Hiroshi Nakaso: Asian economy - past, present and future
Keynote address by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the
Securities Analysts Association of Japan International Seminar, Tokyo, 24 April 2015.
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Accompanying charts can be found at the end of the speech.
Introduction
It is a great honor for me to speak here at the International Seminar hosted by the Securities
Analysts Association of Japan.
Today's seminar is titled "Asset Management in Asia: Opportunities and Future
Development." The participants here today are all engaged in financial markets business,
whether directly or indirectly, and your involvement has contributed to the development of
financial markets in Japan and other Asian economies. Your continued involvement in
financial markets, whether directly or indirectly, has helped build the foundations for the
success of the financial markets. As I will elaborate later, we, the Bank of Japan, have also
been actively making efforts to develop Asian financial markets, through bilateral and
multilateral cooperative initiatives with other Asian economies.
Today, under the title "Asian Economy: Past, Present, and Future," I will first look back at the
growth of the Asian economy and its driving forces, and then share my views on the
challenges ahead for the sustainable growth of the Asian economy.
I. Growth of the Asian economy: Past, present, and future
Asian economic growth in historical context
Let us turn back the clock and reflect on the history of Asian economic growth.
It may come as some surprise to learn that, based on studies by the renowned economic
historian, Professor Angus Maddison, the Asian economy accounted for nearly 60 percent of
the global GDP before the Industrial Revolution which began in the late 18th century
(Chart 1). However, as the Western economies have enjoyed much higher growth since
then, the share of the Asian economies has followed a downward path from that high of
60 percent, to as low as just over 10 percent by the early 1950s.
The Asian economy did not sink without trace, though. A period of strong economic
expansion known as the "Asian Miracle" ensued, characterized by a "flying geese" pattern of
development. This began in the 1960s, with high growth in Japan followed by take-off of the
"Four Tigers," Hong Kong, Korea, Singapore, and Taiwan. In the early 1980s, Malaysia and
Thailand joined these five to enjoy the high growth path. China gained momentum in the
1980s, and started to record double-digit growth after joining the World Trade Organization in
the early 2000s, which made China a driving force of the Asian economy.
Of course, during the history of Asian growth over half a century, the road to success was not
always smooth. Many of you will recall the 1997 Asian Currency Crisis, which followed a
period of high growth in the mid-1990s. Despite the unprecedented impact of the crisis, the
regional economy proved its strength and resilience, with its foundations firmly rooted in a
strong manufacturing base, as many Asian economies soon regained the prosperous
exportled recovery trail. Another more recent illustration of this resilience is the Lehman Shock and
the subsequent global financial crisis. After the crisis, the Asian economy continued to follow
a relatively high growth path.
The resilience and robustness of the Asian economy and its markets was also evident in the
aftermath of the so-called taper tantrum in May 2013. The stability of financial markets in
emerging economies in general was eroded, but Asian stock and foreign exchange markets
remained relatively immune (Chart 2). Returning to the share in global GDP, the Asian
economy today has recovered its share to over 30 percent, and is expected to continue
contributing to the sustainable growth of the global economy.
Mechanism of economic growth in Asia
What then makes the Asian economy so strong and resilient? To this end, I want to elaborate
on two mechanisms or the dual engines which have driven the Asian economy.
The first mechanism is Asia's position as "the factory of the world," a position achieved
through continued expansion of exports driven by direct investment from abroad. Global
trade volumes increased dramatically with trade liberalization and direct investment growth.
Firms in advanced economies proactively engaged in strategic global allocation of production
sites in order to ensure the most efficient means of production. In this way, these firms could
not only cushion the effects of higher wages and saturated demand for goods in advanced
economies, but also reap the benefits of growing demand in emerging economies. Significant
advances in information technologies and inventory management have also contributed to
these movements.
It is only natural that Asia became identified as an attractive candidate in this process, given
its abundant low-cost and highly-skilled labor force and large potential for future growth.
Global firms increasingly moved their production sites to Asia, and traded components and
finished goods with their home or third countries, thus making their supply chains more
global. Asia, as a hub of such trade networks, enjoyed employment opportunities created by
the entry of foreign firms and exports increased significantly. At the same time, adoption of
advances in production technology and resource management enhanced competitiveness,
along with the accumulation of human resources.
The second mechanism that I want to highlight is the autonomous growth in domestic
demand spurred by the development of export industries. As export industries grew, a large
proportion of the labor force moved from the rural agricultural sector to take up employment
in urban factory sites. As income level rose with economic expansion, the number of
middleincome households gradually increased, which underpinned the strong growth in
consumption. As a result, the ground was laid for an autonomous expansion of domestic
demand, which, along with exports, underlined Asian economic growth. As evidenced in the
recent increase in direct investment in the non-manufacturing sector, Asia is now recognized
not only as "the factory of the world," but is also gaining prominence as the world's biggest
"consumer base."
Middle-income trap
The question here is whether Asia can maintain its position as the world growth center in the
future. According to long-term forecasts by international organizations and private-sector
economists, Asia is expected to continue to enjoy relatively high growth and thus its share in
the global GDP will increase steadily.
These forecasts depend largely on the implicit assumption that Asia will maintain its growth
momentum without falling into the "middle income trap." The so-called follower group
economies can move from low-income to middle-income status by continuing on the road to
high growth, leveraging their abundant resources and importing technology. This
catch-upstyle growth will be short-lived though, unless it is underpinned by the gradual sophistication
of the industrial structure. History shows that many economies have faced difficulties in
advancing beyond the status of a middle-income economy. This is known as the
"middleincome trap." A low-income economy can strengthen export competitiveness in the process
of reaching middle-income status by using the abundant inflow of human resources from the
rural agricultural sector, which puts downward pressure on wages. However, wages tend to
rise after passing what is called "the Lewisian Turning Point" in development economics. This
in turn reduces corporate profits and weakens export competitiveness, which together lead to
sluggish economic growth.
Several Asian economies have taken the world by surprise by achieving the "miracle" of
actually escaping the shackles of the middle-income trap (Chart 3). Japan reached the
Lewisian Turning Point in the 1960s, but then marked the "Izanagi" boom years from the
mid1960s to the early 1970s, growing by more than 10 percent year-on-year. The "Four Tigers"
have also continued on a growth path after escaping from the middle-income trap. In these
economies, there were many factors at play. On the supply-side, abundant investment in
plant and equipment led to higher productivity in manufacturing and other sectors together
with higher capital equipment ratios. On the demand-side, the investment in plant and
equipment translated into an increase in demand, and higher competitiveness through higher
productivity led to a sustained expansion of exports. The population shift from rural
agricultural areas to urban areas created a sizable middle-income tier, heralding an increase
in consumption.
II. Challenges for the Asian economy: Expanding productivity
So, how can Asia as a whole continue to enjoy prosperity while ensuring that those Asian
economies still in the early stages of growth continue to progress without falling into the
middle-income trap? I will focus on three issues that need to be addressed or the
"challenges" facing Asian economies.
The first challenge is to ensure a continuous increase in productivity. In particular, there are a
number of issues to be addressed if we are to strengthen the traditional Asian growth model
based on a combination of both exports and domestic demand.
Staying competitive in the changing global environment
In order to remain competitive and further develop export industries, Asian economies need
to keep on adapting to changes in the global competition environment.
The global trade volume has been rather depressed of late compared with global economic
growth. The concept of "slow trade" is now being actively debated among economists
(Chart 4). This "slow trade" phenomenon can be explained in part by the cyclical factor that
investment in plant and equipment, which has a greater tendency to induce imports, is lower
than in the past. At the same time, a more structural factor can also be identified. The
expansion of global supply chains, which has underpinned Asian growth for some time, has
reached its maturity stage, thus contributing to the "slow trade" phenomenon.
One prominent example of these structural changes can be observed in China, which has
been playing a major role as the assembly and export center in global supply chains within
Asia. The growth in exports to China from other Asian economies has been depressed as
China, by increasingly using domestically produced parts, has become less dependent on
imports. Additionally, this year will almost certainly become an epoch-making year for China
when outward direct investment exceeds inward direct investment for the first time. Further
expansion of production base by Chinese firms to neighboring economies is stimulating the
reconstruction of supply chain networks. These developments represent a significant
environmental change for Asian firms.
In addition, there has been progress toward greater integration within the region in the form
of the ASEAN Economic Community (AEC). Such integration will stimulate intraregional
trade as barriers to the free movement of goods and services are removed. It will also
change the flow of goods and capital, and lead to increased competition.
What is required to overcome the challenges posed by such changes in the economic
environment? From the experiences of those economies and regions that have already
overcome the middle-income trap, it is crucial not to cling to past success, but to concentrate
on adapting to the changing environment with an eye to the future direction of changes, and
to keep on pushing into new frontiers. The value of investing in areas such as research and
development should not be underestimated; the strategic development and advancement of
the industrial structure depends upon such investment (Chart 5). If an industrial sector with
competitive advantage is developed, this will translate into increased strength in the export
business.
Nurturing the service sector and urbanization
Turning our attention toward the issue of domestic demand, it is clear that the key to
offsetting the saturation of demand for manufactured goods is to nurture the service sector
and raise its productivity. The service sector is often labor-intensive, and as a consequence,
tends to yield lower productivity compared to manufacturing industry. For this reason, the
Asian economies should be mindful to maintain a high level of productivity in the overall
economy when they shift toward a service economy, by providing high value-added products
with the active implementation of innovations such as in information technology.
Urbanization will play an important role in this regard. China and other Asian economies
have been promoting urbanization as one of their policy targets (Chart 6). Concentration of
the population to cities, with a larger middle-income population, will lead to greater demand
for high value-added products and services.
Increasing investment in infrastructure
Increased investment in infrastructure is likewise vital to stimulating both exports and
domestic demand. However, there are still some Asian economies where insufficient
infrastructure is bottlenecking industrial advancement (Chart 7). For example, a stable supply
of electricity is a prerequisite to persuading manufacturing firms to move their production
sites. Shipping ports and roads are indispensable in order to expand exports. Supplying
sufficient residential infrastructure such as housing, schools, and proper water and sewage
systems is crucial to promoting urbanization.
According to a report by the Asian Development Bank (ADB), the Asian economy is expected
to invest the phenomenal sum of nearly 8 trillion US dollars in the 11 years from 2010, in
infrastructure such as power supply and roads. Infrastructure investment is a stimulus not
only for domestic demand, but would also attract investment by foreign firms that can provide
sophisticated technological expertise, which would in turn contribute to boosting productivity.
III. Challenges for the Asian economy: Adapting to changes in demographics
The second challenge facing the Asian economy is to embrace changes in demographics.
Asia is composed of a diversity of economies, and the patterns in demographics are also
diverse (Chart 8). For instance, while India has some time to enjoy the benefits of the
demographic bonus, the "Four Tigers," China and Thailand are already facing an aging
population and declining birth rate. It is worth mentioning that China and Thailand will be
going from demographic bonus to demographic onus while they are still in the middle-income
tier. Finding the appropriate response to these changes in demographics and sustaining
growth poses a major challenge to the Asian economy.
We could draw lessons from the experience of Japan. One of those lessons is that
demographic onus depresses economic growth through both the supply-side and
demandside factors. On the supply-side, it is widely recognized that labor constraints put downward
pressure on the potential growth rate. There is empirical evidence to support this observation
in the case of Japan where, since the 2000s, the labor force has been shrinking, household
savings have declined, and the pace of growth in capital accumulation has slowed.
On the other hand, the demand-side factors are not so obvious, and they tend to be
overlooked. In the case of Japan, the aging population and declining birth rate have, for
example, induced higher demand for goods and services targeting the elderly, but not all of
this potential demand has been exploited because firms have not necessarily succeeded in
identifying and responding to such changes. As to social security systems, severe fiscal
conditions in pension and medical insurance systems has been interpreted as heralding
potential future increases in payments, which would lead to suppressed consumption.
So, with an eye to these potentially serious negative effects of the demographic onus, it
would be wise to recognize and assess these effects without delay, and to take action to
alleviate them in a forward looking manner.
On the supply-side, labor participation of women and the elderly will need to be increased in
order to address the decline in the working population. In general, the participation rate of
women and the elderly tends to be lower in Asia than in advanced western economies. There
is an urgent need to establish a working environment that is receptive to women and elderly
workers, so as to make the most of their potential contribution. On the demand-side, firms
need to step up efforts to identify and exploit the potential demand of the elderly, adjusting
their product lines to cater to targeted needs in areas such as travel, nursing care, and
userfriendly electronic appliances.
IV. The challenges for the Asian economy: Enhancement of resilience
Capital flows and the Asian economy
The third challenge is how to make the Asian economy more resilient to global shocks.
Asia has successfully maintained its high economic performance so far by attracting and
effectively utilizing the capital flowing into the region. The capital inflow first came primarily in
the form of direct investment, which helped establish Asia's position as "the factory of the
world." Later, portfolio investments joined the capital inflows, resulting in more volatility in
capital flow in and out of Asia, which then developed into the Asian Currency Crisis of the
late 1990s.
This experience prompted Asian economies to review their policy frameworks flexibly so as
to become more resilient to global shocks. For instance, in terms of foreign exchange policy,
the de facto fixed exchange system pegged to the US dollar was replaced by a more flexible
system. Foreign reserves were accumulated at a rapid pace. To make financial systems
more resilient, Asian economies adopted macroprudential policies well in advance of other
regions. On the financial market front, policy initiatives have been introduced to encourage
the development of local currency bond markets. These efforts combined have led to a
strengthening of Asian markets, as proven by the fact that Asian markets were not as
seriously affected by the negative effects of the global financial crisis that followed the
Lehman Shock.
However, we should also recognize the fact that capital flows to and from Asia will inevitably
become more volatile as the Asian financial markets become more integrated into global
financial markets with the irreversible progress of globalization. With this in mind, a major
challenge facing the Asian economy is to further strengthen its resiliency against global
shocks, and I want to share three ways through which this might be achieved.
Making use of the region's abundant savings
The first way is to further promote financial intermediation mechanisms which enable
effective use of the abundant savings in Asia. Traditionally, Asian economies have relied
mainly on the banking sector for financial intermediary services, and this may have been at
the expense of development of the capital markets. Against this background, the abundant
savings in Asia have not been utilized within the region, but have flowed out to the advanced
economies, only to return to Asia as capital flows from advanced economies. In this process
of global capital recycling, even small changes in the risk appetite of global investors have
caused the rewinding of capital inflows, and that has had a disproportionately large impact on
relatively small emerging markets.
In order to resolve this issue, it is essential to work simultaneously on strengthening the
banking intermediary channel and nurturing alternative financial intermediation channels. In
particular, each economy should continue to focus on promoting the development of its local
currency bond market, so as to ensure a more diverse range of investment choices into
which Asian domestic savings can flow.
In this regard, bond markets in Asia have grown significantly since the mid-2000s (Chart 9).
This is largely thanks to the invaluable efforts of market participants like the audience today
to make the market environment more conducive, including making improvements in soft
infrastructure such as enhanced disclosure by Asian firms and standardization of accounting
systems. Looking at data by currency, the share of foreign currency-denominated bonds has
declined overall. A look at the most recent data, however, paints a somewhat contradictory
picture of this trend, with a small increase in foreign currency-denominated bonds as funding
costs have declined against the background of unconventional easing policies in advanced
economies. Due attention should be paid to the influence that the imminent normalization of
the monetary policies in the United States might have on the debt servicing capacity of Asian
firms.
Regional integration and pickup in cross-border trade
The second way to boost resilience to global shocks is to accelerate regional financial
integration, which has been lagging behind the integration of trade and other real economic
activity. Together, these efforts are expected to encourage more activity in the flow of funds,
with a pick-up in cross-border transactions, both inter-regional and intra-regional.
Overdependence on capital from outside the region would expose Asia to sudden withdrawal of
credit provision and sharp unwinding of capital triggered by shocks not directly related to the
region. Expansion of intra-regional cross-border transactions would broaden and deepen the
investor base, contributing to higher resilience of Asian markets.
The financial markets in Asian economies are in various stages of development. This poses
a serious impediment to regional integration, unlike in Europe, which stands as a forerunner
case in regional integration. Even so, it is not farfetched to expect a surge of activity in terms
of cross-border transactions, once market practices and the relevant laws and regulations
are further harmonized.
In this connection, one topic which needs to be duly considered alongside the promotion of
cross-border trades is payment and settlement systems. Central banks, including the Bank of
Japan, are making joint efforts to ensure and enhance smooth cross-border settlements. As
part of these efforts, there is ongoing discussion among the ASEAN economies, Japan,
China, and Korea to establish cross-border linkage between the securities settlement
systems and central banks' payment systems. This would most likely stimulate an increase in
capital transactions within the region, as intra-regional cross-border payments and
settlements will become safer and more efficient. Once this initiative is established, for
instance, Japanese banks would be able to smoothly and effectively obtain funds in Asian
currencies on a Delivery Versus Payment (DVP) basis against Japanese Government
Securities (JGSs) collateral (Chart 10).
Strengthening the regional safety nets
The third way to ensure resilience is to strengthen the regional safety nets. It is especially
important to prevent spillover and contagion triggered by a temporary liquidity shortage in
terms of the balance of payments or funding by financial institutions.
Bilateral swap agreements have already been established among the economies in the
region to deal with any liquidity crisis related to balance of payments. Furthermore, the
economies of ASEAN, Japan, China, and Korea have agreed on the expansion and
strengthening of the Chiang-Mai Initiatives, which help finance short-term US dollar liquidity
among participating economies (Chart 11).
Preventing liquidity crises among financial institutions is another important task for central
banks. The Lehman Shock and the ensuing global financial crisis reminded central banks
around the world of the importance of fostering a sound financial system with a resilient
funding environment for financial institutions and deep and liquid interbank markets. We have
also observed that banks have been increasingly expanding their presence in other
economies in the region. This is one of the reasons why Asian central banks are
progressively making efforts to enhance environments for the funding of local currencies.
The Bank of Japan has already agreed to establish cross-border collateral arrangements
with many Asian central banks (Chart 12). These are arrangements in which, for instance,
Asian central banks provide local currency liquidity to Japanese financial institutions against
yen-denominated assets as collateral, in a situation where the Japanese financial institutions
encounter funding difficulties in the Asian currencies. The Bank of Japan has agreed to
establish such arrangements as a backstop with central banks in Thailand, Indonesia, and
Singapore. In February 2015, the Bank of Japan and Bangko Sentral ng Pilipinas (BSP)
agreed to establish a cross-border liquidity arrangement where Philippine pesos are provided
against yen cash.
In establishing and managing regional safety nets, authorities in the region should recognize
and acknowledge the policy issues that each country faces, and be prepared to cooperate in
addressing any sudden and serious changes in international financial markets. From this
perspective, the Bank of Japan, in cooperation with other central banks in Asia, has been
contributing proactively to the Executives' Meeting of East Asia-Pacific Central Banks
(EMEAP).
Concluding remarks
I have talked briefly today about the history of Asian economic growth, and I have highlighted
three challenges ahead. These challenges will test whether the Asian economy will be able
to realize a sustainable growth path. I believe that Asia has high potential to overcome these
challenges, and, we should be able to celebrate the 21st century as the "Asian Century."
Another important question is how Japan can contribute to sustainable growth in the region,
as well as enjoying the benefits of this growth. I would like to add a few words on this issue.
As Asia becomes more than just "the factory of the world," but also a globally important
market, many changes are being observed in the demand structure in the Asian economy,
such as rising demand for goods in local markets and the shift towards a service economy. If
Japan is to enjoy the full benefits of the region's growth, it needs to adapt appropriately to
such changes. Japanese firms have nurtured strong product lines and business expertise
within a competitive domestic business environment. In order to cultivate local demand, I
think it would be very effective to take advantage of such high-quality products and expertise
with due consideration to the local cultures and customs of each economy. For Japanese
financial institutions, it is essential to focus not only on efforts to support Japanese firms
operating in Asian countries, but also to contribute to local economic development by
supporting local business firms. These efforts are already underway.
Japan has already experienced many of the challenges that other Asian economies will be
facing in the near future, such as environmental and energy issues. We could say Japan is
"in the vanguard of addressing global issues." Japan can use this front-runner advantage as
a business opportunity in providing skills and expertise in these areas, and through this, can
contribute to underpinning sustainable growth in the region.
The Bank of Japan, for its part, has been pursuing aggressive monetary easing, or
quantitative and qualitative easing (QQE), with the aim of achieving a price stability target of
2 percent. Leading Japan's economy out of persistent deflation and putting it on a solid
recovery path should also contribute to upholding the sustainable economic growth of the
Asian economy. I would like to conclude my remarks by adding that the Bank of Japan is
determined to play an active role in enhancing the financial infrastructure in Asia, through
such means as refining payment and settlement systems and strengthening safety nets.
Thank you.
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