Common Predicaments and Challenges both the East and the West Face

Since the U.S. subprime mortgage crisis broke out, it has affected the economy on a global scale in the synchronized fashion. Reflecting upon the root cause of the economic recession worldwide and intricacy of global economy, one gets startled by the similar patterns of predicaments and failures as well as challenges and opportunities emerged through each nation’s crisis and their dealing with it, regardless of the East and the West. One of the reasons behind it may be that the world economy is increasingly interwoven in terms of trade and financial linkage. Another reason may be that this crisis boils down to the moral and value issue beyond the obvious financial troubles.

In the case of the U.S., over-indebted consumers have plagued the U.S. economy. Their financial crisis started with loans given to people who are not qualified, then compounded by the securitization of those loans. This problem was further compounded by derivatives.

Although the major banks of East Asian countries do not have the mortgage problem with far smaller losses than their Western counterparts, they are facing the impact of the global financial debacle. In the cases of Japan and Korea, corporate borrowing was the main cause of their financial difficulties. Japan’s financial problem was derived from bad loans mainly caused by corporate borrowing skyrocketed in the 1980s. As in Japan’s case, the main cause of financial crisis in Korea stemmed from corporate borrowing, mainly heavily indebted chaebols. The financial liberalization of the 1980s had allowed the chaebols to indulge in the risky investments. Their excessive reliance on debt financing burst in 1997. China’s economy has been propelled by the Western consumption-based economy financed through credit which was in large part underwritten by China through treasury purchases. In a way, China’s wealth is built upon foreign debt.

All these countries share commonalities in their financial crisis. The credit crunch caused by excessive borrowing has generated debt-laden economic structure.

In the case of China, the biggest Chinese banks are state-owned, and their biggest enterprises are SOEs. Accordingly, China can force their banks to lend and their SOEs to borrow. Nowadays, China’s leading boom (16% of GDP) is startling.

Japan has experienced 19 years lasting deflation. Japan’s stock market has lost three-quarters of its values and their real estate prices have fell for 15 consecutive years. Although Japan employed policy initiatives such as ultra-low interest rates, monetization of its own debt, and quantitative easing, they haven’t got out of the deflationary mode. Japan has the world’s largest domestic debt for an industrialized country. Ironically, in spite of the Japanese government’s policy failure, these measures have been emulated by the U.S. and other countries in this global crisis.

Most Korean banks went technically bankrupt during the 1997 Asian crisis. In an attempt to revive the Korean banks, massive public money was injected, which made the government the largest shareholder in many commercial banks. Although the Korean economy soon recovered due to reduction in costs and their robust exports, the success of the economic reform effort focusing on financial and corporate sector restructuring was limited.

Both Japan and Korea share structural weaknesses such as cross-shareholding arrangements and bad loans. In sum, it is easy for both governments to manipulate its lending and borrowing practices. The cases of Japan and Korea show how hard it is to overhaul the financial sector and break the tie between the state and big businesses. Japan and Korea seem to be caught in the middle between a statist economy and a market-oriented one.

Both Japan and Korea have experienced difficulties of opening their economy to the full force of global capitalism, especially American-styled capitalism. Both cases have also demonstrated the difficulties of transferring from a statist economy to a market-centered one. Furthermore, both cases have shown that economic growth and development has been closely linked with broader socio-political processes.

Interestingly enough, with the implementation of TARP, quantitative easing, and so on, the U.S. seems to demonstrate many signs of transferring from a market-friendly economy to a state-led one. They should know its ramifications in the light of the two countries’ experiences.

All these economies have shown variations of crony capitalism. For starters, public-private partnership seems to permeate the markets of both worlds, the East and the West. The close-knit relationship between the state and big businesses has hindered market discipline from operating properly in the financial markets. This tight relationship has been bolstered through financial oligarchy. A former IMF economist and MIT professor, Simon Johnson urges to overcome this similar pattern of oligarchy destroying the currency and economy in pursuit of greed in both the developed and developing countries. This relationship has allowed the financial market to be easily manipulated, causing the undesirable consequences in both markets.

Previously, too big to fail mentality ruled in many aspects of Korean economy. One of the reasons why the Korean banking sector lags behind the manufacturing sector stemmed from this mentality. Their major customers were chaebols, which were never allowed to fail. Under this arrangement, the Korean banks did not have to learn advanced banking practices. Given the economic concentration of the chaebols, the state guaranteed the debts of the chaebols during the pre-crisis period. This directly led to the mounting NPLs. During the Asian financial crisis, some conglomerates such as Daewoo went under, but in most cases too big to fail mentality persisted.

This situation has been quite similar to bailouts for financials and automakers in the U.S. since the subprime mortgage crisis broke out. Their bailouts seem to operate along the similar logic: their failures would shake the foundation of their economy

The U.S. has been the world’s super power in terms of economic and military status. The U.S. consumption still drives the export-led economies of East Asia. East Asian countries have accepted U.S. treasuries as part of their bargain. The U.S.’s credit bubble deflation/implosion has put the world economy in a recession. The unwinding of the financial leverage has been ongoing. With the amount of global financial linkages in place, no country seems to be entirely free from the global recession.

It is true that the U.S. officials and diplomats have demanded other nations to open their markets up to American-styled capitalism and the benefits of free trade while they have exercised neither genuine capitalism nor free market principles. The States has pressured the exporter countries to buy their treasuries and depended on the financial-services industry too much.

Therein lies the problem of moral issue as William Black put it eloquently, “our financial problem is at the heart a moral problem.” In my view, this is not purely an economic crisis. We have abandoned the values of morality, integrity, and accountability in favor of greed and excess. This moral decline seems to be a huge component of our debacle. Unless the moral issue is resolved at the top level, a true recovery may be a long way off.

One has to take a close look at the system through which we govern in each country and the values and ideas that work for the proper operation of the system. A system that governs us should be underpinned by a basic morality. Growth at all costs mentality should be abandoned.

A state should be governed by the rule of law. Some level of regulation based on moral principles needs to be enforced to serve the interests of the majority of the population, not those of the selected few. One has to pay close attention to whose interests are most represented in the system. For instance, declining middle income households are problems in all countries. We need to have checks and balances put in the system. Toward this, the critical mass may need to be educated about how the economy works structurally and understand the macro effects of the economy.

Employment is a fundamental stitch in each country’s social fabric. Businesses are the major sources of job creation which can bring income. They can grow and prosper through innovation and production. Consequently, a sound recovery should occur through innovation and production, not through financial reengineering. It is interesting that the U.S., Japan, Korea, and China all have emphasized technology-driven economic growth although their technological capacity is at the different stage. The U.S. still holds the leading position in the basic proprietary technology area. Yet financial engineering got in the way of advancing their economy based on innovation and has become a large portion of it. It trumped the technological innovation side of economy mainly due to greed and corruption. We have to find ways to nurture innovation and boost production in the fair and balanced fashion since they are the real drive of the economy.