A MONETARY POLICY SETBACK, AND LESSONS LEARNED FROM IT:

Monetary Policy in the Global Economy and the Prospects of the Asian Monetary Cooperation Initiative　By　Sadahiko INOUE　Deputy Director-General　JTUC Research Institute for Advancement of Living Standards
Prepared for　Fourth International Progressive Policy Conference　Hamburg, Germany　March 2-5, 2000

Thank you Mr. Chairman. I would like to report on the experiences of Japan and Asia in the 1990s, in the context of the theme of this program, "Monetary Policy and Growth in the Global Economy."

The Crisis of the Japanese Financial System and Its Devastating Impact
As you may well be aware, Japan's economic path in the 1990s was characterized by a series of disastrous policy failures. We believe that we must learn the lessons of these fiascoes. At the same time, the failures may provide useful material for making judgments regarding the on-going endeavors to formulate initiatives for reconstructing both international and national financial systems toward the 21st century.

In Japan, the past decade or decade and a half of economic failures is often referred to as the "the lost decade" or "the lost fifteen years." Specifically, people point to the weak GDP growth of the Japanese economy, which remained as low as 1% per annum or so in real terms throughout the 1990s, and included years of zero or even negative growth. During the same period, the U.S. economy marked annual growth rates of 2.5% or more, and most European countries achieved growth in the region of 2.0%. This record represented "appallingly slow growth" (in the word of the OECD) when contrasted to the "super high growth" experienced by the Japanese economy in the decades between 1950 and 1990. However, none of our historians or economists entered the decade of the 1990s expecting such slow growth. Furthermore, even as the 1990s went on, they were unable to locate the causes of the slowed growth, with most people taking the faltering of the economy simply as a sign that the Japanese economy had caught up with other advanced economies, or saw it as a "system fatigue" of crony capitalism. At present, however, everybody knows the primary causes of the stagnation. They were a series of problems involving monetary policy and the financial system: the economic bubble which began from the latter half of the 1980s, characterized by soaring stock and land prices, the subsequent collapse of the bubble, asset deflation and debt deflation, dysfunctionality in the banking and other financial systems, and a chain of monetary policy failures.

With regard to the destructive power of the collapse of the bubble, which lay in the background of the failure of Japan's financial system, the OECD noted, in its 1998 report on the Japanese economy, that "compared to the 1989-1990 peak level, Japan experienced a cumulative capital loss through 1996 amounting to some \1,000 trillion, or an equivalent of two years of GDP."

The argument that the Japanese economy as a whole ran into system fatigue is indeed off the mark, considering the fact that in contrast with the plight of its financial sector, the electronic and machinery industries continued to record substantial foreign trade surpluses in the same period. Here, the problem is seen as the "excessive strength of Japan's manufacturing industries." At any rate, the simplistic explanation that Japanese crony capitalism is suffering from system fatigue is completely unfounded.

Japanese Monetary Policy under the Floating System and the Collapse of the Economic Bubble

At first glance, the financial system and monetary policy failures seem to constitute, as will be discussed later, domestic causes of stagnation which are specific to Japan. However, behind the scene there were problems involving the floating exchange rate system, or the contemporary dollar standard system. In the past, the yen-based Japanese economy had often been shocked and shaken by drastic fluctuations in the yen-dollar rate, as if it were riding on a roller coaster. When President Nixon announced the suspension of the dollar's convertibility to gold in 1971, the yen stood at \360 to the dollar. In the wake of the 1985 Plaza Accord, however, the yen rose from the level of 240 to the dollar to 120 to the dollar in a short period of time. This placed large deflationary pressures on the Japanese economy, and the period became referred to as one of "structural adjustment due to the strong yen." At that time, the national government was suffering from substantial cumulative deficits accrued from the fiscal measures taken to get through the two oil crises, and was giving top priority to balancing the budget. Thus, to manage this economic setback, it resorted to an extreme easy-money policy. Labor argued that the proper prescription for the strong yen recession would be structural change toward an economy driven by domestic demand, accompanied by aggressive fiscal measures to bring about improvements in the living standards of Japanese people, but the government rejected this idea. The extremely loose monetary position fueled a boom in government-led urban re-development projects designed to expand business districts in major cities and large-scale resort development programs. This in turn led to a rush of speculative investment into financial assets and real estate properties, as well as a substantial investment boom into information technology and infrastructure. Stimulated by the soaring stock and land prices, a huge economic bubble emerged, unrivaled in the modern history of Japan. Then, in 1991, it became clear that this bubble had begun to rupture. However, at just around this time, the government was engaged in a belated effort to liberalize the financial sector, following the textbook of the "Washington Consensus," in order to allow the Japanese economy to better respond to the globalization of financial markets and services. Moreover, in 1996, just as feeble signs of recovery were beginning to appear in the Japanese economy, the then-ruling Hashimoto Cabinet foolhardily launched a full-fledged financial liberalization policy aimed at completing a "Japanese Financial Big Bang" by 2001. On top of this, macroeconomic policy at the time was focused excessively on inflationary pressures, rather than the danger of deflation, and severe fiscal austerity measures were put in place. As a matter of course, the Japanese economy slipped into recession beginning in the middle of 1997, and the depressed stock and land prices, which had once showed signs of recovery, fell back into a downward spiral. In this process, the magnitude of the bad loan problem, which had been hidden in the bubble period, came to the surface, and the stock prices of financial institutions plunged. In November 1997, Hokkaido Takushoku Bank, a major regional bank, and Yamaichi Securities, one of the country's four major securities houses, went bankrupt. These bankruptcies were followed by the temporary nationalization of the Long-Term Credit Bank of Japan and Nippon Credit Bank in the autumn of the following year, as well as by the collapse of dozens of financial institutions and securities firms nation-wide. A major reorganization process is currently ongoing in Japan's financial sector.

Under the effect of the collapse of the financial system, Japan's real GDP growth rate hit zero in fiscal 1997 (the year ending March 1998), and fell to minus 1.9% in fiscal 1998, as a result of credit contraction in the financial sector. The production index and unemployment rate also quickly worsened. For these reasons, Japan, the world's largest creditor nation, was unable to play any significant role in response to the Asian economic crisis in the 1997-1998 period.

Responses to the Financial System Crisis, and Developments in Macroeconomic Policy

Since the beginning of the financial crisis, the Japanese government has implemented large-scale economic stimulus packages on an annual basis, centered on fiscal instruments. This has not, moreover, been limited to recent years. The 1990s have been characterized by governmental business stimulus measures, with the exception of the period the Hashimoto Cabinet was in power (1996-1997). These measures, which were primarily financed by the floating of deficit-covering bonds and local government bonds, have amounted to more than 10% of GDP on a cumulative basis. This substantial pump-priming did mitigate the depth of the business setback, but was not successful in preventing the protracted recession that followed. These experiences suggest that Japan's protracted recession in the 1990s can be likened, in nature, to the Great Depression of the United State in the 1930s, and to the prolonged depression in Britain in the latter half of the 19th century.

At the initial stage of the financial crisis, the government allowed the Bank of Japan to provide special rescue loans to collapsing banks in an attempt of ward off panic, and then the government announced a plan to develop innovative financial stabilization measures. On January 12, 1998, Prime Minister Hashimoto, who was worried that this financial crisis would, in conjunction with the Asian economic crisis, spread over the rest of the world, delivered a message that "we will do all that we can to avert a world-wide depression originating in Japan."

As part of its efforts to develop new stabilization measures, the government decided to set up a Financial Sector Revitalization Commission, and to reinforce the Deposit Insurance Corp. It allotted a total of \30 trillion from the government budget for such measures. In October 1998, when it became apparent that those measures were inadequate, the magnitude of the government fund for bank deposit guarantees was doubled to \60 trillion, and later \10 trillion was added to the deposit insurance fund. Currently, a total of \70 trillion is earmarked as a safety net for the financial sector.

Thanks to these and other measures, the financial system crisis began to subside around the spring of 1999. The economic growth rate in fiscal 1999 turned to a positive 0.6%, and for fiscal 2000, a rate of 1.0% is expected. It may be safely said that Japan's protracted recession is finally running its course.

Thanks to Japan's well-established social safety net, involving relatively well-arranged social and job security systems, in addition to the emergency institutional responses to the financial system crisis, and the macroeconomic business stimulus measures, a tragedy comparable to the American socioeconomic crisis of the Great Depression era has been narrowly circumvented. Nevertheless, the unemployment rate, which remained in the 2% range until rather recently, has risen to the mid-4% range, and strains between labor and management have been increasing. In spite of the business recovery, we cannot be optimistic about the current employment situation.

The Asian Financial Crisis and International Monetary and Currency Policy

The Asian economies, which experienced a regional financial crisis prior to Japan's, have come to question, for the first time, the legitimacy and practice of the existing international financial system and monetary order, and have presented several initiatives to improve the practices of international financial institutions.

This is because it was those countries, such as Thailand, which were most loyal in following the financial policy recommendations of the U.S. government and IMF, which suffered most in the latest crisis. Thailand enjoyed a thriving economy in the early years of the 1990s, due to economic development fueled by a huge inflow of foreign funds. However, the excessive inflow of foreign capital relative to the scale of its domestic economy caused an economic bubble, and as soon as the slightest indication of a setback was felt, there was a sudden and huge flight of foreign investment, triggering economic collapse. Moreover, the expectations that foreign governments and international financial institutions would provide the considerable funds necessary to eschew the financial crisis were betrayed.

The Asian economic crisis, which engulfed Thailand, Indonesia, South Korea and Malaysia successively, has finally reached its end stage. From this regional economic crisis, Asian countries may have learned two major lessons.

The first is that economic globalization and financial sector liberalization cannot by themselves guarantee the stable development of domestic economic society. Rather, on the contrary, commitments to these processes often entail great risks. Accordingly, these countries have learned that they must become actively involved in forming a desirable, and therefore stable international economic order, instead of depending on the existing systems or major countries. One of these endeavors is the New Miyazawa Initiative, which a coordinated Asian monetary fund meant to supplement the IMF. Under this initiative, it is expected that there will be a gradual internationalization of the yen. There has also been a proposal to introduce a currency basket system consisting of the dollar, the yen and the euro as a new foreign exchange system for Asian countries.

I suppose that our ultimate goal for the international monetary system in the 21st century, when economic globalization will certainly progress further, should be a globally unified currency system managed by a global central bank. However, during the period leading up to the achievement of this goal, it may be necessary to establish, as a transitional policy, a narrow fluctuation band between the key currencies, such as the dollar, euro and the yen, as was tried in the EMS, and to gradually have these exchange fluctuations converge.

The common European currency "euro," which was introduced in January 1999, can provide important hints for efforts to structure a global monetary system for the 21st century. As a currency working in conjunction with the dollar, rather than competing with it, the euro could contribute markedly to the process of creating a new international economic order in the 21st century. Needless to say, it will take time for the proposed Asian monetary cooperation initiative to reach the stage of high integration which the euro has achieved. But it is anticipated that between 2020 and 2030, several Asian economies will catch up with Japan, and an increasing number of Asian countries will approach the development stage achieved by European countries. Therefore, it is conceivable that the envisioned Asian monetary cooperation will be materialized sometime in the future.

The other lesson of the Asian economic crisis relates to the following point: Under economic prosperity, traditional village communities in Asian countries have gradually collapsed. Given this situation, major fluctuations in the market economy, such as the recent Asian economic crisis, have direct impacts on the very bases of people's lives and employment, leading to social crisis. The regional crisis has made Asian countries aware of the need for social safety nets, such as social and employment security programs, comparable to those in place in advanced economies. The development of social policy programs in Asian countries is accelerating, and South Korea is the forerunner in this trend. It has already begun to structure a social safety net.

Apparently, the emerging challenge for the region is to re-discover and focus on the social aspects of the Asian development, and to conduct mutual cooperation on the necessary social programs.

Problems of the Economy Led by Global Financial Interests

The circulation of capital in the contemporary world rests on a very dangerous footing. Funds from Japan, Asian countries, Europe and the rest of the world have flowed into the United States to finance that country's huge and growing current account deficit. Japan's cumulative net foreign credits have already grown to as much as $1 trillion, against the United States' cumulative net foreign debts of $1.5 trillion. Multinational financial corporations have gained huge profits by managing this influx of funds into the U.S. and by conducting fund management operations throughout the world. This highly risky international circulation of funds is being done through hedge funds and other forms of financial capital, supported by advanced information technology. If the U.S. economy, supported by its financial sector, becomes a finance-led economy, and if Europe and Japan follow suit, the risks of world-wide economic fluctuations will inevitably increase. Moreover, this would mean a direction for the world economic system in the completely opposite direction of a socioeconomic system that is able to assure working people of the stable employment and better living conditions which they aspire to.

Up until now, the trade union movement has always sided with industry when financial and industrial interests have clashed over future visions for a desirable economic society. Financial capital, which aggressively pursues short-term profits, is prone to turn business corporations into entities that gives priority to the interest of its shareholders, and thus threatens the standing of industry and businesses that seek for secured employment and sound investment activities based on a long-term prospect.

It is questionable, also, whether management practices based on the doctrine of maximizing short-term profits and giving priority to the interests of shareholders have been able to contribute to the optimal allocation of resources and improve productivity. In the long-term, information technology may serve to increase productivity, but it remains an unanswered question whether shareholder capitalism, which aims at maximizing short-term profits, contributes to increases in total factor productivity (TFP). In fact, many people have rightly pointed out that the tendency toward such forms of management has intensified the instability of employment, widened social inequality, and has nurtured an inhumane society. The "high-road" pursued by trade union movements in the United States and in Japan seems incompatible with economic development led by financial capital.

Conclusion

We must face the reality that the progress of economic globalization under the leadership of risky financial capitalism may bring stability in the short-run, but the world has become a fragile economic system with the risk, in structural terms, of running into a world-wide deflationary spiral. The international systems institutionalized in the 20th century have lagged behind the increasing globalization of the world economy, and gaps between the existing systems and globalization have become wider than ever. As economies globalize, the structuring of new international systems capable of managing the process is essential. One of the major tasks for the international community at present is to establish a new and working international commission in this particular area, following after the Brundlandt Commission, which urged global efforts to combat environmental issues. I believe the leaders of the G-8 should take initiatives toward this end at the forthcoming Okinawa Summit. Other tasks include strengthening of activities of the IMF Finance and Monetary Committee, and the introduction of a Tobin Tax-type scheme to control excessive transfers of short-term international funds.

At the same time, the development of social safety nets for employment and working conditions which are now being initiated in Asian countries must be facilitated in every country, and the next U.N. Summit on Social Development should take the role of promoting such efforts. As a result of the lessons from the Asian economic crisis and from the failures of monetary policy in Japan and elsewhere, trade unions in Asian countries and Japan, as well as the ICFTU-APRO, the regional labor organizations with which most of these unions are affiliated, are definitely heading in this direction.

Thank you for your attention.