Annual Report on

The Japanese Economy and Public Finance

2005

- No Gains Without Reforms V -

Cabinet Office

Government of Japan

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Introduction

    Most of the goals raised for the intensive adjustment period imposed for four years until the end of FY2004 have been achieved. The next two-year period starting this fiscal year is positioned as the concentrated consolidation period whereby the objective is to strengthen the foundation for new economic growth. For this, one of the main factors is to construct a small and effective government, while the policy of "from the public to the private sector" serves as one of its underlying basic concepts. That is for the government to promote measures to review which operations and projects it will continue to mange, while leaving to the private sector what it can do. Whether Japan is able to construct a small government is the key to its maintenance of economic vitality when faced with a declining birthrate and aging society in the future.
    A significant change is to take place starting FY2007, after the completion of the concentrated consolidation period. That is the decrease in the overall population and mass retirement of the first baby boomer generation (hereafter "Dankai generation"). Japan will be the first country out of all the developed countries that will be experiencing population decrease and at a rate much higher than any others. We must face this fact and analyze the economic impact that this change will bring upon Japan, so to promote policies to counter these effects.
    Recognizing the importance of these issues, the Annual Report on the Japanese Economy and Public Finance 2004-2005 is comprised of three chapters. The analysis result for each chapter is summarized below.
    Chapter 1 reflects on the economic trend and looks at the current status and future prospect of the Japanese economy. The analysis given in this chapter demonstrates that the negative legacies, which were the main factors of economic downturn in Japan since the 1990s, have been largely eliminated. In particular, as for the disposal of non-performing loans, its target level has been achieved primarily through off-balancing. Furthermore, we learned that consumption has been gradually encouraged through improvements seen in the employment situation. As a result, it is necessary for Japan to further advance the reforms and have the results achieved so far lead to sustainable growth.
    Chapter 2 looks at the achievement status and future challenges of the shift from the public sector to the private sector. The policy of "from public sector to private sector" underlies the long-term development of the Japanese economy. When studying the awareness of the public, it became apparent that, under certain conditions, a small government is preferred. As for the services provided by the local governments, the Designated Management Entity System has been implemented since 2003 and study shows that the efficiency of the services provided has improved with entry of private businesses into this market. As market testing is to be put into full swing in the future, it is expected that liberalization to the private sector of businesses and operations traditionally managed by the public sector will lead to economic vitalization.
    Chapter 3 examines from multiple aspects the impacts the "demographic wave" marking the beginning of decrease in the overall population and mass retirement of the Dankai generation will have on the economy. While it is possible that the pressure of increased labor costs of the Dankai generation led to suppression of youth employment after the burst of the bubble to some extent, the employment of the younger generation has been encouraged as the Dankai generation is reaching the mandatory retirement age in the near future. Furthermore, as the Dankai generation demonstrates heavy consumption of services and time, as well as high risk tolerance level upon selecting financial assets, they are thought to continue leading the Japanese economy.
    During the concentrated consolidation period starting this fiscal year, it is important to gain public understanding that the Japanese economy is at its critical point of whether it will maintain its vitality or not, and that there is a need for the desirable policies to be selected. This report aims to contribute to the enhancement of structural reform for this exact purpose.

Column 1

The Council on Economic and Fiscal Policy (CEFP)

What is the Council on Economic and Fiscal Policy?
    The Council was established in January 2001 in order to exercise the full leadership of the Prime Minister regarding economic and fiscal policy.

List of Members of the CEFP
Chairperson: Junichiro Koizumi, Prime Minister
Member: Hiroyuki Hosoda, Chief Cabinet Secretary
Member: Heizo Takenaka, Minister of State for Economic and Fiscal Policy
Member: Taro Aso, Minister of Public Management, Home Affairs, Post and Telecommunications
Member: Sadakazu Tanigaki, Minister of Finance
Member: Shoichi Nakagawa, Minister of Economy, Trade and Industry
Member: Toshihiko Fukui, Governor of the Bank of Japan
Member: Jiro Ushio, Chairman and Chief Executive of Ushio Inc.
Member: Hiroshi Okuda, Chairman of Toyota Motor Corp.
Member: Masaaki Honma, Professor, Faculty of Economics, Osaka University
Member: Hiroshi Yoshikawa, Professor, Faculty of Economics, University of Tokyo

Recent Major Activities
Big-boned policy
    Since the inauguration of the Koizumi Cabinet in 2001, the "big-boned policy" (Basic Policies for Economic and Fiscal Policy Management and Structural Reform (so-called "Basic Policies")) has been formulated every year. In the "Basic Policies 2005" (Cabinet decision in June 2005) it is stated that the Japanese economy has broken out of the so-called "Post-Bubble" phase after the intensive adjustment period and is entering a critical two-year period. With such understanding, the Basic Policies 2005 introduces as the three challenges Japan shall accomplish during the concentrated consolidation period until FY2006: (1) creation of a "small and efficient government," (2) formulation of an infrastructure that will overcome aging and globalization, realizing a new, dynamic era, and (3) emerging from deflation and achieving economic growth led by private demand. Furthermore, it provides measures for the realization of these challenges.

Basic Principles of the FY2005 Budget and Guidelines for the Formulation of the FY2005 Budget
    In the Basic Principles of the FY2005 Budget (compiled at the CEFP meeting in July 2004) pursuant to the "Basic Policies 2004," budget system reforms which expand model projects and policy packages drastically and reflect the results of policy evaluation to the budget of next year are suggested. It also provides policies to restrict the government general expenditure and to control its total amount in real terms to under the level of FY2004. Furthermore, the Guidelines for the Estimate Budget Request FY2005 was approved at the Cabinet meeting and the Guidelines for Formulation of the FY2005 Budget was adopted by Cabinet decision in December 2004 after the deliberations at the CEFP meeting.

Reform and Perspectives
    The Structural Reform and Medium-Term Economic and Fiscal Perspectives (so-called "Reform and Perspectives") was adopted by Cabinet decision in January 2002 after the deliberations at the CEFP meeting, and it has been revised every January since. In the "Reform and Perspectives FY2004 Revision" adopted by Cabinet decision this January, the basic policy of the medium-term economic and fiscal policy management which aims to achieve a surplus in the primary balance of the central and local governments in the early 2010s is determined. It also provides that until FY2006, the size of the government must be maintained at a level smaller than that of FY2002. Furthermore, it also projects a nominal growth rate of around 2% (1.5% in real terms) or more from FY2006 onwards through strengthening the measures for structural reforms.

Basic Policy on the Privatization of the Postal Services
    With regard to the privatization of postal services, deliberations have taken place at the CEFP meetings repeatedly since October 2003. As a result, the Basic Policy on the Privatization of the Postal Services was adopted by Cabinet decision in September 2004 after a deliberation at the CEFP meeting. The Basic Policy outlines the framework of the organizational structure at the time of privatization (establishment of four independent companies, each specializing in over-the-counter services network, postal services, postal savings and postal life insurance respectively, and to develop them into holding companies, etc.) as well as the modality of each company (i.e. as for the postal services company, make possible for its services to enter the broader logistics business market both domestically and abroad, and impose obligation to provide universal postal services, etc.) and more. The procedures for establishment of the draft bill were taken pursuant to this Basic Policy and the draft bill was submitted to the Diet after the Cabinet adoption in April 2005.

Reform of the Fiscal Relationship between the Central and Local Governments
    As for the local administrative and fiscal reforms, provided in the "Basic Policies 2002" is consideration for the modality of the allocation of the tax revenue sources including the state subsidies and contributions, local allocation taxes and transfer of tax revenue sources in an integrated manner. Then later in the "Basic Policies 2003" it is decided to abolish and reduce state subsidies and contributions to around four trillion yen. Furthermore, the "Basic Policies 2004" (Cabinet decision in June 2004) had that the overall picture of the reform of the fiscal relationship between the central and local governments through FY2006 will be announced by fall 2004. The details are to include the schedule for the implementation of the reform of state subsidies and contributions, the content of transfer of tax resources and the direction of the reform of local allocation taxes discussed in an integrated manner, as well as aim for a transfer of tax revenues of around three trillion yen.

Major Activities of the Special Board of Inquiries
Report on the "Japan's 21st Century Vision"
    To develop the changes that are viewed as constraints that Japan will face due to decrease in population, decrease in birth rate and aging society in the future into opportunities for new growth and to formulate a strategy for further growth of the Japanese economic society are stipulated in the "Basic Policies of 2004." Deliberation on the vision of what Japan will look like in the year 2030 was conducted at the meeting of the Special Board of Inquiries established under the CEFP meeting and "Japan's 21st Century Vision" was reported at the CEFP meeting in April 2005. This Vision promotes that intense reforms must be implemented during the concentrated consolidation period (FY2005, 2006) in order to establish a foundation for future development. Furthermore, provided as goals beyond the implementation of the reforms were, (1) becoming an open, culturally creative nation, (2) healthy life expectancy of 80 years enjoyable by "people who are rich in free time," (3) contented public and a small government, and more.

For more details, please see the website below
http://www.keizai-shimon.go.jp
    Materials distributed at the CEFP meetings are uploaded on the website the same day, and the overview of the discussions is uploaded three days later (Japanese only).

Column 1 Recent Activities of the Council on Economic and Fiscal Policy (CEFP)

December 2003 - January 2004 Deliberation of the "Structural Reform and Medium-Term Economic and Fiscal Perspectives- FY 2003 Revision" (so-called 'Reform and Perspectives FY2003 Revision') (Cabinet Decision, January 19)
April - June 2004 Deliberations of the "Basic Policies for Economic and Fiscal Management Policy and Structural Reform 2004" (so-called 'Basic Policies 2004') (Cabinet Decision, June 4)
July 2004 Deliberation of the "Basic Principles of the FY2005 Budget" (Compiled by Advisors, July 27)
Deliberation of the "Guidelines for the Estimate Budget Request" (Cabinet Agreement, July 30)
August - September 2004 Deliberation of the "Basic Policy on the Privatization of the Postal Services" (Cabinet Decision, September 10)
November - December 2004 Deliberation of the "Guidelines for Formulation of the FY2005 Budget" (Cabinet Decision, December 3)
November 2004 - January 2005 Deliberation of the "Structural Reform and Medium-Term Economic and Fiscal Perspectives - FY 2004 Revision" (so-called 'Reform and Perspectives FY 2004 Revision') (Cabinet Decision, January 21)
April 2005 Report on the "Japan's 21st Century Vision" (April 19)
May - June 2005 Deliberation of the "Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2005" (so-called 'Basic Policies 2005') (Cabinet Decision, June 21)

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