Japan has made substantial progress during the five years since Prime Minister
Junichiro Koizumi assumed power in 2001. This includes addressing many of the
issues that prevented the nation from meeting the challenges of global
competition, which hindered the competitiveness of its corporations and
financial institutions, and limited the ability of the economy to generate jobs
and higher
living standards.
Japan's accomplishments are respected in many ways, including stronger economic
growth, rising prices, a brighter employment picture, vastly improved corporate
projects and efficiency, and a slowdown in the growth of public debt.
Toward the end of this month, the Liberal Democratic Party will elect a new
party president who, in turn, will become the prime minister because of the
LDP's majority in the diet, Japan's parliament. The new prime minister will
face a number of important challenges. These include maintaining positive
momentum with respect to reform efforts, initiating new policies to address the
high ratio of public debt to gross domestic product (GDP), and measures to
mitigate the dislocations that have resulted from past reforms, deregulation
and the rationalization of the business sector.
The next premier also needs to define Japan's place in the world better and to
strengthen its relations with its East Asian neighbors. This is necessary both
to meet Japan's obligations as a global citizen and to support more extensive
economic interactions among vibrant East Asian economies. This is also needed
to provide a foundation to facilitate regional economic integration and to
allow joint efforts to deal with security challenges in the region.
Japan has changed dramatically
Over the past five years, Japan has changed dramatically. This is true not only
in economic terms but also in terms of business structure and practices,
consumer sentiment, regulatory practices, and receptiveness to foreign
participation and investment.
Much of this success has to do with the efforts of Koizumi, who has served
longer than any Japanese prime minister since the early 1970s.
When Koizumi took office in 2001, Japan's real GDP was growing at an anemic
rate of 0.4% per year, and few were optimistic about its growth prospects. In
contrast, in 2004 it achieved 2.3% real GDP growth, followed by 2.8% growth in
2005. The economy's recent performance suggests that Japan may realize a
similarly strong growth rate this year.
In addition, five years ago, prices were falling at a rate of 0.7% per year.
Now, the government acknowledges the economy no longer is "in a state of
deflation". Beyond this, between 2001 and 2005, merchandise exports surged from
US$383 billion to more than $568 billion. A revival of domestic demand is
leading Japan's recovery.
Also noteworthy have been improvements in private consumption, which increased
from 287 trillion yen to 303 trillion yen (about $2.59 trillion) between 2001
and 2005 in real terms. This is an increase of 4.8% for five years or 1.4% per
year. Domestic consumption has been so solid that JPMorgan Securities Japan's
chief economist Masaaki Kanno was prompted to argue, "I think we can say that
Japan's economy is no longer relying on overseas demand."
Accelerating corporate projects have also been part of a brightening economic
landscape. The elimination of excess capacity, debt, and other inefficiencies
has increased corporate projects to the point where they are "at the peak
levels of the late 1980s for both the manufacturing and non-manufacturing
sectors".
Growing profitability has also supported strong business investment, which is
increasing at its fastest rate since 1991. In fact, corporate investment in
machinery has been so strong that it caused Deutsche Securities analyst Seiji
Adachi to comment that "companies are still keen to invest" and "believe the
recovery is for real and the economy is set for a long expansion".
In addition, the seasonally adjusted unemployment rate has plunged from 5.2% in
2001 to a current rate of about 4.2%. This is an eight-year low, and total
employment correspondingly has risen each year since 2002.
Another bright spot has been the performance of the Japanese stock market over
the past five years. The Nikkei 225 has risen more than 100% from the 7,900 low
registered in April 2003 to the close of 16,105.98 registered on August 18,
2006.
Looking at the corporate sector, the rejuvenation of Japan during Koizumi's
tenure is illustrated vividly by the transformation of its once-catatonic
banking sector. Between March 2002 and March 2006, non-performing loans fell
from a high of more than 40 trillion yen to about 10 trillion yen today.
Net lending, which was falling because of a lack of demand for loans and a
dearth of good credit, is experiencing its fastest growth in 10 years.
Banking-sector projects have surged and many Japanese banks have repaid their
government-bailout funds. The transformation of Japanese banks is enabling them
to serve a wider range of customers and to offer a more diverse menu of
services. It has also turned them into employment engines, with Japan's biggest
financial institutions hiring more university graduates than ever before.
Terunobu Maeda, the chief executive officer of Mizuho Financial Group, stated
that "Japan's banks have been focused on restructuring, laying off bankers,
closing branches, and cutting bad loans ... Now we've escaped from that, and we
need to expand." Beyond this, it is enabling, according to Richard Jerram,
chief Japan economist at Macquarie Securities, the banking sector to "play its
normal role in the economy".
Despite these successes, which would have seemed almost unimaginable except to
the strongest optimists only a few years ago, it is clear the next prime
minister will also face a wide range of challenges. The new government must
help the nation to digest the gains of the past five years and position itself
for a new round of achievements. Among other tasks, commentators are calling on
the next prime minister to pursue reforms that encourage new business
formation, bolster innovation and enhance productivity.
They are also encouraging Japan to reduce its public debt and build cordial,
cooperative relationships with its East Asian neighbors. Others such as the
International Monetary Fund (IMF) have highlighted the importance of tackling
Japan's challenging demographic situation and initiating policies that enable
the nation to utilize better the talents of its female workforce.
Japan needs to maintain momentum
Japanese efforts to revitalize and transform its economy have been significant
in recent years by almost any measure. This progress is reflected in improving
economic data, comprehensive regulatory change and major changes in the way
business is conducted in Japan. Progress on the economic front is demonstrated
by numerous indicators.
Progress is evidenced in the numerous moves to deregulate Japan in recent years
and comprehensive programs such as the passage of a new Corporation Law in June
2005. This affords shareholders greater rights, requires more disclosure,
allows foreign companies to use shares to make acquisitions, facilitates
spinoffs and eases the procedures for corporate reorganizations.
Beyond the passage of these measures, the dramatic changes in the way business
is conducted in Japan can be seen anecdotally by recent events such as the
decision by Oji Paper to launch, with the aid of blue-chip financial adviser
Nomura Securities, a hostile takeover attempt of Hokuetsu Paper Mills, the
first such attempt by one blue-chip Japanese company for another.
Hisakazu Amano, a fund manager at T&D Asset Management in Tokyo,
characterized the deal's effect on shareholder behavior and the behavior of
smaller and medium-sized Japanese firms as potentially "epoch-making".
Several weeks ago, Aoki, a men's-wear retailer, made an unsolicited bid for its
competitor Futata. This yields yet more confirmation of the emergence of a new
mindset. The transformation of business in Japan is further illustrated by
changes at Sony, which hired a foreign chairman and CEO, shed jobs and divested
non-core operations and is now, in the words of Hiroshi Takada,
consumer-electronics analyst at JPMorgan in Tokyo, "at the entryway to
recovery".
Stan O'Neal, the chairman and CEO of Merrill Lynch, who only a few years ago
moved to cut Merrill's Japanese operations dramatically, recently cited the
changes in the Japanese business mindset as one reason he was "even more
bullish about Japan than" before.
Forward momentum also exists in the realm of the public sector. For instance, a
law recently came into effect that would permit the Cabinet Office to analyze
whether the private sector could provide a service more efficiently than the
government.
Pursuant to the law, the government will send out tenders for employment
agencies, the registration of life events such as marriages, and the collection
of national-pension premiums. The most dramatic change, however, is undoubtedly
Koizumi's successful effort in 2005 to break up the Postal Savings System
(PSS), which functions as a postal system, financial institution and
life-insurance agency.
Pursuant to the legislation the diet approved, the PSS will, over a 10-year
period beginning in 2007, divide into four large components relating to
banking, insurance, mail delivery and post-office counter services, some of
which will be listed on the Tokyo Stock Exchange.
Reforms and restructuring have accomplished much. Even so, they have brought a
measure of social dislocation. Not surprisingly, then, this disruption coupled
with progress on the economic front have engendered a measure of "reform
fatigue" among politicians, businesses, and individuals.
Signs of reform fatigue have evoked concerns among analysts such as Goldman
Sachs chief economist Tetsufumi Yamakawa, who stated, "There are strong-rooted
concerns in the market about a potential weakening of momentum in structural
reform under the next administration." Similarly, Jesper Koll, an economist at
Merrill Lynch in Japan, observed that "the golden age of reform may be coming
to an end".
Aware of these sentiments, Minister of State for Economic and Fiscal Policy
Kaoru Yosano has stressed the need for Japan to continue with reform if it is
to meet the challenge of global competition. In Yosano's words, "To slow the
pace of structural reform for domestic reasons would be to fall behind in the
world."
At the same time, many are optimistic about the prospects for continued reform
after a new government comes into power. Evaluating the various candidates for
the LDP presidency, Nikko Citigroup opined that there are those who could well
deliver an aggressive liberalization of the telecommunications sector as well
as massive sales of government assets.
In a study on the prospects for continuing economic reform, Morgan Stanley
economist Robert Alan Feldman forecasts significant spending cuts,
education-policy reform, pension reform, medical reform, and a more welcoming
attitude toward immigrants, depending on who is victorious in the LDP
presidency race.
Need to address excessive debt
As Japan struggled to reinvigorate its economy throughout the 1990s and early
2000s, attention was focused on initiating programs that could stimulate
business and economic activity. This included a wide range of public-works
projects and emergency loan packages, many of which could not be justified in
commercial terms.
The result of this activity was an expansion of Japanese public-sector debt to
one of the highest levels in the world, when measured as a percentage of its
GDP. Consequently, rectifying this fiscal imbalance is one of Japan's foremost
policy challenges.
Angel Gurria, the secretary general of the Organization for Economic
Cooperation and Development (OECD), for instance, asserts that Japan's priority
should be "to stop the run-up in the government debt-to-GDP ratio".
Despite the significance of this problem, it should be remembered that Japan's
fiscal deficit has been funded almost exclusively through the yen-denominated
savings of Japanese citizens - instead of the foreign borrowing that has been
used to address shortfalls in the United States and some other nations. This
enables Japan to act in a manner sensitive to the country's domestic political
and economic imperatives rather than those of overseas investors.
Having said this, Japanese policymakers do recognize the need to make progress
in tackling the government's large fiscal deficit and high public-debt-to-GDP
ratio. In fact, since 2002, the government has taken steps to control public
spending by cutting expenditures on public works, privatizing public services,
and reducing subsidies to local governments.
As a result, the primary budget deficit has fallen from 6.7% of GDP in 2002 to
about 4% in 2006. Nevertheless, in the OECD's view, more aggressive action will
be necessary in view of the country's rising expenditures on social security
resulting from an aging population and low birth rate.
More forceful action, however, does not imply rapid or massive tax-rate
increases. Masaru Takagi, an economics professor at Meiji University, observed
that "'if cuts and a tax increase are carried out gradually, the goal of 2011
[ie, a primary budget balance for combined central and local government
accounts] may not be so difficult to achieve".
As well, the OECD has noted that Japan has a variety of options besides
tax-rate increases for enhancing revenue, such as broadening the tax base and
improving tax collection. In any event, policymakers are aware of the
difficulties that ensued when Japan last raised its consumption tax in 1997 in
an attempt to address its fiscal imbalances. Many believe this action cost
then-prime minister Ryutaro Hashimoto his government and contributed to a
premature end of the economic recovery that had been taking shape.
As a result, we are likely to see caution in resolving this issue, and many
believe that 2010 is the earliest likely date for a consumption-tax increase
unless events precipitate an earlier general election.
Need to strengthen foreign policy
During the 1980s and 1990s, Japan was often criticized as being overly focused
on trade and commercial relationships and its perceived preference for engaging
in "checkbook diplomacy" rather than taking on the responsibilities and
obligations normally expected of a country with an economy of Japan's size and
importance.
Over the past decade, however, Japan has tried to address this problem and made
a concerted effort to become more active and assertive in the international
arena. This has been demonstrated in the leadership it has exhibited on
critical issues such as global warming - which facilitated the adoption of the
Kyoto Accord. In addition, the Koizumi government quickly agreed to provide
logistical support for international operations in Afghanistan as well as to
support reconstruction activities in Iraq.
According to Richard Samuels, a professor at the Massachusetts Institute of
Technology and the director of its Center for International Studies, such
initiatives have given Japan "more security options than at any time since the
1940s". More recently, Japan, the second-largest financial contributor to the
United Nations, sought to obtain a permanent seat in the UN Security Council.
However, it should be noted that Japan's expanding international role has been
accompanied by a greater sense of patriotism within Japan. While this in fact
is essential to create the sense of national identity and vision that must
underlie international outreach of this kind, Japan's new assertiveness has
made some countries, especially China and South Korea, uncomfortable and wary.
While there is a long history behind Chinese and South Korean circumspection,
it will nevertheless be essential for the next Japanese prime minister to do
his utmost to face up to these difficulties and to find the balance between
internal and external concerns necessary to stabilize and strengthen Japan's
relations with neighboring countries.
Movement to resolve these tensions will help to promote additional growth and
stability in Asia, the world's fastest-growing market, whose continuing
prosperity and development will depend on closer cooperation within the region.
This will include addressing issues involving North Korea, which may remain
unpredictable, but should not be allowed to destabilize the region or the world
at large.
Japan is more prepared
Irrespective of the outcome of Japan's September 20 LDP election and the
cabinet that it produces, it is clear Japan has moved far past the limitations
that prolonged its long struggle to revitalize its economy and to adopt a more
market-oriented business and financial environment.
This is evident in the rising interest and shareholdings of foreign investors
and financial institutions in Japan as well as the increased competition,
changing attitudes, employment patterns, and deregulation efforts seen in
recent years.
While there will certainly be periods of adjustment, resistance to the rapid
changes adopted since Japan embarked on a course of reform in 1996, and swings
in sentiment among both foreign and domestic audiences, structural change
appears to have permanently altered Japan's economic landscape.
In an article in the IMF publication F&D, Daniel Citrin, the deputy
director of the IMF's Asia and Pacific department, and Alexander Wolfson, a
director at Citigroup Inc, reviewing Japan's altered economic landscape,
asserted that it meant Japan "should achieve much higher growth over the coming
decade", which would allow it "to contribute to a stable and vibrant world
economy".
Over time, further change would seem inevitable as both foreign and domestic
companies guided by the underlying metrics of market growth, shareholder value
and a more transparent and efficient operating environment move to enhance
their profitability and competitive position.
This material is published and disseminated by JETRO in coordination with
KWR International, Inc. E-mail:
kwrintl@kwrintl.com. JETRO New York is registered as an agent of the Japan
External Trade Organization, Tokyo, Japan and KWR International, Inc is
registered on behalf of JETRO.
