SYDNEY — The near-zero interest-rate policy pursued so doggedly by Japan’s government and central bank has created an incentive structure for corporate managers that encourages bank borrowing rather than turning to security markets for investment funds. In so doing, corporate borrowers face less pressure to meet the constant scrutiny that is demanded in more fluid capital markets.
At present, Japanese bank loans amount to nearly 150 percent of GDP. As in much of the rest of East Asia, this dwarfs the value of funds in its bond market, which has a value of only about 75 percent of its GDP. Conversely, the value of U.S. bonds equals nearly 110 percent of GDP, while bank loans to finance businesses amount to only about 50 percent.
Governments in emerging economies that wish to direct development know that bank lending is more sensitive to political pressures. When politicians and technocrats support a particular project, bankers see less need for risk assessment because their governments can shift the burden of losses onto taxpayers.
Constant trading and re-evaluation of the terms of bonds result in more efficient pricing of capital than does bank lending because buyers of bonds demand full disclosure of pertinent information. Borrowers that do not or cannot supply such data will be obliged to pay a risk premium.
The absence of fully developed debt markets helped to deepen East Asia’s crises because of the limitation on choices for investors. Now there is particular concern that foreign funds might go into portfolio investment and withdraw at the first whiff of a downturn. But this is precisely because of the policy-induced restrictions on alternatives.
This is evident in a key feature of the Japanese system that involved cross-shareholding between companies and banks. In 1991, it was estimated that Japanese corporations held 70 percent of stock listings on the Tokyo Stock Exchange, and these issues were rarely traded. Such thin markets of the traded shares were thus highly susceptible to volatility. Infusions or departure of relatively small amounts of foreign funds could cause substantial gyrations in such a market. But it also gave principal shareholders the ability to ramp the market value of their stocks.
In the past, subsidized interest rates allowed Japan’s conglomerates, like those in South Korea, to repudiate short-term profitability and focus on market share. At the same time, political arrangements created an illusion of no risks while constraining competition. Rapid growth in market share seemed to promise profits in some distant future. This induced corporations to invest in wildly different and divergent industries where competence in one activity had no relationship to the other, such as noodles and nuclear power.
Once there is stabilization of the region’s economies, recovery must await more efficient bond markets so that capital can be priced more accurately to meet the enormous infrastructure investments while offsetting heavy losses in the banking sector.
The performance of U.S. economy provides lessons that other countries might wish to consider. There are many reasons for the boom in the U.S. economy. Among these are greater flexibility in corporate restructuring, a high tolerance for immigration and an appetite for risk-taking that encourages entrepreneural initiatives that have generated and supported new technologies.
However, the most important factor behind continued high growth is the increased efficiency of U.S. capital markets. Of crucial importance has been the ability of small companies to have access to startup capital to enable them to undertake dynamic growth strategies. Initial public offerings by U.S. companies have generated over $350 billion since 1989.
Increased capital market efficiency of the United States has allowed growth to continue despite a decline in domestic personal savings, now at its lowest level since the beginning of the 1930s. This is because funds are drawn from economies with less efficient markets given the level of risk.
Those countries that lack a vibrant and active stock market will become increasingly disadvantaged relative to those whose financial infrastructure encourages rapid responses to economic change. A low ratio of stock-market capitalization to bank assets will increasingly become an obstacle to economic growth.
Although global stock-market capitalization has expanded to nearly $35 trillion (an amount exceeding International Monetary Fund estimates of global GDP of $30 trillion), 47 percent is in the U.S. Europe has only about 20 percent while emerging market economies hold only 8 percent. Japan’s ratio of stock-market capitalization to bank assets is small in comparison with the U.S. or the Nordic countries.
Countries with modern domestic-capital markets and large stock-market capitalizations promote private retirement savings through tax-deferred pension plans or by offering significant tax concessions for capital gains. This has led to growth of pension and mutual funds that have encouraged debt and equity securitization. Consequently, corporations have been able to abandon their heavy traditional reliance on bank lending. Along with this change is a decrease in the practice of cross-shareholdings with banks and insurance companies.
Japan, like many other countries suffering from slowdowns, should move toward encouraging the development of its domestic capital markets. While sorting out the messes in the banking sectors is necessary to restore liquidity, banks should no longer be at the center of economic development strategies.
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