Speech

The U.S. and Japan in the Global Economic System, Remarks by Shigemitsu Sugisaki, Deputy Managing Director of the IMF

July 24, 2002

Thank you Bill. It is a great pleasure to be here to honor the twentieth anniversary of the CSIS Japan Chair, and to share the stage with such a distinguished group of panelists.

The topic of this session, "The U.S. and Japan in the Global Economic System," could not be more relevant to a question that concerns us all: namely, how to secure a strong recovery in the global economy? There are many aspects to the answer, but one clearly involves the need for strong growth in the world's two largest economies. Based on the methodology we use at the Fund for the purpose of our global economic analysis—using national GDPs based on PPP weights—the U.S. and Japan presently account for almost 30 percent of the world economy. Thus, it is difficult to conceive of a strong and sustained global recovery unless the world's two largest economies are also performing well.

Of course, that has not been the case for most of the past decade. I couldn't help speculating in preparing for this session how a similar discussion held to commemorate the 10^th anniversary of the CSIS Japan Chair—if indeed there was one—might have differed from the one we are having today. In both cases, the world had just experienced a sharp slowdown—more pronounced in the early 1990s than today—and there was considerable uncertainty about prospects for a sustained recovery. In 1992, we had just seen the bursting of the Japanese asset price bubble, and today, we are witnessing the bursting of a similar bubble in U.S. equity prices. And in 1992, the U.S. economy was weak, and there was considerable pessimism about the outlook, not totally dissimilar to the situation today in Japan.

I checked some numbers before coming here and found that, in the decade prior to 1992, the world economy grew at an average annual rate of 3.4 percent, the same average growth rate that it recorded in the subsequent decade. However, the performance of the two largest economies was radically different. In the period 1982-1991, Japan grew at an annual rate of 4.1 percent, compared with 2.9 percent for the United States. In the 10 years ending 2001, on the other hand, average growth for Japan only barely exceeded 1 percent, while that for the U.S. accelerated to 3.4 percent, and to over 4 percent in the latter part of the 1990s.

Perhaps we can take some comfort from this. Few could have predicted in 1992 that Japan would only grow by one percent a year for the next decade. And if anyone did, I doubt that they would also have predicted that world growth could be sustained at its earlier pace.

But, clearly, these numbers also give reason for concern. First, while the Fund staff, along with most observers, is projecting a moderate recovery in the U.S. economy, it would clearly be unwise to count on a repeat performance of the 1990s. [Indeed, as the FRB paper discussed by Larry reminds us, it is quite possible for policymakers and private analysts alike to get the projected recovery very wrong.] And second, even if the U.S. were to return to rapid growth, such large growth differentials among the major economies as occurred in the 1990s are unlikely to be sustainable for more than short periods. Indeed, the U.S. current account deficit—which remains near record levels—is in large part a reflection of the uneven pattern of global growth. For both these reasons, a recovery in the United States and a significant early strengthening of growth in Japan are critical to the health of the world economy.

I would like to say a few words on the policies needed to achieve this. Today's conference coincides with a discussion in the IMF Executive Board of the annual consultation report for Japan, and the Board's discussion of the consultation report for the United States will take place next week. Both these reports, and the outcome of the Board discussions, will be published on the Fund's web site. Here, I will make a few remarks of a more personal nature.

First, for Japan, I believe the experience of the 1990s, and the global considerations that I have just discussed, both argue strongly for pressing ahead more forcefully on structural reforms. While I share the view that an earlier and more pronounced loosening of macro policies in the early 1990s would have helped cushion the downturn, I do not believe that macro policies alone could have dealt with the legacy of the asset price bubble.

Rather, I believe that Japan's decade-long economic slump owes much to the delays in implementing structural reforms—particularly bank and corporate restructuring—and that there can be little prospect of a strong recovery unless those reforms are now accelerated. While some stronger Japanese companies have restructured quite successfully, there are simply too many weak companies that have so far postponed adjustment and failed to correct their excessive debt overhangs. Until this problem and the associated bank weaknesses are addressed, a lasting recovery in private investment and consumption is likely to remain beyond reach. Thus, a key challenge now facing the Japanese government is to develop a strategy that encourages weak banks and companies to restructure without further delay. If in that process, banks' capital becomes deficient, the government should not hesitate to use public funds to strengthen it, with appropriate conditionality.

Structural reforms are also needed in other areas. I would highlight two: (i) first, public enterprise reform, including public financial institutions such as the postal savings system and housing loan corporation; and (ii) second, public spending reform, including a more thorough cost-benefit analysis of public works projects, and shifting resources to more productive expenditures. Indeed, in addition to focusing on the size of the fiscal expansion in the early 1990s, I would argue that one also needs to look at the composition of public spending and the extent to which better-targeted expenditures could have been more effective in cushioning the downturn.

There is a school of thought that economic recovery in Japan should come before further structural reforms. I do not share this view. For one thing, the experience of the past decade raises major doubts that real recovery is indeed possible without greater progress on reform. Second, it is far from clear whether a deepening of reforms would aggravate or benefit the macroeconomic situation. Indeed, it is quite possible that the positive confidence effects from clear progress on reform would outweigh the negative effects on those directly impacted, even in the short term. Thus, I do not believe that macroeconomic concerns can be used any longer as an excuse to delay. The stakes for Japan and the world are simply too high.

What is clear, however, is that macroeconomic policies must remain supportive while structural reform is more vigorously pursued. This includes a fully accommodative monetary stance—indeed the balance of risks at present would seem to favor more aggressive monetary easing—and avoiding a near-term withdrawal of fiscal support.

Turning to the United States, the consensus view that the economy will rebound quite quickly owes much to the belief that the recent strong productivity growth can be sustained. Macroeconomic policies have turned supportive of the recovery, with the Fed already having eased policy aggressively, and a marked shift toward an expansionary fiscal stance. In addition, the flexibility of the U.S. economy should make it better placed to work off the recent excesses than was the case in Japan at the beginning of the 1990s. This said, there are also considerable risks and uncertainties, not least relating to the reaction of the U.S. consumer to the fall in the stock market. While recent market movements are probably part of the needed adjustment, policy-makers must remain vigilant to signs of a more pronounced loss of consumer and investor confidence, and respond to the corporate governance concerns that have contributed to the stock market decline.

Finally, I would like to say a few words on the global roles of the United States and Japan. Here, I believe considerable progress has been made in the past decade in strengthening the dialogue and mutual understanding on issues relating to the functioning of the international financial system. Indeed, one somewhat overlooked aspect of the Asian crisis is that it prompted a detailed examination and debate on economic policy management, and brought to the surface some longstanding but perhaps formerly unspoken differences. What strikes me now is the similarity between the U.S. and Japanese positions on many of the key issues relating to the global financial architecture. This includes the importance of transparency, of sound and well-regulated financial systems, and of legal and judicial systems that support creditor rights and promote good corporate governance. It also relates to crisis management.

Of course, there have also been differences. One was the proposal to create an Asian Monetary Fund. This idea struck a chord, both in Japan given its desire to exert leadership in the region, and among potential borrowers who sought access to cheap money without significant conditionality. A key problem with this approach is that it was based on the idea that there can be two policy standards—one for the Asia and one for the rest of the world. In my view, such an idea is ill-conceived. I am, however, encouraged by the more recent regional initiative to strengthen financial cooperation through bilateral currency swaps, while moving toward enhanced policy dialogue among the Asian economies. This is a welcome development.

In sum, while there will always be differences, a great deal has been achieved in promoting a mutual understanding, and establishing regular fora for policy-makers to share ideas and perspectives on the key economic issues. This cooperation augers well for both the United States and Japan as they continue to play their leading role in the global economic system in the decade ahead.

Thank you.