Annual Report on the Japanese

Economy and Public Finance

2003-2004

- No Gains Without Reforms IV -

July 2004

Cabinet Office

Government of Japan


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Section 3 Structural Reform in the Regions

1. Structural Reform of Public Finances at the Local Government Level
   

Local government finances are in a severe condition
    Until the beginning of the 1990s, local government finances were in substantially better condition than central government finances. Nonetheless, as a result of increased public works aimed at supporting regional economies in light of Japan's weakened economic growth rate after the collapse of the bubble economy, the fiscal balance of local governments rapidly deteriorated. Looking at the state of local government finances using National Income Statistics, the local government net lending as a share of gross domestic product (GDP) increased abruptly from a surplus of 0.5% in FY1990 to a deficit of around 2% in the mid-1990s. Although the deficit began to contract in FY1999, the deficit was 0.7% in FY2002 (Table 2-3-1). Meanwhile, with regard to local government debts, the sum of local bonds, local allocation tax, loans from the special account for local allocation taxes and outstanding balance of corporate bonds was 193 trillion yen at the end of FY2002 (approximately 39% as a share of GDP). Accordingly, public debt as a proportion of the budget is growing and public finances continue to become increasingly rigid. The ordinary balance ratio is often used as an indicator of the elasticity of the fiscal structure. The ordinary balance is the proportion of general revenues, or expenditures ordinarily disbursed every fiscal year, such as personnel costs and public debt (general revenues appropriated to current expenditures), to general revenues that ordinarily flow in every fiscal year, such as local taxes and ordinary local allocation taxes (current general revenues). The greater the ordinary balance ratio, the less elastic finances are. An examination of look at changes in the ordinary balance ratio demonstrates that it declined once between FY1998 and FY2000, rose again, and marked a record high of 90.3% in FY2002, suggesting that local government finances continue to be in a considerably severe condition.
   
Status of structural reform of public finances at the local government level
    Local governments are taking a variety of fiscal consolidation initiatives to deal with the crucial fiscal situation, but specifically, what kind of changes are being made to revenues and expenditures in local governments as their finances worsen or improve? Recognizing that major differences exist in the fiscal condition of local governments, the following discussion will examine with statistical evidence how changes in revenue and expenditure affect the fiscal condition using individual fiscal data of 641 cities nationwide and the 23 wards of Tokyo for which data was available.
Table 2-3-1 State of Local Government Finance

Status of fiscal consolidation initiatives in areas of spending and revenue
    Looking at the distribution of the ordinary balance ratio of cities and wards nationwide, municipalities are fairly evenly split between those with strong finances and those with weak finances in 2002, with most municipalities falling around the average, or between 85% and 90% (Figure 2-3-2). As for the changes between 1998 and 2002, the ordinary balance ratio is growing overall. In order to find out how such finance rigidity was affecting expenditures and revenues, cities and wards were categorized according to the size of their ordinary balance ratios in 2002, and the changes in the local tax revenue per capita between 1998 and 2002 in that category, investment spending per capita and the number of municipality staffs per 10,000 persons were examined. The characteristics of the local finances were as follows.
Figure 2-3-2 Graph of Ordinary Balance Ratio Distribution
    First, on the expenditure side, the more severe the fiscal condition is of a municipality (high ordinary balance ratio), the greater the decline in the tax revenue per capita. In particular, for several municipalities with an ordinary balance ratio of over 100%, tax revenues have fallen drastically and it is apparent that the drop in revenue is contributing substantially to the worsening fiscal condition (Figure 2-3-3 (1)).
    Second, looking again at changes in expenditures according to the ordinary balance ratio, even if municipalities have strong finances (low ordinary balance ratios), they are cutting back investment spending and the number of their staffs, and measures are being taken to streamline expenditures to an extent (Figure 2-3-3 (2)).
    Third, in particular, the reduction in investment spending becomes noticeably larger when the ordinary balance ratio is over 100%. This is considered to reflect the fact that these municipalities have no other choice but to adopt extremely tough fiscal consolidation initiatives (Figure 2-3-3 (2)).
Figure 2-3-3 Financial Condition of Local Government, Tax Revenues and Investment Spending

Regression analysis showing factors affecting fiscal balance changes
    A regression analysis was conducted using data for 641 cities and 23 wards for which all statistics are available. This analysis was undertaken to statistically confirm how the fiscal condition of cities and wards nationwide changed in the period from 1998 to 2002 (Table 2-3-4). The results show that the following trends are observed simultaneously: (i) increasing employment of government officials and growing ordinary balance ratio (tightened fiscal condition); (ii) rising local tax revenues and declining ordinary balance ratio (improved fiscal condition); and (iii) higher interest payment on public debt in the budget and increasing ordinary balance ratio (tightened fiscal condition). However, these trends, which reflect either directly or indirectly variables constituting the ordinary balance ratio are presumably simultaneously determined rather be in a causal relationship.
Figure 2-3-4 Financial Condition of Local Governments and Causes
    When the changes in investment spending per capita is added together with this basic pattern, the coefficient on the growth of investment spending was negative and a reduction in investment and tightened fiscal conditions were observed at the same time. This suggests the possibility that a cutback in investment alone is insufficient for improving the fiscal condition, but as previously described, it may reflect the fact that many municipalities that are faced with extremely severe fiscal conditions have no choice but to significantly reduce investment spending.
    Finally, elderly welfare costs were incorporated in the projection to measure the impact of the aging population on fiscal balance. It was found that increased elderly welfare costs and a growing ordinary balance ratio (tightened fiscal condition) were observed simultaneously. Therefore, given the advancement of the aging population, it is expected that continued pressures on the fiscal condition will be inevitable in the future.
    To summarize the points to consider in fiscal consolidation in the future given the results of these projections, (i) cutbacks in investment spending are not enough to avoid the rigidity of finances and there is a need to curb current expenditure items, and (ii) it is important to take steps to secure local tax revenue.
   

2. Progress in Administrative and Fiscal Reform in the Regions
   

Overview of New Public Management (NPM) Methods
    Given the severe fiscal situation, measures aimed at New Public Management (NPM) methods have been quickly spreading among local governments beginning in the second half of the 1990s. In particular, in reconsidering the relationship between central and local governments, as seen in the enforcement of the Comprehensive Decentralization Law in April 2000, there is an increasing need for local governments to develop a structure founded on self-determination and self-responsibility compared to before. This is also an underlying factor in the regions strengthening their own efforts aimed at administrative and fiscal reform. The content of NPM has been discussed in detail in the Annual Report on the Japanese Economy and Public Finance 2003. As concrete administrative measures, many local governments have taken approaches such as the following: improving the efficiency and effects of administrative services by policy evaluation, introducing corporate accounting methods, commissioning the development of facilities and operations to the private sector through the Private Finance Initiative (PFI). The following provides an overview of each of these methods and their status of prevalence.
   

(1) Policy evaluation
   
    The purpose of policy evaluation is to improve administrative management and define accountability to residents by clarifying the targets, achievements and degree of achievement for each local government measure and project. A survey conducted by the Ministry of Internal Affairs and Communications shows that in FY2002, most prefectures including those currently conducting trial runs have implemented policy evaluations, and 65% of all municipalities, including those which are considering running them, have carried out policy evaluations (Figure 2-3-5).(11)
   

(2) Introducing corporate accounting methods
   
    Corporate accounting methods serve as the basis for calculating cost totals, including depreciation, when assessing projects or measures, and help improve accountability to the residents. Research groups of the central government have set standards for corporate accounting-style methods in local governments. In addition to the method of creating balance sheets which reveal the state of local government assets, debts and other items, the research groups have come up with a basic concept of the method of calculating administrative cost, or the cost of providing administrative services. Administrative cost statements calculate not only cash disbursements but also non-cash disbursements for a particular fiscal year, including depreciation and retirement benefit allowances for employees.(12) According to a study by the Ministry of Internal Affairs and Communications, as of the end of March 2003, all prefectures and 1,856 municipalities, or 57.4% of the total, had created some form of balance sheet, and 43 prefectures and 982 municipalities, or 30.4% of the total, had created Statements of Administrative Cost Calculation (Figure 2-3-5).(13)
   
(3) PFI    
    PFI is a method of using private funds, management capacity and technological capabilities to design, build, maintain and operate public facilities, among other things. Japan established the PFI Law in 1999 and implementation guidelines have been announced for over 150 PFI projects to date. In a survey of local governments conducted by the Cabinet Office in February 2004, among 2,121 municipalities that responded, 6.7% had already introduced PFI or were considering it, and 22.4% had considered it or intended to proactively consider it in the future (Figure 2-3-5).(14)
   
(4) Outsourcing    
    Outsourcing of administrative services of local governments is expected to improve the efficiency of administration and finances, enhance services for residents, expand private business opportunities and create employment. According to a survey conducted by the Ministry of Internal Affairs and Communications of municipalities nationwide in April 2003, a major share of general office work and facility administrative services of local governments has been outsourced. The share of outsourcing has grown in almost all services compared to figures in the 1998 survey (Table 2-3-6).(15) Looking at the share of outsourcing for each type of general office work, percentages are high for at-home food distribution services (96%), dispatching home helpers (91%), cleaning the main government offices (86%) and general garbage collection (84%), while percentages are relatively low for information and reception (20%), school custodians (20%) and driving public vehicles (29%). Moreover, as for the share of facility administrative services that are outsourced, percentages for sewage disposal facilities (92%), urban parks (91%) and hospitals and community centers (90%) are high, while percentages are comparatively low for nursery schools (60%) and clinics (63%).
Figure 2-3-5 Local Government Efforts with NPM
Table 2-3-6 Status of Services Outsourced in Municipalities

Effects of introducing the NPM method and its challenges
    As examined above, NPM methods have spread considerably among local governments and are believed to have had certain effects on improving the efficiency of administrative services already. According to a questionnaire study of municipalities nationwide carried out by the National Institute for Research Advancement (NIRA) on the effects of NPM methods, the largest number of municipalities reported that administrative evaluation, corporate accounting and PFI had the following effects, respectively: "awareness reform among staff (35.3%)," "accountability (40.2%)" and "budget reduction and fiscal consolidation (42.9%)."(16) In addition, concerning the effects of outsourcing, a survey conducted by Nihon Keizai Shimbun and Nikkei Research Institute of Industry and Markets in February 2004 showed that the effect of outsourcing on reducing revenue (net reduction minus outsourcing fees) was 190 million yen per local government.(17)
    On the other hand, not a great deal of time has passed since NPM methods have been introduced, leaving many challenges.
    First, coordination among each of the administrative and fiscal reform methods is required and there is a need to make further progress in streamlining and prioritizing administrative services. For example, local governments' balance sheets and calculation of administrative costs become useful in streamlining administration and finances only when they are used as determining factors for implementing new projects or continuing existing projects, or as a basis of comparison for public sector and private sector costs to decide whether to outsource or use PFI. However, a survey of the Nikkei Research Institute of Industry and Markets shows that there are only about 20% of municipalities that answered that the numbers generated from their Statements of Administrative Cost Calculation reflected in policy evaluations.(18) Furthermore, although the results of policy evaluations have already been used as reference in reviewing budget requests, administration and projects, it is necessary to devise further methods in the future.(19)
    Second, objective and quantitative methods to evaluate projects have not been sufficiently established for policy evaluation, calculating costs of PFI and other items. With respect to policy evaluation, some municipalities have said in a survey of the Ministry of Internal Affairs and Communications that problems in implementation included issues such as the "content of evaluations tended to be subjective and qualitative" and "how to evaluate measures that are difficult to assess appropriately" (Ministry of Internal Affairs and Communications (2002)). Consequently, municipalities are striving to solve these problems through efforts such as implementing municipal satisfaction level surveys. In a survey conducted by the Cabinet Office, a number of municipalities identified "method of calculating cost differences between traditional public works spending and PFI (Value for Money (VFM))" as a problem in terms of PFI (Cabinet Office (2004)).
    Third, regarding systemic factors that block administrative services from being opened to the private sector, including outsourcing and PFI projects, it is vital to reexamine regulations and immediately eliminate those that can be abolished. In a study of local governments carried out by the Cabinet Office in October 2003, about 30% of the 487 municipalities that responded said that systemic factors impeded outsourcing. More specifically, the study underlined that there were many cases where the management and operation of public facilities including waste disposal facilities, schools, libraries and community centers, and administrative services such as social welfare and insurance could not be entrusted to private businesses due to laws, ordinances and other factors.(20) Under these circumstances, the Program for the Promotion of Regional Revitalization decided in February 2004 included measures to promote the opening of public service management of roads and rivers to the private sector. Furthermore, in cases when the Build-Operate-Transfer (BOT) method (in which private businesses own and operate facilities while the project is underway) is used in PFI, there were problems in the legal status of land use and stability of continuing the project if private businesses had temporary authorization to use the land, which is an administrative property.(21) Therefore, an amendment to the law in 2001 enabled PFI businesses to rent land that is an administrative property, and the introduction of the Designated Management Entity System enforced in September 2003 allowed private businesses to comprehensively manage local government facilities. With such measures, the number of restrictions on the use of public facilities is gradually falling.
    Fourth, it is necessary to bear in mind that competitive pressures must always be placed on outsourcing. As for contracting methods for outsourcing, tendering accounts for a small share and the majority consists of discretionary contracts. However, contractors are not exposed to competitive pressures in regions with few competitors and there is a risk that cost-cutting pressures will not be exerted in the long run. One way to tackle this issue in such cases is to collectively outsource projects through wide-ranging cooperation across municipal borders.
   
3. Special Zones for Structural Reform and Regional Revitalization
   

Overview of Special Zones for Structural Reform
    Special Zones for Structural Reform aim to maximize private-sector vitality and advance structural reform through regional voluntary efforts by introducing exceptions to regulations according to special regional features with a view to revitalizing regional economies. The characteristics of Special Zones for Structural Reform that distinguish them from past regional promotional measures and approach to regulatory reform are that: (i) the national government will not suggest a model in advance, instead local governments and the private sector submit proposals that are in line with a region's distinctive features; (ii) local governments will take responsibility and implement individual projects; and (iii) Special Zones for Structural Reform are front-loaded reform based on regional characteristics, and exceptions to regulations that have not caused particular problems in the special zones will be extended to the rest of the nation. It is expected that successful examples of structural reform in specific regions will lead to regulatory reform at the national level and thereby revitalize Japan's economy as a whole. In addition, it is believed that these efforts in Special Zones for Structural Reform will reveal regional characteristics and make progress in the formation of industrial clusters and creation of new industries in accordance with these characteristics.
    Since the first round of designation of special zones in April 2003, five rounds of designation have been held as of June 2004 and 386 programs have been approved. Looking at the programs by field in descending order, 75 were related to education, 60 concerned agriculture, 51 involved promoting coordination and integration among kindergartens and nursery schools, 49 concerned to exchanges between urban and agricultural areas, and 38 were related to living and welfare (Appended Table 2-3).

Special zones for structural reform and revitalizing regional economies
    Special zones programs are believed to revitalize regional economies through the following three channels.
   
Table 2-3-7 Easing of Restrictions on Entry in Special Zones: Examples of Industrial Activity Facilitation (Up to Fifth Round of Certification in June 2004)
    First, regional companies and other corporations are expected to revitalize regional economies as a result of easing restrictions on entry and greater flexibility in managing regulations. To be specific, examples of easing restrictions on entry include entry into farming by corporations other than agricultural production corporations such as joint-stock companies, simplifying entry by authorizing the establishment of schools by joint-stock companies and relaxing the ratio of holding areas for school buildings and grounds when school juridical persons establish schools, and the provision of advanced medical care by joint-stock companies (enforced October 2004) (Table 2-3-7). Examples of greater flexibility in managing regulations include streamlining procedures of the Large-Scale Retail Stores Location Law and making customs services available 24 hours a day, 365 days a year.
    Second, private-sector business opportunities will expand as the use of public facilities and provision of administrative services becomes open to the private sectors. Such examples include increasing use of national and other facilities at modest prices, outsourcing the provision of meals for public nursery schools, and commissioning the management of special nursing homes for the elderly to the private sector.
    Third, the diversification and enhanced efficiency of administrative services will improve user convenience. For example, diverse educational curricula have been established and joint activities have been held between kindergartners and nursery school children.
   
Special zones and revitalization of local governments
    Moreover, special zones not only provide private businesses with business opportunities, but also give local governments, which plan and implement special zones programs, a chance to harness their uniqueness and promote regional revitalization. Thus, local governments that have been designated as special zones for structural reform were examined to identify their attributes using the same national municipal database as the previous section.(22) In addition, the results of the survey of the Nikkei Research Institute of Industry and Markets were used as a reference indicator of the characteristics defining administrative services of local governments. This survey evaluated the administrative services of national municipalities according to items such as transparency, efficiency, participation of residents and convenience and generated a comprehensive indicator based on these evaluations (hereafter referred to as the Nikkei Research Institute indicators).(23) The following explains the characteristics of municipalities designated as special zones revealed by this analysis.
    First, a look at the financial condition of municipalities that had been designated as special zones shows that many are relatively well-off financially. Nonetheless, despite the fact that only a few municipalities have been designated as special zones, some municipalities with extremely severe fiscal conditions, or an ordinary balance ratio of over 100%, are making efforts in special zones (Figure 2-3-8).
    Second, if the Nikkei Research Institute indicators are used to examine the special characteristics of municipalities designated as special zones in terms of the steps they had taken to improve efficiency, transparency, participation of residents and convenience of administration and finance, it can be suggested that compared to other municipalities many aggressively adopted such measures (Figure 2-3-9).
Figure 2-3-8 Ordinary Balance Ratio and Special Zones
Figure 2-3-9 Designation as Special Zone and Nikkei Research Institute Indicators
    However, it is possible that these special characteristics of municipalities designated as special zones as described above are gradually changing since more than a year has passed since introduction of the special zones for structural reform system. A detailed inspection of the relationship of municipalities designated as special zones, the ordinary balance ratio and Nikkei Research Institute indicators at the time the municipalities received designation shows that generally municipalities that received designation in the first to third rounds of designation were relatively well-off financially and have high Nikkei Research Institute indicators, as was illustrated above, but no such association is apparent for municipalities that had received designation in the fourth round (Appended Table 2-4). One interpretation of these observations is that municipalities that were initially hesitant about structural reform became positive about using special zones by the fourth round of designation. This is presumably because these municipalities were encouraged by the successful preceding examples of municipalities, which possessed the special characteristics described in this section and had received designation in the first to third rounds, spearheading the use of the special zones for structural reform system.
   
4. Tourism and Other Means of Regional Revitalization Harnessing Special Regional Features
   

    As demonstrated above, a framework is gradually being developed for regions to revitalize their economies through their own efforts. On the administrative and fiscal front, a significant amount of authority has been transferred to the regions with the Comprehensive Decentralization Law and further authority and tax resources will be transferred to the regions in the future as a result of the reform of the fiscal relationship between the central and local governments currently underway. Moreover, steps toward Special Zones for Structural Reform and regional revitalization enable deregulation and greater flexibility in managing regulations, which inhibit the advancement of regional revitalization, and also promote the outsourcing of services that so far have been provided by the public sector.
    With the winds blowing toward transferring greater authority to the regions, what specific ways are being followed to revitalize the regions? One instance of economic revitalization employing distinctive regional resources is the promotion of tourism. Given the fact that the number of tourists visiting Japan is less than significant compared to other countries, vigorous measures have been taken to promote tourism to Japan, including the Visit Japan Campaign, and steps are being taken to enhance regional charms by advocating "one region, one tourism" and other means.
    Another major trend is providing support for intellectual technological innovation and industrial clusters that use resources and industries unique to each region. Additionally, a great deal of effort has been made to attract foreign businesses with a view to revitalizing regional economies and creating employment by infusing know-how and capital of foreign businesses. In order to bolster these trends, preferential measures such as extending the maximum duration of stay of foreign IT engineers have also been implemented in special zones for structural reform. The following will offer an empirical analysis of the size of the number of tourists, among other things, using estimates generated from models as examples, and briefly touch upon the recent trends involving clusters and the promotion of foreign direct investment into Japan.
   
Concept of a country built on tourism
    Vigorous measures have been taken at both the national and local government level to promote tourism. The Action Plan to Realize Japan as a Country Built on Tourism, compiled by the Council of Related Ministers for the Realization of Japan As a Country Built on Tourism in July 2003, states that efforts would be made to realize a country built on tourism that is both "a good living habitat and a good place to visit" including: (i) spreading the 21st century track of a country built on tourism; (ii) establishing Japan's charms and regional charms; (iii) transmitting the Japan brand; (iv) developing an environment conducive to a country built on tourism; and (v) promoting strategies aimed at creating a country built on tourism. Specifically, information on Japan's charms are being proactively transmitted abroad in order to encourage tourists to visit Japan. In addition, the process of obtaining entry visas for foreigners has been simplified and expedited and foreign language information boards, signs and other items have been put in place. Furthermore, the theme of "one region, one tourism" has been promoted, as well as town planning focused on bringing out regional charms and human resource development, so as to enable regions to discover their own charms, enhance them and compete with one another.
    The actual number of tourists visiting Japan was 5.35 million in FY2003, a record high that surpassed the figure for FY2002 when the FIFA World Cup was held. Compared to other countries, however, Japan places 33rd in the world as of 2002 and this is a low level considering its population and economic size (Figure 2-3-10). Moreover, a look at the tourism balance of payments in 2003 shows that Japan received approximately 1 trillion yen from abroad in terms of tourism, but paid out 3.3 trillion yen in 2003 as expenses incurred by Japanese tourists traveling abroad. As a result, Japan has a considerable export surplus regarding tourism (Appended Figure 2-5).
   
Estimated inbound tourism in Japan
    Both the public and private sectors are aggressively involved in attracting tourists to visit Japan. How can the number of tourists visiting Japan be assessed considering factors such as Japan's population, economic size and situation of neighboring countries? Past research has used the gravity model to explain this. In the gravity model, the number of tourists to country A from country B is proportional to the population and economic size of countries A and B, and inversely proportional to the square of the distance between countries A and B.(24) Twelve countries from which there are relatively large numbers of tourists visiting Japan were identified. Using the gravity model, the number of tourists from Japan to each of these 12 countries was estimated and vice versa. Looking at the divergence between the projected number of tourists and actual number, even though the projected number is much lower than the actual number for Japan, actual numbers are higher than projected numbers for popular tourist destinations such as France, the US, Canada and Hong Kong (Figure 2-3-11).(25) These results suggest the possibility that the number of tourists visiting Japan is lower compared to the economic size and population of Japan and its neighboring countries.
Figure 2-3-10 Number of Foreign Tourists According to Country (2002)
Figure 2-3-11 Projected Number of Tourists According to the Gravity Model
    Next, the same projected numbers were used to compare projected numbers and actual numbers of tourists visiting Japan by country of origin. Taking particular note of Asian countries, from which there are many tourists to Japan, actual numbers are lower than projected numbers for the Republic of Korea (ROK) and China, even though actual figures are higher than projected numbers for Taiwan. This difference indicates that the number of tourists from the ROK and China are lower, yet higher for Taiwan relative to population, economic size and distance from Japan. Nevertheless, an examination of tourists actually visiting Japan according to nationality shows that the number of tourists from the ROK and China, which had rather low projected figures, is currently growing (Figure 2-3-12).
Figure 2-3-12 Trends in Number of Tourists Visiting Japan According to Nationality (Top Five Countries)

Tourist trends among the regions
    Lastly, the trends concerning tourists to the prefectures will be briefly considered. Here the number of tourists to the prefectures will be used, but it will be necessary to interpret the following analysis with some caution, given that there are numerous statistical problems. They include the fact that the data are not necessarily consistent across prefectures depending on what is being used, the number of tourists includes not only tourists from outside the region but also within the region, and cumulative numbers have been used.
    To begin with, for the situation of the number of incoming tourists by region, including tourists from within the region, there is a trend for regions with large populations as well as large cities to have substantial numbers of tourists (Appended Figure 2-6). Meanwhile, the number of workers employed in tourism-related industries as a proportion of all employees is high in popular tourist regions such as Okinawa, Nagano, Yamanashi, Nagasaki, Hokkaido, Oita, Ishikawa and Kyoto (Appended Figure 2-7).
    In order to study the extent to which these numbers of tourists can be explained by basic factors including population size and distance from regions with large populations, the number of tourists to each region was projected using the population of the region in question and its distance from the Tokyo area as explanatory variables and compared with the actual numbers of tourists (Appended Figure 2-8).(26) According to the results, the actual numbers greatly exceed the projected numbers in popular tourist destinations such as Yamanashi, Oita, Nagano, Hokkaido and Shizuoka. Since the projection model only takes into account a region's population and its distance from Tokyo, these differences between the projected and actual numbers may reflect the so-called "comparative advantages of a tourist destination," including the attractiveness of the region's tourism resources and public transportation convenience. Therefore, assuming that the greater the divergence between the projected and actual numbers, the greater the advantage the region had in its tourism resources, the divergence was compared with the growth in the number of tourists between 1991 and 2001 (Appended Figure 2-9). Consequently, no definite relationship was evident whereby regions with comparative advantage had high growth rates in the number of tourists. There were some regions for which the number of tourists fell sharply even though they had an advantage, and conversely, the number of tourists grew significantly although they had no advantage.
    In fact, there is a trend for many regions which have traditionally been tourist destinations to be experiencing declines in the number of incoming tourists, while the number of tourists is rising steadily in smaller cities where the regional community as a whole is involved in town development.(27) In this way, trends regarding tourism in the regions are not necessarily determined solely by naturally endowed conditions and many opportunities exist for each region to increase the number of tourists through self-help efforts.
    In many developed countries, rural lifestyle experience-based tourism is rapidly developing and such non-conventional types of tourism can be developed in regions that do not possess tourism resources. Rural lifestyle experience-based tourism harnesses the lifestyle, culture, nature, agricultural products and other aspects of regional cities and villages as tourism resources. However, studies by the OECD indicate that in many cases these regions are also lacking know-how in providing tourism services.(28) Hence it is important to thoroughly analyze the size and characteristics of the tourism market in the region in question and respond appropriately to market demands and go through sufficient training so that the region can provide quality services. In doing so, the roles that the public and private sectors should play are for the public sector to gather and provide information and manage regulations in a flexible manner, while the private sector needs to assume leadership to unite the region and develop a cooperative framework under that leadership.
   
Forming clusters
    Clusters refer to the geographic concentration of groups of interrelated companies and groups of relevant institutions such as universities in a specific field. Clusters are like corporate towns given their arrangement and resemble regional industrial clusters. However, what makes clusters very different from industrial clusters is that although the companies in the cluster compete with each other as in the Silicon Valley in the US, they are mutually complementary and connected since they share a certain degree of information amongst each other. These clusters encourage technological innovation through competition and boost the competitiveness of regional companies through synergistic effects. Both national and local governments are working together to form clusters. For example, the Industrial Cluster Plan of the Ministry of Economy, Trade and Industry (METI) offers support to companies that are launching new businesses such as forming broad human networks among government, academia and industry, promoting technological development using regional characteristics and reinforcing the incubation function by developing facilities to nurture entrepreneurs. Furthermore, with the Intellectual Cluster Creation Project centered around the Ministry of Education, Culture, Sports, Science and Technology (MEXT), close coordination is being advanced between measures aimed at forming clusters to produce internationally competitive technological innovation by institutions such as relevant research institutions and research and development (R&D)-type companies with universities at the core.
    Moreover, among the abovementioned measures for special zones for structural reform and urban renaissance, programs that are expected to contribute to the formation of these regional clusters have also been approved. Examples of such clusters and analyses of the merits of industrial clusters and regional economic growth are described in detail in Regional Economic Outlook 2003 of the Cabinet Office. The main conclusion from the findings was that industrial clusters that consist of a variety of industries are more effective than industrial clusters that specialize in particular industries in expanding employment as a result of competition and promotion of technological innovation.
   
Promoting foreign direct investment into Japan
    Japan's balance of inward direct investment is about 2% as a share of GDP, which is remaining at a strikingly low level compared to other foreign countries. Examining the cases of other countries reveals that many countries are revitalizing regional economies by actively promoting inward direct investment. In the case of the US for example, amid concerns about industrial hollowing-out from the 1970s to 1980s, each state made aggressive efforts to attract foreign capital and many Japanese automobile makers located their plants in the US and contributed to expanding regional employment as a result. These effects produced by inward direct investment and regional economies are also becoming widely recognized in Japan and national and local governments together are taking steps to attract foreign capital. To be specific, Japan is tackling the following based on the Program for the Promotion of Foreign Direct Investment into Japan formulated in 2003: (i) clarifying, simplifying and expediting administrative procedures; (ii) improving the business environment by facilitating cross-border M&A; (iii) creating favorable employment and living environments by improving systems for foreign engineers and researchers to enter and reside in Japan; (iv) improving local and national systems that harness special zones for structural reform; and (v) disseminating information domestically and abroad through sales by top executives, overseas establishments and other means. Against the backdrop of these efforts, many preferential measures for accepting foreigners have been approved in the regions designated as special zones for structural reform. For example, preferential measures include extending the maximum duration of stay for foreign researchers and IT engineers and allowing foreigners who have come to Japan for research purposes to conduct investment and financial activities without having to obtain permission for change of status of residence.
   
Summary of Chapter 2
    Finally, the major results of the analyses presented in this chapter will be summarized as follows.
    Section 1 offered an analysis highlighting the disparities between regional disparities. Inter-regional disparities in economic recovery arise when regions that mainly specialize in terms of production in export- and information technology (IT)-related goods and others recover faster than others. In addition, some regions are insensitive to trends toward economic improvements due to differences in the degree of products traded with other regions. Furthermore, on the employment front, unemployment may increase, among other things, if labor migration between industries does not occur smoothly given the trend wherein employment in the manufacturing industries is contracting and expanding in the tertiary industries. In particular, there is a need to provide support to ensure smooth labor migration by enhancing education and training since it is expected that facilitating labor migration between industries including middle-aged and older workers will be vital in the future.
    Section 2 provided an analysis with a focus on inter-regional income disparities. Disparities still exist, although inter-regional economic disparities based on income per capita is on a contractionary trend. These disparities are the result of structural factors such as regional industrial structure and extent of human capital accumulation. Consequently, since disparities in each region arise due to different fundamental causes, it is necessary to develop policies that are in line with regional initiatives rather than undertake nationally uniform policies aimed at regional revitalization. Given the correlation between regional industrial structure and inter-regional disparities in unemployment rate and the connection that unemployment rates are higher in regions with a high proportion of young people, it is essential to tackle the problem of employment among young people in the regions. Moreover, because recently labor migration is not contributing to narrowing inter-regional disparities, there is a need to facilitate labor migration in addition to taking measures in the labor market.
    Section 3 introduced developments in structural reform in the regions. Even though local governments are making progress in administrative and fiscal reform, their fiscal situation remains severe. In order to advance fiscal consolidation, fiscal reform aimed at not only cutbacks in investment spending but also the reduction of current expenditure is required. Moreover, many local governments have implemented administrative and fiscal reform using NPM methods, but coordination among each of the administrative and fiscal reform methods are required and it is necessary to further enhance the efficiency of administrative and fiscal management in the future. Many municipalities that have been designated as special zones for structural reform are relatively well-off financially, but recently special zones are being used not only in a handful of progressive local governments but also by a broader range of municipalities. Considering that authority and fiscal resources are being transferred to the regions through a series of measures including the Comprehensive Decentralization Law, fiscal reform, Special Zones for Structural Reform and the Program for the Promotion of Regional Revitalization, it is necessary to advance regional revitalization in the future using inherent regional resources and human networks. To this end, it will be essential to promote tourism, intellectual technological innovation, industrial clusters and inward direct investments, to name a few examples. In particular, in regard to tourism, steps are being taken to promote tourism to Japan with the target of having 10 million tourists visit Japan by 2010, and vigorous efforts will be expected while harnessing special regional features.


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