Recent Papers & Speeches

"Japan's Economic Outlook and Assessment of Existing Economic Policies"
prepared for a New Frontier Party Delegation to the U.S.

I
Last year, Japan's economy achieved 3.6% growth in real terms. This is the highest growth rate since 1991, when the economy plunged into recession. Between 1992 and 1995 the growth rate remained stagnant at an average of 0.8%. The 3.6% growth rate is therefore an encouraging sign, although last year's growth rate was still lower than the 4.2% average achieved in the 15 years prior to the recent recession. People are starting to feel that the economy has at last gotten out of the long stagnation resulting from the bursting of the bubble.
The relatively high growth achieved in 1996 was due to a sharp increase in public works as a result of government measures to stimulate the economy in the first half of the year, and a recovery of private sector investment, such as housing construction, fixed investment, and inventory investment, and the bottoming-out of net exports in the second half. The growth rate for fiscal 1996, which ended last month, is estimated at 2.5%-3.0%. The government forecast of 2.5% is at the lower end of this range.
In my judgement, however, this high growth rate does not mark the start of Japan' recovery from its long stagnation, since it is based on three temporary supports.
First, it depends on a policy of keeping Interest rates at an extraordinarily low level. Since September 1995 this policy has taken the ODR down to 0.5% and the benchmark government bond yield to 2.15%. Historically and internationally, this level is unprecedented and cannot be sustained long in today's globalized environment, since the eventual consequences will be currency depreciation and inflation. At 126 against the U.S. dollar, the yen rate has, by my estimate, overshot against the PPP for tradable goods. As a result, the rate of inflation in Japan is rising gradually, although it is still low at present. The depreciation of the yen could accelerate, along with the inflation rate, if U.S. Interest rate are raised further. The Bank of Japan will become obliged to raise the rate in the not-so-distant future.

Second, the relatively high growth rate was partially supported by the bottoming-out of net exports. The current account surplus has already begun to increase since the second half of 1996. The surplus will continue to benefit from a weak yen and fiscal consolidation, which increases excess domestic savings in Japan. The U.S. Treasury is already warning Japan the Japan's economic recovery should not be based on the expansion of net exports. This morning it was reported in a newspaper that President Clinton sent the same message to Prime Minister Hashimoto in his letter.

Third, private sector investment in houses, cars, and other durable goods has been front-loaded by expectations of a rise in the consumption tax rate from 3% to 5% in April 1997. A sharp reactive decline in such investment is envisaged in the first half of fiscal 1997.
In addition to these three reasons for the unsustainability of the recovery trend, the situation will also be affected by the budget for fiscal 1997, which includes 9 trillion yen increase in consumption tax, income tax, and social security contributions. These measures will have a deflationary impact on the economy during the course of fiscal 1997.
These are the reasons why even the government is forecasting only 1.9% growth in fiscal 1997, and why the average growth forecast of private research institutes is just 1.4%, despite last year's 3.6% growth. The weakness of stock prices also reflects the anticipated decline in the growth rate.
That is why I say that the 3.6% growth recorded last year does not signed the start of a medium-term recovery trend.

II
You are probably wondering why the Japanese government is implementing such a deflationary budget in fiscal 1997. The answer is that the Hashimoto cabinet regards fiscal consolidation as one of the most urgent reforms in present-day Japan. The government may also feel that the budget will not cause a recession, but merely a pause in growth in the first half of fiscal 1997, and that the recovery will start again in the second half, since capital spending is on a steady rising trend after four years of sharp declines between 1991 and 1994.
We in the New Frontier Party, which is the largest opposition party in Japan, believe on the contrary that if it were not for this deflationary budget, the growth rate of the Japanese economy would accelerate to over 4% in fiscal 1997. In other words, the Hashimoto cabinet lost a golden chance to bring the Japanese economy back to a sustainable medium-term growth path of 3-4% led by private sector spending, without causing increases in the budget deficit or the current account surplus.
As a matter of fact, the New Frontier Party argued in parliament that the reform process, including fiscal consolidation, would not succeed without a continued macroeconomic recovery. We proposed the suspension of the 9 trillion yen increase in taxes and social security contributions. Unfortunately, this proposal was rejected by the majority coalition, which consists of the LDP, the SDP, and Sakigake.

III
As you may perhaps know, the Hashimoto cabinet announced a program of "six reforms" as its basic policy. The program calls for structural changes in the economy, finance, banking, public administration, social security and education.
I believe the "six reforms" are bound to face difficulties for two reasons: First, the macroeconomic framework required to implement them is lacking. Second, the lack of an overall conceptual structure to bind the reforms together means that each has remained separate from the other. Implementing one could well harm another.
Structural reform fundamental enough to change the course of history is bound to cause pain. On the one hand, reform opens up opportunities for new growth and development, but on the other hand, a number of existing enterprises and industries will lose their raison d'etre. There will be frictional and structural unemployment, and equipment and land could be idled. This is not only a great waste, but will also drag the economy down even further into stagnation. Successful structural reform requires sufficient macroeconomic growth to absorb the pain.
The Hashimoto government's "six reforms" lack the macroeconomic framework needed to absorb the pain of reform. They reflect the illusion that merely mouthing the magic word "reform" will be sufficient to pull the economy out of its slump.
My second reason for predicting difficulties for Mr. Hashimoto's "six reforms" is that they do not reinforce each other; in fact, they are in some cases mutually contradictory.
When the Hashimoto government talks of administrative reform, for one thing, it means splitting up the powerful Ministry of finance and creating a bloated new Monetary Inspection and Management Agency. Far from reducing government expenditure, this new agency is likely to increase it.
Nor is there any unified policy concept harmonizing social security reform and fiscal reform. One of the fiscal reforms is to correct the imbalance between direct and indirect taxes. The former will be cut and the latter raised in order to prepare for the aging society of the 21st century. Then why does the government seek to pay for the costs of care, not by means of the consumption tax, but by care insurance fees, which are a form of direct tax?

IV
I should like to conclude my remarks with a somewhat optimistic story.
The fundamental reason why the Hashimoto cabinet has no medium-term strategy for macroeconomic management and no overall policy concept binding the whole reform program together is that it is a minority government assisted by the Social Democratic Party. Although there is no minister from the SDP in the cabinet, it is in essence a coalition government formed by the LDP and the SDP to exclude the New Frontier Party which has the second largest number of seats. However, the LDP and SDP naturally have very different political beliefs and economic policies, which means that they cannot implement any strategic policies. Instead, they resort to stop-gap policies on each single issue facing them, without any long-term view, and they have always postponed decisions on strategic issues as long as possible.
However, they have finally reached the limit of postponement on the issue of U.S. military bases in Okinawa. The gulf between their political beliefs on defense issues is too wide to patch up. Summit talks between Hashimoto of the LDP and Ozawa of the NFP resulted in an agreement on the management of U.S. bases in Okinawa. A related bill was passed by parliament last week with overwhelming majority support, except for the SDP.
More strategic issues of this kind are on the horizon. At the international level, there is the formation of new defense guidelines between Japan and the U>S., while domestically there is the preparation of the many reform laws needed to implement the "six reforms", as well as the formulation of the fiscal 1998 budget, which must be consistent with and supportive to the "six reforms".
Further cooperation between the LDP and the NFP on these fundamental issues is indispensable. In fact, a new study group consisting of members of both parties was formed last month to discuss those issues. I am a member of that group.
Although Japan's economy is missing an opportunity to get on a sustainable medium-term growth path of 3-4% this year, I believe that the LDP and the NFP will reach a policy agreement to implement corporate tax cuts, abolish the securities transaction tax, and deregulate in such areas as financial services, telecommunications, transportation and distribution. Those measures will put Japan's economy on a sustainable growth path from next year. Generally speaking, capital spending in Japan has a medium-term cycle of about ten years, divided into a rising phase of about six years and a four year decline. Four years of sharp decline in 1991-94 have been followed by three years of moderate upward movement in 1995-97. With corporate tax cuts and deregulation, we shall hopefully have another three years of increases in capital spending, which will be strong enough to drive sustainable growth until at least the year 2000. If Japan is able to realize such a scenario, the structural problem of non-performing loans will become easier to solve. Moreover, Japan's money and capital markets and its financial system will survive as an international financial center through a process stimulated by the Japanese "Big Bang".

�œback

�œTOP PAGE