Geoscience Reference
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idiosyncratic shocks. Individuals will invest more in high-risk and high-return
assets if the risk can be shared or diversified (Obstfeld
1994
).
Asia's financial integration is increasing, especially since the 2008/2009 global
financial crisis, but remains limited (Fig
9.4
). Using several welfare measures and
alternative risk sharing scenarios, Azis (
2007
) concludes that “
.while the level of
East Asian financial integration may have increased, its benefits in terms of
consumption and investment risk sharing have been limited. Even the advantage
of having greater resilience to [an] external shock, that could be potentially reaped
from greater synchronization of business cycles, has not been evident.” In an IMF
Working Paper, Borensztein and Loungani (
2011
) also conclude that intraregional
risk sharing in Asia is low. For a given degree of contagion risk exposure, the US
stands out as the one that reaps the most benefit from sharing risks with Asia. The
study suggests that the region should work toward increasing risk sharing without
exposing countries to greater contagion risks: “pursuing these regional policy
avenues should receive a priority over a push for further overall financial inte-
gration whose welfare effect may be ambiguous.”
All in all, while the level of Asia's financial integration may have increased, its
benefits in terms of consumption and investment risk sharing have been limited.
Although the concept of integration-driven risk sharing is ideal and conceptually
sound,
6
the impact of regional integration must be predicated not on an ideal world,
but on the world as it is.
...
9.2.2 Costs and Risks of Integration
When regional initiatives are launched to strengthen integration—for example, those
that boost infrastructure connectivity, risk sharing, and market liberalization—
we hear more of its benefits. Far less is heard on the risks of integration.
Proposition 4
The cascading effect of the Eurozone crisis was a vivid reminder of
the contagion risk of highly integrated systems.
The main argument against excessive integration is that it exacerbates contagion
in times of crisis. Examples abound of financial crises rapidly spreading from one
country to another, especially when integration is deeper due to either geographical
proximity or a regional arrangement.
While a shock may originate in the financial sector of one country, it can rapidly
infect others across a region—affecting entire economies and damaging people's
welfare. For Asia, the damage caused by the 1997/1998 Asian financial crisis is a
6
Under certain circumstances, however, Stiglitz (
2010
) shows that risk sharing can be unfavor-
able. While the more integrated the regional economy the better risks can be dispersed, risk sharing
can lower expected utility when the standard assumption of convexity and concave utility function
does not hold. In particular, this is true when technologies are not convex. Following this dictum,
and given the fact that information, externalities, and learning processes may give rise to a natural
set of non-convexities, the intuition that integration should be desirable is not always accurate.
