Japan Policy Research Institute Working Paper # 70 (August 2000)

The World Bank and Japan:

How Godzilla of the Ginza and King Kong of H Street Got Hitched

By Edith Terry (*)

In 1994, the Harvard economist Dani Rodrik wrote an article for the Overseas Development Council under the whimsical title »King Kong Meets Godzilla: The World Bank and the East Asian Miracle.« In it he argued that the World Bank's famous report of 1993 on East Asian economic growth had opened a serious wedge for wider acceptance of Japan's economic philosophy, despite the Bank's self-declared »victory« over Japanese-style industrial policy (see World Bank, The East Asian Miracle: Economic Growth and Public Policy, New York: Oxford University Press, 1993). »Godzilla« was Japan's Overseas Economic Cooperation Fund, Japan's main loan agency for developing countries, while »King Kong« was the World Bank. Six years later, what Rodrik called a »clash of celluloid titans« has become something more like a marriage of strange bedfellows. The World Bank has not only endorsed the East Asian and Japanese models but it has also become Japan's strongest ally against the U.S.-inspired policies of the International Monetary Fund (IMF).

The mating dance lasted nearly a decade. In the year 2000, Japan is confident enough to extend its courtship to the IMF. Buried in news about the anti-globalization protests, a major theme of the annual spring meeting of the World Bank and IMF in April 2000 in Washington DC, was the Japanese demand for a larger voice for itself and other Asian nations. As protesters stormed the barricades outside, a senior Japanese official told the New York Times, »There's a sense that this has always been a white man's club, and that needs some rethinking« (April 17, 2000).

Among the Washington dramas leading up to the IMF/World Bank meetings was the contest for the top job at the IMF. In November 1999, Michel Camdessus abruptly resigned as managing director of the IMF before the end of his third term. He had been forced to leave in part because of the IMF's mishandling of the financial crises in Asia, Russia, and Brazil. Japan put up Eisuke Sakakibara as a candidate, and despite intense international skepticism about Sakakibara's chances, Tokyo continued to insist on its man. The IMF has traditionally picked a European as managing director, while the head of the World Bank is traditionally an American. Sakakibara resigned as Japanese vice minister of finance for international affairs in July 1999, but he maintained a high profile by taking pot shots at the international financial system, which he blamed for the Asian financial crisis, and by declaring that Japan should use its foreign aid to build up an Asian alliance to compete with NAFTA and the European Union. In March 2000, the IMF finally chose as its head Horst Kohler, former head of the European Bank for Reconstruction and Development. But, as the New York Times put it, »The world's second-largest economy was clearly laying down a marker that it no longer planned to acquiesce to the old order.«

A few weeks earlier, on March 7, 2000, Reuters ran a brief story from its Tokyo bureau that, in its own way, was just as significant a measure of Japan's new clout with the international financial institutions. Sakakibara and Joseph Stiglitz, former chief economist of the World Bank, were about to embark upon a joint research project into Asian economic growth and IMF reform. In terms of the philosophy of the institutions they once represented, this was the equivalent of sleeping with the enemy.

To be sure, Sakakibara was no longer at the Ministry of Finance. In April 2000, he became head of the new Global Security Research Center, or GSec, at Keio University, Japan's first research institute specializing in crisis management, with a charter covering international conflicts and environmental problems as well as currency and financial meltdowns. In January 2000, Stiglitz had also left the Bank. Tensions had been growing between World Bank President James Wolfensohn and his chief economist over Stiglitz's outspoken criticism of the IMF and the U.S. Treasury for their handling of the Asian crisis. There were hints that Treasury may have made Stiglitz's departure a quid pro quo for nominating Wolfensohn for a second term as World Bank president. At the Bank/IMF annual meeting in September 1999, Wolfensohn made disparaging remarks about Stiglitz's views on Russia, which were seen as a warning sign.

Whatever the immediate cause of Stiglitz's departure from the Bank, in the 1980s a cooperative research project between a World Bank economist and a high official of Japan's Ministry of Finance would have been inconceivable. In the World Bank of the 1990s, it was almost inevitable. Japan had begun to usurp the role staked out by the U.S. during the Cold War as standard bearer of an economic ideology. Japan's ideology, however, is just as different from that of the United States as the »Hinomaru« emblem of the rising sun is from the Stars and Stripes.

How did Japan and the World Bank get on the same page? The short answer is, by degrees, beginning with a master stroke on the part of the Japanese Ministry of Finance in providing substantial funding to the World Bank to explore the role of government in East Asian economic growth. This Japanese-financed research project produced the 1993 report on the East Asian Miracle. Japan's goal was to fend off efforts by the international financial institutions and the U.S. Treasury to impose free-market policies in Asia. With this ploy Japan began slowly to alter the agenda. By the end of the decade, Washington barely winced as Japan unveiled a succession of programs designed to shore up Asian economies without requiring American-style economic reforms. Over time, Washington simply opted out of the confrontation with Japan over its role in the Asian crisis and recovery.

Japan Bails Out East Asia

A clear signal of the change in U.S. direction came at the September 1998 annual meeting of the World Bank and IMF in Washington, DC. The U.S. encouraged Japan to present the $30 billion »New Miyazawa Initiative,« even though it was a barely disguised rehash of the Asian Monetary Fund (AMF) proposal of a year earlier, which Washington had attacked and destroyed when Sakakibara introduced it. (The »old" Miyazawa Initiative was a 1988 debt relief plan for Latin America. The Japanese long claimed that it served as the model for Treasury Secretary Nicholas Brady's 1989 »Brady plan« for repackaging debt into tradeable bonds)

In the spirit of the failed AMF, the New Miyazawa Initiative offered loans at below-market interest rates and with few conditions attached. Japan also launched a series of rescue vehicles for Asian economies and the thousands of Japanese multinationals based in them. A »second stage« of the Miyazawa Initiative was designed to encourage wider use of the yen as a reserve currency. It set up a ¥2 trillion fund to guarantee yen-denominated bonds issued by Asia-Pacific economies. The new Japan Bank for International Cooperation, established in October 1999 through the merger of the Japan Export-Import Bank (JEXIM) and the Overseas Economic Cooperation Fund (OECF), was to manage the new fund.

Japan set up another emergency support agency at the Asian Development Bank called the Asian Currency Crisis Support Facility and funded it with ¥367.5 billion ($1 billion). Another add-on to the New Miyazawa Initiative, a ¥600 billion ($6 billion) »special yen facility« (later dubbed the »Obuchi fund«) with unbelievably soft terms, including a ten-year grace period and 0.75 percent interest rate, also failed to draw the ire of the Clinton Administration. The »special yen facility« was intended to sponsor public works projects in Asia, »in principle on a tied basis to Japanese exports,« according to a Japan Export-Import Bank press release. Governments with their economies in crisis promptly submitted loan requests for large pipeline and other infrastructure projects for which they normally would have sought commercial funding.

Most Asians did not care that these special yen loans were tied aid, partly designed to assist the recovery of Japanese firms in Asia. The Japanese, however, did tread carefully. When Indonesia presented a long wish list of projects to be funded from the special yen facility, Tokyo turned down requests for several billion dollars for the Indonesian government to buy two power plants from private investors, including the Sumitomo Corp. However, the U.S. Treasury Department showed little concern. »We don't think the numbers add up,« said one Treasury official. »Why should we be concerned about an effort when it is obviously political?«

In July 1999, Japanese officials began briefing Asians on yet another project, aimed at reviving regional manufacturing. It focused on sectors dominated by the Japanese such as autos and electronics. That September, Toyota Chairman Hiroshi Okuda was appointed to lead this effort and, in November, Prime Minister Keizo Obuchi explained its details to the annual meeting of Association of Southeast Asian Nations leaders. In response to ASEAN's insistence on Japanese help in revitalizing the Asian economy, the »Obuchi plan« proposed using some of the remaining New Miyazawa Initiative funds to launch human resources programs for small businesses and to promote »marketization« in economies such as Vietnam and Thailand. The western press virtually ignored the »ASEAN plus three« summit in Manila in November 1999, despite its explicit overtones of a regional gathering excluding the United States. The meeting marked the first time that in addition to the ASEAN leaders, the »plus three« heads of state - Japanese Prime Minister Obuchi, Chinese Prime Minister Zhu Rongji, and South Korean President Kim Dae Jung - attended and held their own formal summit meeting.

By March 2000, Japan was able to shut down the New Miyazawa Initiative. The Asian economies had weathered the crisis, and even Indonesia was in the early stages of recovery. Most of the funds had been drawn down by the previous July, by which time Japan had disbursed $26 billion associated with the New Miyazawa Initiative and another $42 billion in measures enacted earlier.

The Japanese Export-Import Bank, which picked up about one-third of the Miyazawa Initiative financing, saw its loan volume shoot up by 80 percent, to a record ¥3.8 trillion (about $30 billion at ¥128.5=US$1) in the 1998 fiscal year. In the 1997 fiscal year, 64 percent of all JEXIM lending had been to Asia. The percentage in 1998 declined as the bank loaned more funds directly to Japanese companies in Japan, which then supplied funds to their Asian subsidiaries. JEXIM's funding to Asia alone was almost as much as the World Bank lends in a year.

The U.S. silence was puzzling since Japan's program was in essence a massive bailout of Japanese companies in Asia, designed to replace almost exactly the funds yanked back to Japan by Japanese banks. The implications for non-Japanese companies in the region were unmistakable. When the Industrial Bank of Japan stepped in to jump start Thai exports in late 1997, it raised $500 million in capital for the Thai Export-Import Bank, which then lent it to Thai businesses, many of them Japanese affiliates. The terms were so low that U.S. and European banks were unable to join the syndicate because it violated prudential requirements for return on capital.

Despite the fact that the majority of the Miyazawa Initiative funds were technically untied and backed reforms particularly in the energy sector, U.S. companies on the ground in Asia automatically assumed that most of the contracts for infrastructure development would go to Japanese companies.

In Thailand, a government study found that between November 1997 and January 1999, Japan led all other countries in providing support for its local partners. Of the 244 joint ventures in the study, 129, just over half, received help from their Japanese partners, compared to 14 from U.S. firms. New Japanese investment of $390 billion represented 62.6 percent of all new foreign investment during the period.

The Japanese strategy was successful, indeed, far beyond the imagining of a handful of officials who set it in motion in the late 1980s. The original strategy had been merely to beat back interference by the international financial institutions in Asia. The intent was to preserve Japan's freedom of action as the Japanese government and business set out to create a better environment for industrial policy in Asia. But as a result of the Asian financial crisis that began in 1997 and Japan's aid to the stricken economies, Japan succeeded in fundamentally changing the global policy agenda based on neoclassical economics.

Japan Targets the World Bank

The International Bank for Reconstruction and Development, otherwise known as the World Bank, is a big place - one of Washington, DC's largest employers, with a Washington-based payroll of about 9,000. Founded in 1944 to finance the reconstruction of Europe, over five decades it has become the dominant institution of global development economics. It is certainly the world's largest collection of Ph.D. economists-turned-bureaucrats. Some 2,000 economists dominate the top jobs at the Bank, and a doctorate in economics is required for most high positions.

In April 2000, as anti-globalization protesters massed in Washington, the blocks surrounding the Bank and its neighbor, the IMF, were behind yellow tape and barbed wire. Demonstrators, in a festive mood on April 16, a mild and sunny day, waved »Spank the World Bank« signs and staged mock battles with rubber sharks symbolizing the evils of capitalism. A papier-maché image popular with the crowds and with photographers was a pig with the world stuck in its mouth like an apple.

Normally, the area around 18th Street and Pennsylvania Avenue, two blocks from the White House, has a village atmosphere. Together with the IMF on 19th Street, and the International Financial Corporation a few blocks away on Pennsylvania Avenue, the whole community of workers in the »international financial institutions« numbers around 15,000. In this little township, the World Bank has pride of place. The Bank populates sixteen buildings in the area around the headquarters building, many of them alphabetically numbered. Bureaucrats stroll through the neighborhood with Bank IDs dangling from their collars, greeted by cheery consultants seeking Bank contracts. The atmosphere is particularly inbred at the top, where an elite group of career economists is in charge. These economists have known each other for decades. The institutional culture is focused on the internal hierarchy and how to rise through it. Although they spend weeks and months in developing countries, these officials largely limit their contacts abroad to senior government officials and their own local office staff.

According to Lawrence MacDonald, a former Asian Wall Street Journal correspondent turned World Bank editor, there was »a recognition in the mid-1990s, partly through the efforts of [vice-president] Mieko Nishimizu [daughter of a former chairman of Mitsui and an ex-professor of economics at Princeton] and partly through trends in financing, that we have to make more efforts to see that the Japanese are involved« (interview, December 5, 1996). MacDonald said there was »an institution-wide effort to get rid of barriers that have impeded Japanese involvement. We can't treat the Japanese just the way we treat the Germans or the French. Japan is a special case, because of the size of the Japanese contribution and the declining U.S. contribution« to Bank funding.

When the Japanese began their courtship of the Bank in the early 1990s, they were able to make good use of the intimacy of the Bank's executive structure, where officials are also closely linked with senior bureaucrats at the U.S. Treasury. Japan might have picked the International Monetary Fund for its courtship, but it did not do so for a number of reasons. Whereas the Bank is sprawling and somewhat permissive of dissent, the IMF has a reputation of housing a cadre of uncompromising macro-economists, loyal to an ideal. Moreover, the U.S. Treasury traditionally has kept the IMF on a tighter leash than the World Bank. Treasury tends to view the IMF as a potential beachhead for European influence, partly because Europeans usually choose the head of the IMF, while the U.S. picks the president of World Bank. In the 1990s, as the U.S. administration increasingly lost its battles with Congress over major international financial initiatives, it turned to the IMF as a primary mechanism for exerting influence on world monetary affairs. This would have made it more dangerous for the Japanese to work inside the IMF, promoting policies that ran counter to its purist, free-market stand and that would quickly have generated U.S. opposition.

Another factor shaping the Japanese strategy was that Japan had a much greater web of personal connections within the World Bank than within the IMF. The Japanese Ministry of Finance sends bureaucrats on rotation to the IMF, but nothing like the steady stream that goes to the World Bank. The IMF belatedly set up its Tokyo office in 1997, twenty-five years after the Bank had done so. By that time, the IMF was clearly on one side of the fence, with Japan and the World Bank on the other.

Between 1953 and 1966, Japan itself borrowed $862 million in soft loans from the World Bank, the last of them expiring in 1990. World Bank loans financed Japan's famous »bullet trains,« the shinkansen, and a long list of projects ranging from steel and power plants to a Toyota truck and bus factory. In 1970, Japan »graduated« to the status of a major lending country, and by the late 1970s it had become the principal co-financier of World Bank loans. In 1984, Japan moved from number five shareholder in the Bank to number two, after the United States. By 1991, Japan had emerged as the largest individual donor nation.

A final reason why Japan concentrated on changing the World Bank's operating policies was entirely personal. The Japanese executive director at the Bank who initiated the strategy came out of the Overseas Economic Cooperation Fund (OECF), and the OECF had been on the receiving end of interventions by the World Bank concerning Japanese lending practices in the mid-1980s. Masaki Shiratori, a former vice chairman of OECF, brought a personal animus as well as keen intelligence to his new job, and he made it his mission to impress on the Bank Japan's impatience with its strict free market philosophy.

As it evolved, the Japanese strategy not only made a friend of the World Bank but also introduced a schism between the World Bank and the U.S. Treasury, which had long considered the Bank its bailiwick. During the mid-1990s, Treasury moved closer to the IMF, partly because of harsh congressional reaction to the Clinton administration's $50 billion bailout of Mexico in 1994-95, but it still considered the Bank an impregnable preserve of neoclassical economics. That was soon to change.

The Split Between the World Bank and the IMF

When it came, the break between the Bank and the IMF was disguised by more serious events. It happened in late 1997 as the Korean economy was imploding. The IMF, in concert with the U.S. Treasury, had decided to use the Korean catastrophe to redesign the Korean economy in accordance with American economic ideology and was insistent that Korea accept a long list of conditions before it would extend financial assistance. As of December 4, 1997, donors had pledged $57 billion, including $21 billion of the IMF's money. But after paying out an initial $5.51 billion in emergency balance of payments support, the IMF slammed on the brakes. A second payment of $3.58 billion was due on December 18, and the Koreans pleaded with the IMF to accelerate disbursement in order to prevent a default. But the IMF stood firm. The United States government and the IMF told Seoul that they would go along only if the Koreans would implement at once the reforms they had agreed to, reluctantly, at the beginning of the month.

»There were about 10 days there where it's fair to say the Koreans were acting as if they were not going to do the program,« a senior IMF official told the Washington Post (December 28, 1997). »Instead of getting on and doing the program, they kept asking us for more money publicly. That helped destroy the confidence of the markets.« U.S. Treasury Secretary Robert Rubin was in his »tough love« mode, according to the newspaper, and refused to »put more money into Korea unless [one can] make a judgment that it's going to work.« Only after the Korean elections on December 18 and a visit by Treasury Under Secretary David Lipton to Seoul to meet the newly elected president, Kim Dae Jung, did the Administration's position start to change. On December 24, Christmas Eve, Rubin interrupted a fishing vacation to announce a new $10 billion emergency package for South Korea.

One reason he acted is that the day before, December 23, 1997, the World Bank had taken the radical step of providing its own $3 billion »economic construction loan« to South Korea, part of $10 billion it had pledged three weeks earlier to contribute to the IMF's package. Within the Bank, the move seemed particularly precipitate: it was a snap decision by World Bank president James Wolfensohn, a former investment banker, based on his own reading of the markets and was completely contrary to the Bank's normal lending policies. There were no current sectoral studies on the Korean economy to draw upon, as there had been with Indonesia and Thailand, and in 1994, South Korea had ceased to be a World Bank loan recipient.

The Bank did not even have an office in Korea, and there was no staff within the East Asian vice presidency to handle the matter. The decision to bail out Korea and embarrass the IMF and the U.S. Treasury came from the top. Bank president James Wolfensohn, fearing that American and IMF stalling would send Korea into default, asked Danny Leipziger, a career Bank economist who in the past had written on Korea, to take charge. Rubin was widely credited with having prevented a Korean default, but it was the Bank package that sent a reassuring signal to the markets and helped the Koreans pay $20 billion in short-term debt that was due by the end of December.

In the panicky mood of late 1997, the different positions staked out by the World Bank and IMF did not seem very important as the costs of the Asian financial »contagion« mounted ever higher. By October 1998, however, the split was so public and so extreme that during the annual Bank-IMF meeting in September 1998, Rubin virtually ordered the two institutions to settle their many differences. At the meeting the Bank's Wolfensohn delivered a blistering attack on the IMF, telling an audience of finance ministers and central bankers from 182 countries that too much attention was being given to issues such as currency stabilization and economic reform. »The poor cannot wait on our deliberations,« he said (New York Times, October 7, 1998).

Meanwhile, over the course of 1998, Joseph Stiglitz, the Bank's chief economist and senior vice president, emerged as the main spokesman for the Bank's critique of the IMF's fiscal austerity programs for Thailand, Indonesia, and South Korea. In the policy debate over how to stop the hemorrhaging of the Asian economies, Stiglitz and Wolfensohn prevailed. Slowly, gracelessly, the IMF changed course. By the fall of 1998, it was pushing reflationary policies in the crisis economies as earnestly as it had preached a combination of fiscal and monetary contraction a year earlier. The policy reversal was a humiliation for the IMF as well as for the U.S. Treasury Department, which had stood by the IMF during the dispute with the Bank and other critics.

With the passage of another year, in early 2000, the IMF had come so far as gingerly to support a revived Japanese effort to establish the Asian Monetary Fund. In March 2000, Finance Minister Kiichi Miyazawa told the Yomiuri newspaper that he would propose a formal currency swap agreement among Japan, China, South Korea, and the ASEAN countries at a meeting of the Asian Development Bank in May, as a preliminary step to establishing the AMF. The IMF's regional director, Kunio Saito, agreed: »If the Asian Monetary Fund is ever to be established, the IMF is very happy to cooperate,« although he added that the AMF needed to be consistent with IMF »activities.« Two years earlier, even a hint of IMF agreement with the Asian Monetary Fund would have been inconceivable.

Perhaps the strangest meeting of minds was that between Stiglitz, former chief of the president's Council of Economic Advisors, and Eisuke Sakakibara, Japan's combative chief financial bureaucrat, nicknamed »Mr. Yen« because of his reputed ability to affect financial markets with his pronouncements. Sakakibara, vice minister of finance for international affairs at the time of the Asian crisis, had long insisted on the »plurality« of capitalisms and for nearly as long had opposed »structural adjustment« lending by the IMF and the World Bank. Sakakibara argued that developing countries should try »alternative« paths, following models such as the Japanese »main bank« system, before launching full-scale privatization and deregulation along western lines (see Sakakibara's Beyond Capitalism: The Japanese Model of Market Economics, Lanham, MD: University Press of America, 1993). While he was still serving as director-general of the international finance bureau within the Ministry of Finance, Sakakibara had made a name for himself in the development community by challenging the so-called Washington consensus.

The term »Washington consensus« refers to the agreement that developing economies, particularly in Latin America, had reached regarding remedies for the Latin American debt crisis of the early 1980s. It stressed above all privatization and market liberalization. The author of the original »Washington consensus,« John Williamson, argued that when he first aired the ten policy principles that made up the consensus at a conference on Latin American development in November 1989, he intended them only as a report on developments in Latin American economies, not as a neo-liberal policy manifesto (see John Williamson, »The Washington Consensus Revisited,« paper presented to the Conference on Development Thinking and Practice, Washington, DC, September 3-5, 1996, typescript). Nonetheless, the consensus reinforced Washington's view that with the fall of the Berlin Wall in 1989, capitalism had prevailed over all other economic ideologies. The consensus also gave credibility to the dominant philosophy at the World Bank during the 1980s and for most of the 1990s.

The Washington consensus argues that open markets and the free flow of capital are essential for growth. It became the IMF's credo as it engineered the huge Russian emergency support programs of 1993 and 1995. These were the IMF's first experiences with large-scale social and institutional engineering, and even the collapse of the Russian economy failed to persuade the stalwarts of the IMF that there was anything wrong with their theory.

In his paper for the Conference on Development Thinking and Practice in Washington in September 1996, Sakakibara argued that the neo-classical paradigm had »lost its luster,« and he railed against deregulation, particularly of capital markets, and privatization, both favorite IMF prescriptions. »This neglect of different cultures and evolutionary processes of history is typical of neo-classical prescriptions and has often led to confusion and the collapse of the existing order rather than reform,« he argued. »Does globalization imply that a universal model or uniform set of rules as envisaged in the 'Washington consensus' will eventually spread to all parts of the world and that the world will become homogeneous, both economically and culturally? Definitely not.«

A year and a half later, Sakakibara was urging APEC, albeit unsuccessfully, to adopt currency controls and restrictions on hedge-funds. At a conference in Melbourne in March 1999, he called on Asian finance ministers to enact prudential regulations to prevent »excessive exposure to foreign creditors and check surges in capital inflows.« By this time, at least in his advocacy of capital controls, Sakakibara had plenty of company.


The liberal Stiglitz was a pluralist by instinct. A full professor at Yale by the age of 26, Stiglitz won the John Bates Clark award, given every two years to the best American economist under the age of 40, an honor also accorded Lawrence Summers, who was Rubin's deputy at the Treasury Department and his successor as secretary. In the early 1990s, Stiglitz had begun to view East Asia as a testing ground for his theories on the role of information in capital markets. By February 1997, when he became the World Bank's chief economist, Stiglitz was well versed in the literature on Japanese and East Asian growth and had already taken positions that were distinctly anti-Washington consensus.

While still a professor at Stanford, he had been an enthusiastic member of the World Bank team that produced the »East Asian Miracle« report. This study, led by John Page and conducted during 1991-92, was published in 1993. It became the basis for the Bank's enthusiasm for East Asian growth strategies right up to the time of the crash. After the crisis, it was an embarrassment to numerous officials within the World Bank, partly because its title inspired triumphalist articles by free-market ideologues about the end of the Asian miracle, many of which cast ridicule on the report. Stiglitz, however, regularly quoted from the East Asian Miracle in terms that became more passionate as time went on.

Stiglitz saw the cases of high-speed economic growth in East Asia, starting with Japan, as constituting a body of empirical evidence that opened up new theoretical perspectives, particularly with regard to the role of government in guiding development. Stiglitz concluded, »In a way, my original motivation was in part the view by the Japanese that the most successful countries in the world [economically] had not followed the prescriptions that the World Bank had been recommending to a lot of them« (interview with Stiglitz, August 15, 1997; also see Joseph Stiglitz, »Some Lessons from the East Asian Miracle,« The World Bank Research Observer, 11:2, August 1996, pp. 151-77; and »The Insider: What I Learned at the Global Economic Crisis,« The New Republic, April 17, 2000).

The most influential economist at the World Bank, then, was ready to accept that the key to Asia's recovery might lie in some of the strategies that Asian economies had used in the past. The Asian financial crisis was due to circumstance and human failure, not systemic problems. »The success of East Asia was in no small measure due to effective (and market-friendly) interventions by the government,« Stiglitz told an audience in Bangkok in July 1999. »Many of the problems these countries face today arise not because governments did too much, but because they did too little and because they themselves had deviated from the policies that had proved so successful over preceding decades,« he wrote in an op-ed article for the Wall Street Journal (April 28, 1999). Like Sakakibara, Stiglitz favored short-term capital controls in order to prevent speculative attacks like those that brought down the Asian economies. Temporary controls might give countries a »window of opportunity« to deal with economic turbulence, Stiglitz said. Such views put him at odds with positions strongly held by the IMF and United States Treasury.

During the two traumatic years following the beginning of the Asian economic crash in July 1997, Stiglitz was certainly not the only nor the most outspoken critic of IMF-Treasury policies. Jeffrey Sachs, who had led a research team at the Asian Development Bank that produced a sunny book on the Asian regional economy just before the crash, asserted that by pushing for reform too fast the IMF had destroyed the Asian economies. Paul Krugman, another winner of the John Bates Clark award, argued that the globalization of financial markets made it too easy for investors to move money in and out of emerging markets. He advocated both restricting the flow of capital and rules to block local banks and businesses from pulling money out of an economy suddenly.

Stiglitz's intellectual interest in market imperfections was not the only impulse bringing the World Bank closer to Japan in the fall of 1997. Another reason was the rivalry between the Bank and the IMF that went back to the late 1980s during the second wave of Latin American debt crises, when the IMF first began to get involved with structural reforms. After 1991, this rivalry intensified as the IMF began to meddle with the Russian economy. The World Bank viewed reforms of institutions - so-called structural adjustment - in exchange for loans as lying within its own jurisdiction. The division of labor was supposed to be that the Bank dealt with microeconomy while the IMF supervised macroeconomy. In any case, structural adjustment lending, whether from the Bank or the IMF, involved the lending institution in ordering fundamental alterations to an economy. From the Bank's point of view, the macroeconomists employed by the IMF did not have the skills to undertake such work. From the IMF's point of view, the World Bank did not have the religion to do the job right.

The IMF and Its »Conditions«

From the late 1980s, the IMF ratcheted up the scope of reforms it demanded as well as their scale. In 1989, the IMF imposed sweeping economic reforms on Argentina, calling for the elimination of industrial promotion programs and »other subsidies,« an end to import prohibitions and quotas, and a general reduction of import tariffs. In a series of rescue packages for the Russian Federation between 1993 and 1996, the IMF demanded radical reforms that ran the gamut from liberalization of trade and energy to restructuring the banking sector, cutbacks in social spending, and agricultural reform.

The price tags kept getting bigger, too. Not counting other donors, the IMF paid out $3 billion for Russia in 1993, $18.9 billion for the U.S.-led bailout of Mexico in 1995, and another $16.8 billion for Russia in 1995 and 1996. Then came the Asian »standby« credits - that is, funds to meet balance of payments debts - the first of which, $3.9 billion, the IMF offered to Thailand on August 20, 1997. This was the IMF's contribution to a total package of $17 billion. Next, on November 5, 1997, the IMF authorized $10.14 billion out of a total of $40 billion for Indonesia; and in December, it committed $21 billion out of a total package of $57 billion for South Korea.

The Korean loan was nearly twenty times the IMF's quota, or lending limit, for South Korea. The huge loans of late 1997 attached reforms that potentially would have reshaped the entire Asian economy, and the IMF had not even invited Bank officials to sit in on the negotiations. A team of five IMF officials negotiated the $57 billion Korea package (including other donors) over seven days in November and December 1997. The team's only Asian specialist was a young economist just a few years out of graduate school at Yale, Robert Dekle.

Bureaucratic rivalry reinforced a sense at the Bank that the IMF was on the wrong track. Meanwhile, during the early months of the crisis Japan had emerged as a hero within Asia. When, on July 2, 1997, the Thai baht fell through the floor triggering the crisis, the United States was distracted by its July 4 Independence Day holiday; and Deputy Treasury Secretary Summers had to determine what to do on his own. He decided against providing financial support to Thailand, fearing a reprise of the storm of criticism that followed the U.S.-led bailout of Mexico in 1995, which he and Rubin had engineered.

During the Mexican crisis, Treasury drew from a pool of funds, called the Exchange Stabilization Fund, available to the executive branch to defend the dollar. Following the Mexican bailout, the then chairman of the Senate Banking Committee, Alfonse D'Amato, sponsored an amendment to the Exchange Stabilization Fund law to prevent foreign countries from borrowing more than $1 billion during a six months period. Summers used this restriction as his excuse for inaction, although he did play a role in shaping the IMF reforms for Thailand, insisting that the IMF raise its quota for Thailand and calling for full disclosure of Thailand's forward foreign exchange positions.

The Thais fiercely resented the United States' standing aside while the IMF cobbled together a rescue package and Treasury officials grumbled that the Thais deserved what they got because they had ignored earlier warnings from the IMF that its current account deficit was in the danger zone. In early negotiations with Bangkok, the IMF insisted it could lend no more than $3.9 billion, already 505 percent of the Thai quota. That left Thailand with a $10.5 billion gap for which it had to find financing. Tokyo saved the day by rounding up other Asian countries to help Thailand. At a meeting in Tokyo on August 11, the group came up with $10 billion, and Bangkok was able to meet its payments. Japan not only organized the bailout but put up substantially more money for Thailand than the United States did for all three crisis economies combined. Tokyo put $4 billion of its own funds into the Thai package, and pressured 21 Japanese banks to roll over their Thai loans.

Tokyo's next move was to attempt to launch the Asian Monetary Fund. This began as proposal to assemble $100 billion in standby funds from Asian donors, which could serve as a quick-disbursal mechanism to head off future crises. The Finance Ministry's Sakakibara was the principal mover. Finance Minister Hiroshi Mitsuzuka tabled the proposal at the Bank-IMF annual meeting in September 1997, held in Hong Kong. Asians had already been alerted that the Japanese proposal was coming at a regular meeting of Asian central bankers that Japan had quietly started in 1995. Japan introduced it again in Bangkok in mid-September at a meeting between Asian and European Union finance ministers. Sakakibara himself went on a tour of ASEAN countries before the Bank-IMF meetings in late September. Japanese claims that the idea had come initially from Thailand were unconvincing, but it is clear that the Thai bailout at least provided a model of what an Asian Monetary Fund could accomplish.

The World Bank had decided years earlier to hold its 1997 annual meeting in Hong Kong as a gesture of confidence in the reversion of Hong Kong to China, which occurred on July 1, 1997. Instead, the meetings became the occasion for what New York Times reporter David Sanger called »a nasty skirmish in the escalating war between nations and global markets« (September 22, 1997). Among the more bizarre incidents was a public fight, conducted on giant video projection screens looming over the heads of assembled financial officials and business people, between U.S. financier George Soros and Malaysian Prime Minister Mahathir, who attacked each other for their roles in the crisis. Mahathir described currency traders like Soros as »morons,« while Soros responded by calling Mahathir a »danger to his country«.

The brawl over the Asian Monetary Fund was just as brutal. Asians welcomed the idea, and economists who viewed the region's problems as stemming from currency speculation tended to agree. They argued that it would make sense to have some of the countries in the region, with their large holdings of U.S. dollar reserves, take some of the pressure off the international financial institutions. Earlier in the year, even the IMF had suggested the idea of closer monetary cooperation in the region. Malaysian Deputy Prime Minister Anwar Ibrahim endorsed the Japanese proposal, and Hong Kong's financial secretary, David Tsang, said wistfully, »I wish very much to see some form of standing arrangement whereby we will need to borrow, of course, with the discipline of the IMF, but with an Asian facility, to help any countries under economic attack« (Financial Times, October 9, 1997). Even Salomon Brothers, in its Japan daily comment for September 22, 1997, remarked that if the Asian Monetary Fund were tied to IMF programs, it could serve as a »regional expansion of IMF resources.«

It was not to be. The U.S. Treasury Department, led by Summers, attacked the proposal harshly, challenging it as a new source of »moral hazard« (i.e., avoidance of risk) that would undermine IMF discipline in the region. Americans and Europeans were on the phones during the conference, persuading the Southeast Asians to back off. Moral hazard may have been part of the problem, but there was more to the U.S. Treasury's fierce opposition than that. China and Japan are the largest holders of U.S. Treasury certificates, and the Asian Monetary Fund raised the specter of Asian financial coordination against the United States.

At a meeting of finance and banking officials in Manila on November 18-19, 1997, Summers pushed successfully to replace the Asian Monetary Fund with a proposal for increased regional surveillance, to be conducted by the new IMF office in Tokyo. Southeast Asians looked at the spat as a windfall, hoping that it would prompt the U.S. to play a more active role in sorting out Asia's rapidly growing financial catastrophe. This it did. As Indonesia's troubles mounted in September and October 1997, the U.S. finally became more active, contributing a modest $3 billion to the IMF's package for Indonesia.

Asian monetary officials were disappointed by Japan's lack of backbone in the face of the American offensive. Teh Kok Peng, deputy managing director of Singapore's Monetary Authority, said Japan's timidity was unfortunate but it was even worse to have the two giants bickering while the rest of Asia faced financial collapse. »In the face of U.S. opposition, Japan backed down,« he said. »In a sense they didn't have a clearly articulated position. Japanese policy leadership is weak. Things were breaking out all over the region. [Under these circumstances] there's nothing worse than to have two major countries bickering with each other« (interview with Teh Kok Peng, Singapore, May 25, 1998).

The New Miyazawa Initiative

At Manila, the Japanese formally dropped the idea of an Asian Monetary Fund but went ahead and implemented it in other ways. They had never been specific about the amount of money they would contribute to the AMF, which was supposed to be a multi-country fund. Japanese officials had floated the figure of $20 billion. A year and another $10 billion later, this became the $30 billion New Miyazawa Initiative.

Simultaneously, Tokyo was working to weaken the dominance of the dollar over Asian currencies. The Japanese referred to the latter project as the »internationalization of the yen,« and it reflected Japan's frustration at the ease with which the U.S. could manipulate Japanese economic performance through the money markets. In 1998, the yen was by far the weakest of major trading currencies. Only 15.7 percent of Japan's exports to the U.S. were denominated in yen, compared to 62.9 percent of German exports to the U.S. denominated in Deutschemarks. On a global basis, 36 percent of Japanese exports, and 21.8 percent of imports, were yen-based. In international financial markets, the yen accounted for a dismal 0.2 percent of loans in 1997, compared to 69.8 percent for the U.S. dollar, 15.6 percent for the British pound, 5.3 percent for the French franc, and 3.3 percent for the Deutschemark. As an official reserve currency, in 1997, central banks held only 4.9 percent in yen, compared to 57.1 percent in dollars and 12.8 percent in Deutschemarks. All of these ratios sank in the course of the 1990s. Japan's peak as a reserve currency was in 1991, when it made up 8.1 percent of global reserve holdings.

In 1995, things got particularly difficult for Japan. U.S. policy helped drive the yen to an unprecedented 79 yen to the dollar. As the yen was roaring past the psychological barrier of 100 to the dollar, Asian currencies were blasted by financial contagion from the Mexican crisis. Sakakibara, then deputy director-general of the international finance bureau, thought he saw an opportunity to form a pressure group made up of Asian central banks, using their substantial dollar holdings as a bargaining chip. Financial coordination with Asian central banks implied creating greater liquidity for Japanese government bonds. This was taboo among Sakakibara's colleagues in the Ministry of Finance, where many believed that greater liquidity in the Japanese debt market was tantamount to relinquishing control over monetary policy. Sakakibara had somehow to convince his colleagues that the risk was worth it. »Sakakibara realized that in his current position, he could do nothing without the help of his Asian counterparts,« said Tomohiko Taniguchi, a veteran correspondent for Nikkei Business in London. »He urged his counterparts to pay more attention to Asia« (interview with Taniguchi, Tokyo, June 6, 1996).

Sakakibara's trump card was the scale of reserves that Asian central banks could deploy if they were to act in concert. In 1995, the combined foreign exchange reserves of Japan, Taiwan, China, Singapore, Thailand, Malaysia, South Korea, and Indonesia amounted to $566.5 billion, more than half of all global reserves. Working with vice minister for international affairs Takatoshi Kato and director of the foreign exchange and money market department, Eijiro Katsu, Sakakibara began a secret courtship of Asian central banks.

Their first step was to ask retired vice minister of finance Toyoo Gyohten to set up an informal conference of Asian central bankers through his amakudari position at the Bank of Tokyo. Gyohten had the Bank of Tokyo create a shell organization, the »International Monetary Institute,« to host the meeting in Tokyo on April 8, 1996. Kato traveled around Asia persuading central bankers and heads of monetary authorities to attend. Hong Kong, Singapore, Indonesia, Malaysia, Thailand, the Philippines, China, South Korea, and Australia sent representatives to the meeting. The United States was not invited.

According to Katsu, the Asian countries argued against including the U.S. Treasury or the Federal Reserve Board. »They were afraid of the U.S.,« Katsu said, particularly because of a U.S.-led effort to get a financial services agreement in the World Trade Organization. Taniguchi said simply, »It was elaborately done, internally. It was about forming a sort of political pressure group against the U.S. that, hopefully, will be able to force some discussion on U.S. policy. There is a huge accumulation of U.S. dollar stockpiles in these countries. The Ministry of Finance suddenly realized that if you put them all together they would make a useful bargaining chip« (Nikkei Business, April 22, 1996).

The main result of the Tokyo meeting was to include Japan in a plan initially floated by Australia, China, and ASEAN to set up a network of dollar repurchase agreements. Such so-called repo agreements are useful when a government needs to intervene in foreign exchange markets but does not have sufficient foreign exchange reserves to do so. By using U.S. Treasury bills as collateral, one central bank can borrow foreign exchange from another. Because of the huge size of its U.S. dollar reserves, Japan had never felt the need in the past to employ repo agreements, and it remained reluctant to join the ASEAN plan, which involved short-term loans of dollar funds from other central banks in the event of a speculative attack. However, Japanese doubts vanished with the yen spike of August 1995. In late 1995, Japan reached a »repo« agreement with Singapore, Hong Kong, and Australia; the Tokyo meeting expanded the list to ten countries. The Thai baht crisis revealed how fragile the agreement actually was, but Japan persisted. It used the group to float the idea of the Asian Monetary Fund and, when that crashed, came back in 1998 with something called a »yen funneling system,« similar to the repo arrangement except based in yen. This idea came from the Bank of Japan, and called for providing yen-denominated loans to Asian central banks to promote the use of Japanese currency in trade. In 1999, Finance Minister Miyazawa upped the ante again, with his »new initiative« and the »resource mobilization plan for Asia« that went along with it. The new plan offered ¥2 trillion in loan guarantees for yen-denominated government bonds issued by other Asian countries.

The yen repo story is one more example of Japan's dogged pursuit of a vision for Asia that runs counter to the Anglo-American free-market model. In some respects, the vision also runs counter to market realities. Malaysian Prime Minister Mahathir, too, had proposed greater use of regional currencies to reduce dependence on the dollar. Teh Kok Peng of the Monetary Authority of Singapore described the Malaysian and Japanese proposals as doomed. »I don't know whether Mahathir is a banker,« Teh said in a 1996 interview. »His idea is that we should use more regional currencies for transactions. My sense is that the idea will die a natural death. There is little interest on the part of banks or the private sector. Exporters are not seeking to receive payments in rupiah and so on. If you take Asia as a whole, three quarters of our trade is with countries outside Asia. There's no way you can get them to take Asian currencies. About ten percent of the remaining 25 percent is intra-company trade. At the end of the day, real trade is only 15 percent.«

There was, indeed, a certain element of intentional misrepresentation in Japan's proclaimed goal to internationalize the yen. Officials at the Bank of Japan and the Ministry of Finance had known for years what the problem was. Asian central banks, particularly those carrying a large yen debt as part of Japan's foreign aid program, would have loved to hold more yen to protect themselves from its violent post-1985 swings. The reason they did not was that the Bank of Japan insisted on a ten-day rule for settling accounts, which made it by and large impossible to purchase yen for the sake of currency market interventions. There was a lack of short-term instruments, and no equivalent to U.S. Treasury auctions, in which government bonds are sold directly to the market. What inconvenienced other central banks, however, meant the preservation of control over monetary policy to Japanese finance officials.

Even when, in December 1998, Japan moved to introduce changes to its government bond market as part of the campaign to reduce »excessive« dependence of Asian currencies on the dollar, the Ministry of Finance failed to introduce the real-time settlement provisions recommended by its own advisory committee on the internationalization of the yen. Miyazawa, in a speech to Asian finance ministers a few months later, delicately acknowledged the omission. »Another matter that requires quick resolution is settlement and clearance,« he said. »Real-time gross settlement is a necessary ingredient in truly global transactions« (speech to the APEC finance ministers meeting, Malaysia, May 15, 1999).

Where to Next?

Asians may be skeptical about Japan's efforts to solve Asia's problems through government support mechanisms adapted from Japan's domestic experience, but in the context of the trauma that Asian economies experienced in 1997-98, Japan was at least engaged, putting its money on the line, and not holding the other Asian economies hostage to demands for policy reforms. The contrast with the U.S. and Europe is stark. American and European investors cruised the region looking for cheap assets, while Japanese companies pumped money into existing joint ventures with local affiliates. The end result might be the same degree of foreign control, but Japan at least was not arousing the backlash of resentment that U.S. companies are experiencing in Thailand, Indonesia, and even South Korea.

Japan's new popularity in post-crisis Asia gave the World Bank another reason to become friendlier with Japan. Tokyo and the World Bank were suddenly in the same corner. Both took credit for the boom era, and both were tarnished by the sudden disaster that overtook the region's economies. Both reacted by painting Asia as a victim of global capital flows and IMF policies. Finally, both had an interest in presenting themselves as friends of the region-Japan in order to reduce its isolation and gain clout in its ongoing battles with the U.S. over its economic institutions, the Bank to restore its increasingly threadbare credibility in the age-old war against poverty.

In the era of James Wolfensohn, an investment banker who became president of the World Bank in June 1995, the Bank began to exhort its members to think in terms of »clients« rather than »loan recipients.« The crisis threatened to expose just how cozy some of the Bank's relationships with its clients had become. In February 1999, the Bank for the first time admitted having made mistakes in Asia. It said that Indonesia's rapid growth had created a »halo effect« around Indonesian President Suharto that had made the Bank's managers unwilling to deliver tough messages to him. The Bank had earlier broken ranks with the IMF, declaring in a 200-page report that the IMF-Treasury policy of forcing high interest rates in the early days of the crisis had led to ruin. The blame for the crisis, according to the Bank, lay not with the Asian economies but with outsiders. Stiglitz told reporters, »The heart of the current crisis is the surge of capital flows. The surge is followed by a precipitous flow out. Few countries, no matter how strong their financial institutions, could have withstood such a turnaround. But clearly the fact that the financial institutions were weak and their firms highly leveraged made these countries particularly vulnerable« (New York Times, February 11, 1999). One of the leading architects of globalization had thus become its leading critic.

Looking back, Stiglitz said that there were »moments of evolution,« rather than a single event, that influenced his thinking. One of the more significant of these, however, was the Japanese-funded research project on East Asian growth, the East Asian Miracle report, in which he had been involved in the early 1990s. This project began the slow process by which the World Bank and Japan became true bed-fellows. It may be, as the Japanese like to say, that two can sleep in the same bed and yet have different dreams, but if Japan remains a major source of funds for the Bank it may well supplant the United States in influence.

(*) Paper made available to SvZ by a member of JPRI.

EDITH TERRY is the author of How Asia Got Rich: Japan and the Asian Miracle (M.E. Sharpe, forthcoming). Her earlier reports for JPRI include »How Asia Got Rich,« Working Paper No. 10 (June 1995), and »Crisis? What Crisis? Working Paper No. 50 (October 1998). She lives and works in Washington, DC.