The Present and Future of the Japanese EconomySingapore, September 1, 1999 Bangkok, September 3, 1999

Taichi Sakaiya
Minister of State Director-General, Economic Planning Agency
Government of Japan

I am delighted to be given this opportunity to speak about the present and future conditions of the Japanese economy before this distinguished gathering here today. Thank you very much for your kind invitation.

End of the Growth Myths

The Japanese economy is presently moving towards recovery from a severe recession. Production and demand have bottomed out, and the outlook among corporate managers is regaining brightness. Nevertheless, there are still several serious, fundamental problems that need to be overcome.

With the collapse of the so-called "bubble economy" at the beginning of the 1990s, the long high-growth period for the Japanese economy finally came to an end. This also marked the demise of a key socio-psychological phenomenon: three cherished myths that had been supported by continuous economic growth. The first of these was the "land myth"--the belief that the price of land would always increase, and never decline. The second was the "consumption myth"--the belief that Japanese consumption demand would expand year by year, and never contract. And the third was the "Full employment myth"--the belief that Japan would never suffer serious unemployment problems given the lifetime employment practices and the group orientation of Japanese corporate management.

Among these three, the "land myth" was the first to go. Following the decline in stock prices from 1990, the price of land plummeted, leading to a massive amount of bad debts throughout Japanese society, a large number of corporate bankruptcies, and a decline in the equity ratios of Japanese financial institutions. As a result, the Japanese economy fell into two vicious cycles (Chart1: Two Cycles).

The first of these was the cycle of depressed corporate performance. The credit crunch among financial institutions, worsening corporate finances, and the reduction in capital investment led to demand stagnation, resulting in further corporate anxiety and a monetary contraction.

The second was the cycle of depressed household consumption. With the slump in corporate performance, enterprises cut employees? wages, especially bonuses and overtime payments, creating anxiety in the employment sector. As a result, individual households restricted consumption expenditures and endeavored to increase their savings. Consequently, consumption demand became stagnant and overall demand contracted, resulting in a further deterioration in corporate finances.

The phenomenon whereby a decline in land and stock prices leads to a worsening of overall economic conditions has been seen in all nations at the end of high-growth periods. However, the problems Japan faced in the 1990s were of much greater severity than those previously witnessed in other countries because of the extremely high land prices supported by the "land myth" and the expansion of financing under the herd mentality of Japanese banks.

In response to this situation, the Japanese government adopted economic stimulus measures totaling nearly 60 trillion yen from fiscal 1992 through fiscal 1997, but the results were not as expected. While real GDP grew from 3.0 percent in fiscal 1995 to 4.4 percent in fiscal 1996 due to the reconstruction efforts following the Great Hanshin-Awaji Earthquake and the boom in portable telephones and karaoke rooms, the economy deteriorated shortly after the government adopted a fiscal reconstruction policy in fiscal 1997 and decreased public demand. Japan's GDP growth rate declined to minus 0.4 percent in fiscal 1997 and minus 1.9 percent in fiscal 1998, posting the worst performance in the postwar era. According to the Family Income and Expenditure Survey, real consumption expenditures fell by 2.1 percent in fiscal 1997 and 1.3 percent in fiscal 1998, and thus the "consumption myth" also came to an end.

Emergency Countermeasures by the Obuchi Administration

Given these conditions, upon assuming office in July 1998, the Obuchi administration, which the prime minister named "the economic revitalization cabinet," promptly implemented bold, large-scale policies to break the downward spiral of recession.

The first policy was to rebuild the financial system. Money is the lifeblood of the economy, and the financial system corresponds to the heart, which controls the circulation of this blood. The government of Japan implemented three measures in this field.

To begin with, to assist small and medium enterprises experiencing fundraising difficulties due to the credit crunch, the government expanded the financing framework via the Japan Finance Corporation for Small Business and other financial institutions to 20 trillion yen for fiscal 1998 and 1999. Moreover, the government established a special 20 trillion yen framework for credit guarantees provided by the credit guarantee associations in each prefecture when small and medium enterprises borrow funds from private-sector banks. This rescued many small businesses from their fundraising difficulties, and the number of bankruptcies among small and medium enterprises has declined significantly since last December.

Next, to support middle-echelon enterprises suffering from the credit crunch, the government expanded the financing and debt-guarantee framework via the Japan Development Bank, the Hokkaido-Tohoku Development Finance Public Corporation, and other government-affiliated financial institutions by 7 trillion yen. A portion of these funds flowed to Japanese firms' local subsidiaries in Asia through their parent companies.

The third, and largest, measure implemented by the government for the revitalization of the Japanese economy was a 60 trillion yen financial revitalization scheme to restore soundness to the financial industry and prompt the weeding-out of weak institutions. This 60 trillion yen package was equivalent to 12 percent of Japan's GDP, and in these terms it represented the largest financial policy measure in the history of humankind.

Under this scheme, financial institution deposits and bank debentures are fully guaranteed by the government until April 2001, and financial institutions with a net debt position are closed or temporarily nationalized. As you all know, the Long-Term Credit Bank of Japan, the Nippon Credit Bank, and other financial institutions have since been nationalized in accordance with this scheme. These two banks are scheduled to be sold to the private sector after the bad debts are removed from their balance sheets. Additionally, several regional banks have been closed or merged with other financial institutions.

On the other hand, public funds have been invested as necessary into banks with sound financial positions so they may survive and develop in accordance with their individual roles, and their equity ratios have been upgraded.

For many long years, Japanese government administration of the financial industry adopted the so-called "convoy system" whereby the government ensured that all financial institutions would survive. The fact that this system fostered irresponsible herd behavior among financial institutions is inexcusable. The policies of the Obuchi administration have sent a strong message to the financial sector that market principles will be strictly applied. Henceforth, the Japanese government will focus on restoring financial soundness to regional banks and life insurance companies and prompting the weeding-out of weak institutions in preparation for the "payoff" starting in April 2001.

Policy measures to prevent a financial panic at that time are presently under consideration and will be announced in the near future.

Monetary Policy and the Expansion of Demand

The second economic stimulus policy implemented by the Obuchi administration is the creation of demand. This policy is comprised of three measures: expanded public investment, tax reductions, and the maintenance of low interest rates.

The public investment budget was increased in the emergency economic package adopted last November and in the initial budget for fiscal 1999. The government aims at implementing public works totaling 44.8 trillion yen during fiscal 1999, which represents an increase of over 10 percent from the previous fiscal year. As a result of these allocations, the execution of public works began to increase at the end of calendar 1998, and this is serving to underpin the Japanese economy. The policy of the Obuchi administration is to maintain active economic administration to ensure that a high level of public investment is maintained without interruption.

The tax reduction measures have included a reduction of the maximum income tax rate from 65 percent to 50 percent, and decreasing effective corporate tax rates to around 40 percent, which is the prevailing level in Western countries. Tax incentives have also been devised for the purchase of homes, etc.

Housing construction began to rebound from the beginning of 1999, partly due to these measures, and recovered an annualized rate of 1.3 million units in June. In Japan, one home is now being constructed for every 100 people. On a per capita basis, this is about twice the level in the U.S. and European countries.

Consumption demand is also recovering, with strong sales of personal computers, household appliances, and mini-vehicles.

As for monetary policy, with the ample provision of funds by the Bank of Japan, the authorities are maintaining ultra-low interest rates. Specifically, the overnight call rate has fallen to virtually zero since February 1999, and the three-month CD interest rate has dropped as low as 0.1%. These low interest rates are contributing to the promotion of housing construction and the stabilization of corporate management.

From Lifetime Employment to a Flexible Employment System

Employment measures comprise the third economic stimulus policy being implemented by the Obuchi administration.

After World War II, Japan built up the lifetime employment system whereby once full-time employees are hired they remain with the same company until they reach retirement age without being dismissed during their working lives. This practice gave credence to the "full employment myth," which maintained that Japan would never experience serious unemployment problems. During the recent recession, however, a large number of corporations beginning with financial firms have conducted restructuring, including personnel adjustments, and simultaneously limited their hiring of new employees. As a result, the unemployment rate reached 4.9 percent in June 1999, higher than the levels in the U.S. and the U.K., which are enjoying prosperity. Thus, the "full employment myth" has finally passed away.

In response to these unprecedented unemployment rates, the Obuchi administration has been focusing on employment measures and is launching diverse initiatives to create employment. In the past, the government's employment policy was designed to support the maintenance of workers at their present jobs, but the emphasis shifted from 1999 to promoting the movement of personnel to growing businesses. In particular, the first supplementary budget for fiscal 1999, which was passed by the Diet in July, includes measures to promote the development of new businesses, and aims at creating employment for 700,000 workers.

As employment trends lag behind the business cycle, the employment conditions in Japan will likely remain harsh for some time. However, this will result in the formation of a Japanese labor market with greater mobility, and will become a positive factor for the Japanese economy if it leads to the employment of appropriate personnel at appropriate businesses.

Through all the measures outlined above, the Obuchi administration expects to place the Japanese economy on a stable growth path within fiscal 2000.

Overcoming Three Surpluses--Encouraging Stronger Competitiveness and Entrepreneurship

The Obuchi administration is not just aiming at an economic recovery. While overcoming the present recession, it will also be necessary to encourage corporate restructuring and increase industrial competitiveness. Many Japanese corporations are presently suffering from three types of surpluses: excess capacity, excessive debt, and over-employment. Following the massive capital investment during the bubble period, demand contracted during the recession, and this has resulted in approximately 40 trillion yen of excess capacity. These three types of surpluses must be eliminated for Japanese corporations to boost their profit ratios and make new investments in plant and equipment.

To address this issue, this August the Diet enacted the Industrial Revitalization Law, which makes it easier for corporations to merge and to spin off units as separate companies. Thus, industrial restructuring is expected to proceed in Japan for some time.

Of course, the elimination of surplus employment will entail personnel cuts and reassignments, so the employment problem may become still more severe. Overall, the formation of new businesses and new industries will be important to resolve the three surpluses. Unfortunately, the ratio of establishing new businesses in Japan is just 3.6 percent, sharply lower than that in the U.S., the U.K., and Germany. What is more, this figure has been declining since the end of the 1980s. Japan is one of the few nations where the number of self-employed workers outside of the agricultural sector is declining.

Three Factors for the Foundation of New Companies

There are three factors that are required for the active establishment of new businesses and to ensure their success. These are (1) determined, superior entrepreneurs, (2) an investment and financing system that provides capital to new businesses, and (3) progressive consumers (customers) who are eager to promptly utilize new products and services. In Japan, these factors were in place up until around 1970, but they disappeared during the long period of economic growth.

First, regarding entrepreneurs, because the custom of lifetime employment was firmly established in Japan, workers believed that they would enjoy stable employment until retirement and regular seniority wage increases and promotion if they could enter government service or large corporations. Because of this, many young Japanese believed that gaining employment in government or at large corporations was both safe and advantageous, and the number of individuals launching their own businesses declined. Also, because of the tax system and other factors, even when individuals successfully create new businesses in Japan, it is difficult for them to amass great wealth. In terms of social recognition as well, while the heads of large organizations enjoy an exalted status, successful entrepreneurs tend not to be highly respected.

Turning to the second factor, which is finance, the vast majority of Japanese corporate financing is provided by banks, and new businesses are not permitted to seek public subscriptions for corporate bonds or share issues. The Japanese securities markets are extremely conservative, and only corporations with long performance records are eligible for the listing of shares and corporate bonds. On the other hand, from the 1970s Japanese banks, which believed in the "land myth" that the price of Japanese land would never decline, limited their financing to traditional large corporations and to loans using land as collateral. Even if Japanese banks are capable of judging the value of collateral, they do not have the ability to value businesses.

As for the third factor, consumers became very conservative. In Japan's industrialized society based on the mass production of standardized goods, the belief that it is safe to purchase well-known products and items that meet the established standards became firmly established. In particular, corporate purchasing departments observed government and industry standards, and a belief in the safety of maintaining the status quo became widespread.

In fact, the bubble economy became so large and the amount of bad debts--which resulted in the collapse of the bubble--ballooned precisely because bank managers all pursued the same policies and rushed to provide land financing. In other words, the risk that should properly have been borne by individual companies and individuals was essentially socialized under government initiative and industry coordination. This "socialization of risk" is a phenomenon that is unique to Japanese society.

While this course of action was considered to be absolutely safe, it actually resulted in widespread managerial irresponsibility, and dealt a heavy blow to the entire society.

Henceforth in Japan, we must establish a social environment in which individuals who take risks and successfully found companies and achieve technological breakthroughs receive appropriate compensation and admiration. We must also construct a social system for the clarification of risk and dispersed management so that venture firms can be provided with the requisite capital and personnel. Specifically, in terms of financing, the direct financing market must be greatly expanded and incentives must be given to venture capitalists, who function like angels in fostering new businesses, on an urgent basis.

Moreover, to encourage consumers to purchase new products and services, it is quite important that a Consumer Contract Law be enacted to follow up on the Product Liability Law. The Consumer Contract Law is expected to play a key role in establishing a system to protect consumers from defective products in the service field as well as in the product field. At first sight, it may seem that such a system would discourage supplier entrepreneurship and impede the development of new goods and services. On the contrary, however, it will serve to increase the transparency of goods and services so that consumers are able to feel more confident in choosing new products.

In the future, there are three major changes that Japanese society will inevitably have to face. The first of these is the aging of society and the decline in the birthrate, which will result in a declining population. From around the year 2007, the working population of Japan will certainly begin to decline at a rapid pace.

The second is globalization. With the advances in information and communications technologies and the diversification of demand, the trend toward greater globalization with minimal national barriers will almost certainly move forward.

The third is the arrival of the era of knowledge. The present trend of human civilization is a transition from contemporary industrialized society based around the mass production of standardized goods to a knowledge-based society where knowledge will become the source of value creation and economic growth, as well as the primary source of corporate profits.

For Japan to remain a major player in the global economy as an advanced industrialized nation, the diminishing population will have to be allocated more efficiently, and the scale of the overall Japanese economy must continue to grow. To these ends, Japan must continue to move forward with severe reform and innovation via free market competition. Additionally, to respond to the declining population, the nation will have to procure various factors from overseas. In particular, the acceptance of foreign workers in specialized and technical areas should be seriously considered as a long-term issue over a time frame of about 10 years. The expanded introduction of foreign workers would also be significant in that it would stimulate Japanese society through greater cultural diversity.

On the other hand, it will also be indispensable to establish a safety net to protect the human rights and dignity of the losers in free competition and the disadvantaged. While this net must be set high enough to provide sufficient protection of the human rights and dignity of all citizens, to prevent widespread malcontent, the burden on the working population who will support this net must not be excessive. From now on, the national goal should be to achieve "the greatest freedom and the smallest dissatisfaction."

The major upheavals that Japan is facing today are not limited to economic structural reforms and the revision of established systems. Rather, the greatest change lies in the nation's ethics and aesthetics, which are the basis of everything, that is, the basis for all choices and judgments.

Since the Second World War, Japanese society has viewed efficiency, equality, and safety as aspects of "justice." The concept that efficiency is "just" is common to all contemporary industrialized societies, and it has been recognized as such in Japan ever since the Meiji era. Especially during the postwar high-growth period, efficiency was viewed as the most important aspect of "justice" in Japanese society.

Equality is an aspect of "justice" that has been emphasized in Japan from ancient times. This is not the "equality of opportunity" that is espoused by contemporary thought, but rather an "equality of results." Particularly during the 1970s and 1980s, there were calls for a reduction in income disparity, and extremely progressive tax rates and seniority wage curves were adopted. Equality is still emphasized in school education, and at many elementary and junior high school athletic meets awards are given to all the participants, with no distinctions made for those who came in first or second place.

Safety became recognized as an aspect of "justice" after the war, and has become the most important aspect of social justice since the 1970s. The most important type of safety is peace, the second public order, the third health, the fourth no accidents or disasters, and the fifth the preservation of assets. It is well known that Japan is a thoroughly pacifist nation with superb public order. The Japanese people focus on their health, they are fastidiously clean, and they spare no expense on medical treatment. As a result, the average life expectancy in Japan has become the longest in the world. Massive amounts of money are spent on disaster prevention, and the nation's construction standards are extremely strict. For the preservation of assets, financial institutions are completely protected, and gambling is strictly prohibited. In brief, efforts have been made to create a risk-free society.

Nevertheless, as I stated above, the end result of these efforts has been irresponsible herd behavior and the socialization of risk, and this is by no means limited to the financial sector. In the construction industry, there is a widespread belief that observing the standards is all that is required, and this has resulted in the building of structures that are neither inexpensive nor safe. This became clear from the massive damage suffered during the Great Hanshin-Awaji Earthquake in 1995. When people seek refuge in the standards without competition or innovation, ethics inevitably collapse.

For the future of Japan, freedom must become recognized as a fourth key aspect of social justice in addition to the above three items. To date, Japanese society has acknowledged that "freedom is good," but freedom has not been recognized as an integral part of social justice on the level of efficiency, equality, and safety. Thus, whenever freedom has come into conflict with efficiency, equality, or safety, freedom has been denied at the bureaucratic level without becoming a political issue. I believe that choice and competition must now be expanded by adding freedom as another aspect of social justice.

For the future, Japan should not aim at becoming an inspired nation, led by great sages and powerful bureaucrats. Rather, I believe that we should achieve a flexible society with overall strengths that even permits the expression of fundamental human nature, avarice, capriciousness, and carelessness.

The important thing is to praise success both domestically and overseas and to take simple delight in having fun. At the same time, we must take care not to rationalize suspicion and jealousy. This is the only way whereby Japan can provide foreigners and foreign enterprises with a pleasant and interesting social environment that is easy to work and live in.

"The Japan of tomorrow" that has recovered from the present recession will not be a restoration of the Japan of days past. We shall witness the birth of an entirely new and spirited Japan that will continue to enjoy prosperity in the 21st century. I ask you all for your anticipation and cooperation in this great transformation.

Thank you very much for your kind attention.