I would like to thank CF 40 for inviting me to the Bund summit once again. It is my great honor and pleasure to be here as a speaker. Witnessing growing and worrisome economic tensions in trade, investment and technology between China and the US in recent years, I have thought that my possible contribution to this year’s summit is to look back on the Japanese experiences of the escalating dispute with the US in 1980s and draw possible lessons for all of us—not only China and the US, but also the rest of the world. I hope my brief presentation will offer some foods for thought.
The economic disputes between Japan and the US were wide ranging, including trade, financial markets, technology and macroeconomic policies, among others. It is beyond my capacity to cover all these issues. Reflecting my professional background, I will mainly focus on issues of macroeconomic policies, especially on monetary policy and exchange rate policy, but briefly touch on financial policy and trade policy as well. In doing so, I will organize my remarks around the massive Japanese bubble in late 1980s and its subsequent collapse and financial crisis in 1990s. This was an inflection point for the Japanese economy and thus this experience has been intensively studied by policymakers and academics in many foreign countries including China. In fact, I have always been impressed by Chinese policymakers and academics who had keen interest in understanding the Japanese experiences. This is probably because Chinese experts rightly recognize challenges they are faced now were similar to what Japan was faced almost 30 years ago: the need for smooth transition from a high growth to a stable growth, how to cope with rapid ageing and a declining birth rate, and how to handle the growing tensions with the US.
Looking back on the experience of Japan’s high growth
Looking at history, we find many cases where the strongest country feels its existing power threatened as an emerging country grows rapidly. Japan’ s high growth started from the middle of 1950s and ended with the early 1970s. China’s high growth started from 1990s. As for Japan’s high growth, several factors enabling high growth were at play, but if I am asked to point out most important ones, I want to emphasize the use of competitive market system and the benefit of open trade system. While many Asian countries were not embracing competitive market system, Japan was an exception. And most fortunately, Japan could tap global market thanks to open and free trade system. Japan was really a beneficiary of open and free trade system. The same is true for Chinese high growth. China has also benefitted from the dynamism of competitive market system and more importantly, open and free trade system. I sometimes wonder what would have happened to Japanese economy, if China had embraced competitive market system and joined the GATT much earlier.
The economic disputes between Japan and the US in 1980s
Now, I would like to move on to the disputes between Japan and the US itself. Believe it or not, in 1980s, the US growingly feared that they would be overtaken by Japan. The process might be called as “The Thucydides Trap”, a term coined by American political scientist Graham T. Allison.
What caught the eyes of many people in business and policy arena in the US was a loss of competitiveness of the once-mighty US manufacturing industries. It started from textile in 1960s. Then, it spread to steel in 1970s. It was automobiles and semi-conductor industries that became the hot spots in 1980s. Macroeconomic data painted the same gloomy picture for the US. The gap of GDP between the US and Japan narrowed. In 1989, Japan’s nominal GDP was still 54% of the US GDP, but extrapolating the trend, it was not far distant future when the US GDP would be surpassed by Japan. Dominance of Japanese player was most evident in cross-border bank lending. Looking at statistics on international banking assets, as much as 90% of the overall increase in 1988 was attributed to Japanese banks. Aggressive purchase of the US firms by the Japanese firms invoked some emotion. The most controversial purchases were that of Rockefeller Center by Mitsubishi Real Estate and Columbia Pictures by SONY. Both were the very symbol of the US culture in the eyes of many American. Recalling these, you would be surprised how similar economic relations between Japan and the US at that time were to those between China and the US today.
The US reactions to expansion of Japanese economy at the time was very complex. On the one hand, Japanese system was regarded as “efficient.” So, several books were written by the US scholars with the intentions of learning lessons or “secret” from Japanese corporate management and industrial policy. On the other hand, Japanese system was regarded as an enigma with a lot of suspicion. The word best capturing the latter was “Japan Inc.” which was coined to describe a complex of government and businesses. Unfortunately, this latter reaction became stronger as tensions intensified. The typical perception was that Japan was operating on a rule completely different from the one in western world. Growing surplus on Japanese current account, which stood at more than 4 % of the GDP, was often interpreted as the reflection of unfair trade by the US.
Viewed from Japan, this argument was totally unacceptable and unfounded, but the US government and industries were quite aggressive and demanded Japan to take various remedial actions. The disputes were confined not only to trade. It spread to many areas including domestic financial marker, inward direct investment, government procurements. Pressures from the US was so strong that Japan had to introduce various compromise measures. On trade front, Japan adopted “voluntary export restraints.” On individual markets of goods and services, the US demanded many measures in the hope of increasing the US firms’ presence in Japanese market. On macro-economic policy, in 1985, Japan participated in the famous Plaza Accord which stipulated macroeconomic policy coordination and exchange rate realignment among major advanced countries. More importantly, Japan made a commitment to expanding domestic demand to reduce the current account surplus. Monetary easing was prolonged. What followed was massive bubble and subsequent collapse and financial crisis, which left an incurable scar on the Japanese economy and industries.
The relationship between the Bubble and the US pressure
The topic which I want to take up here is the relationship between this scar and the US pressure, because I have heard many Chinese experts saying, “It was a great mistake for Japan to have signed off the Plaza Accord.” They often attributed the bubble and financial crisis, and for that matter, a decline in Japanese economic power to Japan’s having succumbed to the US pressure. This argument sometimes takes on the tone of “conspiracy theory.” I do not buy into these arguments, although the US pressure itself was quite strong. I am interpreting what happened in the following manner.
The mechanism in which the bubble was formed was quite complex and I do not think prolonged monetary easing was a single cause. But it is also true that the Japanese bubble on such a massive scale would not have been formed without prolonged monetary easing. The greatest mistake was that Japanese government’s commitment to reducing the current account surplus by expanding domestic demand under the name of “international policy coordination”. This was wrong economics and mission impossible. The current account surplus fluctuates depending on the differences in cyclical conditions at home and abroad, but its underlying trend is dictated by the gap between savings and investments at full-employment, which is determined by structural factors, especially stage of demographic change. Remember late1980s was characterized by the population bonus-- the period with the highest ratio of working age-population to total population, which meant savings for retirement, and for that matter, current account surplus was the highest. Nonetheless, if the government made such a commitment, the Bank of Japan would have to continue monetary easing and it actually happened. The scale of the Japanese bubble was unprecedented in modern economic history. Its consequences--the burst of the bubble and financial crisis--were so dire.
Then, you may wonder why the Japanese government supported the idea of international policy coordination. I would point to four reasons.
Number one was obviously US pressures.
Number two was poor understanding of economic consequences of this commitment, as I just mentioned.
Number three was strong voices of export industries who demanded preventing appreciation of yen’s appreciation. Government thought international policy coordination was needed to prevent yen’s appreciation.
Number four was non-existence of inflation threat. Average inflation rate was below 1%. Politicians, corporate managers, economists, media and international organization were against monetary tightening partly because of subdued inflation rate.
So, just finger-pointing to the US pressure was neither accurate nor honest. Prolonged monetary easing was after all, in a sese, “home-made.” The Bank of Japan who though monetary tightening was need, was quite lonely. In those days and still today, policymakers and academics did not fully recognize that financial imbalances accumulated could undermine sustainable growth eventually, even if measured inflation was stable.
What kind of lesson should China learn?
What kind of lesson China should learn lessons from the bitter experiences of Japan from 1980s onwards? Some of Japanese experiences in those day were unique to Japan or unique to this particular period, but I believe there exists somewhat universally applicable lessons. Let me try to pin down these lessons.
First and foremost, we should make strenuous efforts at preventing bubble, or more generally, achieving a sustainable growth. What is most dangerous is hubris. The mechanism of the bubble formation was complex, but one of the causes was overconfidence about the way in which the economy and industries were managed. This situation was quite the same as the US situation prior to the Global Financial Crisis. Hubris is human nature but always dangerous. This general lesson applies to any countries.
The second lesson concerns monetary policy. Monetary policy should not aim at what it cannot achieve. Monetary policy can best contribute to fostering stable financial conditions--price stability and financial stability.
The third lesson concerns the aftermath of the bubble. Once bubble is created, growth rate declines until the excess is eliminated. This is a common feature of any economy in a post-bubble period. What is important is to avoid a collateral damage stemming from the bubble. In the case of Japan, one of them was a delay in responding to the long-run challenges facing Japan, namely, rapid ageing and declining population. Unfortunately, Japan was not attentive enough to the impact of a demographic change which stared to affect the Japanese economy at around this period. This is partly due to a lack of imagination of what would happen in the economy affected by demographic change. But more importantly, both policymakers and businesses were overwhelmed by the imminent task of how to tackle the massive non-performing loan problem after the burst of bubble. The amount of human energy that society can deploy at any point of time is rather fixed. The effort at coping with demographic change was crowded out. The third lesson is we should not be overly distracted by a short-run development, however it is important, and never forget about the long-run challenge a country is face with. In the case of Japan, one of the important challenges was to address demographic change.
To give somewhat concrete flavor to the Chines audience to explain this last point, I will take up pension problem as an example of demographic challenges: how the aged people fund their life after their retirement. In any society, regardless of the exact method used--public pension, private pension or family assistance--, key parameters determining the sustainability of the pension system are just three: the age of retirement, the income level of retiree relative to that of current workers and growth of productivity. These three have to be consistent in order to ensure sustainability in the long-run, but high growth often masks this undeniable relationship. Thus, needed adjustment tend to be delayed. The longer society becomes procrastinated, the more difficult forging a consensus becomes, because the voices of aged people becomes more influential.
The internationalization of the yen
So far, I have talked about macroeconomic policy. Now, let me say a few words about other policy area which has considerable macroeconomic implications. One is the internationalization of the Japanese yen. This was discussed intensively especially in 1980s, which was quite the same as today’s argument of the internationalization of the RMB. After all, Japan had never gained the status of yen in terms of the international use comparable to its economic size. My recollection is this was not a result of coherent decisions by the Japanese government and financial institutions. At the time, some people were quite enthusiastic about the idea of internationalization of the yen, while others were tepid. Taken a s a whole, Japan did not have a strong appetite. It was probably because Japan vaguely feared a potential burden which was thought to be associated with international currency country. It might be also because Japan was not prepared for liberalization of financial market and financial institutions, which was prerequisite for yen’s internationalization. Liberalization calls for good financial supervision and regulation. In a sense, the attitude of the government at the time toward the internationalization of yen was ironically right, because the subsequent financial crisis showed inadequate supervision and regulation.
International key currency is a lingua franca. This status requires not only big economic size but also deep and liquid financial market and rule of law, among others. In any event, trade and finance go hand-in-hand. If Japan really had wanted to expand its economic presence, Japan should have been more proactive, even though it did not mean replacement of the US dollar by yen.
How should a country cope with the trade dispute?
Finally, I have to say a few words about trade policy or trade dispute itself. The word “trade dispute” is usually used in a negative context. Of course, it is negative. But positives as a silver lining also existed. As a fact, the US pressure worked as a sort of driver for implementing deregulation in many important products and services markets, which was very much needed but was effectively blocked by vested interest group. This ultimately benefitted the Japanese consumers. It is better for us not to experience trade disputes, but if it is a part of the life, it is important to utilize this in a productive manner.
Trade dispute starts with the different perceptions of practices in trading partners. Each country tends to look at a practice of trading partner as unfair. Truly unfair practice exists. But, the perception of unfairness sometimes derives from a simple fact that the way in which business is conducted is different between two countries. One example is life-time employment system. Japanese firms, which made implicit contract of continuing to hiring of their employee, had tendencies to produce and export aggressively compared with the US firms in the face of weak demand, because labor cost was a fixed cost at least in the short-run. Viewed from the US firms, the behavior of Japanese firms was sometimes perceived as predatory. This was not the issue of fairness. It was just reflecting the difference in social contract. The same is true for the US practice. Japanese felt some of the US practice unfair, but this might have been reflecting their unique social contract.
We often talk about globalization or globalized world. But this word is somewhat hyperbole. After all, each country has its own social contract. Even within a country, the social contract people want to have is different. There is no quick fix to any dispute between countries, including the one between Japan and the US in 1980s and the one between China and the US today. But we all have to recognize open and free trade and investment system are international public good. Bearing this in or mind, at a minimum, the continued effort at deepening mutual understanding like the discussion at this Bund Summit is quite important. I hope CF 40 will continue to make contribution in this area.
Thank you for your attention.
