But instead of calling the loans, as most Western banks would do, the
bankers refrained. It took years and many government bailouts before real
estate prices stabilized and the banking system returned to normal lending,
with realistic estimates of bad loans and, hence, capital.
I concluded from this and other historical episodes that Japan behaved
differently from other capitalist countries. My epiphany was to realize how
humiliating "loss of face" is to the Japanese. In January 2000, I met with
Kiichi Miyazawa, the Japanese finance minister and former prime minis
*Parts of the euro area, however, have already undertaken considerable reform. Ireland and the
Netherlands particularly have developed programs that lowered the rate of unemployment.
And Germany's incomplete labor reforms of earlier in the decade may be having a greater impact
than previously contemplated.
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THE AGE OF TURBULENCE
ter, in his offices in Tokyo. After our customary exchange of pleasantries
(his English is fluent), I launched into a detailed analysis of the deteriorating
Japanese banking system. I had had many such conversations with Miyazawa;
a very effective policymaker. I now told the story of how in the
United States we'd set up the Resolution Trust Corporation to liquidate
the assets of our approximately 750 failed savings-and-loan associations,
and how, as soon as most of the seemingly unsellable real estate had been
cleared off the shelves, the real estate market had revived and the new,
smaller savings-and-loan industry had begun to prosper. I suggested that
the U.S. government strategy of (1) bankrupting a large part of our failed
thrift industry, (2) placing its assets in a liquidation vehicle, and (3) unloading
the assets at large discounts in a manner that would reliquefy the
real estate market fit the Japanese situation rather closely.
After listening patiently to my lecture, Miyazawa smiled gently as he
said, "Alan, you have analyzed our banking problems quite perceptively. As
to your solution, that is not the Japanese way" Throwing delinquent debtors
into bankruptcy and liquidating their bank collateral was to be avoided,
as was firing people. The Japanese hewed to a code of civility that made inducing
a loss of face virtually unthinkable.
There is no doubt in my mind today, as then, that an RTC-like strategy
invoked during the period of Japanese economic stagnation, from 1990 to
2005, would have shortened the period of adjustment and returned Japan
to a normally functioning economy years sooner. Throughout most of those
years, forecasters, myself included, were continually projecting a recovery.
But it never seemed to happen. What was the invisible economic force
holding Japan back? My conversation with Miyazawa supplied it. The missing
force was not economic; it was cultural. The Japanese had purposely
accepted hugely expensive economic stagnation to avoid a massive loss of
face for many companies and individuals. I cannot imagine U.S. economic
policy following such a track.
Strangely, the same sense of collective solidarity is likely to rescue the
Japanese economy from the retirement financing requirements that will
confront virtually all large developed countries in the years ahead. I recently
asked a high Japanese official how his nation would handle what appears to
be a level of commitments to future Japanese retirees that the government
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THE MODES OF CAPITALISM
may not be able to deliver. He responded that the benefits would be cut and
that doing so would not be a problem—the Japanese would see the changes
as in the national interest, and that would be enough. I cannot imagine the
U.S. Congress or American voters behaving so reasonably.
Continental Europe was able to rebuild its war-torn economies at a capitalist
pace despite the regulatory inhibitions imposed by the democratic
socialist culture that was pervasive at the end of the war. Just as the exceptional
demand to rebuild the Continent never placed a large call on the
safety net of the welfare state, the similar rapid growth of Japan in the first
three decades after the war never required significant discharging of workers
or banks' throwing defaulting debtors into bankruptcy. "Face" was never in
jeopardy.
As Europe's growth rate slowed in the 1980s, welfare-state costs rose,
reinforcing the slowdown. Similarly in Japan, when the real estate price
bubble burst, the refusal of banks to foreclose on borrowers compounded
the economic problem. With the real estate market at a virtual standstill,
banks could not make realistic estimates of the value of the collateral that
supported their assets, and hence could not judge whether they themselves
were still solvent. Caution accordingly dictated that bank lending to new
customers be constrained, and, since banks dominated Japan's financial system,
the financial intermediation so vital to any large developed economy
virtually dried up. Deflationary forces took hold. It was not until the long
decline in real estate prices bottomed out in 2006 that reasonable judgments
of bank solvency were possible. Only then were new loans forthcoming,
producing a marked resurgence of economic activity.
While I have spent much of this chapter tracing the impact of economic
forces on the larger economies, much the same set of forces is at
play, for example, in Canada, Scandinavia, and the Benelux countries. I
have not given Canada, our major trading partner, with which we share the
world's longest undefended border, the coverage it deserves, because many
Canadian economic, political, and cultural trends are mirrored in those of
Britain and the United States, which are already prominent in this book.
Australia and New Zealand are particularly interesting in how they developed
after adopting market-opening reforms and gradually increasing
ties with Asia, especially China. Indeed, Australia and New Zealand are two
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THE AGE OF TURBULENCE
of the seemingly endless examples from the last quarter century of how
opening up an otherwise ossified economy to competition paid off in large
gains in standards of living. Australian Labour prime minister Bob Hawke,
in the 1980s, confronted with an economy held in check by competition-
stifling regulation, embarked on a series of significant but painful reforms,
especially in labor markets. Tariffs were reduced markedly and the exchange
rate was allowed to float. These reforms sparked an amazing economic
turnaround. The economic revival that began in 1991 persevered
through 2006 without recession, increasing real per capita income by more
than 40 percent. New Zealand, goaded by Finance Minister Roger Douglas,
engaged in similar reforms in the mid-1980s with the same impressive
results.
Australia has always fascinated me as a microcosm of the United States
in many ways. It is a land with vast open spaces, similar in many respects
to the American West. The trek of early Australian explorers reaching out
over their huge, virtually uninhabited continent is reminiscent of Lewis
and Clark's exploration of America's Northwest. From a dumping ground
for British felons in the late eighteenth century, Australian society morphed
to a level of culture whose poster image is the Sydney Opera House. I
know I can't generalize on the basis of a few years of observations, but I
nonetheless found myself during my tenure at the Fed looking to Australia
as a leading indicator of many aspects of U.S. economic performance. For
example, the recent housing boom developed and ended in Australia a year
or two ahead of the United States. I continually monitor Australia's current
account deficit, which has persisted far longer (since 1974) than that of
the United States with no evident significant macroeconomic impact other
than large, increasing foreign ownership of Australian corporate assets.
The strong ties that developed between Australia and the United States
during the harrowing early years of World War II persist to this day. Australia,
now with a vibrant market economy, has an unusually prominent footprint
in the United States considering its size (a population of 21 million)
and its distance (7,500 miles from Sydney to Los Angeles). I have always
been impressed by the depth of economic talent in so small a country. I
found Ian McFarlane, the longtime governor of the Reserve Bank of Australia
(Australia's central bank), unusually perceptive on global issues, as is
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THE MODES OF CAPITALISM
Peter Costello, the Australian treasurer (that is, its finance minister). Prime
Minister John Howard impressed me with his deep interest in the role of
technology in American productivity growth. Whereas most heads of government
steer clear of such detail, he sought me out on such issues during
numerous visits to the United States between 1997 and 2005. He needed
no prodding from me on monetary policy. His government in 1996 had
granted full independence to the Reserve Bank of Australia.
This chapter has dealt with the emergence of the various modes of
capitalist practice in developed market economies. But there remain three
important nations that cannot quite be seen as a simple trade-off of unfettered
competition versus restraints from a social safety net: China, Russia,
and India. They all follow market rules to a point, but with significant
deviations that are not easy to categorize or forecast. China is becoming increasingly
capitalistic, with only partial formal rules on property ownership.
Russia has rules, but political convenience dictates the extent to which
they are enforced. And India has legal property rights that are so qualified
by specific regulations, often discretionarily enforced, that they are not as
binding as they need to be to attract foreign direct investment. These countries
comprise two-fifths of the world's population, but less than a fourth
of world GDP. How their politics, cultures, and economies evolve over the
next quarter century will leave a very large imprint on the economic future
of the globe.
293
FOU RTEEN
THE CHOICES THAT
AWAIT CHINA
O
O
n my last visit to China as Fed chairman in October 2005, Zhu
Rongji, China's retired premier, and his wife, Lao An, hosted a
small farewell dinner at Beijing's elegant Diaoyutai State Guest
House, where the Chinese leadership entertains visiting dignitaries. Zhu
and I had a chance to talk during a formal tea before the dinner, and the
manner in which he spoke raised serious doubts in my mind as to whether
he was truly retired, as the official press so consistently maintained. He was
wholly absorbed by and informed about the key issues between our nations
and was as insightful and incisive as he had ever been in our eleven-year
friendship.
As we compared views on China's exchange rate and America's trade
imbalances, I marveled at his detailed knowledge of China's economic
shortfalls and the needed remedies. I was struck again by the level of sophistication
he brought to such matters, unusual even among world leaders.
Over the years we had explored many issues: how China could disentangle
its social safety net from the disintegrating state-run enterprises on which it
depended, the optimum form of bank supervision, the need for the then-
nascent Chinese stock market to be left alone to develop, and more.
THE CHOICES THAT AWAIT CHINA
I had grown quite fond of Zhu and was saddened to realize that we
were unlikely to meet again. We'd become friends when he was vice premier
and head of China's central bank, and I had followed his career closely
He was the intellectual heir of Deng Xiaoping, the great economic reformer
who had brought China from the age of the bicycle to the age of
the motor vehicle and all that that implies. Unlike Deng, who had a broad
political base, Zhu was a technician; his influence, as best I can judge, rested
on deep support from Jiang Zemin, China's president from 1993 to 2003
and Party leader from 1989 to 2002. It was Zhu who had brought to realization
many of the sweeping institutional reforms that Deng had initiated.
As much pragmatist as Marxist, Deng had set in motion China's transformation
from a walled-off centrally planned agrarian economy into a formidable
presence on the economic scene.The nation's march to the market
began in 1978, when, because of a severe drought, authorities were forced
to ease tight administrative controls that had long governed individual
farmers' plots. Under new rules, the farmers were allowed to keep a significant
part of their produce to consume or sell. The results were startling.
Agricultural output rose dramatically, encouraging further deregulation
and the development of farm markets. After decades of stagnation, agricultural
productivity blossomed.
Success on the farm encouraged the spread of reform to industry.
Again, a modest easing of constraints produced greater-than-anticipated
growth, giving impetus to the arguments of reformers who wished to move
more quickly toward a competitive-market template. No advocates ever
dared call the new model "capitalism." They used euphemisms like "market
socialism" or, in the famous phrase of Deng, "socialism with Chinese
characteristics."
China's leaders were far too perceptive not to see the contradictions
and limitations of socialist economics and the evidence of capitalist success.
Indeed, why else would they have embarked on so ambitious an enterprise
so alien to the traditions of the Communist Party? As China was inexorably
drawn further and further down the road toward capitalism, economic
progress became so compelling that the ideological debate of earlier years
seemed to have passed into history.
I first set foot in China in 1994, long after the reforms had begun. I've
