other ASEAN countries
tested.
 
Based on the tests carried out, we can see that there is
convergence among the ASEAN countries, especially among
Malaysia, Thailand, Indonesia and Singapore. The Philippines
economy appears to be converged at the second lowest degree with
the other ASEAN countries. Vietnam appears to be the outlier for
all the analysis conducted. Vietnam and the Philippines may not
be able to enter the monetary union in the first phase. However,
these countries can do so in the second phase when their economy
has converged at a higher degree with the other ASEAN countries
stated above. The same thing goes with other ASEAN countnies
which had just joined the ASEAN, such as Myanmar, Laos and
Cambodia.
 
Some of the reasons for economy convergence among these ASEAN
countries can be justified through financial integration between
these countries. Take a look at some of the financial schemes
that have been carried out by ASEAN. The major ASEAN economic
integration schemes include the ASEAN Investment Area (AIA),
ASEAN Free Trade Area (AFTA) and the ASEAN Industrial
Cooperation (AICO) scheme. Based on the graph in the Appendix,
although these ASEAN countries' growth varied during the period
of 1970-1980, there is broad acceptance of the key policy
settings that have contributed to the region's strong economic
fundamentals, as stated by John Hicklin, David Robinson, and
Anoop Singh (1997) in their paper, "Macroeconomic Issues facing
ASEAN Countries".
 
In addition to that, during the 1970's and the 1980's, the
business cycle in ASEAN countries moved closely with those in
the industrial countries (Hicklin, et al., 1997). Since the late
1980's, growth in the ASEAN region has been less influenced b
fluctuations in economic ativity in. North America and Europe.
This can also be seen in the Appendix (Direction of Trade for
both Import and Export), whereby the trades among the five
countries were highest during the period 1990 to 1998 among
Asian countries compared to North and Central America and
Western Europe.
 
Investment
 
Investments would also help in analysing the applicability and
the advantage or the disadvantage of forming a monetary union in
the ASEAN region based on the optimum currency area as applied
in the European Monetary Union (EMU). This point would help in
answering the question of whether the ASEAN Monetary Union would
create better conditions for firms making long-term decisions to
invest in ASEAN. If firms are to take up investment
opportunities, they must be confident that these countries'
macroeconomic stability is maintained.
 
The reduction in transaction costs from the formation of a
single currency is a benefit to a monetary union. This helps to
enhance investment since exchange rate uncertainties have been
reduced. The formation of a monetary union, which focuses on
lowering interest rates to boost investments would help to
enhance the ASEAN countries' investments. The reduction in
exchange rate volatility and uncertainty plus transactions costs
should increase trade. Furthermore, exchange rate uncertainties
reduce price transparency as it discourages foreign finns to
sell in the foreign markets, but with the existence of the
single currency, it helps to reduce the uncertainty and costs,
thus increasing transparency, which makes people or a specific
country more comfortable in investing or making transactions. In
addition, if the cyclical convergence appears to be synchronized
among member countries, it won't be hard for those countries to
adapt to an interest rate criterion set by a currency board. As
stated by City Economist Dr Gerard Lyons (2001), it is easier
for unions to survive when the economic cycle is favourable, and
monetary unions that are politically independent such as the
European Monetary Union (EMU) can fail when there is an external
shock, thus showing that the European Monetary Union (EMU) is
politically independent and not economically independent.
 
Other than transaction costs, the removal of currency barriers
for cross-border investments within the monetary union will
allow greater international diversification of portfolios in the
financial market (UK Membership of the Single Currency, 1997).
The creation of a large and liquid market is also a result in
the financial market with the existence of a monetary union.
Deeper bond markets could encourage more firms to issue bonds,
and credit risk rather than currency risk will be irnportant.
This will help ASEAN in enhancing or promoting its bond market.
Developing an ASEAN Bond Market was one of the ASEAN responses
in handling the financial cris (ASEANWEB). Recognizing the
importance of financing sources other than bank lending and
exchange-rate risks facing the corporate sector, ASEAN has also
embarked on an effort to develop local bond markets and put a
place infrastructure that would enable a corporation or a
government to raise funds in any bond markerwithin the region.
 
International investors look carefully at the stability of a
country's economy stability before making their investments. If
a monetary union creates stability in the economy, then it would
definitely help to promote investments, lessen volatility in
exchange rates and lower interest rates. The single currency
will complement the ASEAN Investment Area, reducing transaction
costs and exchange rate uncertainties, maintaining inflation,
and increasing price transparency, and removing currency
barriers for cross-border investment, which can boost trade.
This coincides with ASEAN's goal to further liberalize its
investment regimes and to provide competitive and attractive
investment environments.
 
In the banking industry, we can see that there may be a single
market for single currency loans and more corporate customers
will find it easier to apply for a loan to open up businesses
across countries since transaction costs have been reduced.
Other financial accounts would be easy to apply for throughout
cross-border banks and withdrawing your money would be a simple
task since only a single currency is involved here.
 
Employment and Growth
 
A successful monetary union has the potential to encourage both
growth and employment in the ASEAN region. The single currency
can assist in increasing trade and can help to further develop
the ASEAN Investment Area, which is rather similar to the Single
Market developed in the EURO. The removal of the exchange rate
uncertainty will help increase investment, jobs and growth in
ASEAN. It is only worthwhile to adopt the single currency if it
is applicable to the region and thus increases growth. Based on
the United Kingdom's fundamental test of Employment and Growth
in Joining the European Monetary Union (EMU), it is noted that
encouraging greater competition in products markets and greater
factor mobility would help in reducing employment, and by giving
a boost to the Single Market plus improving price transparency,
European Monetary Union would help to create the conditions in
which unemployment falls.
 
The European Monetary Union might also increase the mobility of
factors of production, labour and capital, which reduces the
mismatch between supply and demand that creates higher
unemployment. Comparing this with ASEAN and the emergence of the
ASEAN lnvestment Area, we can see some similarities.
 
The Investment Incentives in the ASEAN Investment Area are as
follows:
 
The ASEAN Investment Area aims to make ASEAN a competitive,
conducive and liberal investment area through the following
measures:
 
a) Implementing coordinated ASEAN investment cooperation and
facilitation	programmes
 
b) Implementing a coordinated promotion programme and investment
awareness activities
 
c) Immediate opening up of all industries for investment, with
some exceptions as specified in the Temporary Exclusion List
(TEL) and the Sensitive List (SL), to ASEAN investors by 2010
and to all investors by 2020
 
d) Granting immediate national treatment with some exceptions as
specified in the Temporary Exclusion List (TEL) and the
Sensitive List (SL), to ASEAN investors by 2010 and to all
investors by 2020
 
e) Actively involving the private sector in the ASEAN Investment
Area (AIA) development process
 
f) Promoting freer flows of capital, skilled labour, professional
expertise and technology among the member countries
 
g) Providing transparency in investment policies, rules, procedures
and administrative processes
 
h) Providing a more streamlined and simplified investment process
 
i) Eliminating investment barriers and liberalizing investment
rules and policies in the sectors covered by the Agreement.
 
 
Part (f) of the above highlights promoting freer flows of
capital, skilled labour, professional expertise and technology
among the member countries. It shows that the ASEAN Investment
Area is also encouraging factor mobility, which helps to reduce
unemployment. Therefore, the formation of a successful single
currency could be positive for employment as seen in the factor
stated above. In addition, it encourages growth and investments;
for example, the level of trade between ASEAN countries can
increase due to price transparency and reduction in transaction
costs.
 
CONCLUSION
 
There are several strong points that can help to forward the
idea of forming a monetary union in ASEAN. One of them is the
analysis of the cyclical convergence among the members of ASEAN
(the six countries mentioned). There is convergence among these
countries and that can be a headstart in forming a monetary
union, apart from knowing that transaction costs and exchange
rate uncertainties can be reduced. This reduction as discussed
above can increase trade and investments, not to mention
increasing growth. An interesting point has emerged during the
analysis: it is noticed that ASEAN members have shown strong
financial integration, based on the financial integration scheme
that emerged during the 1990's. Strong financial integration can
give ASEAN a headstart in forming a monetary union, since it can
boost liquidity and fiscal transfers or capital mobility. It is
encouraged that a country does so based on the optimum currency
area theory, which is the backbone of forming a monetary union,
especially in the case of the European Monetary Union. However,
the negative aspects should also be taken into consideration
before any decision is made. To form a monetary union or not to
form a monetary union - that is the question.
 
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