Why now the problem of International Financial System

1. Currency crisis of Thai Bath started in 1997 was soon called Asian Crisis, because of its wide regional effect and its seriousness. There were different analysis as to its cause and its effect to the real economy. Today, the Asian Crisis is considered to be overcome. It is the time to clarify the causes of this Crisis, and to establish the measures to avoid its recurrence.

2. One argument strongly put forward at the time of Crisis by many scholars and policy officials particularly in the US was to find the main cause at so-called Asian Crony Capitalism. Yet, the rapid recovery from the Crisis clearly shows that this theory was wrong. Because, if the Crony Capitalism was the cause, and if it was a particularity of Asian economy, then it would not have been possible to change the nature of the Asian economy in few years and recover from the Crisis. The Indonesian economic and political system that was criticized as a typical Asian Crony Capitalism has experienced a parallel crisis of economy and politics, as a result of which the greater political democracy and economic liberalization has been achieved. Yet Indonesia still faces the serious economic problem and will be the latest to achieve the economic recovery. The Asian Crony Capitalism Theory cannot explain the continuation of difficulty in Indonesia after the economic and political reforms.

3. The Crisis developed in those countries that adapted Dollar-pegged exchange rate system, the liberalization of capital market, faced the worsening situation of trade balance, the unbalance between foreign reserve and external short-term debt, and had insufficient amount of foreign reserve to cope with currency speculation. Yet, the direct cause of Crisis was a deliberate speculation on Thai Bath in order to get colossal benefit. The Malaysian Crisis was also caused mainly by currency speculation from outside. In the case of Korea, the direct cause was the refusal of rollover of short-term debt by the international banking group. The Currency Crisis was rapidly subsided when the banking group accepted the rollover at the request of industrialized countries. In relation with IMF, the delicate case was Indonesia. In the middle of conflict between Indonesian Government and IMF, the withdrawal of capital from Indonesia was started by foreign investors under the influence of Bath Crisis, then it was massively followed by the fleet of domestic capital, which in turn aggravated economic situation, that was considered not serious at first, but actually developed into an economic and political crisis.

4. The IMF demanded at first these Asian countries to achieve structural reforms, tight budgetary and financial policy. This IMF policy was criticized afterward as wrong policy based on the misinterpretation of the nature of Crisis. The IMF changed soon its policy in favor of relaxed budgetary and financial policy.

5. Looking back the process of Asian Crisis, this Symposium is expected to exchange opinions on necessary measures to avoid the recurrence of the Crisis.
 

Toward the Stability of International Financial and Currency System

6. The causes of Asian Crisis were now identified. It is necessary to workout the policy and system to avoid its recurrence. First of all, it is necessary that each country should achieve sound macro-economic balances, especially trade balance, the balance of foreign reserve and short-term foreign debt. These are preconditions to avoid crisis, but they are not sufficient. At the time of speculation on Thai Bath, it is assumed that 10-20 billion dollar was transferred. It is very difficult to cope with the massive speculation by an individual country. To prevent speculation, the information of lenders and speculators should be clarified, and they should be duly controlled and taxed. The difficulty is that this measure needs much time, because it cannot be done without international cooperation.

7. At the time of currency and financial crisis, the most important is the quick and massive response to speculation. For this, the close cooperation among countries is necessary. Among the countries where mutual trust and understanding have been developed, it is necessary to make agreement on mutual lending of foreign currency to mobilize massive fund as quick as possible to stop speculation at the start. It is very much welcome that an agreement was established in this direction among East Asian countries. A project to create Asian Monetary Fund would be an important step forward.

8. For the development of world economy, the stability of exchange rate is important. One of the reasons of East Asian Miracle was the liberalization of capital and Dollar-pegged stable exchange rate, which facilitated foreign investment in these countries. But the liberalization of capital and Dollar-pegged exchange rate can be an easy target of speculators, especially for small and middle-sized countries. Therefore, the liberalization of capital should be decided pragmatically by individual country on the basis of its reality, rather than from the theoretical point view on the righteousness of liberalization or restriction. At the same time, from the middle and long-term viewpoint, and on the basis of experiences of EU and the currency integration of African CFA with Euro, the establishment stable international currency system should be sought.
 

Toward the Development of East Asian Economic Area

9. Successive currency crisis in Europe led to the creation of ECU on the basis of basket system of different currencies, coupled with the unlimited lending agreement on currencies. Transition to EURO from 1999 made impossible any currency speculation. It is a great step for economic stability. This process would not have been possible without close economic relation and deep mutual trust among European countries.

10. It is natural that there develops a strong voice for Asian regional cooperation on economic and financial area after the Asian Crisis, in order to respond quickly to crisis and to avoid crisis. As to the Asian Monetary Fond, there was strong criticism and doubt from the US, when it was first proposed in 1998. Now, there seems to be no strong criticism against Asian Monetary Fund.

11. All over the world, there are already many free trade or investment areas, in Europe, American continents and in Africa. In Asia, diversity of cultures, complexity of history and the relation among different peoples, and different political systems are regarded as an important obstacle for the development of Asian Economic Region. Yet, new phenomenon is developing, for example, the consultation between Japan and Korea, on free trade and investment; the two countries with very difficult past history. Asian Crisis was an occasion for Japan as a biggest economic power in this region to review its role in Asia.

12. Therefore, another role of this symposium is to discuss the possibility and difficulty of East Asian Economic Area on the basis of experiences in Europe and in North-south American continents. The development of East Asian Economic Area should not create any anxiety or doubt from other parts of the world. Therefore, this development should be accompanied by the transparency and openness on the purpose, needs and content of such Area, and in full accordance of international regulations in this respect.
 

1. Lessons of the Economic Crisis

One of the fundamental causes of the East Asian economic crisis was that governments and corporations in the region failed to make efforts to effectively respond to the changes in the international economic environment.

In the 1980s, the world economy underwent two major transformations of historic magnitude. First, trade in goods and services and international financial transactions were liberalized in line with the trend toward deregulation and the expansion of markets beyond national borders, a phenomenon now called "globalization." The essence of globalization is that economic competition is no longer conducted within national boundaries but always on the global marketplace, forcing governmental economic policymakers and corporate managers to pay heed to the background of global competition as they manage their national economies and businesses. For instance, although real estate is not internationally transferable, when customers and residents are able to migrate freely across borders, even this business comes to inevitably face global competition. 

Railways and roads are other assets which are not internationally tradable. However, if the airline industry, which is a rival to these industries in the domestic market, is liberalized, they too will be exposed to international competition, albeit indirectly. Likewise, national tax systems, social security, and even education are unable to avoid global competition.

The second historic change was the revolutionary advance in information and communications technologies. This IT revolution gave rise to a nearly unlimited variety of goods, services and related industries destined for global use. Consequently, it has not only brought profound change to existing industries and companies, but has also completely altered the shape of industry. At the same time, it has broken down the traditional monopoly and concentration of information in the hands of a few, enabling all consumers, taxpayers, shareholders, voters and employees to simultaneously share information of the same quality. 

Governments and corporate management must now run their national economies or companies on the assumption that they have no advantage based on privileged information; thus transparency and accountability have become the most important elements in their respective areas of governance.
The methods of national economic management, market functions and corporate management in place in East Asian countries proved to be extremely effective within the environment that existed before these changes took place. There was a mechanism of close collaborative relationships among politicians, business leaders and bureaucrats, supported by a national consensus which gave top priority to national economic development. International competition was stifled for the sake of protecting domestic industries, and governments controlled the allocation of funds, created export-dependent industrial structures, and maintained employment. The banking industry was protected and supervised to serve these national objectives. The primary aim of this protection and supervision was not to enhance the soundness and efficiency of banks, but simply to secure the smooth flow of necessary funds. Indeed, in many cases, policy loans and investments were granted at the expense of the soundness and efficiency of banks.

Core industries were controlled by a small group of families which had close connections with politicians and bureaucrats. There were few conflicts of interest between corporate managers and shareholders, and the primary goal of corporate managers was to maximize their own profits and to beat domestic competitors. Companies were run under the strong influence of paternalism, where fierce labor-management confrontations were not allowed. Traditionally, the majority of the population was docile to the control and supervision of the government, and was hardworking.

The development policies pursued by governments in this environment produced phenomenal results in many East Asian countries. Supported by sustained high economic growth, absolute poverty was reduced and income gaps were narrowed. It was indeed the "East Asian Miracle."

However, globalization and the IT revolution profoundly transformed the environment facing the East Asian economies. First, the volume of funds available for international investments expanded enormously, as a result of the global balance of payment imbalances triggered by the oil crises in the 1970s, and the increase in financial assets such as pension funds associated with the aging of populations in industrialized countries. In the 1990s, the global trend toward the deregulation of capital flows and the technological revolution turned the world into a huge whirlpool of investment funds, both short- and long-term. Inevitably, the East Asian economies became the most attractive destinations for international investment money, because they were relatively small, fast-growing and eager to absorb foreign capital. Unfortunately, these nations failed to fully understand the risks accompanying the benefits of becoming targets of such investment, and little serious attention was paid to the question of what should be done to mitigate the risks.

The responsibility for Crisis should also fall on international investment groups, primarily those from industrial countries, however. Driven by greed for economic gains, they simply put in or pulled out massive amounts of funds, and gave very little thought to how best to contribute to the stable development of developing economies.

I mentioned earlier that as a result of the IT revolution, transparency and accountability have become the keywords of the governance of governments and corporations. From now on, the performances of governments and corporations will be evaluated not only according to their long-term prospects, but also by the extent of fulfillment of these two key requirements. Indeed, governments and corporations in industrialized countries have come to understand that the calls for transparency and accountability are irreversible, and have tried at great cost to respond to them, sometimes at the expense of efficiency.

Unfortunately, East Asia had a serious handicap in this respect. The past circumstances in East Asia required neither transparency nor accountability. Rather, the methods of economic and corporate management that had been astonishingly successful in the region were of quite the opposite nature. As a result, even when the environment was poised for drastic change, East Asian countries failed to make efforts to dramatically alter their traditional ways of doing things. They simply could not do it.

The widening gap between the rapidly changing international environment and the inertia of East Asian governments and corporations led to growing discomfort and distrust in the markets. Once the sentiment became bearish, the market began searching for clues to vindicate its concerns. It was eventually discovered, as if for the first time, that East Asia was plagued by deteriorating current accounts, mismatches of foreign-currency debts, and fragile financial systems. Investors fled in stampedes, leaving the economic crisis in their wake.

Fortunately, the East Asian economies have been recovering since the second half of 1999. This recovery has been supported by strong worldwide demand for semiconductors, sustained U.S. economic strength, an increase in imports by Japan, a recovery of exports thanks to enhanced price competitiveness in the wake of currency declines, and increased domestic consumption stimulated by the easing of monetary policy and increased fiscal spending. Because the decline in 1998 was so sharp, and the capacity utilization fell so low, the recovery from the bottom was steep. Most of the East Asian economies are estimated to have now recovered to their pre-crisis levels.

Serious efforts were launched in many East Asian countries to address the problems underlying the economic crises: reforms of the governance of both corporations and governments, and the strengthening of financial systems. Although the extent of progress has varied from country to country, it is encouraging to note that the most serious efforts are being made in countries that were the hardest hit. At present, the market is responding positively to such reform efforts, and is displaying a strong sense of expectation. However, if the economic recovery generates a sense of complacency, resulting in a suspension or reversal of efforts to tackle the fundamental problems, the risk of a recurrence remains intact.
 

2. Responding to the Market

It is widely argued that democracy and market-oriented economies have become global paradigms since the collapse of the communist political system and the centrally-planned economy of the Soviet Union. The concept of the market economy seems to be one of the pillars of the flourishing debate about the East Asian economic crisis. In many cases, the debate focuses on comparisons between laissez-faire policies and market principles, on the one hand, and government intervention on the other.

It seems to me that such debates are conducted on the tacit assumption that the market is a private entity which exists and operates on its own, and that the only force that can engage it is public authority. However, this assumption is overly simplistic; the misperception stems from an insufficient understanding of the nature of the market.

We must begin by asking what the market actually is. In my view, it is an aggregate of the judgments of all participants who are able to influence economic phenomena. What is especially important in discussing the market is the recognition that the composition of participants and their judgments are in constant flux. During the initial creation of a market, there are only producers and consumers. Later, however, new participants come on board one after another: intermediaries, corporate managers, investors, public entities, etc. A particularly important group today is the providers of information. The most powerful motive at work in the formation of judgments by this ever-growing and ever-changing group of market participants is the maximization of their respective economic benefits. But individual judgments are also affected by differing variables. In addition, when one considers profit maximization in the long run, a set of totally different considerations, such as environmental protection, support of the under-privileged, and maintenance of equality, must be introduced into the picture.

After all, the market is a dynamic and ever-changing creature. In the process of constant transformation, it is often exposed to the risks of herd mentality, misjudgments, as well as excesses due to the fallacy of composition and to irrationality. The market is not always correct. The theory of the "invisible hand" tells us simply that the judgment of the market, in the long run, will come around again to the starting place of rationality. In other words, the market is not an established, fixed private entity.

If this understanding of the nature of the market is correct, then it follows that no government or corporation can afford to ignore or antagonize it. What they must do is correctly understand the composition and judgment of the market's participants, and try to find harmony with the market through a two-way interaction. The correct approach to the market, therefore, seeks not to suppress it as an adversary, but to try, as a member belonging to it, to transform the aggregate. In the aftermath of the East Asian crisis, some argue that the market is an evil, and urge governments to try to isolate national economies from it by way of intervention or regulation. I have to say that such responses are sheer rubbish.

3. Regional Cooperation

The most important lesson of the East Asian crisis is the painful discovery that the region was not equipped for the prevention and management of the crisis. As long as globalization means intensified competition on a global scale, it is quite natural for governments and corporations to strengthen their collaboration and groupings, on top of efforts of their own, in order to strengthen their competitiveness. What we have been witnessing in North America and Europe is precisely this type of development. If the East Asian economies agree that it is desirable and necessary to enhance interdependence in intra-regional trade and investment, then they should initiate studies of what sorts of arrangements are needed to promote and reinforce it. It is gratifying to note that in the wake of the East Asian crisis, there is a stronger and broader recognition of the need for such regional cooperation.

Compared with North America and Europe, however, we must duly recognize that East Asia faces many difficulties in the process of strengthening regional cooperation. Regional cooperation in North America is unipolar and vertical, centering around the United States' overwhelming status as an economic and military power. Furthermore, the United States is capable of providing the region with a standard for monetary and fiscal policy; the dollar is the de facto common currency of the region. Regional cooperation in Europe, by contrast, is multipolar and horizontal. Although Germany and France carry relatively large weights, the European Union is still a group of many states that are more or less homogeneous in tradition, culture and economic levels. Importantly, they share a common political aspiration for the unification of Europe.

East Asia is different from either of those: it has no single pole, like the United States in North America. There is a future risk of rivalry between Japan and China, and at present there is no economic and political homogeneity comparable to that of Europe. Due to historical circumstances, East Asia is much less self-sufficient than either North America or Europe. Therefore, regional cooperation needs to proceed in a way that always leaves the region open to the outside. In other words, East Asia must explore a third path. In developing the strategies required to promote closer regional cooperation against this background, the following four points seem to be of importance.

First, efforts are needed to strengthen regional relationships of substantive interdependence. Intra-regional trade and investment have increased steadily, but a broader horizontal division of labor must be realized through the process of further liberalization, even while making use of comparative advantages. It will be of particular importance to encourage the exchange of human resources and information, in addition to goods and money. This will generate more flourishing exchanges of technology and culture, make the region more homogeneous, and provide a more solid pedestal for cooperation.

Second, regional cooperation should be pursued in stage. At present, East Asian regional cooperation is still at a very early stage, quite understandably in light of the variety of difficulties I have already mentioned. Recently, the leaders of the various economies have voiced high expectations for regional cooperation and aired many ideas, such as the establishment of a mechanism for mutual policy surveillance, free-trade arrangements, investment agreements, emergency lending facilities, currency systems such as currency baskets and a common currency unit, regional settlement mechanisms, and regional social safety nets. But we have not yet reached a stage where we can engage in joint studies based on concrete common proposals. It is also true that there are large differences in degree of interest and enthusiasm among the region's countries. Thus, we need to start by discussing those items on which the majority can participate. From this standpoint, the first candidate, in my view, would be to discuss the establishment of a mechanism for mutual policy surveillance. We need to create a viable forum, composed of representatives of governments and central banks, whose role would be to accurately and promptly disclose and exchange relevant information and to conduct studies and discussion. We also need some sort of mechanism through which the views of financial institutions and corporations can be fully reflected in the deliberation. If we want to make the forum a true foundation for regional cooperation, it goes without saying that it should be equipped with institutionally binding authority to provide mutual advice and recommendations, as well as a strong political commitment to back up that authority. In this respect, we should never forget that the single most important factor contributing to the creation of the EMU was the enforcement of the Solidarity Pact under the Maastricht Treaty.

Third, it will be necessary to launch a form of core group for cooperation. East Asian diversity is so undeniably vast now that it is unrealistic to consider starting off with a substantive arrangement encompassing the entire region. Therefore, it is desirable to form an initial core group of economies which have relatively high degrees of economic and political homogeneity: Japan, South Korea, Singapore, Australia and New Zealand, as well as Hong Kong and Taiwan if the consent of China can be obtained. The greatest significance of forming such a core group would be to verify and demonstrate that East Asia can achieve a type of multilateral cooperation, equipped with the ability of self-discipline, in a manner different from that of North America or Europe. If a group of economies which share a common respect for the market and possess open political and social systems can forge solid cooperation in the above-mentioned areas, it will dramatically improve the global perception of East Asian regional cooperation. It will also have a strong impact on other countries in the region, and generate enormous momentum toward closer regional cooperation.

Fourth, constant efforts should be made in order to at least keep the trilateral relations – Japan-China, China-U.S. and U.S.-Japan – from becoming adversarial. It is obvious that the peaceful development of East Asia depends crucially upon the success of this endeavor. The importance of these trilateral relations for East Asia is equal to, or even greater than, that of the Franco-German relationship in Europe. Only with stability in this trilateral relation can East Asia maintain stable relations with Europe, Russia and other regions, and thus establish a strong presence on the world stage.

For Japan, the most important and complicated of these triangle relationships is, of course, Sino-Japanese relations. The Japan-China relationship is uncommon in the world in being a bilateral relationship that has been sustained for as long as 2,000 years. A string of events that took place since the end of the 19th century helped spawn the present mixed feelings of affection and enmity between the peoples of the two countries.

The Japanese have fears about China becoming a military and economic power. They find it repulsive that China still teaches anti-Japanese education in its schools, more than 50 years after the end of the Sino-Japanese War and in spite of the fact that Japan has been providing huge sums of economic assistance during all these years. Furthermore, as China has yet to firmly establish the rule of law, many Japanese corporations have had bitter experiences doing business in China, and this has become a source of indignation and spite toward China. On the other hand, China has suspicions that Japan, in collaboration with the United States, is trying to contain the spread of its influence. They are discontent that the Japanese never seem to be repentant about the enormous damage their country inflicted upon them during the last war. Also, some Chinese are repelled by the fact that Japan, which was once a small tributary state to China, has become a major industrial power.

It is undeniable that there are so many elements in the rivalry between Japan and China that cannot be eliminated easily. There is a long road to tread before Japan and China can forge a mature friendship comparable to U.S.-British or Franco-German relations. At the same time, however, it is clear that a peaceful and stable relationship between Japan and China can bring great benefit to both countries, and will also be essential for the stable development of East Asia as a whole.

At present, it is difficult to predict the future shape of Sino-Japanese relationships, and it is also impossible to find a convergence of perceptions on these prospects between the two countries. Japan and China should undertake joint endeavors to remove the destabilizing elements that exist in the current bilateral relationship, starting from whatever is possible. Japan should begin by reviving the national sentiments of affection and respect the Japanese used to have toward China. China for its part should establish as quickly as possible a civil society that is self-corrective and open both internally and externally.

Of greatest necessity in succeeding in those endeavors will be the improvement of education in both Japan and China, active personnel and cultural exchanges, joint research into various issues on which the views of the two countries differ, and the promotion of mutually beneficial joint projects.
 

4. Japan's Role

We Japanese are fully aware of the role Japan should and can play in promoting East Asian regional cooperation, and there is nothing new to be added to what has already been discussed. What remains to be done is to take action. Frankly speaking, however, the list of actions that should be taken is long and fraught with difficulties.

First, Japan must resolve the economic problems it still faces. The major issues are the strengthening of the competitiveness of the financial industry and market, industrial restructuring and reform of corporate governance, and in the longer term, fiscal reconstruction through the reform of the fiscal structure and tax system. I must stress that progress made in these areas will ensure a strong recovery of Japan's economy.

Second, there is a need to carry out a third major opening of Japan to the world. Only with the success of this third opening effort can Japan become a leading state which East Asian countries can trust and cooperate with.

Third, there is a need for Japan to play a positive and creative leadership role in addressing specific issues of regional cooperation. In order to realize the ideas for cooperation listed earlier, the Japanese government and private sector should collaborate and prepare concrete plans to stimulate regional interest, and encourage study and discussion on them. No regional cooperation will materialize unless somebody takes the initiative. If Japan can demonstrate fair and constructive initiatives and leadership, I am sure East Asia – and the whole world – will not turn them down.