IP: Ed Lincoln Talk at GW's ESIA

[Dave Farber <farber () cis upenn edu>]

Date: Wed, 4 Mar 1998 00:24:35 -0500 (EST)
From: Brown Robert L <rbrown7i () gwis2 circ gwu edu>




Dr Ed Lincoln, senior fellow at the Brookings Institute and dfs
subscriber, spoke today at GWU's Elliot School of Int'l Affairs as part of
the Sigur Center for Asian Studies' lecture series. The notes below are my
own, and any mistakes are likely mine as well. I also apologize for the
abrubt style of writing, I copied the following directly from my notes.


"Wallowing in Japan's Financial Mess"


Japan has not performed well in the 1990's because of bad debt, etc. Ed
Lincoln is pessimistic and not encouraged.


Macro Causes: Beginning in 1985, the Yen underwent a rapid rise.
Presumably, exports would decrease, imports would increase, and a possible
recession would occur. The government was engaged in measures to eliminate
the deficit, so fiscal measures were not considered. The government
decided upon monetary policy: pushing interest rates down and using
administrative guidance over banks to expand lending. The resultant
economic stimulation lasted 5 years and was beyond the expected potential
growth rate. In addition to maintaining low inflation at about 3.6%, the
growth rate was about 5%. But, there was tremendous asset inflation; both
stocks and land values approximately tripled. By 1989 the Ministry of
Finance (MOF) knew there was a bubble and acted to release some of the air
out of the bubble by raising interest rates and restricting lending. MOF
hoped to  let the bubble slowly reduce, but the bubble burst. Stocks began
to recover slowly in the early 90's, but land prices are still in decline.
The consequences of the burst bubble was economic stagnation
(approximately 0.6% for 4 years), a mountain of bad debt (recent estimates
are approximately US$800 billion, though the government admits to only
about US$600 billion). The mess of the 90's is largely a consequence of
bad debt and the burst bubble.


Micro Causes: In general, a financial system serves to connect savers and
investors, and there is usually a correlation between risk and return on
investment. Japan was much different. The government did not establish
rules for governance, it wanted to guide the economy. Especially, it did
not want the bond and stockmarkets to play a significant role. Private
bond sales were limited to a few companies (only NTT in the 1960's). Stock
trading was also limited, they became only a speculative game and not a
means to transfer ownership or corporate governance. The financial system
had only a few big banks and the government guaranteed a certain return on
investment in exchange for guidance; the government controlled interest
rates and entry into the market of new banks. The banks benefited from
this arrangement and received big profits. However, corporations carried a
heavy debt load, and a high debt to earnings ratio is perceived in the US
as a bad sign. There is a significant lack of oversight in Japan; without
an effective stock market the private sector can't evaluate these
companies (via stock prices as a measure of strength). Corporate


governance is in the hands of the company's main lending bank, and lesser
banks trust the main bank's oversight ability. If the comapany is
experiencing serious problems, the main bank is supposed step in and
direct changes and/or fire managers.


What went wrong?
1. Ossification of the banks: banks downgraded the importance of oversight
personnel and increased reliance on personal contacts as a vehicle for
oversight. However, over the course of years, the personal contacts
develop into social reasons which prevent the banks from backing out of
lending.
2. Privacy of relationships with banks: due to the legal relationship, the
privacy rules require that the banks be honest in their corporate
oversight. However, this makes it easy to hide problems. Another result is
collusion to hide problems that includes the MOF, which is supposed to
enforce, not overlook, violations.
3. Lack of innovation: The US is better at understanding and evaluating
risks than Japan. Innovations include management and computer systems.
4. Shifting demand for funds: As older customers require less funds, banks
have shifted to 2 new customers: real estate investment and
internationally (to recycle the current account surplus). Again, Japanese
banks have a lack of evaluative expertese and ossification of oversight.
All of the above (#1-4) leads to disaster.


The Future: Banks need to create new, "good" debt, but is doing poorly.
Some fiscal measures are causing growth which reached 3.6% in 1996. MOF
responded by returning to its austerity measures and increased taxes
(income and consumption taxes) which threw Japan back into stagnation.
Japan is now trying to repair the April, 1997 mistake. Plans include a
structural bailout, including increasing deposit protection insurance.
Japan is also proposing the purchase of US$100 billion in new bonds from
banks to infuse them with cash. This was a bad idea, it was a moral hazard
and gave MOF too much power at a time when deregulation should be a
concern. Other programs include accounting games (differential treatment
of land and stock revaluations, and declaring only the net amount of loans
-amount of loans minus amount of deposits), the government decision to buy
land now for future planned public works projects, and the use of postal
savings to prop up stocks.


Conclusion: Probably, Japan will muddle through, but is hampered by its
slowness to cope. Vested interests are too tied into the system. There is
a need to overhaul the government-economy relations. The strategy of the
rest of Asia to recover depends partly on Japan importing more.


Questions:
1. Are there solutions that would be specific to Japan? Answer: There is a
need to overhaul the financial system to be more like the US, though we
are unlikely to see the same exact institutions. Bond and stock market
development requires information flow, which Japan is not confortable with
that.
2. Japan's problems are on the political and not the economic side; why is
there no political pressure for change? Answer: There is not enough pain,
only stagnation. There won't be pressure until the situation is real bad.
There was single party rule without the incentive to reform, then the


coalition of '93 was a failure. Japan moved back towards the LDP, partly
as the people are particularly risk-averse. The possibility of major
change has created anxiety over the loss of personal security (life-time
employment, etc).
3. If Korea or a Southeast Asian state is successful at rebuilding after
the crisis, how likely is Japan to learn from the sucess? Answer: Doing so
would require a complete reversal of Japanese thinking about its place in
the world. It may be more effective than US pressure. Germany is a
possible model.
4. Big-bang Deregulation? Answer: is supposed to proceed over the next few
years. It is likely that the reforms will occur, but there will be
significant tinkering around the edges to cushion the impact on domestic
companies.
....End....


Robert Brown


http://gwis2.circ.gwu.edu/~rbrown7i/
Elliot School of International Affairs, at GWU




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