(provisional translation)

Summary of the Study Group on International Economic and Financial Systems by Chair Mr. Toyoo Gyohten

The Revitalisation of East Asia and the Role of Japan

1. Lessons of the Economic Crisis

The root cause of the East Asian economic crisis was that East Asian governments and corporations neglected efforts to respond to changes in the international economic environment.

As it entered the 1990s, the global economy was swept away on the tide of two historical changes. The first of these was that trade in goods and services, as well as international capital transactions, were liberalised following a wave of deregulation, and markets transcended national borders as they expanded to a global scale. This process is what we now know as "Globalisation." In a word, the characteristic of globalisation is that is has allowed economic competition to take place not only in the domestic market of a single country, but also in the global marketplace. In this context, both the national management of the economy and corporate management have had no choice but to pay due consideration to this background of global competition. Needless to say, the international movement of land has always been an impossibility. However, as long as clients and residents are able to move about freely, the real estate industry is unable to avoid international competition. Railways and roads too are not international goods. But if the aviation industry which maintains competitive ties with these domestically is liberalised on an international scale, then railways and roads are also indirectly exposed to international competition. Similarly, tax systems, social security systems and education are all subject to international competition.

The second of these historical changes is the revolutionary progress in information technology (IT). One the one hand, the IT revolution has given rise to globally-competitive goods, services and related industries which are in the main unrestricted. This has not only instilled considerable change in existing industries and corporations, but has served to transform industry as a whole. At the same time, the IT revolution has enabled all consumers, taxpayers, shareholders, voters and employees to share collective information simultaneously, by shattering the way in which information used to be monopolised and unevenly distributed. And the IT revolution has transformed economic operations and corporate management, which require administrators and managers to perform their tasks with this as their prerequisite. In this way, transparency and accountability have become the most essential elements in the governance of both national administrations and business management.

The economic management, market functions and corporate management conducted extensively throughout East Asia were extremely effective in the environment that existed prior to these changes. With the national consensus to make development of the national economy the primary objective, a co-operative structure of close interdependence among politicians, business and administration emerged. While protecting their domestic industries by placing restrictions on international competition, East Asian countries controlled the distribution of capital, created an export-based industrial structure, and maintained employment. By paying service to these state objectives, the finance industry became the subject of protection and supervision. However the aim was to maintain the flow of necessary capital at all costs, and not to improve the robustness and efficiency of the finance industry itself. Indeed, in many cases the political investments and loans that were provided sacrificed the robustness and efficiency of financial institutions.

The core sector of industry was controlled by designated family combines with close linkages to politicians and government. With no confrontation between business managers and shareholders, the major objectives of business managers were to increase their own profits and ensure competitive dominance over their domestic rivals. Confrontation between labour and management also never reached fever pitch as business management was undertaken within this framework of family cronyism. The greater majority of citizens were traditionally able to adapt easily to government rule and supervision, and were hard working.

Upon this bedrock, the economic development policies spearheaded by governments produced breathtaking results in East Asian countries. As high growth continued, countries were able to reduce levels of extreme poverty and narrow the gap between rich and poor. This, indeed, was the "East Asian miracle."

Globalisation and the IT revolution have significantly altered the East Asian economy. The increase in pensions and other financial assets due to imbalances of international payments throughout the world and the ageing of developed countries' populations - both of which have occurred since the oil crisis of the 1970s - has led to a rapid expansion of capital that can be invested internationally. Accelerated by deregulation of capital movements and the information revolution, the world of the 1990s transformed into a huge single market into which flooded vast amounts of long- and short-term investment capital. Economies similar to those of East Asian countries, which were small in scale, had high growth rates and were enthusiastic about introducing foreign capital, naturally became the major target of interest for international capital. Unfortunately, East Asian countries never seriously contemplated the benefits and risks to be generated from being that target of interest for international capital, or what they could do to alleviate those risks.

It is evident that part of the reasons for the outbreak of the Asian crisis lies in the fact that international investor groups were mainly from developed nations. Their motive - to generate movement of vast amounts of capital - was driven by their desire to pursue economic profit, and did nothing to support the stable growth of developing economies.

As mentioned earlier, the IT revolution has meant that transparency and accountability have become keywords in the governance of both national administrations and corporations. It has become such that evaluation of governments and corporations is not determined merely by expectations for their achievements in the long-term, but also by the extent to which they have put these keywords into action. Recognising that this trend is irreversible, the governments and corporations of developed countries have spent huge amounts of money repeatedly sacrificing efficiency for the sake of addressing this issue.

East Asian countries were, unfortunately, in a highly disadvantageous position in this regard. The environment in which East Asia had found itself until that point had not required transparency and accountability. Indeed, we can say that the economic and business management methods that had spurred the breathtaking growth in East Asia could not have been further dislocated from transparency and accountability. Therefore, despite the fact that their environment was experiencing rapid change, East Asian countries neither made efforts to drastically alter their own traditional methods, nor in fact, were they able to.

What emerged was a changing international environment coupled with unchanging East Asian governments and corporations, and consequently unease and distrust of markets toward this disparity gradually heightened. Markets turned pessimistic and began to undertake extensive fault-finding exercises. Having highlighted that the faults were the deterioration of current balances, mismatches of foreign currency debt, financial system fragility and other problems, the markets moved together in the same direction, thereby causing the outbreak of the crisis.

Thankfully, the East Asian economy has been recovering since the latter half of 1999. The recovery has revolved around heightened activity in a strong demand for IC products, the continued booming US economy, a Japanese import recovery and the strengthening of competitiveness due to currency declines, which have in turn led to improved demand for exports and increased consumption domestically as a result of financial deregulation and stimulus packages. As the economic slump of 1998 was a severe one and capacity utilisation ratios fell sharply, the bottom-up recovery is best illustrated by a V-shaped upturn. At present, most countries have returned to pre-crisis levels.

Countries have begun making earnest efforts toward improvements in the reform of the governance of corporations and national administrations and the strengthening of financial systems, which formed the basis of the East Asian crisis, but their respective states of progress vary. Still, it is heartening to see that the countries most deeply affected by the crisis are those pushing ahead with the most ardent reforms. At present, markets have positively appraised such reform efforts, and hold high expectations for them. However, the risk of crisis will once again rear its ugly head if they allow themselves to take the economic recovery for granted and their resolution of basic challenges is checked and reversed.

2. Response to Markets

Since the collapse of the former Soviet communist structure and the centrally-planned economic structure, democracy and market economics have become common global paradigms. In the debate revolving around the East Asian crisis, the concept of market economics can be envisaged as one axis of co-ordinates. There has been much debate on how far economic trends can be entrusted to market principles, and specifically debate has focused on the comparison between "hands-off" policy vis-a-vis markets through market principles and interference in markets by government. This argument assumes a "market" to be a private entity which exists and acts independently, and is consequently premised by the fact that only public powers are able to get involved with it. However, this premise is not particularly well thought out. The reason for this misinterpretation is a lack of understanding as to what a market really is.

But what indeed is a "market"? A market constitutes the total sum of decisions of all participants in a position to affect economic phenomena. Therefore, it is especially important when discussing markets for us to recognise that market participants and their decisions are in a constant state of change. Markets, which from ancient times comprised solely producers and consumers, have welcomed new participants one after the other brokers, business managers, investors, public authorities, and, especially important in recent years, information providers. The major motives for this vast number of constantly changing participants in making their respective decisions is to maximise economic profit from their relative standpoints. However the decision-making process of humans is also affected by the different variables that each person possesses. Moreover, in considering maximum profit from the long-term perspective, it is necessary to take stock of a completely separate set of elements, for example environmental safety, assistance for the vulnerable and upholding justice.

The market is, then, dynamic and constantly changing. In this process of change, it is only natural that a market will give rise to irrational trends and excess action due to mob psychology, error and collective misunderstanding. Markets are by no means always correct, and the "invisible hand" amounts to nothing more than saying that in the long term, the nature of market decisions is to return to their rational origins. In other words, the market is not an established and fixed private entity.

If we are to conceive of markets in this way, then governments and corporations can neither ignore markets or oppose them. Governments and corporations must gain an accurate understanding of the composition of market participants and their decisions, and work to harmonise markets by approaching them from both directions. The correct response to markets is not to gain supremacy over those who oppose them, but rather to instil change in a collective framework of which the individual is a single member. There are some who, following their experiences of the East Asian crisis, consider the market in a negative context and argue that we should simply isolate ourselves from markets through government intervention and control. But this argument is surely nonsense.

3. Regional Co-operation

The most important lesson learned from the East Asian crisis is that East Asia must build its capacities as a region to prevent and respond to crises. Since the term "Globalisation" also signifies competition on a global-scale, it is evident that in addition to individual efforts, states and corporations must work toward alliances and mergers in order to bolster competitiveness. This is indeed apparent in what is happening in North America and Europe. Assuming that there is a consensus that it is of vital importance for East Asian countries to strengthen relationships of interdependence in trade and investment within the region, then there is a further need to consider the arrangements to be made for promoting and enhancing these relationships. It is extremely encouraging to see that awareness toward such needs has heightened among countries in the wake of the East Asian crisis.

However, when making a comparison with North America and Europe, we must fully recognise that regional co-operation in East Asia is fraught with difficulties. Regional co-operation in North America is a vertical model centred around unipolarity. It is a group that is comprised mainly of the overwhelming economic and military superpower, the United States, which also has the power to provide coverage within the region in both its financial and fiscal policies. In reality, the dollar is a common currency. Regional co-operation in Europe is a multipolar horizontal model. While France and Germany are considered relatively important, the European Union (EU) constitutes a highly homogenous group of states in terms of tradition, culture, economic standards and other aspects, and also shares political aspirations toward European integration.

East Asia varies from both of these models. For a start, there is no evident unipolarity as in the North American Model. There is also the additional risk in the future of competition between Japan and China over leadership. At the same time, an economic and political homogeneity such as exists in Europe also cannot be found at present in East Asia. Furthermore, due to its historical background, the East Asian region falls short of the self-sufficiency of North America and Europe. Thus a prerequisite for whatever regional co-operation is envisaged is the opening of the region at all times to influences from outside the region. In short, East Asia will always require a third way.

Against this backdrop, what sort of strategies should we take to promote regional co-operation in East Asia? I would consider the following four points essential.

First, we must exert efforts to strengthen substantial relationships of interdependence within the region. Although trade and investment within the region has been steadily increasing, it is essential to achieve a more widespread horizontal division of labour by promoting further liberalisation, while making active use of the merits of areas of comparative advantage. It is especially important that this does not stop at goods and money, but also involves the activation of human resources and information exchange. This will allow for building the foundations for co-operation by stimulating technical and cultural exchange and further promoting equality within the region.

Second, co-operation must be advanced on a step-by-step basis. Co-operation within the East Asia region is currently in its preliminary stages. This is to be expected considering the difficulties mentioned earlier. There are many expectations for co-operation in the minds of leaders of East Asian nations, and many ideas have been expounded. These include: a mutual policy monitoring system; free trade agreements; investment agreements; an emergency financing system; a currency basket and currency systems, such as a common unit of currency; an intra-regional settlement system; and the concept of social safety nets. At the same time, the creation of specific proposals that will serve as the common starting point, as well as joint discussions within the region, are yet to begin, and there remain significant differences among countries in terms of interest and enthusiasm. It is therefore necessary to begin with items that allow for the greatest number of countries to be involved in deliberations. Working from this angle, the first candidate for deliberation would probably be the creation of a mutual policy monitoring system. In this context, authorities, including governments and central banks, would swiftly and accurately disclose and exchange relevant information, and create dependable fora in which to study this information. It is also essential to provide a mechanism capable of fully reflecting the decisions of private-sector financial institutions and corporations. Needless to say, ensuring that these fora can serve as the foundation for achieving regional co-operation requires systemic binding power to allow for not only debate, but also mutual assistance and advice, and political commitments that will guarantee this. We should remember that it was united agreement on the Maastricht Treaty that brought about the European Monetary Union (EMU).

Third, we should set in motion the groups that will serve as the focus for co-operation. We cannot overlook the fact that the East Asia of today is massively diverse, and it would be unrealistic to begin by considering substantial agreements that encompass the entire region. The most desirable approach would therefore be to establish a core group in the early stages, to include those economies deemed the most economically and politically homogeneous, namely Japan, the Republic of Korea, Singapore, Australia, New Zealand and depending on agreement from China, Taiwan and Hong Kong. Although it would take on a different form to North America and Europe, the major significance of this core group would be that it would provide real evidence that independent multilateral co-operation could be achieved in East Asia. If a group of economies comprising an open socio-political structure that paid due respect to markets were to co-operate in the various areas outlined above, the international appraisal of regional co-operation in the East Asian region would undergo sweeping change, there would be a tremendous impact on other East Asian countries, and this would ultimately lead to greater centripetal force toward regional co-operation.

Fourth, unceasing efforts must be exerted to ensure that the triangular relationship between Japan and the United States, Japan and China, and the United States and China is in no way confrontational. Indeed, the peaceful development of East Asia rests heavily on this issue. Its importance is similar in vein to the agreement between France and Germany in Europe, perhaps even more important. As long as the triangular relationship continues to maintain at least the minimum of stability, both stability with other regions, such as Europe and Russia, as well as the maintenance of East Asia's global standing, will be possible.

Within the triangular relationship, it is needless to say the relationship between Japan and China is considered to be the most serious and most complex. The Japan-China relationship is unique throughout the world, in the sense that bilateral relations have been maintained for over 2,000 years. The various incidents that have occurred since the 19th century have served as the basis for the mingling emotions of friendship and enmity that exist in the present-day relationship.

Japan for its part is concerned that China will become a military and economic superpower. Over a half century has elapsed since the conclusion of the Japan-China War, yet there is still bad feeling that despite the fact that Japan provides China with vast amounts of economic assistance, China continues to conduct anti-Japanese education. Furthermore, since China is yet to establish a constitutional government, Japan is indignant that many Japanese corporations are having bitter experiences there, and therefore harbours contempt toward China. At the same time, China has suspicions that Japan and the United States are collaborating to hinder the expansion of China's influence. There is also dissatisfaction that Japan has never truly reflected on the huge number of victims in China caused by the Japan-China War, as well as bad feeling over the fact that Japan, once a dependent country of China, has developed into a major developed nation.

It is evident that there exist many areas in the bilateral competitive relationship that cannot be easily resolved. It will no doubt require a considerable length of time before the Japan-China relationship can develop into the mature friendly relationships that epitomise US-UK and France-Germany relations. However at the same time it is obvious that a peaceful and stable Japan-China relationship is both of significant mutual benefit and an essential element for ensuring the stable development of East Asia as a whole.

It would be difficult at this current point in time to project how the Japan-China relationship will evolve in the future, and in this regard there is no possibility at present of realising collective recognition between the two. If this is the case, the two countries must work together to eliminate any elements of instability in the relationship that can be resolved. For Japan, this will involve manifesting in the hearts of its people the friendship and respect it has long held toward China. For China, this will require the earliest possible establishment of a civil society which is capable of self-reform and open both internally as well as to the outside world.

The most essential areas to this end for both countries domestically toward achieving these goals: improvement of education; activation of human resources and cultural exchanges; co-operative research on issues where Japanese and Chinese opinion varies; and the promotion of co-operative projects of mutual benefit to both countries.

4. The Role of Japan

The role that Japan should play in future East Asian regional co-operation has already been discussed and fully acknowledged by Japanese people themselves, and I have nothing further to add here. Indeed, all that is left is implementation. At the same time, it has to be said that the list of items is both long and complex.

First is the resolution of economic issues that Japan is currently facing. Needless to say, the main areas of concern are strengthening the competitiveness of the finance industry and financial markets, corporate restructuring and corporate governance reforms, and in the mid to long term, financial restructuring through the structuring of annual expenditure and tax reforms. Forward movement on these issues will ensure a growth recovery.

Second is the third instance in its economy and society of opening Japan to the outside world. Opening up the country will enable Japan to become a leading state that can be trusted by East Asia and co-operate with East Asia.

Third is the demonstration of proactive creativity and strong leadership with respect to specific issues of co-operation. Japan must heighten interest within the region and advance discussion by encouraging co-operation among the public and private sector to come up with various ideas for co-operation and create specific proposals in the areas mentioned earlier. Nothing can be achieved unless someone is willing to take the initiative, and in this context neither the world nor East Asia opposes Japan demonstrating fair and constructive leadership.