The Japan of Tomorrow, Different from Yesterday Speech at CSIS (Center for Strategic and International Studies), Washington D.C. April 1999

by Taichi Sakaiya, Minister of State

Economic Planning Agency, Government of Japan

It is a great honor for me to be given this opportunity to speak about the conditions of the Japanese economy here today. Thank you very much for your kind invitation.

The Crisis Has Been Avoided

The conditions of the Japanese economy remain extremely severe. The government has been making every effort to achieve economic recovery. Moreover, the entire nation is in the midst of a major reformation - grand structural reforms that may change Japan's cultural and social environment.

Since the launch of the Obuchi administration on July 30, 1998, the government has implemented swift, large-scale countermeasures to the recession. As a result, there are now signs of an impending recovery in certain sectors and the overall decline of the economy is ending. While it cannot be said that a distinct recovery has arrived, I can say with all confidence that the worst danger of falling into a deflationary spiral has now been averted.

At the end of last July, when Prime Minister Keizo Obuchi assumed office, the Japanese economy was in a dangerous state. Most of the nation's financial institutions were holding massive amounts of bad debts. They were strengthening their measures to reduce loan assets in order to survive without making serious efforts to restructure: in other words, they were creating a credit crunch. These developments took place because the huge volume of loans made through 1990 using real estate as collateral turned into bad debts as the value of land plummeted.

As a result, even financially sound quality enterprises encountered difficulty in fundraising. Individual firms reduced their capital investment, and a substantial number of firms were in danger of falling into bankruptcy.

What is more, the conditions in Asian economies surrounding Japan were also very bad. Japanese exports to Asia declined, and overseas Japanese subsidiaries facing management difficulties or even suspending operations were common.

When I entered the cabinet at the request of Prime Minister Obuchi, to be frank, I was terrified by the economic conditions at that time.

To respond to the situation, the Obuchi administration called a special session of the Diet on August 4, just days after taking office on July 30, and immediately began deliberations on economic stimulus measures. At that time, we viewed the problems of the Japanese economy with all due gravity, and decided to implement the most effective measures on the largest scale as quickly as possible.

From the collapse of the economic bubble in 1990 up until the time the Obuchi administration took office, the government had already implemented approximately \75 trillion in economic stimulus measures. However, the results were not entirely sufficient. While real GDP grew at 3.0 percent in fiscal 1995 and 4.4 percent in fiscal 1996 due to the reconstruction efforts following the Great Hanshin-Awaji Earthquake and the spread of portable telephones and other new products, GDP growth peaked in the beginning of 1997 and then rapidly declined.

Causes of the Recession and Response of the Obuchi Administration

The primary cause of the recession was that almost all of Japan's financial institutions were holding massive amounts of bad debts because the value of land and stocks fell by more than two-thirds following the collapse of the bubble economy in 1990.

Up through the 1980s, the Japanese financial industry was characterized by the so-called convoy system, whereby risk was spread evenly as all banks pursued similar actions under the supervision of the Ministry of Finance. Under this system, it may be said that the financial risk was essentially socialized. Each bank collected deposits by offering the same interest rates, and cooperative lending based on agreements among relevant banks frequently took place. The "convoy system, facilitated lending by financial institutions and resulted in limitless growth of financing using real estate as collateral. It was also the reason why the collapse of the bubble resulted in such a large volume of losses - a disease that has been very difficult to cure.

From the early 1990s, even after this fact had been revealed, it was as if the managers of financial institutions and the bureaucrats responsible for supervising the financial industry were treating a festering internal infection, but relied on prayer because they were afraid to perform surgery. Rather than taking positive action and disposing of the bad debts, they expected the prices of land and stocks to rise once again, and put off efforts to resolve the problem. By last summer, however, this had shaken the soundness of the financial system, worsened corporate fundraising conditions, and spread deep anxiety among all citizens. Naturally, this also led to anxiety regarding job security and provoked a contraction in consumption.

In response, the Obuchi administration worked for the enactment of the Financial Function Early Strengthening Law and the Law Concerning Emergency Measures for the Revitalization of the Functions of the Financial System to alleviate concern about the financial system. Even from a global viewpoint, these represent unusually bold policies. The government worked toward restoring health to the financial industry by prompting the weeding-out of weak institutions, devising a \60 trillion financial revitalization scheme, guaranteeing the full amount of deposits and bank debentures, and simultaneously injecting public funds into viable financial institutions. The \60 trillion yen package (approximately $500 billion) was not only the largest financial assistance package in the history of the world in absolute terms, but was also unprecedentedly large on a relative basis as the expenditures were equivalent to 12 percent of Japan's GDP.

In accordance with this scheme, at the end of 1998, among the nation's 20 leading banks, Hokkaido Takushoku Bank, which had already fallen into bankruptcy, was closed, and the Long-Term Credit Bank of Japan and Nippon Credit Bank were temporarily nationalized. Both of these banks will be sold to other financial institutions once the necessary adjustments have been made to their debts and claims. They may be sold to foreign-affiliated financial institutions. These efforts have sent a strong message to the markets and to Japanese citizens that the Obuchi administration has put an end to the bureaucrat-led "convoy system." This March, the administration provided public money totaling nearly \7.5 trillion as capital injection to 15 major Japanese banks. Henceforth, the weeding-out of financial institutions, including regional banks, and the restoration of soundness to the financial industry will likely proceed at a rapid pace.

Another financial policy measure implemented by the administration from last October is the expansion by \20 trillion of the government credit guarantee framework for loans to small and medium enterprises through credit guarantee associations. As a result of this measure, bankruptcies of small and medium enterprises have declined rapidly from the end of last year, and this is creating stability in the Japanese economy. The Obuchi administration plans to further expand the framework of the credit guarantee system if this becomes necessary.

Fiscal and Monetary Measures to Boost Demand

The Obuchi administration's second measure to address the recession is the creation of demand. The emergency economic package approved on November 16, 1998, and the fiscal 1999 budget stipulate an increase of approximately 10 percent in public works expenditures (including the comprehensive reserve fund for public works, etc.) compared with the beginning of the previous fiscal year. In the selection of public works projects, the government is emphasizing three criteria: immediate efficacy, the ripple effect, and future orientation. Immediate efficacy in boosting demand and the ripple effect are critical to fully support the Japanese economy. This orientation has been criticized in some quarters as merely continuing the traditional pattern of public works in local areas. Nevertheless, the advancement of practical works with immediate efficacy and a ripple effect is indispensable to achieve the requisite scale of works to effectively underpin demand in the Japanese economy.

At the same time, to promote the development of new industries and create an abundant society, the government is also actively pursuing projects that have a future orientation. To this end, four Leading 21st Century Projects will be implemented during fiscal 1999 under the leadership of Prime Minister Obuchi to improve information networks (to configure a state-of-the-art electronic nation), urban infrastructure (to support future urban transportation modes and ways of living), lifestyle amenities (to respond to the aging of society and the declining number of children per household and to protect the environment), and the labor market (to realize stable employment with high-level skills and high mobility). Moreover, this January the government decided on the Plan to Double the Size of Living Space, and local government bodies nationwide will be submitting their draft implementation plans this May.

In addition, the fiscal 1999 budget incorporates over \9 trillion in tax cuts. The maximum income tax rate, including central government and local residence taxes, has been decreased from 65 to 50 percent, and the lower tax rates have been reduced proportionally.

Meanwhile, corporate taxes have been reduced to an effective rate of 40 percent, equivalent to international levels.

Moreover, the tax deductions for housing construction have been substantially expanded, and a policy decision was made to keep the interest rate charged by the Housing Loan Corporation at a low level of 2.4 percent for the time being. As another tax reduction measure, corporations and personal businesses will be permitted to depreciate in a single fiscal year the full costs of computers purchased for up to \1 million.

Under these bold large-scale policies, there have been emerging signs of brighter economic conditions: public works have been increasing since autumn 1998, and housing construction has picked up from the beginning of this year.

The Obuchi administration and the Bank of Japan have also implemented bold monetary policies. From February 12 of this year, the Bank of Japan adopted a policy to provide ample funds and guide the uncollateralized overnight call rate to virtually zero percent. Consequently, the interest rate on ten-year government bonds is now well below 2.0 percent. These measures demonstrate the firm resolution of the government and the Bank of Japan to continue working for economic recovery. The Japanese stock markets have reacted favorably to this resolve and are on a recovery trend. Stock prices have now increased by approximately 30 percent compared with the lows posted last October. What is more, the Japan premium on international money markets has virtually disappeared.

Employment Measures and the Structural Reform of Enterprises

Nevertheless, the Japanese economy as a whole is still facing severe conditions. In particular, the employment situation is deteriorating. The unemployment rate rose to 4.6 percent at the end of February, the highest level recorded since these statistics were initiated in 1953, surpassing that in the United States and reaching the level prevailing in the United Kingdom.

Up until just two years ago, full employment with an unemployment rate under 3.0 percent was considered as a matter of course in Japan, with its lifetime employment practices. But the lifetime employment system is now beginning to collapse. New private-sector capital investment will be required to achieve a full-scale economic recovery. For businesses to invest, the expected rate of return on investment must rise. Cost reductions from improved labor productivity will also be important. This implies that for many enterprises, excessive capital equipment and employment will have to be eliminated. One may say that Japan is now becoming "an ordinary country," at least as far as employment conditions are concerned.

In response, the emergency economic package and the fiscal 1999 budget incorporate a greatly expanded \1 trillion employment promotion scheme which places an urgent focus on worker retraining, especially for white-collar workers. Effective steps under this scheme will be implemented shortly.

The government will not attempt to preserve the postwar, Japanese-style practices premised on lifetime employment and "keiretsu" corporate groupings. Rather, we aim to increase the efficiency of the entire Japanese economy by promoting greater mobility in the labor market, upgrading worker skills, and advancing the appropriate allocation of personnel. Henceforth, employment promotion measures will not only be the key to alleviating the citizens' anxiety and expanding consumption demand, but will also represent the most important policy to promote the structural reform of enterprises.

Regarding the outlook for the Japanese economy, it appears that most analysts expect negative GDP growth again in fiscal 1999 due to the continued stagnation of private consumption and the major contraction in corporate capital investment plans. Most international organizations and domestic think-tanks are also projecting slight negative growth. Nevertheless, the government is firmly determined to achieve positive growth in fiscal 1999. We have carefully scrutinized the implementation of the emergency economic package to realize this goal this April. The policy is to continue to press forward further in all areas where the anticipated implementation has not taken place.

A Free Environment and International Cooperation

Promoting stronger international cooperation is another key policy of the Obuchi administration. Regarding international trade, I can definitively state that at least as far as industrial goods are concerned, Japan is the freest nation on earth with no quantitative restrictions whatsoever and low customs tariffs compared with other industrialized nations. While problems still remain concerning the high tariffs on certain agricultural and forestry products, overall Japan has an extremely liberal trade system.

Additionally, the ongoing changes in economic conditions and reform policies will significantly improve the investment environment in Japan for foreign corporations. First, the resolution of the bad debts held by Japanese enterprises and the decline of the lifetime employment system will rectify the high-cost structure of Japanese society, and result in conditions which will facilitate foreign capital investment. In particular, the recent decline in land prices and low interest rates can be said to have greatly improved the investment climate for foreign capital in Japan. Today, Japanese youth and middle-aged businesspeople with a wealth of experience have not only lost their resistance to working at foreign-affiliated firms, but there are actually a large number of Japanese workers who eagerly choose to work for such businesses. There are also plans to re-examine the restrictions on land usage. Japan's management and investment environment is expected to improve further.

As for Japan's international cooperation, contributing to the revival of Asian economies is currently an especially important point. Japan has already provided $48 billion for the reconstruction of Asian economies. In addition, the government has decided to allocate another $30 billion under the New Miyazawa Initiative. A portion of these funds has already been disbursed to Thailand and Malaysia.

Asian nations experienced extremely serious economic declines during 1997 and 1998. But they have now recovered to the point that most of these economies are projected to record positive growth in 1999. I believe that the recent Asian economic and monetary crisis is a temporary downturn that is part of the industrialization process, similar to that experienced by Japan in 1965, and that Asian economies will be able to recover within a relatively short period of time. Japan, which has close ties with Asia, will be pleased when Asian economies begin to recover.

Establishing an Economic Structure Based on a Belief That Free Competition Is Truly Just

I believe the greatest contribution that Japan can make to the global economy is to revive the Japanese economy itself and offer an abundant and free trade and investment market to the world. To this end, the Obuchi administration plans to create a long-term vision and implement structural reforms that will remove citizens' anxiety about the future. On January 18, Prime Minister Obuchi directed the Economic Council, which is comprised of domestic and foreign economists and scholars, to hold deliberations on the "Japanese Socioeconomy in the 21st Century and Policies for Economic Rebirth" with a ten-year outlook. As the cabinet minister responsible for the Economic Council, I plan to submit the council's final report around July.

I think that "freedom" must be the foundation for the reforms, and that we must build up a consumer-driven economic structure based on the understanding that free competition is truly just. During the postwar era, horizontal and vertical business ties were established in the Japanese economy. The horizontal ties are the "convoy system" whereby enterprises in each industry were all protected under bureaucratic initiative. However, because of the recession since 1990 and the bold reforms of the Obuchi administration, this system has already collapsed in most industries. The above-mentioned developments in the financial industry are a typical example. The abolition of regulations is progressing in the transportation, retail, and other industries, and significant results are being achieved in the information and telecommunications field. As I mentioned before, the Obuchi administration is actively implementing free competition.

On the other hand, the vertical ties are the "keiretsu" corporate groupings, which mostly have leading financial institutions at the pinnacle of each group. There are also other "keiretsu" groupings for the provision of parts and the sales of goods centered around large manufacturers, which have united into solid blocs from many years of business transactions and personal relationships. The corporate groupings are rapidly collapsing amid the recession. Most financial institutions no longer have the strength or leeway to maintain huge "keiretsu" corporate groups. Large manufacturers have begun rational parts procurement to win the cost competition. Additionally, many small and medium enterprises that belong to these groups are now refusing to accept the appointment of management personnel transferred from the leading companies in their groups. The fact that Nissan Motor Company and other traditional large Japanese firms have accepted the participation of foreign capital may be viewed as one clear sign of this trend. The reorganization of financial institutions, the restructuring of construction firms and the distribution industry, the expansion of the information industry, and other structural shifts should also further promote alliances and joint ventures with foreign capital. We welcome these developments as they will advance the globalization of the Japanese economy. The entry of foreign capital and the alliances between Japanese and foreign enterprises are expected to increase the exchange of goods, money, people, and information.

Japan is now in the midst of a revolutionary transition in both the fundamental form and constitution of the economy and the temperament and nature of civil society.

For over 50 years since the end of World War II, Japan has worked to achieve three types of justice - efficiency, safety, and equality - under the direction of the nation's bureaucrats. During the first half of this period, up until around the middle of the 1970s, the greatest emphasis was placed on efficiency and on promoting a standardized mass-production modern-style industry.

From the mid-1970s, as greater emphasis was placed on safety and equality, enhancing social welfare, maintaining lifetime employment, fostering small and medium construction companies, and protecting educational and medical institutions became important issues. The protective supervision of financial institutions under the "convoy system" was one aspect of this trend.

As a result of these policies, Japan has an extremely efficient standardized mass-production manufacturing industry. But the society as a whole is inefficient and suffers from high costs.

Moreover, most young people desire employment in organizations that benefit from regulatory protection, and there are very few Japanese with the desire to create new businesses. Japan is an oddity among the industrialized nations in that the number of self-employed workers outside the agricultural sector is declining.

I believe we must change Japan from a nation with fixed organizations to one with flexible competition, in other words, we must create a Japanese society in which "freedom" is viewed as "just" along with efficiency, safety, and equality. Some 13 years ago, in my book Knowledge Value Revolution, I predicted that the advent of a "knowledge value society" would be the next historical stage in the development of modern industrial society. I believe that this has already been realized to a considerable extent in the United States and the United Kingdom. In Japan, however, the creation of "knowledge value" is still limited to just a few fields. I believe that the current conditions provide an excellent opportunity to transform the Japanese economy: now is the time for Japan to free itself from the bonds of bureaucratic regulations and corporate "keiretsu" groupings, and for countless new enterprises that create value from diverse wisdom to arise.

The Japan that has recovered from the recession will be unlike the Japan of days past. It will be a more flexible and more open "knowledge value" country that provides greater pleasure and wealth to Japanese citizens and to the world.

Thank you very much for your kind attention.