Geoscience Reference
In-Depth Information
Unlike in Europe, the process of integration in Asia is more market-driven,
institution-light and bottom-up. Given the region's huge diversity of development
level, the essence of Asian integration is to manage the diversity, not to seek for a
“United Asia”. To the extent greater integration poses risks—including financial
contagion—both benefits and costs should be gauged carefully. The ultimate goal
remains improved welfare. The market-driven process of integration needs to be
carefully managed to reap its benefits while minimizing potential costs. It is argued
that better and effective regional cooperation can indeed better manage integration
and its potential risks. Strengthening financial safety nets is one important example
of regional cooperation, given the uncertainty and volatility in financial markets.
On the seeming disconnect between financial sector growth and income
inequality, I delve into the interconnections between financial and real sectors by
simulating a general equilibrium model with financial module under a scenario of
increased bank-led flows as experienced by many emerging market economies.
When a large portion of the enhanced liquidity caused by capital inflows is
invested by banks in financial assets and other risky loans, the impact on overall
welfare is unfavourable. In particular, household income falls, most dramatically
on the rural-poor. The only rising income derives from returns on financial assets,
which is why the income gap between the rich and the poor widens, and the
disparity between rural and urban households worsens. As investing in financial
assets—as opposed to lending to firms—has a lower employment-generating
capacity, the drop in unemployment is smaller than when banks act prudently.
Indeed, prudent behavior is better from both macro-financial stability and income
distribution perspectives.
The policy analysis suggests that during the tranquil period capital outflows
should be encouraged to help stabilize net flows in times of market turmoil, at the
same time strengthening competitiveness as the exchange rate weakens. But after
taking into account the costs and the risks of such measure, imposing levy on bank-
led flows is preferable. The resulting stable financial market feeds into the real
economy, boosting factor income rather than returns on financial assets, suggesting
that it will also reduce inequality. Through some sensitivity tests, the result is found
to be robust. Clearly, taking one-sided approach in evaluating policy alternatives by
neglecting the potential costs and risks of the policies may produce a sub-optimal
result.
Appendix
The presence of feedback influences in a network model requires a large matrix—
known as supermatrix—that contains a set of sub-matrixes. The supermatrix
captures the influence of elements in a network on other elements in that network.
Denoting a cluster by
C
h
,h
¼
1,
m
, and assuming that it has n
h
elements
......
e
h1
,e
h2
,e
h3
......
., e
hmh
, and laying out all the clusters and all the elements in each
cluster both vertically on the left and horizontally at the top, we have the following
supermatrix:
