While many of us might have been preoccupied with the reform agenda at home, we must not forget another significant event that will happen soon, and it's going to have a direct effect on our economy. If you're thinking a three-letter word, you're probably right. By the time this year ends, the Asean Economic Community (AEC) is scheduled to emerge as one of the world's most important and dynamic markets.
Although AEC has become a buzzword only recently, the idea dates back to December 1997, when regional leaders announced the Asean Vision 2020. Still plagued by the Tom Yam Kung crisis at the time, they envisioned closer economic integration, alongside stronger political-security and sociocultural links.
Some of the economic plans have been achieved, more or less, including free trade and an improved flow of investments in services within Asean. Others lag seriously behind such as the promotion of a modern and competitive small and medium-sized enterprises (SME) sector and use of Asean to help ease "unequal economic development, poverty and socioeconomic disparities".
Overall, Asean may not be as integrated as we hope, and academic studies support that point. Tony Cavoli, deputy director of the University of South Australia's Australian Centre for Asian Business, based on his research in 2012, concluded the original Asean members — Indonesia, Malaysia, the Philippines, Singapore and Thailand — appear to be "well integrated" in accordance with several economic and financial metrics. However, these Asean-5 economies are not as well integrated with the rest due to differences in levels of development, although financial liberalisation could deepen the relationship.
As we prepare for a single market and production base, it's timely to take a closer look at the Asean-5 economies. After all, these countries will be committing the bigger share of the capital to the AEC as well as shaping the future direction of surveillance and risk-sharing capabilities.
At TMB Analytics, we work with numerous analytical tools to try to uncover underlying relationships within and between economies. One of the tools we invented, the Delta-Output Risk Measure (Dorm), applies a hypothetical put option on the economic series to measure the current downside risk level in the economy. Though technical in nature, it produces intuitive results, giving us clear benchmarks to compare different levels of economic performance over different time periods. For instance, Dorm hit the 100% ceiling during previous major crises (see graphic). It also allows us to benchmark the level with different economies and see how they may move together.
Our measure reveals one striking feature. Initially, we would have thought that given their similar characteristics and the fact that the Asean Free Trade Agreement has been in almost full effect since 2003, the five economies would move tightly together, in decline as well as recovery. In other words, trade integration should have led to more "risk-sharing" between economies, whose movements are mostly influenced by factors outside Asean. Not necessarily.
Why should more trade promote risk-sharing? Think of trade channels as leakage. If an economy is completely closed, with no trade and no tourists, any slowdown would be fully absorbed by domestic sectors. With opening to trade (in both goods and services), a domestic slowdown would lead to fewer imports. Sectors that could export have more leeway to ship abroad. Hence, the effect of the slowdown is dampened. This transformation would allow the economy to mitigate economic swings, using trade channels as a buffer to pass on excess volatility to trade partners.
So has Asean shared economic risks? Pradumna Rana of Singapore's Nanyang Technological University found business cycles in Asean were becoming more synchronised, which is conducive to integration. His 2007 study found that, especially after the 1997 financial crisis, correlations in GDP growth converged towards 100% in most of the Asean-5 thanks to intra-industry trade. But again, correlations are significantly lower among the other Asean members.
Our own findings shed further light on the issue. That's good news on the surface. Yes, it seems our economies move together. Unfortunately, such movements are not equal in good times and bad. Take the 1997 crisis. Thailand's devaluation of the baht marked massive panic sell-offs across the region. Hence, risk-sharing or not, the Tom Yam Kung disease proved highly contagious, and correlation skyrocketed.
This was also the case for the dot-com mini-crisis from 2000-01 and the sub-prime crisis in 2008. During good times, however, the correlation falls close to 40%. In other words, we lose most of our co-movement when economic seas are calm. To put it succinctly, in the Asean-5, together we fall, but separately we get up and go our own ways.
This makes the case for highly effective surveillance and risk-sharing institutions for Asean, which won't be dominated by other big Asian economies but can tap into larger liquidity lines. Other scholars such as Craig Parsons and J David Richardson, using a historical perspective, also argue market integration will be "quite ordinary" if not coupled with formal, institutionalised judicial and regulatory pushes. Examples include the Chiang Mai Initiative of May 2000 for currency swaps and financial cooperation in Asean+3 (Asean plus China, Japan and South Korea). The Asean+3 Macroeconomic Research Office was established last October as an international surveillance unit for this purpose.
Evidence shows that when it rains in Asean, it pours on all countries. Only in times of crisis will we know whether we have put in place enough to weather the storm. And it will come. Welcome to the year of the AEC.
TMB Analytics is the economic analysis unit of TMB Bank. Behind the Numbers is co-authored by Benjarong Suwankiri and Warapong Wongwachara. They can be reached at tmbanalytics@tmbbank.com