Abenomics and Asia

Lee Jong-Wha

08 April 2013
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SEOULJapanese Prime Minister Shinzo Abe’s economic agenda – dubbed “Abenomics” – seems to be working for his country.
Expansionary monetary policy is expected to inject liquidity into the Japanese economy until inflation hits the Bank of Japan’s 2% target, while expansionary fiscal policy is expected to continue until economic recovery takes hold.
As a result, consumer and investor confidence is returning. The Japanese stock market has soared more than 40% since November of last year, when it became clear that Abe would form the next government, and exports and growth are also picking up. With a large output gap and low inflationary pressure, expansionary policies show great potential for reviving economic activity.
But other countries – including neighboring Asian economiesfear that Japan is devaluing the yen to bolster exports and growth at their expense. Some have accused Japan of fueling a globalcurrency war.” Anticipation of aggressive monetary expansion has sharply weakened the yen, which has fallen by almost 20% against the dollar in just over four months.
Of course, Japan’s escape from its 15-year deflationary trap and two decades of economic stagnation would be good for the world. Japan remains the world’s third-largest economy, the fourth-largest trader, and the third-largest export market for neighboring China and South Korea, which thus stand to benefit if “Abenomicsrevitalizes Japanese domestic demand. More broadly, given Europe’s slide into recession and only a slow rise in world trade volume, renewed growth and stronger import demand in Japan would support global recovery.
The question now is whether Abenomics can achieve its goals without destabilizing the world economy, especially neighboring Asian economies. Doing so requires Japanese policymakers to focus on more sustainable growth while averting a vicious cycle of competitive devaluation and protectionism with Japan’s trade partners. In particular, expansionary monetary and fiscal policies – which are helpful in the short termmust be accompanied by fundamental structural reforms.
Japan’s deflation and economic stagnation over the last two decades stemmed largely from a dysfunctional financial system and a lack of private demand. The collapse of asset bubbles in the 1990’s left Japan’s financial system and private sector saddled with a huge debt overhang.
Recovery began only after the balance-sheet weaknesses in the financial, household, and corporate sectors were addressed. Sustainable growth requires sustained private-sector demand.
Monetary easing and fiscal stimulus, combined with structural measures to restore private firms to financial health, would stimulate household expenditure and business investment. Indeed, the impact of real exchange-rate depreciation on growth is likely to be short-lived unless increased corporate profits in the export sector lead to higher household consumption and investment. And yet risks to financial and fiscal stability could arise if higher inflation and currency depreciation were to spoil investors’ appetite for Japanese government bonds, thereby pushing up nominal interest rates.
That is why the success of “Abenomics hinges not on the short-term stimulus provided by aggressive monetary expansion and fiscal policies, but on a program of structural reform that increases competition and innovation, and that combats the adverse effects of an aging population.
Japan, of course, is not alone in using exchange-rate policies to keep exports competitive. Many emerging economies’ authorities intervene in currency markets to prevent exchange-rate appreciation and a loss of export competitiveness. But if Japan starts to intervene directly in global currency markets to ensure a weaker yen, neighboring competitors will respond in kind. The danger of a currency war and protectionism should not be underestimated.
In South Korea, the government and business leaders worry that a stronger won, which recently rose to its highest level against the yen since August 2011, will hurt key export sectors, including automobiles, machinery, and electronics. One report by a Korean research institute shows that the Korean economy will slip into recession if the yen-dollar exchange rate nears 118, its average level back in 2007.
Moreover, unlimited quantitative easing by the Bank of Japan, the Federal Reserve, and the European Central Bank also increases the risk of volatile capital flows and asset bubbles in Asian emerging economies. Chinese policymakers have raised serious concerns about the growing risks of inflation and property bubbles.
This delicate situation could escalate into further currency intervention, trade protectionism, and capital controls. Beggar-thy-neighbor policies could lower total trade volume – a zero-sum game from which no one would benefit. After all, Japanese exports rely on emerging and developing markets, with East Asia alone accounting for nearly half of Japan’s foreign sales.
The regional economy would benefit from closer coordination of exchange-rate and monetary policies. Mechanisms like the G-20 and ASEAN+3 (ASEAN, with China, Japan, and South Korea) should be used more actively for policy dialogue and surveillance. East Asian economies could then, over time, cooperate to enhance regional exchange-rate stability, thereby creating a more conducive environment for intra-regional trade.
Japan’s economy is moving at last, which bodes well for Asia and the world. But, despite its new vigor, the benefits of recovery could prove to be short-lived unless a sustainable and cooperative growth path is found.
Lee Jong-Wha, a senior adviser to the president of South Korea and Professor of Economics at Korea University, was Chief Economist and Head of the Office of Regional Economic Integration at the Asian Development Bank. His most recent book, edited with Robert Barro, is Costs and Benefits of Economic Integration in Asia.

April 7, 2013 10:31 pm
Companies: Up in arms
Investors are eager to maintain the momentum from last year’s spring revolt and keep the lid on executive packages
Martin Blessing, Commerzbank AG CEO, and a shareholder wearing a protest shirt©Getty

In January last year a handful of shareholders, representing some of the most powerful investment groups in the City of London, met Vince Cable, the business secretary, to discuss ways to restrain the excessive pay of some of Britain’s bosses. More than a year later, shareholders who were at that meeting say it was a catalyst for the City’s 2012 spring pay rebellion that led to deep-rooted changes in the way companies set executive salariesnot just in London but across the globe.

In Britain, executives will face a binding shareholder vote on pay that comes into force in October. There will also be stricter rules on the presentation of remuneration reports, which should set out an executive’s performance targets for bonuses and stipulate an individual’s overall pay.

The pay debate has intensified since, with the EU proposing curbs on the bonuses of bankers and asset managers while a referendum in Switzerland last month backed radical proposals to limit executive earnings. In France there are plans to increase shareholder rights over pay and restrict pension deals. Even in the US, where there has traditionally been more tolerance of high salaries, there are signs of more restraint as shareholder activism has increased.

Earnings of chief executives v full-time employees

G037X, executive saleries

Yet attention remains focused on the City, where the pay debate first kicked off and another spring season of shareholder votes is about to start in earnest. Observers are looking for signs of whether government reforms and a new mood of restraint among company bosses will lead to a lasting cultural change, with pay more closely aligned with performance.
Peter Montagnon, senior investment adviser at the Financial Reporting Council, the UK regulator that oversees shareholder engagement, says: “Last year was a stage on a journey. There is more dialogue between companies and investors and more shareholder activity. This has helped to produce more sensible pay policies.”
Keith Skeoch, chief executive of Standard Life Investments, one of the UK’s biggest asset management groups, adds: “Last year’s so-called shareholder spring is an unfortunate phrase. It gives the impression that it was some kind of Arab spring, which involved dramatic changes. But it was not like that. This is not a revolution. It is evolution. We are gradually moving forward.”
Investors argue that changes have been taking shape since the financial crisis in 2007, when falling stocks and the economic slowdown jolted shareholders out of their complacency. In hard times, shareholders were no longer prepared to accept big pay increases that were often not linked to strong performance.
The head of corporate governance at a UK asset management group says: “Stocks and performance went down yet pay was going up. As investors, we were losing money as our shares dropped yet company bosses were not losing money in their pay. That wasn’t acceptable.”
The investor was at the January meeting with Mr Cable, held in the minister’s office near the Houses of Parliament. “There wasn’t a eureka moment at the meeting,” he says. “But views did harden that we, as shareholders, had to take a tougher stand against [excessive] pay and vote against egregious rewards. If we hadn’t, there was a sense the government might have come up with more draconian measures beyond a binding vote on pay that would limit not just the salaries of chief executives but possibly our own.”
Investors generally do not balk at multimillion-pound salaries but the boss must perform. This is something chief executives are increasingly aware of and explains a shift in pay towards bigger bonuses and long-term incentives through shares at the expense of the fixed part of the salary.
The chief executive of one FTSE 100 company, who earned more than £2m last year, says: “I am up at 6am and I work a 12-hour day. Can I justify my pay? Yes I can. But more than half my salary came from shares in the company that vested. I have skin in the game. When the company does well, my salary does well. Performance is paramount. It is harder now for executives to earn large amounts if they do not produce.”
He says there should be restraint and, like other executives, has come under pressure from shareholders to justify his salary. From evidence this year, this pressure to rein in excesses appears to be working. Consultants Towers Watson say that of the 35 FTSE 100 chief executives who have disclosed their salaries for 2013, 11 have had their pay frozen and the median increase was 2.5 per cent, below the rate of inflation.
Robert Hingley, investment director at the Association of British Insurers, which represents shareholders holding a fifth of the UK stock market, says: “We are hoping for a relatively quiet pay season and, genuinely, that seems to be happening. So far the indications are that most companies are exercising restraint.”
Tom Gosling, head of the reward practice at PwC, the professional services firm, adds: “I think the message of restraint has hit home. We are unlikely to see the same level of shareholder rebellion as last year.”
Investors say it is difficult to assess which companies will face rebellions this year, although there are rumblings at groups where there was dissent in 2012. These include WPP, the advertising group, where Sir Martin Sorrell, the chief executive, suffered the biggest pay defeat of the year among FTSE 100 bosses, Tullow Oil, the explorer, SABMiller, the brewer, and Resolution, the insurer. However, all these groups insist they are working closely with investors to insure there is not a repeat of the protests.
It is also significant that banks are no longer a focus for dissent as they were last year. Although there are still concerns about the banks, pay has been curbed. The chief executives of Barclays, HSBC, Lloyds Banking Group and Standard Chartered face pay freezes in 2013.
. . .
A year on from last spring’s rebellions, investors and executives say one of the biggest worries is the dominance of remuneration in company discussions. This overshadows other important areas such as company strategy, succession planning and the quality of management and auditing.
The chairman of one FTSE 100 company says: “We spend too much time on remuneration. It was only natural in a way as it is very important to get pay right, but it is just one part of governance. Pay is dominant because that is what politicians and the public are interested in. Auditing doesn’t capture the imagination.”
The spread of the pay debate to Europe, where Brussels wants restrictions on bonuses of bankers and asset managers, has also alarmed some big investors. “The pay debate started in London last year because it is the main financial centre, and the debate was a sensible one,” says the head of equity at one of Europe’s biggest asset managers. “But the reforms Europe wants will have negative consequences.”
He says Brussels’s plans to restrict the ratio of fixed salary to bonuses for bankers and asset managers to 2 to 1 will lead to job losses as costs will rise. This is because a limit on bonuses will lead to higher fixed salaries that cannot be cut in a downturn, meaning jobs will be lost instead.
However, some policy makers on the continent disagree as momentum behind pay reforms builds. In France, there are plans to ban golden goodbyes while the Swiss supported a binding shareholder vote on pay, similar to the UK moves. Angela Merkel, the German chancellor, also wants tighter regulations on executive pay.
Elsewhere, the debate has been at a lower key. In the US, companies have not come under the same pressure as in Europe. A survey of 2,215 companies in the US carried out by Semler Brossy Consulting Group found that only 57, or 2.5 per cent, failed to receive majority support on pay.
Aspiration to make big bucks is part of the American dream. In Britain and Europe, there is a different mindset,” says a US fund manager, now based in London. But even in the US, investors say the new threat of a vote on pay, although not binding, has forced companies to engage more with shareholders.
The critical question, however, is whether shareholder activism and pay restraint will stand the test of time.
John Kay, the author of last July’s far-reaching report on the UK equity markets, fears the 2012 shareholder spring will leave no legacy. “I’m not sure anything will come of the shareholder spring. The problem is that investors in the UK are a disparate lot. Usually, top 10 shareholders only hold between 2 per cent and 5 per cent of a company. Nobody has very much influence.”
. . .
Deborah Hargreaves, director of the High Pay Centre, the think-tank that monitors remuneration, agrees. “The worry is that there is an element of ‘If we keep our heads down, then we can go back to normal in a few years’ time and start paying ourselves big salaries again.’ This is why we have to strike now to put structures in place to restrain pay when the economic cycle picks up again.”
She would like to see workers represented on company boards as they are in Germany. “It is important to challenge the cosiness of boards, which are made up of the same sort of people, usually bankers or executives.” She cites FirstGroup, the UK rail and bus company, which has appointed a train driver to the board’s remuneration committee, as an example of where worker representation has proved effective.
Others say the pay debate is far from over. “This is going to snowball up until the 2015 UK election campaign,” says an equity fund manager at a UK group. “Labour will look at capping bonuses and will probably call for workers to sit on boards. I think Vince Cable would like to see workers on boards, too.”
Pay, he says, will be a central part of the UK election campaign, highlighting the continuing evolution of the corporate governance debate. Last year’s rebellions were a significant but small step in this evolution, he adds.
In years to come, people will say that this period was an important stage in this debate, says another investor who was also at the meeting with Mr Cable.
“That meeting will go down as a little footnote in the corporate governance story. But it will be an important one as it helped trigger the protests and emboldened investors to say enough is enough. I don’t think this is a passing fad. I think the rebellions have left a lasting imprint on the City and the way it functions.”

Attracting talent: Life in a different world

Increases in chief executive pay in the UK have far outstripped the salaries of workers since 2000.

The median earnings of a FTSE 100 chief executive have risen 266 per cent to £3.24m over the past 13 years, according to data provider IDS. In contrast, the median earnings of a full-time worker have risen 40 per cent to £26,462.
This means the salary of a FTSE 100 chief executive is 120 times that of the average worker. It is a pay differential that is hard to justify, says Deborah Hargreaves, director of the High Pay Centre, the independent think-tank that monitors company remuneration.
“I think the pay situation is unjust and unsustainable,” she says. Companies are run by people who do not live in the same world as the rest of us who struggle to pay bills and the mortgage. They lead these sheltered lives of luxurylives that are made easier by having these huge pay packages.”
However, investors typically argue that high pay is essential to attract talent, adding that a good chief executive is often worth a big salary because of the value they add to the company and its stock.
Richard Belfield, director of executive remuneration at consultants Towers Watson, says: “Institutional investors do not mind a chief executive being paid a lot of money, if they perform and produce strong returns.”
An equity fund manager at a European group adds: “For investors, it is about alignment with performance. We do not have a problem with a multimillion-pound salary, if the boss is good.”
Copyright The Financial Times Limited 2013.

Three New Lessons of the Euro Crisis

Arvind Subramanian

08 April 2013

 This illustration is by Tim Brinton and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

WASHINGTON, DCWhile some observers argue that the key lesson of the eurozone’s baptism by fire is that greater fiscal and banking integration are needed to sustain the currency union, many economists pointed this out even before the euro’s introduction in 1999. The real lessons of the euro crisis lie elsewhere – and they are genuinely new and surprising.
The received wisdom about currency unions was that their optimality could be assessed on two grounds. First, were the regions to be united similar or dissimilar in terms of their economies’ vulnerability to external shocks? The more similar the regions, the more optimal the resulting currency area, because policy responses could be applied uniformly across its entire territory.
If economic structures were dissimilar, then the second criterion became critical: Were arrangements in place to adjust to asymmetric shocks? The two key arrangements that most economists emphasized were fiscal transfers, which could cushion shocks in badly affected regions, and labor mobility, which would allow workers from such regions to move to less affected ones.
The irony here is that the impetus toward currency union was partly a result of the recognition of asymmetries. Thus, in the aftermath of the sterling and lira devaluations of the early 1990’s, with their resulting adverse trade shocks to France and Germany, the lesson that was drawn was that a single currency was needed to prevent such disparate shocks from recurring.
But this overlooked a crucial feature of monetary unions: free capital mobility and elimination of currency riskindispensable attributes of a currency area – could be (and were) the source of asymmetric shocks. Currency unions, in other words, must worry about endogenous as much as exogenous shocks.
Free capital mobility allowed surpluses from large savers such as Germany to flow to capital importers such as Spain, while the perceived elimination of currency risk served to aggravate such flows. To investors, Spanish housing assets seemed a great investment, because the forces of economic convergence unleashed by the euro would surely push up their prices – and because there was no peseta that could lose value.
These capital flows created a boom – and a loss of long-term competitiveness – in some regions, which was followed by an all-too-predictable bust. To the extent that monetary and fiscal arrangements fail to reduce or eliminate moral hazard, the risk that capital flows créate these endogenous asymmetric shocks will remain commensurately high.
A second insight from the case of the eurozone, advanced by the economist Paul de Grauwe, is that currency unions can be prone to self-reinforcing liquidity crises, because some vulnerable parts (Greece, Spain, Portugal, and Italy at various points) lack their own currencies. Until the European Central Bank stepped in last August to become the central bank not just of Germany and France, but also of the distressed peripheral countries, the latter were like emerging-market economies that had borrowed in foreign currency and faced abrupt capital outflows. These sudden stops,” as the economists Guillermo Calvo and Carmen Reinhart call them, raised risk premiums and weakened the affected countries’ fiscal positions, which in turn increased risk, and so on, creating the vicious downward spiral that characterizes self-reinforcing crises.
The most appropriate analogy is with a country like South Korea. In the aftermath of the Lehman Brothers collapse in 2008, South Korea needed dollars, because its firms had borrowed in dollars that domestic savers could not fully supply. Thus, it entered into a swap arrangement with the Federal Reserve to guarantee that South Korea’s demand for foreign currency would be met.
Of course, the euro crisis was not just a liquidity crisis. Several countries in the periphery (Greece, Spain, and Portugal) were responsible for the circumstances that led to and precipitated the crisis, and there may be fundamental solvency issues that need to be addressed even if the liquidity shortfall is addressed.
Finally, a less well-recognized insight from the euro-crisis concerns the role and impact of a currency union’s dominant members. It is often argued that the United States, as the major reserve-currency issuer, enjoys what then French Finance Minister Valéry Giscard d’Estaing famously called in the 1960’s an “exorbitant privilege,” in the form of lower borrowing costs (a benefit estimated to be worth as much as 80 basis points).
There was always a downsidepreviously ignored but now highly salient in our mercantilist era – to this supposed privilege. If investors flock to “safe US financial assets, these capital flows must keep the dollar significantly stronger that it would be otherwise, which is an unambiguous cost, especially at a time of idle resources and unutilized capacity.
But, in the case of Germany, exorbitant privilege has come without this cost, owing solely to the currency union. Weakness in the periphery has led to capital flowing back to Germany as a regional safe haven, lowering German borrowing costs. But, yoked to weak economies such as Greece, Spain, and Portugal, the euro has also been much weaker than the Deutschemark would have been. In effect, Germany has had the double exorbitant privilege of lower borrowing costs and a weaker currency – a feat that a non-monetary-union currency like the US dollar cannot accomplish.
The future of the eurozone will be determined, above all, by politics. But its development so far has forever changed and improved our understanding of currency unions. And that will be true regardless of whether the eurozone achieves the closer fiscal and banking arrangements that remain necessary to sustain it.

Arvind Subramanian is a senior fellow jointly at the Peterson Institute for International Economics and the Center for Global Development.