Japan is back, says economist

China, watch out. Japan is a contender again, says top Nomura economist Richard Koo.
FinanceAsia: How do you see the rivalry between China and Japan stacking up?
Richard Koo: Frankly, itÆs a horrendous challenge for Japan. China is simply so big. If ten per cent of the Chinese population were doing what the Japanese are doing now, they would be level with Japan.

The Chinese are hard-working and creative in many ways û from nuclear submarines to satellites.

The importance of China goes back a long way. You could argue that countries like Japan and Korea and SE Asian countries have been lucky: they have benefited from the fact that China, over most of the past fifty years, has been going in the opposite direction. In that sense, the challenge of China to countries like Japan is nothing new.

One of the most serious problems is the pull of China. Taiwan for example is losing many of its best young people. They are traveling to places like Shanghai to explore better opportunities.

Japan has to concentrate on where it will position itself. In terms of labour costs and dexterity, the Chinese are very strong.

So what are the Japanese really good at?
I suspect that the Japanese are very good at organizing themselves to move forward towards a common purpose.

I think that the Chinese may even have greater individual ability than the Japanese, but when it comes to moving forward in a unified manner, they find it more difficult. Sun Yatsen, the founder of Chinese republicanism, accurately described the Japanese as similar to a block of cement, while the Chinese are more similar to a tray of sand.

Organizationally, the Japanese have an advantage.

Now, this ability is perfectly suited to high-quality manufacturing. The Americans invented the car, but itÆs the Japanese who invented the car that doesnÆt break down.

I donÆt think the Japanese should follow the US and British model and allow the extinction of their manufacturing sectors. I see Japan following the path of the Germans, whereby they focus on very high quality items.

How do you see the Japan/Chinese rivalry playing out in the rest of Asia?
Japan and China are very complementary in many ways. Japanese high-tech and Chinese labour intensity is a fruitful alliance. But many parts of Japan are not high tech, producing crops and textiles. These are hurting badly from the Chinese onslaught.

In Japan we have 100Yen shops, now. They are a good example of how the low-end is being swamped by China, and they are driving out Japanese workers. But thatÆs as can be expected, and the Japanese have in a sense, been fortunate that they have been insulated from the Chinese threat for so long.

The solution is the opposite of protectionism. Japan has to use globalisation and market opening to drive down the cost of living for the average worker. That means that even if his income does not go up, he will still be able to cope. This is what the US has done successfully.

Where do you see Japanese outsourcing going in the event they are focusing on high-end stuff? Will this make outsourcing to Malaysia and China less important?
Remember the cause of Japanese outward expansion. It was the strong yen, forced to record high levels after the Plaza Accord. But the yen is now stable and not very strong.

The other point that is new now, is that Japan has had a balance sheet recession, which Japan is now coming out of.

In that time, the Japanese were investing in the rest of Asia, but for primarily defensive reasons: they were competing with each other (not with Chinese companies) on a cost basis, so they followed each other into China.

Now the balance sheet recession is over. The debt is cleaned up, and they want to invest. If Japanese companies want to do something new, they want to research and test them in Japan. They still have that mindset that if you want to do something very well indeed you do it in Japan, and then you manufacture it in China. As a result, you see a very significant pickup over the last few years in Japanese investment in Japan. So itÆs not a zero sum game, that investment in China is not subtracted from investment in Japan.

In terms of attractiveness and desirability, would Southeast Asian countries prefer Japan or China to invest?
As I have written in my book, I believe the Crisis was brought on by Western investors and speculators, not Japanese investment.

In contrast, the Asian miracle was largely the result of Japanese investment.

When the value of the yen shot up following the Plaza Accord, the Japanese were forced to lower costs by diversifying into lower cost bases abroad. But in 1995, the yen peaked. The Southeast Asian countries didnÆt realize this. The massive rise in their standards of living was the result of the yen strengthening. Their currencies should have followed the yen down. Instead, they kept their currencies tied to a strengthening US dollar.

To make things worse, Western investors belatedly saw the boom in Asia and began to pour large amounts of capital into the region û not understanding that, in effect, the party was over as soon as the yen started trending down.

In addition, many of these investors didnÆt have a clue about the countries they were investing in û as you can see by the outrage over the deficiencies in Thai bankruptcy laws û as if this wasnÆt obvious to everyone long before the crisis occurred.

The end result was a massive outflow of hot money belonging to Western investors. This had a horrendous effect on the local economies. As a result, there is still, even now, a great deal of bitterness towards the US idea of globalization.

In contrast, Japanese companies tried to keep their factories running and their staff employed.

Since then, with the central bankers I have spoken to, there is a strong understanding of which side their bread is buttered on. They know they have to allow their currencies to track the yen and ensure they donÆt get too much out of kilter. So I think JapanÆs image in Asia is pretty good.

WhatÆs your view on the role of former prime minister KoizumiÆs in JapanÆs regeneration?
He was really lucky. He screwed up many things, but he got elected at a time when major reforms were underway, and he reaped the benefits. His economics minister Takanaka was completely ignorant of many of the differences between the US and Japan when he advocated US methods of non-performing loan disposal. He should have reformed Japanese tax rules to equate to the US treatment of NPLs first. Instead, he caused a huge amount of confusion. As a result banks like UFJ (which was forced to merge with Tokyo Mitsubishi Bank) had to disappear, even though there was nothing fundamentally wrong with it. At the time, many people thought that TMB was wrong to pay such a lot of money for UFJ. But as you can see from the recent very high profit figures, TMB was right - many of these so-called NPLs were paid back.

In retrospect, do you see the Japanese crisis as a financial crisis, with its root in a poorly performing banking system?
No, not at all. The financial system was the victim of what happened during the collapse of the bubble and the aftermath. Just like the Great Depression in the US, if asset prices fall catastrophically, banksÆ balance sheets will inevitably become underwater.

Japanese companies were still making the best cars and cameras in the world, as you can see from the trade surpluses Japan was running all through the recession.

But you had a corporate sector frantically paying down debt, and a household sector saving money, and as a result you had no expansion in domestic demand, and of course very little bank borrowing.

ThatÆs what I mean about a balance sheet recession û everybody is paying back the banks instead of borrowing and expanding. It wasnÆt a structural problem with the Japanese economy at all.

CouldnÆt you argue that such a huge bubble was a sign of structural weakness?
All countries have bubbles...

But why did it take so long to get over the bubble? The US seems to get over its bubbles in six months.

The US recovered from the 2001 tech bubble by 2003. But that was a small bubble. The amount of wealth lost was equivalent to six months of GDP. In Japan, the losses in land value and share prices alone amounted to three years of GDP. That's the largest loss any country has experienced in history during peace time.

Does JapanÆs recovery from debt make you more optimistic than most people about ChinaÆs ability to solve its NPL problem?
They are doing it slowly, and they should do it slowly, because it's a systemic problem. They are rightly ignoring the foreign investment banksÆ advice to resolve the problem in one fell swoop.

I was a syndicated loan officer at the New York Fed during the Latin American debt crisis in 1982. At that time, seven out of eight money centre banks were underwater. The Americans realized then that you have to keep these banks going because the option of shutting down the economy doesnÆt exist. You have to support these banks out until the problem is behind you.

So all this talk of shock therapy is nonsense. You clean up the banks all right, but destroy the economy in the process.
Yes. Somebody actually tried that: Andrew Mellon, the US treasury secretary under president Hoover. The result was the Great Depression and the US lost half its GDP in four years.

In Japan, the silver lining to the disaster was that this didnÆt happen. Despite losing three years worth of GDP, JapanÆs GDP stayed at 500 trillion yen. The problems were sorted out in the banks without a collapse in the wider economy.

So itÆs important to first see if just one or two banks are affected, or if itÆs a systemic problem. If itÆs the former you clean them up immediately to avoid problems further down the road. If the majority of the banks are involved, you change your priorities.

In the Latin American debt crisis, only JP Morgan amongst the US banks was above water. Everybody else, Citigroup and Bank of America, they are making big noises today, but they were bankrupt in 1982.

Can you confidently say that Japan is back on the world stage?
Yes, I can say that. There will be ups and downs, but the fundamental problem has been resolved. Companies are no longer paying down debt and they are spending.
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