A Five-Year Economic Report Card

The administration of Prime Minister Koizumi Jun’ichirô, launched in April 2001, is at its end in September 2006. The Annual Report on the Japanese Economy and Public Finance 2006 (white paper) that was released in July was given a long subtitle: "Japanese Economy Heading for New Growth Era with Conditions for Growth Restored." From the birth of the Koizumi administration until last year the annual economic white papers carried the subtitle "No Gains Without Reforms." This year, however, the subtitle was changed. There are several implications to this change. It is in effect a proclamation of victory, claiming that Japan has overcome deflation and the excesses in indebtedness, production capacity, and staffing levels, and that it has entered a new period of growth. Although it is not too clear how effective the Koizumi reforms have been in achieving these results, it is nonetheless true that Japan has declared an end to its prolonged recession. Here I will review the characteristics of Koizumi’s economic policies and offer my own report card on them from both the macroeconomic and microeconomic perspectives.

OVERHAUL OF THE POLICYMAKING PROCESS

Challenges abounded for the newly inaugurated Koizumi administration in 2001. The disposal of nonperforming loans held by banks had been put off, no sweeping measures had been taken to cope with the failures of financial institutions, and fiscal deficits had mounted due to increased government spending, which was the traditional response to economic downturns.

In approaching public-sector reform, including cutting back public spending and privatizing the postal services, Koizumi thoroughly reshaped the policymaking process. In the traditional process the ministry or agency in charge would write up a draft, and after prior consultation with the so-called zoku giin ("tribes" of lawmakers affiliated with particular ministries and special interests) belonging to the ruling Liberal Democratic Party, followed by party approval, the government would reach a decision. Adhering to this practice would have made it impossible to achieve reform of the public sector. Instead, Koizumi made full use of the Council on Economic and Fiscal Policy that had been established shortly before he took power. The CEFP, an advisory panel consisting of seven cabinet members and four private citizens (two members each from the business and academic communities), came to formulate economic outlooks and guidelines for the overall budget, primarily through the drafting of the annual Basic Policies for Economic and Fiscal Management and Structural Reform, nicknamed honebuto no hôshin, or "thick-boned policies," and the Structural Reform and Medium-Term Economic and Fiscal Perspectives.

Neither the LDP nor the special-interest legislators initially expected the thick-boned policies to take on a very significant role. But from the second year of the Koizumi administration on, they began to devote a large amount of energy to having their desired policies included in the council’s annual policy document. Thus, important policies came to be set forth by the CEFP, and the prime minister’s leadership in policy planning grew stronger. The thick-boned policies first targeted the disposal of nonperforming loans and "structural reform without sanctuary" in 2001, followed by the establishment of Special Zones for Structural Reform, reform of the social security system, the "trinity reforms" involving the administrative and financial systems of the central and local governments, and privatization of postal services. As these reforms proceeded, bureaucrats desperately scrambled to secure their vested interests. While there was resistance from bureaucrats and opposition from special-interest legislators in the process of shaping the particular policies, the basic course of the major policies remained unchanged. One example is the reduction in public works spending: A cut of about ¥2 trillion was achieved by fiscal 2006 (the current fiscal year, ending next March).

AN OVERALL RECOVERY

Japan’s gross domestic product began to recover in fiscal 2002. From fiscal 2003 onward, moreover, the expansion accelerated (see the table). Upon taking office Prime Minister Koizumi made clear that he would prioritize the disposal of nonperforming loans even if it meant enduring negative growth, and indeed the economy contracted significantly for the first three quarters of his administration. Annual GDP growth was in the vicinity of 2% in fiscal 2003 and 2004, and the rate jumped to 3.2% in fiscal 2005. The growth was initially led by exports, but in 2004 and even more so in 2005 it was powered by increases in domestic demand, such as consumer spending and capital investment. Whether or not the deregulatory moves and other reforms implemented by the Koizumi administration accounted for the expansion of domestic demand is a question that needs further study. But the growth of new businesses, the emergence of new business models, and increased capital investment in the information, communications, and other nonmanufacturing industries appear to have been the outcomes of regulatory reform.

Meanwhile, business sentiment and corporate profits clearly improved during Koizumi’s term. In the Bank of Japan’s tankan survey of business sentiment, large manufacturing enterprises reporting favorable business conditions have outnumbered those reporting unfavorable conditions since mid-2003, and similar results have been seen among small and medium-sized enterprises since 2004. And according to statistics on corporate performance issued by the Ministry of Finance, both the total ordinary profits and the average ratio of ordinary profits to sales of all enterprises have increased for four straight years from fiscal 2002 to 2005. Moreover, these figures have reached levels exceeding those recorded during the economic bubble of the late 1980s (see the figure). Increased sales and suppressed labor costs are two factors behind this trend. While the upturn in revenues has contributed to a recovery in capital investment by businesses, there are criticisms that the lower labor costs have been caused by reductions in regular employment and increases in contractual and part-time employment. According to the most recent labor force survey by the Ministry of Internal Affairs and Communications, one-third of the labor force consisted of nonregular employees in 2005. In addition to industries in which nonregular employment is traditionally prevalent, such as wholesale and retail trade, nonregular employment is also increasing in the financial services, real estate, and communications industries.

Employment conditions also began to recover after a time lag. The unemployment rate took a downturn after reaching 5.5% in April 2003 and fell to 4.0% by May 2006. The effective ratio of job offers to job seekers surged from the latter half of 2003, exceeding 1.0 by the end of 2005. As far as new job openings are concerned, the number of openings had surpassed the number of job seekers by the beginning of 2003. But improvements in income were slow to come even as the labor market recovered; it was only in 2005 that the incomes of employed persons rose over the year before. And there is a gap between the incomes of regular employees and nonregular employees, one that grows wider at higher ages.

INCOME DISPARITIES: DON’T BLAME KOIZUMI

Some blame Koizumi’s policies for causing increased disparities in incomes and other indicators of economic performance. But this is not a correct assessment. Income disparity as measured by the Gini coefficient has been steadily rising ever since the 1980s. The Gini coefficient is affected by changes in household composition: Decreases in household size lead to increases in lower-income households, thereby widening the gap. The rise in disparity becomes smaller when adjusted for household size. Also, the 2006 economic white paper points to growing income disparities among elderly people, and a rise in the ratio of elderly households would give the impression that disparities are growing in the general population. But the widening disparities among elderly households are due to individuals’ careers being reflected in their income levels, as well as to differences between pensioners and those who continue to work after retirement age. It follows that the contrast between the fashionable and thriving new Roppongi Hills development where successful entrepreneurs congregate and the older commercial districts where local stores are rapidly closing down, a phenomenon that allegedly symbolizes the Koizumi reforms, is not the cause of increased disparities in incomes.

We need to be somewhat concerned, however, about widening gaps in the income levels of young people, particularly of those under 25 years old. The government faces the questions of how best to alleviate the severe employment conditions for young people, stop young people from becoming permanent "freeters" (furîtâ, workers flitting from one temporary job to the next), and counter the growth of the NEET population (those "not in education, employment, or training"). Abe Shinzô, who looks set to succeed Koizumi, is making a sound move by focusing on giving these young people fresh chances at employment.

Under Koizumi, substantial success was achieved in the disposal of nonperforming loans and the recovery of the financial markets. The amount of nonperforming loans reached ¥42 trillion in 2002, and the ratio of nonperforming loans at major banks rose to 8.4%. But by March 2006 the figures had fallen to about ¥15 trillion and 1.8%, respectively. What helped promote the disposal of nonperforming loans were infusions of public funds, the zero-interest-rate and quantitative easing policies of the Bank of Japan, the restructuring of banks, and the upturn in stock prices, among other factors. The capital adequacy ratios of banks have recovered, and with higher risk tolerance the financial intermediary functions of banks have been recovering as well. In the face of intensifying global competition, however, Japanese financial institutions, which are tending toward conglomeration, are confronted with the challenge of overcoming information asymmetry in the financial markets.

AN "F" FOR FISCAL REFORM

In the area of fiscal reform, the Koizumi administration’s efforts must be rated a failure. Thanks in part to recovering economic conditions, in 2006 Koizumi was able to reduce the issuance of government bonds to less than ¥30 trillion, as he had pledged at the time of his inauguration. But the scenario expressed in the CEFP’s most recent set of basic policies for achieving equilibrium in the primary balance (the general account balance excluding debt service) is far from clear; concrete measures to achieve that end, such as raising the consumption tax and further cutting expenditures, are not explicitly set forth. These outstanding issues will be passed on to the administration headed by Koizumi’s successor.

All in all, the Koizumi administration achieved needed reforms, and its basic stance was correct. However, it cannot be denied that the government he led was tardy in reforming the public sector.

Translated from an original article in Japanese written for Japan Echo.

© 2006 Japan Echo Inc.