With Masahiko Aoki. Interview. "Economists Examine Multifaceted Capitalism." Interviewed by Toru Kunisatsu. Daily Yomiuri, 4 January 2000.

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1 With Masahiko Aoki. Interview. "Economists Examine Multifaceted Capitalism." Interviewed by Toru Kunisatsu. Daily Yomiuri, 4 January The second in this series of interviews and dialogues features Prof. Emeritus Milton Friedman and Prof. Masahiko Aoki. The two prominent economists discuss how capitalism will evolve in the 21st century. The Yomiuri Shimbun: The 20th century saw the birth of socialism, which, despite once attracting wide support, eventually collapsed in many countries. What do you think are factors behind he victory of capitalism over socialism? Friedman: I think all such questions treat capitalism in an overly simple way. Every country in the world is capitalist in one sense. Capitalism refers to the ownership and operation of physical capital of factories and buildings. The Soviet Union was a capitalist county. It was a government capitalist country. Government ownership and operation of the means of production has proved to be a system that is very inefficient, and the reason for the inefficiency is very simple: nobody spends somebody else s money as carefully as he spends his own. That is the really key proposition in such questions. Aoki: When there was a final demise of communist regimes in the early 90s, there was a degree of euphoria in capitalist economies as well as in Russia, where the people were suppressed for a long time, and it that time three measures were implemented very quickly. The first was privatization of business enterprise; secondly, there was the liberalization of markets; and thirdly, the government confined itself to stable macroeconomic forces. It found out that the outcome of the intended reform was not so encouraging and the GNP (gross national product) of the Russian economy shrank by 40 percent in this decade. I think the government can play a very important role in the market economy. But in Russia, the government lost its power to define and enforce private property rights. In the Russia of today, the government simply lost the ability to define and enforce private property rights, and the cynical view could be that one of the most successful privatizations in Russia is contractual

2 enforcement through violence by the mafia and so forth. One of the important lessons we can draw from the last decade of the 20th century is that the government still has a role to play in the enhancement of the markets. Do you think any new system will emerge in the 21st century to replace capitalism? Friedman: I don t think there are any other concepts that can emerge. I think the big problem for the 21st century will be to keep governments from growing too powerful. The great threat to free markets is from excessive government control. For example, in the United States, as governments have become more powerful, crime has risen. It hasn t fallen, and yet one of the fundamental functions of government is to enforce law and order and to prevent one member of society from hurting another. It is less efficient in performing that function than it was 100 years ago. Aoki: When considering the appropriate level of the role to be played by government, it is interesting to note moves toward regional integration as in the case of the European Union a kind of federal system. Financial policies have been integrated under the European Central Bank. With the emergence of the common currency, the euro, central banks of EU member nations have lost the right to issue currency, a major role of a central bank. Member nations must compete in the market to make up for fiscal deficit. A tight hoop was effectively put in place to prevent a government from becoming too powerful. It is extremely difficult for Asian countries to adopt a common currency as in the EU. But I think it will be possible and necessary in the 21st century to establish a particular kind of mechanism that brings Asian economies closer. Do you think that the Japanese type of capitalism, as represented by lifelong employment, can survive in the 21st century? Aoki: In the 1970s and 1980s, there was a more reciprocal information flow between the top and bottom and also laterally between development teams and the manufacturing side. This close information sharing was a very important aspect of Japanese corporations and gave some competitive advantage in the automobile industry and so forth. But with the advent of the digital age in which information was shared much faster and more efficiently, Japanese firms lost some of their advantage. 2

3 In an age of tremendous uncertainty, planning becomes more and more important, and a better technological system is selected in a more evolutionary way as in Silicon Valley. So I think the Japanese crisis can be overcome when Japanese firms achieve organizational innovation that melds better with the current state of communications technology. Friedman: I am sure that Prof. Aoki is right about the institutional transformation, but I think it is necessary to separate the problems of the long term and the problems of the short term. I have no doubt that over the longer term Japan is engaging in a process of institutional reconstruction that will undoubtedly strengthen society and make it more efficient. I think it was before, in the 1980s, that monetary policy in Japan was too expansive and helped sustain the bubble economy. And then, in 1989, the bubble burst with the help of the Japanese central bank, which restricted monetary growth very sharply. What you need to do is avoid a deflationary policy and, for that purpose, I believe Japan at the moment needs monetary growth at something like a 5 or 8 percent rate. There is nothing to prevent the Japanese central bank from making monetary growth whatever it wants it to be, and it seems to me that is what they need to emphasize rather than emphasizing this particular zero-interest rate policy. With the development of capitalism, the power of speculative money has become stronger to the extent that it cannot be controlled by state authorities. Does this mean that capital markets are crossing national borders? Friedman: In my opinion, the IMF (International Monetary Fund) is mostly to blame for the financial collapse in East Asia. If there had been no IMF in existence there would not have been an East Asian crisis. Countries like Thailand, Indonesia, Malaysia and South Korea were all encouraged by the IMF to maintain a system of a pegged exchange rate with the U.S. dollar. Why is it that Japan did not have the same kind of external crisis that these other countries had? It was because Japan did not do that. Japan had an independent central bank with a floating exchange rate. Japan has had many internal difficulties, but it has had no external crisis. So I think the problem in East Asia was not capitalism. It was the International Monetary Fund. 3

4 Aoki: Let me talk about the Asian crisis. I think this Asian currency crisis developed via some gap between the development of a global financial market and immature domestic financial institutions in those countries. Because of the development of information and communications technologies, global financial markets become more and more integrated, but in East Asian countries such as Thailand and South Korea the sound banking system hasn t developed very well. China was immune to the currency crisis contagion because Chinese financial institutions were insulated from the international markets. So I think one way of responding to this situation, as adopted by Malaysia, is probably to place some kind of control on short-term capital movement and to insulate domestic markets to some extent so that those countries have enough time to develop sounder banking institutions. Friedman: I agree with Prof. Aoki that there is a difference between international financial integration and banking conditions within a country, but I do not agree that it is desirable to introduce any controls over short-term capital movements. None of these countries would have had these problems if they had had floating exchange rates. The Bretton Woods system centering on the IMF and the World Bank is said to be reaching its institutional limits. What kind of an international financial system will emerge in the 21st century? Friedman: I am afraid that the IMF and the World Bank will be a major part of the system. I say I am afraid because I think they have done more harm than good and that the world would be better off today if they were allowed to perish as they should have done a couple of decades ago. The problem with international organizations is that there is no way of controlling them. The IMF, for example, is a force unto itself. No country has effective control over it. The IMF spends the taxpayers money of member countries, but taxpayers have very little say about it, so I don t think international organizations that are unconnected to the political structure of democracy are a desirable way to improve matters in the future. Aoki: We are in the process of searching for what could be the best global arrangements. Of course, a certain kind of international mechanism needs to be established to deal with globalized markets. 4

5 As we are witnessing in the European Union, some kind of regional mechanism is starting to evolve, and nongovernmental organizations are playing very important roles in the area of pollution control. In the first few decades of the 21st century, I think the roles of international institutions, regional organizations, central and local governments will overlap intricately to form a complicated matrix. How do you evaluate economic reforms in Russia and China? Friedman: The development of a primarily free private market system requires the rule of law and the ability to enforce it. But in Russia those things were not present and as a result the near collapse of communism did not create a viable free private market So what you really need in Russia is to have a greater freedom for individuals to proceed. Simply switching state-run companies to private hands cannot lead to enhancing efficiency because nothing will change from the time of state control. Aoki: I wonder if the attempt by Western advisers to transplant the Anglo-American model in a big bang way is somewhat out of place because it may not have been consistent with the historical past of Russia. So whenever we try to think about reforms like in Japan we really had better think about the conditions peculiar to each country. I agree that the law is very important, but at the same time all the contracts cannot be enforced by law only. There are substitutes for enforcing the law, like social norms and reputations. There are a variety of capitalistic systems. The role of a government, social norms and the rule of law are combined in a somewhat different way depending upon the country. Friedman: I don t believe the issue is of transplanting Anglo-American ways. I believe there was no difficulty in the case of Hong Kong. There are the ways of free private markets. There are the ways of the rule of law. There are the ways of the enforcement of contracts. Prof. Aoki is absolutely right in asserting that it requires more than a formal law. It requires a pattern of attitudes and cultures, but that attitude and culture is everywhere. It is not only in Anglo-American countries. There was no difficulty in Hungary, no difficulty in Poland, no difficulty in the Czech Republic in introducing the elements that Prof. Aoki was calling the Anglo-American way. Why? Because there was a big difference between those countries and Russia. In those countries, collectivism or central control was 5

6 imposed upon the people. It did not arise from within the country. Moreover, they had suffered under that system for a much shorter period, so they had a residual culture dating from before the communist system that was compatible with free private markets. In Russia, on the other hand, you never had a period of free private markets no matter how far back you go. The centralized collectivist communist system had been imposed on the people for something like 75 years. So there was no basic underlying culture, and finally you never had a basic fundamental reform from the top down that would open the way. China, on the other hand, proceeded under Deng Xiaoping to free the economic system first while maintaining political control. That opened up in China the real possibility of privatization from below. I believe that you are going to have in China a great conflict between the pressures produced by the private sector and the pressure produced by the political system, which is centralized. You had one manifestation of that at Tiananmen Square, but I think you will have additional manifestations of that conflict in the future. I think what will be enormously interesting for us economists is to see how Russia and China develop in the future. The 1990s turned out to be the lost decade for Japan. Aoki: The environment surrounding the Japanese economy has been changing sharply due to a substantial demographic change, development of communications and information technologies, and globalization of financial markets. The Japanese institutional arrangement hasn t adapted to this institutional change yet. Prof. Friedman may not remember, but actually I met him for the first time almost 40 years ago. I was a graduate student at the University of Tokyo. Friedman: You didn t look the way you look now. Aoki: At that time, I posed a question to Prof. Friedman, who was very critical of the central planning method. I raised the question that in capitalist or market systems there are huge organizations like General Motors and IBM which have even larger planning organization apparatus, and why do they work well? Obviously, Prof. Friedman s answer was that they are competing in the market and if they cannot make a profit, the organization cannot survive. 6

7 Friedman: I don t know that anything is wrong with Japanese capitalism. In fact, I don t think I know what is Japanese capitalism as compared with American capitalism, or British capitalism, or Hong Kong capitalism. What I do think was wrong with Japan was the conduct of monetary policy. One of the factors that serve to create short-term problems in the 90s has been the mistaken attempt by the government to use what it calls fiscal stimulus with a belief that it will promote the economy. But all of them have been failures; none of them has had any significant effect on promoting the economy. That is not a surprise because the fiscal stimulus is not a stimulus. It is not good for a government to spend the people s money instead of letting people spend it for themselves. It is my understanding that much of the so-called fiscal stimulus has involved infrastructure products that have a very low productivity and, in my opinion. Japan would have recovered much more rapidly and would be amid less of a problem now if it had not had any of these so-called fiscal stimuli. This left Japan with a very high long-term debt that will become a serious problem as the country is entering an era of aging society. Aoki: I quite agree with Prof. Friedman s view that fiscal stimulus is not effective for resolving the Japanese problem. In Japan, each industry has an association representing its interest and with connections to government offices that have jurisdiction over it. By making use of the interest-group system, the construction industry pulled in more and more public money, thereby boosting the number of workers employed by the industry in the 1990s. The system doesn t really contribute to improvement the productive economy. It is rather harmful in promoting efficient institutional reform. It seems that the Japanese government is shifting the policy emphasis more to providing the framework for development communications technologies rather than trying to keep a vested interest. I believe tax reforms will be instrumental in reinvigorating the Japanese economy. To help increase the number of holding companies that would contribute to streamlining corporate organizations, it is indispensable to introduce a consolidated accounting system promptly. Friedman: Japan, remember, is a very efficient, very productive society. I think that the United States owes a great debt to Japan. I think it was the competition from the Japanese automobiles, electronic 7

8 industries and so on in the 1980s that was a major stimulus to the reconstruction of American corporations. I do not be believe that GM and Ford and the others would be producing cars at as low a cost as they are now if it hadn t been for the competition from Japanese companies. I have no doubt that Japan will emerge from its present difficulty and will continue to be a very strong and progressive and growing economy. 8