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When historical tensions and financial cooperation collide

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In Brief

Worsening political relations between South Korea and Japan, though troubling, are unlikely to endanger plans to deepen regional financial integration through the Chiang Mai Initiative (CMI).

Tensions between the two countries flared up in August 2012, after Lee Myung-bak became the first incumbent South Korean president to land on the disputed Dokdo/Takeshima islands. The visit generated a fiercely negative reaction from the Japanese government.


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Following the incident, one of the most vivid signs of the deteriorating bilateral relationship was the decision of both governments not to renew a US$57 billion currency swap contract on 9 October 2012. In July this year, both countries also allowed another US$3 billion swap contract to lapse. This has resulted in the lowest level of bilateral currency swaps since 2006, which at US$10 billion is US$60 billion down from 10 months ago. Although both governments cited economic reasons for their decisions, such justifications flew in the face of many of the furious accusations that ensued in the wake of the Dokdo/Takeshima incident. The first contract would have automatically rolled over as originally planned by both parties but for the historical provocation.

A key question is whether the strained relationship between the two countries will nip the development of region-wide financial cooperation in East Asia in the bud. The CMI has encouraged proponents of East Asian financial cooperation to hope that a fully-fledged Asian Monetary Fund is just around the corner. Since it was first set up by the ASEAN+3 (China, Japan and Korea) in May 2000, the CMI has successfully multilateralised bilateral currency swap arrangements. It currently has a total funding pool of US$240 billion (since 2012), and also has rules on agenda-setting and voting on major issues, such as new membership and financial extension. In May 2012, the ASEAN+3 agreed to reshape the Asian Macroeconomic Research Organization into the first regional financial institution with international institution status. Both South Korea and Japan fully supported this breakthrough.

But sceptics of East Asian financial cooperation have long argued that the powerful dilemmas of history and reconciliation will continue to haunt East Asia, and eventually dwarf any meaningful efforts to deepen institutional cooperation. From this perspective, the fragile nature of East Asian cooperation could not have been much clearer than from the way South Korea handled its economic emergency in 2008. South Korea did not rely on the CMI. Instead, South Koreans relied on the US Treasury Department when they were in dire need of foreign reserves. Why the US? Would it not have been much easier to turn to Japan or China, co-members of the CMI? South Korea did end up concluding bilateral swap arrangements later on with China and Japan. But this does not help to account for its first choice.

Now that South Korea and Japan are mired in the apology politics behind the territorial dispute, the sceptics believe that this will surely take away both governments’ appetite for investing in regional goals.

Yet there are at least three reasons to think otherwise.

First, the engine for financial cooperation is the two countries’ financial officials who share the vision of making East Asia a more autonomous financial region. They have developed a dense network of cooperation over the last 15 years, which has survived the ebbs and flows of bilateral political relations. These financial officials’ insistence that the two lapses of the bilateral swap contracts are due to ‘purely economic reasons’ can be arguably interpreted as indicating that both governments will cooperate with each other in the future.

Second, the two countries have common strategic interests in managing China’s rise. Jettisoning the CMI would see both countries lose an important platform to work with in taming China’s rise. In multilateralising the CMI in 2010, the ASEAN+3 managed to construct a non-hegemonic form of institutional cooperation where no single country wields veto power and sets agendas predominantly. This kind of institutional cooperation may not be possible without the robust partnership of South Korea and Japan.

Last but not least, both South Korea and Japan want to play a larger role in the making and remaking of global economic order. They are no longer content to simply follow Western directives during the G20 and IMF reform process. The two countries would have harder time accomplishing this aim without a competing East Asian institutional alternative.

The historical dispute between South Korea and Japan has not yet prevented them from furthering the institutional consolidation of East Asian financial cooperation. East Asians are much closer to the making of a fully-fledged Asian monetary fund. But the full consequences of unresolved history still remain to be seen. It is clear though that an Asian monetary fund will require deep trust from all parties, above and beyond vision-sharing and mere technical adjustments.

Yong Wook Lee is an Associate Professor of Political Science and International Relations at Korea University.

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