Lecture Outline

Global Economic Crisis and East Asian EconomyEast Asian Economy

August 2009

JUNG Ku-HyunSamsung Economic Research Institute

Topics to be covered

• Global Economic Crisis: Causes and Prospect

• Impact on Korean economy and Government Policy

• Impact on China and Japan

• Regional Cooperation: Finance and Real Sectors

1

• Regional Cooperation: Finance and Real Sectors

• Impact on Corporations: Japan vs. Korea

• Implications for Hokkaido Economy

2008 Global Financial and Economic Crisis

VIX Index

Real Economy Citi, GMCrisis

� 2007. 8 Subprime Mortgage Crisis Emerged

� 2008. 9 Lehman Brothers Bankruptcy

� 2008. 10 From Financial Crisis to Economic Crisis

� 2009. 5 Financial Market Stabilized

2

15

25

35

45

55

65

75

08/1/1 08/3/1 08/5/1 08/7/1 08/9/1 08/11/1 09/1/1 09/3/1 09/5/1

6/128.9

32.2428.54

Bear StearnsCrisis of GSEs

31.01

Monoline 36.22

Lehman Brothers Chapter 11

70.33

Real Economy Nosedived Crisis

80.86

32.1

Stress Test ofAmerican Banks

600

700

800

250

300

NASDAQ(1995.1 = 100)

Housing index(1995.1 = 100)

WTI spot(2002.1 = 100)

IT Bubble

Two Bubbles Burst after “Goldilocks Economy”

Bubble Cycles

3

0

100

200

300

400

500

600

1995 96 97 98 99 00 01 02 03 04 05 06 07 200850

100

150

200

* source : Global Insight

Housing Bubble

Commodity Bubble

Causes of Global Financial Crisis of 2008

� Immediate Reasons

Low interest rates and excess liquidity of 2002-2004

Manufactured products of China keeping inflation under control

Liquidity flowing into asset markets: real estate and stock

Housing market bubble and Subprime Mortgage Crisis

� Structural Reasons

Global Imbalance: the U.S. vs. East Asia and Oil Exporters

4

Global Imbalance: the U.S. vs. East Asia and Oil Exporters

Triffin Dilemma: Role of U.S. Dollar as Global Currency

� Systemic Problems

Anglo-American Capitalist System

Lax Regulation of Financial Markets/Institutions (derivatives market)

Management of Financial Institutions: risk-taking and compensation

Global Responses and Policy Coordination

� Massive government spending and Zero Interest Rates

Massive Capital Infusion on Financial Institutions

Fiscal Deficits of G7 Countries: 3-14% in 2009

Zero interest rates and unlimited supply of money

� Policy Coordination

Main Reason for Great Depression: Lack of Leadership

Spread of Protectionism has been under control

5

Spread of Protectionism has been under control

New Coordination Mechanism developed: G20 meetings

� Prospect of Recovery

Financial Meltdown unlikely

Emerging Markets seem to be robust, esp. China

Reaching the bottom of cycle?

Prospect of Economic Recovery

� Exit Strategy very difficult to manage

Unemployment still increasing and housing prices declining

Government budget deficits, excess liquidity and inflation pressures

������ ������ �������

6Source : BEA, C.Romer(1989), Datastream

-15

-10

-5

0

5

10

15

1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939

(yoy: %)

Slump + Recovery

U.S. Economic Growth after Great Depression

Korean Economy: Vulnerable but Resilient

� Vulnerable Because of ‘open, small economy’ High Dependence on External Trade

High Degree of Capital Market Openness

Small Domestic Market

Case Study: ‘Success Cost’ of Shipbuilding Industry and Short-term Capital Problem

� Resilient thanks to 1997 Financial Crisis, or “IMF Crisis” IMF Imposing Austerity Policy as Conditions for Emergency Funding

7

IMF Imposing Austerity Policy as Conditions for Emergency Funding

More than one half of 30 Business Groups Closed down or Sold out

Business: Low Debt-to-Equity Ratio and Emphasis on Liquidity

Housing Loans were Regulated through Strict Rules (LTV and DTI)

Government Debt Level on Lower side among OECD Countries

� Other Reasons for Relative Stability Social Costs Reduced Thru ‘Job Sharing’

Chinese Economy Showing Robust Growth thanks to Fiscal Spending

Stock Market and Foreign Exchange Market Performance

KOSPI : 1,435.26 (2007.1.2) � 1,360.54 (2009.6.23)

Won/USD : 925.6 (2007.1. 2) � 1,372.80(2009.6.23)

1,800

2,000

2,200

1,800

2,000

2,200

KOSPI

KOSPI Won/USD

8

800

1,000

1,200

1,400

1,600

800

1,000

1,200

1,400

1,600

2007.1 07.7 08.1 08.7 09.1 2009.6

Won/USD

Why is the Korean Won Vulnerable to Global Instability?

22.6 30.562.8 71.9 69.4

337.0

23.8 31.560.7 72.4

92.3

361.4

USA Japan China Germany Korea Singapore

2007 2008� Foreign Trade/GDP (%)

9

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

19.6

42.0

32.4

28.8

37.3

39.740.1

3636.6

30.1

21.9

29.3

2009 6

� Foreign Investors’ Share in Equity Market(%)

Korean Economy Bottomed out in 2Q 2009

� Quarter on quarter, the economy recorded positive growth of2.3% in 2Q 2009 thanks to government spending.

� Year on Year base, the economy will move to positive growth in 4Q, 2009.

GDP Growth Rates

�������������� ������������6.0

10

Q on Q, %

Y on Y, %

-6.0

-4.0

-2.0

0.0

2.0

4.0

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

2007 2008 2009

1997 Crisis and the Current Global Crisis

� Similarities Sharp drop of stock prices and currency (won) value

Outflows of foreign portfolio investment

Pessimistic views on Korean economy prevailing in the market

� Differences Sound Public and Corporate Sector

• Government Budget in Surplus

11

• Government Budget in Surplus

• Debt/equity ratio of manufacturing industry− 1997 : 396.1% ��2007 : 97.8%

Banking Sector more robust compared to 1997(BIS ratio)• 1998.6.: 9.14% - 6 of 12 commercial banks’ ratios below 8%

• 2008.6.: 11.16% - all banks’ ratios above 10%

Foreign Exchange Reserves over 240 billion U.S.dollars

Prospect of Korean Economy in 2009 and 2010

� Signs of Recovery

Stock market index (kospi) back to pre-Lehman period

Corporate profit performance surprising in 2009.2Q: Is this a sign of competitiveness or result of weak Korean won?

Retail sales and credit card sales back to pre-crisis level

Real estate prices in Kangnam(Seoul) area back to pre-crisis level

� Uncertainties and Problems

12

� Uncertainties and Problems

Exports still sluggish, especially excluding ships

Exports Very much dependent on Chinese Economy

Corporate investments still lagging: -22.8% in 1H, -7.5% in 2H

Corporate performance sustainable with higher value of Won?

Decrease of jobs(20,000), mainly due to closing-down of subsistence retail stores and service est.

Impact of Global Crisis on China’s Economy

� China Expected to Achieve 8% GDP Growth in 2009 Despite Sharp Export Decline of over 20% in 1H

Thanks to expansionary government programs

� China’s stimulus package includes Government spending of 5.6 trillion yuan over 2 years (2009-2010)

• 60% to stimulate domestic demand (such as farm income support)

• 40% to enhance growth potential (such as solar energy and electric cars)

13

• 40% to enhance growth potential (such as solar energy and electric cars)

Monetary Policy

Interest rate reduction from 7.47% to 5.31%

Increase of money supply to stimulate investments

� Key Question: Can domestic consumption and investments substitute for export declines? China’s economy has been export- and investment-driven

Investments driven by size expansion of SOEs and monetary incentives that local government officials get from land sales and other incomes

China’s Export and GDP Growth

Export Growth GDP Growth

� � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � ! � " # $ % � & ' ( � ) * + , � - � . / 0 ! . 1 2 3 � 4 � � � ! � 5 6 � � 7 8 � 9 : � x � � � 6 8 " ; < = � � � � � � > ? ! @ A ! � 5 6 � �

30

40

800

1,200

Exports Growth

Imports Growth

(US$100 mil.)(Year-on-year growth, %)

Net Exports � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � ! � " # $ % � & ' ( � ) * + , � - � . / 0 ! . 1 2 3 � 4 � � � ! � 5 6 � � 7 8 � 9 : � x � � � 6 8 " ; < = � � � � � � > ? ! @ A ! � 5 6 � �� � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � ! � " # $ % � & ' ( � ) * + , � - � . / 0 ! . 1 2 3 � 4 � � � ! � 5 6 � � 7 8 � 9 : � x � � � 6 8 " ; < = � � � � � � > ? ! @ A ! � 5 6 � �16

18

Year-on-Year

(%)

Year-on-Year

(%)

14

-40

-30

-20

-10

0

10

20

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

-1,200

-

-400

0

400

800

2007 2008 2009

-

-

-

-

-800

-

2

4

6

8

10

12

14

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

Year-on-Year

Quarter-on-Quarter

2007 2008 2009

Year-on-Year

Quarter-on-Quarter

Consumption and Investments in China’s GDP

China’s GDP Components

15

30%

35%

40%

45%

50%

55%

60%

1990 1995 2000 2001 2002 2003 2004 2005 2006 2007

ConsumptionWage

Weights of Consumption and Wages to GDP

Difficult Policy Choices facing PRC

� Foreign Exchange Reserves: 2 trillion dollar question

China’s foreign exchange reserves reaching 2 trillion U.S. dollars

2/3 of reserves are dollar-denominated securities, including close to 800 billion U.S. T-bills and T-bonds

China is concerned about sudden fall of value of dollar, but does not have viable alternatives

Talking about SDR and diversifying out of dollar holdings, but actually purchasing U.S. government securities

16

� Basic Dilemma of China’s Economic Policy

China’s economic policy: “state-managed mercantilist policy”

• Export promotion by managing exchange rates

• Centralized foreign exchange control

Strong incentives to increase investments

• Creating unemployment problems and social unrest

Difficulties of increasing private consumption

• Shares of wages and consumption are gradually decreasing relative to GDP

Impact of Global Crisis on Japan’s Economy

� Most Severe Impact on Japan

2008 4Q -13.5% and 2009 1Q -14.2% Growth (Q-on-Q base)

Exports Declining 11.9% in 2008 4Q and 38.7% in 2009 1Q (on dollar base, Y-on-Y base)

Export Decline affecting production, profits, employments, investments and consumption in a vicious chain reaction

� Why So Severe Export Decline?

Contribution of Net Exports to GDP Growth Rate very high

17

Contribution of Net Exports to GDP Growth Rate very high

Yen Appreciation adding further declines due to price competitiveness

Dollar exports are translated into even smaller Yen exports, further weakening exports’ contribution to GDP

Yen appreciating due to wind-down of Yen Carry Trade

� Export Declines Hitting Leading Industries Heavily

Autos(-64.5%), auto parts(-47.7%), heavy machinery(-59.7%) and electronics(-40.7%) in 2009 1Q on dollar base(Q-on-Q)

Sales and Profits of Large Corporations Severely Hurt by Export Declines1

Japan’s GDP Growth Rates

Quarter on Quarter Year on Year

(%)

6.0

3.0

0.0

(%)

4.0

2.0

18

Net Exports

Gov’t Expenditures

Private Investment

Private Consumption

0.0

-3.0

-6.0

-9.0

-12.0

-15.0

2005

GDP growth rate

2006 2007 2008 20092005

-10.0

Net Exports

Gov’t Expenditures

Private Investment

Private Consumption

GDP growth rate

0.0

-2.0

-4.0

-6.0

-8.0

2005 2006 2007 2008 2009

Government Stimulus Package has Limited Impact

� Government Stimulus Package totaling Yen 75.4 trillion

Including 11.8 trillion Yen Budget Expenditures

Projected Budget Deficit of 9.9% of GDP for 2009

Others include Increase in Bank financing/guarantees and tax reductions

97.2% of the package directed at vulnerable families and SMEs, with only 2.8 % on expanding growth potential

� Freefall slowing down in recent months

19

But unemployment is increasing, consumption sluggish and private investments continue to decline in 2H, 2009

GDP Expected to decrease by 6.9 % in 2009 on top of 0.7% in 2008

Potential growth rate of Japanese economy could decline to 1.5 % level, meaning almost five years required to recover 2007 level of economic activities

Summary: Impact of Global Crisis on Three Countries

� China: Robust but Systemic Imbalance

Robust economic growth thanks to strong growth momentum

“State-managed Growth at any cost” strategy creating imbalances

External imbalance generating exchange rates/reserves dilemma

� Japan: Shock Absorbing but Ineffective Policy Response

Deep pockets (savings and reserves) absorbing external shocks

Trapped in Low Growth/Deflation spiral

20

Trapped in Low Growth/Deflation spiral

Government has limited options to tackle economic stagnation

� S. Korea: Vulnerable but Resilient

Vulnerable due to high degree of openness in trade and capital

High crisis management capability due to Financial Crisis of 1997

Government policy: responsive and flexible

Can Regional Cooperation Help Reducing Vulnerabilities?

� Forex reserves to increase shock absorption capacity

Three Countries have over 3 billion dollar reserves

Large amounts of reserves both costly and problematic

China, in particular, has a dilemma

� Pooling Forex reserves in East Asia can reduce high costs of maintaining reserves – Chiangmai Initiative(CMI)

Multilateralized Currency Swaps totaling USD 120 billion

80 percent of the total shared by three NEA countries

21

80 percent of the total shared by three NEA countries

A good start, but still a small amount compared to total reserves that the region has

� Future Direction of Regional Monetary Cooperation

Next 10 years: US Dollar and Euro will be dominant

IMF-Compatible Asian Monetary Cooperation?

Asia Monetary Fund or Regional Currency Bloc Unrealistic

Tasks in Real Side: Expanding Regional and Domestic Growth

� East Asia’s Dependence on External Markets

Consumption in the U.S. expected to decline from 72% to 67% of GDP over the next few years.

Global economy and Asia should find alternative markets to substitute for American consumption.

Asian exports’ dependence on external markets is still 67%, including processed exports. (In terms of initial destination, 48%)

� Policy options to expand regional demand

22

� Policy options to expand regional demand

Freer Trade and Investments

• Regional FTA

• Regional Development Bank for Infrastructure Investments

Tapping Services Sector

Low-carbon, Green Growth

Final Demand Composition of Asia’s Export in 2006

23

Does the Services Sector Have the Promised Potential?

� Is the Regional Services Sector really underdeveloped?

Services Sector in emerging markets undervalued due to non-tradable goods

Services Sector has more traditional establishments due to social reasons; e.g. one-man est. account for ¼ of S. Korea’s labor force

Asian services sector has more employment due to high standard of services demanded by Asian consumers.

� Areas of Potential Growth in Asian Services Sector

Finance

24

Finance

Education and Professional Services

Health Care

Tourism

Retail and Physical Distribution

� What is needed?

“Asia-centered Hub and Spoke Network”

“Asia-centered Knowledge and Intellectual Leadership”

Areas of Collaboration in Low-Carbon, Green Growth

� New Engines of Growth for the Coming Decade Renewable and New Energy Low-carbon Production and Consumption Bio and Healthcare

� What East Asia has in Low-carbon, Green Growth Most energy-efficient economy Technology leaders in electric and energy-efficient cars High R&D expenditures of East Asian countries

25

� Areas of Potential Collaboration Cap and Trade in greenhouse gas Technology collaboration Combating cross-border pollution, such as yellow dust

Critical Question: How to derive synergy in the coming technology

competition in East Asia?

Impact of Global Crisis on East Asian Corporations

� Global Financial Crisis and Global Corporations

Non-financial corporations are relatively robust despite slow-down in sales and profits

Biggest shock waves in the global auto sector due to GM and Chrysler –Global industry shakeout likely in coming years

Even in other industries, new winners will emerge from current crisis: companies with liquidity and intangible assets

� Impact of Current Crisis on East Asian corporations

26

� Impact of Current Crisis on East Asian corporations

Japanese giants in electronics and heavy industry are hard hit.

Korean global corporations are in good shape: depreciation of won helped them, but competitiveness of some KGCs are at high end.

Big Chinese companies are least affected by the crisis due to the stable value of yuan and strong domestic demand – they are likely to emerge as actors in the next wave of M&A globally, especially in high-tech and resources industries

Recent Performance of Korean vs. Japanese Companies(’08.1Q � ’09.1Q)

Toyota

20

40

80

Japanese companies

Korean companies

Revenue (U.S. $.billion))

Honda

27

10

20

-25 -20 -15 -10 -5 0 5 10 15 20 25

OperatingProfit Margin(%)

Honda

Sony Panasonic

Nippon Steel

Canon

Samsung Elec.

Mitsubishi Heavy

POSCOHyundai Heavy

LG Elec.

Hyundai Motor

note1: Sales revenues were converted into dollars by multiplying quarterly average of won/dollar and yen/dollar exchange rates.2: Sales revenues of Korean companies were based on parent-only financial statements and those of Japanese companies were

based on consolidated financial statements.Source: KIS-Value (Korean companies), Thomson One Banker (Japanese Companies)

Some Bold Projections for the Next Decade(2010-2020)

� The Global economy enters a period of low-growth, high-inflation.

� Center of Economic Growth will shift to Emerging Markets, esp. BRICs and Asia

� For the next decade, the United States will maintain the leadership position, but Pax Americana will gradually change into more fluid, multi-polar era.

� U.S. Dollar and Euro will share the role of reserve and transaction currencies, and the role of RMB will be limited.

28

currencies, and the role of RMB will be limited.

� Biggest Challenge for the world and region will be how to live with ‘rising China.’

� It is possible that new values emerge in capitalism and management philosophy; ‘sustainable, post-growth economy.’

� Key words for next growth industries will be low-carbon, green and bio/health (green, smart and secure).

New Perspectives on East Asia

� East Asia as Multiple Hubs and Spokes Still dominated by three nation-states, but

East Asia has six main economic hubs and multiple sub-hubs

Hubs and sub-hubs should have multiple linkages with others

� East Asia as a Time Machine Has Five Centuries living together

Backward, Agricultural, Industrial, Information and Post-IT sectors

29

Backward, Agricultural, Industrial, Information and Post-IT sectors at the same time

Advanced sectors have information and knowledge to share

� Japan as an advanced society is in a peculiar position: Most aged society

Most energy-efficient, clean society

Sophisticated, post-growth consumption society

Galapagos Islands or Regional Life-style Hub?

Implications for Hokkaido Economy: Three Key Words

� Emerging Markets Linkages to Northeast China, Russia and North Korea Should develop logistics networks Utilize Tokyo and Honshu but develop linkages with other hubs

� Low-Carbon, Green Growth Excellent Potential as “Clean and Green” lifestyle Climate Change can have positive effects on Hokkaido

30

Climate Change can have positive effects on Hokkaido Should have “active population policy”

� Service Industry Bio and Healthcare Natural or organic food Sports tourism Alternative Energy How to reduce costs?