Jeffrey Frankel Harpel Professor, Harvard University Harvard Project for Asian & International Relations 2010 Con

1. Asia, the US, and the G20 in 2010 Jeffrey FrankelHarpel Professor, Harvard University Harvard Project for Asian &International Relations 2010 Conference February 19, 2010

2. Each decade gives rise to a new conventional wisdom • 1990:20 years ago, many had drawn a lessonfrom the1980s: Japan had developed a kind of capitalism, which outperformed the US. • 2000:10 years ago,many had drawn a new lessonfromthe1990s: The US offered the superior model after all. East Asia should emulate the US, to solve the structural flaws that had led to the 1990s crises. • 2010:Today, many have drawn the obvious lesson from the2000s: The US suffers from the same flaws (“crony capitalism”). The future belongs to China.

3. 20 years ago: Lessons from the 1980s • The US was said to be in decline: • The “hollowing out” of manufacturing. • Paul Kennedy’s The Rise and Fall of the Great Powers: Imperial overstretch would be the downfall of the US, just as with its predecessor. • Reagan’s legacy was tarnished, • by the Iran-Contra scandal • and twin deficits (big fiscal & trade deficits).

4. Japan was thought a juggernaut, taking over the world economy. • Journalists and “revisionists” extrapolated that Japan would overtake the US in coming decades. • The new national security competition between countries was said to be economic, not military. • Japan was thought a juggernaut, taking over the world economy. • Journalists and “revisionists” extrapolated that Japan would overtake the US in coming decades. • The new national security competition between countries was said to be economic, not military. • Best-selling books caught the mood: • Ezra Vogel’s Japan as Number One; • Chalmers Johnson’s MITI and the Japanese Miracle; • Michael Crichton’s Rising Sun (1992).

5. Japan (and the Asian NIEs) were said to have a superior model of capitalism Vs. Anglo-American model • “Asian values” • Long horizons • Keiretsu / chaebol • Low cost of capital • Lifetime employment • Relationship banking • Government guidance • Pro-saving financial system • Firms maximize size (capacity or market share) Corporate governance maximizes profits & stock prices for shareholders. Financing via securities markets . Competition in goods and labor markets. Consumerculture

6. Minority voices: International politics • Joe Nye’s Bound to Lead (1990): • US global leadership was not exhausted. • East Asian countries were important allies. Minority voices: Financial economics • The 1987-89 bubbles in land & stock markets • were due to • Low Japanese interest rates • which were in turn due to high saving.

7. Minority voices: International economics Most economists: • Japan’s trade surplus was not attributable • to a superior economic model, • nor to strategic trade policy, • nor to US naively keeping markets open to imports. • Rather it was due, again, to National Saving • which in 1990 was as high in Japan as it was low in the US. • High Japanese saving was in turn probably due to demographics more than culture or policies.

8. As soon as the 1990s started, the 1980s conventional wisdom was proven wrong • The US triumphed militarily in the Gulf War (1991). • The US triumphed politically with the fall of the Soviet Union (1991). • The Japanese model burst, • along with its land-stock-market bubble (1990) • and economy (1991-…) .

9. And as the 1990s progressed, • the US experienced the longest economic expansion of its history. • The budget was restored to surplus, with the help of actions by G.H.W.Bush (1990) & Clinton (1993, 98). • America was declared to have a New Economy. • IT carried the US stock market to stratosphere by 1999. • Korea, Thailand, Indonesia & other NIEs carried the mantle of the Asian miracle, until severe currency crises hit them in 1997-98.

10. Asians were told to emulate the US model 10 years ago: Lessons from the 1990s • especially its financial system: • corporate governance, • accounting standards, • consumer finance, innovative products, • securities markets, rating agencies, and • Anglo-American style banking (market-oriented & arms-length)

11. But as soon as the 2000s started,the 1990s assumptions were proven wrong • Bursting of the US dot-com bubble (2000). • Failure of US electoral institutions (Nov.2000). • Failures of Sept.11 (2001) & US response (Iraq, Guantanamo) • Failure of US corporate governance in scandals of Enron, etc. (2001). • Decade of flat median income and rising debt.

12. Financial crisis (2007-2009) • Bursting of US housing bubble (2006) • inevitably led to sub-prime mortgage crisis (2007). • Less predictably, failures of US financial system led to disappearance of liquidity (2008) • and the 2nd recession of the decade, • the worst since the 1930s. • The rest of the world followed.

13. The US has lost its claim as an exclusive model for others to emulate The desirable principles haven’t changed, only the claim that the US uniquely embodies them • Open democracy, rule of law, human rights • Competition in goods & labor markets • Corporate governance should focus on long-term shareholder value, • not executives’ options prices • nor empire-building. • Government intervention to address market failure • E.g., tax pollution (don’t subsidize fossil fuels). • Supervise banks, under rules (don’t take them over).

14. The US is in a hole • Adroit monetary & fiscal management has succeeded in limiting the length & severity of the recession. • The turning point was probably early summer, 2009 • => we have avoided the mistakes of • the Depression (1929-1937), • or Japan’s lost decades (1991-2010). • But the long-term fiscal outlook – already bad – has gotten worse.

15. The same with other major industrialized economies. • A remarkable role-reversal: • Debt/GDP of the top 20 rich countries • (≈ 80%) is already twice that of the top 20 emerging markets; • and rising rapidly. • By 2014 (at ≈ 120%), it could reach triple the big emerging market debt levels.

16. The US financial positionhas deteriorated internationally • The twin deficits • China became our largest creditor • The dollar appears in long-term decline.

17. Exorbitant Privilege of $ • Among those who argue that the US current account deficit is sustainable are some who believe that the US will continue to enjoy the unique privilege of being able to borrow virtually unlimited amounts in its own currency.

18. When does the “privilege” become “exorbitant?” • if it accrues solely because of size & history, without the US having done anything to earn the benefit by virtuous policies such as budget discipline, price stability & a stable exchange rate. • Since 1973, the US has racked up $10 trillion in debt and the $ has experienced a 30% loss in value compared to other major currencies. • It seems unlikely that macroeconomic policy discipline is what has earned the US its privilege !

19. The “Bretton Woods II” hypothesis • Dooley, Folkerts-Landau, & Garber (2003) : • today’s system is a new Bretton Woods, • with Asia playing the role that Europe played in the 1960s—buying up $ to prevent their own currencies from appreciating. • More provocatively: China (& Asia) is piling up dollars not because of myopic mercantilism, but as part of an export-led development strategy that is rational given China’s need to import workable systems of finance & corporate governance.

20. My own view on “Bretton Woods II”: • The 1960s analogy is indeed apt, • but we are closer to 1971 than to 1944 or 1958. • Why did the BW system collapse in 1971? • The Triffin dilemma could have taken decades to work itself out. • But the Johnson & Nixon administrations accelerated the processby fiscal & monetary expansion (driven by the Vietnam War & Arthur Burns, respectively). • These policies produced: declining external balances, $ devaluation, & the end of Bretton Woods.

21. There is no reason to expect better today: • Capital mobilityis much higher now than in the 1960s. • The US can no longer necessarily rely on support of foreign central banks: • neither on economic grounds(they are not now, as they were then, organized into a cooperative framework where each agrees explicitly to hold $ if the others do), • nor on political grounds(China & OPEC are not the staunch allies the US had in the 1960s). 3) A possible rival currency to the $ exists.

22. When will the day of reckoning come? • Not in 2008: In the short run, the financial crisis caused a flight to quality which evidently still meant a flight to US $. • Chinese warnings in 2009 may have marked a turning point: • Premier Wen worried US T bills will lose value.On Nov. 10 he urged the US to keep its deficit at an “appropriate size” to ensure the “basic stability” of the $. • PBoC Gov. Zhou in March proposed replacing $ as international currency, with the SDR.

23. The global monetary systemmay move from dollar-based to multiple international reserve currencies • The € could challenge the $. • The SDR is again part of the system. • Gold in 2009 made a comeback as an international reserve too. • Someday the RMB will join the roster with ¥ & ₤. • = a multiple international reserve asset system. SDR

24. Decoupling? • Initial hopes of decoupling succumbed at the height of the crisis: • Financial contagion • Asian exports were especially hard-hit.

25. Asian exports plummeted via RGE Monitor 2009 Global Outlook

26. But, in the end, there was a measure of decoupling after all. • China, India & Indonesia kept growing throughout. • All of Asia has now come roaring back. • Asia now constitutes an independent “growth pole” in the world.

27. Developing Asia growth rates > 8% Year-over-year growth rates. Source: IMF WEO Jan. 2010 Projections 2008 2009 2010 2011 World output 3.0 -0.8 3.9 4.3 Advanced economies 0.5 -3.2 2.1 2.4 Developing Asia 7.9 6.5 8.4 8.4 China 9.6 8.7 10.0 9.7 India 7.3 5.6 7.7 7.8 ASEAN-5 4.7 1.3 4.7 5.3

28. 2010: Lessons from the 2000s • America is not as “exceptional” as claimed. • Domestically, US democracy fell short. • In international relations, our leadership faltered. • The US economic system suffers from problems of “crony capitalism” too. • “The future belongs to China.” • Dynamic entrepreneurship has moved there. • China as wealthy creditor will claim its due power.

29. What might this new conventional wisdom of 2010 be forgetting? • China is not yet ready to be global leader • It is not ready politically. • It is still quite a poor country. • It will run into its own problems, e.g., a banking crisis somewhere down the road. • Asians don’t want to be dominated by either China or Japan, and will always welcome the US as a counterweight.

30. Developing Asia is now a large share of world GDP, growth, reserves… • But even after recent adjustments, its share in IMF voting shares, for example, is still disproportionately small: • China 3.81 % • Korea 1.36% • India 2.34% • Singapore 0.59%

32. History will judge one of themost important developments of 2009: the G-20 suddenly supplanted the G-7. • G-20 meetings in 2009: • London in April • Pittsburg in October

33. How successful were the measures supported by US & Korea at the G-20 meetings (2009)? • Coordinated fiscal stimulus to fight the recession • as in the locomotive plan of G7’s Bonn Summit of 1978: • no formal agreement, but it seemed to happen anyway. • Unexpected revival of the SDR and tripling IMF resources • The usual agreement for a standstill/rollback in trade barriers. Some backsliding followed, & little progress in Doha Round; • on the US side: • tariffs on Chinese tires, • inability to ratify FTAs (US-Korea, etc.). • But, so far, not a bad trade record, for a severe recession. SDR

34. Whatever the causes of the great recession, the policy response avoided 1930s mistakes: • No Smoot-Hawley tariffs • No failed London Economic Summit • Aggressive monetary expansion rather than contraction. • Fiscal expansion too.

35. The true significance of the G-20 in 2009 • The G-20 accounts for 85% of world GDP. • A turning point: The more inclusive group has suddenly become central to global governance, eclipsing the G-7, and thereby at last giving major developing/emerging countries some representation, • after decades of fruitless talk about raising emerging-market representation in IMF.

36. Australia Canada France Germany Italy Japan Russia UK USA EU G-20 membership • China • India • Indonesia • Republic of Korea • Saudi Arabia • South Africa • Turkey • Argentina • Brazil • Mexico

37. The G-20 in 2010 • Korea has assumed the presidency this year • the first non-G7 host of the G20. • Canada & Korea will host the meetings in June & November, respectively.

38. Implications for Korea • Korea is the bridge between the G-7 and developing countries. • Especially China & India • What can the G-20 accomplish for Korea? • What can the G-20 accomplish for the world?

39. Opportunity/burden for Korea • Will chairing the G-20 help consolidate Korea’s status as an advanced economy? • Yes, as did: • hosting the Olympics, • joining the OECD, • attaining the per capita income of some industrialized countries ($20,000 ≈ Portugal). • But Korea should now seize the chance to exercise substantive leadership. • Otherwise, the risk is Czech presidency of EU…

40. Four items on G-20 agenda for 2010 • Possible financial regulatory reform • Some steps underway in Basle, Financial Stability Forum • The Europeans would like more, but are unlikely to get it. • Personally, I might favor a small global tax on financial transactions. • Macroeconomic exit strategies • Global imbalances between developing countries and industrialized • US and China should both admit responsibility • US: the budget deficit is too big. Needs to be fixed. • China: RMB is too low. Needs to be unfixed. • Post-Copenhagen progress toward new agreement on climate change to take effect 2012.

41. Two principles of multilateral institutions 1. It is inevitable that more power go to large-GDP countries than small. • This is why IMF works better than UN . • The problem is that China, India, Korea, Brazil, etc.,are larger than Canada, Netherlands… Hence the G-20. • The outcome must leave small countries better off, of course, or they will not go along. 2. Conversation is not possible with more than 20 in the room.

42. Example: many rounds of trade negotiations under the GATT. • Worked well for years, • with small steering groups (US-EU, the Quad & G-7) • and few demands placed on developing countries. • Failed when developing countries had become big enough to matter, • but were not given enough role: • Doha Round

43. Conversation is not possible with more than 20 people in the room. • Delegates just read their talking points. • The latest evidence: The Climate Change CoP in Copenhagen • The UNFCCC proved an ineffectual vehicle • Incompetent management of logistics • Small countries repeatedly blocked progress • Obama was able to make more progress at the end with a small group of big emitters. • Korea is in a good position to build on this progress • as the 1st non-Annex I country to take on binding emission targets. • To be honest, the G-20 is too big. • My recommendation: an informal steering group within G-20.

44. Emissions targets taken on under Copenhagen Accord(Jan 31, 2010 deadline)

45. Emissions targets taken on under Copenhagen Accord(Jan 31, 2010 deadline)

47. Addenda • 1. Global climate change negotiations. • A proposed new architecture. • Climate change and trade • 2. The global financial crisis of 2007-09 • Origins • Lessons • 3. The US current account deficits • What about the economists who argue that they are sustainable?

48. 3 Points • Proposal for a Global Climate Agreement: Setting Emission Targets by Formulas • Global Trade and Global Climate Change What form should border measures take? • Modalities: Lessons from 2009. How Should We Proceed in 2010? • Charts with details: The Proposed Target Formulas

49. 1. Proposal: target formulas designed pragmatically,based on what emissions paths are possible politically: • unlike other approaches based purely on: • Science (concentration goals), • Ethics (equal emission rights per capita), • or Economics (cost-benefit optimization). • Why the political approach? • Countries will not accept burdens that they view as unfair. • Above certain thresholds for economic costs, they will drop out.

50. Proposal Stage 2:When the time comes for developing country cuts, targets are determined by a formula incorporating 3 elements, designed so each is asked only to take actions analogous to those already taken by others: • Stage 1: • Annex I countries commit to the post-2012 targets that their leaders have already announced. • Others commit immediately not to exceed BAU. • a Progressive Reduction Factor, • a Latecomer Catch-up Factor, and • a Gradual Equalization Factor.