G-20 Series: Head of Economic Research For Morgan Stanley Japan Says Recovery Can Happen Fast

Big Think recently approached top economic thinkers from around the world for policy recommendations that could catalyze the needed structural changes to pull the global economy out of recession. Included here are ideas from Robert Feldman, Head of Economic Research at Morgan Stanley Japan Securities.

The inspiration for a series on global economic policy solutions came from Dr. Takenaka, who in 2002, acting as Japan's economics minister, successfully tackled Japan's banking crisis with his Plan For Financial Review, or, as it is widely known, the Takenaka Plan. His measures were largely successful after he convinced reluctant banks to write down billions in bad assets.

Feldman has published three highly regarded books on Japanese financial markets. A fluent speaker of Japanese, he is a regular commentator on World Business Satellite, TV Tokyo's nightly business program. Mr. Feldman worked for the International Monetary Fund from 1983 through 1989 and received his Ph.D. in economics from the Massachusetts Institute of Technology.

The following is excerpted from an essay submitted by Mr. Feldman.

"Will Rogers once said, “History does not repeat itself, but it rhymes.” While not in a position to give advice to the U.S., I can relate the history of what happened in Japan, where I have worked as an economist for the last 20 years. In Japan’s case, successful financial reform required five factors to be present simultaneously.

The first was an economic growth strategy, formed with macro, micro, and global economic trends in mind. In Japan’s case, this strategy began to form in the 1980s, with the Mayekawa Plan for structural reform, and accelerated in 1995, when PM Murayama, a Socialist, reacted to the surge of the yen to Y80/US$ by shortening a 5-year deregulation plan into 3 years. A more comprehensive plan was formed by PM Obuchi’s Economic Strategy Council in 1998. This Council’s recommendations became the core of the economic platforms of both major political parties. Implementation accelerated when PM Koizumi won a landslide victory in the Upper House election of 2001, with a popularity rating near 80%.

The second factor was a safety net to maintain confidence in the financial system (e.g. by expanded deposit insurance and by money market support) and to aid those hurt by economic reforms. Japan found this difficult because of the balance between maintaining confidence while still avoiding moral hazard. In practice, there was a series of crises and support packages before the right balance was found. Coordination between the many stakeholders – such as taxpayers, depositors, financial institutions, Diet members, bureaucrats, equity holders, etc. – proved very complex. Much of the lost decade was lost because of Japan’s own “collective failure to make hard choices.”

The third factor was capital injections to restore confidence in financial institutions, but with conditionality. The first attempts at capital injection in the mid-1990s foundered on a public perception of inadequate conditionality. Later attempts succeeded, after intense public debate. The main opposition party offered its “Phoenix Plan” for financial system revival, and the ruling party proposed its own “Total Plan.” Intense debate, against a background of end-1997 financial panic (during which two major securities companies and one major bank failed) produced a much-improved system. With the rules clarified and agreed, capital injections became a technical issue, not a political one.

The fourth factor was public support, which emerged from the combination of stringent measures taken against weak companies and weak bank managements, and periodic market crises. These crises reminded all parties of the collective need to make hard decisions. Japan was well served by vigorous democracy with open debate. In addition, regulatory and accounting changes, along with active investor relations outreach by companies, improved disclosure and transparency, and increased public confidence.

The fifth, and hardest, factor was strict assessment of the value of assets held by financial institutions. New capital from the private sector was simply not available, so long as investors lacked confidence in the accuracy of asset assessments. Once the authorities tightened inspection standards and implemented uniform standards across institutions, the spigot for new capital opened. The most successful action was a near-miracle: The Industrial Revitalization Corporation of Japan (IRCJ) was a government-led corporate restructuring agency, which revived 41 firms, made money for the taxpayer, and shut down.

Cleaning up an old mess was one thing, but preventing new messes was another part of Japan’s financial reform history. A key problem for Japan was regulatory balkanization. When Japan’s crisis hit in the early 1990s, many different agencies had jurisdiction over different parts of the financial system. Over time, these functions were largely concentrated in the newly formed Financial Services Agency. Private sector research shows a large improvement in the confidence in the expertise of the regulator. As the system recovered, further measures were taken to improve consumer protection (such as tightening so-called suitability requirements). These protection measures reduced the impact of asymmetry of information between financial professionals and their clients.

Japan’s experience comprised not only the needed factors but also their interrelationships: All factors had to be present before financial reforms succeeded. Unfortunately, it took Japan more than 10 years to get all factors in place. However, once all the factors were in place, recovery came quickly. The first four factors were largely in place in October 2002, when Financial Affairs Minister Heizo Takenaka formulated the “Takenaka Plan,” with strict asset assessment. In May 2003, he proved that he was serious about strict assessments, with heavily conditioned capital injections into a large, capital-short bank. The stock market soared, and economic growth accelerated almost immediately. Real GDP growth reached 2.7% in 2004, from 0.2% in 2002.

Thus, the lesson from Japan was not that post-bubble financial sector problems take hopelessly long times to heal. Rather, the lesson is that healing was remarkably fast, once all of the necessary factors were in place."

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