Asia and the New Financial Asia and the New Financial ParadigmParadigm

Joseph E. StiglitzJoseph E. StiglitzSeoul, KoreaSeoul, Korea

November 14, 2007November 14, 2007

GlobalizationGlobalization

Has created global banking Has created global banking institutions and other global financial institutions and other global financial institutionsinstitutions• Facilitating movements of capital from Facilitating movements of capital from

areas of capital abundance to areas of areas of capital abundance to areas of capital scarcitycapital scarcity

• Facilitating global adoption of “best Facilitating global adoption of “best practices”practices”

Banking (and other Financial Institutions) Banking (and other Financial Institutions) are Information Industriesare Information Industries

Gathering, processing, and disseminating Gathering, processing, and disseminating informationinformation

Deciding on which projects should be Deciding on which projects should be undertaken (i.e., undertaken (i.e., whowho is creditworthy) is creditworthy)

Monitoring (ensuring that funds are used Monitoring (ensuring that funds are used appropriately)appropriately)

Enforcing (collecting money due, Enforcing (collecting money due, terminating credit)terminating credit)

Banks are like the Brains of the EconomyBanks are like the Brains of the Economy

A Strong Financial Industry is A Strong Financial Industry is ImportantImportant

Both for allocating resources Both for allocating resources within within a a countrycountry

And for allocating resources And for allocating resources betweenbetween countries countries

And as a source of income And as a source of income • High information rentsHigh information rents• Several countries’ successes have been Several countries’ successes have been

based on their financial sectorbased on their financial sector

Financial InstitutionsFinancial Institutions Financial institutions not only Financial institutions not only

“intermediate” between savers and “intermediate” between savers and investorsinvestors• Helping ensure savers get highest returns for Helping ensure savers get highest returns for

their investmenttheir investment• Helping investors get capital at lowest costHelping investors get capital at lowest cost

But financial institutions also help manage But financial institutions also help manage riskrisk• Transferring risk from those less able to bear Transferring risk from those less able to bear

risk to those more able to bear riskrisk to those more able to bear risk• With new products designed for the risk profile With new products designed for the risk profile

of investors and saversof investors and savers

What is Required for a Successful What is Required for a Successful Financial Center?Financial Center?

Performing these roles requires information Performing these roles requires information about both savers and investorsabout both savers and investors

High technology for gathering, analyzing, High technology for gathering, analyzing, transmitting informationtransmitting information

Highly skilled peopleHighly skilled people Highly networked people and institutionsHighly networked people and institutions SecuritySecurity

• Legal frameworksLegal frameworks• Regulatory environmentRegulatory environment• Institutions that can be trustedInstitutions that can be trusted

Rapid Changes in Global Financial Rapid Changes in Global Financial StructureStructure

Changing “industrial organization”Changing “industrial organization” Changing sources of fundsChanging sources of funds Changing technologyChanging technology Changing knowledge baseChanging knowledge base Changing global securityChanging global security

1. Changing Industrial 1. Changing Industrial OrganizationOrganization

Supply Chain Economics: Globalization of Supply Chain Economics: Globalization of manufacturing has entailed breaking up manufacturing has entailed breaking up production process into many stagesproduction process into many stages

• Taking advantage of local comparative Taking advantage of local comparative advantages for each stage of the production advantages for each stage of the production processprocess

• But using best globally available “appropriate” But using best globally available “appropriate” technology at each stagetechnology at each stage

But successful supply-chain But successful supply-chain economics is economics is information intensiveinformation intensive

• Requires knowledge of global Requires knowledge of global technologiestechnologies

• Requires knowledge of local supply-side Requires knowledge of local supply-side conditionsconditions

• Requires knowledge of demand-sideRequires knowledge of demand-side

Most ImportantlyMost Importantly

Requires coordinationRequires coordination• Linking each stage to final productLinking each stage to final product• Based on customer’s needs and preferencesBased on customer’s needs and preferences

Many forms of “industrial Many forms of “industrial organization”organization”• Vertically integratedVertically integrated

But given importance of local information, But given importance of local information, relatively rarerelatively rare

• Various forms of contractingVarious forms of contracting

So, too, in FinanceSo, too, in Finance

Financial markets intermediate between Financial markets intermediate between savers and investorssavers and investors

With globalization, savers and investors With globalization, savers and investors can be scattered all over the worldcan be scattered all over the world

But savers and investors in different parts But savers and investors in different parts of the world have different needs and of the world have different needs and opportunitiesopportunities

• This is why This is why local informationlocal information is so important is so important

2. Changing Sources of Funds2. Changing Sources of Funds Asia has become major source of global Asia has become major source of global

savingssavings• US savings rate has been zero or negativeUS savings rate has been zero or negative• Especially as other countries have built up Especially as other countries have built up

huge reserveshuge reserves Yet, money is sent from Asia to money Yet, money is sent from Asia to money

centers in West, and then lent backcenters in West, and then lent back• Large margin—difference between interest Large margin—difference between interest

rates received and interest rates paidrates received and interest rates paid• With much of the risk borne by AsiaWith much of the risk borne by Asia

Exchange rate riskExchange rate risk Interest rate riskInterest rate risk Exemplified by East Asia crisisExemplified by East Asia crisis

3. Changing Technology and 3. Changing Technology and KnowledgeKnowledge

Finance has become IT intensiveFinance has become IT intensive Success requires best available IT Success requires best available IT

technologies for gathering, processing, technologies for gathering, processing, and disseminating informationand disseminating information

But these technologies are global But these technologies are global technologies, accessible anywhere in the technologies, accessible anywhere in the worldworld

4. Changing Knowledge Base: 4. Changing Knowledge Base: Globalization of Human CapitalGlobalization of Human Capital

Knowledge has become Knowledge has become globalglobal• With rapid changes in comparative advantagesWith rapid changes in comparative advantages• More engineering, science graduates in Asia More engineering, science graduates in Asia

than in Europe and US combinedthan in Europe and US combined• The knowledge required for running a The knowledge required for running a

successful financial institution has become successful financial institution has become globalglobal

• No one has a “monopoly” on good practices — No one has a “monopoly” on good practices — or on bad practicesor on bad practices

America’s Mortgage ProblemAmerica’s Mortgage Problem

• Should have realized the deep problems Should have realized the deep problems facing American economy facing American economy

Growth for past 5 years has been highly Growth for past 5 years has been highly dependent on real estatedependent on real estate

Large numbers of individuals had taken out Large numbers of individuals had taken out mortgages in excess of 80% of value of mortgages in excess of 80% of value of property, with “teaser” rates involving property, with “teaser” rates involving negative amortization for first 2-3 yearsnegative amortization for first 2-3 years

• In expectation of continuing low interest rates and In expectation of continuing low interest rates and perpetually rising housing pricesperpetually rising housing prices

• So they could refinance their mortgagesSo they could refinance their mortgages• Not sustainable in the long runNot sustainable in the long run

That Which is Not Sustainable Will That Which is Not Sustainable Will Not Be Sustained…Not Be Sustained…

Only issue was Only issue was whenwhen bubble would bubble would breakbreak

And when it broke, how deep and long And when it broke, how deep and long the resulting real estate crisis would the resulting real estate crisis would bebe

And what would be the form of And what would be the form of government interventiongovernment intervention

The bubble has now brokenThe bubble has now broken

The Double-Edged Sword of The Double-Edged Sword of SecuritizationSecuritization

Risks spread around the worldRisks spread around the world• France, Australia, others affected directlyFrance, Australia, others affected directly• Many more affected indirectly as a result of change in Many more affected indirectly as a result of change in

risk premium (Indonesia)risk premium (Indonesia)• More people affected, but impact on US reducedMore people affected, but impact on US reduced

Banks do a better job at ascertaining Banks do a better job at ascertaining creditworthiness, monitoring, enforcementcreditworthiness, monitoring, enforcement• Security markets often free-ride on information provided Security markets often free-ride on information provided

by banksby banks• Securitization created new problems of information Securitization created new problems of information

asymmetryasymmetry Renegotiation (debt-restructuring) more Renegotiation (debt-restructuring) more

difficultdifficult• Parallel to problem in sovereign debt marketsParallel to problem in sovereign debt markets

Clear inadequacies in America’s regulatory Clear inadequacies in America’s regulatory systemsystem

But problems have spread around the worldBut problems have spread around the world• Innocent victims even in countries that did not Innocent victims even in countries that did not

buy the “toxic” mortgagesbuy the “toxic” mortgages In East Asian crisis, IMF and US Treasury:In East Asian crisis, IMF and US Treasury:

• Talked about lack of transparencyTalked about lack of transparency• Told countries to raise interest ratesTold countries to raise interest rates• Said there should be no bail-out of “bad firms”Said there should be no bail-out of “bad firms”• Argued that the problem was inadequate Argued that the problem was inadequate

regulationregulation

In sub-prime mortgage crisis:In sub-prime mortgage crisis:• Lack of transparency was cause of credit Lack of transparency was cause of credit

crunch — no one knew where toxic crunch — no one knew where toxic mortgages were hiddenmortgages were hidden

• Fed lowered interest ratesFed lowered interest rates• Bailed-out banks by purchasing Bailed-out banks by purchasing

mortgagesmortgages• IMF cautioned against need for new IMF cautioned against need for new

regulations, dangers of over-reactionregulations, dangers of over-reaction Clear double-standardClear double-standard

5. Changing Global Security5. Changing Global Security

Sound legal and regulatory framework is Sound legal and regulatory framework is essential for depositors and savers to have essential for depositors and savers to have confidenceconfidence• America no longer viewed as “safe haven,” America no longer viewed as “safe haven,”

especially for investors from Middle-Eastespecially for investors from Middle-East• With repeated financial crises (1987, 1999, With repeated financial crises (1987, 1999,

2007) and scandals, lack of confidence in 2007) and scandals, lack of confidence in American regulatory structureAmerican regulatory structure

But off-shore banking centers are But off-shore banking centers are increasingly under attackincreasingly under attack

New Global Landscape for New Global Landscape for FinanceFinance

Changes just described imply that the old Changes just described imply that the old “architecture” of the global financial “architecture” of the global financial system no longer makes sensesystem no longer makes sense

New financial centers are arisingNew financial centers are arising Different centers will perform different Different centers will perform different

functionsfunctions Intermediating between different savers Intermediating between different savers

and investorsand investors• Malaysia Malaysia • SingaporeSingapore

Key to SuccessKey to Success

Mixing global and local knowledgeMixing global and local knowledge Global technology — best available IT Global technology — best available IT

technologies for gathering, processing, technologies for gathering, processing, and disseminating informationand disseminating information

Global practices — best techniques for Global practices — best techniques for marketingmarketing

Innovation — new financial products Innovation — new financial products and risk managementand risk management

But the Most Important Information is But the Most Important Information is Still LocalStill Local

Especially concerning small and medium-Especially concerning small and medium-sized enterprisessized enterprises• Ascertaining creditworthinessAscertaining creditworthiness• MonitoringMonitoring

Concerning nature of marketsConcerning nature of markets• Problems highlighted by sub-prime mortgage Problems highlighted by sub-prime mortgage

crisiscrisis• Many international firms bought these Many international firms bought these

mortgages, without evidently understanding mortgages, without evidently understanding details of American marketdetails of American market

• They were among those most adversely They were among those most adversely affectedaffected

Knowing needs of customersKnowing needs of customers• With internet banking, relationship With internet banking, relationship

between banks and customers has between banks and customers has weakenedweakened

• Securitization has also weakened linksSecuritization has also weakened links Knowing circumstances of customersKnowing circumstances of customers

• Is firm facing a temporary problem, a Is firm facing a temporary problem, a short term cash-flow problemshort term cash-flow problem

• Or is there a more fundamental Or is there a more fundamental problem?problem?

Localization of information provides a limit Localization of information provides a limit on globalization on globalization • Countries where international banks have Countries where international banks have

largely taken over local banks have faced largely taken over local banks have faced problemsproblems

Drying up of credit for small and medium-sized Drying up of credit for small and medium-sized enterprisesenterprises

Lower growth ratesLower growth rates

• But the problems are not inevitableBut the problems are not inevitable And this helps explain And this helps explain whywhy there will be a there will be a

multiplicity of financial centersmultiplicity of financial centers

Combining Global and LocalCombining Global and Local

At the same time, competition occurs At the same time, competition occurs at global levelat global level• Success requires best of global Success requires best of global

technologies and global practicestechnologies and global practices Including those required to ascertain Including those required to ascertain

creditworthiness, monitoring, enforcementcreditworthiness, monitoring, enforcement And those required to meet needs of saversAnd those required to meet needs of savers New and appropriate financial instrumentsNew and appropriate financial instruments

Challenge is to Combine Global and Challenge is to Combine Global and Local InformationLocal Information

Rich ecology of institutional arrangementsRich ecology of institutional arrangements• Some international banks serving multinational Some international banks serving multinational

corporations and large domestic clientscorporations and large domestic clients• A few international banks developing A few international banks developing

international expertise in some specialized international expertise in some specialized marketsmarkets

• Some international banks acquiring local Some international banks acquiring local information by buying local banksinformation by buying local banks

• Most firms engaged in only part of supply chain Most firms engaged in only part of supply chain — with contracting relationships with other — with contracting relationships with other parts of the supply chainparts of the supply chain

Living with GlobalizationLiving with Globalization

Challenge for each financial Challenge for each financial institution is to ascertain its institution is to ascertain its dynamicdynamic comparative advantage, to locate comparative advantage, to locate itself within this ever evolving itself within this ever evolving ecologyecology• Some will become international banks or Some will become international banks or

international financial institutionsinternational financial institutions

But Most will Have a Particular But Most will Have a Particular NicheNiche

Part of the global financial “supply chain”Part of the global financial “supply chain”• Linking themselves with other firms and Linking themselves with other firms and

financial institutions and with global securities financial institutions and with global securities marketsmarkets

Success, as always, entails information about these Success, as always, entails information about these other financial institutionsother financial institutions

And knowledge of global securities markets and their And knowledge of global securities markets and their limitationslimitations

Using local knowledge and informationUsing local knowledge and information But taking advantage of global best But taking advantage of global best

practices and global technologiespractices and global technologies

Challenge for Each FirmChallenge for Each Firm

Not only to figure out their dynamicNot only to figure out their dynamic comparative advantagecomparative advantage• What their particular “niche” should beWhat their particular “niche” should be

But to develop the supply-chain relationships But to develop the supply-chain relationships required for success required for success

Answering these questions is Information Answering these questions is Information intensiveintensive• best “fits”best “fits”• Identifying those who have best information about Identifying those who have best information about

local supply and demand side conditions and are local supply and demand side conditions and are using that information bestusing that information best

Combining Global Knowledge and Combining Global Knowledge and Local KnowledgeLocal Knowledge

And simultaneously to draw upon best of And simultaneously to draw upon best of global knowledge and practicesglobal knowledge and practices

Including knowledge and practices for Including knowledge and practices for managing local information managing local information • New instrumentsNew instruments• New technologiesNew technologies

Successful Financial CentersSuccessful Financial Centers

Same logic applies to successful financial Same logic applies to successful financial centerscenters

Different financial centers need to find their Different financial centers need to find their niche within a rich ecology of financial niche within a rich ecology of financial centerscenters

Some common ingredients of successSome common ingredients of success• TechnologyTechnology• InfrastructureInfrastructure• Human capital, including:Human capital, including:

Knowledge of the industry Knowledge of the industry

• Location — to obtain “local information”Location — to obtain “local information”

These are among the ingredients which These are among the ingredients which Korea already hasKorea already has

But there are other ingredients that may But there are other ingredients that may be needed to acquire — or at least to be needed to acquire — or at least to acquire the reputation that one has theseacquire the reputation that one has these• Network of long-standing relationshipsNetwork of long-standing relationships

Including networking with other financial centersIncluding networking with other financial centers• Which can form the basis of trust, so essential Which can form the basis of trust, so essential

in financial marketsin financial markets• Strong, well designed regulatory and legal Strong, well designed regulatory and legal

frameworksframeworks Protect investors and saversProtect investors and savers Without imposing excessive transaction costsWithout imposing excessive transaction costs

Seoul within AsiaSeoul within Asia

Given the changing global landscape, Given the changing global landscape, it is inevitable that the locus of it is inevitable that the locus of finance will shift towards Asiafinance will shift towards Asia• The question is only how muchThe question is only how much• And how fastAnd how fast• And the extent to which Western And the extent to which Western

financial institutions will transform financial institutions will transform themselves into Asian financial themselves into Asian financial institutionsinstitutions

New centers are emerging, New centers are emerging, importance of old centers is changingimportance of old centers is changing• Shanghai, Hong Kong, SingaporeShanghai, Hong Kong, Singapore

There is an Important Role for Seoul to PlayThere is an Important Role for Seoul to Play

Korea’s earlier development demonstrated Korea’s earlier development demonstrated that what mattered was not static that what mattered was not static comparative advantage, but comparative advantage, but dynamic dynamic comparative advantagecomparative advantage

The questions that need to be asked are:The questions that need to be asked are:• What will Asia’s financial markets look like 25 What will Asia’s financial markets look like 25

years from now?years from now?• What niche will Seoul eventually play?What niche will Seoul eventually play?

• And what can Seoul do now to play that role?And what can Seoul do now to play that role?