Asia has undergone some dramatic changes in the past few years. They include the economic and financial crisis of 1997 and its aftermath, the reform and renaissance of Korea, the emergence of China as a global power, and stagnation in Japan. Toyoo Gyohten argues that equally radical changes will be necessary in the next 10 years. –
Three events have dominated the Asian economy over the past 10 years. The first was the Asian financial crisis and recovery from it. The second was the phenomenal development of the Chinese economy and the emergence of China as a global power. And the third was the stagnation of the Japanese economy following the bursting of the economic and financial bubble in the early 1990s. Japan accounts for two-thirds of the region’s economy.
In the financial crisis of 1997, east Asian countries became the first victims of globalization. This took the form of the global sharing of information and the globalized free flow of massive capital.
The affected countries were inadequately prepared for dealing with the impact of globalization. Their banking systems were vulnerable to large risks. Their systems of financial supervision were flawed and ineffective. And their corporate governance was not properly attuned to the scrutiny of the global market.
Oblivious to these serious shortcomings, the affected countries had opened up their capital markets. They were moved to do so partly by the desire to attract foreign money to boost domestic investment. But they also succumbed to strong pressure from the US Treasury and US financial multinationals, which were preaching the benefits of capital market liberalization.
The lessons that these countries learnt from the ensuing economic and financial crisis are clear. First and foremost, they learnt that it is vital to build a strong financial system, supported by rigorous supervision and credible governance. They also learnt that capital liberalization must only proceed under prudent and realistic programming.
For the most part, east Asia has recovered reasonably well from the crisis. Several factors have contributed to this. The worldwide boom in information technology (IT), which developed in 1999, supported exports. Regional and multilateral support programmes were also effective.
But the most important factor in the recovery has been the effort made by the affected countries themselves to carry out much-needed reforms. In some cases, reform was forced upon them by market forces, but in other cases governments demonstrated real leadership.
South Korea weathers the storm
The success of South Korea is exemplary in this respect. South Korea weathered the bursting of the IT bubble in 2000 and resumed growth. That success is attributable to efforts made in four major areas.
The first was the restructuring of inefficient banks and business corporations. The second was the encouragement of new venture businesses and service-sector employment.
The third was the shift of the labour force from old to new industries. And the fourth was price adjustment and enhanced international competitiveness.
Recovery in other parts of east Asia has not been as remarkable as in South Korea. However, it is fair to say that most east Asian countries have made commendable achievements in shifting towards domestic-led growth, strengthening their service sectors and enhancing regional cooperation. Compared with five years ago, east Asian countries have ample reserves and lower external debts. Their domestic political situation is, on the whole, more stable than at any time since 1997.
Most of the virtues that contributed to the “Asian miracle” in the 1980s – strong entrepreneurship, a young and hard-working labour force, high savings and a general aspiration for development – are still in place.
The strong progress of east Asia was interrupted by the crisis of 1997 but it was not halted. The Asian tigers were wounded but they will come back roaring – and with greater wisdom and resilience.
China steps onto the world stage
The emergence of China as a great power in recent years has been truly spectacular. With astonishing speed, China has converted itself into a world centre of production – not only of low-tech manufacturing but of an increasing number of hi-tech products. China is also developing as the world’s largest consumer market.
China’s success has been made possible by a combination of many factors. The most important is skilful policy management by the government. Since the bloody demonstration at Tiananmen Square in 1989, the Chinese leadership has resolutely pursued two major goals of national policy management.
One is continued economic growth and the other is the maintenance of social and political stability. To achieve rapid and sustained growth, the government has depended primarily on expansionary fiscal and monetary policies.
It is financing numerous large-scale infrastructure projects. Government employees’ pay has been raised. State-owned banks are providing large amounts of credit to state-owned enterprises.
In addition, China has succeeded in attracting large inflows of foreign direct investment – especially in a wide range of manufacturing sectors. Furthermore, private business people have been allowed to demonstrate dynamic entrepreneurship and to seize a variety of business opportunities.
The combination of these three policies has been the key to the phenomenal emergence of China as a global economic power. Economic growth and political stability are the two pillars that support China today. They are inseparable and interdependent.
It is arguable that China is now in an historic phase of national ascendancy. The people of China are elated by a sense of national pride, prompted by such events as Asia Pacific Economic Cooperation (APEC) meetings, accession to the World Trade Organization (WTO) and the decision to stage the 2008 Olympic Games in Beijing. All in all, the Chinese leadership has elevated the country to the status of a global power in a matter of two decades.
China’s future holds extraordinary possibilities. The sheer size of its 1.3 billion population – with its formidable capacity for production and consumption – and the high speed of growth have dazzled many observers. But it is also possible to draw a picture of China’s future as one full of problems and uncertainties.
China cannot afford to continue its current fiscal spree for much longer. While the national debt is piling up, the burden of problems that need attention is growing – the disposal of banks’ non-performing loans, for example, the restructuring of state-owned enterprises or improvements in the social security system.
Acceptance of the obligations that derive from WTO membership will intensify competition with foreign firms. State banks and state-owned enterprises, many of which are already technically bankrupt, require overhauling without delay. This exercise will cost a huge amount in money and lost jobs.
If the rapid expansion of economic activities is to continue, a stable supply of energy resources and food – together with environmental safety – will become an urgent issue. In the shadow of spectacular economic development, meanwhile, there is a growing income gap between rich and poor, cities and farms, coastal regions and inland areas.
The introduction of a capitalistic market mechanism has provided a strong incentive for people to become innovative and hard-working as they seek greater personal wealth. But on the other hand, greed has fertilized the ground for rampant corruption of all kinds among civil servants and business people.
The strong momentum of growth still exists in China. It is likely that it will continue its great leap forward during the first decade of this century and that its role in the world economy as a major producer and consumer will be greatly enhanced.
But long-term Chinese development will depend on how successfully China can deal with the various problems outlined above. It should also be noted that China’s economic future is closely linked to its social and political development. When China has finally succeeded in becoming a free and open society, it will be able to secure its status as a regional and global leader.
Challenges facing Japan
Japan’s economy has been stagnant for the 10 years since the bursting of the economic bubble in the early 1990s. The causes of this unusually long period of stagnation are complex.
Put bluntly, however, it was largely caused by complacency arising from the memory of past success. Japan had basked for too long in the glory of its almost miraculous recovery and development during the 1960s and 1970s.
It ignored the sea change that had occurred in the global economy as a result of the irreversible trend of globalization. In hindsight, it was obvious that Japan needed to alter the structure and operation of its markets and system of governance – at both corporate and government level.
The Japanese economy worked well in the protected and noncompetitive environment that prevailed until the 1970s. But in the rapidly globalizing market that started to emerge in the 1980s with the free flow of capital and information, the key characteristics were global competition, transparency and accountability.
In this respect, there was room for improvement in Japanese politics and business. Unfortunately, when the bubble burst in the early 1990s – causing serious damage to the balance sheet of the government, private corporations and the household sector – the Japanese failed to see this as a wake-up call for bold reform.
Instead, they hoped that the good old days would come back sooner or later. They thus wasted valuable time while avoiding the painful restructuring that was required. The effort needed to carry out such reform is truly daunting. It is precisely because performance in the past had been so good that faith in the old system was so deeply rooted.
The challenge of reform that Japan faces is more serious than in other developed countries. The plight of the Japanese economy is a combined product of the damage done by the bursting of the bubble and the delay in bringing about structural reform. To a considerable degree, the macroeconomic problem and the microeconomic problem have aggravated each other and made the situation more intractable.
Since April 2002, under the leadership of prime minister Junichiro Koizumi, Japan has embarked on a serious effort to address the problem. Many foreign observers have tried to discount the significance of his initiative, cynically suggesting that he is the fourth or fifth Japanese prime minister in the past 10 years to have advocated reform.
But such cynicism is unfair – for two reasons. Koizumi is the first prime minister to have understood that real reform of Japan cannot be undertaken without the reform of political institutions. Secondly, he is the first who has been able to present a concrete agenda for reform within a comprehensive framework.
Nevertheless, Koizumi is faced with a loud chorus of disappointment, frustration and criticism – from both inside and outside the country. Many of the reform items on his agenda are still half-developed. Politicians, the media and academics all complain about his lack of leadership, skill and consistency. Some even argue that his days are already numbered.
The present climate is certainly not favourable for Koizumi. But the gloomy outlook put forward by these critics is not convincing.
There are three reasons for this. First, despite all the adverse winds, Koizumi himself is totally unshaken. He is as firm as ever in his determination to carry out the job.
Second, what he has achieved so far – although admittedly incomplete – is significant. Tackling the major reform items on his agenda, Koizumi has successfully established important beachheads from which to advance further reform.
These include elimination of the undue influence wielded by the political parties on the policy-making process, the reform of electoral districts that had unduly favoured rural areas, the privatization of inefficient quasi-governmental corporations, a reduction in wasteful public works and reform of the tax system, social security and local government finance.
The third reason for the unfairness shown by Koizumi’s critics is that there is no contender – in either his own party or the opposition – who can replace him as prime minister. I believe he has a good chance of staying on in his job and scoring more successes in the reform exercise.
Having said that, the macroeconomic situation does not warrant premature optimism. There are certainly increasing signs of recovery in consumption, production and investment – all supported by the improved prospect of corporate earnings.
Addressing the problems
If the recovery of the US economy materialises, the Japanese recovery should also strengthen. However, there are still several underlying problems that must be addressed aggressively.
The first problem is the public debt. Government debt running at 140% of GDP is clearly unsustainable. The first step to improve this situation is to contain the expansion of expenditure within GDP growth, thereby reducing the deficit. The second step is to restore the primary surplus of the budget by 2010.
Japan’s fiscal deficit problem is serious and its solution will be a long haul. At the same time, there is no risk of fiscal disruption. All debt is denominated in yen and 95% of it is held by Japanese citizens. Japanese households possess financial assets amounting to twice the government’s debt.
The second problem is getting to grips with the bad assets held by banks. The government and the banks must bear the blame for having delayed any decisive solution of the problem for so long. It was only a year ago that they seriously set their minds to it. Significant progress is now being made. In two years’ time, I believe, the situation will become manageable.
The third problem is in the corporate sector, which in Japan’s case is divided into two strongly contrasting groups. On the one hand there is a group of manufacturing and service companies that are highly competitive in the international arena because of the high quality of their products and good business models.
But there are also industries – such as distribution, construction, real estate and other domestically oriented activities – that are inefficient and uncompetitive. They have been allowed to survive because of regulation and protection by the government.
These companies have accumulated excessive debt, equipment and work forces, and have become the major cause of bad bank assets. Now these industries have been forced to restructure, prompted by market forces and foreign competition. The streamlining of these industries is crucial to enhancing the competitiveness of the Japanese economy as a whole.
The fourth problem is excessive saving by the household sector. Japanese households need to be encouraged to consume more and invest more. It is understandable that, against the backdrop of an aging population and lacklustre economic performance, people are tempted to put their money into savings accounts.
In addition to the improvement of the general economic climate, Japan needs to provide an investor-friendly capital market and attractive goods and services for consumers.
A host of challenges confronts the Japanese economy. The problems are critical and pressing, and the efforts of the Koizumi administration are having a rough ride against resistance and sabotage by groups with vested interests. But progress is being made steadily on most fronts and we can expect more. It will take another two or three years for Japan to be able to declare that it is out of the woods.
A world in shock
The whole world has problems right now. Even the mighty US finds itself in suspense. The September 11 attacks and the Enron scandal have dealt a serious blow to perceptions of the invincible strength of US society and the US market. The trauma will not go away easily and the suspicious mood has spread rapidly to other countries. Despite the seeming recovery of the American economy, stock markets around the world are suffering an agonizing reappraisal.
What the Enron scandal – and others that have followed – have brought about is a loss of trust in the integrity and ability to self-correct of the big corporations, which had previously been seen as the standard bearers of a triumphant capitalist market. It is saddening to find, in all the cases of misconduct, that the ultimate culprit is personal financial greed. The scandals have mercilessly reconfirmed that it is a matter of the genetic make-up of the capitalist market.
Here we find ourselves in a serious dilemma. On the one hand, it is clear that the relentless pursuit of maximum profit is the source of the dynamism that keeps the capitalist market moving. At the same time greed, like a cancer, destroys the sound functioning of the market.
If we look back at the development of capitalism in Europe, the US and Japan, we see that the leaders of society have always undergone serious soul-searching. They firmly believed that the emancipation of human aspirations was vital for the development of society. But they were also convinced that emancipation must come with a proper sense of self-restraint.
Business leaders have always demonstrated amazing ability and ingenuity in creating business and making profits. But many of them also practised self-restraint to ensure that their business activities would not undermine the importance of trust and fairness in society.
As we have seen in the recent spate of scandals, many business leaders – blinded by the success of capitalism – have been unable to see the critical importance of self-restraint, which is the central pillar of capitalism.
The US market is the one that must face this dilemma most squarely. However, Asia cannot and should not remain indifferent to the US dilemma. Asians must recognize that the real source of resilience of the Anglo-Saxon market is its capacity for thorough self-reflection and its ability to take self-corrective measures.
In other words, the most reliable guardian of the market is not a powerful official regulator or charismatic business leaders. It is the readiness and willingness of society to reflect upon how best to make economic development and human integrity compatible with each other. It is the strength of an open and mature society.
Asia has achieved phenomenal economic development since the 1970s. A strong aspiration for development shared by government and people, a massive inflow of foreign capital and technology and dynamic entrepreneurship have all made it happen.
Inevitably, the shining success also has its dark side. All kinds of misconduct – fraud, bribery, embezzlement – are rampant in most Asian countries. Although governments are ostensibly trying hard to reduce the incidence of such misconduct, there is little sign of any genuine or spontaneous pressure from society for serious reflection on the problem.
If Asia wants to become a pivotal player in the world, along with North America and Europe, it must develop a society and a market that respect trust as the highest value – and do not hesitate to admit their own defects and correct themselves.
This is particularly important now, when the image of the US market is badly tarnished. It will take some time to restore confidence, but US society will do everything in its power to overcome the challenge.
Asia, too, must continue to change – and I for one believe that it will.
Toyoo Gyohten is president of the Institute for International Monetary Affairs and a former chairman of Bank of Tokyo. He served for many years in the Japanese finance ministry, retiring in 1989. He also worked for the IMF and the Asian Development Bank. He chaired Working Party III of the OECD in Paris from 1988 to 1990. He was a visiting professor at Harvard Business School and Princeton University, and co-authored Changing Fortunes with Paul Volcker.