East Asia’s Future Role in Defining U.S.-Japan Relations

Keynote Speaker
Richard Armitage, President, Armitage International; Former Deputy Secretary of State

Presider
Tsuyoshi Sunohara, Senior Staff Writer, NIKKEI, Inc.

Presenters
Heizo Takenaka, Senior Advisor, Japan Center for Economic Research; Professor, Keio University; Former Minister of Internal Affairs and Communications
Glenn Hubbard, Dean, Columbia Business School; Former Chairman, President's Council of Economic Advisers

Moderator
Naoaki Okabe, Senior Executive Editor, NIKKEI, Inc.

Japan Society joined with Nikkei to present the perspectives of three distinguished speakers on the dynamics of change in the U.S., Japan and East Asia today.

Richard Armitage
Photo: Alex Wong

"There is a lot of flux out here in Asia," said keynote speaker Richard Armitage, President of Armitage International and former Deputy Secretary of State. Japan is about to have a new prime minister; Korea, Taiwan and Thailand will hold elections within the next few months; "John Howard right now in Australia is fighting the fight of his life, and it looks like there'll be a change in Australia."

Although "those who do look to the future say you can't see with much clarity out more than about 12 years, perhaps 15 years," there are some absolute certainties, he said. "Globalization is irreversible. The uncertainty associated with it is whether laggard nations can be brought into the globalized economy in a timely enough fashion--because if they can't, if they fall out the bottom, you run the risk of a failed state."

The world economy will continue to grow; what's uncertain "is whether the distance between the haves and the have-nots," and the attendant risks posed by displaced people, displaced populations, can be lessened.

Also certain, Mr. Armitage said, is that urbanization will continue apace. But it's uncertain if "the governments of great megacities, like this one we're in today in New York, can make infrastructure decisions in a timely enough fashion to serve the needs of their population."

"And I'm not just talking about roads and airports; I'm talking about access to fresh water, to sanitation and to health," he said. If governments can't act with agility to provide for these basic needs, they risk "having what in military terms would be strategic centers of gravity which could direct their activities against governments."

The rise of China "will be the most important event in the first half of this century," Mr. Armitage said, "certainly as important as the rise of a united Germany was in the 19th century, and probably rivals the rise of the United States in the 20th century."

"There is no question that the whole center of gravity of the world for a time has shifted to East Asia"; the Pacific region, which includes the U.S., has six of the 10 most populous nations in the world, as well as six of the 10 largest militaries, six of the top 10 users of resources, and five of the top 10 GDPs, he noted.

The past 30 years in Asia have seen "rather remarkable peace and stability, I believe in large measure because of the U.S.-Japan relationship," Mr. Armitage said. There's been "rather remarkable economic success, economic interdependence" in the region, "and notwithstanding the lectures we used to get from some Asian countries, particularly Singapore, about unique Asian values, we've seen democracy: Korea and Taiwan come to mind."

On North Korea, his former colleague Chris Hill, State Department envoy to the Six-Party Talks, is doing a "bang-up job," Mr. Armitage said, but he has personal reservations about the prospects for getting North Korea to give up nuclear weapons. "I can't see them doing it, and I fear that my nation may change from one which has as a policy denuclearization of the peninsula to one of countering proliferation from the peninsula."

Turning to South Korea, Mr. Armitage said that the U.S. may have even more of a negative history to overcome than does Japan, going back to 1905 when then U.S. Secretary of State William Howard Taft and Prime Minister Katsura agreed, literally in the middle of the night, without notice to Korea and in complete disregard of the 1882 Treaty of Inchon, to swap U.S. recognition of Japan's sovereignty over Korea in return for Japan's recognition of U.S. rule over the Philippines and Hawaii. Korea is "already the 10th largest economy in the world," he noted. "They've got a very large military and we're going to have to have very capable and agile diplomats, both of us, to continue to manage this with good sense and with dignity."

China, with 27 years of mostly double-digit economic growth, is "playing the role of a power ready to take a larger role on the world stage, and that's all, as far as I can see, a good thing," he observed. "They're promoting people in their military and in their bureaucracies not for party purity or seniority, but for skill and ability. They've got a man in space. They're going to host the Olympics next year. They've got 150 peacekeepers in Haiti in our hemisphere."

However, "we're not happy with China's activities in Darfur or Sudan. We do think you are known by the company you keep, and that's bad company." There are questions about the transparency of the Chinese military buildup, whether it's to address a "Taiwan scenario" or issues of sea-lane access or something more; and "the real test, I think, of Chinese military activities will be if they open a port in Burma on the Andaman Sea," he remarked.

Russia can't be ignored in discussions on East Asia, given Russian geography and resources, particularly oil, "and given the aggressive diplomacy of Mr. Putin," Mr. Armitage said. Nor can the ASEAN countries, which sit "astride the most strategic position I can think of in the world, the Straits of Malacca, through which 40 percent of our trade and 50 percent of our petroleum pass." Indonesia, the world's largest Muslim nation, has like other ASEAN countries a very youthful population, with an average age of just 23. Nor India, a multi-ethnic, multi-religious, democratic country with an express look-East policy: "The relationship between India and Japan is growing apace, and it's a good thing for all of us," he declared.

"I'm often asked what do we, the U.S., want from Japan," Mr. Armitage said.

"We want from Japan a nation which sees herself as more of a global power."

"When you say that, people say, what do you mean? We're not a global power; we don't have global military reach; we don't have embassies like the U.S. does in 163 countries and whatnot."

However, "Japan sure has global reach through your great system of trading companies."

Moreover, he said, and notwithstanding that the U.S.-Japan alliance creates a "sort of big brother, little brother unequal relationship" between the two countries, the relationship between the U.S. and Japan remains "the most important in the world"--not because Japan ranks second in the world in GDP and in overseas development assistance, second in funding support for the UN, although these things are true, but "because the people of Japan, through their government, allow us to use the bases to extend our security reach in Asia unlike any other part of the globe."

"It's not fair to stand up and say what we want from Japan without saying what the U.S. has to do," Mr. Armitage stated.

The U.S. must give greater attention to the message it sends to regional forums, he said. "Hu Jintao of China went to Sydney for the APEC meeting. He went early and signed a gas deal with the Australians and stayed the full time. We went a day early, signed no deals and left early."

"And ultimately if we're going to play in Asia in the way that most Asian countries want us to and we need to, then we are going to have to be absolutely true to our national values," he concluded.

"For the past several years, since six years ago unfortunately, we have all, as Americans, been exporting something which is very foreign to us. We've been exporting anger and we've been exporting hate rather than those traditional exports of hope and enthusiasm and opportunity. The faster we get back to those traditional exports, the faster we get back to both enunciating and doing what are in our national values," the sooner "we'll be able to play the role that I believe almost every country in Asia wants of us."

Presider Tsuyoshi Sunohara of Nikkei asked:

With the Koizumi-Bush era over, there's a bit of a separation between the governments of Japan and the U.S. right now. Is there something now to bring us closer together again?

"There is a fear about the lack of "Asia experts" in the administration, and in truth, other than Deputy Secretary Negroponte there is not a great deal of Asian expertise in the political side of the house," Mr. Armitage replied. However, on the military side, the Pacific command, Chief of Naval Operations Gary Roughead, and new Joint Chiefs Chairman Michael Mullen "are all very much steeped in Asian-U.S. relations; so in a way that's going to be a bridge."

If the Democrats come in, they have strong views on trade and thus they'll view the U.S.-Japan relationship more benignly, U.S.-China less benignly, he added.

Where do you see U.S. policy on North Korea going in future?

"I don't know the answer as to whether North Korea will come off the terrorism list," Mr. Armitage responded. If news reports of possible North Korean nuclear transfers to Syria are correct, then that will slow things down, he said.

"It was Secretary Powell and I who made sure that the question of abductees couldn't just be washed away, but we didn't do it because we were in love with Japan, and we didn't do it because of great affection for the Yokota family, though I have developed affection for Mr. and Mrs. Yokota and the trauma that they've endured," he continued.

"It was because we didn't know how we could trust a nation like North Korea if they couldn't answer basic questions about basic human rights, in this case the basic rights of Japanese who were abducted." Until North Korea can have a meaningful dialogue with Japan about this, in his view, North Korea should be kept on the terror list.

Questions from the audience followed:

Could you comment on the potential role and changing role of women in Asia?

"It's clear to me that things are changing rather rapidly," Mr. Armitage replied, citing Park Geun Hye, runner-up in the Grand National Party in Seoul, along with Japan's recent Defense Minister Yuriko Koike, Indonesia's former President Megawati Sukarnoputri, and Helen Clark in New Zealand; "and then waiting in the wings are such people as Daw Suu Kyi in Burma."

"To the extent that women are more empowered, meaningfully empowered, they can be good wage earners, which delays the onset of greater problems in terms of social security" in Japan, he said. "Some of the great corporations are doing it, some better than others."

What is the U.S. role in improving relations between Japan and Korea, particularly North Korea?

"The first and most important role is not to get into the middle of the two, but to stand on the outside and try to set the circumstances that allow for comity and allow for congenial discussion," he replied.

Japan has its own issues; "Korea is in the midst of a big campaign, probably a massive change in direction; China has one thing on their mind, besides Taiwan, and that's the 2008 Olympics. So nationalism is down for a little while, and this is the time perhaps we can make a little hay, if you will, toward lowering the temperature on a more permanent basis."

***

Panelist Heizo Takenaka, former Minister of Internal Affairs and Communications and for the past year a professor at Keio University and Senior Advisor at the Japan Center for Economic Research, observed that "in 2001 when Koizumi began, we thought we had to do two general reforms," namely "reactive reforms," to clean up nonperforming bank loans--a signal success, with the bad-loan ratio now down to just 1.5 percent--and "proactive reforms," such as the privatization and breakup of the postal system.

Post-Koizumi, three economic topics remain, Mr. Takenaka said: first, increasing the economic growth rate, which is back up to about 2 percent but must be raised further, to 2.5 or 3 percent; second, conquering deflation, which persisted in fiscal 2006, with the GDP deflator at minus .07 percent; and third, addressing the government's fiscal imbalance. On the budget imbalance, "to cap spending and not increase debt was our greatest goal" and "so far those policies worked," he said, with the primary balance, the excess of expenditures over revenues (ignoring bond revenues, interest payments and debt redemption), down from ¥28 trillion to ¥8.5 trillion, without a raise in the consumption tax.

At the same time, there's risk that "the high yen will continue to accelerate," Mr. Takenaka said. "For the next couple of years, I think, many countries will increase their yen reserves," which have fallen to 3 percent worldwide versus 7 percent in 1999. And, he added, "today the U.S. lowered interest rates. The Bank of Japan will keep interest rates stable or raise them. So, the interest rate differential will have a strong potential impact on higher yen."

Moreover, he said, though economists differ on whether the shrinking weight of Japanese exports to the U.S. has brought about something of a decoupling of the Japanese economy from the American economy, his own feeling is that "Japan will continue to be very impacted by the U.S. economy," and if U.S. private consumption slows, that "is a very important factor going forward."

"In Japan, very often we often talk about the shadow of reform," Mr. Takenaka continued. This is deeply felt among the Japanese people, for example in concerns about the widening gap between rich and poor. The issues are complex: "The reason that the regional economies are doing poorly is that they haven't been able to compete in the globalization of the world economy. It's not only a result of reforms. It's the shadow of the globalization of the economy."

The LDP is about to elect Mr. Fukuda as the new prime minister, Mr. Takenaka noted. "I think in principle he will continue the path towards structural reform. But what will he do for the provinces? Will he increase our public spending or will he do something else? I think it's important that he clarifies exactly what he intends to do."

"Within the Koizumi cabinet, he was a real individual and a strong leader. At that time Mr. Fukuda's role was working underneath the very strong leader, so he was adjusting," Mr. Takenaka said. "Here he's going to be on his own and he needs to raise growth and must have a clear set of agendas that he'll use to achieve that."

Mr. Takenaka concluded, "For five and a half years we had a very unusual prime minister--Mr. Koizumi. I think that there were a lot of episodes with him, but one thing I can't forget when I was a special minister for economy we had a lot of opposition to cleaning up the nonperforming loans. Every day I got a phone call from Mr. Koizumi. You know what he said? 'Mr. Takenaka, no matter what anyone says, if you think something is right, do it. I appointed you. I support you.' He would encourage me every day. He was a very charming guy. He also would say to me every day, 'It's very important to have discussions with these hard-headed bureaucrats. You don't have to listen to them--but talk to them.'"

Glenn Hubbard of Columbia University, former Chairman of the Council of Economic Advisers, observed that in the near term, the challenge for both the U.S. and Japan is to maintain aggregate demand; in the longer term, the challenge for each is to maintain important structural reforms--"those are different, but the topics are the same"--and "to retain appreciation for our shared economic and security interests."

"In terms of the current outlook, I do not count myself among those who think the U.S. economy is headed imminently toward recession," Mr. Hubbard said, with "probably an outlook for U.S. GDP growth around 2 percent over the next year or so."

"The real wild card of course in the real economy has been housing," continued Mr. Hubbard. "I think it's fair to say, and I mean no criticism, that the Federal Reserve perhaps was a little slow to anticipate the size of the subprime problem in the real economy in the U.S. and the financial propagation from certain risky credit instruments that led to a seizing up of credit markets in the U.S. way beyond the markets for very risky debt. I'm talking about a seizing up even at the very high quality end of the credit market."

The issue for an economist, he said, is "whether we are in the period of a liquidity crunch at the moment, about which the Fed can do much, or whether we're in a capital crunch, about which the Fed could do relatively little." The answer is something that will become apparent over the next few months.

In the current outlook for Japan, "there is a question to many economists as to why this mild deflation," which persists despite the stabilization of asset prices, hasn't been more harmful to growth since 2002, he commented.

"One thought, for what it's worth: it may have increased the political ability to constrain government expenditures even though growth since 2002 has generated substantial revenue increases on the tax side."

In any event, Mr. Hubbard said he shares the concern of many economists, including Mr. Takenaka, "that the BOJ should not raise interest rates until it's clear that deflation has been meaningfully conquered."

"Much of the improvement in American economic performance in the past generation has been traced to very strong reforms," he said, not only reforms in central banking policy, but also "performance and productivity gains from deregulation, from very strong capital markets and a market for corporate control and reductions in marginal tax rates."

Mr. Hubbard added, "I raise these, because exactly as is the case in Japan, these are not manna from heaven and they are not things that we can take for granted." They are "heavily influenced both by the business climate and by politics," and "the subject of great pull and tug" in the ongoing U.S. presidential election campaign.

Corporate governance and market reforms "have proceeded apace in Japan," but "much remains to be done," he said. "I think it's fair to say that managements remain entrenched in many quarters in Japan and a stronger market for corporate control would be very much in the interest of Japanese shareholders and asset values."

"Reforms will also help strengthen I think Tokyo's role as a financial center," he commented. "At present regulation and corporate tax rates limit what might be a more natural role for such a large financial center in a very large economy."

On the regional and global stage, the rise of China has created a significant new market for both countries, particularly for Japan, with China now Japan's largest trading partner, but for U.S. businesses as well, he noted. "China has also been a source of important competitive discipline in product markets and in financial markets for both of our economies."

Yet much of China's very rapid growth "is facilitated by directed credit from financial institutions that are operating outside the normal disciplines of the marketplace. That cannot go on forever. That cannot even go on for a very long time," he said. "While China will grow rapidly over the next several years," there's a legitimate concern for both the U.S. and the Japanese economies "that the possibility of banking and financial problems in China are very real."

"That is something that the experience of both of our economies can be useful," he said. "We approach this with humility, having made mistakes ourselves on both sides of the Pacific and I think this, more so than the currency issue, is the issue to press the Chinese."

***

Naoaki Okabe of Nikkei began the Q&A:

Regarding the unseen risks of subprime loans, to what extent will this problem grab the ankle of the global economy beyond the U.S. and Europe?

It won't be known for several months, Mr. Hubbard responded, whether "consumers can finance their planned spending, and what the effect will be on businesses as a result," and whether this represents a liquidity problem or a capital problem.

If the former, commercial paper and other vehicles will come back in, but if the latter, "new capital will have to be raised and some lending curtailed."

Mr. Takenaka commented, "The securitization of housing loans that are owned all over the place--the banks have the advantage of getting rid of some risk, but who owns the debt? There's no information for authorities, and it's very difficult to know who holds what. So it's a new kind of financial uncertainty."

"Japanese financial institutions have very limited direct holdings" of subprime-related instruments, he noted, but "at this juncture, the fall in the Japanese market is larger than in the U.S. market--that's a very important point. Every stock market worldwide is related, so the fall in demand for U.S. assets results in a stronger yen, which harms Japanese exporters and the Japanese market."

Mr. Hubbard added that "no commercial bank in the U.S. is in any particular significant trouble," but two issues perhaps have been overlooked.

One is correlation, where an aggregate shock overrides idiosyncrasies of risk, as with Long Term Capital, he said. The other is liquidity, which "is just economist-speak for the word trust--and trust can evaporate very quickly when there's not much information."

"So I share Takenaka-san's concern that much better information is going to be needed on these vehicles if they're to have a life going forward."

October 18 is the 20th anniversary of Black Monday, and we're 10 years now from the Asian financial crisis--is there now a decoupling of the U.S. economy, reducing the risk of global financial crisis?

In the view of both Mr. Hubbard and Mr. Takenaka, there's no significant decoupling of this sort; "the whole world, including Japan and China, is affected by the U.S. economy, no matter what," said Mr. Takenaka.

What reforms can Mr. Fukuda implement and strengthen to solidify Japanese economic growth?

Deregulation, fundamental reforms in agriculture, adjustments in vested interests--"it's really going to take a lot of strength," especially with the upper house in non-LDP hands, said Mr. Takenaka. Tokyo University needs to be privatized and brought into the top five universities worldwide, from top 20 now. Tokyo must be a financial center. Haneda airport needs to be open 24 hours a day so people can go between Tokyo and Hong Kong in a single day.

When will there be reforms in individual tax rates and the social welfare system?

Reforms aren't adopted because they've been proven to create a more efficient economy but "because a political leader is able to tell a story," as Koizumi did, a story that says that the economy has to adapt or it will fall behind, Mr. Hubbard responded. The U.S. benefits from the high Japanese corporate tax rate--"they're the only one worse than we are, and so we need you to stay so high"; with labor hours shrinking in Japan, "Japanese growth will be more than entirely a story of productivity growth."

What is the Takenaka vision of fiscal reform?

"In the second year, in 2002 of the Koizumi cabinet we had a strategic tax reduction. I wanted to do more but I was opposed. But we offered an investment tax credit and that has contributed to today's additional cap ex in Japan," answered Mr. Takenaka.

"To keep tax burden to a minimum, keep government to a minimum," while funding the social security system and restructuring the provinces, Japan needs a "wide, shallow tax system," he said; and though it's difficult politically, for the economy's sake, Japan needs to reduce corporate taxes.

What will be the impact of the U.S. presidential election contest on the U.S.-Japan relationship?

There's concern that the American people will simply tune out, because the current campaign has been going on for so long, Mr. Hubbard said. This would be a mistake, because policy debates on the domestic economy, health care, national security and America's position in the world, "are really fundamental, and the fault lines between the two political parties are actually quite significant."

"At a grassroots level," Mr. Takenaka commented, the intellectual exchange between the U.S. and Japan "is very wide and broad. I went to a U.S. university when I was younger, and I think there are plenty of people in the room who did." However, relationships at this level have weakened, and going forward they need to be strengthened, because they're very important.

Mr. Okabe reflected that the "Japan bashing" of the 1980s was a bad period, "but we'd be more upset if we get to 'Japan-passing,' with the U.S. focus so much on China." FDI in Japan is still only 2.5 percent of GDP, and "if we don't increase that number, it will be difficult to deepen the relationship further."

Questions from the audience followed:

What will be the impact of METI's recent guidelines on ant takeover measures and the new legislation on cross-border mergers?

"Regarding various technical problems, we'll certainly be interested to see how the government grapples with them," but Japanese laws in this area aren't so different from those in the U.S. and other developed countries, said Mr. Takenaka; and he noted that Japanese M&A has increased five-fold over the last several years.

What is the risk that the new government in Japan will simply retreat from reform?

The LDP and the DP both have many young, internationally minded politicians, Mr. Takenaka commented. And when elected, politicians "have a tendency to change," Mr. Nakasone being an example. "No one expected that Koizumi would be able to implement so many reforms either. So it's very difficult to speculate," and "what sort of timing, and what kind of good decisions they'll be able to make, I think that will be key."

A rise in oil prices beyond the highs we've already seen, how much damage can that inflict on the U.S. and Japanese economies going forward?

The old rule of thumb typically "was every $10 increase in the price of crude might subtract say 3/10ths of a percentage point from American GDP growth," said Mr. Hubbard. "That rule came from a period in which most shocks were supply shocks; of course much of what we're seeing today is really just demand driven in a growing economy." International capital flows complicate the issue: with Middle Eastern economies having domestic financial systems that are fundamentally broken, their influxes of oil money are immediately sent back out to the international capital markets, "and so capital market prices aren't really reflecting the underlying state of the economy as well."

"The chances of significant increases in the price of oil from present levels strike me as not that high and dependent on specific supply shocks, given the slowdown in economic growth," he added.

Mr. Takenaka said that in Japan, despite the country's almost complete dependency on overseas oil, "the percentage of GDP represented by oil has probably not changed" since the first oil shock. "It shows how efficient Japan has become in its use of energy... Of course there's no guarantee that this will continue, and we're looking nervously of course going forward at the potential for rises in oil prices."

The U.S. made major investments in academic partnerships with India starting 40 or 50 years ago--is there a concern that Japan has been missing out on "soft power" exchanges with India, on the kind of business and financial innovations that these partnerships brought to Silicon Valley, for example?

Over the last six or seven years, visits to India by former Prime Minister Mori, by Koizumi and by Abe have focused greater attention on the intellectual exchange between Japan and India, which has indeed been very weak, Mr. Takenaka said.

"The Indian government, I think, has been rightly concerned about the lack of managerial talent as a key constraint on growth," and it's an area where the U.S., Japan and other countries can be important partners with India, Mr. Hubbard reflected.

This event was held on September 18, 2007. Event summary by Katherine Hyde.