LIGHT AT THE END OF THE TUNNEL?

Talk of a recovery in Japan is becoming more persuasive. Gross domestic product has grown in real terms for six consecutive quarters, and in the April–June quarter, the latest for which GDP statistics are available, growth over the previous quarter was recorded even in nominal terms. In September, responding to the Bank of Japan’s quarterly tankan survey of business sentiment, the number of big manufacturing companies stating that business is getting better exceeded the number with a pessimistic view for the first time in two years and nine months.

So can we conclude that the phase of falling asset prices has finally come to an end? Is the nation’s reform and restructuring endeavor finally paying off? These are the kinds of questions people are now asking. Many are somewhat dubious about the latest data because the yen is now gaining strength. This is a bad sign for exports, and it is precisely in the export sector that business sentiment has been most upbeat. Another reason for skepticism is the view that the recently revised method of compiling statistics tends to produce somewhat inflated real GDP values. The deflator for capital investment, a measure of price movements, took a sizable fall in the first half of 2003. If we base our reading on other statistical measures, such as industrial production data, we find that the economy is basically just marking time.

This section’s first article is by Tanaka Naoki, an economist whose opinions Prime Minister Koizumi Jun’ichirô respects. Tanaka believes that asset deflation has reached an end. What has sparked the change is, in his view, the return to vitality of companies and other economic actors, not the government’s macroeconomic policies or the injections of public funds into banks to liquidate bad debts. To be sure, Tanaka has praise for two government measures. One is the introduction of a tax credit for corporate investment in experimental research. This credit, which over the first three years of implementation is to be a generous 10%–12% of the relevant outlays, will give a boost to the “differentiation strategies” firms are pursuing. The other is a revision in taxation of securities designed to encourage a shift of the nation’s savings from bank accounts into the stock market.

An increase in consumer spending is being held back by continuing deterioration in the employment income picture. The household savings rate has fallen below 10% (on a national accounts basis). Because of the income pinch families are feeling, business is still slumping in nonmanufacturing industries, which rely heavily on consumer expenditures. People are also holding back from spending because of uneasiness about the long-term health of the pension system.

Such is the business climate in which an election for the House of Representatives has been called. A new feature in this year’s general election is the party platforms—“manifestoes,” as some of the parties are calling them—that have been released to appeal to voters. Among the pivotal economic issues are the evaluation of the Koizumi reform program, the prescription for an economic recovery, the state of public finance, and the outlook for the pension system. In the attached box we compare the positions of Koizumi’s Liberal Democratic Party and of the Democratic Party of Japan—the main opposition party, which has recently absorbed the Liberal Party—on economic policy.

The two parties’ platforms are about as ambiguous as the public pledges Japan’s parties have always made going into elections. The LDP promises that it will achieve nominal economic growth of 2% or faster by the fiscal year starting in April 2006. The DPJ declares that it will formulate a five-year economic revival plan during fiscal 2004. The pronouncements on the government budget deficit are also rather vague, with the LDP stating that it will achieve a surplus in the “primary balance” (which excludes debt-servicing costs) early in the 2010s, and the DPJ pledging that it will have a fiscal reconstruction plan ready by the summer of 2005. In terms of growth goals and government finances, accordingly, voters are pretty much left in the dark.

The DPJ platform contains a number of populist planks. For instance, it places emphasis on a big increase in the subsidies for small businesses and housing loans. The LDP platform, meanwhile, talks grandly about the creation of 3 million jobs over the next two years—but does not explain how they are to be created. It had been hoped that the unveiling of the manifestoes would encourage a more substantive debate among the parties on how the economy should be managed. For that to happen, though, the manifestoes would have to be drawn up in such a way as to clarify the differences between the parties.

It seems reasonable to assume that the consumption tax will have to be hiked sooner or later to keep the public pension system going, but none of the parties had the courage to say it intended to hike this tax. As Tanaka discusses in the above-mentioned article, capital investment is currently rebounding partly thanks to the tax cut introduced for research outlays. But taxation is an issue that the parties chose to say little about in the platforms they presented to the public.

THE YEN AND THE YUAN In its September 6 issue, Britain’s Economist warns that the Bush administration in the United States, which is having a hard time stabilizing Iraq and is anxious to find some way to head off a slowdown of the US economy, risks producing negative effects at home by pushing for revaluation of the Chinese yuan and other Asian currencies. The American industries that are clamoring for the yuan’s revaluation are those that have suffered a decline in their competitiveness, such as materials industries that can gain few benefits from pursuing globalization. The rationale for a stronger yuan is far less persuasive in the case of Japan’s industries, which are in a somewhat different position.

Japanese companies that have constructed plants in China in a bid to optimize their division of labor would not welcome a strong yuan. There are thus many Japanese who urge Tokyo to take a cautious stance on the yuan’s revaluation, keeping the good of the overall Japanese economy in mind.

As Beijing sees it, Tokyo was forced to allow the yen’s value to climb in the 1970s and later under intense pressure from Washington. Beijing further takes the view that the skyrocketing of the yen after the 1985 Plaza accord on currency realignment was one cause of the subsequent stagnation of the Japanese economy. If this is the lesson the Chinese think they have learned from Japan’s experience, we cannot expect them to capitulate easily to American pressure for the yuan’s revaluation.

In this connection, our second selection in this section is compiled from a series of articles carried in the Nihon Keizai Shimbun, Japan’s premier business daily, on the theme of the yen and the yuan. The series presents various episodes highlighting the rapidly expanding ties between Japan and China at the local level. They demonstrate how companies and local governments are forging Chinese alliances and establishing shared interests without waiting for a go-ahead from Tokyo.

Our last selection, an article by Taniguchi Makoto, is related to the yuan and Japan’s policy toward China. It is a proposal for the creation of an East Asian economic zone through initiatives in a variety of areas, such as the creation of an Asian bond market and the formation of an Asian currency zone. This article provides an indication of one unintended consequence of America’s recent push for a realignment of Asian currencies. By touching off a new round of yen strengthening and dollar weakening, Washington has cast a shadow over Japan’s nascent economic recovery, and this is awakening the Japanese to their country’s need to stop following Washington, at least with respect to the yuan.

There are a number of good reasons for Tokyo to pursue a separate yuan strategy. First, while Japan is one of the countries running a deficit in its trade with China, its exports to China would no doubt be hurt by a stronger yuan, which would damage Chinese businesses by reducing their price competitiveness. Second, damage would also be done to the division of production processes now taking shape between Japan and China. Chinese plants set up by Japanese, South Korean, Taiwanese, and other foreign corporations are in fact responsible for about half of China’s exports. If the yuan gained in strength, all the countries from which direct investment in China has taken place would be likely to see a decline in their exports of capital goods to China. Third, the demand for a stronger yuan is mainly politically motivated. It is a reaction to cries from sunset industries, and the less competitive these industries are, the more loudly they are crying. Fourth, there is a danger that yuan revaluation at this point in time could trigger an eruption of China’s various internal contradictions. A strong yuan might exacerbate the tendency for asset prices to fall in China, and this in turn could aggravate the global deflationary trend.

One of the lessons of the 1997 Asian currency and financial crisis is that American-style capital liberalization is not a good prescription for all countries, that the degree of development of each country’s financial systems must also be taken into account. In this regard, one issue for study is how a stronger yuan would affect the value of the currencies of other Asian countries.

To be sure, the yuan’s revaluation cannot be put off indefinitely. But when determining what process currency realignment should follow, Japan needs to apply its own logic, not just mimic the response of the United States. In this way the yuan represents a touchstone of Japan’s economic strategy toward Asia. (Nariai Osamu, Professor, Reitaku University)

MAJOR ECONOMIC POLICY PLANKS OF THE LDP AND DPJ MANIFESTOES

SLOGANS

LDP We are determined to revitalize the economy.

DPJ Carry out economic revival to create a dynamic economy with no unemployment.

OVERALL ECONOMY

LDP Realize nominal GDP growth of 2% in fiscal 2006; complete the program to generate 5.3 million jobs; create 3 million jobs over the next two years.

DPJ Formulate a five-year economic revival plan during fiscal 2004; formulate a fiscal reconstruction plan by summer 2005; lower the unemployment rate below 4.5% during term of office (four years).

FINANCIAL SYSTEM

LDP Halve bad loans during fiscal 2004 and bring an end to the bad-loan problem; restore health to financial institution management; strengthen regional finance.

DPJ Move rapidly to implement the DPJ Financial Revival Final Plan, with the objective of restoring credit creation and financial intermediation functions within two years; establish a clear distinction between small-business and big-business financing; prepare inspection manuals for small-business financing emphasizing cash flow rather than collateral.

ADMINISTRATION AND PUBLIC FINANCE

LDP Transfer enterprises from the public sector to the private sector; privatize Japan Highway Public Corporation in 2005 and Japan Post in April 2007; promote restructuring of the public sector and create a small government in two years; cut national government subsidies by ¥4 trillion and transfer tax revenue sources to local governments by 2006.

DPJ Cut public works controlled directly by the government by 30% (¥900 billion) by the time of the fiscal 2006 budget; limit the powers of the central government and establish local autonomy; abolish ¥18 trillion in tied grants and allow the regions to take responsibility for the use of these funds; abolish Japan Highway Public Corporation and make most expressways toll-free; facilitate participation by private-sector companies in postal services; secure ¥1 trillion in funding for agricultural reform by reducing civil-engineering projects.

SMALL BUSINESSES

LDP Strengthen regional finance; end requirement for small business owners to provide personal collateral when borrowing; make use of government-affiliated financial institutions to improve financing for small businesses.

DPJ Increase the budget for small businesses sevenfold (from approximately ¥90 billion in fiscal 2003); enact a law to facilitate regional finance; abolish the requirement that individuals provide guarantees for small-business loans from government-affiliated financial institutions.

INDUSTRIAL BASE

LDP Carry on with the second Science and Technology Basic Plan (fiscal 2001–5), investing ¥24 trillion in government research and development funds; double the research funds for young researchers from ¥300 billion in fiscal 2000 to ¥600 billion in fiscal 2005; promote 1,000 university-based ventures by the end of fiscal 2004; establish a high court for intellectual property; speed up patent application processing.

DPJ Firm up basic legislation for the protection of intellectual property; stimulate private enterprise by eliminating regulations on businesses.

PENSIONS

LDP Keep the national burden ratio from exceeding 50%; promote a national discussion on hiking the consumption tax and reach a conclusion; draft a bill for revising the pension system and submit it to the ordinary session of the Diet in 2004, providing for an increase in the treasury-funded portion of the basic public pension from one-third to one-half.

DPJ Cut waste from the national budget starting in fiscal 2004 and use some of the savings to raise the treasury-funded portion of the basic public pension in stages from one-third to one-half within five years; derive additional funds for the pension system by revising tax deductions for pensions and applying a portion of consumption tax revenues, premised on a return to stable economic growth.

© 2003 Japan Echo Inc.