Global Economy
An Update of Three East Asian Economies

Jahyeong Koo and Dong Fu look at the recent economic developments in Japan, China and Korea

Countries in the same geographic region often have synchronized business cycles. However, recent developments of three East Asian economies—Japan, China and Korea—show that geographic proximity and, consequently, tight trade relation, do not necessarily result in similar business cycles. Political factors, epidemics and industrial structures have led to startlingly different growth patterns in these three countries.

Japan
The Japanese economy seems to be finally turning the corner. In the second quarter of 2003, GDP grew 1 percent quarter to quarter (annually 3.9 percent) (Chart 1), of which domestic demand contributed 0.8 percent and international trade 0.2 percent. We believe the recovery is solid. It has been mainly propelled by private nonresidential investment (4.7 percent), originating from expectations of higher profitability, and not merely by exports. In the last fiscal year (April 2002 to March 2003), the 201 listed companies in the Tokyo Exchange had, on average, a 42 percent surge in net income. Moreover, 87 percent of them expect profit growth this fiscal year.

Chart 1

Further evidence bolsters our cautious optimism. First, industrial production rose 0.5 percent in July from June, exceeding the expected 0.1 percent. Second, the long-term government bond yields rose to 1.5 percent, an 18-month high, reflecting an improved economic outlook. Third, consumers are spending more, as household savings slipped to 6.6 percent of disposable income in 2002, down from 11 percent four years earlier.

Nevertheless, Japan’s banking system still needs to be reformed into an efficient financial intermediary. The injection of base money has had no multiplying effect on the broad measure of money (Chart 2). As a result, most of the price measures are still in the realm of deflation.

Chart 2

China
China's economy keeps growing at a torrid speed despite the abrupt interruption caused by SARS. GDP was up 8.2 percent year over year in the first half of 2003. The travel industry, including hotel and air transportation has suffered the most during the SARS crisis. However, real estate, iron and steel and automobile manufacturing are all showing signs of overheating. For the first time since the 1997 Asian financial crisis, a serious power shortage appeared in the summer 2003. Deflationary pressure has eased, with CPI up 0.6 percent year over year (Chart 3).

Chart 3

Another sign of overheating is M2’s 20.8 percent growth in the first half of 2003, the highest since 1998. Furthermore, bank credit shot up 22.9 percent. However, state commercial banks are under pressure to lower their bad-debt ratios. This has led banks to dilute outstanding bad loans by issuing supposedly sound new loans on a large scale. In reality, much of the new loans are concentrated in a few hot zones, such as speculative real estate. The central bank is obviously worried about property bubbles, prompting a rise in the reserve ratio from 6 to 7 percent to curb real estate lending.

Korea
South Korea has officially entered the second recession in its modern history in 2003. (Chart 4) Triggered by domestic economic policies rather than by contagion from neighboring countries, the current recession is more serious than the first one during the Asian Crisis.

Chart 4

To support the ruling party’s candidate in the December 2002 presidential election, the government has deregulated consumer loan markets and has led credit booms since 2001. Loosening regulations on household loans and credit cards had pushed up domestic demand and caused a housing markets boom, but it only led to a bust. GDP fell in first quarter 2003, mainly due to a drop in consumption, which had been inflated artificially by the credit boom. GDP fell again in the second quarter, with worsening investment as the new government of President Roh Moo-Hyun tacitly supported labor strikes as a means of attaining “fair” income distribution. Furthermore, working hours are being reduced to 40 from 44 hours per week. As a result, business risk has jumped, thus hindering capital investment.

There is little hope for the economy to bounce back briskly as it did the last time. Economists predict Korea’s economy will grow 2.7 percent this year, less than half of the consensus average of non-Japan Asia.

Foreign Exchange Policy
Notwithstanding their different growth paths, these economies have one thing in common: foreign exchange policy. So far this year, their currencies have not appreciated against the dollar as much as they have against the euro. This was achieved by frequent and powerful interventions in the foreign exchange markets. (Chart 5) Japan’s foreign reserve increased 19 percent ($87 billion), China’s rose 24 percent ($70 billion) and Korea’s is up 12 percent ($15 billion).

Chart 5

Each country has its own reason for controlling the currency. Japan is afraid that a slowdown in exports may jeopardize the nascent recovery. China expects that accelerating imports will eventually lead to balanced trade, thus rendering adjustments unnecessary. Finally, still traumatized by the 1997–98 currency crisis, Korea is accumulating foreign reserves as much as possible. In general, the policymakers of these countries may be sharing the same sort of mercantilist view. However, it is increasingly pressing for them to consider the cost of holding such large foreign reserves.

Conclusion
The Japanese economy is surely on the mend. China will continue to grow rapidly as long as it stabilizes its financial sector. Japan and China will have a positive impact on the world economy and fill the gap caused by declining Korea, whose economy is only about 10 percent the size of Japan's and 35 percent of China's at market prices.

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