THE ECONOMY

Global Change and Japanese Reform

Japan’s economy is now in a historic transitional phase. On the domestic front, the nation is facing a population that is graying faster than any other in the world. It is concurrently facing the need to create a new "post-catch-up" model for development to replace the one that drove its growth during the decades of its efforts to catch up to the world’s advanced industrialized economies. Externally, meanwhile, massive waves of globalization are causing various elements of production to move freely across national borders and bringing about shifts in the division of labor among the world’s economies. New economies like China and India are rising in the midst of these waves, and Japan must also grapple with their emergence.

It was against this backdrop that Prime Minister Fukuda Yasuo chaired this year’s deliberations of the Council on Economic and Fiscal Policy, which each year helps to determine the basic direction for management of the Japanese economy. In February 2008 the council established a committee to examine the present state of the economy and discuss the issues it will face and the course it should take over the longer term. Formally named the Expert Committee on Structural Changes and the Japanese Economy, this group, of which I was honored to serve as vice-chair, issued its final report in July this year, titled "Living with the Globalized Economy: Re-creation of the Japanese Economic System" (see the attached summary).

This report has been labeled the "new Maekawa report" by many who see it as the twenty-first-century analogue to the April 1986 Maekawa report, produced in response to Japan’s ballooning trade and current account surpluses and the resulting economic friction with other nations, particularly the United States. That report was the product of the Advisory Group on Economic Structural Adjustment for International Harmony, headed by Maekawa Haruo, former governor of the Bank of Japan.

The advisory group compiled its report in the midst of the rapid appreciation of the yen against other currencies in the wake of the September 1985 Plaza accord on currency revaluation. In the mid-1980s economic friction between Japan and the United States was at its peak. The Maekawa report was a preemptive maneuver taken a month ahead of the May 1986 Group of Seven economic summit in Tokyo, a way for Japan to present concrete solutions to the issues affecting its economic ties with other participating nations. Nakasone Yasuhiro, who was then prime minister, took active part in all the group’s meetings. The report’s basic recommendation was for Japan to make steady progress on reducing its trade imbalance (surplus) in order to achieve harmony with its international partners, defining this as a national policy goal and showing firm resolve toward its achievement. In terms of specifics, the report stressed the need for Japan to boost domestic demand and to increase its outflows of direct investment.

Now, more than 20 years after the Maekawa report, the global economy is again undergoing dramatic change, as is the economic situation in which Japan finds itself. I must stress that this year’s "new Maekawa report" is not a revised version of the earlier document but an independently crafted approach to the completely new issues that face the nation today.

At present there is no severe economic friction to speak of between Japan and the other major industrialized nations–and not a trace to be found of the view prevalent in the 1980s, particularly in the United States, of Japan as a threat. In marked contrast with that earlier age, when Japan’s rapid rise was a source of tension in the world’s economic structures, today our national economy has undergone years of stagnation, lessening its presence on the global stage to the extent that we have moved beyond Japan bashing to an era of "Japan passing." The issues we address in our report are Japan’s alone to deal with as it finds a way to reinvigorate its economy. The subtitle, "Re-creation of the Japanese Economic System," reflects this focus.

In 1994 Japan’s gross domestic product accounted for fully 17.9% of the global total. By 2007 this share had fallen to 8.1%. During this same period, Japan’s per capita GDP fell from second among all members of the Organization for Economic Cooperation and Development to eighteenth. Japan had once been perceived as an overly powerful economic threat, but came to be a cause for concern for other reasons: The financial crisis that afflicted Japan from 1997 on, for instance, caused other nations to worry that a serious meltdown here could spread to their economies.

In any case, the new Maekawa report of 2008 is one that contains no pledges from Japan to the rest of the world. It is rather an internally directed call for action, urging the Japanese themselves to bring vigor back to their nation’s economy.

A DISMAL REFORM REPORT CARD

In recent years some people have noted the symptoms of "reform fatigue" in Japanese society. A string of prime ministers have called for fundamental reforms to Japan’s institutions, and each successive administration has produced its own reform report. From 1993 to the present, however, Japan has seen nine prime ministers in office, from Hosokawa Morihiro (1993—94) through today’s Fukuda, and every one of them has headed a coalition government. These coalitions have tended to be ramshackle partnerships, with the prime example being the administration of Murayama Tomiichi (1994—96), based on an unlikely alliance between the Socialists and the Liberal Democrats, ideological opposites in every respect. With these coalitions at the helm, the realization of deep reforms to Japan’s systems and institutions has been all but impossible.

To make matters worse, the coalition governments in power since 1993 have lasted an average of less than two years each. One of them barely made it past the two-month mark. Koizumi Jun’ichirô (2001—6) presided over one of the longest administrations in recent years, and he was able, with the backing of considerable public support, to push through a number of reform measures. The Koizumi reforms did not aim to revitalize the nation’s economy, though–they were fundamentally political reforms meant to smash various vested interests in the political sphere. Koizumi saw through the successful privatization of the state’s massive postal savings system, for example, but the end result was nothing more than the appearance of yet another massive, private-sector institution for indirect finance, the Japan Post Bank. The reforms truly needed in Japan’s financial system were steps to address overbanking (the existence of too many deposit-taking institutions) and shift the system from one focused excessively on indirect financing to one emphasizing direct financing and the role of capital markets.

Whatever the reasons, fundamental economic reform has been utterly insufficient in Japan to date. And now, with the opposition in control of the upper house of the National Diet, the main political parties are neglecting serious policy debate in favor of political gamesmanship with an eye on the next general election. All the while, the sluggish economy has led companies to increase their reliance on nonpermanent hires receiving lower wages than regular full-time employees. Growing inequalities between haves and have-nots are coming to the fore as a social issue, with some observers describing these as "the pain of reform"–a development that threatens to spark widespread opposition to reform in general.

In truth, most of the painful developments seen in the economy today are due not to the reforms that have been adopted but to the fact that reforms have not been implemented as soon as they should have been. In the political arena, though, all we seem to hear is talk of the hardships and disparities supposedly resulting from the reform process. Our committee produced this year’s report to combat this antireform atmosphere. In it we urge pressing ahead resolutely with the reforms Japan truly needs.

The 1986 Maekawa report had as its main target the reduction of Japan’s external surpluses, a factor that was not on our radar screen at all this year. We focused rather on the need to attract high-quality financial, human, and other resources to Japan’s shores, using this input to rejuvenate the economy. While the Maekawa report urged Japan to increase its outflows of direct investment and shift its export capacity to offshore production bases, our report calls for moves to attract inflows of foreign direct investment into Japan.

Our report describes the need for Japan to remold itself as an "open platform." The nation must retool its domestic economic system to match new global economic realities and establish a scheme to grow with the world. It will be essential for Japan to re-create its economic system, extracting itself from the one it has known since its high-growth period and outfitting itself to integrate the dynamism of global economic growth.

The "open platform" concept means making Japan a place that attracts fresh ideas, advanced technologies, and human resources with sophisticated skills, spurring intellectual innovation and the sustainable creation of added value. To make Japan into such an open platform, our economic system must be attractive to people around the world. It must allocate the right human resources in the right ways, smoothly provide funds to growing sectors, and make it easy for venture entrepreneurs to participate actively. It must also feature markets based on fair rules. To date, Japan has done a poor job of putting structures like these in place.

How successful will Japan be in revitalizing its economy? This depends entirely on the speed with which the country moves forward with true reform. This is because ever since the end of the Cold War in the early 1990s, the world’s economies have been competing in the arena of reform itself. If Japan remains mired in its old systems, it will not be able to rejuvenate itself economically. It will remain unable to inspire dreams among its younger generations, or to halt the trend toward fewer births. If the burden of supporting the older generations, who are in control of the lion’s share of the nation’s vested interests, is placed on the shoulders of younger Japanese, we will see intergenerational frictions intensify. For all of these reasons, it is clear that the nation now stands in a historic economic and social transitional phase.

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

© 2008 Japan Echo Inc.