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Whither A Currency Union in Greater China?

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Abstract

The paper attempts to evaluate the prospect of creating a currency union in the “Greater China” economic area. Despite of the political deadlock and military confrontation in the Taiwan Strait, the Greater China area has experienced rapid and spontaneous regional integration in the past decades as a result of increasingly cross-border trade, foreign direct investment (FDI), technology contracts, and other arrangements in accordance with changes in comparative advantage and industrial upgrading in these economies. In this study, we focus on the symmetry in shocks that is perceived as one of the major preconditions of a currency union. In contrast to the previous studies, we investigate the time-varying correlation of supply, REER and monetary shocks by using the Kalman filter technique to assess the dynamic changes in structural similarity and convergence among the Greater China economies. We also examine the costs of forming a currency union in the area due to the loss of monetary autonomy in each economy. Our results suggest that there is a rising structural symmetry between the Greater China economies, and this area has become increasingly a better candidate for a monetary union.

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Notes

  1. Macau is not included in this study due to the lack of data.

  2. See, for example, Bayoumi and Eichengreen (1994), Bayoumi et al. (2000), and Zhang et al. (2004).

  3. Taiwan had a trade deficit with the world for three consecutive years from 1998 to 2000, totaling over US$2.3 billion. The trade surplus with the Mainland exceeds Taiwan’s total trade balance in any single year from 1987 to 2001, the lowest by one time in 1997 and the highest by 97 times in 2000 (see Zhang et al. 2003).

  4. Data used in this section were adopted from ADB: Key indicators 2003 and MOFTEC: Almanac of China’s Foreign Economic Relation and Trade, various issues, with authors’ calculation.

  5. We use 5-digit SITC bilateral export and import data to calculate the IIT shares in the manufacturing (SITC categories 5– 8) between China and Hong Kong and Taiwan. The results are not reported but available upon request.

  6. It was estimated that the presence of Taiwanese in Shanghai has grown from tens of thousands in the early 1990s to as many as 250,000–350,000 by 2001. To many Taiwanese, Shanghai has become their “second home” after Taiwan.

  7. We also grouped the three economies to calculate a time-series of the coefficient of variation using GDP per capita data for each year for the period 1985–2003 (results are available upon request). We find that for all samples a growing divergence in GDP per capita is the major phenomenon up to 1994, and since then there is a clear tendency for these economies to approach each other. Even if we control for the effect of China’s dual exchange rates reunification in 1994, there is still a clear sign of declining coefficient of variation during the period, indicating the trend of economic convergence in the Greater China area.

  8. The theory of optimum currency area (OCA) suggests several preconditions for establishing a currency union. See Kawai (1987), Tavlas (1993) and De Grauwe (2005) for a comprehensive survey, and Bayoumi and Eichengreen (1994), Bayoumi et al. (2000), and Zhang et al. (2004) for assessing the business cycle synchronization and the correlation in structural shocks using the VAR technique developed by Blanchard and Quah (1989).

  9. Shioji (2000) proposes the method of removing the effect of monetary shocks in comparing shock correlations between the US and EU regions, since, under the conventional 2-vairable VAR framework, common monetary shocks among the US sub-regions may improve symmetry in supply and demand shocks.

  10. Recently several studies apply the Generalized-Purchasing Power Parity (G-PPP) model to an analysis of OCA in East Asia with an investigation of the possible cointegrating relationship in real exchange rates among these economies. See, for instance, Liang (1999) and Ogawa and Kawasaki (2006).

  11. Our dynamic correlation approach is a modified version of the time-varying parameter convergence approach developed by Haldane and Hall (1991), Boone (1997) and Babetskii et al. (2004).

  12. Boone (1997) and Babetskii et al. (2004) include a time-varying constant in Eq. 5, which is probably not appropriate because the structural disturbance series has a zero mean property. In addition, Boone (1997) and Babetskii et al. (2004) use a different order of economies represented in superscripts from ours, i.e., i, j, k denote the regional key economy, regional economies and the rest of the world, respectively. We use this ordering of the economies as well for the robustness check.

  13. We thank George S. Tavlas for advising us to use the maximum likelihood estimates.

  14. We use EViews 5.1 for empirical analysis. Seasonality is adjusted using Census X-12.

  15. For the static analysis, we conduct the structural VAR estimation for the whole sample period. The series of identified structural shocks are then divided into two sub-samples to analyze the changes of correlation patterns before and after the financial crisis. We exclude the crisis-period (1997Q1–1998Q4) to avoid possible influence of the financial crisis. However, even if we include this period, the results discussed below do not change much.

  16. We have also tested if the order change of economies i and j in Eq. 5 will affect the results, but found the results remain unchanged.

  17. The country’s output costs of joining a currency union are assessed by the following output loss function: \( L_{{\text{t}}} = 1 - \exp {\left[ {{{\left( {\varepsilon _{{\text{t}}} - \varepsilon ^{c}_{{\text{t}}} } \right)}\alpha } \mathord{\left/ {\vphantom {{{\left( {\varepsilon _{{\text{t}}} - \varepsilon ^{c}_{{\text{t}}} } \right)}\alpha } {{\left( {1 - \alpha } \right)}}}} \right. \kern-\nulldelimiterspace} {{\left( {1 - \alpha } \right)}}} \right]} \) if \( \varepsilon _{{\text{t}}} < \varepsilon ^{c}_{{\text{t}}} \), where ɛ t denotes the productivity shock (the identified supply shock) to the individual country, \( \varepsilon ^{c}_{t} \) the shock to the currency union (the GDP-weighted average of individual member country’s shocks), and α the labor share. See Ghosh and Wolf (1994) for the details of the model.

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Acknowledgement

An earlier version of the paper was presented at the CITS Research Workshop at Yokohama National University, Japan and the 9th EAEA Convention in Hong Kong. The authors wish to thank Paul De Grauwe, Menzie Chinn, Rasmus Rüffer, Masahito Kobayashi, Hiroyasu Uemura, Craig Parsons, George S. Tavlas, the editor of the journal and anonymous referee as well as participants in the conference and seminar for their helpful comments and suggestions. The authors also thank Nagendra Shrestha for his capable research assistance. This study was completed while the first author was visiting the CITS, Yokohama National University. He wishes to thank YNU for its hospitality and research support. The authors wish to acknowledge the financial support of the JSPS through the Grant-in-Aid for Scientific Research (B), 116330059.

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  1. School of Accounting, Finance and Economics, Edith Cowan University, 100 Joondalup Drive, Joondalup, WA, 6027, Australia

    Zhaoyong Zhang

  2. Yokohama National University, Yokohama, Japan

    Kiyotaka Sato

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  1. Zhaoyong Zhang
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  2. Kiyotaka Sato
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Correspondence to Zhaoyong Zhang.

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Zhang, Z., Sato, K. Whither A Currency Union in Greater China?. Open Econ Rev 19, 355–370 (2008). https://doi.org/10.1007/s11079-007-9048-2

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