Pacific Exchanges is a new podcast from the Federal Reserve Bank of San Francisco. The show features interviews with experts from the world of economics and finance to explore developing trends in the Asia-Pacific.
The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.
Asia’s Latest Trade War: Japan vs. South Korea
In this episode of our series Rethinking Asia, we spoke with Chad Bown, Reginald Jones Senior Fellow at the Peterson Institute for International Economics. Chad is an expert on trade, having worked on the issue at the World Bank, the White House Council of Economic Advisors, and the World Trade Organization.
We sat down to discuss the recent trade disagreement between South Korea and Japan. While, rooted in the countries’ deep historical, political, and social tensions dating back to the early 20th century, the attitudes and tactics adopted in the dispute reflect broader global sentiments surrounding trade. Key takeaways from the discussion include:
A new front in global trade wars has opened, with South Korea squaring off against Japan. Specifically, the Japanese government put export restrictions on various exports to South Korea and, most recently in early August, removed South Korea from its so called ‘white list’ of countries that enjoy special trade terms with Japan. The move requires Japanese companies to follow a bureaucratic process when exporting to Korea, disrupting supply chains for Korean microchip and display manufacturers that rely heavily on Japanese inputs. Today’s tensions date to the Second World War, when Korea was a Japanese colony and Japanese companies used forced Korean labor. In 1965, the two countries signed a treaty to normalize the relationship under which Japan paid restitution to South Korea. Recently, however the South Korean Supreme Court ruled that the treaty only applied at a country level and that individuals could bring cases against Japanese companies. Japanese export restrictions are seen as retaliation for the decision. The deterioration of the trade relationship between Japan and South Korea reflects current attitudes and trends in trade by which countries are increasingly using trade as a lever to resolve political and social disputes once mediated through diplomatic channels. This dispute reveals that a focus on bilateral disputes may make it harder for countries to form regional or global trade agreements. Prior to the dispute, according to Bown, South Korea was interested in acceding to the Japan-led CP-TPP (Comprehensive and Progressive Agreement on Trans-Pacific Partnership) trade agreement among 11 countries. It is unlikely to follow through in light of current tensions. It is hard to say whether the current attitudes toward trade will upend the trend toward globalization established in the aftermath of the World War II. Recent results are a mixed bag: while high profile cases of anti-trade rhetoric and behavior have garnered the most attention, other countries continue to sign free trade agreements. The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.
The State Strikes Back: The Diminishing Role of China’s Private Sector
In this episode of our series Rethinking Asia, we sat down with Nick Lardy, senior fellow at the Peterson Institute for International Economics. Nick is one of the world's most prominent analysts of China's economic development and the role of its private sector in generating growth.
We sat down to discuss Nick’s new book, The State Strikes Back: The End of Economic Reform in China? Nick walked us through some troubling statistics about the Chinese private sector’s diminishing role as measured from a number of data sources and qualitative indicators of slowing economic reform. Key takeaways from the discussion include:
The role of the private sector has been significantly diminished over the last decade as indicated by a wide range of data related to access to credit and share of investment, and sector-level growth.
China’s state sector has undergone a massive amount of consolidation, with the number of state-owned enterprises (SOEs) declining by roughly 50%, while at the same time state-owned assets grew five-fold. Despite this consolidation—or perhaps because of the implied reduction in competition it brings—the efficiency of SOEs continues to lag that of private companies by a wide margin.
While Chinese President Xi Jinping has recently indicated the banking sector should direct more funds to the private sector, it remains to be seen whether this state-oriented growth pattern will reverse any time soon.
Should China continue down this path of diminishing support for private sector activity, the implications for long-term growth, employment, and innovation could be substantial. On the other hand, a future downturn in the Chinese economy could make Chinese leadership more receptive to reform-minded economists that argue for better policy support for the private sector. The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.
Tracking Cross-border Capital Flows in Asia
In this episode of our series Rethinking Asia, we spoke with Brad Setser, a Senior Fellow for International Economics at the Council on Foreign Relations. Brad also served as the deputy assistant secretary for international economic analysis in the U.S. Treasury and was previously the director for international economics, serving jointly on the staff of the National Economic Council and the National Security Council.
Brad walked us through the evolution and recent trends in cross-border capital flows in Asia. In the wake of the Global Financial Crisis, capital flows were primarily driven by current account surplus countries in Asia, whose governments were investing money abroad to offset appreciatory pressures on their exchange rates. In recent years, however, divergent global interest rates, economic developments, and a search for yield have spawned a complex web of flows across the Pacific. Key takeaways from the discussion with Brad include:
Throughout the post-crisis period, Asia has been a net exporter of capital. The bulk of financial outflows arose through a buildup in foreign exchange reserves among Asia’s current account surplus economies, though movement out of Japan was also driven by private investors seeking higher yield in a zero-interest rate environment. Immediately after the crisis, China experienced significant capital inflows. This reflected China’s gradual liberalization of its financial account. Comparably higher interest rates in China led to a growing carry trade, but these inflows reversed sharply in 2015 as the economic outlook deteriorated. In recent years, however, flows have stabilized as China restricted outflows and entered a modest economic recovery. Capital inflows into emerging Asia have generally followed global investors’ interests in emerging market exposure more broadly. While bank flows were a major component of pre-crisis inflows to the region, regulations have changed to limit banks’ short-term and foreign currency exposure compared to the pre-crisis period (though China is a notable exception). Portfolio flows into the region have taken on a greater role post-crisis. Across Asia, financial institutions increased purchases of offshore assets in a search for yield as the Fed began rate normalization. The biggest shift in trend over the past five years has been the rise of private capital flows, assuming the dominant role of official flows immediately post-crisis. The ongoing trade dispute has had a relatively minimal impact on regional capital flows, particularly when compared to the tumultuous effect of China’s exchange rate adjustment in 2015. U.S. tariffs have put downward pressure on the yuan, which in turn put regional currencies under pressure. Rising production costs in China have raised the appeal of neighboring economies, and could lead to rising foreign direct investment in other Southeast Asian nations. Funding mismatches among the Asian financial institutions is a growing vulnerability. In particular, growing dollar balance sheets in Asia have become an important source of funding for the U.S. economy and recall the experience of European banks pre-crisis. This risk is mitigated somewhat by large reserves in surplus countries and international swap lines, but the systemic implications of the global network of funding demand greater attention. The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.
The Slow Introduction of Open Banking and APIs in Japan
In this episode, we continued our ongoing series on fintech in Asia with Toshio Taki, the co-founder of Money Forward, a Japanese fintech firm that provides financial management tools for individuals and small businesses. In addition to his role at Money Forward, Toshio also serves as a director of the Japan Association for Financial APIs, promoting the use of open APIs (application programming interface) in Japan.
Toshio talked us through the open banking and API landscape in Japan, highlighting where recent changes in regulation are encouraging further development, and comparing Japan to global peers in this area. Through his work both at Money Forward and with the Association, Toshio is pushing for greater adoption and integration of financial technology services among Japanese clients, and looking in particular to help draw Japan’s economy away from its heavily cash-reliant systems.
Roughly 80 percent of all consumption in Japan is cash-based, placing Japan as a distinct outlier relative to other developed economies. One of the key factors for Japan’s high dependence on cash is the lack of a dominant electronic payment network that is universally accepted in Japan. Compared to China’s Alipay and WeChat Pay, for example, Japanese providers are fragmented and lack merchant integration. Japan’s Banking Act was amended in June 2018 to promote open banking. However, the regulation lacks clarity on data portability, and implementation of open banking components among Japanese companies remains voluntary. Nonetheless, roughly 130 chartered banks in Japan among the largest 140 have plans to open up APIs by mid-2020. In its early stages, there are already around 20 Japanese companies using open APIs to provide account information services. Personal finance and corporate accounting services are expected to be significant beneficiaries of open API. Other opportunity sectors will likely include peer-to-peer payment platforms and the development of personal electronic money accounts. Standardizing bank practices and data formatting across different countries remains a challenge. In part, this reflects the local nature of API development and lack of cross-border services driving international collaboration. This multiplicity is evident even in Japan by itself, where a handful of system vendors have created multiple standards around API infrastructure. Rather than rushing to standardize, however, now may be the optimal time to let early movers experiment and learn what works well and what doesn’t. Fintech development in Japan is happening quite differently from the way it is evolving in the United States. The U.S. model is based on small disruptors creating a very successful user experience and using this base to alter specific banking functions. In Japan, by contrast, fintech development is occurring in partnership with the larger, more traditional providers. In part, this reflects the difference in Japan’s credit landscape, where households are generally happy with current banking services and SMEs have not faced credit constraints the same way U.S. businesses have post-crisis. Looking forward, financial services and the banking sector writ large are expected to face major upheavals. For Japanese banks, the transition away from cash will transform the way they attract customers, shifting the major attraction of local banks from their ATM proximity to how exciting their apps are and their exclusive product offers. In addition, a new credit cycle in Japan could usher in novel credit channels – similar to the way peer-to-peer lending was catapulted forward in the U.S. post-crisis to fill the gap left by traditional credit providers.
The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.
The U.S.-China Trade Dispute
In this episode, we continue our ongoing Rethinking Asia series with Louis Kuijs, the head of Asia Economics at Oxford Economics. His background includes a particular focus on China, reflecting experience in both the public and private sectors covering banking, macroeconomic, and policy issues in the world’s second largest economy.
We spoke with Louis about the ongoing trade tiff between the United States and China. He shared his thoughts on the regional economic and structural effects of evolving international trade patterns, China’s path to further integrating into the global financial system, and consequences for the broader U.S.-China relationship from the trade dispute fallout.
The mood in the U.S.-China trade talks has seen some improvements as progress is being made. More broadly, the ongoing trade dispute reflects the change in American mentality; in the U.S., the narrative on U.S.-China relations has shifted from cooperation to rivalry. When measuring the near-term effects of the U.S.-China trade tiff, the impact on business confidence is often overlooked. Indeed, the effect of uncertainty could be larger than the direct impact of the tariffs via weaker exports and higher prices. Over the medium term, however, the trade dispute may have much larger effects via a global reconfiguration of supply chains and growing underlying tension between the U.S. and China which is centered on technology. While China serves as a well-known hub in the global supply chain, Chinese demand and China’s rapidly growing role as a destination for imports have been major drivers for regional trade. Tariffs will ultimately result in a net loss for regional trade partners by reducing Chinese growth and demand. Gains in trade for partner countries associated with receiving relocated production facilities, for example, will likely be overwhelmed by slower growth. Despite the U.S.-China dispute, appetite for free trade agreements in Asia remains strong. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which came into effect on January 1, includes greater flexibility in several provisions relative to the TPP version. Another regional agreement, RCEP, can potentially add an additional layer or extension of trade liberalization that compliments CPTPP. Over the longer term, China’s stated liberalization objectives have implicit contradictions. On the one hand, policymakers plan to continue taking steps to open up the country, further integrating China into the global economy and financial system. On the other hand, policymakers have underscored their commitment to maintain China’s current model, whereby the Party remains at the heart of economic decisions and state-owned enterprises have a central role. The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.
Fits and Starts For Japanese Corporate Governance Reform
In this episode of our series Rethinking Asia, we spoke with Ken Hokugo, head of Corporate Governance and the director of Hedge Fund Investments at Japan’s Pension Fund Association, which manages more than $120 billion in assets. Ken is also a globally recognized expert on and strong advocate for Japanese corporate governance reform. The opinions expressed by Ken in the podcast are solely his and not those of his organization, the Pension Fund Association.
Ken discussed some of the challenges that Japan faces implementing corporate governance reform. Notably, the practice of cross-shareholdings and the lack of truly independent directors sacrifice corporate success for management stability and dampen investor confidence in Japanese stocks. Ken discusses how cross-shareholding, among other practices, is entrenched due to a host of historic and structural factors. Some of our main takeaways from our exchange with Ken include:
Poor market performance among Japanese stocks suggests a failure to create value and a lack of management accountability. Combined with a refusal to heed international investor concern, this has led to a lack of enthusiasm for Japanese stocks on the part of foreign investors in the past few decades. The use of cross-shareholding, which is common in Japan, is often cited as the poster-child for Japan’s need for corporate governance reform. Cross-shareholding refers to the practice whereby a web of companies hold significant quantities of each other’s shares, on the promise that each will vote to approve management initiatives. Holding cross-shares has origins among keiretsu, conglomerates that dominated Japan’s modern economic development. In post-World War II Japan, keiretsu used the practice to provide capital to companies involved in Japan’s re-industrialization. While the conglomerates were dissolved under government law, the practice of cross-shareholding remains, in many cases prizing management control over corporate success. The appointment of independent directors to corporate boards is relatively new in Japan. A small group of appointed “independent” directors monopolizes the position for thousands of companies and remains beholden to management in most cases. There are only a handful of reform success stories taking root in Japan. Beyond this, Ken believes collective engagement of domestic and foreign investors can help change corporate behavior. The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.