Romain DuvalBy Romain Duval

(Version in 中文, and 日本語)

In recent decades, trade integration within Asia has increased more than in other regions. In valued-added terms, intraregional trade grew on average by over 10 percent a year from 1990 to 2012, twice the pace seen outside of Asia. Likewise, financial integration within the region has started to catch up, although it still lags behind trade integration. Concomitantly, business cycles in Asia have become steadily more synchronized over the past two decades, with the correlation between ASEAN economies’ growth rates almost reaching the very high levels seen within the Euro Area.

As outlined in the IMF Asia and Pacific Department’s latest Regional Economic Outlook, these facts are related. Namely, increases in trade and financial integration have strengthened the propagation of growth shocks between regional partners, leading Asian economies to move more in lockstep. One driver of this synchronization of business cycles has been the increase in size and connectedness of China’s economy. Looking ahead, we expect regional integration agenda and a bigger China to further increase spillovers and growth co-movement across the region. Greater international cooperation, particularly regional and global financial safety nets, can help countries respond to the associated risk of more synchronized, sharper downturns, and thereby help Asia make the most of greater regional integration.

Trade integration has been an important synchronizing force for Asian business cycles

On the trade side, our study brings a novel finding: what makes two economies co-move—by propagating shocks across borders—is the intensity of their bilateral trade in value-added terms, not in gross terms. The iPhone supply chain example illustrates why this makes sense: although China exports the product to the US, its domestic firms add only a small fraction of the overall value added, so that gross exports vastly over-estimate the dependence of the Chinese economy on final demand from American consumers. The reverse holds for Korea or Taiwan POC, which reap sizeable value added through exports of components to China even though they don’t export any iPhones to the US. Overall, the trend increase in the value-added traded between Asian economies over the past two decades has accounted for around one-quarter of the concomitant increase in business cycle synchronization across the region.

Financial integration has been a more ambivalent force. Across the world, it has magnified the impact on business cycle synchronization of large global shocks like the global financial crisis, as global banks pulled funds back across the board. But in normal times, it has lowered synchronization somewhat, possibly by facilitating international reallocation of capital when a shock hits one country. However, this has been less of a factor in Asia, where cross-border financial claims and flows have so far been comparatively small. 

China’s rise means larger spillovers and greater business cycle co-movement

A further source of cyclical co-movement is the growing importance of China’s domestic demand for the rest of the region. In its (declining) role as the “assembly hub” of Asia, China’s economy does not directly affect its trade partners much, since it primarily propagates shocks coming from advanced economies through the regional supply chain. But as a growing source of final demand, China now has a bigger direct impact than in the past. Indeed, economies whose trade dependence on China’s final demand has increased over the past decade have generally experienced a greater increase in their cyclical co-movement with China.

APD REO Chart Chapter 3

Because many Asian economies (such as Korea, Malaysia or Thailand) depend more on China for their exports of final goods and services than exporters in other regions, they would be more affected by growth shocks originating from China. Based on our empirical results, a one percentage point decline in China’s growth lowers GDP growth in the median Asian economy by about 0.3 percentage point after a year, compared to 0.15 in the median non-Asian economy. 

Preparing for the future

Given the room across the region for further trade liberalization and catching up on financial integration, spillovers are likely to rise and business cycles to become more correlated, particularly during crises. A bigger China, when hit by shocks, will be a further source of synchronization.

The main challenge for policymakers will be to reap the major gains from further integration while minimizing the side effects from greater spillovers. International policy cooperation can play a role here. Stronger co-movement means Asian economies would tend to face synchronized downturns and—depending on the nature of the shocks they would face—simultaneous external financing pressures. Self-insurance through further reserve accumulation can help individual countries buffer such shocks, but this approach is costly and does not provide risk sharing between countries. This points to a potential stabilizing role for regional financial safety nets, such as the Chiang Mai Initiative Multilateralisation (CMIM) or bilateral swap lines between regional central banks. These initiatives can usefully complement bilateral swap lines with non‑regional central banks and the global financial safety net provided by the IMF, which will be most useful in the event of shocks spilling over to the region as a whole—such as, for instance, shocks originating from China.