Yen or Yuan? The law of one price and economic integration in Asia

Abstract Using highly comparable local retail prices of 146 goods and services across 18 Asian countries over 1990–2014, we analyse price dispersion and test convergence to the law of one price ( LOP ) for these prices around three price benchmarks—Asia‐average, Japan and China prices—to gain insight about market integration in overall Asia as well relative integration of Asian economies to Japan and China. Cross‐Asia price dispersion around China‐price benchmark, for both tradables and non‐tradables, diminishes significantly over the sample period whereas that around Japan‐price benchmark increases considerably, particularly after the 2008 crisis. There is convergence to the LOP for about half of goods and services in China‐ and Asia‐average price benchmarks. The percentage of convergent prices is significantly smaller in Japan‐price benchmark. Direct estimates of the convergence speed parameter also confirm these observations. Overall, our results show evidence of increasing economic integration in Asia in the last two decades. The process of price convergence appears to be driven by the emergence of China as the centre of economic gravity in the region. There is much room for improvement as economic integration in Asia is still far below that in Europe in the 1990s or USA in the 1980s.