LAST CHANCE FOR REFORM

Prime Minister Koizumi Jun’ichirô secured a public mandate for his reforms by leading the Liberal Democratic Party to a solid victory in the July 29 House of Councillors election. The political focus now shifts to how he will go about fleshing out his promised agenda. His first big test will be getting concrete reforms into the budget for fiscal 2002 (April 2002 to March 2003). On August 10 the government announced the guidelines for the ministries to follow in making budgetary requests. Among other things, the guidelines call for (1) a 10% reduction in public works spending, which has come to symbolize pork-barrel politics and has become a less effective macroeconomic tool; (2) priority spending in seven areas, namely, the environment, education, information technology, countermeasures for a graying society, science and technology, urban renewal, and regional revitalization; and (3) reduced fiscal support for government-affiliated “special corporations.”

There is no guarantee that Koizumi will get his reforms implemented. For one thing, there is strong resistance within his own LDP—the largest force in the National Diet—out of fear that reforms will mean relinquishing vested interests. The general public, moreover, has been clamoring for change, but will it continue to support the reform program after it starts to generate actual pain? Another problem is that the economy is slowing down, leading to renewed calls for stimulus to put the economy on a recovery track before pressing ahead with painful reforms.

There can be no gain without pain, however. The bitter medicine must be swallowed now, while there is strong public support for sweeping reform. Otherwise the needed changes may never come to pass. Japan could be facing its last chance for reform.

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The economy has been floundering for a decade, ever since the speculative bubbles of the 1980s burst in 1991. Since 1992 some ¥140 trillion has been budgeted for 10 separate economic stimulus packages, all of them centered on expanded public works spending. But because the packages simply augmented demand without making any institutional reforms, growth remained weak and short-lived; the average real growth rate over the past 10 years has hovered around just 1%.

Some economists call this a “10-year recession,” but since recession properly refers to the contracting phase of a business cycle, it would be better to describe it as a “great stagnation.” The Japanese economy is currently experiencing its third cyclical downturn in the context of this overall sluggishness.

What the nation needs are not cyclical countermeasures to boost aggregate demand but policies to push up the long-term growth rate. This will require lifting the trend line in productivity growth and inducing a higher potential growth rate.

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In this regard, the administration is advancing reforms centered on cuts in and reapportionment of public works spending, abolition or privatization of special corporations, and reductions in revenue-sharing grants to local governments. The disposal of financial institutions’ nonperforming loans, which proliferated after the bubbles’ collapse, brooks no delay, to be sure, but writing off bad loans will not push up the potential growth rate; it will simply clean up of the mess left behind by a decade of macroeconomic policy failures and banking mismanagement. Banks will be unable to contribute significantly to a higher potential growth rate even after they dispose of their problem assets; at best, they can avoid acting as a drag. More than restoring the health of the banking sector, what is needed is a shift to direct financing though stocks and bonds so as to provide funds for those who undertake risky endeavors.

With economies around the world slipping into an adjustment phase, the Japanese economy is clearly losing steam. As summer draws to an end we are sure to see an intensification of the tug of war between the reform drive and the demand for stimulus to counter the economic slowdown and the pain of reform. Structural changes will induce deflation over the short term, and many will begin clamoring for additional government spending and monetary relaxation. Against this backdrop, on August 14 the Bank of Japan decided to adjust its money market operations and increase its purchases of government bonds with the aim of achieving further quantitative relaxation. The stock market has reacted coolly, though, prompting some in the government to call for the BOJ to adopt inflation targeting in order to present its antideflationary stance more clearly. Koizumi’s reforms face their severest test yet in the face of mounting pressure for macroeconomic stimulus.

In a nutshell, structural change means wresting control of economic resources from bureaucrats and placing it in the hands of the private sector. Neither prosperity nor cultural achievements are wrought by politicians or bureaucrats; they are the products of private initiative, including that of nonprofit groups. Public entities merely take the wealth generated by the private sector in the form of taxes and redistribute it.

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Katô Hiroshi’s article in this section addresses this topic. Japan’s high-growth era generated a large economic pie, and the parceling out of generous benefits from this pie helped maintain social stability. But the task of redistribution conferred extensive powers on those deciding who gets what, which eventually fossilized into vested rights. Those on the receiving end—local governments included—also began to see their allotments as prerogatives, and this produced a highly corruption-prone situation.

Peter Drucker identifies six “deadly sins in public administration,” noting that any two will render an organization ineffective. He adds, though, that almost all public entities commit all six of them, which include setting only vague targets; failing to identify policy priorities; not learning from experience and receiving no regular feedback; and refusing to change course midway even when mistakes are detected.

From this perspective, the revamping of Japan’s special corporations is imperative. These 77 special-status entities receive fiscal support from the government, enabling them to undertake projects even when there is little prospect of turning a profit, as in the case of the Japan Highway Public Corporation. The problems with the way this road-building corporation is operated are elaborated in Katô Hideki’s article below. The postal savings system, moreover, is in effect the world’s largest bank, with assets (deposits) totaling ¥250 trillion. Because of its special status, however, it pays no taxes, is not a member of the Deposit Insurance Corp. (which all private-sector banks must join), and is exempt from maintaining non-interest-bearing reserves with the Bank of Japan. The system’s deposits are funneled into the government’s fiscal investment and loan program—known as the nation’s “second budget”—under the jurisdiction of the Ministry of Finance and loaned to special corporations. This government-operated financial institution has heightened the economy’s reliance on indirect financing and kept the securities market from playing a bigger role as a source of capital.

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To develop the kind of capital markets where entrepreneurs and other innovative managers can raise funds, the postal savings system must be split up and privatized. Matsubara Satoru’s article offers a timetable and scenario for this transformation.

Prime Minister Koizumi has promised to keep new issues of government bonds to no more than ¥30 trillion next year, reckoning that government fat cannot be trimmed without fiscal discipline. In the United States, President Ronald Reagan created a smaller government by cutting taxes, but revenue shortfalls in Japan have not stopped successive administrations from priming the pump; bonds were recklessly issued to cover the ballooning deficit, and public works projects continued to expand.

Decentralization is also important in enabling the regions to exercise greater autonomy, show their distinctive colors, and induce greater activity. The present setup concentrates revenues in the center for redistribution to local governments in the name of “fair” and “balanced” national development. This, however, encourages bland uniformity and stifles regional variety.

Deregulation and privatization can be thought of as the devolution of authority from the public to the private sector, while the granting of greater fiscal and political powers to local authorities represents a shift from the center to the regions. Both are fundamental to reform. Without them the creativity and competitiveness of our country’s economy and society will fall into decline, and the “deadly sins in public administration” will produce an enfeebled Japan. (Kojima Akira, Managing Director, Nihon Keizai Shimbun)

© 2001 Japan Echo Inc.