GOPAL GARUDA, Staff Writer, Harvard International Review
Skeptics who question whether East Asia's rapid growth will continue indefinitely often cite Japan's banking crisis and prolonged recession as proof that the "Asian miracle" was inherently unsustainable. More recently, such critics have pointed to the Asian currency crisis as further evidence that the region's success was built on a weak foundation. According to these individuals, fundamental weaknesses in the Asian economies--including political corruption, flawed industrial policies, and excessive government intervention in financial decision-making--are responsible for the region's current troubles. Others, including Malaysian Prime Minister Mahathir Muhammad, take a decidedly different stance, arguing that currency speculation not rooted in fundamental weaknesses is the primary cause.
Steve Radelet and Jeffrey Sachs of Harvard's Institute of International Development argue that neither view is completely accurate. Macroeconomic imbalances such as overvalued exchange rates are certainly important factors, as are bad loans in the Korean and Indonesian banking sectors. For the most part, these imbalances are deviations from a strong foundation of growth and can be remedied by sound economic policies that include internal banking reforms and floating the exchange rate. Extreme measures, such as complete overhaul of the region's financial sector, are probably not necessary.
Although Japan was not directly involved in the currency crisis, it is clearly the dominant economic power in the region. Since other Asian countries rely on Japan's huge capital markets as a primary source of foreign investment, the growth prospects of the region will depend in part on Japan's ability to reform its banking sector without completely cutting off its investment in other Asian nations. The stability of the Japanese banking sector, in turn, will depend on Japan's ability to preserve the basic structure of the "main bank system," which has guided the financial decision-making in that country for the past half-century.
Japan's Main Bank System
For most of the postwar period, Japan's economic system worked so well that it was cited as a model for reform elsewhere. US policy experts, for example, often called for a national industrial policy similar to that implemented by the Japanese Ministry of International Trade and Industry (MITI) and other government bureaus. However, the recent banking crisis and the ongoing recession have begun to shift the balance of power in the Japanese financial market. Bank loans have traditionally been the primary source of funds for corporate expansion, but recently the largest Japanese corporations have become increasingly reliant on stock offerings and internally generated funds. As a result, the government's ability to direct corporate behavior through credit control and targeted loan approval is waning. For similar reasons, the ability of banks to control corporate behavior is also decreasing. The increasing access of Japanese firms to global capital markets, as well as the deregulation of Japanese financial markets, have allowed pension funds and insurance companies to compete with the largest Japanese banks in providing capital to firms. All of these factors indicate that significant changes in the "bank-based" Japanese financial system are likely.
At the heart of these changes is a need to reconsider the role of main bank relationships in the governance of large Japanese companies. The ties between large listed firms and their principal lenders, or main banks, are extremely close; banks sometimes have the right to appoint some officials to the boards of directors of their clients due to their significant equity holdings in the firms. These ties between banks and their client firms give the Japanese lenders both the motivation and the knowledge to improve the way the firm is managed. The bank's motivation to optimize firm performance is generated through the bank's significant equity holdings in the company, while its knowledge of the firm's performance comes from its access, as the primary lender, to the firm's accounts and records. …