Are East Asian Economic Models Sustainable?

• Background
• Understanding East Asia's Economic Models
• Impacting the Global Economy
• Unsustainable Economic Models?

This document will suggest that the methods that have been the basis of 'economic miracles' in East Asia since the 1960s may be unsustainable in the international economic environment that follows the global financial crisis (GFC).

Several years ago it was speculated that China's / East Asia's growth might be decoupling from US growth.  The GFC initially suggested that this assumption was premature. Though some of the region was then able to recover rapidly, because of a lack of direct exposure to financial losses, this seemed likely to be temporary because dependence on the strength of others' (mainly US) financial systems remained. Moreover in the medium term East Asian societies may face severe difficulties in creating the more macroeconomically balanced economic regimes that will be needed in the post-GFC environment.

In brief this document, after outlining the origin in the 1980s of the present writer's efforts to understand the intellectual basis of East Asian economic models, suggests that:

• a key feature of such models appears to involve coordination of economic production through social relationships rather than by search for financial profitability. While this is effective in creating strong production capabilities, financial institutions would tend to fail unless large current account surpluses are maintained to provide sufficient cash flow to obviate the need to borrow in international markets;
• the apparent incompatibility of East Asian economic models and the prevailing global financial regime led to increasing difficulties including Japan's stagnation after 1990, the Asian financial crisis of 1997 and subsequent efforts across East Asia to accumulate large foreign exchange reserves to guard against financial risks;
• this adversely affected prospects for sustainable global growth - a risk that was temporarily concealed by economic globalization and innovations in monetary policy that allowed the US, as the 'consumer of last resort' to compensate for demand deficiencies that have been intrinsic to the East Asian economic models;
• these financial imbalances were a major factor in the GFC but have been overlooked by G20 efforts to deal with that crisis, because analysts lack information about the cultural features of East Asian economic models which necessitate such imbalances. 

However, attempts to develop alternative strategies (eg mainly domestically driven growth in a China-centred economic 'world' within the world) will be anything but assured. .

The present writer was involved in detailed study of global debates about economic development strategy for much of the 1980s on behalf of an Australian state government. At that time Japan's industry policy methods were seen as very significant because of the perceived 'miracle' of its rapid growth and development to the point where it was viewed as the major economic rival to the United States.

As a result of earlier involvement in, and study of, organisational development using 'strategic management' methods, theories about a systems approach to economic development were developed and these were found to help in understanding the methods that Japan used as the basis of its economic 'miracle'. 

Explanation: 'Strategic management' is a technique, which in effect involves accelerating learning within an organisation in response to new information. This was widely adopted in the 1990s as an alternative to the 'strategic planning' methods which had emerged to deal with faster changes in organisational environments in the 1970s. The latter had involved centralized attempts by planning staffs to determine the implications of that information (see Strategy Development in Business and Government, 1997).

'Strategic management' techniques had (unknowingly) been used with some success for organisational development by the Queensland Government in the 1970s - because of a decision to build on existing capabilities / systems in learning to respond to then 'issues of critical concern' (ie regional development and environmental management).

A parallel approach to economic development which the present writer developed in the 1980s involved accelerating 'learning' within the real market economy in response to emerging opportunities and threats - involving techniques that could be referred to as 'strategic market management'.  The basic principles were incorporated into a 1993 book, and are explored online in Defects in Economic Tactics, Strategy and Outcomes (2000), and Probable Breakthrough in Understanding Economic Development (2004).

Practical experiments conducted using this technique in the 1980s showed that the method could be reasonably effective, but great care was needed in managing the relationship with the democratic political process because the latter would tend to: (a) be out-of-date in terms of potentially-commercially-relevant options (see Economic solutions are beyond politics, 1995); (b) be subject to rent-seeking interest groups; and (c) over-ride the market-responsive outcomes required for economic success in terms of increasing productivity. Methods to manage these relationships in democratic societies were suggested in Developing a Regional Industry Cluster (2000), and in A Case for Innovative Economic Leadership (2009). The latter described a possible method for enhancing the ability of Australian firms to innovate out of the severe economic downturn in 2009.

This background aided in understanding the basis of Japan's economic model in terms of (say): the practice of 'bottom-up' decision making; Total Quality Management (involving the development of production systems to prevent defects from arising in the first place); industry policy techniques such as MITI's vision development and administrative guidance (which was a technique to accelerate real-economy learning); and the strict control of government by bureaucratic elites behind a democratic 'face'.

These involvements led in turn in the late 1980s to concept development for the Queensland Government's response to a proposal  for a centre for technological and cultural exchange put forward by Japan's Ministry for International Trade and Industry (MITI).

As a result of research undertaken for that project, a substantial document ('Towards an Understanding with Japan', unpublished) was produced. This gave an account of the intellectual basis of Japanese society and economic methods in ways that the writer had not seen from any other source. Japanese connections took this to a 'philosopher' in Japan who (without contradicting it) elaborated it with hundreds of detailed notes. Similar work was described by Chalmer's Johnson (author of MITI and the Japanese Miracle) as dealing with matters on the leading edge of the social sciences.

The intellectual basis of the economic model that Japan originated, and encouraged other East Asian ethnic communities to adapt in the 1960s and 1970s, seems radically different to that which has been the basis of Western economic methods.

An account of both the different ways of using information and the practical consequences in terms of the nature of  power, governance, strategy and economic goals was outlined in East Asia (in Competing Civilizations, 2001).

In brief the latter refers to:

• the lack of the notion that Western societies inherited from classical Greece that abstract ideas usefully model reality - and thus:
  • an orientation to intuitive rather than rational / analytical problem solving;
  • valuing outcomes that are 'real' or 'concrete' - with little importance attached to 'abstracts' such as ideas, ideals, law, financial returns or intellectual property;
  • a lack of universalist ethics, or obligations towards those with whom one does not have a direct relationship;
• concepts of power in terms of social hierarchy, rather than the right to make decisions;
• exercise of power through control of access to information which influences others' decisions;
• government by educated elites whose role is as teacher and guide;
• a preference for invisibly by those who are truly powerful;
• coordination of economic activities through social relationships amongst elites and Confucian obligations of subordinates to superiors with limited regard to financial calculations;
• a strong savings ethic - noting Confucian notions that wealth should be accumulated by limiting consumption;
• communitarian / mercantilist economic goals;
• strategic methods - featuring deception and the absence of distinctions between war, business, politics, social relationships and even criminal activity (all being orchestrated by bureaucratic elites);
• traditional strategies to defeat 'barbarian' invaders by serving them, and thus making the 'barbarians' dependent and weak.

Of particular significance is that the East Asian economic models rely on neo-Confucian social relationships amongst elites (called 'guanxi' in China) and the obligations of subordinates to superiors, and give little attention to financial (ie symbolic) outcomes in coordinating economic production (see Structural Incompatibility Puts Global Growth at Risk, 2003). 

While this arrangement can be very effective in creating production capabilities, savings tend to be used wastefully and financial institutions tend to have poor balance sheets. The latter can only be protected from financial failure by:

• state-owned banking, and regulatory regimes that tolerate poor balance sheets in financial institutions;
• avoiding the need to borrow in international capital markets by suppressing domestic demand so as to generate cash flows from current account surpluses (op cit);
• rigging markets to produce favourable outcomes for state-connected enterprises;

Following decades of 'miracles' by accelerating development of its production systems, Japan ran into severe difficulties in the 1980s because of its structural focus on production capabilities and lack of concern for financial outcomes. Huge quantities of credit were created on the basis of inflated land values, and invested in excess industrial capacity and acquiring assets world-wide with little regard to price.

The apparent incompatibility of East Asia's economic models and the global financial systems based on Western principles has led to increasing problems since the 1980s - though this was probably not obvious to average Western observers who had no way to understand the underlying cultural issues (see An Invisible Clash of Financial Systems). 

The latter refers to:

• China's conversion from Communism to a variation of the Japanese economic model after 1979;
• attempts by the US to engineer a rebalancing of its trade deficit with Japan in 1985 (under the Plaza Accord) which failed because changes were sought by adjusting exchange rates and the way in which Japan's financial system directed funds to production and suppressed consumption was ignored;
• the bursting of Japan's financial 'bubble' in about 1990, which was followed by: (a) no serious reforms of financial institutions - presumably because this would have required disrupting Japan's whole system of socio-political-economy; and (b) a decade of stagnation;
• the 1997 Asian Financial Crisis - brought on by the withdrawal of a great deal of foreign capital, when the lack of serious attention to profitability was recognised;
• the traditional unwillingness to discuss such weaknesses with outsiders;
• the widespread adoption of strategies to suppress demand and so accumulate large foreign exchange reserves (mainly $US) as the best method to reduce the risk of financial crises;
• efforts by Japan to sponsor the establishment of an Asian Monetary Fund to operate in ways that would be compatible with its economic model - and the creation of large quantities of virtually zero-interest credit that was exported through 'carry-trades' to boost import demand for Japan's exports (mainly from US);
• increasing concern (eg by Bank of International Settlements and World Bank) about the risks to the global financial system of East Asia's continued dependence on US demand and escalating US debts;
• the hope that Western-style financial systems might be made redundant under a new global financial order, and a possible relationship between this and the West's clash with Islamist extremists after 2001.

Following the Asia financial crisis of 1997, East Asian societies were urged (especially by the IMF) to reform their financial systems to make them more transparent.

What was not apparently recognised was why this was culturally impossible (see Understanding the Cultural Revolution, 1998). The latter referred (for example) to: fundamental differences in way information is used; the need to change economic goals from economic 'power' to financial returns; the inseparability of economic issues from questions of social / political power; and the lack of appropriate legal systems.

In practice, all that happened was that (with IMF encouragement) strategies were adopted to suppress demand and so accumulate large foreign exchange reserves (mainly $US) as the best method to reduce the risk of financial crises. After all Japan and China had done this with apparent success.

In late 2009, the 'mystery' of why Chinese companies maintained high savings rates was examined by the IMF [1]. Some observers: (a) noted that this made their growth dependent on debt-fuelled consumption elsewhere (mainly in the US) - which would no longer be sustainable) and (b) suggested that the explanation of their high savings rate was that those companies were state owned and had no no one to pay dividends to [1]. Such explanations, which do not take account of cultural factors and the similar situation in Japan, are only part of the story.

The necessity to boost production and suppress consumption in East Asian societies that adopted variations on the Japanese economic model led to structural demand deficits (and so-called 'savings gluts') within those economies. This was compounded by one of Japan's solutions to the challenges it faced in the 1990s because of its economic model (ie creating credit at virtually zero interest rates which was exported through 'carry trades' to boost demand elsewhere).

Large domestic demand deficits were macroeconomically unsustainable within affected economies. In the 1930s Keynes identified the risk that demand deficits (ie unspent savings) posed to economic growth, and advocated counter-cyclical public spending as the remedy. Moreover these large demand deficits made global economic growth unstainable (see Structural Incompatibility Puts Global Growth at Risk, 2003), though the problem took many years to manifest itself.

In recent decades innovations in macroeconomic management and economic globalization provided a temporary means for compensating for demand deficits, by allowing them to be countered by excess demand elsewhere (mainly in the US). 

East Asia's demand deficits could be accommodated for a time because:

• changes to the global financial system in the early 1970s (ie the move from a gold standard to the $US's role as a global reserve currency), permitted the US to sustain persistent trade deficits, as these could be financed by boosting money supply (rather than balanced with gold reserves);
• Keynesian counter-cyclical public spending, which had been economic orthodoxy in the post-WWII years, tended to lose credibility in the 1970s as governments had difficulty getting the timing right (ie such tactics tended to amplify, rather than smooth, booms and busts). Monetary policy, based on setting the interest rates that reserve banks charge financial institutions to maintain an acceptable rate of CPI inflation, tended to take its place in stimulating or damping economic growth, Moreover easy monetary policy proved effective (originally in the US stock market crash of 1987) in preventing financial crises from affecting the 'real' economy;
• an apparently 'virtuous circle' in trade and investment arose as: (a) easy money policies were needed to sustain US growth, given the drag of its current account deficit; (b) easy monetary policy encouraged the rapid growth in asset values, which in turn sustained high rates of consumer, business and government spending  [1, 2] and ensured a large trade deficit; (c) cheap imports from Asia inhibited the CPI inflation that would normally make very easy monetary policy seem unwise; and (d) the US current account deficit was balanced by capital inflows mainly from East Asia;
• industrial structure in advanced economies changed as capital intensive manufacturing lost productivity and shifted to lower wage economies. Knowledge-intensive functions expanded in their place of which one of the most important was financial services - and the latter tended to attract savings from elsewhere;
• high and perhaps unsustainable levels of public spending were needed to maintain demand in many other major economies (as well as the US).

It may be that US authorities (presumably as a by-product of Cold War strategies to promote world development on a democratic-capitalist basis and with Japan's encouragement as a US 'ally') sought to exploit those innovations to maintain global growth in the face of East Asia's demand deficits, in the expectation that market forces would eventually force real financial reforms in Asia (see An Invisible Clash of Financial Systems?).

However the US's ability to take on the role of 'consumer of last resort', which had made export-driven growth a feasible economic tactic, could not be a permanent solution as the resulting financial imbalances led to problems (eg a large and persistent US current account deficit and accumulated debts).

The financial instabilities that emerged in the US in 2007 (related initially to losses on very complex structured financial assets - ie sub-prime mortgages) and were transformed in 2008 into an unprecedented global financial crisis had many causes (eg see Financial Market Instability: A Many Sided Story (2007) and Global Financial Crisis: The Second Test of Globalization?).  However global financial imbalances (which, as noted above, also had many causes) were key components of the problem.

Despite their importance most GFC analysts (because of the lack of information about the East Asian economic models that necessitated such imbalances) have focused simply on arrangements within Western financial systems and economies. Moreover the G20 Summit in April 2009 essentially ignored the imbalance issue, and was thus unable to create any solid basis for sustainable economic growth (see Announcing 'Peace for our Time'?). 

By September 2009, however, the US and Europe had recognised the necessity for systematic efforts to reduce imbalances (and raised this in the context of a G20 meeting) - a focus to which China objected [1].

• New Economic Strategies?
• Need to Avoid Exposing Financial Institutions
• Japan's Predicament
• China's Predicament
• Creating a New International 'Confucian' Economic and Political Order?
• Balancing Supply and Demand

Unsustainable Economic Models?

Large international financial imbalances involving the US can not continue, both because of their role in the GFC (as above) and because, in the post-GFC environment, the US's financial system will no longer be strong enough to compensate for large demand deficits in East Asia (or elsewhere).

The Need to Reduce Global Financial Imbalances

The ability of the US to provide the excess demand that allowed export-oriented industrialization to be a viable strategy for economic development (particularly in East Asia) depended on the strength of the US financial system and ongoing asset inflation (see Financial Imbalances).

Even if modest growth resumes in the US and elsewhere in (say) 2010, it will necessarily be based on much lower levels of consumer and government demand (and much lower levels of financial imbalances) because of:

• an ongoing requirement to reduce debts;
• the absence of rapid asset inflation to (a) generate tax revenues; and (b) borrow against to fund household spending;
• the potential difficulties in funding US budget deficits.

Though this issue was ignored by the G20 Summit and it may thus be impossible to engineer global economic recovery, the need for such adjustments has been increasingly recognised (see Structural Indicators of Ongoing Recession / Depression, and 1, 2). The latter suggested that the solution could lie in both increased welfare services and higher quality investment opportunities in China, which would slowly reduce its high savings rate.

Professor Martin Wolf has argued (realistically) that "Creditor countries [mainly China, Germany and Japan] are worrying about the safety of their money. .... (However this will be safe) ... only if the creditor countries facilitate adjustment in the global balance of payments. Debtor countries will either export their way out of this crisis or be driven towards some sort of default. Creditors have to choose which". [1]

However without radical change, East Asia's growth would continue to depend on now-unreliable US demand [1].

New Economic Strategies Must Be Found

Thus a shift in the basis of East Asia's economic growth and development would be needed away from the export-oriented industrialization strategies that Japan (primarily) had spread through the region (with World-Bank and US endorsement) [1, 2].

Recognising the Challenge

People in East Asia are starting to realize that they face the end of the era of export-oriented industrialization (EOI) which has been applied for 40 years. Success by Taiwan and Korea convinced World Bank in 1970s that EOI should be supported, as the alternative to import substitution. The latter could have worked only with large redistribution of income and wealth - which regional elites opposed. While the World Bank encouraged export processing zones, little happened until the US sought to overcome its trade deficit with Japan by currency revaluation under the Plaza Accord. This made much manufacturing unaffordable in Japan - so kieretsu moved labour intensive components to China and SE Asia. Japanese capital inflows allowed NICs to avoid the credit squeeze of the early 1980s. Rapid growth in NICs resulted, driven by Japanese foreign investment. Japan sought an Asia Pacific platform for re-export to third countries. China later mastered this model. The process depended on the US market - and there was no shortage of credit as Asian countries loaned to US on a massive scale. China's demands created the illusion of decoupling - after its demands eased the effects of the Asian financial crisis. But this continued to depend on US demand. Now the whole edifice - which depended on debt-financed middle class consumption in US - has collapsed. While income inequality in Asia had actually increased, rising wealth took the edge off this - but with growth collapsing radical protest and social revolution are now possible across East Asia  [1]

As noted above the US and Europe raised the need for systematic efforts to reduce imbalances in the context of a September 2009 G20 meeting  [1].

To sustain growth within a Western-style market economy would require more macroeconomically-balanced economic systems (ie those without a large demand deficit and savings surplus). 

This requirement would bring the incompatibility between the prevailing Western-style global financial regime and East Asia's economic models into sharper focus, because it is likely that any shift towards sustainability within Western-style financial traditions would require a large (and probably culturally-unachievable) change in social, political and economic practices.

The Need to Avoid Exposing Financial Institutions

The most obvious difficulty under Western-style international arrangements (mentioned above) is that because economic production is coordinated through 'Confucian' social relationships (amongst elites and the obligations of subordinates to superiors) rather than by serious concern for return on capital, losses have tended to accumulate in financial institutions. In the past these could be ignored by suppressed consumption and thus generating large current account surpluses so that sufficient cash flow was available to make it unnecessary for banks to borrow in international markets.

In future, without support from a strong external economy (to provide excess demand and productively invest surplus savings) or major changes to business and financial practices, financial crises like that in 1997 would be likely.

Though financial systems in Asia seemed reasonably secure against external financial shocks in early 2009 [1], they would need to be radically transformed were growth to be driven by domestic demand in the medium to long term. Growth would inevitably have to be funded by borrowing in international markets rather than from cash flows derived from trade surpluses.  While sound balance sheets might be fabricated if there is no outside scrutiny, this would not be feasible if external investment had to be sought.

There are precedents for radical transformations as part of East Asia's economic strategies (eg Japan's initial challenge to Western economies in the 1950s and 1960s came unexpectedly through moving into the highest productivity and most demanding segment of developed economies - which at the time involved capital intensive manufacturing). While similar tactics, ie moving into what had been the high ground of Western economies - financial services, might be seen as an option, in practice this seems unlikely. 

Developing financial systems under which economic outcomes were driven by a search for the profitable use of capital rather than social relationships would probably be impossible because of cultural aversion to abstracts (see An Invisible Clash of Financial Systems?).  Moreover in responding to the impact of the GFC, China (for example) made no obvious move towards Western-style changes to its financial system (see China: After the Bubble) any more than Japan did in the 1990s.

The possibility that alternative ways of making state-supported companies and banks 'profitable' (by rigging markets through communitarian networks) is suggested below.

Japan's Predicament

Presumably Japan recognised in about 1990 the profound difficulties that the financial principles built into the prevailing international financial regime (ie the emphasis on return on capital and sound balance sheets) created for its economic model, and adjusted its strategy on that basis. Japan chose not to, and perhaps was unable to, adjust its system of socio-political-economy to conform to the requirements of the Western-style international financial regime.

 'An Invisible Clash of Financial Systems' is the present writer's speculative view of international events in terms of a 'clash of civilizations' that may have been obvious to Japan though it was invisible to rational Western mindsets who had no way to understand the predicament of those who adopted variations of Japan's economic model.

Japan's international relationships since 1990 need close attention from this viewpoint - by both East Asian nations and especially by the US, as the latter may have been subjected to the greatest con game in history by Japan's 'good cop' routine.

In October 2009 it was indicated that 'Japan wants its culture back' - in reference apparently to claims that it had become 'Americanised' and wanted business to operate in a traditional communitarian style rather than concerning themselves over-much with profitability (see Which Identity Does Japan want Back?)

China's Predicament

As a result of creativity, effort and the adoption of a variation of the Japanese economic model, China achieved spectacular progress from the 1980s in the face of immense difficulties to be seen as a potential economic super-power.

There was even an expectation some years ago that Asia's economic growth (led by China) would decouple from the growth of the US economy (see Decoupling: A New Urgency?). The need for decoupling has been amplified by the GFC and the consequent inadequacy of export-led industrialization strategies.

In June 2009 it was suggested that emerging economies might have been less adversely affected by the GFC and be able to maintain strong growth without dependence on demand from the US and Europe. However, without radical changes, this seemed likely to be only a temporary respite.

China: After the GFC speculates about China's position - basically suggesting that China's response has involved both: (a) high levels of government spending; and (b) some efforts to transform its society and economy which may long have been planned to overcome the constraints implicit in the economic model it copied from Japan (ie its dependence on the strength of the US financial system).

Creating a New 'Confucian' Economic World? [Preliminary]

Various observers have suggested that China has been challenging the US dollar - but China may not be seeking to replace the $US with the Yuan. Rather China (and presumably Japan) may be seeking (and possibly have been seeking for some years) to reduce the role which any currency (ie money) plays in influencing economic affairs, and replace it with neo-Confucian social relationships within a substantial part of the global economy.

In simplest possible terms the goal could be to reduce the constraints on the rule by traditional social elites that arise where financial considerations determine economic activities and where law is the basis of government - because it is presumed that the interests of ethnic communities (as determined by integrative-intuitive consensus amongst social elites and their subordinates) should dominate over the interests of rational individuals (as electors, politicians, consumers or entrepreneurs).

That such a development (which would make econometricians and many political scientists redundant) might be considered and might be consistent with emerging events, is considered below.

The constraint on the economic models Japan promoted throughout East Asia lies on the demand side (ie on its dependence on export demand - especially from the US, and on the ability that the US had had to productively absorb surplus savings) and no amount of additional supply capacity is going to solve that difficulty. In the absence of strong external demand, under Western global economic principles growth driven by domestic demand would merely run down foreign exchange reserves and eventually lead to a financial crisis because of the lack of traditional capitalistic attention to profitability that characterises those models (see above).

A solution might be seen to lie in creating an updated version of the China-centred economic 'world' that existed prior to prior to the expansion of Western influences - which interestingly would also give effect to Japan's WWII goal of creating an 'Asian Co-prosperity Sphere'.

Characteristics of the former 'Confucian' International Order - a China-centred tribute trade system 

It was a world within worlds (rather than a universalist global system). In this China-centred 'world' within the world: (a) economic activities were subsets of political relationships between China and its tributaries: (b) major trade and financial flows were managed by the state - though there were minor amounts of private trade.  Historical Perspectives on States, Markets and Capitalism, East and West

[to be completed]

Features of such an international Confucian 'world' might be expected to involve:

• a China-centred trade / tribute system in which 'tributaries' (who might be states, ethnic groups or even individual businesses or political leaders) paid nominal allegiance and gave largely symbolic gifts to China's elites, while the latter (a) controlled that 'world' and (b) ensured that China's people work hard for limited material reward, so that 'tributaries' gained real net benefits from the arrangement;
• primary reliance on socially-coordinated (ie power rather than profit-seeking) economic transactions within and amongst China and its 'tributaries' - though with profit-seeking enterprise allowed on the margins;
• rigging domestic markets through social networks similar to that used to orchestrate production, so that favoured (large state-owned or socially-linked) enterprises appear 'profitable' - at the expense of the rest of the economy - by setting favourable upstream and downstream prices (see below);
• seeking a net current account surplus with the outside world by suppressing consumption, while being able to handle some current account deficits by creating special financial institutions and institutions to which 'profit-focussed' investments could be attracted by rigging associated industrial activities through cartels;
• no attempt to create a 'global' system - because of the particularist traditions and a lack of commitment to general / universal principles. This would be a 'world' within the world, not a new global order - though efforts would presumably be made to undermine the effectivensss of global institutions that have operated on Western-style political principles;
• achieving changes by behind-the-scenes activity without public disclosure or discussion - as debate / abstract analysis is not a favoured method for problem solving.  The 'East' was not seen to be 'mysterious' for nothing.

The apparently incompatibility of East Asian economic models and the prevailing international financial regime have led to indications that alternative regional arrangements were being considered for decades to consolidate the long-established role that China's Diaspora have played as a China-focused economic 'empire' especially through SE Asia.

For example, An Emerging East Asian International Order? referred to:

• claims by leading officials that Japan is a 'non-capitalist market economy' - which is reasonable as profit-seeking (the key feature of capitalist enterprises) has not appeared to be the main driver of businesses in Japan;
• reference to the emergence of a 'Confucian union'  - based on the concept of a 'worker caste system' in which bureaucrats / technocrats would have power which would be different to the 'merchant caste' system in which capital is the source of power;
• China's practice of 'sharing' the protection offered by a current account surplus with countries that provide inputs to its export industries, whose economic methods would otherwise result in financial crises;
• proposals, led by Japan, for the establishment of a Asian Monetary Fund as an alternative to the IMF (and the considerable strengthening of that proposal under the Chiang Mai initiative) which would:
  • provide a framework for financial and monetary systems in which social elites enable resources to be directed towards boosting the economic power of their ethnic communities without serious concern for return on capital from meeting their people's demands as consumers;
  • involve shared access to foreign exchange reserves to prevent crises associated with withdrawal of capital in any particular country;

The possibility that socially-coordinated cartels (rather than reliance on conventional market transactions) may be being put into place to promote the 'profitability' of state-favoured enterprises and banks is suggested by:

• the massive boost in China's corporate profits / savings from 2003 that was described by The Myth of Chinese Savings;
• the pre-GFC balance-sheet health of Asia's corporate and banking sectors [1], when this faces massive cultural obstacles through Western-style business techniques,
• claims of such rigging by Eammon Fingleton, a close Japan-based observer of the region;
• the increased concentration on larger enterprises, and the credit constraints facing SMEs which the IMF reported [1]

China's 2009 responses to the GFC may be consistent with a desire to create a new China-centred trade / tribute empire as speculated above - though this is by no means certain. Steps taken have had the effect of::

• boosting growth within such a potential China-centred 'world' (both in China itself, in potential 'tributaries' and in developing countries) presumably in order to strengthen demand for its products from other than the US (and other 'capitalist' countries);
• potentially retaining socially-coordinated control of economic and financial transactions within such a 'world';
• establishing special financial centre and financial institutions  - perhaps so that (hopefully) small amounts of profit-seeking investment to cope with any net current account deficits that arise can be officially controlled while giving the impression of financial profitability;
• making it harder for anyone (especially the US which has favoured a different approach) to create an effective global financial system.

Specifically it is noted (eg see Doing China's Own Thing?) that:

• China has made no attempt to reform its economic / financial system on Western principles. Emphasis has continued to be placed on state-owned enterprises and state banks neither of which are noted for taking Western-style approaches to profitability seriously - and the environment for private enterprise is very poor;
• foreign banks have started operating profitably in China arguably because of the same sort of market-rigging by cartels that allows state-owned enterprises to appear profitable;
• domestic consumption has been moderately boosted;
• significant amounts of China's foreign exchange reserves have been diversified away from $US. In particular, reserves have been used to: (a) make loans to key trading partners; (b) acquire businesses; (c) stockpile commodities; (d) acquire future key energy / commodity inputs; and (e) gain support;
• proposals have been presented for the development of Shanghai as a international financial centre with 'Chinese characteristics' - perhaps involving regulatory reforms and creating a market for $US denominated bonds;
• proposals exist to upgrade established industrial regions on China's coast to succeed on the basis of independent innovation - while transferring traditional industries inland;
• the use of the Yuan has been encouraged as an international trade currency amongst  key trading partners;
• concern has been expressed about reliance on the $US as the global reserve currency with SDR's issued by IMF suggested as an alternative. Concern has also been expressed about the need to rely on US demand;
• the Ministry for State Security was reportedly placed in charge of China's economic dealings - a move which could be expected to dramatically curtail foreign commercial involvement within China.

China's efforts in late 2009 to subvert United Nations talks intended to negotiate an international agreement on responding to climate change may indicate the start of an attempt to limit the effectiveness of global institutions which operate (as the UN has sought to do) on Western-style political principles and perhaps establish alternative 'Asian-style' machinery.

Explanation:  In December 2009 it was noted that China's tactics at the UN's Copenhagen climate change summit appeared to be aimed at preventing any outcomes being achieved [1]. This reportedly involved:

• a complete refusal to engage in talks;
• China-engineered procedural blocking tactics (in conjunction with developing nations) to prevent political debate on draft resolutions by claiming that they were a plot to 'kill' the Kyoto Protocol;
• the refusal of China's Premier to participate in talks with the US President - with a third-rank official substituting;
• avoiding engagement by top political leaders for two weeks by insisting that everything had to be done by consensus amongst 192 countries;
• encouraging involvement of a hardline Sudanese negotiator who described developed nation's approaches to climate change as like Nazism; endless rhetoric about historic responsibilities of the West and rants about the evils of capitalism - which meant that there was no top-level discussions about practical action.

This is significant because the UN has been based on Western-style political processes. The latter rely upon debate amongst representatives as the means of reaching decisions. This is incompatible with East Asian traditions in which:

• entirely different assumptions are made about the feasibility of reaching appropriate decisions through rational debate (see East Asia);
• political power is associated with NOT making decisions, but rather with having social subordinates who make them on behalf of the powerful (see Pye, Asian Power and Politics). An insistence on 'consensus' (amongst social subordinates) is compatible with these traditions.

While some observers suggest that China's obstructionism merely reflects an inward focus on its own needs [1, 2], the possibility that China might seek to develop alternative means for developing practical responses to international issues such as climate change through consensus amongst those countries whose elites accept a subordinate status within a China-centred 'tribute' system should be recognised.

The UN, it may be noted, has been ineffectual in dealing with global issues in any event (and for much of the previous decade the US, which originally took the lead role in setting up the UN, had emphasised unilateral rather than multilateral action - because of the US's apparent preference for trying to defeat ignorance on the battlefield rather than in the academe). China's new efforts to subvert UN machinery are likely to simply be further justifications for seeking serious reforms.

Though massive and difficult adjustments would be required in East Asia to adapt to the dominant global order (ie involving a rule of law and a capitalistic search for profit), there are reasons to suspect that the alternative outcome (despite its benefits) would involve short-term risk, would be not in the interests of ordinary Chinese people and would ultimately be ineffective.

In the short term the hypothesised  plan would involve a race against time. It would be vital to create alternative 'tame' markets within a China-centred trade / tribute regime before foreign exchange reserves became depleted - in an environment in which recovery by major past export markets was not assured, and the latter's ability / willingness to sustain large current account deficits would be limited.

From the point of view of China's ordinary people such an arrangement may have been best assessed by a former premier of China who was critical of the path that China's leaders took at the time of the Tiananmen Square massacres because of: (a) the lack of political stability where only a few rule; (b) the commercial focus of those with political power; (c) rampant corruption; (d) social inequality; (e) pervasive inefficiencies; (f) the lack of benefit to ordinary people of their hard work

Zhao Ziyang (former Chinese premier) argued that parliamentary democracy would be the best option for China. After believing that socialist nations' 'peoples congresses' were better than parliamentary democracies, it was recognised that the former resulted in rule by only a few. Without a broadly based parliamentary democracy societies can't be politically stable or have a modern market economy, and developing countries will run into problems that have plagued China such as commercialization of power, rampant corruption and polarisation between the rich and poor. For China the transition requires allowing the existence of other parties and more democratic processes in the Communist party.  [1]

Zhao Ziyang was one of architects of China's economic boom but condemned its political leadership following the Tiananmen Square massacre. His urge for reform was based on recognition of deficiencies of China's economic system. Removing those deficiencies and the creation of an effective market economy were seen to require the creation of property rights. His initial concern was with increasing efficiency - which required transparency and freedom to trade. Ensuring that Chinese people gained returns for their labour was more important than pursuit of production growth. However under new leadership that path has been reversed. The dominance of SOEs in industry and banking is a major problem - and regulators are unable to control them because of the influence of government policy and the party. There is no separation of China's political and legal systems. Though growth allowed the emergence of a middle class, the GFC has strengthened the position of party whose default position is control. There are many examples of economic inefficiency in China. Economic and political reform is inextricably linked. Without parliamentary democracy China can't have a modern market economy.  [1]

It can be noted also that China controls the flow of information to its own citizens who may thus be unaware of the fact that under such an arrangement their hard work would remain largely unrewarded so that China's elites could control a new trade / tribute empire.

From the point of view of the rest of the world, a Chinese trade / tribute empire that was more-or-less self contained in terms of net supply and demand would be less macroeconomically risky than has been the case for export-led industrialization in the past. However:

• its radically different modus operandi would prevent the emergence of any effective and uniform 'global' systems (ie global financial regulation) - and this would be mildly irritating;
• the renewed inflationary risk from using monetary policy as a tool for macroeconomic management (which would arise when cheap imports became less of a constraint on producers' pricing power) would be a greater problem;
• external investors would probably find that their projects remained forever marginally profitable unless they received official state endorsement - as legal and financial systems would never be created to allow independent success in those terms. Concerns expressed in January 2009, that Chinese policies that promote domestic firms and create barriers for foreign ones might cause US firms to lose interest in China, may be noted [1];
• states that were not full participants in the system would find that the local influence of 'Diaspora' was reflected in attempts to gain economic benefits through insider political influence;
• conspiracy theorists would find entirely new factions to gossip about.

However in the medium to long term, quite severe problems could well arise internally within such a trade / tribute 'empire'.

China's future aspirations are limited by diverse environmental, demographic and political challenges which constrain its ability to create the sort of 'world' speculated above.

Constraints (in China's Development: Assessing the Implications) referred, for example to:

• economic issues including: unbalanced state driven development; 'blunt' economic management tools; a weak private sector; a tendency to cronyism; problems with economy driven by market-share (rather than profitability from meeting customer demands); poor competitiveness rankings; imbalance between production and consumption;
• potential future financial bubble if dependence remained on massive investment with limited concern for return on capital; 'blunt' tools for reforming financial systems
• environmental concerns, which external observers have suggested must limit its growth and development;
• demographic challenges related to the world's most rapidly aging population;
• an autocratic political system subject to constant internal stresses.

Though the creation of an alternative political and economic 'world' might reduce some of the economic and financial constraints, the others would remain.

While there may be ways in which an economic system could be organised primarily on the basis of social relationships and with limited reliance on money as a means of exchange, store of value and indicator of the need for economic change, such a system would probably eventually prove unworkably complex and inefficient.

A Fundamental Problem: Balancing Supply and Demand  [Preliminary]

The major challenge to the creation of 'Confucian economic world' (no matter how effective it could be in organising production and rigging markets to provide some with an appearance of 'profitability') would be the lack of practical means to balance supply and demand - which are critical to sustainable economic growth.

Mercantilist economic models prevailed in Europe in the 18th century where the goal was to use state power to boost economic production - so as to accumulate a stock of treasure (eg gold). Adam Smith's Wealth of Nations critiqued those mercantilist economic models. He suggested that wealth would best be achieved by a free market. A key characteristic of the latter is the ability it provides to balance supply and demand - through an effective price mechanism and sensitivity by producers to profits.

These have not been features of East Asian economic models so that no matter how effective the latter are in strengthening the production side of an economy and arranging markets so that favoured enterprises are 'profitable', unless a way can be found for (say) 'Confucian' obligation to balance supply and demand internally, they are not likely to prove any more sustainable than: (a) the European mercantilist systems that Adam Smith criticised; (b) the Soviet Union, whose command economy was seen to achieve sensational growth in the 1950s by producing goods that no one wanted; and (c) Japan in the 1980s.

In the past balancing supply and demand has not been an issue that East Asian economies have had to worry about - because this tended to be achieved by expansion of (mainly) US demand through easing monetary policy to compensate for demand deficits in East Asia.

In addressing export markets, the strategies of 'East Asian' producers can (over-simplistically) be said to have involved maximizing market share in export markets (through low cost quality goods) rather than maximizing profits.  Though some claim that seeking market share laid the foundation for long term profits, low cost quality goods were achieved (amongst other things) through modest wages and a high savings rate to provide capital for investment which did not have to be used particularly profitably.

However for domestically driven growth within a 'Confucian economic world', household incomes (from wages and investments) would have to increase - or else domestic demand would be unable to more closely balance supply. Thus there could be no high savings to provide ready access to capital for investment. Moreover capital would need to be used efficiently - in ways that minimize costs (rather than merely relying on modest wages, and fabricated 'profits'). This requires that firms be genuinely profit sensitive, which seems incompatible with organising production and markets primarily on the basis of social relationships.