Hu Sheng-cheng
Richard C. Koo
But the experience of the Japanese economy in the last 10 years, which seems to be happening in Taiwan today and also in the US, is that the economy is failing to respond to the lowering of the interest rate. That worries me a lot, in the sense that something is not working in this economy. When the monetary policy is not working, chances are high that Taiwan might be in what I call "a balance-sheet recession."
PHOTO: LU CHUN-WEI, TAIPEI TIMES
A balance-sheet recession happens usually after a large asset crisis. In Japan's case, up until the 1990s [there was the] land crisis, the stock crisis. A lot of people had a lot of borrowings, but the asset crisis kept on going up ... which means the balance sheets were completely destroyed. [Whoever is in this situation] will end up doing the same thing: they will use the cash flow from the main lender business to pay down debts, to rebuild the balance of the sheet.
Fortunately, this is what happening in Japan. Of the 3,500 listed companies, more than 2,000 are paying down debt, even though the interest rate is the lowest in the history of mankind ... Your first order of business is to clean up your balance sheet problems, and not worry about how low the interest rate will go. That is when the economy stops responding to the lowering of the interest rate.
In that situation, the normal policy of lowering interest rates is useless. When everyone is doing the same thing [to pay debt as quickly as possible to avoid bankruptcy], the net result is depression in the sense that the money that used to go to productive activities is now used to pay debt. There is no consumption, no investment and the economy weakens. When the economy weakens, the asset and land prices fall even further ... that's how you fall into depression.
When you are in this situation, the only way to keep the economy going is for the government to provide the demand to keep the vicious circle from starting.
Over the last 10 years, the Japanese government has been doing that. Everytime deflationary gap develops, the government came in, borrowed the money, uses the money to build roads and bridges to fill the gap. ... The next year the same thing happened, that's how over the past 10 years the Japanese government managed zero percent growth. People say zero percent growth is bad, but the alternative is minus 20 or 30 percent. In that sense, I think Japan did reasonably well, given what happened in its asset crisis and the wealth loss during this process.
Some people say "Hey, there is no crisis and still zero percent growth, so we want something different. So we have Koizumi running the show. But I think this is a rather dangerous direction because the treatment was actually correct. In retrospect, we managed very well. But if Koizumi starts go to in the wrong direction, we might have another balance-sheet crisis.
Hu: Taiwan is facing similar situation. Would you describe the debate in Japan about responding to the situation?
Koo: There are arguments in Japan that both monetary policy and fiscal policy don't work; even though the interest rate has come down so low, and so much money has been spent while economic growth is still zero, so the problem must be structural. So we have to change the structure of the economy, that's basically where the Koizumi government got the idea. They try to use supply-side ideas like Reagan and Thatcher.
But while Reagan and Thatcher had supply-side economics, the situation was vastly different from that of Japan today. Everything was exactly the opposite but Koizumi's government wants to use the same [method]. In my view, that is the wrong medicine for the patient. Because they were all led to believe that fiscal policy was useless ... but actually it is working. But it is very difficult to prove to the average public because we continue to avoid crises.
Today I see Prime Minister Koizumi making some adjustments. So even though he started out by distancing himself from fiscal stimulus, he seems to be coming closer to it, which I think is very much needed in Japan.
As for the bank issue, Japanese banks face problems similar to Taiwan's banks in the sense that the collateral problems are serious. Koizumi has argued that his first priority is to deal with the banking crisis. But I believe this emphasis is also misplaced because if the banking crisis is the real cause for economic slowdown in Japan, there should be many credit-worthy borrowers competing for limited supplies of funds. If that's the case, the interest rate in Japan should be rising, not falling.
They all look at the supply-side problems and think that the NPL's [non-performing loans] problem should be fixed so the banks can lend again. But the emphasis is misplaced because there is too much money available and too few borrowers.
Hu: [In this recession we have a similar situation] we tried to have an expansionary fiscal policy extended in a way to public construction. We have collateral fund for credit-worthy businesses ... but there are businesses which cannot find funds for their operation. So the government tries to help these businesses. To an extent we also have debates in Taiwan about how much we should expand our economy and how much we should do on the structural changes.
Koo: If the companies are viable, but [having problems] because of falling collateral value, I think the government should step in ... by providing government gurantees on loans ... If the companies are not viable and the collateral is bad, then the companies should disappear.
I think this is also true for Taiwan. In Japan there is a lot of pressure from the US to have quick solutions to the NPLs. They argue that the economy would be improved by quickly removing the NPLs because that was what happened in the US in 1989 and 1990.
That argument, I am afraid, does not work in Japan and would not work in Taiwan either -- because interest rates in these two countries are falling, which means demand for funds is weak and fund supply is plentiful. If you quickly remove the NPLs, it doesn't mean the banks can lend again.
In Japan, because the land prices fell so much, almost all banks have problems. In that situation you cannot adopt such a solution. You have to go slowly.
Hu: Taiwan's NPLs problem has been worsening since 1995, rising from 3 percent to 7-plus percent, with the total amount of over NT$1 trillion ... What the government has done is to reduce the value-added taxes by 3 percent ... this would help the bank to relieve their NPLs. And, in the next few years, I think we will reduce the VAT by another 2 percent.
Meanwhile the government has established the RTC (Resolution Trust Corporation) to take over the banks that are in trouble and eatablish asset management corporation to take over bad assets.
The Ministry of Finance recently stepped in on 36 community financial institutions, taking over their management and this would have cost the government about NT$ 70 million ... so we are trying to regain the confidence of the public and the international community in the soundness of the financial structure.
Koo: I think the Taiwanese government's approach to clean up the small problems is appropriate in that you have small and big problems all together and it's very difficult to deal with, so to get rid of the small ones first is easier to manage. As long as the government stands strongly behind these financial institutions through frequent inspections, making sure that there is no hazard problem and that banks continue to improve their management over a long time. To a point that it does not destroy the economy, I think that is the best way to go.
We have to be careful about one thing: If you have a systemic banking crisis, and if something goes wrong and the economy loses its stability, then all the buyers who are knocking on our doors will also disappear. That's what happened in Japan in 1997 and 1998.
Before 1997, a lot of people would have liked to buy Japanese assets, so we thought that was the bottom of the Japanese asset crisis because of all the international interest. So then-prime minister [Ryutaro] Hashimoto decided to cut the budget deficit and the economy began to contract and when the whole economy began collapsing, there were no buyers left. The economy kept on collapsing and finally prime minister [Keizo] Obuchi came in with a very large fiscal stimulus package, a very large capital injection package. Once these packages were in place, the economy started to stabilize and then all these foreign buyers came in to buy Japanese assets.
The lesson is that the stability of an economy has to be maintained at all costs, you cannot let the economy go in the name of reform.
Hu: I agree with you that the financial reform is very important. President Chen Shui-bian (
Koo: I think the Taiwanese government is moving in the right direction with more stimulus [measures], but I also hear there are a lot of political problems in the legislature, where all the right policies are being blocked by the opposition. I find this most unfortunate because in this kind of environment ... the faster you move, the cheaper the medical bill is going to be. If political opposition delays the implementation of the fiscal stimulus, the gap becomes bigger and it will cost more to deal with later.
In Japan, for example, Hashimoto tried to reduce the budget deficit in 1997, [which at that time was] ?22 trillion. When he cut the budget deficit, the Japanese economy collapsed, and we had five quarters of negative growth, the worst economic growth of any major industrial country. As a result, tax [receipt] disappeared and the budget deficit skyrocketed. By 1999, Japan's budget deficit, after raising taxes and cutting spending, was up to ?37 trillion. That is the kind of danger we face in a balance-sheet recession. So I strongly support President Chen's initiative in applying more fiscal stimulus early.
Hu: You have pointed to a real problem. The NT$ 810 billion project was not passed by the the Legislative Yuan until late June this year. If this bill was passed earlier, the economic situation would be in a better shape right now.
Now the problem is we have a budget deficit ceiling law, constraining how much the government can use. Currently we are hitting the ceiling, and the government tries to work with the opposition to remove the ceiling in order to pursue the fiscal policy.
And that is perhaps why president Chen declared that he would form an alliance [for national stabilization, (
Koo: The US also has this debt ceiling as well, and this kind of thing is not so bad in an ordinary recession ... that is to keep politicians from spending too much money. But once you are in a balance-sheet recession ... the debt ceiling is the absolute enemy of the country because it can delay the quick treatment to the problems ... I think your national stablization alliance should move quickly to remove these things so that you can treat the [problems] quickly and in a flexible manner.
Hu: I agree with you that the debt ceiling is very good in normal times ... but in special times, we have to worry about whether there is too much constraint on the government and hindering it from reviving the economy.
Additionally, our deficit situation is not as bad as people think. Currently it is about 30 percent of our GDP, compared to 55 percent in the US and 130 percent in Japan, so we are in a good situation.
The challenge to the government and the opposition is how to maintain the financial soundness ... by giving [more] flexibility.
Talking about other problems, with the entry into the WTO, we are facing more competition from abroad, especially in the banking and financial sectors. So the government has reviewed laws and restrictions [and] allowed for financial holding companies to do other non-banking businesses, like stock transactions.
At the same time, banks are also encouraged, through mergers and acquisitions, to yield their scales so that they can be competitive in the international market. Can you comment on this?
Koo: You touched upon the fiscal soundness issue. When we talk about fiscal soundness, we should not make some sort of arbitrary decision that 100 percent is sound and 130 percent is not sound. This kind of decision should be made by the market. That's what the market is for.
This very low interest rate is actually an opportunity to upgrade the infrastructure at the lowest cost of the taxpayers. As I understand the interest rate in Taiwan is also the lowest in the history of the Republic of China.
So both in Taiwan and Japan and increasingly in the US, there are a lot of lenders but there is a lack of borrowers. And now only the government performs the function of borrowing money and then spending it and that is the only way money can come out of the financial sector [and go] into the general economy. So if the government stops borrowing now, not only the economy but also money supply would contract.
Hu: In August our Economic Development Advisory Conference [reached recommendations on] how to rebuild the economy, increase the employment rate, upgrade our industries and improve our investment environment, and more importantly, on how to deal with economic relations with China. The government has decided to open up trade with China. What's your comment on this policy?
Koo: It sounds rather greedy to me to be able to achieve all that in one stoke. But China is going to be a real issue, not just for Taiwan, but for the rest of the world. I had a sense that we have the so-called free trade system -- GATT, now the WTO -- precisely because two countries were not in it -- China and India.
When Japan came in the system then Korea, Singapore and Hong Kong followed. Each of them caused some shocks to the system but within five to 10 years the system managed to absorb the shocks. But China is a different story ... it would take decades for things to be adjusted. Honestly, I don't have the answer to the Chinese challenge, but we need to find an answer because after China there is India.
At the same time, we cannot go back again because the Chinese want to get rid of the Communist system and to be rich again. So you will have to find a way to live with them. But since Taiwan has a special problem with China, my own sense is that Taiwan should go slowly [before] opening too many areas or establishing direct links with China before they renounce using force to unite the country.
Hu: Previously we had the "no haste, be paient policy (戒急用忍),"... but it was estimated that about 40 or 50 percent of the investment abroad actually goes to China. With Taiwan's entry into the WTO, it was time to review the policy and now it is replaced with the policy, "active opening and effective management." Perhaps the solution is not to stop the flow of investment into China, but to take advantage of the investment and [use] our advantages to establish Taiwan as a regional operation center and a global logistical center. With the entry into the WTO, we are forced to rethink our economic strategy toward China. What's your impressions about our collateral government fund to deal with the economic recession and structural changes?
Koo: Balance-sheet recession does take a long time to fix. For the first time in many years, the land price in Taiwan is falling. Since no one expected this, the [shocks to] peoples' psychology is more than you can forecast because they lose their frame of reference.
Let someone else establish a new frame of reference on what is cheap and what is not and the best way to do it is to bring in foreign investors. If they starting buying, that means that those prices not only make international sense, but domestic investors may come in as well. In the current circumstances we cannot be too picky; then Taiwanese domestic investors should also be confident in investing in those assets. So the first priority should be to establish the floor in asset prices.
Hu: Actually the falling real estate price is the root to Taiwan's NPL problems, and it is compounded by flooding and landslides in hilly area.
Now we have opened up the real estate market to foreigners and mainland Chinese. This not only meets international requirements but also helps to prop up our real estate market.
The next problem is the structural problems that demand structural change. In order to stay competitive, we need to move from traditional manufacturing to high value-added manufacturing industries.
Koo: I have to be more realistic on the financial sector side. Given Taiwan's special status relative to China, an that relations between the two are somewhat unstable, I don't think we can truly hope that Taiwan can become a major financial center. But within that realism, there is still a lot of room for improvement for the financial sector to upgrade.
Recorded by Wu Pei-shih.
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