Speech by Minister Koji Omi The Royal Institute of International Affairs(Chatham House)

London, 29 April, 1998


Distinguished guests, ladies and gentlemen,

I deeply appreciate this opportunity to present my ideas on the Japanese economy, because we have just made up a new policy package to recover the economy on Friday last week. On Monday and Tuesday this week, I explained this new economic package at the OECD Ministerial Meeting in Paris, and the ministers attending welcomed our decision. Today I am here in London to discuss it with you, and tomorrow I will be in Washington D.C. in the United States to explain it. I will spend this weekend in Moscow. I am so enthusiastic about presenting the new package around the globe that I feel no jet lag.

Anyway, thank you very much for giving me this chance. No better timing exists for introducing our newborn package.

In recent months, the Japanese economic situation has been very severe. After a fairly high growth with 3.9 percent in 1996, the first half of 1997 showed modest performance although there were some effects of the consumption tax hike. In autumn, a series of difficulties, including the failures of banks and security firms, threatened to collapse the financial system. In addition, the economic turmoil in some Asian countries led by currency depreciation has had a significant impact on Japanese exports, foreign direct investment and business confidence. The fourth quarter of 1997 recorded minus 0.2 percent GDP growth.

Indeed, last December and January, Japan was on the edge of crisis. The Japanese government promptly secured 30 trillion yen, equivalent to 140 billion Sterling pounds, for stabilizing the financial system, which I will explain later.

Since then, confidence in the financial system has been restored gradually at home and abroad. The Nikkei stock index rose from around 14,500 yen in mid-January to around 16,000 yen in March. The worst period is over in terms of financial stability.

On the other hand, the bank failures and other incidents have damaged the real side of the economy by significantly dampening the confidence of consumers and businesses, resulting in very weak consumption and investment. In the first quarter of 1998, industrial production and investment continued to decline, and unemployment rate was 3.6 percent in February, a record high in Japan. We must admit that our economy has stagnated and has become more severe recently.

Behind the stagnation there exist fundamental problems such as the mounting non-performing loans stemming from delayed adjustment to the burst of the bubble in the early 1990s. In addition, in the tide of globalization, structural reform, in particular drastic deregulation, is also needed for strengthening fundamentals and stimulating vitality in private sector of the Japanese economy.

Economic policy must address these financial and structural problems which have been impeding economic growth in recent years. Otherwise any fiscal stimulus would have only limited effect. What we should pursue for a robust and sustained economic recovery is macroeconomic policy combined with structural reform and further financial stabilization.

Following the line of this idea, the Japanese government has implemented several economic policy measures since the autumn of 1997, including income tax reduction of 2 trillion yen, equivalent to 9 billion pounds, financial stabilization and drastic deregulation.

Among them, for maintaining stability in the financial system, the government decided to secure 30 trillion yen, equivalent to 140 billion pounds at the end of the last year. In this scheme, 17 trillion yen is allocated to protect depositors 100 percent and give them confidence in the financial system. The remaining 13 trillion yen is assured as fund for capital injection to strengthen the capital of prospective surviving banks through purchasing subordinate bonds and preferred stocks. So far these measures have worked very well, restoring confidence in the Japanese financial system both at home and abroad.

In spite of this restored confidence in the financial market, the real economy saw various economic indicators deteriorate in the winter.

On the 9th of April, the next day after the budget for FY 1998 was approved, Prime Minister Hashimoto announced a framework for a new ambitious economic policy package.

Since then, we have worked literally day and night. Just last Friday, on the 24th of April, the government decided the details of the new economic policy package, which aims at achieving domestic demand-led growth.

The total size of this new economic policy package is more than 16 trillion yen, equivalent to around 75 billion pounds. It includes 12 trillion yen fiscal expansion that consists of 8 trillion yen in government expenditures and 2 trillion yen in tax cut in this year. This 10 trillion yen is what is often called "pure water", the amount of fiscal burden of measures which will have a positive impact on the real economy. The remaining package includes public works and projects through the Finance and Investment Loan Program employing postal savings and public pension funds.

What I would like to emphasize, however, is not just the package's size but also its design and underlying ideas. The package consists of three main pillars: fiscal policy for domestic demand expansion in the short run, economic structural reform enhancing growth potential in the long run, and resolving bad loans problem which has dragged down economic recovery.

Let me elaborate these three.

First of all, the government decided on an additional 7.7 trillion yen, equivalent to 35 billion pounds in fiscal expenditure to effectively expand domestic demand. This spending focuses on public investment which is the most useful for enhancing economic growth potential, rather than conventional public works. Examples include infrastructure for science and technology, telecommunications, and efficient distribution logistics. Such infrastructure expenditure aims at pushing the economy back on the domestic demand-led growth path and also strengthening the fundamentals of the Japanese economy.

We will also introduce Private Finance Initiative, or PFI, studying the UK experience. It is a very stimulating idea to take advantage of technology, management and financing by the private sector for developing public infrastructure.

Second, the government decided to implement an income tax cut amounting to 4 trillion yen, equivalent to around 0.8 percent of GDP, during 1998. In the following year, 1999, half of this income tax cut, or 2 trillion yen, will be maintained. We also decided to thoroughly review the whole income taxation system. The income tax reduction will raise consumption via increased disposable income and thus have a positive impact on the economy.

At the time of globalization of business activities, reduction of corporate tax is really important. We have already reduced the effective tax rate from about 50 percent last year to about 46 percent this year. Under this package, this tax rate will be further reduced to the international level as soon as possible in three years. In addition, a special tax deduction was decided as an incentive for business investment and housing purchases.

In this connection, it may be worth mentioning our commitment of fiscal consolidation in the medium term.

Fiscal consolidation is critical for Japan's future amid a rapid ageing society. At present, the fiscal deficit of the central and local governments is now 4.7 percent of GDP, and accumulated government debt has climbed to 103 percent of GDP in fiscal year 1998, on the high side among the OECD countries. Therefore we will definitely not change our basic stance toward fiscal consolidation.

However, in order to address this emergent economic situation, the Japanese government decided to revise the law for fiscal consolidation. A flexibility clause will be incorporated in the law so that it is able to temporarily expand fiscal deficit. In addition, the target year of reducing the fiscal deficit to 3 percent of GDP will be delayed from the year 2003 to 2005.

Third, we decided to take effective measures to resolve bad loan problems which have dragged down economic recovery. To this end, we decided a comprehensive program to accelerate the disposal of non-performing loans and to facilitate more effective land use, by setting up a special cordinating committee, securitizing land assets, and making use of public funds for land development program. With this program in effect, I expect the bad loan problem will be resolved and thus an important obstacle to economic growth be removed in a few years.

Recently, some signs are observed that land prices appear to have stopped declining in city centers. In this regard, it is reported that several foreign companies began purchasing real estates in Japan.

Fourth, we are strongly committed to promoting economic structural reform including drastic deregulation, creating an attractive environment for venture businesses, and implementing the financial reform, "Big Bang".

I would like, in particular, to look into the details of policies for venture businesses.

Venture businesses are essential for enhancing dynamism in the economy, creating new businesses and employment. In Japan, venture businesses have created 1.6 million jobs in recent ten years, while it is said that in the 1980s in the United States as many as 16 million jobs were created by ventures. Since the population size of the US is twice as large as Japan, the rate of venture job creation in the US is, in fact, five times higher than in Japan. Thus stimulating entrepreneurship is key to tackling stagnation in the Japanese economy.

In this package, I proposed creating various channels of funding for ventures as well as extending government guarantees for small- and medium-sized enterprises. Conventional financing in Japan is indirect finance by bank loans. It is true that this system, called "main bank system", has contributed to the Japanese economic miracle in postwar period. But the recent asset deflation raises questions about the limitations of a system centering on bank loans with collateral of real estate. Thus the government decided to promote direct financing options for ventures through such means as the over-the-counter securities market.

Furthermore, it is important to raise the efficiency of fund managing, thereby making effective use of a huge amount of Japan's financial assets. In this regard, we decided to implement deregulation related to fund managers and investment advisers. Now we are trying to enliven the Japanese financial market by introducing a pension scheme with fixed contribution and portability, similar to 401K-type pension funds. This will provide a wider variety of financial resources and enable workers to move easily.

Science and technology is another vital source for stimulating entrepreneurship and new businesses. One fundamental principle of our policies is to make our country "a Science- and Technology-Oriented Nation" ,which is advocated as a key concept in the Fundamental Law on Science and Technology that I proposed and the Diet approved in 1995. Based on this law, in the budget for this fiscal year, the government decided to increase expenditures for research and development activities by about 5 percent, while the total government expenditures are to be cut by 1.3 percent. In addition, the recent economic package provides another 1 trillion yen, equivalent to 4.5 billion pounds for advanced telecommunications, and science and technology. These will produce strong effects not only on the demand side, but also on expanding venture businesses, helping the Japanese economy to flourish toward the 21st century.

I am sure this package will have a considerable impact on the Japanese economy from various sides.

As for fiscal policy, the effect of the public investment with multiplier 1.32 is estimated to be around 1.9 percent of GDP. 2 trillion yen income tax reduction has an effect around 0.2 percent of GDP including multiplier effect 0.46. In total, the economic impact including its multiplier effects is estimated, at least, around 2 percent for a year. As a result, the official projection of 1.9 percent real economic growth in fiscal 1998 will be fully achieved.

In the long run, such fiscal stimulus effects combined with positive impacts of the other structural measures in the package will surely contribute to economic recovery. This will lead to fully developing the potential of the private sector, expanding domestic demand, and putting the Japanese economy back on a sustainable growth path.

Japan has accumulated enormous assets, including external assets, totaling 800 billion dollars, and foreign reserves of more than 220 billion dollars, the largest in the world. Japan also has more than 1200 trillion-yen in household financial assets, which are 5.6 trillion pounds, an abundant, highly skilled, and well-educated labor force, and a high level of technology. I do not see any point in questioning the growth potential of the Japanese economy. The package intends to reform fundamentals toward new economic development in the 21st century, maximizing the economy's potential. Thus, once the economy is back on a growth path with the policy measures, recovery will gradually regain the strength.

The Japanese economy accounts for a substantial portion of around 60 percent of the Asian economy and around 15 percent of the world GDP. In view of this significance, I believe that Japan's steady and robust economic recovery will contribute to that in Asia.

With regard to the Asian economy, my view is that the critical period is over and the economy will gradually recover. In the new package, we have incorporated measures for supporting the Asian economies in the crisis and urging their structural reform.

The year 1998 should be noted as the first year of a historical economic reform in Japan toward the 21st century. I have no doubt the Japanese economy will begin to back on the sustainable growth path in a few months. Thus I believe it is the best time to buy Japan.

Thank you very much.