September 19, 1997
Thank you, Mr. Chairman.
More than six months ago, the organizers of this meeting approached me and asked me to write a piece on the success of East Asian economies. I said "okay." In a few months, the topic assigned to me changed to "Current Difficulties Faced by East Asian Economies." Naturally, my topic today is--well, we economists sometimes say supply creates its own demand--so my topic today is "Success Inevitably Created Causes for Difficulties."
Having said this, I would like to emphasize that the scope of my presentation is fairly limited. I am not going to create a complete list of the causes of the success of East Asian economies or the current crises of East Asian economies. Rather, I would like to pick up some of the developments in the 1980s and 1990s that might have had some bearing on what has happened so far this year.
Also, I am not going to discuss financial or monetary aspects of the current crisis but will talk about real aspects of the economies that probably have become the cause of financial difficulties.
Finally, I am going to ignore important diversities within the region. I guess what I am going to give is the Japanese perspective on the question of East Asian economies. The chairman used the metaphor of doctor and patient. Japan has been a patient since the early 1990s, so this is a patient's perspective on another patient, let us say.
Let me first run down the list of some stylized facts about East Asian economic growth; most of them are familiar, but I will need some of them in later discussion.
First, there have been very large investment booms in East Asian economies since perhaps the 1980s. This is but if you could turn to one of the handouts--Association of Southeast Asian Nations figure 3--there is a chart that shows the investment share in gross domestic product (GDP) for six East Asian countries. By that, I mean Korea, Singapore and four large ASEAN (ASEAN) countries. I couldn't include Hong Kong and Taiwan, for lack of data.
Clearly, the ratio has been increasing almost steadily from the mid-1980s, but you can see sharp increases in the late to early 1990s, and again, some increase in 1990 and 1995.
Second--again, these facts are well known--a significant portion of this investment has been financed by foreign funds, especially for ASEAN countries. Especially for ASEAN, direct foreign investment has been a crucial component of foreign funds, and Japan obviously played a large role here.
The next fact that I would like to point out is the following: These East Asian investment booms have coincided with stagnant behavior of investment in Japan, especially in the 1990s. If you could turn to figure 4, the chart shows the ratio of Asian investment--I mean investment in the six countries I mentioned--relative to Japanese investment. There is a sharp drop in the ratio in 1986, which was due to the sharp appreciation of the yen, but since then, it has been more or less increasing steadily. Again, you can see that there was a sharp increase in the late 1980's and again, sometime in the mid-1990s--1994, I think. The ratio went up further in 1995.
So in fact, there is a correlation--it is not a coincidence, I think. Many Japanese firms have created subsidiaries in East Asia at the expense of capacity expansion in Japan. Some surveys show that international firms with Japanese origin carried out 62.5 percent of investment in foreign economies relative to investment in Japan in electronic machinery.
Now, these investment activities--a significant number of which were led by foreign firms, not just Japanese--were aimed at meeting the demands not just in local markets in East Asia but also in other markets like Japan and North America. As a result, trade flows involving Asia have changed a lot. Let me turn to figure 5, which shows the trade flows among Japan, the United States, and Asia.
"Asia" here means the ASEAN-4; "Asian" means those four plus China. There are four numbers attached to each arrow. They mean the following: For example, if you look at the arrow extending from Japan to Asia, "45" means Japanese exports to Asia in 1985; "194" is the figure for 1995. The numbers in parentheses are trade surpluses of Japan against Asia. In 1985, there was, I think, a $14 billion U.S. surplus for Japan against Asia.
If you look at that chart, you notice something very striking. In 1985, Japanese exports to the United States the largest among the three numbers on exports. Also, the Japanese surplus against the United States is the largest among the three trade balances. But in 1995, exports from Japan to Asia become the largest; also, in terms of the trade balance, the Japanese surplus against Asia is the largest.
However, exports from Asia to the United States and the trade surplus of Asia against the United States are comparable to those from Japan to Asia.
Clearly, the location of production has been shifting from Japan to Asia. Asian countries are now importing from Japan the capital and intermediate goods necessary for such relocation of production.
The final fact I would like to point out is the following: Literature or technical literature on East Asian economic growth has shown that indigenously generated improvements in technology are scarce in Asia. That is, Asia--especially East Asia--has not invested much in research and development, trying to create its own technologies.
People have not liked this conclusion, and there are also many technical problems with the analysis in the literature. But let me say that this is the conclusion that one gets when standard techniques are applied to the existing data.
Now, what can we make of these observations about what have been the driving forces of these characteristics of the region? I would like to point out two things. First, there have been policy changes. East Asian countries have increasingly adopted more open, liberal policies for foreign trade and capital movement. Especially, they welcome foreign capital inflows initially, and foreign direct investment later, in other forms.
However, I am not going to talk about this aspect of East Asian economies in my presentation, because that was more or less fully covered by Stan Fischer's presentation during the luncheon. So let me move on to something else, which is exchange rate movements.
I think exchange rate movements, especially that of the yen-dollar rate during the last 10 years or so, have been the key to many developments in Asia, especially East Asia.
Let me turn to Figure 7, which shows what we call real exchange rates, and this is just relative prices of traded goods among Japan, Asia,and the United States. There are two theories in the chart. One is the relative price of Japanese trade goods against those of the United States, which is labeled "U.S." The other is the relative price of Asian trade goods to U.S. trade goods, which is labeled "Asia/United States." I could have just plotted Japan versus Asia, but I wanted to show the relative attractiveness of Japan versus Asia as an export center to the United States.
The chart shows that the two theories moved in similar fashion until about 1985, but after that, Japan became very unattractive as a location for food production. An upward movement in the chart, for example, for the Japan-U.S. theory means that Japan is losing price-competitiveness. The gap between Asia and Japan, or Asian and Japanese competitiveness, widened more significantly in the late 1980s and around 1994-1995.
This timing of the sharp appreciation of the yen coincides roughly with the movement in investment in East Asia that we saw earlier. I guess the real appreciation of the yen was a big factor behind the investment boom in East Asia.
Let me try to go a step further and place the argument in a larger perspective. Consider a world made up of, say, the United States, Japan, and East Asia. Assume that Japan makes a lot of technological advancements. Assume that East Asia makes none, to keep the story very simple. This would perhaps create a real appreciation of the yen against other currencies. As a result, some of the trade goods produced for Japan would become noncompetitive, and the production of these goods would shift to East Asia. The process of shifting production location to Asia would require a lot of investment. In reality, this shift was partially financed by foreign sources.
Having this picture in mind, I now turn to the discussion of why this process may lead to a period of difficulties for East Asia. There are a couple of reasons for this.
As a first approximation, the process I have described is a one-shot adjustment that is spread over a number of years. Once it is over, growth rates in East Asia will have to slow down--of course, by how much is a difficult question--and of course, I am exaggerating a bit here, because the same process can start again with new shocks, new technology improvements in Japan or in the United States. But I am just saying that a big, one-shot adjustment is more or less over.
Also, the adjustment process involves a rise in the demand for labor in East Asian economies and a resulting rise in wages there. That suggests that the emergence of an economy with lower wages--for example, China--would become a threat to East Asia.
Now, if we could go to Figure 7, we can see that the competitive edge of East Asian economies created by the appreciation of the yen in the late 1980s and mid-1990s is more or less over. The last points in the chart correspond to the first quarter of this year, 1997.
I could show more or less the same thing in a different way if you would turn to figure 8 of the handout. It compares absolute levels of similar products--in this case, machinery and equipment--between Japan on the one hand and the United States and China on the other, based on a survey carried out by the Japanese Ministry of International Trade and Industry and calculations done at the Bank of Japan. It shows the relative price of Japanese goods to other goods: "1.0" means the goods carry the same price levels; numbers above "1" mean Japan is less competitive; numbers below "1" mean Japan is more competitive.
Clearly, whatever price advantages the United States had over Japan in 1994-1995 are gone by June 1997, but China still maintains competitiveness. I hasten to add that in June, the yen-dollar rate on average was 114.3 yen per dollar.
To digress for a moment, if the above story or process is initiated by Japanese technological improvements in equilibrium, the yen should stay higher than before in real terms, I think.
If we could go back a page or two to figure 6, we can see the real, effective yen for the last two to three decades--upward movement in the chart means appreciation of the yen. As of the beginning of 1997, the yen was at about the average of the last two and a half decades. In that sense, the yen was probably undervalued, and other currencies--especially Asian ones--are overvalued earlier this year. Thus, the depreciation of Asian currencies by, say, 10 to 30 percent against the yen over the past few months is perhaps consistent with economic fundamentals.
There is yet another sense in which this mechanism has created a turbulence in East Asia. The same figure 6 indicates that the yen was overvalued significantly perhaps in 1994 and 1995. People around the world became, I think, too optimistic about the future of East Asia and carried out too much financial and physical investment in the region because of that.
It should be easy to see that such an overly optimistic investment attitude has been one of the causes of the recent financial problems in some East Asian countries. Surely, this is a familiar story for us Japanese. In fact, I could go a step further and point out some causal relationships between the Japanese financial crisis and the current Asian crisis based on the above discussion.
With the bursting of bubbles in Japan, Japanese investors, especially institutional investors, increasingly became risk-averse in the 1990s. They stopped buying risky assets, including foreign currency denominated assets. Together with a large current account surplus, this created a sharp appreciation of the yen in the mid-1990s, which in turn led to macroeconomic volatility in East Asia similar to that Japan experienced between the late 1980s and early 1990s in the manner I just described.
I would like to finish with a couple of concluding remarks. I may have given you the impression that the good days are over in East Asia, but this is not what I intended. The fundamentals of the economies are very good, so long as savings rates remain high, free policies toward foreign trade and capital movements are maintained, et cetera. I just pointed out that some extra stimulus to the economies during the past few years or decade is perhaps over.
Second, given that there is some excess fiscal capacity in the region and that financial sectors have some serious problems, I would guess that the adjustment to the difficulties would take some time. It won't end in a few months.
During the adjustment process, I hope East Asian economies will learn from the mistakes Japan made in its handling of the "bad loans problem."
Finally, I think my story shows that the market can go wrong at times. Many countries have tried to correct this without, hopefully, killing the healthy--by, say, stabilizing speculation--but so far in vain. I can only say that we have to live with this. Perhaps a more intimate coordination among monetary authorities in the region is one of the few things that we could do.