Introduction

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Introduction

The Japanese economy that is suffering from prolonged stagnation

The Japanese economy has been stagnating for as long as ten years since the collapse of the bubble economy. During this period, the Japanese-style employment practice and corporate system that supported the post-war Japanese economy began to show cracks and Japanese people have increasingly begun to have gloomy outlooks for the economy and society. The economic recovery that began in the spring of 1999 proved to be short-lived and the economy has been deteriorating since the beginning of 2001. The outlook for the Japanese economy has been increasingly uncertain as the global economy shows signs of slowing down further due to the large-scale terrorist attacks in the United States in September.

In order to cope with the economic stagnation in the 1990s, the government repeatedly implemented economic measures and expanded public investment and other government spending. As a result, budget deficits have increased substantially combined with a decline in tax revenues caused by slow growth and tax cuts. These measures, however, did not bring about a sustainable recovery of private demand and failed to shore up the stagnant economy.

Why has the Japanese economy been stuck in a slow growth? Of course, many factors are complicatedly involved in the prolonged stagnation of the Japanese economy. But the following two downward forces are seen as important.

First, Japanese banks are still saddled with a large amount of non-performing loans. The prolonged economic stagnation has aggravated the problem of non-performing loans and, at the same time, the problem of non-performing loans is hampering growth of the Japanese economy.

Second, as a result of the prolonged economic stagnation, firms and consumers are unable to have bright prospects for the future and such "bearish mood" of firms and consumers is making the actual economy weak. The Japanese economy is trapped in the vicious circle of "depression causing bearish mood and bearish mood causing depression."

With the Japanese economy unable to extricate itself from the prolonged stagnation, Japan' s public finance as it stands now is facing the risk of accumulating budget deficits and falling into a financial ruin. The risk of Japan' s public finance is a risk of the Japanese economy and it will have adverse effects on future economic growth. Since government spending has increased with the allocation of funds rigidly fixed, precious economic resources have not been used productively. In this respect, Japan' s public finance has already been a factor that hampers growth. Meanwhile, the aging of the population with less children, a trend that will have a major effect on Japan' s public finance, including social security, has been advancing at a rapid speed not seen in other countries.

Open bright prospects by promoting structural reform

The government is now actively promoting structural reform. Structural reform will develop the real power of the Japanese economy by shifting Japan' s precious resources, such as labor, capital, and technology, from fields with low productivity to fields with high productivity and high social needs. In the 1980s, U.S. President Reagan and British Prime Minister Thatcher carried out structural reforms in their respective countries to abolish old regulations and revitalize their economies. Their policies established the foundations for the two countries' growth thereafter. The United States achieved a long-term economic boom in the 1990s by overcoming the crisis of savings and loan associations and commercial banks that occurred in the 1980s through 1990s and becoming freed from the burden of the problems of non-performing loans. If Japan promotes drastic structural reform and changes the rigid economic and social structure, we can enhance the potential of the Japanese economy and brighten our future prospects.

Composition of this Report

This year' s "Annual Report on Japan' s Economy and Public Finance--Report by the Minister of State for Economic and Fiscal Policy--" analyzes the main problems of Japan' s economy and public finance from the standpoint of how to deal with them in order to restore the Japanese economy. The Report is composed of three chapters.

Chapter 1 is a review of recent economic trends. Especially, it answers the question of why the economic recovery that started in the spring of 1999 was short and turned downward again, and why the Japanese economy has fallen into the kind of deflation that no other industrialized countries have experienced since the end of World War II. It will also study economic outlooks on the basis of analyses of the present economy. The analyses will reveal that behind the weak recovery of the Japanese economy lies the facts that business and consumer confidence has declined and that they are unable to have bright prospects for the future of the Japanese economy.

Chapter 2 deals with the mechanism by which the problem of non-performing loans disturbs the growth of the Japanese economy. It also studies to what extent the Japanese economy can grow, if the problem of non-performing loans is resolved and the structural reform designed to raise the productivity of the Japanese economy is promoted. The structural and long-term problems such as non-performing loans and potential growth ability are presented as undercurrents of the short-term economic trends seen in Chapter 1.

Chapter 3 analyzes Japan' s public finance from a viewpoint of economic analysis. It analyzes the present state and problems of Japan' s public finance from the three viewpoints of (1) calculation of the flows, such as budget deficits, (2) calculation of stocks, such as assets and liabilities, and (3) benefits and burden of the current and future generations. In addition, it analyzes local finances that are now in a critical situation and investigates how reform of local finances should be directed.

Three characteristics of the Report

The Report takes a fresh look at the Annual Report on Japan' s Economy (Economic Survey of Japan) that has been published for 54 years since the end of World War II. Although the Report takes over the accumulation and tradition of economic analyses of the Economic Survey of Japan, its contents are considerably different from those in the former Survey.

The Report, which is the first annual report by the Cabinet Office, was prepared under the following three basic policies:

(1) "Reader friendly" contents

The contents must be "reader friendly" so that messages can be clearly conveyed to readers in easy-to-understand language. The Report was prepared on the assumption that it will be read not only by experts on economic analysis but also by a wide variety of people, including private business people, government officials, Members of central and local assembly, and students, who are interested in the problems of economy and public finance. Therefore, the contents of the Report, though they are backed up by high-quality analyses, must be easy to understand for non-experts and the conclusions of the analyses must be clear by avoiding technical explanations of economic analyses and difficult descriptions.

(2) Comprehensive analysis of economy and public finance

The Report analyzes the Japanese economy and public finances comprehensively and give an analytical base to deliberations of the Council on Economic and Fiscal Policy. The Cabinet Office plays an important role as the Secretariat of the Council on Economic and Fiscal Policy that deliberates basic economic and fiscal policies, etc. With its objective analyses, the Report supports the deliberations on structural reform and macro-economic management at meetings of the Council on Economic and Fiscal Policy.

(3) "Forward looking" analyses

The Report conducts "forward looking" analyses that will contribute to judging the future economic trends and in planning and drafting new policies. The data on which the analyses in this Report are based are, of course, those of the past and present. However, the purpose of the analyses in this Report is not a "backward looking" one that simply looks back on what happened in the past, but a "forward looking" one that will be helpful in judging the future trends of the Japanese economy and in planning and drafting future economic and fiscal policies.

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