Asia in '86 Jude Wanniski August 6, 2004

Memo To: SSU Students
From: Jude Wanniski
Re: Three Weeks in Asia

This week and next, I'm publishing a client letter I sent in September 1986 upon returning from a three-week trip to Northeast Asia, with stops in Seoul, Tokyo, Beijing, Taipei and Manila. I've not previously made this available to the public or SSU students, but as you will see it reads well with hindsight. We start with Korea and Japan, concluding next weekend with the People's Republic of China, Taiwan and the Philippines.

A TRIP TO NORTHEAST ASIA

By Jude Wanniski

From August 1 to 21 I traveled to five countries in Northeast Asia, whistle-stopping in South Korea, Japan, the People's Republic of China, the Philippines and the Republic of China on Taiwan. It was an efficient "fact-finding" trip organized by the World Media Association, a Washington outfit financially backed by the Unification Church of the" Reverend Sung Myung Moon. About 25 journalists, academics, and Asian scholars made the trip, led by Douglas MacArthur II, former Ambassador to Japan, now a sprightly 81. Meetings were arranged (where possible) with high-level government officials, opposition representatives, the U.S. ambassadors, academics and businessmen. Dr. Bo Hi Pak, president of The Washington Times and the Rev. Moon's right hand, said the objective was to heighten the sensitivity of u.s. opinion leaders to the region at a time of great change there -- as opposed to the predominant focus in the u.s. on the Atlantic region. There were several spirited speeches by Dr. Pak along the way, extolling the relative merits of freedom, liberty and democratic capitalism. But otherwise the itinerary could just as well have been set by the Rockefeller or Ford Foundations, and it was extremely useful in understanding the region's immediate dynamic. Herewith, my observations on a country-by-country basis, taken in sequence, with some comments on the region as a whole following.

September 9, 1986

* * * * *

SOUTH KOREA (Seoul)

The central fact of South Korea in this summer of 1986 is the approach of the 1988 Olympics, which it will host. In both direct and subtle ways, the enormity of the Olympics to a nation the size of Indiana influences almost all important political and economic behavior. It's only the second Asian nation to host an Olympics -- and because the power elite in the population of 43 million believes the 1964 Tokyo games propelled Japan into an industrial power of the first rank, it is obsessed with a similar dream. As Korea accelerates into the gravitational pull of the 1988 games, pressures to clean house intensify.

The most important pressure is political reform. President Chun Doo Hwan is an unusually unpopular head of state, given the fact that the economy has boomed in his six years. A hardnosed ex-military man, Chun is still blamed for the deaths of 200 students in May 1980, whose demonstrations following the assassination of President Park Chung Hee were ended with savage military efficiency.

A long-promised democratic constitution is in the works, although it still hasn't been decided whether the new system will be a parliamentary or presidential one. In any case, Chun has promised to retire. Candidate selection is planned for 1987, with elections in the spring of 1988. The schedule is such that the profound skepticism among the democratic forces of opposition has been allayed, knowing the power elite doesn't want a mess on its hands in the summer of 1988 and would like to have the games introduced by a popularly elected head of state. Chances are the constitution will call for the parliamentary form favored by Chun's Democratic Justice Party, and the prime minister will be his hand-picked successor. The New Korea Democratic Party favors a presidential form, figuring one of its "two Kims" would stand a better chance of winning a popular vote.

Curiously, there isn't a political leader or faction identified with "the left," even a milquetoast left standing for "social justice" and such. It's as if the entire political class ranged across the right side of the Republican Party's political spectrum. The ruling DJP will put up the equivalent of George Bush. Kim Dae Jung, who stands for democracy but has no other visible agenda, might be the Howard Baker of Korean politics. Kim Yung Sam, who carries the banner for entrepreneurs and lifts an eyebrow at the corporate elites, seems to be the Jack Kemp in the picture. There is a premium on education in the political class. The U.S. Ambassador, Richard (Dixie) Walker, points out there are more advanced degrees in the top tier of the Korean government than in any other country in the world, including the United States.

The Threat From North Korea

Kim II-sung, the leader of communist North Korea since 1945, will turn 75 soon, and perhaps choose the time to formally turn power to his son, Kim Jong-il. According to an account in the Korea Herald in Seoul, of the 40 motion pictures produced in Pyongyang in 1985, 13 were designed to idolize the elder Kim and rationalize the power transfer to his son. On the minds of South Koreans to a rather surprising degree is the possibility that the North will take some kind of military action before the Olympics to undermine its success.

The common rationale is that time is running out for Kim II-sung in more ways than one. The population of the North is less than 20 million and its per capita GNP about $800, while the South's is about $2,200. The North spends 40% of its GNP on the military, the South only 7% to stay even, and these gaps are widening in the South's favor. At the same time, Pyongyang's one-time benefactor in Beijing is moving toward geopolitical alliance with the western nations as the PRC experiments with western-style economic reforms. Asked whether he'd like to see a militarily stronger or weaker mainland China, one of the highest ranking generals of the ROK Army told me "Stronger, of course stronger!!"

It defies logic that there would be a strike against the South, given the geopolitics of the moment and the 41,000 U.S. military personnel in South Korea. But an American businessman who's been posted in Seoul for several years assured me I wasn't hearing plain and simple paranoia. "There's a real fear that the Kims will do something wacko," he shrugged. The atmosphere is nudging Seoul into a coaxingly conciliatory policy to the North, to demonstrate to the world that it isn't trying to prevent an improvement in relations: It has offered to let Pyongyang hold the archery and ping-pong events in 1988 (but the communists want much more). In early August, North Korea did not show for long-scheduled bilateral economic talks at the truce village of Panmunjom, without a reason, raising the irritation level. But then there was Mikhail Gorbachev's July 27 Vladivostok speech, unveiling Moscow's Asia initiative. This was part of the buzz everywhere we traveled, and in Seoul it was of course particularly noted that the Soviet leader had said it was vital "to eliminate the tension on the Korean peninsula..." (The Kremlin lately has been stepping up its military help to Pyongyang.) The guessing is that Moscow, which boycotted the Los Angeles games in 1984, in fact wants the 1988 games to be held and will work to keep anything "wacko" from being planned. Meanwhile, more than a million troops remain deployed on either side of the Demilitarized Zone, "a tragic waste," says Ambassador Walker, an extremely impressive fellow.

The Economic Dynamic

Imagine living in an Indiana that instead of being part of the U.S. is a separate nation. The Hoosiers have been hardworking people and they get along with their neighbors in trading relationships. But to live in this Indiana, which has an "export-led" economy, certain special rules apply. Only two kinds of automobiles are allowed, Fords and Chryslers. You can drink Schlitz beer and smoke Marlboros, but none other. Eat pork and ham but not beef and veal. And if you want to travel as a tourist to Ohio, unless you are older than 55 you have to apply for special permission, which the government rarely gives because that would mean the loss of precious foreign exchange. It's not hard to see that Indiana might still have a thriving economy, but that it would have an added burden competing for world class talent in all fields.

This is South Korea, which has had a 45% GNP growth since 1981 and has fantasies of someday overtaking Japan, its rival, where growth has stalled. Seoul, a city of 10 million, has the appearance of a modern European metropolis, with an imposing skyline, broad boulevards, and magnificent hotels. But you soon notice that there are only two types of autos in the streets, the Korean-made Hyundais and Daiwoos. In five days I spotted one Fleetwood and one Mercedes. A Korean businessman advised me that the government permits entry of a handful of foreign luxury cars each year -- with import tickets for them going to executives of companies with the best export growth.

This is almost a caricature of the export-driven model devised by Korean manic-Keynesians trained in the U.S. after the Korean war. Consumption is okay as long as it doesn't involve foreign exchange, and until very recently Korean nationals could actually go to jail for being caught smoking a foreign cigarette. (Michael Deaver's lobbying on behalf of Philip Morris in Korea involved the tobacco and wine monopolies whose profits provide the government with 7% of its revenues.) Hundreds of other import items are simply banned, or with duties so steep -- as on computers -- that they are effectively banned. I was told that U.S. soldiers do a thriving business buying U.S. goods at the PX and selling them on the black market -- Hellman's mayo goes for $3 a quart.

The rule on tourist travel is another dizzy one. In 1985, tourist passports were issued to fewer than 2,000 Koreans, 0.4% of the total number of outgoing Koreans (on business or emigration). Kimpo Airport, as a result, is very small for the size and wealth of the country. Here again, the 1988 Olympics is putting pressure on the system -- with the travel industry beating on the government to relax tourist travel for people over 40. The Asian Games scheduled for September 20 - October 5 will test the already-completed athletic facilities, but the Olympic crowds will dwarf anything the Asian Games will hit Kimpo with.

Trade

In its years of extremely rapid growth, South Korea ran up sizeable trade deficits as capital poured in. Foreign debt is now about $47 billion, but almost all is private debt. The trade account went into surplus in 1985 because of what the Koreans call the "three lows" -- the lower won (stronger yen), lower oil price, and lower international interest rates. A lower growth rate than has been usual, of 5%, also helped, and the trade surplus with the U.S. went to $4.3 billion. The "three lows" went even lower this year and the bilateral surplus with the U.S. may hit $6 billion in 1986.

Thus, the U.S. Treasury's open pressure on Seoul to appreciate the won by 15% to 20%, which brought an outburst of indignation and student demonstrations against the U.S. while we visited. The U.S. Embassy was irked at Treasury for "overloading the circuits," a rather protectionist multi-fiber textile agreement having just been shoved down Seoul's throat. The Korean Herald correctly identified C. Fred Bergsten, the manic dollar-devaluationist who served in President Carter's Treasury, as the source of this foolishness. Bergsten, now running the U.S. Institute for International Economics in Washington, had been in Seoul earlier in the summer, wagging his finger at the Bank of Korea for keeping the won steady against the dollar. His counterpart in the Reagan Treasury, David Mulford, is just as dim and arrogant. To push Korea and Taiwan into a currency deflation, as he has, would only widen their trade surpluses with the U.S. by slowing their economies. This kind of "Ugly American" imperiousness has had a sour effect on Korean attitudes toward the Reagan Administration. There is a "We-must-not-let-the-superpower-take-advantage-of-us" posture among Koreans, who correctly sense there are U.S. politicos who think they can use military leverage to extract trade concessions from them. It's one thing for Jim Baker to urge our trading partners to expand; it's quite another for Mulford to press them to contract.

Taxes

At first glance, the Korean tax structure seems relatively onerous, with a 71% top marginal income-tax rate at $26,000 (including surtaxes for residence) defense and education). The 31% bracket is encountered at $14,500 of taxable income. But there are big loopholes designed by the conservative Keynesians to boost capital formation -- which have positive supply-side effects. The biggest is the top rate of 16.75% on all dividend and interest income. The corporate rate is 20% on the first $60,000 of profits, 30% thereafter. And foreign-source income can be repatriated without tax (Koreans making fortunes in Japanese real estate pump capital back into the home industries and clip coupons with that 16.75% top rate on unearned income.) A 10% VAT provides 26% of all government revenue (the income tax only 11%). Exports are excluded. So are enterprises with sales of under about $1,000 a month -- which is why there are a few hundred thousand mom-and-pop enterprises in Seoul.

The system keeps little enterprises little and invites bigness at the top, with an atrophied middle ground. As the work force moves into higher brackets, though, the tax system is bound to pinch off productivity. The Finance Ministry should be thinking about a tax reform to hike thresholds on earned income and pull down the rates. But the government's attention is devoted to spending, prettying up Seoul for 1988, putting in miles of flower beds on the banks of the Han-gang, widening highways, etc. There's no talk of tax reform and probably won't be until the games are over and the new electoral process allows these issues to be opened to partisan debate.

So much depends on the Olympics. As 1988 approaches it's likely we'll see a transfer of power in both the Koreas, which seems to be coming the geopolitical center of gravity in Asia. In almost every way, the pressures the games are putting on South Korea to reform are positive. I left Seoul feeling good about what I'd encountered, a sense that Korea is in the process of shaking off adolescence and entering young adulthood, that good things will happen there politically and economically in the era ahead -- including the beginnings of reconciliation with the north. It's a side to the Olympics I'd never given a thought to. Perhaps the 1964 games in Tokyo had a similar effect in the maturing of modern Japan.

*****

JAPAN (Tokyo)

To an American traveler, the most startling fact of Tokyo these days are the prices. Tokyo has been an expensive city for decades, but with the 40% appreciation of the yen against the dollar in the last 15 months the prices are truly stupefying. A sushi lunch for two at a Seoul airport restaurant, abundant and delicious} came to $8 with one beer and one coke. Dinner for two at the Japanese restaurant at the Hilton International in Tokyo, two Kirin beers each, was $160, and we left the table hungry. (A bottle of imported wine on the Hilton wine card starts at $100.) The airport bus, for goodness sakes, was $17.50 into Tokyo. In the city, our group spent odd hours "shopping" in the Ginza, reading price labels in horror. Doctor Alvin Rabushka, the Stanford economist saw a gold Rolex that sells for $9,000 in Tiffany's -- and for $7,000 in Hong Kong -- in a swanky Ginza jewelry store for 3,900,000 yen: about $26,000. Richard Grenier, columnist for The Washington Times, observed that the "ladies by the hour" in the Shinjuku district were ignoring obvious Americans (who didn't have the yen?).

"Going to Tokyo from New York these days is like going from Mexico City to New York," someone remarked, more in the context of the psychological impact than the physical -- a vague feeling of inferiority that creeps in with the prices of things. One gets the same effect quickly by going from Macy's to Bergdorf's. It was also observed that the unfailingly polite Japanese are fraying around the edges, showing irritation and impatience with Americans in small ways. We could imagine the waiters at the airport hotel running a prisoner of war camp.

But there is, after all, a general awareness that the stalling of their economy has been arranged to accommodate Americans over the bilateral trade deficit. The Japanese businessmen are as anguished over the exchange rates as we were at their prices. Their frustration is compounded as they watch Japan's trade surplus rise month after month in dollars even as exports in yen are in steady decline. (Think about that, and you will eventually realize why exchange rate changes don't change trade flows.)

Our Ambassador to Tokyo, Mike Mansfield, began his briefing to us by declaring that "Japan's $50 billion trade surplus with the United States is intolerable!!" Mansfield, Senate Majority leader back in the LBJ/Nixon years, was disappointing, a beloved anachronism here, reeling off statistics amidst a patter of cliches to demonstrate his mind is still sharp at 75.

"I don't like our country being the biggest debtor country in the world. Last year the interest on our debt was $133 billion! This year it will be $145 billion! We no longer hold the enviable position we had following the world war!.Protectionism is not the answer! It might bring some temporary relief, but it would only be temporary! We have to do something about the deficit!!.American businessmen have to get off their duffs!"

There were some useful tidbits. Asked about why the Bank of Japan is resisting a cut in its discount rate, he suggested we wait and see what Germany does and that we give the new Finance Minister time to "get his feet on the ground." The economic attache mentioned the tax reform being cooked up behind the scenes, for presentation this fall: They want to bring the rates down, but the desire is for revenue neutrality. There's talk about a VAT to pay for the income-tax cuts, but since a VAT is export exempt, it would stimulate exports, the problem to begin with; maybe some tax on savings accounts.

While we were in Tokyo, Prime Minister Nakasone's chief spokesman announced that a drastic income tax cut was needed as part of the tax reform aimed at correcting an unfair tax burden on salaried workers, and that government intends to help workers and companies affected by the yen's rapid appreciation -- even though the combined national/local debt is now 200 trillion yen! That's $1.3 trillion!!! (Get off your duffs, boys.) Also, the Daily Yomiuri lavished editorial praise on the Reagan tax reform, urging Nakasone to get going: "Japan must lower corporate rates and not raise them to compensate for the revenue loss from cutting personal income tax. Distortions in the income-tax system in Japan are so great that they need immediate remedy. But it is not clear whether the government intends to finance a personal income tax cut by increasing indirect taxes or settling the issue by reforming personal income tax only. Nakasone should clarify to all what he intends to do."

In the absence of clarification, the Tokyo stock market has been on a roller coaster, albeit trending ever upward. The top income tax rates (30% at $40,000 equivalent, 50% at $100,000, 70% at $530,000) will be knocked down sharply. How does Japan do so well at those rates at all? Loopholes! On the first $65,000 of salary income, 21% is exempt. Plus employee housing allowances are taxed lightly. Plus the personal exemption is $2,100. Plus Social Security tax is deductible. Plus most retirement income is exempt. Plus dividend and interest income is capped at 35% tax. There is also no tax on portfolio capital gains. On rumors the reformers have their eyes on this source, the market plunged. There are plenty of supply-side vibrations in Tokyo, though, suggesting they will get it right. (I had an added thought in Tokyo that not long after the plan is unveiled Seoul will have its attention forced to tax reform -- just as Canada is being nudged by its business community to follow the U.S. reform.)

Geopolitical Realm

In the geopolitical realm, there was a medium buzz in Japan over Gorbachev's Vladivostok initiative. Gorbachev has ambitious plans to develop the eastern regions of the USSR, and wants access to Japanese capital and technology. He's visiting Tokyo in January and Nakasone is talking about going to Moscow in '87 (a shrewd domestic political ploy by Nakasone -- remember he's trying to get his political party to let him stay as prime minister beyond next spring). As always, the key issue is the northern territories, the Kurile Islands that the Soviets grabbed from Japan in 1945. So far, we're told at the U.S. Embassy, the Japanese reaction to Gorbachev's overtures has been cautious. There are no illusions here.

Another item worth mentioning was a Reuters dispatch I spotted in the Korea Herald about Nakasone's newly appointed and just dismissed education minister, Masayuki Fujio, 69, described as the "most aggressive post-WWII Japanese politician." In his first two weeks, "he has insulted China, raised the specter of Japanese militarism, accused the western allies of arrogance in Japan after World War II and severely embarrassed his government"

In a "recent outburst," Fujio said Japan's postwar generations were twisted by enforced Western values: "Who gave the victors the right to judge the losers? It's wrong to think prewar Japan was all bad and the occupation period perfect." He has also urged parents to hoist the Japanese flag in their homes and to instill love of country in their children. "Many Japanese, who remember prewar military drills in schools beneath the Flag of the Rising Sun, were appalled." Fujio also blasted the execution by the allies of seven Japanese wartime leaders.

What's going on? Why did Nakasone put up with this fellow (who actually seems like my kind of guy)? According to Reuters, one view was that "By letting Fujio loose, the prime minister can gauge international reaction to such provocative views and yet look good himself by taking the role of pacifier. And, if Fujio oversteps the mark, Nakasone can remove him whenever he wants."

Fujio's recent remarks that Korea shared responsibility for its 1910 annexation by Japan threatened to jeopardize Nakasone's visit to Seoul later this month. When the outraged Koreans postponed this week's meeting between the countries' foreign ministers Nakasone dismissed Fujio.

Hmmm. First $100 wine. Then the ladies of Shinjuku spurn American gents. Then Fujio was unleashed. Next we'll be hearing about a Greater East Asia Co-Prosperity Sphere. So much for the benefits to the U.S. of a weak dollar. Bye-bye Japan.

*****

(Here we come, next week, Red China.)